What Affects The Price Of Oil
There are a number of factors that affect the price of oil, simple economics of demand and supply, exogenous or unexpected shocks, alternative energy sources, the movement of the dollar and market speculation.
When economic activity increases in an economy, demand for oil rises. Without a similar rise in supply, the price of oil will rise.
When recession hit in 2008 and economic activity dropped in many of the world’s leading economies, the price of Brent plummeted from $145 a barrel in July that year to below $40 within a five month period.
Thereafter China’s demand rose and prices higher over the following five years. To control this rising prices and efficient marketing bring on extra supply.
The supply of oil comes from two broad areas OPEC and non-OPEC nations. OPEC supplies around 30 million barrels of the one hundred and fifty million barrels at the world uses every day.
Oversupply by OPEC nations has been cited as one of the main reasons behind the near sixty percent dropping Brent from June 2014 to January 2015.
What Are The Substitutes For Oil
Good value alternatives will see the price of oil drop. Nuclear, wind and crop based oil are all good examples where consumers could switch from one source to another However this depends on a constant supply and competitive pricing an exogenous shock is an event that moves market prices, and cannot be explained by economics.
These are mostly event risks that a sudden and unpredictable. Natural events like Hurricane Katrina in August 2005 provided a substantial exogenous shock to the oil markets, immediately taking out a substantial supply line.
Terrorist activity is another example. With oil being priced in US dollars a move in the foreign exchange markets will have an effect on demand through price action.
A stronger US dollar against sterling pushes down the cost of oil for us here in the UK, this assuming all other factors are unchanged or feed through to prices at the pump.
A weaker dollar has the opposite effect. Oil prices are set by the futures market and there is much speculation as to where demand and supply will be in the future.
Will China announced more nuclear plans? Will the growing global population demand more cars or air conditioning units? Will government bring in legislation to control the unabated use of oil based fuels?
This will all have an effect on demand while new technologies, like fracking, could bring on more new supply For the moment, at least, there is still plenty of easily accessible oil.
However, unless oil companies have the incentive to invest in new exploration or build new technologies to extract otherwise inaccessible oil, there will come a time, within a generation, that will see the price of all rise through the simple economics of there being limited supply in an environment of increasing demand.
Thanks to IG.com for contributing this simple but understandable video for our readers.