Oil Prices Are Affected by Long List of Variables
The world uses 86 million barrels of oil per day.1 That is a staggering amount, no matter how you look at it. The world has become so dependent on oil that most economies simply could not exist in their present forms without it.
No wonder, then, that the world oil market has developed an array of hot buttons, any one of which can send oil prices soaring or plummeting.
A range of factors can affect oil prices. Some of them may surprise you.
Supply Interruptions
As any economics student can tell you, a product’s price is always affected by the supply. Although the availability of quality crude oil is an ever-present concern, it’s only one source of supply woes. Supply can be constricted when pipelines that carry crude to the refineries are off-line due to failures or routine maintenance. Further supply problems can strike when refineries are unable to operate due to weather events, human error, or maintenance. Competing demand from other nations can also crimp supplies.
Dollar Strength
The value of the U.S. dollar can affect oil prices because the world oil market is priced in dollars. Other countries must exchange their own currencies for dollars in order to buy oil. If a country’s currency is strong against the dollar, oil becomes cheaper for the buyer, who is likely to buy more. This additional demand can in turn send oil prices higher.
Geopolitical Tensions
The Organization of the Petroleum Exporting Countries (OPEC) is a cartel of 12 member countries that supplies 40% of the world’s crude oil and possesses about 78% of the world’s proven oil reserves.2 Some OPEC nations, particularly those in the Middle East, have a history of political and armed conflict, both among themselves and with other nations. When unrest threatens to flare, the oil market, which operates based on futures contracts, may fear a supply interruption, which in turn makes existing oil supplies more valuable, regardless of whether the threat materializes.
Investor Behavior
When other areas of the financial markets such as real estate and equities are behaving poorly, investors seeking higher returns may pile into energy contracts, increasing demand and thus prices.
Oil prices are critical because they play a role in nearly every product and service in the marketplace. Staying abreast of the causes of oil price fluctuations could help you make better portfolio decisions.
1) The Wall Street Journal, October 24, 2007
2) Investopedia, 2007; The Wall Street Journal, October 24, 2007