What Affects Oil Prices?

Explaination of the factors that determine the valuation of Oil

Every country in our global economy depends upon crude oil for its day to day operations. As such, it is the most valuable natural resource on earth. Holding such precedence in the global economy, oil is literally the grease that keeps the wheels of commerce and industry moving. It should come as no surprise then that crude oil is the most widely traded commodity each and every day. The amount of daily trading activity, in combination with other factors, plays a large role in the daily price fluctuations the precious commodity undergoes nearly every hour of every day. According to the U.S. Energy Information Administration, oil prices are determined by several key factors.

Production

Remarkably, 40 percent of the world's oil supply comes from the Organization of Petroleum Exporting Countries, otherwise known as OPEC. Furthermore, 60 percent of all the oil traded on the markets daily comes from OPEC as well. Due to the vastness of OPEC's crude oil market share, every action taken and every word spoken by OPEC has far reaching consequences on the price of crude oil. Additionally, any production cuts from these oil producing countries can be immediately witnessed through price increases in the commodities market.

Supply

All of the non-OPEC oil producers combine for a staggering 60 percent of the world's oil production market. Unlike OPEC that holds vast reserves of crude oil ready for refining, these non-OPEC producers operate at their full capacity most of the time. Although they do not have the direct ability to manipulate market prices like OPEC, any reduced supply by these producers can be used by OPEC as further reason for price manipulation if it is needed.

Global Oil Inventories

These inventories help keep supply and demand in a harmonious balance. Excess crude oil supplies can be stored whenever production exceeds demand, and when consumption exceeds production the oil inventories can be tapped to satisfy the market demand. If there is a build-up of crude oil inventory, the market makers usually drop oil prices to keep supply and demand in balance. On the other hand, if oil futures rise then there will be an increased emphasis on limiting supply in order to focus on building inventory reserves.

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Financial Markets

Rather than merely selling physical crude, oil brokers and speculators also trade future delivery contracts, otherwise known as futures. Oil producers sell futures contracts in order to lock in a certain price over a specific time period. Though relatively unknown to the masses, futures purchasing plays a significant role in establishing oil prices.

Spot Market

Though traders deal primarily with crude oil, there are many different types of finished oil products, such as gasoline, heating oil, various petroleum products and so on. Though everyone talks about crude oil futures, the price of these finished oil products is much more important. Since these products are derived from crude oil, their prices move hand-in-hand with crude prices. Events like natural disasters, political events, and terrorist attacks can disrupt the flow of supply and demand, leading to increased price volatility. This is especially true of the futures market.

The variety of factors at play in establishing crude oil prices makes it extremely easy for any disruption to the system to cause a swing in crude oil prices. Unfortunately, approximately half of the world's oil supply is located in areas that have been known to be politically unstable. All of these factors contribute greatly to the volatility of the crude oil market and the price ordinary consumers pay at the pump.

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