What Affects the Price of Oil?
On March 9, 2020, the moves we saw across multiple financial assets were monumental. The plunge in oil prices came about after Russia had rejected a proposal by OPEC to cut 1.5 million barrels per day of production. In response, Saudi Arabia not only cut its forward crude price to Chinese customers by as much as $6 or $7 per barrel but it also reportedly looked to raise its crude output by as much as two million barrels. This was a very loud and clear message to Moscow and a power play to grab most of the market share. Consequently, Crude prices tanked because of the ongoing feud between the two oil superpowers.
In the past few months, we have seen increased volatility in oil prices. In this guide, we explain what influences oil prices especially as this certain commodity plays a greater role within the global economy.
There are two primary factors which influence the price of oil on the commodity market:
- Supply and Demand
- Market Sentiment
Supply and Demand
The Organisation of Petroleum Exporting Countries (OPEC) consists of the world’s major oil-producing nations and was founded in 1960. OPEC is a group that aims to control and maintain the supply of oil which in turn will set the oil price in the commodity market, the group aims to avoid fluctuations which could, in turn, impact the global economy.
Countries that are part of OPEC include Saudi Arabia, Iran, Iraq, Kuwait, Venezuela, United States of Arab Emirates, Libya, Nigeria, Algeria, Angola, Gabon, Equatorial Guinea and Congo.
As we have recently seen, supply disruptions have been affected by tensions between oil superpowers. Supply levels have been affected by external political events which then cause oil prices to fluctuate on the commodity markets. Examples of political events which have impacted the price of oil include the Arab oil embargo, the Iranian Revolution and the Persian Gulf War among others.
Supply of oil can also be affected by weather, production costs, transportation costs and new innovations within the oil industry. An example of this is shale oil which is extracted from the U.S. This particular oil is extracted from the rock and has since become a major source of global oil supplies. Shale oil production went from 1 million to 4.9 million barrels per day causing what is known as an oil glut. Due to this, the price of oil went down to $29 per barrel by February 2016.
Future supply can also depend on oil reserves and can come into play when we look at the different factors affecting oil prices. Oil reserves can be accessed as a way of increasing the supply if the price of oil was rapidly increasing more than expected.
If global economies see strong growth and industrial production is also strong then there will be an increasing demand for oil. Again there are other factors to consider which will affect the levels of demand such as transportation, population growth in a country and seasonal changes.
OPEC+ and its Influence Over Supply Levels
OPEC+ will decide as a group on how much oil needs to be produced and this can directly affect its price on the global markets. Therefore, its best interest is to keep the price of oil high on the Crude Oil market as a bid to increase profitability. If the price of oil were to be low on the markets then OPEC+ would cut supply levels so that the price would then increase. This isn’t the best decision for most countries as there is a chance of compromising revenue for the individual country, therefore, OPEC+ ideally wants the price of oil to increase while they also increase oil supply in order for revenues to rise. As we saw in recent months there was a pledge made by OPEC+ to cut the supply of oil, which had led to spikes in oil prices. On the other hand, OPEC+ also has the means to pledge for an increase in supply and this is always supported by the likes of Saudia Arabia and Russia who are the two largest exporters of oil in the world and they have the ability to increase supply levels in order to maximise profit. In 2018, OPEC+ called for an increase in supply as a measure to push Venezuala who had drastically low output at that point. There are also countries that won’t want to ramp up production as they don’t have the means to and will, therefore, be opposed to an increase in supply.
How Does Market Sentiment Affect Oil Prices?
Market sentiment describes the overall attitude of traders towards a particular financial asset. This can be reflected through price movements which reveal the overall tone and feel from buyers and sellers. If the price is increasing then this is what we call a bullish market sentiment and in the same respect, if the price is decreasing, we call this a bearish market sentiment. If traders believe that demand and supply levels are going to change drastically at a certain point then this can be reflected in the Crude Oil market as prices could increase or decrease to support the market sentiment. If traders believed that demand levels are likely to increase then this will cause oil prices to hike, whereas, if they thought that demand levels will decrease at some point then this would have an opposite effect on oil prices.
If you are interested in trading oil then check out our ‘How to Trade Brent and WTI Crude Oil’.