The Determination of Oil Price in the International Market

During important political and economic crises, people are often interested in oil prices, because it is regarded a serious indicator of the future of any state. Today, oil prices are low and many analysts are interested in predicting the possible direction of their fluctuation. Recently, there has been a great number of forecasts regarding oil prices, in which experts considered different factors and their effect on oil value. It is necessary to understand that oil is a commodity that is one of the most important world goods and, thus, oil prices are formed under the influence of many factors, such as the law of supply and demand, the political situation, the weather, and the US dollar rate.

How and Why Oil Prices Fluctuate

A large number of factors have an effect on the formation of oil prices on the world market. The most considerable factor is the ratio of supply and demand. In addition to it, geopolitical risks, the growth of the world economy, and other factors, including oil reserves, weather conditions in producing territories, investment volumes, currency exchange rates, OPEC decisions, and opportunities to increase production volumes, have a great impact on the value of oil (Guesmi, Boubaker & Van Son Lai, 2016). All of these factors affect the prices on the world market.

The elements listed above can be conditionally divided into two groups, short-term factors and fundamental factors. The latter include supply of oil to the market, demand for it, the availability of geological reserves, transportation costs, and dynamics of production. Recently, several new factors have been added to this list (Sabah, Palliam & Salem, 2016). They include growing competition from natural gas, speculation in the trading of derivatives in oil futures on stock markets, and increasing technological and scientific progress, which allowed oil to be produced from bituminous shale sands with relatively low costs (Sabah, Palliam & Salem, 2016). One of the greatest examples of these new important factors is the fast growing oil production from oil sands in Canada and bituminous shale in the United States. Over the past 10 years, the USA has increased the production of shale oil fivefold, from 40 to 200 million tons a year (Sabah, Palliam & Salem, 2016). Thus, it has reduced the import of oil from 70% to 30% of the total demand of the state (Sabah, Palliam & Salem, 2016). This fact resulted in an excess of supply over demand on the American market and became one of the causes of the decline in world oil prices. Factors of short-term effect include military conflicts in the regions of the world where large-scale oil production is conducted, political instability, and natural and technological disasters (Sabah, Palliam & Salem, 2016). Therefore, a combination of short-term and fundamental factors affects oil prices.

The political situation in oil-rich territories can become a reason for price fluctuations. There are many examples of oil price depending on the political situation in a particular area. One of the examples was the price per barrel of oil becoming $140 in July of 2008 (Guesmi, Boubaker & Van Son Lai, 2016). This record was associated with the fears and concerns of consumers about wars in Iraq and Afghanistan (Guesmi, Boubaker & Van Son Lai, 2016). Another example is an oil-rich country becoming politically unstable. In this case, the supplier market responds by rising oil prices so that the supplies are available to the entities who offer the highest price (Guesmi, Boubaker & Van Son Lai, 2016). Thus, comprehension of the deficit of supply can increase prices even at an unchanged level of production.

Natural disasters and weather are two more factors causing changes in oil prices. As with other commodities, seasonal changes in weather have an effect on the demand for oil (Hassler, Krusell & Olovsson, 2010). In summer, people drive more and use more gasoline, while in winter oil is consumed for heating. Despite the fact that markets usually know when to expect these periods of increased demand, oil prices rise and stabilize at the beginning of a new season every year (Hassler, Krusell & Olovsson, 2010). On the other hand, extreme weather conditions, such as thunderstorms, tornadoes, and hurricanes, frequently have a physical effect on the infrastructure and production facilities, reducing the supply of oil and causing an increase in prices. Therefore, weather conditions are extremely important in the determination of oil prices.

Another important factor is the dollar rate. It is necessary to mention that oil is sold and quoted internationally in US dollars (Guesmi, Boubaker & Van Son Lai, 2016). Generally, a decline in the US dollar rate raises the demand for oil and its price respectively. On the other hand, the strengthening of the dollar declines real incomes in consuming states, reducing the demand for oil and its price (Guesmi, Boubaker & Van Son Lai, 2016). Therefore, when analysts make predictions concerning oil prices, they study the situation associated with the dollar.

Supply and Demand

The law of supply and demand is considered to be one of the most important factors forcing world prices to change. When supply exceeds demand, prices become lower, and vice versa (Guesmi, Boubaker & Van Son Lai, 2016). The oil production in the world is controlled predominantly by the Organization of the Petroleum Exporting Countries also known as OPEC (Guesmi, Boubaker & Van Son Lai, 2016). This organization has the most significant effect on the fluctuation in oil prices. The main purpose of the organization is to retain a stable oil price. A group of analysts believe that OPEC became the major cause for cheap oil (Guesmi, Boubaker & Van Son Lai, 2016). It is connected to the fact that the organization refused to cut production, which resulted in a drop in oil prices. Being a producer, OPEC has a great effect on oil prices. Nonetheless, the price depends on demand. The demand of the biggest oil importers including Japan, Europe, India, and China likewise affects oil prices (Guesmi, Boubaker & Van Son Lai, 2016). For instance, the decline in oil prices may be connected to lower demand in these areas along with a stable supply from OPEC. Redundant supply of oil can cause prices to fall considerably. A rise or fall in prices can be caused by the cost of production. While oil production is cheap in the Middle East, its extraction in the United Kingdom or Canada is more expensive (Guesmi, Boubaker & Van Son Lai, 2016). When the supply of cheap oil is spent, the oil price can increase if the only oil is in the areas with expensive production.

The Current Situation

Oil prices fluctuate all the time. It is necessary to recall that in 2008, during the previous world crisis, the minimum price of oil was fixed at $36.72 per barrel (Baumeister & Kilian, 2016). At that time, experts believed that a greater fall was impossible. Analysts predicted $100 per barrel by 2017 (Baumeister & Kilian, 2016).  Unfortunately, their forecasts were not fulfilled. These days, the situation on the world market is highly complex and forecasts are changing all the time. It is connected to the fact that the political situation is highly unstable in regions rich oil and the supply of oil considerably exceeds demand.

The Future Trends

Today, analysts do not make long-term predictions regarding oil prices. The prospects for the oil market for the next ten years are being perpetually revised. It is connected to the fact that oil production grows, while China’s economy continues to slow down. As noted above, the political situation influences oil prices. The war in Syria is not expected to end soon, and Saudi Arabia and Iran still experience unrest in the territory of Yemen. Therefore, these factors have an effect on oil prices fluctuations. Until they remain unchanged, it is hard to make any predictions for the future. However, some experts are sure that oil prices will be rather low for the next several years. It is connected to the fact that the surplus of oil on the world market will continue because production in three major areas – North America, the Middle East, and Russia – remains high, meaning that the supply is higher than demand. Oil prices can grow if OPEC shocks the market with a decision to reduce production.

Conclusion

People frequently notice the phrase “oil price” on the radio, on TV, and in newspapers. Many analysts and experts make predictions and demonstrate numerous graphics regarding oil prices in the future. Nonetheless, this phrase often leads to delusions, because there cannot be a single stable oil price. Just as the price of any commodity, oil is regulated in accordance to the major economic law – the law of supply and demand. In addition, this indicator varies depending on the quality and the place of origin of the oil, as well as the market where it is sold. Moreover, such factors as weather condition, the political situation, the US dollar rate, and several others have an effect on world oil prices. Only by studying them thoroughly, it is possible to make forecasts concerning oil prices in the future.