Factors that Determine the Price of Oil in the Market

The Organization of Petroleum Exporting Countries (OPEC)

It is a consortium of 13 counties and is the largest single entity that impacts on world’s oil supplies. It provides for 40% of oil in the world, and sets rules and regulations among its members to meet global consumption of oil. By increasing or reducing oil production among its member states, OPEC is able to affect the price of crude oil.

When oil production exceeds its demand, the excessive supplies can be stored. If consumption is more than the demand, inventories may be tapped in order to meet the increased demand. The connection between oil inventories and oil prices enables corrections in both directions. Although non-OPEC are 50% larger than OPEC, they lack sufficient reserves to enable them control price and can only react to market fluctuations. OPEC can influence market pricing directly, especially when oil supply from non-OPEC countries reduces.

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The majority of oil production and reserves in the world are controlled by companies that are run by the government. The oil market, therefore, is heavily politicized and functions far from a competitive market. Taxes and policies in oil-rich countries also have an effect on the price of oil. If, for example, oil exploration is banned in reserve proven places, the oil market marks this as a loss in supply in crude oil and consequently, it results in increase in gas prices.

Effects on Oil Prices

Political instability in an oil-rich area has a big effect on oil prices. To begin with, supplier markets react to this instability by bidding up oil prices such that oil supplies are still available to the highest bidder. In this case, even with production level remaining constant, the perception of reduced supply also increases oil prices.

Physical factors determine the properties and amount of oil found, the location of reserves, and the extraction cost among others. Being a nonrenewable natural resource, physical factors affect significantly the cost of supplying oil from a certain reserve. Additionally, substantial investment is needed to discover and develop continuous new reservoirs.

Buyers and sellers of crude oil are matched by oil brokers, and contracts of trade for future oil delivery, also known as “futures”. Clients buy futures to protect themselves against increase in prices of oil that could have an adverse effect on their profitability. Producers of oil sell contracts of oil futures to enable them lock in a price for a certain period and oil brokers buy oil futures to ensure future oil delivery at a specific price.

Seasonal weather changes affect oil demand, just like in most commodities. During the winter season, more heating oil is used and during the summer period, more gasoline is used since people drive more. Although markets are aware of when to expect these demand periods that have increased, oil prices rise and balances with the season every year. Weather conditions that are extreme such as tornadoes, hurricanes and thunderstorms can have a physical effect on facilities of production and infrastructure thus interfering with oil supply and bring about increase in oil prices (Gautier 2008).

It brings about a varying cost for all products that are oil based, because those who speculate trade futures contract on the open market. Speculation of oil also makes investors buy more contracts when there is a negative tension in the oil market. Oil speculators in 2008 were thought to have created a price level that was unsustainable by bidding up oil prices. Prices fell by late 2009, because there was not enough demand to support the price level that had been inflated (Shi, Albada, van Dongarra & Sloot 2007).

US dollar is used to sell and trade oil internationally. Depreciation of the dollar tends to lead to increment in oil demand and thus, the price of oil also increases. Equally, when the strength of the dollar goes down in consumer countries, it leads to decrease in the demand for oil thus oil prices are lowered.

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Consumption of oil in developing countries that do not form part of the Organization of Economic Cooperation and Development (OECD) has gone up in recent years. While consumption of oil in OECD states has reduced between 2000 and 2010, oil consumption in non OECD countries has gone up by more than 40%. During this period, India, Saudi Arabia and China have had the highest growth in consumption of oil among the non OECD countries.

A number of factors lead to a decrease in the demand for oil that makes oil prices drop. First, consumers reduce their expenses, driving being one of the expenses that are cut. Most employers allow their employees to work from home once in a while since they understand the financial strain that their employees are going through. As a means of saving money, this reduction in driving leads to decrease in the demand for oil that results in the decrease in oil prices (Kpodar 2006). Decreased demand for products also affects oil prices in a recession. The demand for oil reduces as very few products are shipped to consumer countries from manufacturers, when consumers cut down on their spending. Less demand for the shipment of goods leads to reduced demand for oil. The total demand of oil in the United Kingdom has risen by an average of 5.5% per year over the past ten years. This has been due to the 1990s increase in oil-fired power generation. Demand and supply are both highly inelastic in the oil market- in the short-term. Irrespective of the cost of petrol, one’s car cannot simply switch to another fuel (Peterson & Ford n.d.). Airplanes and ships cannot shift from kerosene and diesel oil for their driving force.

The cost of pumping a marginal oil barrel is moderately low at the moment the capital expenses of prospecting and constructing an oil rig are in place. An oilfield costs roughly the same to manage whether it is producing at full capacity or 50% of capacity. Given this, once an oil field is set, producers tend to pump at the maximum sustainable rate. Consequently, the result is that the market is one where small changes to the demand or supply curve cause big changes to the price of clearing.

With deteriorating production in the North Sea, the United Kingdom has now become a net importer of oil. It continues receiving supplies from a diverse collection of countries. Estimates show that 80% of oil consumed in the United Kingdom by 2016 will have to be imported. The United Kingdom, in order to balance supply and demand, has conventionally relied majorly on the flexibility of offshore supplies of its own. These are supplemented by offshore gas storage and a salt cavity limited storage.

There are new sources of supply. These are new import projects such as BBL and Langeled pipelines, with a number of other large terminals being built. These are able to provide substantial additional oil to the United Kingdom. These may change the oil market structure in ways that may affect the volatility of oil prices, thereby reducing chances of pulling new capital towards construction of additional storage capacity.

Another factor is the availability of new means of energy production. These include alternative energy sources such as wind and water. These alternative sources are more preferable to oil, because of their environmentally friendly nature. They are also not as expensive to put up and operate as those for oil (“The EU’s Target for Renewable Energy”).

Technology also plays a part in affecting the supply and demand of oil in the United Kingdom. Technologies used to development and production of unconventional oil ought to advance in order to allow economic production. The main production methods are cold production by use of horizontal wells, open pit mining, steam-assisted gravity drainage and steam flooding. Locating an unconventional oil source is a challenge in itself. Despite being technologically developed, the United Kingdom suffers from technological problems. These include high costs of maintenance and inadequate personnel to operate these machines. This has led to reduced production that leads to a reduction in supply. This in turn leads to an increase in demand (Holditch & Chianelli 2008)

Media plays a major role in the perception of a company to the public. Specialized media outlets provide information about a particular company in business reports. In the UK, the media, in providing financial analyses, oil prices and shifts, affect the basic supply and demand of oil in the UK.

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