Key Global Economic Geopolitical Impact on Oil Price Fluctuations

Key Global Factors That Determine Oil Prices: Explained

Oil has been a vital component of the global economy for decades despite ongoing efforts to reduce its usage and explore alternative green energy sources. From its accidental discovery during drilling operations in the early days to becoming the world's primary fuel source, oil has shaped industries and economies worldwide. However, have you ever considered the factors that influence oil prices? We will examine how oil prices are determined and discuss the geopolitical forces that affect the price of this essential commodity globally.

Key Highlights

  • Oil futures contracts are binding agreements that enable buyers to purchase oil at a pre-defined price on a specific date in the future.

  • About 40% of global oil originates from OPEC. OPEC was founded in the 1960s to influence global oil and gas prices, but its charter does not say so.

  • Oil prices depend on current production, future supply, and global demand. Geopolitical events like hostilities or economic sanctions affect the supply side. In contrast, economic development or global crises affect the demand side. 

What Are the Top Factors That Determine Oil Prices?

Let's explore how oil prices are determined. Three significant factors determine the oil prices. These are:

  1. Supply and Demand 

  2. Oil Market Participants

  3. Market Sentiments

Supply and Demand: The Fundamental Drivers

A fundamental economic principle that influences oil prices is supply and demand. Prices typically rise in response to changes in supply or increases in demand. Conversely, if demand decreases or supply surges, the price usually drops. However, the actual determination of oil prices occurs in the oil futures market.

Oil futures contracts are binding agreements that enable buyers to purchase oil at a pre-defined price on a specific date in the future. These contracts enable the creation of an oil financial market where investors may forecast changes in oil prices. One crucial factor that affects oil prices is the equilibrium of supply and demand in the futures market.

Oil prices decreased dramatically during the economic crisis that began in the spring of 2020. OPEC and its allies have enforced historically low output levels to stabilize prices. Despite the diligent efforts of oil sector stakeholders, the price of oil has plunged to an unparalleled record low, unmatched in the preceding two decades. This example shows how the oil industry's fluctuating supply and demand affect the market price.

Oil Market Participants: Hedgers and Speculators

Within the oil futures market, two types of traders play a significant role: hedgers and speculators. Hedgers, such as airlines, purchase oil futures contracts to protect themselves against potential price increases. In contrast, futures traders only participate in the market to accurately forecast commodity prices, such as oil. 

These merchants don't want the oil, unlike other market players. Instead, they focus entirely on using their knowledge, expertise, and analytical abilities to navigate the futures market and capitalize on price swings. By carefully researching, analyzing market trends, and using advanced trading tactics, these traders try to maximize earnings by precisely projecting oil price fluctuations. Thus, they use the futures market to leverage their speculative skills rather than buy the product.

The Chicago Mercantile Exchange (CME), a major financial exchange, reports that less than 3% of futures deals entail physical commodity delivery. Instead, speculators drive most trade in this volatile environment. This demonstrates how expectations and speculative activity impact short-term price fluctuations.

Market Sentiment: The Psychology of Oil Prices

The sentiments of the market are a significant factor in determining oil prices, in addition to supply and demand factors. The current state of oil prices might fluctuate dramatically based only on the notion that future oil demand would either increase or decrease. Speculators and hedgers act on these sentiments by buying or selling oil futures contracts accordingly.

It is important to note that oil prices can be swayed by market psychology alone, as sentiments strongly impact trading behaviors. The influence of market sentiments further exemplifies the complexity of determining oil prices and how they can deviate from fundamental supply and demand principles.

How do Geopolitical Forces Shape Oil Prices?

Oil prices depend on geopolitics and supply and demand. Geopolitics—including political, economic, and social factors—often affect oil prices. Political instability in major oil-producing nations can disrupt supply and generate price volatility. Civil instability, government transitions, and geopolitical conflicts can hamper manufacturing. OPEC, consisting of these 13 nations, is the world's dominant oil producer and supplier.

  • About 40% of global oil originates from OPEC. OPEC was founded in the 1960s to influence global oil and gas prices, but its charter does not say so.

  • OPEC's production and price policies affect global energy markets and economies. OPEC is vital because of its large reserves and production capability. 

  • OPEC controlled oil prices by raising prices and limiting supply throughout the 1970s and 1980s. Even OPEC members produced more than their limits to gain market share as governments attempted to maximize income. Growing oil output by the US, Canada, China, Russia, and other non-OPEC nations has made it harder for OPEC to maintain its market dominance.

  • Oil prices dipped significantly in 2014. This reduction was primarily due to OPEC's refusal to cut supply despite falling prices. The Russian invasion of Ukraine in 2022 was a major event. In the international economy, this invasion had major effects. Due to this military intervention, many nations put economic sanctions on Russia. 

  • These sanctions, meant to deter aggression, significantly influenced oil and gas markets. The Russian invasion and sanctions disrupted the oil and gas industry, causing major issues. One of the most enormous repercussions was rising oil costs. The interconnected global oil markets spiked prices in response to geopolitical unrest.

Conclusion

One must understand how oil prices are determined to understand the global economy. Supply and demand fundamentals continue to regulate oil prices, but market sentiment and geopolitical worries can also affect them. As we navigate the ever-changing energy economy, people, corporations, and governments must closely monitor the elements in question. Oil prices depend on supply and demand, market sentiment, and geopolitical events. These factors affect the value of this priceless resource.

FAQs

What factors affect oil prices?

Oil prices depend on current production, future supply, and global demand. Geopolitical events like hostilities or economic sanctions affect supply, while economic development or global crises affect demand. OPEC controls 40% of the global oil supply, affecting prices.

How much is the highest price oil has ever been?

With inflation, crude oil prices peaked in June 2008. The price rose to $166 in June 2022 dollars after inflation. This oil industry milestone illustrated how inflation influences commodity prices, a global economic turning point. 

When did oil reach its lowest price ever?

Oil prices worldwide fell significantly and persistently throughout the turbulent 1930s and 1940s when the Great Depression and the following financial crisis hit. In June 2008, oil prices dropped from their record highs, changing the global oil market.

Which countries are the leading crude oil producers?

Five nations dominate the world's net oil output as of 2022. These countries—Saudi Arabia, China, Russia, Canada, and the US—help supply global energy demands. 

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Douglas Allan 16 Nov, 2023

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