Political instability and the global nature of the oil trade have made the price of oil particularly sensitive to all news. In other words, the complexity of the factors that affect oil prices makes it significantly more volatile than other assets.
Here, we have sorted out some relevant influencing factors for investors’ reference.
- Demand side
Countries in the Organization for Economic Cooperation and Development (OECD) are the world’s major crude oil demand countries, including Britain, France, Germany, Italy, Japan and the United States. The United States is the largest demand, followed by Europe, followed by China.
Generally speaking, economic growth is in direct proportion to the future demand for crude oil. For example, during the 2008 financial tsunami, pessimism about the future economy led to a decline in the demand for crude oil, resulting in a sharp drop in the price of oil.
But most of the time economic forecasts are rough numbers that can only be used as a guide to the general direction. Each issue of the report, which includes OPEC’s expectations, can be found on the organization’s website.
- Supply side: OPEC countries’ crude oil production
Supply can be measured by production from the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC countries. Currently, the 12 members of OPEC alone account for 30 percent of total supply.
Among non-OPEC countries, the largest producers are the United States, Russia, Canada, and China.
OPEC’s production is important because they have very low reserves and low production costs. When oil prices fall or demand falls, if the production costs are higher than the production costs, the production costs may be shut down.
Production costs in the Middle East and Russia can be as low as $10 to $20 per barrel, while in the U.S. and elsewhere production costs can be more than $30 to $60 per barrel, so production costs limit supply.
OPEC’s forecasts, which include supply, demand and stock changes, can be seen on their website, but they are linear and are for reference only.
- War and policy factors
When there is a war, embargo, production increase, production cut and other factors, will affect the oil price, although the war may cause the oil price to rise, but also may cause OPEC to decide to increase production and cause the oil price to fall quickly.
The 1973 Israeli-Arab War:
The Middle East oil embargo against Israel and the European and American countries, contributed to oil’s rally.
The Iran-Iraq War, 1980:
Oil prices soared. When the war ended in 1988, oil prices fell.
Iraq invaded Kuwait in 1988:
Oil prices soared, then, OPEC agreed to increase production, prices fell back quickly.
- Alternatives to crude oil
The US, Germany and parts of Germany are planning to adopt electric cars and ban diesel and petrol-powered cars in an effort to combat climate change and reach the Paris climate agreement. Over the next 20 years, electric vehicle (EV) production will become more prominent as production increases in countries such as China, the United States, Japan, Germany, France and South Korea.
In addition to being used as fuel, there are alternatives to crude oil in other ways. Of course, any alternative has a production cost. When the oil price rises to a certain level, or when the production cost of the alternative decreases as the technology improves, then the alternative will be relatively cheap and the demand for crude oil will decrease.
- Currency exchange rate – US dollar index
Oil is currently priced mainly in dollars, so changes or expectations in the greenback also affect oil prices. Historically, the trend of the dollar index has sometimes been inversely correlated with oil prices, which usually, but not always, rise when the dollar index falls.
Higher oil prices can lead to higher inflation and higher demand for consumer goods, but in turn, expectations of higher inflation in the future can also lead to higher oil prices.