Buying Oil Investments – Chapter 4: The determinants of Oil Prices

This is chapter number 4 out of 12. Read the rest:

Read Buying Oil Investments – Chapter 1: Introduction
Read Buying Oil Investments – Chapter 2: Getting started in oil investments
Read Buying Oil Investments – Chapter 3: Factors which affect the price of oil

The very fact that crude oil is a primary commodity required in the major economies of the world make its influences on our lives undeniable. Any fluctuations in its price will definitely work its way into our lives directly or indirectly regardless of whether we like it or not. Thus, it is important for all of us who wish to get involved with this market to know what can cause its price to fluctuate. The two main factors which determine the price of oil are:

1. Its Supply & Demand
2. The Market Sentiment for oil

 

The Supply & Demand of Oil:

The laws of supply and demand are based on the economic concept that when prices fall, demand will rise and supply will decrease. On the contrary, when prices rise, demand will fall and supply will increase.

Demand of oil:

It has been estimated by the Organization of Petroleum Exporting Countries (OPEC) and IEA that the 2008 global daily consumptions are between 86 million to 87 million barrels per day. In the US, demand will decrease when the overall price of oil increases. Nevertheless, the emerging economies of the world have a different set of expectations as opposed to the US. These countries are facing positive economic development and as such their demand for oil is not price elastic.

In fact, some of these emerging economies have fuel subsidies for retail consumers. An estimated one quarter of the 2008 global demand for oil comes from countries which have such kind of fuel subsidies. Although such fuel subsidies may ease the burden of the consumers in times of price spikes, they may not be beneficial for the country economically as they will artificially boost demand. If such subsidies are removed, they will help boost the country’s production and also help ease any shortages which might have resulted from the artificial demand. Refineries then will have additional incentive as a result of the higher priced petroleum derivatives.

Supply of Oil:

With regards to supply, it is estimated that 85 million to 87 million barrels of oil are produced daily. New discoveries are constantly being discovered although on a lesser scale than before. On top of this, the reserves in the North Sea andMexicoare also declining. Most OPEC members also lack the operating capacity to pump more oil out of the ground exceptSaudi Arabiawhich has a spare capacity of an estimated 1.5 million barrels per day.

At the same time,Nigeriawhich is a major oil producing country is plagued by political instability and its production infrastructures are prone to sabotage by terrorists. As such, the country is not able to operate at its full capacity of 2.5 million barrels per day but instead only pumps out 1.5 million barrels per day.

Sources: OPEC

Sources: OPEC

Based on present estimates, 78% of the world’s proven oil reserves are located in OPEC countries, with theMiddle Eastmaking up the majority of this group. Additions to OPEC reserves are also being added as new fields are being discovered and new technology improving the yields of current fields. To date, OPEC’s available proven reserves stands at over 900 billion barrels. 

Read Buying Oil Investments – Chapter 5: Trading in Oil Futures: (The impetus of the market sentiment)
Read Buying Oil Investments – Chapter 6: Investment Options
Read Buying Oil Investments – Chapter 7: Exchange Traded Funds
Read Buying Oil Investments – Chapter 8: The Risks Of Investing In The Oil & Gas Industry
Read Buying Oil Investments – Chapter 9: Advantages Of Investment In The Oil & Gas Industry
Read Buying Oil Investments – Chapter 10: Investments in Gold versus Oil
Read Buying Oil Investments – Chapter 11: Peak Oil
Read Buying Oil Investments – Chapter 12: Conclusion