The Oil Industry and the Factors that influence Oil Prices – Chapter 9: When Supply and Demand isn’t the answer

This is chapter number 9 out of 10. Read the rest:

Read The Oil Industry and the Factors that influence Oil Prices – Chapter 1: History of the Oil Industry
Read The Oil Industry and the Factors that influence Oil Prices – Chapter 2: Oil Prices Determinants
Read The Oil Industry and the Factors that influence Oil Prices – Chapter 3: The Sentiment of the Market
Read The Oil Industry and the Factors that influence Oil Prices – Chapter 4: The Origin of Oil and its Composition
Read The Oil Industry and the Factors that influence Oil Prices – Chapter 5: The Drilling & Production of Oil
Read The Oil Industry and the Factors that influence Oil Prices – Chapter 6: Comprehending Price Fluctuations
Read The Oil Industry and the Factors that influence Oil Prices – Chapter 7: The Supply of Crude Oil and Its Prices
Read The Oil Industry and the Factors that influence Oil Prices – Chapter 8: The Components of Gasoline’s Retail Price

As mentioned earlier in Chapter 2, the Futures markets play a very important part in stabilizing oil prices. However, it is also a very liquid and speculative market as almost 97% of the volume traded on the Futures markets are dominated by speculators rather than hedgers. Speculators are in the Futures market hoping to make exceeding large amount of money. As such, if they feel that a commodity is ripe for the picking, an immense amount of money will pour into the trading of Futures contracts for that commodity. This is what caused the upsurge in oil prices in 2008. Fuelled by optimism that oil prices will continue to rise, speculators pumped the oil Futures market with liquidity driving the price up until rationalism takes over cause the price to collapse.

Research has shown that within a 5 year period, investors, hedge funds and commercial banks had pumped over $287 billion up from $13 billion. In 2008, for every 27 barrels of crude oil that is traded on the York Mercantile Exchange, only one barrel is actually consumed in theUS. This shows that the 26 other barrels traded are a result of speculative demands.

Based on this observation and analysis of the production and consumption trends, we can conclude that the upsurge in oil prices in 2008 was not a result of fundamental laws of demand & supply at work. In fact, based on economic theory, oil prices should have been going downward and not upwards. However, contrary to economic fundamentals, prices jumped. For example, on 22^nd September 2008, the price of oil rocketed by $25 in a single day. What was extraordinary was that, there was no supply disruption on that particular day which could justify such a big jump in price. This was a record high in oil price for a single and day and last year $147 per barrel price was also a record high in the history of oil prices. Thus, the only thing which could have explained the sudden and huge increase in oil prices was the increase in speculative demand. 

Read The Oil Industry and the Factors that influence Oil Prices – Chapter 10: Conclusion