Oil Market Drivers

Oil Market Drivers

The price of oil can be influenced by a wide range of factors:

Supply and Demand

Oil is a tangible and in-demand commodity. The largest consumer and importer of oil in the world is the United States, followed by China and Japan. Anything that disrupts the supply of oil is guaranteed to influence its price. Factors such as extreme weather, war, terrorism, political unrest, and OPEC production decisions have the potential to push the price of oil up and down.

Since oil is used in the manufacture of many different consumer products, from gasoline and heating oil to fertiliser and cosmetics, the demand for these products can also have an effect on the value of crude oil. When consumption falls in these products, the demand for crude oil also falls, and this can have a negative effect on prices.

Inventory numbers, sales figures and the EIA petroleum status reports all serve to shed light on the difficult task of measuring overall oil consumption. Traders can look to these reports and announcements to better understand the factors influencing the consumption of oil.

Seasonal Factors

The seasonal consumption pattern can also have an effect on the price of crude. During cold-weather months, more heating oil is consumed than in warmer months. In contrast, the "summer driving season" in the US frequently sees a rise in the price of gasoline, in reaction to increased demand. The hurricane season in the Gulf Coast of the United States also has potential to influence the price of oil, since hurricanes pose a threat to refineries located in the Gulf of Mexico. Speculators are aware of these patterns and their sentiment may influence their trading decisions.

Speculation

Recently brought to the forefront of the global oil debate, thanks to the extreme price-spike in the summer of 2008, is the role of speculators in determining the price of oil. While speculators do serve to provide liquidity to a market, the fact that traders without the need for physical delivery of the commodity have the ability to significantly move the price of oil has raised eyebrows around the world. The most fundamental fact regarding speculators' presence in the market is that traders' sentiment may not be strictly supply and demand based, and as such the expected influence of supply and demand on prices may not always be as important as the overall market sentiment towards the direction of oil prices.

Currencies

Since oil is quoted in U.S. Dollars, many of the factors influencing the dollar can carry over into the oil markets. In a general way, the direction of oil prices is regarded as being opposite to the direction of dollar strength. A stronger dollar means that it takes fewer dollars to purchase a barrel of oil. This is typically good for consumers. Inter-currency relationships then come into play, since a barrel of oil worth $100 is good for producers (and bad for consumers) when the dollar is strong relative to other currencies. However, if $100 only translates to 64 Euros (a weak dollar), high oil prices might not mean as much to producers, since their profits in dollars would not be worth as much.

Next: Oil Leverage and Margin