What moves oil prices?

Every year we have a new story about where the oil market is heading, how the global economy is impacting prices and just how much black gold we actually have left.

So what really moves oil prices?

Just like anything else, surely it’s a simple case of supply and demand? Not quite – if it were totally straightforward, commodity trading would not be such a fine art. Oil is impacted by a range of factors, some measurable and some a lot less so.

Demand

Overall, if the world’s economies are growing, then demand for oil goes up and drags the price with it. Looking at the long-term trend over the past few years, we can see that fast industrialising nations like China and India are driving up prices.
Similarly, when the global economy went into recession, prices could be seen to fall. Brent Crude tumbled from over $140 a barrel to little over $30 between the summer of 2008 and January 2009, when the full realisation of the meltdown had hit.

Supply

Opec can help to drive up the cost of oil by tightening its grip on supply. Opec oil accounts for approximately 35m of the 80m barrels released each day, so this is pretty important.
Similarly, perceptions about how much oil is left in the world affect prices. Crude oil is a finite resource, and the idea of the planet one day running out of the stuff remains entrenched in people’s minds, even if explorers are finding new reserves every year.

Disruptions to supplies can cause short-term fluctuations. For example if there is war in the Middle East we can expect prices to edge higher as there are concerns about how much oil be exported to consumers in the West.

Speculation, aka the Crowd

With oil, price is not a simple matter of supply and demand. If there is speculation that prices will rise in the future then that can be enough to make it move. Similarly, as soon as the market decides that demand will fall, the cost of a barrel will plummet.

If there is a belief that China will buy a couple of million more cars next year, the perception is that demand for oil will stay strong. If America starts pouring troops and aircraft carriers into the Persian Gulf, the market will believe a serious supply chain disruption is imminent.

“So how can we benefit, as small traders? Simple enough – trust what the charts are telling us.”

How does the crowd really influence oil prices?

If it were just a matter of how much oil there is available versus how much is being used, it would be a lot easier to predict. But oil prices are not set by real-world consumers and producers, but by the oil futures market.
In fact, the majority of futures trading is done by speculators. Figures from the Chicago Mercantile Exchange show less than 3% of transactions result in the purchaser of a futures contract taking possession of the commodity being traded. So most of the trade in oil is actually being done by people making bets on where they think the price will go.

Fundamentals versus speculation

According to the European Central Bank, up until 2004 you could easily track the price of oil with fundamentals – supply and demand. “Thereafter, trend chasing patterns appear to be better in capturing the developments in oil futures markets,” the banks states.

Essentially, since 2004 there been a lot more market interest in the price of oil from speculators trading commodities. This moves the market in ways that suggest merely looking at raw production and consumption data is not sufficient. The ECB notes that “noise trading, herding behaviour and speculative bubbles” are playing an increasingly important role in determining oil prices.

Other factors

How does Forex trading affect oil?

Oil is priced in dollars, so a movement in the Forex market will affect the price of oil. The weaker the dollar, the higher the dollar price of oil because it takes more greenbacks to buy a barrel.

Interest rates

The money supply may also impact oil. According to the European Central Bank, excess liquidity and low interest rates could be contributing to price increases. Low interest rates would result in the expansion of money supply and decrease the demand for liquid assets by sovereigns like China, Chile or Dubai.

Both effects would eventually lead to an increase in prices, though not everything will move at the same speed as some prices are more flexible than others.
Among the most flexible, according to the ECB, are commodity prices.

Source – TradingTheEasyWay.com