17 Aug What drives oil prices? Spot prices.

Points to take from this read

Both crude oil and petro­le­um prod­uct prices can be affect­ed by events that have the poten­tial to dis­rupt the flow of oil and prod­ucts to mar­ket, includ­ing geopo­lit­i­cal and weath­er-relat­ed devel­op­ments.

The size and dura­tion of a poten­tial dis­rup­tion, they also con­sid­er the avail­abil­i­ty of crude stocks and the abil­i­ty of oth­er pro­duc­ers to off­set a poten­tial sup­ply loss.

Weath­er can also play a sig­nif­i­cant role in oil sup­ply. How­ev­er, the influ­ence of these types of fac­tors on oil prices tends to be rel­a­tive­ly short lived.

Disclaimer

Most of the infor­ma­tion here comes from the U.S. Ener­gy Infor­ma­tion Administration’s web­site (EIA) and some from Wikipedia. I am not pre­tend­ing to come up with all this infor­ma­tion myself. The only thing I did was go through the infor­ma­tion and put togeth­er pieces of it to make it eas­i­er to under­stand and access for myself. This, I want to share with you and I hope it ben­e­fits you in some way. All the praise goes to the good peo­ple that put this up on the EIA and Wikipedia website.

Please go over to these respec­tive web­sites for a lot more information:

EIA on the bal­ance of ‘What dri­ves Crude Oil?’ finan­cial markets

https://www.eia.gov/finance/markets/crudeoil/spot_prices.php

Keep­ing it simple

As I tried explain­ing in the dis­claimer this post is just going to be the sum­ma­riza­tion of ‘facts’ I have found on the inter­net. Sort of like a cheat sheet for any­thing on the finan­cial mar­kets that are involved with crude oil. Above you can find the sources for the infor­ma­tion list­ed here so head on over and look up more details if you wish.

So here it goes…

Dif­fer­ent grades of Oil

• Crude oil is trad­ed in a glob­al mar­ket. Prices of the many crude oil streams pro­duced glob­al­ly tend to move close­ly togeth­er, although there are per­sis­tent dif­fer­en­tials between light-weight, low-sul­fur (light-sweet) grades and heav­ier, high­er-sul­fur (heavy-sour) crudes that are low­er in quality.
• Both crude oil and petro­le­um prod­uct prices can be affect­ed by events that have the poten­tial to dis­rupt the flow of oil and prod­ucts to mar­ket, includ­ing geopo­lit­i­cal and weath­er-relat­ed devel­op­ments.
  • These types of events may lead to actu­al dis­rup­tions or cre­ate uncer­tain­ty about future sup­ply or demand, which can lead to high­er volatil­i­ty in prices. 
  • The volatil­i­ty of oil prices is inher­ent­ly tied to the low respon­sive­ness or “inelas­tic­i­ty” of both sup­ply and demand to price changes in the short run. 
  • Both oil pro­duc­tion capac­i­ty and the equip­ment that use petro­le­um prod­ucts as their main source of ener­gy are rel­a­tive­ly fixed in the near-term. 
  • It takes years to devel­op new sup­ply sources or vary pro­duc­tion, and it is very hard for con­sumers to switch to oth­er fuels or increase fuel effi­cien­cy in the near- term when prices rise. 
  • Under such con­di­tions, a large price change can be nec­es­sary to re-bal­ance phys­i­cal sup­ply and demand fol­low­ing a shock to the system.

What are pos­si­ble dis­rup­tions to oil supply?

• Much of the world’s crude oil is locat­ed in regions that have been prone his­tor­i­cal­ly to polit­i­cal upheaval, or have had their oil pro­duc­tion dis­rupt­ed due to polit­i­cal events. 
  • Sev­er­al major oil price shocks have occurred at the same time as sup­ply dis­rup­tions trig­gered by polit­i­cal events, most notably 
    • the Arab Oil Embar­go in 1973–74,
    • the Iran­ian rev­o­lu­tion and 
    • Iran-Iraq war in the late 1970s and ear­ly 1980s, 
    • and Per­sian Gulf War in 1990. 
    • More recent­ly, dis­rup­tions to sup­ply (or curbs on poten­tial devel­op­ment of resources) from polit­i­cal events have been seen in Nige­ria, Venezuela, Iraq, Iran, and Libya.

• Giv­en the past his­to­ry of oil sup­ply dis­rup­tions ema­nat­ing from polit­i­cal events, mar­ket par­tic­i­pants are always assess­ing the pos­si­bil­i­ty of future dis­rup­tions and their poten­tial impacts. 
  • In addi­tion to the size and dura­tion of a poten­tial dis­rup­tion, they also con­sid­er the avail­abil­i­ty of crude stocks and the abil­i­ty of oth­er pro­duc­ers to off­set a poten­tial sup­ply loss.
  • For exam­ple, if the mar­ket has ample spare pro­duc­tion capac­i­ty to off­set a pos­si­ble dis­rup­tion, its like­ly impact on prices would be small­er than if spare pro­duc­tion capac­i­ty was much lower. 
  • When there are sig­nif­i­cant con­cerns about the poten­tial for a dis­rup­tion at a time when spare capac­i­ty and inven­to­ries are not seen as suf­fi­cient to sub­stan­tial­ly off­set the asso­ci­at­ed loss in sup­ply, prices may be above the lev­el that might be expect­ed if only cur­rent demand and sup­ply were con­sid­ered, as for­ward-look­ing behav­ior adds a “risk premium.”

Weath­er

• Weath­er can also play a sig­nif­i­cant role in oil sup­ply. Hur­ri­canes in 2005, for exam­ple, shut down oil and nat­ur­al gas pro­duc­tion as well as refiner­ies. As a result, petro­le­um prod­uct prices increased sharply as sup­plies to the mar­ket dropped. 
• Severe­ly cold weath­er can strain prod­uct mar­kets as pro­duc­ers attempt to sup­ply enough of the prod­uct, such as heat­ing oil, to con­sumers in a short amount of time, result­ing in high­er prices. 
• Oth­er events such as refin­ery out­ages or pipeline prob­lems can restrict the flow of oil and prod­ucts, dri­ving up prices. How­ev­er, the influ­ence of these types of fac­tors on oil prices tends to be rel­a­tive­ly short lived. Once the prob­lem sub­sides and oil and prod­uct flows return to nor­mal, prices usu­al­ly return to pre­vi­ous levels.

Thanks for reading

I hope this post helps to make the role of the finan­cial mar­kets in rela­tion to oil prices more clear.

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