How the Price of Sweet Crude Oil is Determined
Commodity traders are basically accountable for the price of oil by making bids on oil futures contracts. Such contracts are agreements to sell or buy oil on a particular date later on the agreed price. They are implemented on the commodity exchange floor by registered traders of the Commodities Futures Trading Commission. Trading in commodities has been going on for over a hundred years but since the 1920s it is being regulated by CFTC.
Commodities traders are divided into two groups. Representatives of companies actually using oil, buy it for delivery at the fixed price on a future date. This helps them make financial plans as they know the oil price therefore reducing risk by hedging. There are other traders who are speculators and their only aim is to earn money from fluctuation in oil price.
Factors Considered by Traders to Determine Oil Prices
There are several factors that commodities traders consider when the develop bids for determining oil prices:
- Existing supply related to output, in particular the OPEC set production quota. When traders expect decline in supply, they bid for higher price and if they think that it will increase they pay the same and the price falls.
- Oil reserves that is present in U.S. refineries and the storage in the Strategic Petroleum Reserves. It is easy to access these reserves and can increase oil supply when prices go very high. Saudi Arabia has a huge reserve capacity. When they are ready to tap their reserves, traders let the price of oil to fall.
- Oil demand predominantly from the U.S. plays a key role. Energy Information Agency provides the estimates every month and the demand typically goes up during the summer being the driving holiday season. Travel forecasts from AAA are used to establish potential use of gasoline to forecast demand in summer and weather forecasts are used in winter for likely home heating use of oil.
Price of Oil: Effect of World Crises
Certainly, likely crises in oil-producing countries can considerably increase oil prices. This happens as traders expect limited supply due to the calamity. This was seen in 2012 January following inspectors finding additional proof that Iran’s has increased capability of making nuclear weapons. European Union and the U.S. brought about financial sanctions, which spiralled into Iran’s threat to shut the Straits of Hormuz. The U.S. reacted with the assurance to reopen the Strait even by use of military force if required. Another concern was the likelihood of an Israeli strike.
This resulted in the oil prices from November through January moving to about $95-$100 a barrel. Oil went over $100 a barrel in mid-February and continued there. Gas prices also increased to $3.50 per gallon. It was forecast that gas would remain at $4.00 or more a gallon during the summer driving season.
There is an increase in oil price due to unrest in the world seen in 2011. Investors became concerned about unrest in Tunisia, Libya and Egypt 2011 March and it became famous as ‘Arab Spring’. Oil prices reached over $100 per barrel in beginning of March and went up in late April to $113 a barrel.
The Arab Spring revolt was active all along summer, resulting in the overturn of governments. Initially commodities traders were concerned about the disruption in oil supply due to Arab Spring, but that did not happen and oil price by mid-June got back to less than $100 per barrel.
There was an increase in price of oil by $10 a barrel when there was a threat of war between Israel-Lebanon with Iran. Oil increased from its expected $70 a barrel in May to a record high of $77 per barrel in end July.
Oil Prices: Effect of Disasters
There can be a rise in oil prices due to man-made or natural disasters if they are serious enough. Oil prices increased by $3 a barrel during Hurricane Katrina and the cost of gas in 2005 went up to $5 a gallon. 19% of the oil production in the country was affected by Katrina. It came just after Hurricane Rita and they together destroyed 113 gas platforms and offshore oil as well as damaged 457 gas and oil pipelines. Mississippi River flooding during 2011 May, resulted in the gas prices to reach $3.98 a gallon. There was a concern among traders that oil refineries would be damaged due to flooding.
In contrast, there was no increase in the price of oil due to the Exxon-Valdez oil spill. A key reason behind it was that the price of oil in 1989 was just about $20 a barrel and the spill included just 250,000 barrels. This had a shattering effect on the coastline of Alaska, but did not really upset world oil supply.
Over 18 times the oil was seen in the BP oil spill as compared to Exxon Valdez, but the gas and oil hardly moved due to it. This was because global demand for oil was low during the time with people slowly recovering from the recession and financial crisis of 2008. Another reason was that even after 174 million gallons of oil spill; it happened over an extended period and was not a very big percent of total oil needed by the U.S. It was just about 9 days of oil for the U.S. that in 2010 used 6.99 billion barrels of oil as per the Energy Information Administration U.S. This would mean just a little more than 19 million barrels a day.