OPEC Influences Prices
OPEC, or the Organization of Petroleum Exporting Countries, is the main influencer of fluctuations in oil prices. OPEC is a consortium that, as of 2021, is made up of 13 countries: Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, the United Arab Emirates, and Venezuela.
Supply and Demand Impact
As with any commodity, stock, or bond, the laws of supply and demand cause oil prices to change. When supply exceeds demand, prices fall; the inverse is also true when demand outpaces supply. The dramatic drop in oil prices in 2014 has been attributed to lower demand for oil in Europe and China, coupled with a steady supply of oil from OPEC. The excess supply of oil caused oil prices to fall sharply.
While supply and demand impact oil prices, it is actually oil futures that set the price of oil. A futures contract for oil is a binding agreement that gives a buyer the right to buy a barrel of oil at a set price in the future. As spelled out in the contract, the buyer and seller of the oil are required to complete the transaction on a specific date.
Natural Disasters
Natural disasters are another factor that can cause oil prices to fluctuate. For example, when Hurricane Katrina struck the southern U.S. in 2005, affecting almost 20% of the U.S. oil supply, it caused the price per barrel of oil to rise by $13 In May 2011, the flooding of the Mississippi River also led to oil price fluctuation.
Political Instability
From a global perspective, political instability in the Middle East causes oil prices to fluctuate, as the region accounts for the lion’s share of the worldwide oil supply. For example, in July 2008, the price of a barrel of oil reached $128 due to the unrest and consumer fear about the wars in both Afghanistan and Iraq.
Production Costs and Storage
Production costs can cause oil prices to rise or fall as well. While oil in the Middle East is relatively cheap to extract, oil in Canada in Alberta’s oil sands is more costly. Once the supply of cheap oil is exhausted, the price could conceivably rise, if the only remaining oil is in the tar sands.
U.S. production also directly affects the price of oil. With so much oversupply in the industry, a decline in production decreases overall supply and increases prices.
Interest Rate Impact
While views are mixed, the reality is that oil prices and interest rates have some correlation between their movements. However, they are not tightly correlated. In truth, many factors affect the direction of both interest rates and oil prices. Sometimes those factors are related, sometimes they affect each other, and sometimes there’s no rhyme or reason to what happens.
One of the basic theories stipulates that increasing interest rates raise consumers’ and manufacturers’ costs, which reduces the amount of time and money people spend driving. Fewer people on the road translates to less demand for oil, which can cause oil prices to drop. In this instance, we’d call this an inverse correlation.