It’s the spring of 2003, a massive drilling machine called Discoverer Enterprise tries to reach the ocean bed, around 1.6 km deep with 3 more kilometers of mud and rock. As reward for their efforts, the US discovers its biggest oil field in three decades. Recently, the oil prices in many countries have hit a negative low. The negative pricing illustrates that since the demand for oil is low, the inventory is stacking up and we don’t have enough space to store all of it. Our oil repositories are soon going to become crammed up. The United States is predicted to hit 100% storage capacity sometime in August 2020, with some parts of the country reaching full capacity much earlier. The instance begs that question, if ‘Black gold’ is indeed as essential as we believe it to be, just why is its current price so paltry?
Without oil, much of our daily necessities would grind to a halt. Such dependence on “Black Gold” showcases its essence in mundane activities like electricity production, fuelling airplanes, making cosmetics, waxes, manufacturing plastic, the list goes on and on. Such a high degree of dependence gives impetus to dig into the causes of changes in oil prices and how they are deter-“mined”. There are multifarious everyday aspects that impact oil prices all over the world, here we look at a few of them.
1. OPEC
The world produced 80,557,000 barrels of oil per day in 2016 of which 44% was generated by OPEC countries. OPEC is the organization of the petroleum exporting countries, which was formed with two basic objectives-
I. Securing fair and stable prices for all the petroleum-producing countries.
II. Providing regular supply to its customers.
OPEC controls around 80% of the world’s supply of oil reserves. Generally, OPEC wishes to keep the price of oil more than $100 per barrel, but since the summers of 2014, its price has plummeted to as low as $50 per barrel. When we see such a scenario it’s majorly because of the decision taken by the consortium wherein they decline to cut down the oil production, leading to unprecedented swings in the oil prices.
For any commodity, supply and demand play a major role in price changes altogether. The oil prices are no exception to this universal rule. Principally, when supply exceeds demand, prices eventually see a downtrend. For instance, in 2014 a major dip in the price of oil was noticed when there was a low demand for oil in the European market and still, OPEC kept a steady supply of oil.
2. Natural and man-made issues.
Natural disasters are another factor that influence the fluctuations in oil prices. For instance, the 2005 Hurricane in the US named Katrina, struck the southern states consequently affecting an average 20% of oil supply, which eventually lead to an increase in prices of oil barrels by $13. Similarly, the flooding of the Mississippi River in the US-led to fluctuations in oil prices as it lead to the shutting down of various oil refineries in different areas. As a result, the oil prices dipped, as the infrastructure dampened and the oil storing capacity came to a standstill.
Adding to this, the geopolitical disturbances can also cause price fluctuations. An instance of political instabilities affecting oil prices in the past, is that of the Iran-Iraq war of 1980 which resulted in crude oil prices crossing the mark of $100, subsequently leading to a price correction i.e. a forced decline of 10% or greater in price. Such financial and geopolitical crisis affects the oil prices in general.
Thus, while fluctuations in oil prices can be a result of man-made actions like, the outbreak of war or political hostility due to failed negotiations, they can also arise from some natural disaster. It is important to understand that the oil prices have no fixed trend in such geopolitical happening. Further any attempts at predicting the exact after-effects of such geopolitical disturbances on crude oil prices are frustrated since in certain scenarios, we can notice the price dipping to as low as $20 and in some other crossing a $115.
3. Production Costs
The production cost of oil is a major determinant of its price. Chiefly, the US production of oil affects its prices all over the globe. The US single-handedly produces an average of 12 million barrels of oil daily. Thus, a decline in production decreases overall supply and increases its price. Similarly, the oil storage capacity is a significant aspect to be considered as it regulates the movement of investments into the oil industry. The oil repositories aids investors by alleviating their fears of too much supply which would ultimately lead to rising oil prices. In the present situation of COVID, we can notice the phenomena of ‘Contango’. ‘Contango’ refers to the situation where the future price of a commodity is higher than it’s current price. Bloomberg claims, “Oil has collapsed into a structure of super-contango as crude for delivery this year trades at a steep discount to contracts further out.”
Key-points
● Other reasons that ultimately lead to oil price fluctuations are interest rate impact, changes in weather conditions, oil spills, etc. Some experts believe that interest rates and oil prices may have some correlation between them.
● As of 2019, OPEC controlled roughly 75% of the world's total crude oil reserves and produced 42% of the world's total crude oil output.
● Although OPEC still has the ability to drive prices, the U.S. has limited the cartel's pricing power by ramping up production whenever OPEC cuts its output.
● The time-to-time fluctuations in oil prices are inevitable. A downward movement in oil prices helps the oil-importing nations to take up various reforms and rationalize oil subsidies.
● On the contrary, and upward trend in oil prices helps oil-exporting countries to strengthen their economic development.
-Vasudha Jha
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