Why Do Oil Prices Go Up and Down?

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It’s always hard to predict which way the price of oil is going to go – up or down. Unlike the more steady propane, oil prices can fluctuate day by day, hour by hour, even minute by minute. In the US, gas (natural and propane) is mostly produced at home, with some coming from our immediate neighbours. But our oil comes from home and far-flung countries, especially the Middle East, and we have less control over its cost.

The Largest Factor Affecting the Price of Oil is ‘Supply and Demand.’

The more oil is needed, the higher the price; the less oil is produced, the higher the price. In turn, supply and demand is affected by market traders who buy oil futures contracts – agreements to buy or sell oil on a specific future date at a predefined price. The traders set the price according to known facts, but also according to educated guesses – if enough traders believe that oil demand will increase dramatically at some point in the future they can cause an immediate and often rapid rise in oil prices today. The reverse is also true.

What Do Oil Traders Base Their Beliefs and Actions On?

Determining factors affecting oil trading prices are many and varied but the big one is current supply. There are oil reserves around the world but the biggest are in Saudi Arabia. If the Saudi oil producers announce that they will tap into their oil reserves the likelihood is that prices will fall around the world. Conversely if, at times of geopolitical tension, the Saudis announce they will not tap into reserves, prices will probably rise. Demand, especially in the US, which consumes 20% of all the world’s oil production, will affect prices. If a lot of cars take to American roads through the summer, prices might rise. In New England, a bad winter will set local prices climbing as more people turn up their heat.

And then there’s world affairs, which can dramatically affect supply and therefore prices. In 2011 the Arab Spring caused traders to worry about interruptions to supply chains and prices reached $113 per barrel. When international sanctions were imposed on Iran in 2012 oil went over $100 a barrel. And just last month the trouble in Iraq sent the price for a barrel of crude up to $115.

Will Oil Prices Come Down?

The truth is no one can predict the future with complete certainty. The only unassailable fact is this: oil prices will go up, they will almost certainly come down again, but they will never remain the same for very long.

Sources: investopedia.com; useconomy.com; wikipedia.com

Comments 2

  1. Brian

    Hi, are oil prices related to the american $$$. I mean does a stronger dollar mean a reduction in the price of oil, thanks from brian.

    1. Post
      Author
      Jenny Marshall

      Hi Brian,

      Thanks for the question. The short answer is that, yes, there is a direct correlation between the US dollar and the price of oil. Looking at weekly data for the last ten years, analysts on marketrealist.com see a correlation coefficient of -76%.

      According to Jeffrey Rosenberg writing in December 2014 on marketrealist.com, “The sharp […] drop in oil prices from its highs in June reflects dramatic changes in the marginal supply of oil, shifting expectations for demand and, critically, a change in the outlook for monetary policy. The resulting stronger dollar is weakening its equivalent measure in the price of oil.” He goes on to say that the reasons behind the decline in prices are, in this order: Fall in oil demand, the rise in supply, and the dollar. Because oil is “US-dollar denominated, the rising dollar indicates a fall in the value of oil relative to the US dollar. […] A rising dollar has and will continue to put downward pressure on oil prices…”

      Also on marketrealist.com Russ Koesterich, writing in late February 2015, said, “A stronger dollar is one reason—along with a slower global economy—that commodity prices in general, and oil in particular, continue to fall. Since oil is traded in US dollars, when the dollar moves higher, oil prices tend to fall.”

      However, like Rosenberg, Koesterich went on to say that “the dollar alone isn’t responsible for the slump in oil prices. Softening growth in Europe, Japan, and China—among other countries—has led to subdued demand for oil [and] OPEC has been unwilling to cut production as US refineries have kept production high.” He noted that, in February of this year, “oil prices [increased] due to the cut in production in the US.”

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