Robert CaldwellWhy Are Oil Prices So High?
June 3rd 2008 14:10
Intro
Oil prices have skyrocketed over the last year, leaving consumers bewildered. The question of "why oil prices have risen so rapidly?" remains largely unanswered. It appears the price increase is partially due to fundamentals, but other factors do come in to play.
Fundamentals
In order to gauge the fundamentals of the oil market, one must look at its supply and demand. Demand for oil has increased dramatically over the past few years. Demand is spiking in emerging-markets. The most noted examples are China and India, who's economies are growing at a rapid pace. In order to fuel the growing output, these countries are gobbling up more fuel, increasing global demand.
The problem is, supply has not kept pace. While consumption of oil has increased dramatically, supply has steadied. Russia, the leading contributor to global crude oil production, appears to have peaked. Globally, production of crude was the same in 2007 as it was in the year prior.
As demand increased and supply roughly held steady, prices have jumped. Prices spiked through the $100/barrel mark and have not slowed since. Crude oil prices currently sit at $130 a barrel.
Other Factors
Oil producers sell oil for dollars. As the dollar depreciated, it has negatively affected oil producers profits. In order to reap higher profits, producers have charged higher prices for a barrel of oil. Therefore, one other area that has pushed oil prices higher is currency markets.
Speculation is another factor that has forced oil prices higher. The volatility in oil markets highlights the amount of speculation. Market movers, such as reports from OPEC, have had record impacts on the magnitude of price changes. Speculation on the part of oil investors is keeping supply low.
Geopolitical tension, especially in the Middle East (Iraq and potentially Iran) and South America (Venezuela), has also caused a large amount of concern regarding expectations of supply. In other words, the risk involved in oil investment has increased.
Summary
Oil prices have risen primarily due to a large increase in demand. The lack of supply to offset this increase has caused the price growth. Nevertheless, there are other factors that have contributed to the rise in oil prices. First, currency fluctuations have altered producer profits. As the dollar weakened, producers (who make their money in dollars) charged a higher price. Second, speculation has caused volatility in the market. As speculation becomes a larger part of the price equation, a bubble over the fundamental (supply and demand) price has increased. Lastly, geopolitical tensions have been elevated. Most of these geopolitical events or threats of events have taken place in large oil producing countries.
Factor in all these events and it becomes a little more clear why we are seeing $4 plus for a gallon of gas these days.
If you are looking for more analysis or client-specific work, please contact me at schmidpat@regionaleconomiccon sultants.com
Oil prices have skyrocketed over the last year, leaving consumers bewildered. The question of "why oil prices have risen so rapidly?" remains largely unanswered. It appears the price increase is partially due to fundamentals, but other factors do come in to play.
Fundamentals
In order to gauge the fundamentals of the oil market, one must look at its supply and demand. Demand for oil has increased dramatically over the past few years. Demand is spiking in emerging-markets. The most noted examples are China and India, who's economies are growing at a rapid pace. In order to fuel the growing output, these countries are gobbling up more fuel, increasing global demand.
The problem is, supply has not kept pace. While consumption of oil has increased dramatically, supply has steadied. Russia, the leading contributor to global crude oil production, appears to have peaked. Globally, production of crude was the same in 2007 as it was in the year prior.
As demand increased and supply roughly held steady, prices have jumped. Prices spiked through the $100/barrel mark and have not slowed since. Crude oil prices currently sit at $130 a barrel.
Other Factors
Oil producers sell oil for dollars. As the dollar depreciated, it has negatively affected oil producers profits. In order to reap higher profits, producers have charged higher prices for a barrel of oil. Therefore, one other area that has pushed oil prices higher is currency markets.
Speculation is another factor that has forced oil prices higher. The volatility in oil markets highlights the amount of speculation. Market movers, such as reports from OPEC, have had record impacts on the magnitude of price changes. Speculation on the part of oil investors is keeping supply low.
Geopolitical tension, especially in the Middle East (Iraq and potentially Iran) and South America (Venezuela), has also caused a large amount of concern regarding expectations of supply. In other words, the risk involved in oil investment has increased.
Summary
Oil prices have risen primarily due to a large increase in demand. The lack of supply to offset this increase has caused the price growth. Nevertheless, there are other factors that have contributed to the rise in oil prices. First, currency fluctuations have altered producer profits. As the dollar weakened, producers (who make their money in dollars) charged a higher price. Second, speculation has caused volatility in the market. As speculation becomes a larger part of the price equation, a bubble over the fundamental (supply and demand) price has increased. Lastly, geopolitical tensions have been elevated. Most of these geopolitical events or threats of events have taken place in large oil producing countries.
Factor in all these events and it becomes a little more clear why we are seeing $4 plus for a gallon of gas these days.
If you are looking for more analysis or client-specific work, please contact me at schmidpat@regionaleconomiccon sultants.com
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