Oil is one of the world’s most valuable commodities, as it influences almost everything we do in our lives. Even the screen you’re using to read this on has been made possible by the advances driven by Brent Crude and WTI oil.
It’s also an extremely volatile commodity, with a wide range of factors that affect demand, supply and ultimately price.
Let’s look at five key factors that influence oil prices.
Strength of US Dollar
As the world’s reserve currency, almost all oil transactions are exchanged in US dollars.
This means that oil prices are heavily influenced by the value of the dollar. A weaker dollar tends to nominally increase the price of oil, while a strengthening of the value of the greenback is likely to lead to a fall in oil prices.
Oil prices are heavily influenced by what investors think could affect global demand and supply in the future (because oil prices are set in the futures markets). For example, escalating tensions in an oil producing region such as the Middle East is likely to inflate prices even before demand is affected, as buyers and speculators brace themselves for potential changes to supply availability.
On the other hand, an increase of fracking in oil-producing countries such as the US could see an increase in supply and thus a drop in oil prices. Speculators are able to predict changing regulatory environments relatively far ahead, and oil price is likely to be affected long before laws are eventually enacted.
OPEC, the Organisation of Petroleum Exporting Countries, is a cartel made up of oil producing countries. By forming into a cartel, 14 major oil exporters are able to control the price of oil (within limits) by agreeing to control supply.
In the news, you’ll often hear that OPEC has decided to increase or curtail production. An increase in production tends to lead to a drop in price, while a cut in production is usually intended to support oil prices above and ensure they stay above a certain level.
The expansion of the American fracking industry has resulted in the decline of influence that OPEC has over the oil markets. The cartel has stated that excessive fracking in the US could likely lead to a global surplus, which could cause oil prices to crash.
The US is not a member of OPEC.
Global Economic Performance
Demand for oil comes primarily from the USA, Europe and China. The health of their respective economies is therefore essential to maintaining steady and predictable levels of demand.
Economic crises in these regions are likely to curtail output by industry, resulting in falling demand for oil. For example, the covid-19 pandemic actually led to negative oil prices because of the halt to industry, while in 2008, the financial crises saw the price of Brent Crude decline by more than $100 over five months.
Renewable / Green Energies
The advent of renewable energy sources and technology is likely to have a major effect on oil prices in the years ahead. As advancements in the renewable sectors accelerate, reliance on oil will wane. Most developed countries are already envisioning a world with 100% electric road vehicles. As accessibility to electric cars expands, the cost of oil is likely to continue to drop.
Traders who deal in the oil market should keep an eye on the development and increasing popularity of alternative energy sources to ensure that they are placing trades in line with industry trends.