What Makes Oil Prices So High?

What Makes Oil Prices So High explained by professional Forex trading experts the “ForexSQ” FX trading team.

What Makes Oil Prices So High?

Oil prices are rising because OPEC agreed to reduce supply on November 30, 2016. Members agreed to cut production by 1.2 million barrels per day (mbpd) as of January 2017. In response, traders bid oil prices to $51 a barrel in December 2016. That’s twice the thirteen-year low it was $26.55/b in January 2016.

Oil prices are volatile right now because OPEC is battling U.S. shale oil producers for market share.

Shale producers pushed U.S. oil production to 9.4 million mbpd in 2015. That knocked OPEC market share to 41.8 percent in 2014 from 44.5 percent in 2012. Oil prices fell as supply rose. For more, see U.S. Shale Oil Boom and Bust.

Normally, oil and gas prices have a predictable seasonal swing. They rise in the spring and fall in autumn. That’s because futures traders anticipate increased demand for the summer vacation driving season. Even though heating oil rises in the winter, it’s not enough to offset the post-vacation drop in gasoline demand. Here’s Today’s Oil Price and the Forecast for Oil Prices from 2017 Through 2040 .

High oil prices are also driven by a decline in the dollar. Most oil contracts around the world are traded in dollars. As a result, oil-exporting countries usually peg their currency to the dollar. When the dollar declines, so do their oil revenues, but their costs go up.

Therefore, OPEC must raise the price of oil to maintain its profit margins and keep costs of imported goods constant. (Source: “Oil Briefly Spurts Near $104 per Barrel,” USA Today, March 3, 2008.)

OPEC doesn’t want oil prices too high, or alternative fuel sources start to look good again. OPEC has said its target price for oil is between $70-$80 a barrel.

But U.S. shale producers need $40-$50 a barrel to pay the high-yield bonds they used for financing. Therefore, OPEC must accept a lower-than-ideal oil price to maintain market share.

Compare to Past Oil Price Hikes

2015 – Snapback from a 40 Percent Decline in the Prior Year

By 2015, U.S. shale oil production fell in response to lower prices. The number of drilling rigs declined 44 percent in the first quarter. (Source: Josh Mitchell, “Businesses Remain Reluctant to Spend,” Wall Street Journal, April 25, 2015.)

U.S. oil prices (West Texas Intermediate) had fallen 40 percent from $106/bbl in June 2014 to $59/bbl in December. That was in response to higher supply. At the same time, forex traders drove up the value of the dollar by 15 percent in 2014. Since oil is priced in dollars, this insulated OPEC and other foreign producers from much of the oil price decline. That’s why Saudi Arabia go after market share instead of cutting production and raising prices. For more, see the 3 Factors That Determine Oil Prices. (Source: “This Week in Petroleum,” Energy Information Administration, November 13, 2014).

2013 – A Year of Volatile Oil Prices

In late August 2013, prices for October delivery of Brent crude oil rose to $115.59 a barrel, the highest in six months.

Prices for West Texas (WTI) crude rose to $109.98 a barrel, a 2-year high. Traders bid up prices after the United States announced it would use air strikes to punish Syria’s President Assad for using chemical weapons to kill hundreds of civilians.

Syria is not a major oil supplier, but traders worried about the possible implications of the strike. These include disruption of oil from Iran, Syria’s principal ally; turmoil in Iraq; and further disruptions in Egypt. (Source: “U.S. Oil Futures Settle at Two-Year High Amid Syria Concerns,” Wall Street Journal, August 28, 2013.)

On July 18, 2013, oil prices hit $109.71 a barrel for Brent crude oil. The catalyst was the removal from office of Egypt’s democratically elected President, Mohammed Morsi. Commodities traders worried, without reason, that Egypt would close the Suez Canal if unrest spread.

In January 2013, oil prices rose when Iran played war games near the Straits of Hormuz. Traders saw that as a potential threat to this strategic shipping lane. By February 8, oil had reached $118.90/barrel. That sent gas prices to $3.85 a gallon by February 25.

2012

Oil prices started rising much sooner in 2012 than they did in 2011. The price for WTI crude oil broke above $100 a barrel on February 13, 2012, two weeks earlier than in 2011. Rising oil prices drove gas prices above $3.50 a gallon that same week. Gas prices had already breached $3.50 a gallon on the East and West coasts in January.

By March, Brent crude oil peaked at $125 a barrel. It settled down to $95 a barrel in June, but rose $113.36 by August. Normally, oil prices drop in the fall and winter. However, commodities futures traders were bidding up oil prices to offset the Fed’s expansive monetary policy. They were betting the dollar would drop. That would drive up oil prices. They were wrong about the dollar, but oil prices rose despite lower demand. (Source: “The Price of Oil Is the New Economic Spoiler,” Forbes, September 12, 2012.)

2011

Crude oil prices reached a high of $113.93 on April 29, 2011. Prices had been increasing steadily since February 2009, when prices dropped to $39 a barrel. Prices hovered at a comfortable $70-$80 a barrel until late 2010. High oil prices translate to high gas prices. Petroleum is also an ingredient in fertilizer. This, combined with higher transportation costs, increases food prices. The forces driving high oil prices were similar to what happened when oil hit an all-time high in 2008.

The All-Time High Was $143.68 a Barrel in 2008

Oil prices hit an all-time high of $143.68 a barrel in July 2008, after skyrocketing 25 percent in three months.This drove gas prices to $4.17 a gallon. Most news sources blamed this on surging demand from China and India, combined with decreasing supply from Nigeria and Iraq oil fields. For more, see Gas Prices in 2008. (Source: “Oil Price May Hit $200 a Barrel,” BBC, May 7, 2008.)

But that wasn’t logical since the economy was already in a recession. Global demand in 2008 was actually down and global supply was up. Prices rose, nevertheless. Oil consumption decreased from 86.66 million barrels per day (bpd) in the fourth quarter 2007 to 85.73 million bpd in the first quarter of 2008. At the same time, supply increased from 85.49 to 86.17 million bpd. According to the laws of supply and demand, prices should have decreased. Instead, they increased almost 25 percent in that time – from $87.79 to $110.21 a barrel. (Source: EIA. See Google Spreadsheet)

The EIA pinned part of the blame on volatility in Venezuela and Nigeria, and an increase of demand from China. It also questioned whether an influx of investment money into commodities markets could have affected prices. Investors were stampeding out of the falling real estate and stock markets. Instead, they diverted their funds to oil futures. This sudden surge drove up oil prices. (Source: “Short-Term Energy Outlook,” Energy Information Administration. “The Simple Economics of Commodity Price Speculation,” M.I.T., July 2013. “When Oil Prices Jump, Is Speculation to Blame?”, Federal Reserve Bank of St. Louis, April 2012.)

This asset bubble soon spread to other commodities. Investor funds swamped wheat, gold, and other related futures markets. It drove up food prices dramatically around the world. That created food riots in less-developed countries by people facing starvation. (Source: “Commodity Boom Continues to Roll,” BBC, January 16, 2008. “Riots, Instability Spread as Food Prices Skyrocket,” CNN, February 18, 2008.)