*This post originally appeared on adamkuettel.net.
From August of 2014 to January of this year, the price of oil has trended downward. Yet for the past nine months, the price has been rising, and analysts expect this trend to continue. What’s behind these two different trends? This post will explore some of the factors that determine the price of oil and how the price affects the economy.
How The Price Of Oil Is Determined
In general, three things determine the price of oil: supply, demand, and market sentiment. When the demand for oil goes up and the supply is low, the price increases. Conversely, when the supply of oil is greater than the demand, the price goes down. Market sentiment is simply the attitude that investors feel towards the market or a particular security. Market sentiment can be affected by any number of things, and this sentiment, in turn, affects the behavior of investors.
Future traders further complicate how the price of oil is determined. For example, speculators guess what the price of oil will be but don’t plan to actually buy it. Their actions can create artificial markets for oil where the laws of supply and demand don’t apply anymore.
Why Did The Price Of Oil Recently Drop?
Investors think it will take years before the price of oil rises to $100 per barrel again. One reason that the price fell in the first place may be due to increased production from the US. As a result of increased US production, nations that typically sold to the US had to find other markets to sell to. Other countries, like Canada and Iraq, also saw increased production. As the amount of oil on the market increased, the price began to fall. Global demand has also been low due to weak economies and the trend of fuel-efficient vehicles.
Numerous factors have led to the recent rise in oil prices. First, a number of oil companies have either gone out of business or are shutting down production. It’s just not profitable for them to operate when the price of oil is low. Their actions, in turn, make the price go up. Second, OPEC has hinted at a production freeze multiple times this year.
Back in April, OPEC held a meeting in Doha to discuss a production freeze; however, the deal didn’t go through. OPEC has planned another meeting for this month, though, and OPEC member Saudi Arabia recently signed an agreement with Russia that aims to stabilize the oil market. The prospect of a production freeze has caused an increase in the price of oil. If a production freeze agreement is reached, then the price of oil will only continue to rise.
The price of oil has many effects on the economy. When the price is down consumers benefit in various ways. For example, the price of gasoline, diesel, and heating oil usually go down as well. Yet low prices also have many negative effects. Countries that rely on oil production to boost their economies, like Venezuela and Nigeria, suffer economically. Venezuela is also experiencing political instability as a result of the low prices. States like Louisiana that benefit from high oil prices also suffer economically when the price falls. Finally, when the price of oil is low, oil companies see their profits decrease and cut employee salaries.
When the price of oil is high, it usually costs businesses more to operate, and the increased costs are passed on to consumers. However, increased oil production also means more jobs. North Dakota saw a huge economic boom as a result of oil fracking. Oil companies usually seek the assistance of banks to fund their operations; therefore, bankers and investors make money when oil companies expand their businesses.