Many people wonder about the high price of oil. But, is it really high? The main controls on oil price are supply, demand, the value of the dollar and OPEC oil market quotas. Let’s look at how these factors interplay to affect the price of oil.
Oil prices will be high when global oil demand is high, oil supply from producers in low, or the value of the dollar falls. If two or three of these factors occur simultaneously, the price rise will be more severe. High oil prices can also ensue when OPEC artificially limits the quotas for export from their member countries.
Oil prices also follow a regular seasonal pattern. Demand rises in the spring and summer when more people drive their vehicles for longer distances. Consequently, oil price tends to rise. In the fall and winter, most people drive less. In these seasons, demand and price tends to be lower. Demand for heating oil picks up in the cool-weather months, but this is generally not sufficient to offset lower prices during the winter season.
The activities of oil traders also factor into the price of oil. Commodity futures traders anticipate increased seasonal demand and begin bidding up the futures contracts as early as January, in anticipation of the warm-weather months. Traders also bid up oil futures when they learn of impending disasters or the threat of war. When the threat of crisis is minimal, the oil futures decrease as well.
Most oil contracts are traded in US dollars. As a result, oil-exporting countries peg their currencies to the dollar. When the value of the dollar declines, so do their oil revenues, but their costs go up. A drop in the dollar’s value forces OPEC to cut production. It must then raise the price of oil to maintain profit margins and keep the cost of their imports in check.
The ebb and flow of oil prices are generally not due to an emergency, but to normal market forces. An outbreak of war in a major oil supplying country would be an example of a true emergency. This could result in millions of barrels of daily oil output taken offline. A sudden event such as this would rock the oil market and cause oil prices to rise greatly.