Oil Prices, The Price of Oil
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What drives the price of Oil and other Hydrocarbons?
Oil prices have skyrocketed over the past decade. Demand for a commodity usually exhibits an inverse relationship with price. However, this does not seem to be the case for oil. Moreover, crude oil production is currently estimated to be higher than the demand. This should exert pressure on prices. So, why are the prices rising?
Oil prices are largely dependent on the interplay of various factors, such as demand, availability from local sources or supply, processing and distribution costs, the local currency valuation. The cost of gasoline for the consumer is also dependent on the national pricing policy, such as high gas taxes or subsidized costs. Needless to say, the United States and other Western nations have historically been the largest consumers of oil. Now, however, the emerging economies of India and China are fast catching up in terms of demand for oil.
Analysts forecast that we are fast reaching peak oil and unless measures are taken to conserve and use alternate sources of fuel, this century could well see huge oil shortage. Following the low of $16 per barrel in January 1999, oil prices have seen a steady rise, breaking all records on July 11, 2008, when prices reached $147.27 per barrel. Although the crude oil prices fell to $125 per barrel on July 24, 2008, a significant decline in prices is unlikely, given the current demand scenario and political issues in many of the oil producing nations.
The good news is that while oil demand is projected to increase through 2008, analysts expect crude oil production to be significantly higher than the demand. So why are oil prices rising? A combination of factors is likely to be affecting crude prices at present – the weak US dollar, geopolitical uncertainties and market speculation. Over the past year, market speculation has been fuelled by the unrest in Nigeria, expectations of a war between the US and Iran, uncertainties regarding oil supply from Venezuela, among others.
So, what does this mean for investors? If you’re interested in investing in oil stocks, this might be a good time. Yes, there are a lot of proponents of the “oil bubble will burst soon” theory. And the current high oil prices seem to support them. The fact, however, is that despite all attempts to control demand by various nations, demand is likely to follow closely behind supply for many years to come. Innovation with alternate fuel sources will take time to translate into everyday use and will take even longer to replace petroleum-based fuels.
However, with the maturing wells in most parts of the world, focusing on the deep water segment of the oil industry is probably a good idea, especially in the Gulf of Mexico. More and more oil companies are investing in deep water wells and, consequently, all segments associated with deep water drilling are likely to benefit, from subsea equipment to contract drilling.
Again, focusing on the relatively “safer” oil producing regions might make for more stable energy stocks. Political uncertainties in the Middle East and Nigeria have been reflected in fluctuating oil prices. Investors are also likely to benefit from focusing on the natural gas sector, since consumers are likely to switch more readily to natural gas when there is a lack of crude supply rather than trying the totally new concept of biofuels.
The bottom line is that oil prices are fairly inflexible in the short-term view because inflation and rising prices do not have a significant immediate impact on oil demand. Consumers will still need to get to work and heat their houses in the winter. The picture would change over the long term, however, with innovations and government focus on increasing awareness of biofuels, creating incentives for the use of alternate energy sources and the general public slowly shifting from oil to other sources of fuel over time.
The only concern then is how long it will take for oil producers to reach peak oil. Peak oil is the highest level of production, beyond which oil production would begin a systematic decline. Projections of the world reaching peak oil vary from 2020 to 2050. But the inescapable truth is that we are slowly approaching a scenario where the global oil reserves will begin a slow decline to the end.
For the consumer, high oil prices translate directly into controlled spending. The prices of food and other consumer products are directly linked to oil prices. So, as the price of oil rises, so does the price of commodities. But this isn’t good news for the retail industry because with rising prices comes a dip in consumer sentiment. The end result is that the general public uses their cars less, reduces their shopping sprees and just waits it out till the economy and/or personal finances show an improvement.
This is the quintessential cycle then of the multiple factors that go into oil price fluctuations – from OPEC controlling supply and to an erratic extent oil prices, demand and supply variations, government intervention to control pricing and the economy waxing and waning just like consumer confidence.
The current situation is this – inventories have risen marginally in July 2008, contrary to expectations. Demand in the US and Western Europe has seen a decline of sorts. Unfortunately, this decline in demand has been more than made up for by the rising demand from the emerging economies of India, China and the Middle East. Geopolitical unrest has also eased to some extent, with fears of the US-Iran war now being put to rest and positive news flow from Nigeria.
Whether we like it or not, the world is largely going to remain dependent on petroleum-based fuels for a long time to come.
The Oil Industry in Detail
Oil Jobs
World Oil Industry
