3 Factors Dramatically Affecting the Price of Oil

Oil is a tricky thing. On the surface, it seems so simple. It's a single commodity that's extracted, refined, and sold. Much to the chagrin of Adam Smith, though, the price of oil rarely is based on simple supply and demand. It's one of the most complex commodities in the world because of the economic and political implications it carries. To quote Daniel Yergin, author of The Prize and one of the foremost authorities on energy security:

"The major obstacle to the development of new supplies is not geology but what happens above ground: international affairs, politics, investment and technology."

Let's look at three factors that can have a profound effect on the price of a barrel of oil.

1. Economic growth. You could argue for days on whether oil prices determine economic growth or if economic growth has dictated oil prices. So let's settle on the fact that they both go hand-in-hand. Since 1975, almost every U.S. recession has been accompanied with a pullback in oil prices. It should come as so surprise, then, that oil and the S&P 500 0000have moved in tandem as well. 

US GDP Chart

US GDP data by YCharts. Shaded areas represent recessions.

This applies to almost everywhere around the globe. In the past couple of months, the price of Brent crude, the benchmark for global oil trading, has dropped 18% in large part because of weak U.S. and Chinese GDP figures. Perhaps to be more general, economic growth is dependent on the price of energy; it just happens to be that oil is the predominant energy source around the world, supplying more than one-third of the world's energy demand. So unless some other source of energy captures the top spot from oil, then oil will remain the bellwether for energy prices around the world. 

2. Geopolitical risk. Oil is a very delicate commodity, and any potential disruption of supply could lead to large changes in prices. During the Libyan revolution, Total (NYSE: TOT  ) , BP (NYSE: BP  ) , and several other oil companies halted operations, and a country that was once repsonsible for 1.6 million barrels per day came to an almost screeching halt. From January to May 2011, as Libyan oil prosecution had tumbled 88%, Brent crude jumped almost 30% even though Libya supplied only 0.5% of total global exports.

The same can be applied to the value of companies as well. Apache (NYSE: APA  ) has about 20% of its production in Egypt, and in its recent annual report it highlighted the Arab Spring and the Egyptian election as major risks that could drastically affect production numbers for the company. Whenever companies invest heavily in regions of the world with political uncertainty, they're taking a much larger risk that can affect their operations and market value. 

3. OPEC production decisions. If you were to ask an average person on the street to name the world's largest oil company, the first response you get would almost undoubtedly be ExxonMobil (NYSE: XOM  ) . But that's not even close. Exxon lags behind the large nationalized oil companies that are part of the Organisation of Petroleum Exporting Countries, more commonly known as OPEC.

Multiple sources, author's calculations.

While the U.S. may have the world's third largest petroleum reserves, they're divided up among several hundred companies, and very rarely is there excess supply. That's not the case with OPEC members. These countries, most notably Saudi Arabia, have excess production capacity and will set production targets that more or less dictate the price of crude around the world.

While normally this will bring a certain stability to the price of oil, it can also lead to dangerous consequences. Take, for example, the big run-up in oil prices leading to the financial collapse in 2007-2008. At that time, excess production capacity for OPEC nations was much lower than normal, and they were less able to control prices.

Source: US Energy Information Administration.

As long as OPEC controls more than 40% of global oil production and has the ability to dictate global supply levels through production targets, it will continue to have a major influence on oil prices.  

What a Fool believes
As much as we want to take control of our energy future, there are just some factors that are out of our control. Unfortunately, several of those factors are working against us, and it's very unlikely we will ever see cheap oil again.

Coming back to Mr. Yergin: "The starting point for energy security today, as it has always been, is diversification of supplies and sources." Certainly wise advise for energy policy, and investment strategy. 

If you're on the lookout for some currently intriguing energy plays, check out The Motley Fool's "3 Stocks for $100 Oil." For free access to this special report, simply click here now.


Read/Post Comments (26) | Recommend This Article (8)

Comments from our Foolish Readers

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  • Report this Comment On April 21, 2013, at 10:05 AM, BartHugens1 wrote:

    So, what you're saying in this article is that factors of supply and demand totally determine the price, just exactly as economic modelling requires. Yet your teaser tie-in to the article says that it ISN'T simply supply and demand that determine the price. Well, which is it? Everything in this article is directly connected to supply and demand factors, so I guess the article is pointless as a "revelatory" piece of financial writing. Time to get back to my graphic novel.

  • Report this Comment On April 21, 2013, at 10:12 AM, crazyme1957 wrote:

    I blame all of the high price of oil because of the greed of wall street and nothing more they will do anything to screw the american people.

  • Report this Comment On April 21, 2013, at 10:19 AM, danno228 wrote:

    Your article is b.s. Before oil was a commodity is was based on supply/demand. Thank the two Bush's for the high cost of oil.

  • Report this Comment On April 21, 2013, at 10:40 AM, serioso777 wrote:

    100% Greed, that's what oil is based on...It was 4 dollars a gallon in the beginning of the repression, so it goes down for economic reasons is pure BS...and gas prices been high as oil fell , so its all BS, say what you want, its simply pure GREED !

  • Report this Comment On April 21, 2013, at 10:55 AM, bugmenot wrote:

    Obama is the current reason for the high cost of oil. If Obama let US companies drill and frack for oil, the US would already be energy independent. Obama is the single reason the US economy is in the dumps. Cheap energy could revitalize manufacturing making US labor costs profitable. Expensive energy drives jobs away. The Keystone Pipeline equals jobs plus cheaper energy. Why won't Obama approve it? Because cheap energy may take the poor out of poverty and make the middle class strong again. Then the media couldn't convince them to vote Democrat.

  • Report this Comment On April 21, 2013, at 11:11 AM, Mark1946 wrote:

    "Supply and Demand" is the "catch-all" propaganda word used by the Wall Street bandits to arbitrarily jack-up crude oil prices at their every whim. Numerous additional excuse are used almost every time the MYMEX betting crowd decides to hike the crude oil price, which of course directly affects the cost of gasoline at the pump. For those who would debunk this fact, I invite them to watch the 60 Minutes special, "The Price of Oil" aired in January 2009, and narrated by Steve Kroft. Bottom line, Wall Street SPECULATOR GREED reaps a good two thirds profits above actual refinery production costs for a gallon of gasoline, and the Securities & Exchange Commission does nothing about it.

  • Report this Comment On April 21, 2013, at 11:12 AM, 98059 wrote:

    The article is a lot of garbage. If oil had never been put in the comodities market greedy wall street traders would never have been involved. Also "bugmenot" is correct about Obama and the current administration except that I don't necessairly agree that prices would come down because the greedy traders on wall street are still involved. Oil needs to be taken off the commodities market if supply and demand are to be the primary determining factors in the price of oil.

  • Report this Comment On April 21, 2013, at 11:46 AM, mateonelson wrote:

    The chart showing the proven reserves is a joke. All of the opec member countries have over inflated reserves. These "proven" reserves have stayed the same for the last 35 years. For instance, Saudi Arabia in the 1980's increased their "proven" reserves overnight by 100 percent because of the quotas the cartel set on the amount of oil each member country could produce. Since then their "proven" reserves have stayed the same and over 60 billioin barrells of oil have been pumped out of their wells. The fact is in Saudi Arabia, they have not found any significant oil discoveries since the late 60's that could account for any increases in reserves since that time. Also, their largest oil field, Ghawar, has been in production since 1948. They have relied on this field for half of their production and currently they pump in seawater into the field to get out the remaining oil in the field. More astonishing, 50 percent of the fluid coming out of the field is Seawater. This field is in decline just like the cantarel field in Mexico. So you can take the OPEC "proven" reserves and the actual "proven" reserves is about a third of what they actually report.

  • Report this Comment On April 21, 2013, at 11:54 AM, kanawah wrote:

    The only reason is just plain old oil company GREED.

  • Report this Comment On April 21, 2013, at 12:55 PM, super45 wrote:

    We have almost 503 billion barrels of oil in the Welliston Basin better know as the Bakken in N. Dakota. Just 10% of this pumped will yield 5.3 TRILLION DOLLARS to the USA economy. We estimate that we have 2 TRILLION BARRELS of oil under the Rocky Mountains. We have 500 times more oil than Yemen. Enough oil to run the USA for over 2,000 years. Makes you wonder why we are not pumping. Maybe OPEC?

  • Report this Comment On April 21, 2013, at 1:00 PM, luckyagain wrote:

    The price of oil has been manipulated since Rockefeller set up the Oil Trust in 1863. The only difference is who is pulling the levers. Now a days it is the Saudis. Any time the price of oil starts to fall, the Saudis cut back production to reverse the falling price. It has happened again and again since the oil embargo of 1971.

    The only thing that American consumers can do about the price of oil is cut their consumption as much as possible. The best way is buy electric and hybrid cars. Every time an electric car is sold, the oil barons lose thousands of dollars a year. So expect continue attacks in the news media about electric and hybrid cars because they are the only real way to hold down the price of oil.

  • Report this Comment On April 21, 2013, at 2:35 PM, abmabardy wrote:

    Well, I was going to say

    ....greed, greed, and, ... uh, ... greed.

  • Report this Comment On April 21, 2013, at 6:09 PM, Rick1599 wrote:

    They missed corruption and greed.

  • Report this Comment On April 21, 2013, at 6:31 PM, truthiscomplex wrote:

    A choice of how to power your vehicle would give oil companies pause when they decide how to price gasoline. (Plug-in today or fill?) Plug-in hybrids can reduce air pollution in cities and high traffic areas by covering frequent trips and still give people an enormous driving range and the option of filling up with conventional gasoline when needed, such as on road trips and in remote areas. Email or call your auto-manufacturers today and demand more choices in energy sources for popular vehicles.

    Oil and natural gas production is over a 50 year high in Colorado as of 2012-2013. They have also had over 900 spills....the reported ones, that is. Cattle ranchers say there are many more that go unreported.

  • Report this Comment On April 21, 2013, at 6:42 PM, thelordmoose wrote:

    This article is complete horse manure. Does the writer really believe people are that stupid? or maybe HE'S just that stupid. Oil and gas prices are where they are because of GREED! period! I did a paper for economics back in 2010 when Exxon/Mobil was the highest earning company in the world. Their earnings were more than double the earnings of the #2 and #3 companies, combined. They could have slashed their revenue in half, in half! and they would have still been the highest earning company. so don't tell me about the ebb and flow of oil prices. that is pure unadulterated BS! GREED is why gas is what it is. Just like most things in this country, It is run by GREED!

  • Report this Comment On April 21, 2013, at 6:59 PM, rongone wrote:

    Manipulation of worldwide oil pricing is most influenced by commodity speculators around the world. That's what all the mumbo-jumbo in the article about geo-political risk, economic growth, and OPEC production numbers is talking around.

    Saudi Arabia also has successfully drilled wells that have been capped to control the flow out of their fields.

    Lack of modern refining capabilities in the U.S. (the aging facilities are continually failing) and the lack of interest of big oil in the U.S. to update these facilities (their cost base analysis keeps them from making the needed upgrades) adds to big oil's control of the market market price of refined oil products as they essentially supress supply even if demand decreases. This allows them to maintain their defined revenue stream and huge profits even in depressed economic conditions.

  • Report this Comment On April 21, 2013, at 9:17 PM, wskadavis wrote:

    The price of oil has never been about supply and demand. OPEC has always keep the supply a little less than the demand to get as much as they could, oil has been plentiful for more than the last century. Then there are the wall street speculators who inflate the price of oil just to make money. The only way to stop the speculators is to require them to take delivery of their purchase.

  • Report this Comment On April 21, 2013, at 11:13 PM, wgcross2 wrote:

    It still utterly amazes me when I read some fool posting about the Keystone XL Pipeline as some kind of silver bullet. Let me clarify- the XL Pipeline will transport predominately Bitumen (Tar), not conventional crude oil. All studies have suggested that the pipeline will create a few thousand 'temporary' jobs over 2 years. And maybe a couple of hundred permanent jobs. One only has to look back at Keystone Phase I and II to gather the necessary data/statistics. The pipeline is headed for Texas for the following reasons: refining capacity, refining technology for heavy crudes, free trade zones and the Gulf of Mexico. Transcanada has already stated that the refined products, ie gasoline, diesel, kerosene, etc are to be 'exported'. They are NOT for domestic consumption. There will not be, can not be, any impact at the pumps. Texas also has the ports that can handle the newer super tankers. The Gulf is the gateway to Europe, Mexico, Central and South America where the refined products will bring a much higher price than domestically. So let's drop this Keystone XL fantasy.

  • Report this Comment On April 21, 2013, at 11:21 PM, wgcross2 wrote:

    And while we're debunking rhetoric, commodities are controlled by speculators, NOT classic supply and demand economics. A good example of this are diamonds. The supply is kept artificially low to keep prices high. OPEC and Non-OPEC nations can open and throttle back valves to control the outputs while agreeing on how much oil will be available. This of course sets world base prices and then enters Wall Street and the Speculators and up goes the prices. Look at what they did to corn when the methanol mandate was signed. Food suppliers that depend on corn for feed got hit hard. That then gets passes onto the consumer. Chicken is a good example here.

  • Report this Comment On April 22, 2013, at 4:02 AM, amvet wrote:

    It is well known that oil prices are not set by supply and demand but be giant banks and hedge funds buying and selling trillions of dollars of futures contracts.

    If Mr. Crowe is interested in informing the public, he could give the daily value of oil futures traded globally compared to the value of daily oil consumption.

  • Report this Comment On April 22, 2013, at 4:06 AM, amvet wrote:

    wgcross,

    Typically, Saudi Arabia overproduces oil to keep the price down and help the US economy. In return, we help keep the royal dictators in power. The Saudi public knows this and is not pleased.

  • Report this Comment On April 22, 2013, at 8:34 AM, mikeflynn57 wrote:

    you forgot to even mention the role of speculators in 2007-08.

    or, more important the value of the dollar which has the most direct inverse relationship to the oil price than any "supply and demand" factor. inflated, cheap, fake dollars = high oil price. "strong" dollar = low price.

    i do get that a rising china and india put long term demand pressure on the price, however.

  • Report this Comment On April 22, 2013, at 10:08 AM, Grandpastu wrote:

    The pricing of oil is made complex intentionally in order to keep the exorbitant money flowing into the pockets of the oil company CEO's pockets and into the pockets of the inside trading oil company board members and their Congressional cronies! Nobody but the oil companies know how the oil prices are obtained and they're happy with that!

  • Report this Comment On April 22, 2013, at 5:34 PM, XXF wrote:

    This place is turning into MSNBC or CNN Money.

    There is nothing complicated about this - if oil companies are "greedy" which is the layman term for earning excess profits, then all anyone in the world needs to do in order to earn a risk adjusted return on their investment is to start an oil company. Failing that please can it with your inarticulate nonsense.

  • Report this Comment On April 24, 2013, at 10:14 AM, Tomohawk52 wrote:

    Or alternatively invest in the "greedy" oil companies. Get in on the massive profits!

  • Report this Comment On April 27, 2013, at 4:28 PM, sheldonross wrote:

    Hear, hear XXF, lots of ignorant whining, yet they all still line up at the pump. It's been highlighted again and again how (american) oil company profit margins are usually in the single digits, yet the rabble chants "Greed! Corruption!"

    Probably while posting via their iphone and it's 50% margins. Yet they worship at the alter of Apple.

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