What Really Moves The Prices Of Oil?
Have you ever wondered why oil prices are so volatile? The simplest way of looking at oil price movements is the result of supply and demand — more supply means lower oil prices and more demand means higher oil prices.
But it is actually not that simple. There are more to than just “supply and demand” to the volatility of oil prices, as discussed in one of the most popular economic podcasts on iTunes, Planet Money.
The hosts of the podcast show went to the Wall Street trading floor to find some answers from brokers, oil speculators, and even an oil well owner. Rumour has it that the speculators were the main reason why oil prices are volatile.
The truth is, the oil prices are decided largely by those who decide whether or not to turn on the taps of oil rigs, offshore or onshore.
Speculators are like gamblers
This is not a new fact for most people — speculators basically trade contracts that bet on future oil prices, a year, three, five or even ten years later. Most people would think that because they are the main traders of such contracts, they are essentially “moving” the market.
Think of it this way, gamblers (and speculators) betting on a soccer match would only affect the odds of the overall betting system. But never will the betting odds affect the result of the soccer match — the teams wouldn’t be affected by the odds, hopefully.
Likewise, for the oil markets, speculators who trade contracts of oil futures wouldn’t exactly affect the current price of oil. Conversely, the current price of oil affects the value of the oil futures contracts! So, what would exactly affect the oil prices?
Oil rig owners hold the power
This should be very clear but not all oil rig owners hold the same power. The ones who are able to pump oil at the lowest possible price — US$8 or US$10 per barrel — as mentioned by Planet Money’s hosts, hold the most power.
And these oil drillers are typically those who extract oil straight from the ground, those are the cheapest. The most expensive oil is located underneath the seabed, like those in the US and our little red dot, Singapore.
So as long as the oil prices — which are decided by the entire world’s oil market — are over an oil driller’s cost price of pumping oil, it will carry on pumping to earn as much money as possible.
Offshore oil rigs suffer losses
However, we know that oil prices are less than half of what it used to be at its peak years ago. So how about those rigs, typically offshore, what would happen to them? Well, they either continue pumping to survive or shut down the rigs.
Either way, they suffer losses. Which is why many oil companies — again, typically offshore ones — have been going bankrupt. The world’s daily consumption of crude oil is some 90 million barrels a day.
But because everyone around the world has different costs in pumping oil, the ones whose operating costs are higher than the current oil price wouldn’t want to sell, if they could.
Oil prices in the near future
Of course, the daily oil consumption and demand is volatile too. So with all these intricacies and difference in operating costs across the globe, every tiny bit of decision to turn on or off an oil rig would affect oil prices.
The true question is, would oil prices climb back to its peak or even higher? Many different experts across the board have contrasting opinions but we know that oil prices crashed very briefly after hitting almost US$115 per barrel.
And just recently, it was reported that the Organisation of Petroleum Exporting Countries (OPEC), supposedly one of the largest (group of) players in the world, is likely not lifting oil prices for some time.
What to expect? Volatile oil prices that hover around current levels, at least until the big boys (low operating costs per oil barrel) decide to give the other players a bigger piece of the pie.
*Key points in this article are taken from Planet Money‘s podcast.
