By Nathan Boardman
Traders in the commodities market actively bidding on oil futures contracts significantly influence oil price levels since their bids are informed by their expectations for the future supply and demand of oil. Futures contracts and oil derivatives trading have a sizeable daily influence on oil price fluctuations. Each day’s oil price is different since it is based on the trade results that took place during that day.
Traders base their offers on analyzing the market’s current supply and demand conditions. The Organization of the Petroleum Exporting Countries (OPEC) and other governments can affect traders’ bids by changing market dynamics or oil production/storage levels.
As a commodity, oil has a well-deserved reputation for extreme price swings. If you’re considering getting into oil trading or doing any business with oil derivatives, you must have a firm grasp on all the factors that set the oil price. Traders, governments, and consumers all play crucial roles in developing and influencing this pricing, and their contributions should not be overlooked.
Traders Are a Major Factor in Determining the Price of Oil
Trading in oil futures contracts occurs on the trading floor of a commodity exchange, a specialized marketplace for such transactions. The New York Stock Exchange and the Chicago Mercantile Exchange are two of finance’s most well-known commodities exchanges.
For over 150 years, goods produced in the United States have been traded internationally. The Commodity Futures Trading Commission (CFTC) is a highly regarded regulatory organization that has been monitoring the actions of commodity dealers since the 1920s. Dealers must verify that they are registered with the CFTC.
Hedge funds and speculators are the two main types of commodity trading.
Hedgers serve as representatives of corporate entities engaged in the production or consumption of oil. Implementing hedging strategies enables entities to ascertain the prevailing oil price, facilitating informed financial planning. The contractual agreements establish a predetermined price point that mitigates potential risks for both the buyer and seller, safeguarding their respective companies against fluctuations in market prices.
Individuals falling within the second classification are commonly referred to as speculators. The sole objective of the individuals in question is to generate financial gains through capitalizing on fluctuations in the value of petroleum. Futures speculators typically exhibit a keen interest in oil derivatives, engaging in trading activities that capitalize on marginal price-level changes.
Oil Prices Are Determined by Traders Based on These Three Factors
The development of bids that influence oil prices is contingent upon considering three primary factors by commodities traders. The following information pertains to the present supply, anticipated future supply, and projected demand.
Current Supply
The existing supply represents the aggregate global production of petroleum. The Organization of the Petroleum Exporting Countries (OPEC) is responsible for approximately 40% of global crude oil production, exerting significant influence over international oil prices.
From January 2011 to December 2014, there was a significant increase in shale oil production within the United States, with output growing from one million barrels per day (b/d) to approximately 4.8 million b/d. The observed escalation in production resulted in an excess oil supply, commonly referred to as an oil glut, wherein the quantity of oil produced surpassed the prevailing demand. The rise in oil production in the United States resulted in a significant decrease in the price of imported crude oil, reaching approximately $27 per barrel (/b) in February 2016.
In late 2019, shale oil production surpassed a significant milestone of 12 million barrels per day, while the average price per barrel of oil stood at approximately $57 throughout the year. The annual production figure for 2020 recorded a decline, reaching 11.28 million barrels per day. The yearly production of the year 2021 concluded with a fall, reaching a total of 11.16 million barrels per day. According to the available forecasts, it is anticipated that there will be a notable rise in production levels for the year 2022, reaching a projected figure of 12.01 million barrels per day.
The average price of West Texas Intermediate (WTI) crude oil in 2021, as reported by the U.S. Department of Energy’s Short-Term Energy Outlook, stood at approximately $68.21 per barrel. The projected average price for the year 2022 is roughly $97.96 per barrel.
Future Supply
The availability of future supply is contingent upon the existence of oil reserves. The composition encompasses the inventory present within refineries in the United States and the funds held within the Strategic Petroleum Reserves. The accessibility of these reserves facilitates their utilization for augmenting the oil supply in the event of excessive price levels, diminished oil inflow resulting from natural calamities impacting the United States, or any other circumstances necessitating the availability of oil, as per the stipulations outlined in the Energy Policy and Conservation Act of 1975.
Demand
Traders analyze global oil demand, focusing on the United States and China. The Energy Information Agency furnishes monthly estimates for the United States. The need for gasoline experiences an upward trajectory during the summer driving season, while it undergoes a decline during winter. To anticipate demand, AAA’s travel forecasts are employed to ascertain potential gasoline consumption during the summer season, while winter weather forecasts are utilized for the same purpose.
Other Important Factors Affecting Oil
OPEC Decisions
The Organization of Petroleum Exporting Countries (OPEC) is an international alliance comprising several oil-producing nations, which collectively exercise influence over a substantial share of the global oil production. The determination of production levels holds significant power over the fluctuations observed in oil prices. In the event of a rapid decline in oil prices, it is plausible that OPEC+ nations may opt to engage in a collective decision to curtail oil production, thereby mitigating the surplus supply within the oil market and consequently arresting the downward trajectory of prices.
Economic Conditions
The interplay between the global economy and oil prices is an essential factor to consider. During periods of economic expansion, there is typically a corresponding rise in the oil demand, resulting in an upward pressure on prices. On the contrary, during periods of economic downturn, there is a noticeable decline in the market for oil, consequently leading to a reduction in costs. It is widely anticipated by analysts that there will be a notable surge in China’s demand after the lifting of COVID-19 restrictions. The current market exhibits a sufficient supply. Thus, a rise in demand can potentially induce an escalation in oil prices.
Geopolitical Events
The occurrence of political instability, armed conflicts, and geopolitical tensions in significant oil-producing areas has the potential to disrupt the supply chain and consequently lead to an escalation in prices. Following the incursion of Russia into Ukraine, a notable escalation in oil prices ensued, primarily attributable to the subsequent refusal of European nations to procure Russian oil, thereby causing significant disruptions in supply chains.
Please provide another example. Amidst the global COVID-19 pandemic, numerous economies across the globe experienced a considerable downturn, leading to a substantial reduction in travel activities among individuals. The demand experienced a significant decline, whereas the supply maintained a considerable level. The circumstances above precipitated a swift decrease in the value of crude oil.
Natural Disasters
The occurrence of natural disasters, such as hurricanes and earthquakes, has the potential to significantly disrupt the production and transportation of oil, consequently leading to an escalation in prices. Pipeline disruptions resulting from adverse weather conditions have the potential to impede the flow of oil supplies substantially. A disruption in supply refers to a situation where the collection of a particular product or resource experiences a decrease. The increase in demand for oil leads to a corresponding escalation in its price.
