Learn about the factors that influence crude oil prices.
There are a multitude of factors that influence crude oil prices, and experts do not always agree on the precise role each factor plays in driving price up or down. The laws of supply and demand, however, are well established and irrefutable, and when demand is high, prices increase, as well. Crude oil is the raw ingredient in gasoline; according to the U.S. Department of Energy, as of March 2009, the cost of crude oil accounts for 55 percent of the per-gallon price of gasoline.
Due to its heavy dependence on cars, the United States uses roughly 25 percent of the world's oil supply, which translates to 20 million barrels a day (each barrel contains 42 U.S. gallons of oil). Investopedia, a Forbes Digital Company, reports that the European Union's consumption comes in second at 14.5 million barrels each day. At present, the third largest consumer of oil is China, and its demand is growing exponentially at an estimated 7.5 percent each year. That, combined with expanding markets in India, Russia and Brazil, means that demand for crude oil will likely grow steadily over the long term.
It is cheaper to draw oil from some geographic locations than it is from others, and this affects production costs. The Energy Information Administration reports that in 2007, it cost an average of $3.87 a barrel to lift oil from Central America; in Canada, it cost roughly $10. In addition, there are costs associated with developing new oil fields. Middle Eastern nations, for instance, spent less than $5 per barrel to find new oil sources, while companies in the United States spent almost 10 times that amount exploring offshore options deep in the Gulf of Mexico.
Though finding and lifting costs have a predictable impact on the price of oil, any type of disruption in production and distribution can also have an effect. Events that tend to drive up crude oil prices include:
• Armed conflicts that make it difficult to drill in an oil-producing area
• Hurricanes that damage oil rigs or port facilities
• Regularly scheduled oil rig maintenance
• Lost or damaged oil tankers
• Political embargoes, such as the 1967 Oil Embargo
• Labor strikes, such as the one that led to the Venezuelan Oil Crisis of 2002
Founded in 1960, the Organization of the Petroleum Exporting Countries (OPEC) has a stated objective of coordinating production policies amongst members, stabilizing oil supplies and prices, and ensuring that petroleum industry investors get a good return on their money. OPEC currently consists of 12 oil-producing nations, including Saudi Arabia, which has the world's largest oil supply. To increase the price of crude oil, OPEC can decrease the number of barrels it sells to the world market. Conversely, if high oil prices drive down demand, OPEC can coordinate increased production to decrease the price per barrel.
According to the International Monetary Fund, (IMF) OPEC nations produce a combined 40 percent of the world's oil and hold 70 percent of known crude reserves. The United States and Canada are also big oil-producing nations -- in fact, Canada is the world's second-largest oil producer -- but both countries have a lesser ability than OPEC nations to impact price. This is due to their comparatively limited reserves and the fact that both countries generally produce near capacity. Therefore, Canada cannot simply decide to slow or increase production to drive oil prices one way or the other.
However, when demand for oil is high, OPEC also has a limited ability to control price. In 2005, when oil consumption was rapidly growing, OPEC was producing at near-record capacity. The organization had no way to bring prices down, and the increasing value of oil reflected an increase in demand spurred by growth in markets like China and India.
Supply and demand is just one part of the equation; market sentiment also affects the price of crude oil. In this case, market sentiment is expressed by the value of an oil futures contract, a binding agreement that grants the holder the right to purchase a barrel of oil at a predetermined price at a set time in the future. Commodity futures, including oil futures, are traded through platforms like the Chicago Mercantile Exchange, which allows investors worldwide to speculate on the likely demand for oil.
Occasionally, companies invest in oil futures to hedge against the rising cost of oil. Airlines, for instance, have been known to purchase oil futures to offset their expanding fuel budget. However, a vast majority of oil futures investors are speculators. Opinions vary as to how much speculation actually impacts the cost of oil. Some experts claim that rising oil futures become a self-fulfilling prophesy -- if enough investors have a hunch that the price of oil will rise, oil futures increase and drive up price in the short term. The IMF concludes the opposite - speculation has little impact on spot prices but can drive up longer-dated futures.