How Are Oil Prices Determined?

Answer: Commodity traders are responsible for oil prices by bidding on oil futures
contracts. There are many factors they look at when developing the bids that create
oil prices:

• Current supply in terms of output, especially the production quota set

by OPEC.
• Oil reserves, including what is available in U.S. refineries and what is
stored at the Strategic Petroleum Reserves.
• Oil demand, particularly from the U.S. (as estimated by the Energy
Information Agency . During the summer, forecasts for travel from
AAA are used to determine potential gasoline use. During the winter,
weather forecasts are used to determine potential home heating oil use.

Of course, potential world crises in oil-producing countries can also dramatically

increase oil prices. This happened in July 2006 with the Israel-Lebanon war that
raised fears of a potential threat of war with Iran.

Price of petroleum

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This article is about the price of crude oil; see gasoline usage and pricing
for information about derivative motor fuels.
Brent barrel petroleum spot prices, May 1987 – Oct. 2008. The red dot indicates
the price as of 24 December 2008

Weekly reports on crude oil inventories or total stockpiles in storage facilities like
these tanks have a strong bearing on oil prices

The price of petroleum means the spot price of either WTI/Light Crude as traded
on the New York Mercantile Exchange (NYMEX) for delivery in Cushing,
Oklahoma, or of Brent as traded on the Intercontinental Exchange (ICE, into which
the International Petroleum Exchange has been incorporated) for delivery at
Sullom Voe. The price of a barrel of oil is highly dependent on both its grade,
determined by factors such as its specific gravity or API and its sulphur content,
and its location. The vast majority of oil is not traded on an exchange but on an
over-the-counter basis, typically with reference to a marker crude oil grade that is
typically quoted via pricing agencies such as Argus Media Ltd and Platts.[citation needed]
Other important benchmarks include Dubai, Tapis, and the OPEC basket. The
Energy Information Administration (EIA) uses the Imported Refiner Acquisition
Cost, the weighted average cost of all oil imported into the US, as its "world oil
price".
The demand for oil is highly dependent on global macroeconomic conditions.
Some economists[who?] say that high oil prices have a large negative impact on the
global growth. Others argue that the recent run-up in oil prices over the past few
years actually led to an acceleration in global growth: the huge surpluses built up
by oil exporting countries were recycled through sovereign wealth funds and the
banking system and (through the money multiplier) greatly increased investments
in emerging markets and helped hold down long-term U.S. interest rates.

The Organization of the Petroleum Exporting Countries (OPEC) was formed to

maintain the price of oil at a level most beneficial to its membership considered as
a whole, and is considered to be a cartel by some observers.[1]

Oil prices have witnessed a significant fall since July 2008, and have been trading
around US$40 a barrel on December 6, 2008. On December 24, 2008, oil prices
traded at US$35 a barrel. [2]

[edit] History

Main articles: 1967 Oil Embargo, 1973 oil crisis, 1979 energy crisis, 1980s
oil glut, and Oil price increase of 1990

Long-term oil prices, 1861-2007 (orange line adjusted for inflation, blue not
adjusted). The blue dot indicates the price as of 24 December 2008: 37.64 US$
[edit] Recent price history

Main article: 2000s energy crisis

Price for United States oil from 1999 to November 2008 in US$. Source:
eia.doe.gov

A recent low point was reached in January 1999 of $16 (all prices are in US$ per
barrel), after increased oil production from Iraq coincided with the Asian financial
crisis, which reduced demand. Prices then increased rapidly, more than doubling
by September 2000 to $35, then fell until the end of 2001 before steadily
increasing, reaching $40-50 by September 2004. [3] In October 2004 light crude
futures contracts on the NYMEX for November delivery exceeded $53 and for
December delivery exceeded $55. Crude oil prices surged to a record high above
$60 in June 2005, sustaining a rally built on strong demand for gasoline and diesel
and on concerns about refiners' ability to keep up. This trend continued into early
August 2005, as NYMEX crude oil futures contracts surged past $65 as consumers
kept up the demand for gasoline despite its high price. Crude oil futures peaked at
a close of over $77 in July 2006, and in December 2006 at about $63. That is just
about where they began the year 2006.[4] In September 2007, US crude (WTI)
crossed $80. Multiple factors caused this high price. OPEC announced an output
increase lower than expected.[5] US stocks fell lower than experts predicted[6],
changes in federal oil policies [7], and six pipelines were attacked by a leftist group
in Mexico. [8] In October 2007 US light crude rose above $90 for the first time, due
to a combination of tensions in eastern Turkey and the reducing strength of the US
dollar.[9]

On January 2, 2008, a single trade was made at $100[10], but the price did not stay
above $100 until late February.
Oil prices for Brent in US$ and Euro

Oil broke through $110 on March 12, 2008[11], $125 on May 9, 2008[12], $130 on
May 21, 2008 [13], $135 on May 22, 2008, $140 on June 26, 2008 and $145 on July
3, 2008[14]. On July 11, 2008, oil prices rose to a new record of $147.27 following
concern over recent Iranian missile tests[15].

However, oil prices declined by more than $20 over the next two weeks, settling
around $125 a barrel on July 24, 2008, [16]A strong contributor to this price decline
was the drop in demand for oil in the US. Miles driven there in a month were down
in March-May 2008 compared to 2007, with the 4% decline in May being the
largest drop in history. [17] Oil further dropped down to its lowest price in 3 months,
at around $112 a barrel, on August 11, 2008[18], and on September 15, oil price fell
below $100 for the first time in seven months.On October 11, oil fell as much as
8.89$, or 10.17%$ to 77.70 USD per barrel as global equities slide .[19] Oil traded
below $70 on October 16, 2008. On December 21, 2008, oil was trading at $33.87
a barrel, less than one fourth of the peak price reached four months earlier.

The price of oil, like the price of all commodities, is subject to major swings over
time, particularly tied to the overall business cycle. When demand for a commodity
like oil exceeds production capacity, the price will rise quite sharply because both
demand and supply are fairly inelastic in the short run. Users of oil might be
shocked by much higher prices, but they have commitments and habits that
determine their energy use, and these take time to adjust. On the supply side,
especially at the outer edge of existing production capacity, adding new capacity is
time-consuming and expensive. Over time, however, both businesses and
individuals figure out ways to cut back their oil consumption in response to high
prices, and the high prices promote new investment in production and the arrival of
new sources in the market, gradually restoring a supply-demand balance. The
extraordinary spike in prices in mid-2008 represents to a large extent the
consequences of a brief period where global oil demand outran supply. When
supply exceeds demand, on the other hand, microeconomic theory says the price
should collapse to the marginal cost of production of the most expensive source.
As the price drops, the most expensive wells become uneconomical and are shut
down, at least temporarily. Price equilibrium is reached somewhere near the
production cost of the most expensive source needed to meet global demand. The
swing from what the market will bear in the first days of shortage to the marginal
cost of the last well in times of surplus can be huge. Most commodity prices
(metals, grains, even manufactured commodities like NAND flash memory) are
subject to similar large swings over time.

As global oil production begins to decline (after "peak oil"), the medium-term
volatility of oil prices is likely to be higher than before, because the range of
production costs among all sources supplying the market will much greater. Major
oil fields exist where the cost of production is comfortably below US$10 per
barrel, and these were adequate to supply all global demand for many years. A
large portion of the world's supply still comes from such inexpensive sources.
Future shortages and high prices, however, will spur the development of oil
sources with production costs of $50, $70, even $100 per barrel, including deep
water sites, tar sands, oil shale, and secondary recovery from depleted fields. In the
language of microeconomic theory, the supply curve will be much steeper than in
past years. Shifts in demand, either up or down, will cause relatively larger swings
in market price.

[edit] Market listings

Main article: Commodities markets

Oil is marketed among other products in commodities markets. See above for
details. Widely traded oil futures, and related natural gas futures, include:[20]

• PETROLEUM
o Nymex Crude Future
o Dated Brent Spot
o WTI Cushing Spot
o Nymex Heating Oil Future
o Nymex RBOB Gasoline Future
• NATURAL GAS
o Nymex Henry Hub Future
o Henry Hub Spot
 o New York City Gate Spot

[edit] Speculation

The surge in oil prices in the past several years has led some experts to argue that
at least some of the rise is due to speculation in the futures markets.[21][22] This has
led to an investigation, which reached an interim conclusion that speculation was
largely not responsible for the rise. Economist James K. Galbraith believes that
much of the rise is due to the "Enron loophole" drafted in a rider by former Texas
senator Phil Gramm, which allowed energy futures to avoid Commodity Futures
Trading Commission oversight. Galbraith cites Masters, a hedge fund manager,
who observes that index speculation tied to commodities by pension funds and
other investment vehicles has risen from $13 billion in 2003 to $250 billion in
2008. Galbraith observes that with Goldman Sachs predicting a rise in the price to
$200 and Gazprom $250, suppliers may react to the rise by restricting supply until
they can sell their product at a higher price.[23]

[edit] Futures investigation

The U.S. Commodity Futures Trading Commission (CFTC) announced "Multiple

Energy Market Initiatives" on May 29, 2008. Part 1 is "Expanded International
Surveillance Information for Crude Oil Trading." The CFTC announcement stated
it has joined with the United Kingdom Financial Services Authority and ICE
Futures Europe in order to expand surveillance and information sharing of various
futures contracts.[24] This announcement has received wide coverage in the
financial press, with speculation about oil futures price manipulation.[25] [26] [27]

The interim report by the Interagency Task Force, released in July, found that
speculation had not caused significant changes in oil prices and that fundamental
supply and demand factors provide the best explanation for the crude oil price
increases. The report found that the primary reason for the price increases was that
the world economy had expanded at its fastest pace in decades, resulting in
substantial increases in the demand for oil, while the oil production grew
sluggishly, compounded by production shortfalls in oil-exporting countries. The
report stated that as a result of the imbalance and low price elasticity, very large
price increases occurred as the market attempted to balance scarce supply against
growing demand, particularly in the last three years. The report forecast that this
imbalance would persist in the future, leading to continued upward pressure on oil
prices, and that large or rapid movements in oil prices are likely to occur even in
the absence of activity by speculators. The task force was continuing to analyze
commodity markets and intended to issue further findings later in the year.

[edit] Oil price and stock market

Even though stock market fluctiations are sometimes attributed to oil price
changes, no significant short-term (daily or weekly) correlation between the two
have been found [28][29] if the data is taken for a sufficiently long pe