What Makes Oil Prices So High
Oil prices are rising because OPEC agreed to extend production cuts through 2018. On November 30, 2016, the organization first agreed to cut production by 1.2 million barrels per day (mbpd) starting January 2017. In response, traders bid $65 a barrel, a 30-month high.
OPEC has been battling U.S. shale oil producers for market share. Shale producers pushed U.S. oil production to 9.4 million mbpd in 2015. That knocked OPEC market share to 41.8 percent in 2014 from 44.5 percent in 2012. This increased supply caused oil prices to fall. That created a boom and bust in the U.S. shale oil industry.
OPEC doesn't want prices too high, or for alternative fuel sources to start to look good again. OPEC's target price for oil is $70-$80 a barrel. But U.S. shale producers need $40-$50 a barrel to pay the high-yield bonds they used for financing. Until 2016, OPEC accepted the lower price to maintain market share.
Normally, oil and gas prices can be forecast by a predictable seasonal swing. They rise in the spring and fall in autumn. That's because futures traders anticipate increased demand for the summer vacation driving season. Even though heating oil use rises in the winter, it's not enough to offset the post-vacation drop in gasoline demand.
Another factor that determines oil prices is a dollar decline. Most oil contracts around the world are traded in dollars. As a result, oil-exporting countries usually peg their currency to the dollar. When the dollar declines, so do their oil revenues, but their costs go up. Therefore, OPEC must raise the price of oil to maintain its profit margins and keep costs of imported goods constant.
Comparison to Past Oil Price Hikes
2015 - Snapback from a 40 Percent Decline in the Prior Year
By 2015, U.S. shale oil production fell in response to lower prices. As Josh Mitchell reported in the Wall Street Journal, the number of drilling rigs declined 44 percent in the first quarter.
U.S. oil prices (West Texas Intermediate) had fallen 40 percent from $106/barrel in June 2014 to $59/barrel in December. That was in response to higher supply. At the same time, forex traders drove up the value of the dollar by 15 percent in 2014. Since oil is priced in dollars, this insulated OPEC and other foreign producers from much of the oil price decline. That's why Saudi Arabia went after market share instead of cutting production and raising prices.
2013. In late August 2013, prices for October delivery of Brent crude oil rose to $115.59/barrel, the highest in six months. Prices for West Texas Intermediate crude rose to $109.98/barrel, a two-year high. Traders bid up prices after the United States announced it would use airstrikes to punish Syria's President Assad for using chemical weapons to kill hundreds of civilians.
Syria isn’t a major oil supplier, but traders worried about the possible implications of the strikes. These include disruption of oil from Iran, Syria's principal ally, turmoil in Iraq, and further disruptions in Egypt.
On July 18, 2013, oil prices hit $109.71/barrel for Brent crude oil. The catalyst was the removal of Egypt's President Morsi from office. Commodities traders worried, without reason, that Egypt would close the Suez Canal if unrest spread.
In January 2013, oil prices rose when Iran played war games near the Straits of Hormuz. Traders saw that as a potential threat to this strategic shipping lane. By February 8, oil had reached $118.90/barrel. That sent gas prices to $3.85 a gallon by February 25.
2012. Oil prices started rising much sooner in 2012 than they did in 2011. The price for WTI crude oil broke above $100/barrel February 13, 2012, two weeks earlier than in 2011. Rising oil prices drove gas prices above $3.50 a gallon that same week. Gas prices had already breached $3.50 a gallon on the east and west coasts in January.
By March, Brent crude oil peaked at $125/barrel. It settled to $95/barrel in June, but rose to $113.36 by August. Normally, oil prices drop in the fall and winter. But this year, commodities futures traders were bidding up oil prices to offset the Fed's expansive monetary policy. They were betting the dollar would drop and drive up oil prices. They were wrong about the dollar, but oil prices rose despite lower demand.
2011. Crude oil prices reached a high of $113.93 April 29, 2011. Prices had been increasing steadily since February 2009, when they dropped to $39/barrel. They hovered at a comfortable $70-$80 a barrel until late 2010. High oil prices translate to high gas prices. Petroleum is also an ingredient in fertilizer. This, combined with higher transportation costs, increases food prices. The forces driving high oil prices were similar to what happened when oil hit an all-time high in 2008.
2008. Oil prices hit an all-time high of $143.68/barrel in July 2008, after skyrocketing 25 percent in three months. This drove gas prices to $4.17 a gallon. Most news sources blamed surging demand from China and India, combined with decreasing supply from Nigeria and Iraq oil fields.
But the recession was the real cause. Global demand in 2008 was actually down and global supply was up. Oil consumption decreased from 86.66 million barrels per day (bpd) in the fourth quarter of 2007 to 85.73 million bpd in the first quarter of 2008. At the same time, supply increased from 85.49 to 86.17 million bpd. According to the law of demand, prices should have decreased. Instead, they increased almost 25 percent, from $87.79 to $110.21 a barrel.
The EIA pinned part of the blame on volatility in Venezuela and Nigeria and an increase of demand from China. It also questioned whether an influx of investment money into commodities markets could have affected prices. Investors were stampeding out of the falling real estate and stock markets. They diverted their funds to oil futures instead. This sudden surge drove up oil prices.
This asset bubble soon spread to other commodities. Investor funds swamped wheat, gold, and other related futures markets. It spiked food prices around the world. That created starvation and food riots in developing countries.