What Makes Oil Prices So High
The Four Factors That Drive Up Oil Prices
High oil prices are caused by high demand, low supply, OPEC quotas, or a drop in the dollar's value.
Demand for oil and gas typically follow a predictable seasonal swing. Demand rises in the spring and summer due to increased driving for summer vacations. Demand drops in the autumn and winter. Even though heating oil use rises in the winter, it's not enough to offset the post-vacation drop in gasoline demand.
Low supply occurs when war or natural disasters curtail exports from oil-producing countries. Traders often bid up prices when they hear of impending disasters or the threat of war. Oil prices decline once production resumes.
The third factor is when OPEC members reduce their output. That's what caused high oil prices in 2017 and 2018. On November 30, 2016, the organization first agreed to cut production by 1.2 million barrels per day starting January 2017. It agreed to extend production cuts through 2018.
OPEC has been battling U.S. shale oil producers for market share. Shale producers pushed U.S. oil production to 9.4 million barrels per day in 2015. That knocked OPEC market share to 41.8% in 2014 from 44.5% in 2012. The supply bump caused oil prices to fall. That created a boom and bust in the U.S. shale oil industry.
OPEC doesn't want prices to be too high or for alternative fuel sources to start to look good again. OPEC members are generally looking for a target price for oil of $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.
The fourth 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 peg their currency to the dollar. When the dollar declines, so do their oil revenues, but their costs go up. A drop in the dollar's value forces OPEC to cut production. It must raise the price of oil to maintain its profit margins and keep costs of imported goods constant.
Comparison to Past Oil Price Hikes
Oil prices notably spiked five times in the past decade. Most recently, prices skyrocketed in 2015, 2013, 2012, 2011, and 2008.
By 2015, U.S. shale oil production fell in response to lower prices. U.S. oil prices, as based on the benchmark West Texas Intermediate grade of crude, had fallen over 40% from $105/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% 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.
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 $109.01/barrel, the highest in 18 months. 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 $3.78 a gallon by February 25.
Oil prices started rising much sooner in 2012 than they did in 2011. The price for WTI crude oil broke above $100/barrel on Feb. 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 $128.14/barrel. It settled to around $90/barrel in the third week of June but rose to $117.45 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 Federal Reserve'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.
Crude oil prices reached a high of $113.93/barrel on April 29. 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.
Oil prices hit an all-time high of $145.31/barrel in July 2008, after skyrocketing 25% in three months.
This drove gas prices to $4.11 a gallon. The recession was the real cause. Global demand in 2008 was actually down and global supply was up. Oil consumption decreased from 88.42 million barrels per day in the fourth quarter of 2007 to 87.94 million bpd in the first quarter of 2008. At the same time, supply increased from 86.18 to 86.60 million bpd. According to the law of demand, prices should have decreased. Instead, they increased by almost 20%, from $80.31 a barrel for WTI crude on October 1, 2007, to $101.54 on March 31, 2008.
The Energy Information Administration 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.
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