What determines the oil price? Part I

By | October 20, 2021

The oil price is important for the Norwegian petroleum industry, central government revenues, the size of the Petroleum Fund (Government Pension Fund Global) and thus for the Norwegian economy and its inhabitants in general. Internationally, oil is an important input factor in most countries’ economic activities and is the single commodity in international trade with the largest turnover.

  • Why can the oil price vary greatly?
  • What and who affects the oil price?
  • What are the major oil exporting countries?
  • What does the oil price mean for different countries?

The price of oil is of great importance for economic development in and income distribution between oil-importing and oil-exporting countries. Industrialized societies, both in Western and in “new” countries in the world economy such as China, according to THEMEPARKTOUR, have largely based their economic development on imports of oil (and gas) from countries under other skies and with other political systems, especially the Middle East. Similarly, most oil-exporting countries (more than Norway ) are in part very dependent on the income from oil exports as a basis for their welfare and ability to govern.

When the oil price rises, it leads to large income transfers from importing countries to exporting countries – and vice versa when it falls. This means that strong industrial and political interests at all levels are linked to the oil market and the oil price. The oil market thus also defines much of the geopolitical situation of oil-producing countries, especially in the Middle East where large parts of the conventional (see facts) oil reserves are located.

2: Three different time horizons

It often takes a long time between events and decisions concerning production and consumption conditions. When, for example, an oil field has been found, development must be planned and then carried out before production enters the market. In the North Sea, the time lag can typically be 5-10 years.

Similarly, consumers who perceive the price of petrol as too high will often want a car that uses less petrol . The car manufacturers then register that the market for cars with lower petrol consumption is increasing. Therefore, they are starting to make more fuel efficient cars and cars that run on other energy (such as electricity). However, it takes many years before smaller oil-dependent cars are on the market and before consumers can afford to buy a new car to an extent that means something to the market balance.

Similarly, it takes a long time to develop commercially viable renewable energy carriers after the first technology has been found. We will separate the analysis of the oil market in the short, medium and long term.

  • In the oil market, “short term” means a few days, weeks, months and maybe a whole year. In this perspective, the price is greatly influenced by individual events and market participants – brokers, buyers and sellers – and their expectations of what these events may lead to. These may be acts of war and political events in oil-producing countries (especially around the Persian Gulf), changes in inventories (oil stocks) in consumer countries , economic developments on world stock exchanges, decisions in the Organization of the Petroleum Exporting Countries (OPEC), rumors and new information from the International Energy Agency (IEA), currency turmoil, extreme weather such as extreme cold or heat, etc. When such factors change significantly, expectations of the supply and demand balance also change. Then the oil price also changes immediately, sometimes quite dramatically. This often results in large, short-term fluctuations in the price.
  • In the “medium term”(approx. 2–10 years), more basic supply and demand conditions are most important. These reflect what is and is assumed to be the market balance (cf. supply and demand) based on major trends in production and consumption data. After China entered the world economy fully (became a member of the World Trade Organization (WTO) in 2003), it led to strong production and export growth in the country. The high growth led to a sharp increase in demand for energy , including oil, in China (tight oil market). Thus, the oil price rose until 2014 (with a short-term break just after the financial crisis in 2008). Another example is shale oil production in the USA, which accelerated from 2008, and which after a few years contributed greatly to an imbalance between supply and demand (weaker market) and thus a fall in oil prices in 2014.
  • In the «long term»(10–30 years or more), there is disagreement as to whether the trend is towards falling or rising oil prices. Crude oil is a limited, non-renewable resource ; many believe this must lead to scarcity as global demand rises, and thus to ever higher oil prices. However, competing energy production (such as gas, nuclear power, solar and wind) and energy efficiency (better transmission lines and less energy consumption per unit of GDP) set limits for how much oil demand and price will be able to grow. Large growth in shale oil production and in many forms of renewable energy are also increasingly competitors to conventional oil production. Better geological knowledge and technological change will also increase the supply of oil. Technological innovation on the demand side makes energy consumption more efficient; then we can achieve the same as before with the use of less energy. An average car used around one liter of petrol per mile 20 years ago, while large parts of the car fleet now use only 0.3–0.4 liters per mile. The emergence of alternative energy carriers means that there are limits to how high oil prices can remain over time.

What determines the oil price 1