Do you hear someone talking about oil prices these days? As soon as someone starts the topic of oil prices, people become curious and they want to participate in the discussion about why oil price is moving up or down. Analysts at Goldman Sachs & such combined together can decide the fate of a company stock by just talking about oil prices. Okay its not that bad but you see my point, right? Alright, let me start my oil price discussion now 
So once again we saw oil getting more expensive last week to reach above 77 dollars a barrel. In last 18-24 months we have seen oil prices vary from $ 150 dollars a barrel to $35 dollars a barrel. To a common man all that is a black box which somehow predicts oil prices to be in certain way. I decided to do some research and the first question that I had in my mind was: “So what is true price of one barrel of oil”. Is oil really black gold or is it made into precious commodity by cartels of oil producing countries like OPEC? Now thats very intriguing for me and some people I usually discuss such matters with.
The above two graphs show us the variation of oil prices over the past several years. The graphs also indicate pattern on how much sensitive oil prices have become to small changes around the world. Lets go ahead and try to make a list of major factors that determine these prices:
- US crude oil inventory levels: We all know that most of the crude oil that US uses gets imported from other countries which are rich in oil. To prevent the nation from going without oil, the governments has invested in building and maintaining about three months worth of reserve capacity of oil. That means if these OPEC countries decide to not export oil to US for whatever reason for a short period of time, the country can survive on just the reserves for three months! Also US is the largest consumer of oil in the entire world. Whenever the reserve capacity falls down in US for any reason (such as cold winter or heavy travel), the demand for oil goes up and that pushes the oil prices to end up higher.
- Instability in Middle East. Middle East still currently supplies 80% of world oil. The only other big supplier outside of Middle East are Russia and Venezuela which are not our best friends. The Middle east countries have been facing political difficulties in forming stable democratic governments. So whenever there is power struggle in these countries, investors get concerned about the supply of oil and start selling their holdings which push the prices up.
- Influence of Cartel (OPEC): Many of the OPEC countries have their entire economy based on high oil prices. Therefore for market manipulation at times they reduce the supply of crude oil by reducing production and that again increases the cost of a barrel of oil.
- Recession: In a recession people reduce the amount they spent on travelling . Travelling industry is one of the biggest consumer of oil. Therefore in a recession demand for oil reduces. That in turn brings the prices down for oil in the market.
- Speculations: Similar to MBS many investment bankers have created complex products around the crude oil prices. There are many double and triple indexed funds which are based on the price of oil. If uncertainty is high these products amplify the impacts on the actual prices and prices go up and down much more faster. You will be surprised to know how big of a role speculations play on the actual price of oil to consumers.
Now that we know what affects the oil prices in the open market, lets take a moment to understand the true cost of extracting oil. Question that we will have to answer is whether it is going up or down. Well the answer is that it depends on region to region. In Middle East countries it still costs less than $10 per barrel to get oil out of the ground. However as more and more countries are trying to become self reliant on oil and therefore doing deep sea drilling, the average cost of oil increases to almost $50 per barrel.
The prices of manufacturing the oil has been consistent because of the fact that as supply goes up, companies like Sclumberger come up with more efficient technologies like horizontal drilling. That reduces the overhead needed to produce oil for such companies and hence helps them remain competitive.
So to conclude my thought process, for a stable economy it is essential for us to maintain our reliance on foreign oil as low as possible. We should be more conservative in the ways we are using our resources and try to invest in finding alternative sources of energy. Someone once said to me if we had invested the money we spent in Iraq war into the alternative energy source R&D, we would have probably become totally independent in that regard by now.
Tags: Oil Investment, Oil Prices today
I am glad I am not young anymore. Because I do not want to see what happens when our fossile fuel oil is all gone. No matter how much we drill. At the rate we are using it up. It will all be gone. Your car you have today will only make for a good planter in your yard. No one believes it will happen. Fossile fuels will run dry.
Med Guy,
That is exactly why alternative energy related companies are going to explode, but remember to look at their business model and the people who are involved in execution.