Oil prices have a significant impact on share markets. We have recently seen oil prices plummeting with US oil prices turning negative. This unbelievable situation has led to global share markets to fall as well. In this article we discuss what can influence the price of oil.
OPEC stands for Organization of Petroleum Exporting Countries. It is a cartel which consist of 12 oil-producing countries. They include Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Qatar, Indonesia, Libya, The United Arab Emirates, Algeria, Nigeria, Ecuador, Gabon, Angola, and Equatorial Guinea. OPEC is a permanent intergovernmental organisation which is headquartered in Vienna, Austria.
The organisation controls 78 percent of the world’s oil exports. As these OPEC nations produce such a significant portion of the world’s oil supply, they can manipulate the price per barrel. They do this by controlling the barrels per day that they sell on the market. OPEC decides when they want to increase or decrease production.
Why was OPEC formed?
OPEC was formed in 1960 to prevent the world’s largest oil producers from lowering the price of oil. Once one country reduces their oil price, other countries would do so to compete in the international market. This would lead to a depletion of oil reserves at a more rapid rate. If prices drop below OPEC target prices then countries will restrict their supply so prices can push higher.
2.Demand or Supply
Like anything that is traded, the price is determined by supply and demand. Too much supply means the price decreases and too much demand means the price increases. Demand and supply can fluctuate due to economic issues, natural disasters and political issues. Economic issues can cause the demand for oil to decrease. The recent COVID-19 pandemic has caused economic growth to slow globally and this has impacted the price of oil. The lockdown of many countries has decreased the demand for oil. However, oil suppliers are still extracting oil. This has caused an oversupply and therefore a decrease in oil prices. Natural disaster can affect the oil price as transportation of oil may be blocked. This means oil providers may not be able to receive new shipments so they increase oil prices in the meantime. Political issues can also impact the transportation of oil which will then have implications to the oil price.
3.Oil future contracts
The price of oil change is also impacted by the trading activity on oil futures market. Future contracts are agreements made between two parties to buy oil at a predetermine price in the future. There are two types of traders in oil futures market. One group are companies that use oil and need some certainty in the oil price so they can organise their financial obligations and the second group are speculators who are people who are trading just to make a profit.
Why have oil prices gone negative?
As discussed above, COVID-19 has caused demand for oil to decrease significantly. Oil companies have all this supply of oil and they need storage space to place this unsold oil. Storage facilities are drying up so oil companies are paying people to take the oil. The main reason for this is it is cheaper for them to sell oil at a loss than to stop producing oil and shut down wells.
Lauren Hua is a private client adviser at Fairmont Equities.
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