Ollie Barell's Market News  

What causes prices to fluctuate?

Historically:

Up until the late 1970's the availability of crude oil supplies was limited to a few countries, making such countries extremely powerful in the world energy stakes. One only needs to remember the effects of oil embargoes to realise the power that producers had over consumers. Since the 1970's alternative sources of crude oil supply have been developed and now countries like Canada, Mexico, and Russia are major players in the world petroleum markets. Although the Middle East countries still provide a tremendous amount of crude oil into the world market, they no longer have the ability to shut off the world's supply causing volatile price spikes. With the increase in the number of countries supplying into the world market different factors have become important to the market as a whole. We will consider some of these below.

Political or military conflict in an oil producing region:

Conflicts in oil producing regions often have dramatic effects on oil prices although they are commonly short term. During the Gulf war in 1990 prices only increased modestly and supplies remained available throughout the conflict.

Increased global demand:

The increase in global demand for oil, particularly from the emerging Third World countries, has put extra burden on the world market. This increase has been relatively steady and predictable, and has to a large degree been offset by the increase in global crude oil production, as well as increased refinery capacity.  

Weather:

For some petroleum products demand is dictated by the weather. Heating oil is probably the most weather sensitive oil product, and the price is most likely to low when demand is low, and more expensive when demand is high. Thus in simple terms an exceptionally cold winter will force heating oil prices higher than a mild one. Petrol and diesel fuel are also seasonal, with the greatest demand coming for such in the summer months.

Production and shipping disruptions:

One common cause of price volatility over the last decade has been problems with refineries, or problems with ships transporting products. A fire or shut down of a key refinery can immediately take thousands of barrels of finished product out of a market place. If this occurs the price will spike upwards, however the effect is usually only short term and negated as soon as the disruption is overcome.

"Just in time" stock management:

This factor is perhaps the key to the oil price volatility experienced over the past three years. Just in time stock management is a business philosophy that has been adopted in the manufacturing industry and maintains that a minimum amount of stock should be kept to reduce the cost of holding that stock, and to protect against downside price fluctuations for that stock. Over the last decade the number of tanks available to hold stock has steadily reduced, as has the amount of stock held in those tanks. Whereas previously an oil company may have had a buffer stock sufficient to cover ten days requirements, the same company is now more likely to only have one days worth of stock. The buffer is now far smaller and insufficient to cover an unpredicted surge in demand. Should such a surge occur it will be met with an equal surge in price with deliveries only going to those consumers who are willing to pay the market price for the fuel.

Commodities Exchange

One of the most overwhelming changes to take place in the oil markets is the globalisation of the trade in oil and oil products, by the use of the world commodities exchange. Commodities such as crude oil, timber, and precious metals etc are bought and sold on several key global commodities exchanges, such as Nymex, London, and Tokyo. The very nature of the commodities exchange provides a new level of volatility due to the fact that the majority of all transactions that take place are not for physical product, but for the contract to purchase such a product. In other words most sales are actually paper exchanges rather than product exchanges.

This exchange of paper rather than the physical goods facilitates the rapid movement of transactions for a given market, and with this ability to move quickly market change and volatility are increased dramatically. Talk of a political uprising in an oil producing area causes immediate price increasing effects on the commodities exchange. Likewise word of over supply can cause rapid price reductions.