3 Critical Factors that Determine Oil Prices

Forex traders have learned that oil prices have a profound effect on the values of currencies, with rising oil prices helping certain countries (such as Canada and its CAD) and falling oil prices leading to these currencies losing value.  Smart Forex traders understand that keeping an eye on oil prices can be helpful to spot trends in the market as early as possible, and to that end, they watch oil prices for changes that could have an effect on the currencies they trade.

To better understand how these oil prices are determined in the first place, this article will take a look at the three main factors considered by commodities traders when they develop the bids that create oil prices:

3 Factors Commodities Traders Use To Set Oil Prices

#1 – Current supply in terms of output. For many years the current supply of world oil was controlled by the Organization of the Petroleum Exporting Countries (aka “OPEC”) and its production quotas. However, when U.S. shale oil production doubled between 2011 and 2014, an oil glut was created, and the price of oil fell as low as $45/barrel in 2014.

Prices fell again in December 2015 to a low of $36.87 a barrel, and typically OPEC would have cut supply to keep oil at OPEC’s target of $70 a barrel, but it instead allowed prices to fall, knowing that money would still be made as long as oil remained above $20 a barrel.

Unfortunately for the new shale oil producers, they required a price of at least $40-$50 a barrel to stay financially solvent, and OPEC saw this as a way to remove their new shale oil competitors.

OPEC bet correctly that the shale oil producers would go out of business, allowing OPEC to keep its dominant market share, which began to happen in 2016.

#2 –  Access to Future Oil Supply. Along with the current oil supply, investors in oil keep an eye on oil reserves, which include what’s available in U.S. refineries as well as in the Strategic Petroleum Reserves, an emergency fuel storage of petroleum maintained underground in Louisiana and Texas by the United States Department of Energy. (This is the largest emergency supply in the world, with the capacity to hold up to 727 million barrels.)

These reserves can be accessed very easily, increasing oil supply if prices get too high. Saudi Arabia can also tap into its large reserve capacity.  For investors, the existence of these oil reserves serves as a balance to low demand and subsequent rising prices.

#3 –  Demand for Oil. Ultimately, and unsurprisingly, the world’s demand for oil — particularly from the United States — is a huge factor that influences prices. Each month, the Energy Information Agency provides estimates for the demand for oil. In general, demand usually rises during the summer vacation driving season beginning with Memorial Day, and to predict this summer-time demand, forecasts for travel from AAA (the American Automobile Association) are used to determine potential gasoline use. During the winter, the Energy Information Agency uses weather forecasts to determine the potential use of home heating oil.

One other factor that is impossible to predict, but absolutely has an impact on oil prices, are unforeseen crises in oil-producing countries. These potential world crises often dramatically increase prices, especially when traders worry that a crisis will limit the supply of oil.

One example of a crisis like this happened in January 2012 after inspectors found proof that Iran was closer to building nuclear weapons capabilities, after which the United States and the European Union began financial sanctions.

Iran threatened to close the Straits of Hormuz, and the U.S. responded with a promise to reopen the Strait with military force if necessary. The possibility of an Israeli strike was also a concern.

As a result, oil prices bounced around $95-$100 a barrel from November through January, anc then by February, oil broke above $100 a barrel and stayed there. You probably remember that gas prices in the U.S. also went to $3.50 a gallon, with forecasts saying that gas would be at least $4.00 a gallon through the summer driving season.

Along with these factors, oil traders also watch out for natural disasters and other events that could prevent the production of oil. As a Forex trader, you should take the time to learn more about oil prices and how they are set so you may be able to profit from trends that result from this important commodity.