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Why Do Oil Prices Rise and Fall?

Oil prices are always changing. Consumers do not always know what to expect when they pull up to the gas pump to fuel their vehicles or when they need to order heating oil for their homes. For example, during the winter season of 2008, the price of heating oil hovered between $3 and $4 a gallon. In 2016, heating oil prices were closer to $2 a gallon during the winter months. With prices constantly fluctuating, it can be a challenge to make financial plans.

Despite oil price fluctuations, oil is an important part of our lives. Although we only consume a small amount of crude oil in the United States every day, petroleum products like gasoline and heating oil keep the country running. In 2017, the United States consumed about 19 million barrels of petroleum products each day, or about seven billion barrels a year.

All Americans are affected by oil in one way or the other, yet many do not understand how oil prices change. The economics of oil prices is a complex subject because many different factors contribute to price fluctuations. In this post, we'll explore the top oil price factors to provide a clear understanding of how the pricing process works. With greater knowledge of oil price information, you'll feel more in control when it's time to make an oil purchase.

What Affects Oil Prices?

Oil is a commodity, meaning it is a raw material that can be bought and sold. Examples of commodities include oil, corn and gold. Commodities are commonly sold through legal agreements known as futures contracts.

Buyers purchase futures contracts to lock in prices when they are low. This way, they save themselves from the possibility of higher prices in the future. Sellers of commodities, like farmers, benefit from futures contracts because it removes the risk of price fluctuations for them as well. Commodities must meet uniform standards. For example, if a buyer purchases corn, they will receive the same quality of corn no matter who produces the corn.

In general, commodities are products we need. Imagine how life would be without oil, for example. How would you get to work on time or run your business? Because we need commodities, we are willing to pay for them even when their prices go up. Here are common reasons oil prices rise and fall, so you know what to expect when the seasons change or if tension builds between major oil-producing countries.

Why Do Oil Prices Rise and Fall?

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1. Organization of Petroleum Exporting Countries

The Organization of Petroleum Exporting Countries (OPEC) influences oil price fluctuations more than any other factor on this list. The organization is made up of 15 member countries, which are:

  • Congo
  • Angola
  • Ecuador
  • Kuwait
  • Equatorial Guinea
  • Algeria
  • Iran
  • Nigeria
  • Saudi Arabia
  • Libya
  • Qatar
  • United Arab Emirates
  • Venezuela
  • Iraq
  • Gabon

OPEC's mission is to provide stability within the oil market by establishing uniform policies, regularly supplying petroleum to consumers and ensuring producers receive a fair income. In short, OPEC helps bring order to the oil market. OPEC was formed by five oil-producing countries in the 1960s.

According to 2016 estimates, 81.5% of the world's crude oil reserves are located in OPEC countries. OPEC does not decide how much oil costs but can influence prices by controlling oil production. They aim to set production to meet global demand, but if they increase or decrease oil production levels, they can affect the price of oil. Generally, when production goes down, prices go up.

Saudi Arabia is OPEC's largest oil producer and the world's largest oil exporter. OPEC makes decisions based on current supply and demand and also considers future expectations.

2. Supply and Demand

The law of supply and demand is a basic rule in oil economics and a major factor when it comes to price. Demand refers to the amount of a product consumers want and are willing to pay for. Supply refers to how much of a product is available. The relationship between supply and demand affects all commodity prices, including oil. Here are a few examples of how supply and demand work:

  • High supply and low demand equals low prices: When the supply of a product increases, the price goes down. When the price goes down, the demand goes up because consumers want to pay a lower price. For example, if a farmer grows more corn than he can sell, he will lower the price to try to get rid of the excess. Once customers realize they can purchase corn at a very low price, they will demand more of it.
  • Low supply and high demand equals high prices: When there is too much demand for a product, the supply will run low. When there is not enough of a product to meet the demand, prices increase. When prices increase, the demand eventually decreases because people do not want to pay high prices for the product. Prices will fall once demand goes down. For example, if hundreds of customers all want to purchase the same toy as a holiday gift and there are not many toys available, prices will go up. Once customers no longer want to pay such a high price, the price will decrease.
  • Equilibrium as the goal: When equilibrium is reached, the amount of available supplies equals the demand. For example, if a balance is reached between the supply and demand of oil, customers can expect stable gas prices.

Buyers and sellers use the rule of supply and demand to predict how prices might change in the future. For example, if oil prices drop in the winter, buyers might predict a price boost in the summer when people need gasoline to travel. They might buy a futures contract to eliminate the risk of future price changes resulting from supply and demand.

3. Futures and Commodities Traders

Futures are the promise from various companies to buy oil at a set price. This drives the cost up and down for crude oil and has an impact on the amount the consumer pays at the pump and for electricity.

Futures allow buyers to lock in a price, which prevents large price fluctuations from affecting them. At the same time, sellers benefit from a futures contract because they lock in the price of their product. Even if the price falls, they have the contract in hand and an assurance of a certain amount of income.

Simply put, commodities traders determine the price of oil by bidding on futures contracts in the commodities market. Oil prices can change depending on what happened in the market that day. Traders consider three main factors when creating bids that determine oil prices. Those are:

  • Current supply: The United States is growing as a crude oil producer thanks to shale oil production. For example, in 2015, traders were able to bid the oil price down to about $37 a barrel. In response, OPEC allowed their oil prices to fall.
  • Future supply: Future supply refers to oil reserves, which could be used if prices get too high.
  • Demand: The Energy Information Agency provides monthly estimates to help traders predict demand changes. They'll consider weather and travel forecasts, for example.

The buyer of a futures contract is obligated to purchase a certain commodity when the contract expires and the seller is obligated to provide the commodity at that time.

Oil producers sell their oil using futures contracts so they can lock in a price and when they know they will sell their oil and deliver it at the end of the contract. Buyers use futures contracts to purchase oil at a price they know they are going to pay to avoid price fluctuations. Manufacturers, for example, might use futures contracts because they regularly require oil deliveries and they can rest assured that they will have oil when they need it a price they agreed to pay.

Commodities traders are usually representatives of companies who use oil. They buy oil in advance for delivery in the future to prevent risk to their company. Other traders are speculators who aim to make money from price changes.

The government and OPEC can influence bidders' decisions, but they do not actually set the prices. When oil prices are low, the government can stockpile oil to tap into when prices go up again or to use in emergency situations. America is home to the Strategic Petroleum Reserve (SPR) — the world's largest supply of emergency crude oil.

4. Changes in the Energy Industry

Changes in the energy industry affect prices as well. As more people turn to sustainable options, such as wind or solar power, the demand for oil diminishes. It's estimated that by the year 2022, renewable electricity will grow 40 percent around the world. Another area that limits the need for oil and causes prices to drop is the increase in the availability of hybrid and electric vehicles.

OPEC keeps tight control of the price of oil because if they raise prices too high, then people will begin to seek out alternative fuel sources in earnest, which could impact them long term as fewer people use oil as their fuel source. On the other hand, if they lower their prices too much, then it's difficult to cover costs while still making a profit.

5. Seasonal Demands

Seasonal changes greatly influence crude oil prices. For example, prices tend to rise in August when people travel and demand gasoline. Also, hurricane season peaks between August and September, driving up oil prices. It is also worth noting that, in the summer, refineries switch to summer-blend gasoline production, which is more expensive to make than winter-blend. The Clean Air Act requires that different fuel is used for different seasons. In the winter, cars use a blend which allows them to start in colder weather. However, winter-blend gasoline would release more emissions if used in the summer. Summer-blends cost more to produce and it is estimated they add three to 15 cents per gallon of fuel.

Crude oil prices often fall in October and they hit bottom in December. However, home heating oil prices tend to go up in the winter to meet the demand. Sometimes, in the winter, it is hard for refineries to keep up with the demand for home heating oil, causing an increase in price. Some people worry supplies will run out, so they stockpile oil. Nevertheless, other factors, like politics, can make a greater impact on prices than weather changes.

6. Natural Disasters and Politics

Natural disasters can cause crude oil prices to fluctuate by affecting the oil supply. For example, in August of 2017, U.S. oil refineries shut down to prepare for Hurricane Harvey, causing gas prices to rise almost 10%. If pipelines are destroyed or damaged, oil distribution slows down, repairs need to be made and prices temporarily spike.

Hurricane Katrina, which slammed the Gulf of Mexico in 2005, damaged U.S. pipelines and oil platforms along the coast, causing oil prices to temporarily rise above $70 a barrel. President Bush tapped into the SPR to help refineries get back into operation and get prices back down.

Politics can make a strong impact on oil prices as well. For example, in 2013, the cost of crude oil went up to over $115 a barrel because traders bid up the price of oil after the U.S. announced they would use air strikes on Syria. Although Syria is not a major source of oil, traders worried how an air strike would affect other oil-producing countries, including Iran.

Another example was the Arab Spring, a series of political uprisings, that drove oil prices up in 2011. Oil prices rose to almost $120 a barrel because traders feared they would not be getting oil from Libya, an OPEC country, for a while.

There are plenty of examples where political matters have caused a disturbance in oil production and affected prices. Many Americans remember the 1973 Oil Embargo, when OPEC members imposed an embargo, or ban on trade, on the United States for re-supplying the Israeli military. Oil barrel prices first doubled and then quadrupled, and soon there was a gas shortage.

In general, traders worry war will limit oil supply. When traders are afraid they'll lose oil, they are willing to pay a higher price.

Check Prices at Smart Touch Energy

It’s difficult to predict the rise and fall of oil costs. When prices are low, stock up as much as you can and when they are high you’ll have a buffer in place to see you through. As long as everything runs smoothly, prices rarely fluctuate outside of a 30 to 50 cent range. However, any number of factors can impact the cost and drive prices up unexpectedly.

Although you can't control natural disasters or political tension, you can control how much you choose to pay for heating oil. At Smart Touch Energy, we put the power in your hands to find the lowest local prices. To get started, all you need to do is:

  • Enter your zip code
  • Check for service availability and the best pricing in the area
  • Choose your delivery options
  • Place your order and expect delivery within three business days

Although it might seem unrelated at times, the fact remains: crude oil prices impact home heating oil. Heating oil prices fluctuate for various reasons, including:

  • Seasonal demands: Home heating oil prices typically go up during the winter months. Someone who lives in the Northeast might use up to 1,200 gallons of oil during the winter.
  • Crude oil price changes: When disaster strikes or war breaks out in other countries, crude oil prices are impacted. When crude oil goes up, so does the price of heating oil.
  • Local competition: The number of heating oil suppliers in an area can affect the cost of heating oil. For example, if there are many different suppliers in one area, chances are good prices will be lower than a location with few suppliers. Companies will compete with each other and offer the best prices to make customers happy. In rural areas, customers might pay more for heating oil if less competition is around.
  • Regional operating costs: Costs vary greatly depending on the part of the country the oil is being delivered to. For example, it might cost more to deliver oil to a remote location than to a heavily populated area. Some parts of the country get oil from other parts of the world, which can cost more.

Smart Touch Energy offers heating oil services in the Northeast, serving Maryland, New Jersey, Massachusetts, Connecticut, New York, Pennsylvania, Rhode Island, New Hampshire, Maine and Delaware. We buy oil when prices are low, allowing our customer to enjoy unbeatable savings. Our online ordering system makes fuel delivery fast, easy and affordable.

We believe heating oil and a delivery service you can depend on shouldn't cost a fortune. To check heating oil prices, sign up for an account and start enjoying the benefits of Smart Touch Energy today!