Belfast Telegraph

Lock, stock and barrel: factors that influence the price of oil

Why are there wild swings in the cost of petroleum? Zoe Fiddes finds out what causes such a volatile market

Crude oil is used in the production and distribution of countless industrial products and its price has a huge impact on industries as well as the cost of regular consumer products. Crude oil trades with wide swings and is more volatile compared with the major currency pairs.

Oil prices are predominantly driven by global supply and demand as well as a number of geopolitical factors such as wars, recessions and natural disasters. Speculation by investors and the mindset of commodity brokers can often mean that market-moving events are priced in before they have even happened. For example, the rally from $83 to $85.50 on the Friday afternoon before Hurricane Irene was due to hit the US recently may have been the market pricing in the risk of threat to supply. A similar reaction was observed, with a much larger shift up, in 2005 when Hurricane Katrina halted oil production along the Southern Gulf Coast of the US.

Worldwide oil production is controlled by the Organisation of the Petroleum Exporting countries (Opec), which aims to ensure the stabilisation of oil markets and its price per barrel. Persistent high prices cause concern in the Opec camp since it often leads to a fall in demand. When the Middle Eastern revolt began the market became anxious that oil supplies from these countries would be cut-off. This expectation squeezed oil (WTI) to over $100 a barrel. Troubles in the Middle East continued and oil prices remained high which lead to an emergency Opec meeting to decide whether to increase oil production. The meeting collapsed with the proposal being rejected by six of the 12 members. As a result, there was an immediate rush in the market with everyone jumping on the same oil wave and prices immediately shot up by over $3 a barrel.

This is not the first time political instability in the Middle East has caused great concern. In July 2008 prices reached $136 due to the wars in Iraq and Afghanistan. And in 1973 the price of oil quadrupled from $3 to $12 because of the Arab oil embargo during the Yom Kippur war.

But what causes oil prices to drop? Oil tends to fall during economic contractions. For example, prices fell after the Japanese nuclear crisis this year. This was no surprise as Japan is the world's third largest oil consumer; the US is the first and China the second.

More recently, downbeat economic figures have increased bearish sentiment such as recent manufacturing figures which revealed that the slowdown is hitting factories hard throughout the western world.

It is likely that a worldwide slowdown in growth especially from the US and China will bring oil prices down as demand declines. However, any political uncertainty from the oil producing countries can spook investors and drive the price up as people are forced into the market.

Hence when trading oil, from a fundamental point of view, you must follow the political news as well as financial data announcements from the West and China.

When trading oil you must follow the political news as well as financial data from the West and China

Zoe Fiddes, UK branch manager of Easy Forex Trading