InvestorQ : I find the price of oil going up and down in a volatile manner. What exactly impacts the price of this crude oil and why is to so volatile?
Chandralekha Desai made post

I find the price of oil going up and down in a volatile manner. What exactly impacts the price of this crude oil and why is to so volatile?

Mitali Bhutta answered.
3 years ago

When you talk of crude oil, you need to understand that there are 2 broad types of crude oil in the world viz. Brent Crude and WTI Crude. The Brent Crude is popular across the Middle East and Europe and is also called North Sea Crude. This is the benchmark for nearly 65% of the global crude. The WTI (West Texas Intermediate) is more popular among the US, Mexico and Canada and is not so popular in other parts of the world. There are also other variants like Dubai crude, Singapore crude and Russian crude but their acceptance is quite low. Normally, in India when you refer to crude you talk about the Brent Crude numbers only.

Brent Crude is currently quoting at $62/bbl (British Barrel), where 1 barrel is approximately equivalent to 159 litres. The price of Brent had touched a high of $145/bbl in 2007 but post the Lehman Crisis it crashed all the way down to $50/bbl. The recent high in oil prices was at around $115/bbl in 2014 but from that point, the price of oil consistently fell to as low as $32/bbl in February 2016 as US shale production entered the oil market in a big way and reduced prices. From that point, oil touched a high of $85/bbl in December 2018 before falling all the way back to $51/bbl. From that point, oil has been extremely volatile. Here are some of the key triggers that impact the price of crude oil and make it volatile.

1. Oil demand is a major factor impacting oil prices. Normally, when oil demand from refineries, automobiles and home heating goes up, the price of crude oil also goes up sharply. This is one of the primary drivers of oil prices and in the last few days, the oil prices have fallen because the worry is that if the global economy goes into slowdown then demand for oil will also go down and so will the prices.

2. Oil supply is another factor that impacts the price of crude oil. Currently, the total supply of oil on a daily basis is around 100 million bbl. The three largest oil producers; the US, Russia and Saudi Arabia account for nearly 35% of the total daily oil output. The OPEC, a cartel of oil producers, used to account for over 50% of total global output but now accounts for only 35% as the share of the US and Russia has gone up substantially. Higher supply means lower prices of crude as yousaw post 2014.

3. Sentiments play an important role in the price of crude. When there is an increasing shift from diesel and petrol cars to electric cars, there is a sentimental shift out of crude oil and that reduces the prices. Similarly, when the US imposes sanctions on Iran, there is a sentimental shift as markets expect a shortage in the oil market. This pushes up the oil prices. When there are expectations that the global growth could slow down due to the trade war then the weaker sentiments leads to lower oil prices. When the alternative energy sources become cheaper, that again turns sentiments against fossil fuels and reduces the prices of crude oil. Countries like China and India are two of the largest consumers of oil, especially the imported version. Hence any economic shifts in these countries change the global sentiments towards oil demand.

4. Geopolitical risks play a major role in the price of oil because of most of the regions that produce oil are quite sensitive geopolitically. For example, countries in the Middle East, Africa and Latin America tend to be more vulnerable politically. For example, the political strife in Venezuela led to US sanctions and an immediate impact on oil prices. Similarly, political strife in Libya and Nigeria has also had an impact on oil prices. Most importantly, the geopolitical risk in the Middle East creates panic in the oil market for two reasons. Firstly, oil exporters are predominantly located in the Middle East and West Asia with Saudi Arabia, UAE, Kuwait, Qatar, Iran and Iraq contributing in a big way to global oil exports. Secondly, some of the most important oil trade routes like the Strait of Hormuz are controlled by Iran and any geopolitical uncertainty in this region also results in an impact on oil price movement since the Strait of Hormuz alone accounts for nearly 35% of global oil trade.

Apart from the above factors, other ancillary factors like the fresh investments in oil extraction, refining capacities, new distribution channels, laying of new pipelines, emergence of alternatives to oil, discovery of new reserves like Alaska, Siberia etc can all have an impact on oil prices.