In this week’s blog, we continue with our discourse on oil. In the last blog, we looked at the impact of oil prices at the local level, how oil prices change, and the impact of these changes on the economy. Today, we look at the causes of changes in oil prices on the international scene, how to anticipate these oil price changes, and, armed with knowledge from the previous blog, what impact this will have on you.

Definitions

First, let’s define what oil is. Oil is a naturally occurring commodity that is refinable into different types of fuels. The key word in this definition is ‘commodity’. Why so? A commodity is any raw good used as an input in the process of making other goods. This is important because oil as a commodity derives its value from the growth of output of other goods. Oil in itself has no utility.

Secondly, let’s define what the oil industry looks like. The oil industry is divided into various sectors, which are:

1. Exploration – This is the process of finding oil reserves, determining the quality of the oil, and how large the reserves are.
2. Extraction – This is the process of drilling into the ground to bring the oil to the surface.
3. Refining – This is the process of transforming oil into the various useful products we know such as petrol, diesel, kerosene, etc.
4. Transporting – This is the process of moving oil from the refineries to the global markets.

Causes of Changes in Oil Prices

With the two definitions above, we can now look at what causes oil prices to increase and decrease from two angles; one of demand and the other of supply.

Demand

The level of demand for oil plays a key role in the increase or decrease of the price of this commodity. What affects oil demand? Looking at the definition of oil as a commodity, we noted that it is an input in a process. This means that oil demand is a function of the demand of the processes that use oil. Therefore, if oil is used as fuel to power airplanes, then the demand for oil will increase as the demand for flying increases. The inverse also holds true. It is therefore important to know the major processes that have oil as an input as growth or decline in these areas will have an impact on the price of oil. The use of alternative forms of energy also affects oil prices.

Below is a non-exhaustive list of the major users of oil:

1. Transport sector – road, rail, sea, air
2. Manufacturing sector
3. Mining sector
4. Households

Anticipating Oil Price Changes

To determine whether the price of oil will increase or reduce, one has to look at the growth trends in some of these sectors. An increase in mining activity without the use of alternative fuels or improvement in innovation will lead to an increase in oil demand and, with it, the price of the commodity. The same concept applies to transport, manufacturing, and household consumption. These sectors grow or decline in tandem with the economic growth of the various regions and countries in the world. This is why when most countries went on lockdown in 2020 due to Covid 19, the processes that depended on oil reduced activity leading to a drop in global oil prices from $50 to $20 a barrel. As the economies began to open up in the latter half of the year, the prices began increasing and currently stand at $76 per barrel.

Brent Crude Oil Prices

Source: www.macrotrends.net

It is also important to monitor the growth trends in the aforementioned sectors in the regions below. These are the largest oil consumers and any change in their economic momentum significantly affects the price of oil.

The 10 Largest Oil Producers And Share Of Total World Oil Production In 2020

Source: International Energy Statistics, Total oil (petroleum and other liquids) production, April 1, 2021

It is, however, paramount to state that the above analysis of oil demand and its impact on oil prices only makes sense if supply remains relatively constant. In the interest of keeping it short, look out for part 3 of Oil – Black Gold or Mute Assassin where we will discuss the supply side.