Prices of crude oil recently rallied to a high of 14 years. The Brent crude oil price attained a high of $127.98 a barrel on 08th March 2022, while the WTI crude oil peaked at $130.50 a barrel on 07th March 2022. Both the benchmark indices are nearing their all-time high, formed during the 2008 global financial crisis. Ever since the Russian invasion of Ukraine began, crude oil prices have been witnessing heavy fluctuations; it recently has crashed more than 20% after soaring to 14-years high.
To understand and trade (or invest) on crude oil prices – its rise and fall. We need to understand the historical backdrop of the industry, price movement, and volatility. Furthermore, understanding the fundamental factors influencing the prices of crude oil will aid us in making informed decisions, including any volatile situations that we may face subsequently, like the one we face currently.
Notable events that impacted crude oil prices (1970 – present):
1 – Arab Oil embargo, 2 – Iranian Revolution, 3 – Iran-Iraq war, 4 – Gulf war, 5 – Asian economic crisis, 6 – 9/11 attack, 7 – US invasion of Iraq, 8 – Global financial crisis, 9 – The Great Recession, 10 – COVID-19 pandemic, 11 – Russian invasion of Ukraine.
It is evident from the chart above that those significant events with the potential to disrupt global oil supply and demand have always affected the price of crude oil and will continue to do so, as the current conflict in Ukraine.
So far, we have understood the historical background of the global crude oil industry and prices, how major international events affect the de
mand and supply of crude oil, and its prices. Next, we shall look at the various crucial factors shaping crude oil prices.
Factors affecting the prices of commodity – crude oil:
Three major factors: supply, demand, and geopolitics, affect crude oil prices significantly.
The Organization for Petroleum Exporting Countries (OPEC) can significantly influence the global supply of oil. OPEC is comprised of nations with some of the world’s largest oil reserves. Its members controlled 71% of the world’s crude oil reserves and accounted for about 40% of its crude oil production. It exercises significant influence on crude oil prices by setting production targets or quotas for its members. With technological advancement facilitating increased US shale production, the US, too, is increasingly playing a meaningful role in the global supply.
Access to future supply depends on oil reserves. Many countries have Strategic Petroleum Reserves (SPR) to safeguard their economy and help maintain national security during an energy crisis. Use of these reserves to cover any shortterm supply disruptions is the intent. The release of strategic reserves does have little or no impact on crude oil prices in the long term.
Economic growth is one of the most significant factors affecting petroleum products and crude oil demand. Flourishing economies increase demand for energy in general, especially for delivering goods from suppliers to consumers. The global logistics and transportation sector hinges significantly on crude oil products. Numerous nations also rely heavily on petroleum fuels for their energy needs – petroleum products made from crude oil one-third of total world energy consumption.
Other important factors that affect demand include population growth and seasonal changes. For instance, the need for oil for transportation increases during busy summer travel seasons and in the winter as demand for energy increases, particularly in nations that rely heavily on petroleum products for their energy needs.
OPEC’s policies may be influenced, in turn, by geopolitical developments. In the past, supply disruptions triggered by geopolitical affairs have caused prices to shift drastically; the Iranian revolution, Iran-Iraq war, Arab oil embargo, and Gulf wars have been especially noteworthy.
In addition to these three significant factors, natural and artificial disasters also play a vital role in the demand and supply of crude oil. Case in point, the COVID-19 pandemic led to a dive in global oil prices.
Why have crude oil prices spiked and crashed in quick succession?
As mentioned earlier, crude oil prices are near their all-time high. This soar is primarily on account of the Russian invasion of Ukraine on 24th February 2022.
In response, the US and its allies have imposed harsh sanctions on Russia, the world’s top exporter of crude oil products combined, at around 11.5 million barrels per day (bpd) or 12% of global supply. The resulting fear of supply chain disruptions consequently contributes to soaring oil prices. OPEC, responsible for about 40% of the world’s crude oil supply, has been scaling production slowly. But it has limited spare capacity and is cautious not to oversupply the market again.
Private producers are also cautious about allocating capital for increasing production. The crude oil production has very long investment cycles, lasting around a decade to reach the first production. They had learned their lessons from an oversupplied market when oil prices dropped to minus $40. There is also intense pressure on the industry not to develop new fields, hold or decrease investment in maintaining and growing production, and divert the capital to green investments.
All these factors contributed to the recent spike in crude oil prices.
While the following elements contributed to the crash –
The Chinese government has started imposing lockdowns in key manufacturing cities as Covid cases spike. This would slow down consumption and doesn’t bode well for the crude oil industry as China is the world’s largest importer. As Russia approved the renewal of the Iranian deal, there is a strong possibility of Iranian crude oil inflows into the market. Finally, the ongoing talk of a ceasefire between Ukraine and Russia also reflects the recent crude oil prices crash.
What are the consequences of rising crude oil prices?
There is a strong correlation between crude oil prices and inflation. Inflation is forecasted to rise to an unprecedented level in many countries, with natural gas prices hitting all-time highs, soaring energy prices, eating deeply into households’ purchasing power across the globe.
For its heavy reliance on Russian exports for its energy needs, Europe may need to look for other sources like the Gulf countries as mounting sanctions will make business transactions more challenging and complex. Europe’s search for alternative energy sources may further contribute to soaring crude oil prices, which will affect inflation.
Hit to Economic Growth:
Increasing crude oil prices can stifle the economy’s growth by affecting the demand and supply for goods. Crude oil prices indirectly affect costs such as transportation, manufacturing, and heating leading to high inflationary pressures. Due to the increasing cost of goods and services, consumption and savings may decrease, which will reduce the potential for economic growth.
In the US, the Federal Reserve System reckons that every $10 per barrel rise in oil prices cuts growth by 0.1 percentage point, though private forecasters see a more muted impact. Despite these effects on supply and demand, the correlation between oil price increases and economic downturns is not perfect.
Cost-induced inflation caused by rising crude oil prices presents a dilemma to policymakers. Higher inflation usually requires higher interest rates to keep inflation on target. But, reducing interest could not be appropriate as output could be well below its potential.
In 2008, policymakers gave too much importance to cost-push inflation and too little weight on the impending economic downturn.
Adoption of alternative energy sources:
The Russia-Ukraine war saga has led to a spike in oil, gasoline, and natural gas prices. Due to the unreliability and volatile nature of fossil fuels’ prices, it could mean increased and faster adoption of clean and renewable energy, shifting to nuclear power, rapid adoption of Electric Vehicles, etc.
As per the International Energy Agency (IEA), renewable energy sources are expected to make up 95% of the world’s increase in power capacity through 2026. Germany, for instance, has pledged to spend $220 billion for its industrial transformation as per the Paris accord.
Some analysts believe that the current spike in oil prices could derail efforts to transition toward clean energy in the short-to-medium term as officials look to secure supply chain resilience but speed it up in the long run.
What are the impacts of falling crude oil prices?
Diminishing Inflationary Pressures:
A fall in crude oil prices will cause reduced transportation and fuel costs for firms, benefiting consumers. This will lessen the pressure of inflation, effectively increasing the disposable income of households. Also, falling oil prices will have varying effects depending on the country. Oil importing countries like Germany, India, and Japan will generally benefit from low crude oil prices, while nations relying on crude oil export like Russia and Venezuela could witness a significant fall in export revenue.
Boon to Economic Growth:
As falling crude oil prices mean higher disposable income of households. It will lead to increased savings, contributing to economic growth. A booming economic growth will, further, demand more oil, which may consequently impact crude oil prices.
Reduced Profitability for Alternative Energy Sources:
Over the last few years, there has been increasing pressure and incentive to invest in renewable energy sources. A prolonged fall in crude oil prices may encourage consumers and firms to stick with oil, leading to delayed investments into alternative “greener” energy.
Exploration and oil production has been significant job growth sources in major oil-exporting countries. It indirectly results in the creation of more jobs as many supporting businesses sprout up in that area to meet the need and demands of the workers
Lower crude oil prices would mean less exploration and drilling. This will lead to the laying off of workers, consequently affecting the surrounding supporting businesses.
What to expect in the near future?
It is difficult, near-impossible, to predict the future direction of crude oil prices. The current geopolitical crisis in Ukraine is also contributing to spiraling market volatility. However, we may look at some fundamental and economic news to make sense of the market noise.
Case 1: Rising crude oil prices.
Some energy analysts have warned that prices could go as high as $160 or even $200 a barrel if buyers continue to shun Russian crude. Filling the gap of Russian exports without relying heavily on demand reduction would require a combination of new supplies. Sharp output increases from OPEC countries with spare capacity could play a vital role. A deal with Iran could also allow further inflows of 1.3 million barrels of crude oil per day.
Strategic Petroleum Reserve (SPR) could be the most significant short-term cushion. The US Strategic Petroleum Reserve (SPR) alone has a 4.4 million barrels per day theoretical maximum drawdown rate. In the coming months, prices are likely to depend on the US shell production, the decisions of the OPEC-led coalition, and how the Asian demand shapes up.
Case 2: Falling crude oil prices.
Rising cases of Coronavirus will also be a factor in crude oil prices. Increasing COVID-9 infections could slow the current pace of consumption as nations shift to lockdowns.
De-escalation in the Russia – Ukraine conflict will lead to a fall in crude oil prices. As peace may lead to withdrawal of sanctions targeting Russia, buyers may again look to Russia’s energy exports, Black Sea ports of both countries might open up, etc., giving some relief to supply-chain disruption.
The revival of the Iranian nuclear deal, formally known as the Joint Comprehensive Plan of Action (JCPOA), would lift sanctions on Iran’s oil sector. This would allow further inflow of 1.3 million barrels of oil per day into the market, easing the supply shortage.
Long-Term Technical Analysis of WTI Crude Oil:
Monthly Chart of WTI Crude Oil Futures.
How can I trade crude oil?
After understanding the points mentioned above, a trader or investor can efficiently and accurately anticipate the prices of crude oil and trade crude oil by making sense of the various fundamental factors that influence crude oil prices.
Several online brokers and exchanges offer several financial instruments that allow traders to speculate on the price of crude oil:
- Share of oil companies.
- Contracts for differences (CFDs)
- Exchange-traded funds (ETFs)
How to trade crude oil using CFD?
Contract for Difference (CFD) is a contract between a trader and a broker to exchange the difference in price between the enter and exit price. Leverages can be fixed or variable based on the broker’s margin requirement.
To trade oil CFDs, head over to Capital Street FX. It provides leverage up to 1:1000, meaning for every dollar in your trading account, you can take positions of $1000 to amplify returns with trade execution in less than 0.5 seconds.