As is the case with any commodity, oil prices are subject to the laws of supply and demand. When supply exceeds demand, the price of oil falls; inversely, when demand outpaces supply, the price of oil rises. However, a variety of factors can influence the magnitude of these fluctuations and the impact they have on economic outcomes.
A large share of the oil price fluctuation is due to production levels set by major producers, specifically OPEC (Organization of Petroleum Exporting Countries), which controls 79.5% of the world’s crude oil reserves. As such, any change in their production can have a dramatic impact on the price of oil.
Other factors that can affect the price of oil include geopolitical tensions in key producing regions, weather events that slow or interrupt the flow of oil and its products to market (e.g. Hurricane Harvey in 2017), or seasonal demands (e.g. home heating oil in winter). The latter can drive up prices when supplies from the Gulf Coast or Europe need to travel to colder climates, which increases their cost compared to shipments earlier in the year.
In addition, hedging instruments reduce the responsiveness of oil demand and supply to price changes in the short run. As a result, even though a fall in oil prices hurts companies that produce or use oil, overall GDP growth is not necessarily impacted. This is because the economy is so diverse that growth in sectors that are dependent on oil and gas can be offset by other industries.
About the Author
