International oil markets are a prominent feature of the news on a daily basis, which is unsurprising considering the massive impact oil has on the global economy. However, many people only interact with oil prices indirectly through gasoline costs or home heating bills.
If people only see oil prices in the small-scale domestic expenses, the oil market is about as broad and international as possible. More than many other commodities, oil prices are the result of complex international forces, from shifts in production to rising and falling demand. Ultimately, the interactions between thousands of different smaller economies and even individual businesses play a role in determining the price of oil for everyone else in the world.
Supply and demand
The most fundamental component of oil prices is how much businesses and individuals are inclined to use. This in itself is in part determined by the price in a feedback loop that defines much of the market, but broader economic circumstances also determine demand for oil by establishing demand for the products made either from or using petroleum. Economic slumps like the recent downturn depress demand for oil and generally push down prices.
On the other hand, however, disruptions or boosts in supply can have dramatic impacts on oil prices, particularly when demand is high. The Organization of the Petroleum Exporting Countries attempts to partly control the price of oil by imposing limits on production for its member countries. The U.S. Energy Information Administration notes OPEC controls most of the world’s spare production capacity, making it a particularly important group for curbing spikes in oil prices.
Despite the international character of oil prices, looking at investing sites will still reveal countless different “brands” of oil at different prices. This diversity paints a much more cluttered picture than the single line presented on the evening news. This is because both news services and the oil trading industry as a whole relies on a few key oil products to provide a benchmark for the rest of the industry.
Oil benchmarks provide a single well-established oil product that moves in a reliable and predictable manner that other products can base their prices around, either adding a premium to providing a discount depending on the quality of the oil compared to the selected benchmark. The prices of these benchmarks fluctuate based on prices established through trades occurring throughout the day.
Most of the world uses Brent Blend crude oil, produced in the North Sea, as a benchmark. However, U.S. firms often instead rely upon West Texas Intermediate and some prices reference the OPEC basket, which includes a combination of crude from many OPEC nations.
Oil in financial markets
Crude oil is sold in two primary types of contracts: spot and futures. Spot contracts involve purchasing oil based on the current benchmark price for immediate delivery. Futures contracts assure the delivery of an amount of oil in a specific month at a separate price established when the contract is purchased, incorporating dealer’s expectations for the market’s outlook. These contracts allow both producers and consumers to better anticipate their costs and revenue in coming months.
In addition to the ultimate consumers of crude oil and the producers, there is also a large portion of the financial sector devoted to trading in crude oil, speculating on how the market will change in the hopes of profiting exclusively off the sale of futures and other similar contracts. While speculation is often viewed negatively as inflating the price of crude oil, this process is meant to better predict changes in prices and provide a more reliable – or liquid – market for oil contracts.