Modern society runs on oil. Whether its food, travel or healthcare, almost everything familiar to us is dependent on it. It’s a curious thing then to see how often and how violently its price can fluctuate. So how and why does the price of oil surge, crash or steady?
Well, if you are young chances are you haven’t experienced the full severity of the change in the price of petroleum. In day to day life, contact with petroleum and its price is generally limited to petrol stations – but the prices there do give a good insight to what exactly is going on.
At its core, as almost everything in a free market, the price of oil is dominated by supply and demand. This potentially leads to two situations: undersupply, where an increase in demand leads to an increase in price, or oversupply, where an increase in supply leads to a drop in price.
Keeping that premise in mind, there are a national, regional and international factors which impact on the price of oil.
On a national and regional level there are relatively few things that affect the price of petroleum. As a starting position, all prices for fuels in Australia are based on the Singapore price, which in the case of petrol is labelled the MOPS95. With some lag, the price of petrol in Australia reliably runs lockstep with the MOPS95 price, although sudden economic conditions and weather events can both affect it on a national level.
After shipping costs, considerable government taxation and a bump up from the wholesale price, petrol and other retail fuels receive one final modification. This comes in the form of discounts on a saw-tooth cycle, a process very visible to consumers. Generally what this means is in areas where competition is fierce, suppliers will offer incremental discounts until it is no longer sustainable, after which the price will surge back to its original position and the cycle will start over.
However, the real price surges and crashes originate from international events. In many cases the price changes based on the economic progress of states, for example China, whose 2008 growth boom sky-rocketed both the demand for oil and its cost. But quite often the change in price comes from a much more centralised source.
This source is OPEC – The Organisation of Petroleum Exporting Countries. Totalling 14 member states including Iraq, Saudi Arabia, Venezuela and Indonesia, the motivation behind OPEC is clear: To coordinate and unify the petroleum policies of member countries.
Whilst this may seem like a fair enough alliance of interests, the group has repeatedly shown that by producing 43% of the world’s petroleum and holding 80% of the earth’s oil reserves, they wield immense power.
But how exactly does the organisation function? Put simply, it coordinates production quotas between members. By controlling each member’s petroleum production, OPEC can effectively control the supply and thus the price. Although the organisation might sometimes be reasonable, quite often politics or economics can lead to OPEC dropping or raising the price exorbitantly.
For instance, over the past few years OPEC has been oversupplying the world with barrels of oil. Month after month they have been raising their production ceiling, in turn lowering the price of petroleum and making it more competitive. Whilst this seems a noble action – after all, it’s cheaper for everyone – it was primarily done to combat the growing success of alternative fuels and the United States’ energy independence.
On the other hand, members of OPEC have in the past shown a willingness to raise prices through production cuts or even apply blanket oil embargoes to certain nations. One of the most devastating examples of this occurred during the 1970’s, when the Arab nations of OPEC issued a petroleum embargo against the United States and several European nations for their support of Israel. This move resulted in a price explosion, extensive government initiatives to control the situation –such as banning any ‘unnecessary’ Sunday driving – and the collapse of the post-war booming economy.
So whilst demand and supply is key to the price of oil, to understand the whole picture you need to understand all the national, regional and international efforts which affect it.
– Connor Pound