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Saturday, July 4, 2020

Why the price of oil and gas is so volatile

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Being commodities, oil and gas values fluctuate much more than many other investments such as stocks, shares and currency. Prices can go up and down dramatically, largely influenced by the laws of supply and demand. A further overriding factor is the way that the global industry is regulated, as the Organisation of Petroleum Exporting Countries (OPEC) determines the output of most of the major oil-producing nations.

Susceptible to pressure

Oil and gas are particularly susceptible to political unrest, economic pressures and natural disasters, which can affect both demand and production. When demand falls, storage costs are a major contributing issue. Recently we’ve seen an oil price war between Saudi Arabia and Russia and of course this year the COVID-19 crisis has had an unprecedented impact on the industry overall.

Decimated demand

The pandemic has decimated demand, as most air flights are grounded, there are far fewer vehicles on the world’s roads and many oil and gas-consuming industries are closed. In the US, oil prices actually turned negative as the cost of storage outweighed the value to buyers.

In Aberdeen, we’ve seen the price of North Sea oil drop by a massive 70%, with Brent Crude now selling for around $20 per barrel. This, in turn, makes investment in new oil fields, drilling and production less likely. While there are still many undeveloped oil fields in the North Sea, many may not be viable due to the low prices seen this year. The Scottish oil and gas sector is also under pressure to conform to carbon emission targets, and Aberdeen’s future may involve switching to non-fossil energy sources such as wind and hydro-power.

Future prices

In the investment market, oil futures are actually more important in setting prices than current supply and demand. These are contracts giving the buyer the right to purchase oil at a set price in the future, the transaction to be carried out by a specified date. These contracts can be traded in their own right on many trading platforms: see City Index reviews for an example.

Hits on supply

On the supply side, political turmoil and natural disasters can have a major impact. In 2005, Hurricane Katrina hit the south-west of the US and hugely disrupted that country’s oil output. Political unrest and conflict in the Middle East have historically affected the price of oil and gas around the world, as that region is by far the planet’s biggest oil producer.

Interest rates

Oil and gas consumption by ordinary people is also affected by the overall economy. When people have more money, they travel more, buying petrol for their cars and boosting air travel. This has led many to see a correlation between oil prices and interest rates, with low interest rates driving demand, although the relationship is more complex than it might appear.

The degree to which oil and gas are integral to the global economy and to geopolitics largely accounts for the volatility of their market price. The fact that both are a limited, non-renewable resource is also a major factor. Unlike many other investment commodities, oil and gas have a real-world impact, and the conditions of supply and demand are consequently very much real issues as well.

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