Why High Oil Prices

High Oil Prices Situation
Not Reflect The Law of Supply and Demand
Oil prices have been increasing dramatically in recent years. As a result, consumers are forced to endure increased costs for energy and gasoline.

Oil prices affect the economy as a whole. Increased oil prices have an impact on costs involved in manufacturing and transporting goods; as such, they tend to result in aggravating inflationary trends.

The Contributing Factors

Supply Disruption
Contrary to the laws of supply and demand, the increase in oil prices has not increase in supply. It is not an actual lack of oil supply, but rather problems that are due to supply disruptions. For example, the flow of oil in Iraq has been reduced due to ongoing war. And if you can recall, in 2005, oil supplies from the Gulf of Mexico were disrupted as a result of devastating hurricanes. In fact, there are concerns about possible disruption of oil supplies in Iran.

The OPEC Effect
Organization of Petroleum Exporting Countries (OPEC), a cartel that has traditionally been regarded as an oligopoly, has muscles in terms of adjusting supply quotas and thereby setting prices. OPEC’s prowess was particularly notable during the 1970s, when minor reductions in the cartel’s supplies led to “oil shocks” and thus global increase in price.

Commodity Traders
Other economic factors have also played a role. For instance, the price of oil is affected by the behaviour of market investors. It doesn’t matter if oil supplies are actually low or if threats to oil supplies actually exist; the mere perception of a possible threat to oil supplies can lead to an increase in trading, thereby driving up the price. Commodity traders have recently been concerned about geopolitical risks in Iran, Nigeria and Venezuela; and also the low level of spare OPEC crude oil output capacity.

Then, there is a trend known as “contango”, a situation that has existed in the oil market since autumn of 2004. Because prompted cargoes are at discount versus later deliveries, it pays to buy crude and refined products now, store them and use them later. This tendency to stockpile surplus oil has resulted in an increase in demand, which in turn, has helped to keep oil prices at their current high levels.

Summary

Oil is a necessity rather than a luxury and there is a lack of viable substitute products at this time. The high oil price is related in part to a decrease in supply. However, it has much to do with the supply disruption and lack of production capacity than the actual shortage per se. Because of such factors, oil producers have not been able to substantially increase the supply, despite the persistent demand and incentive provided by the high prices. The perceptions of investors and market traders also have impact as I mentioned before.
Changes will have to occur in order to bring oil prices back down. These include resolutions to conflicts that are causing supply disruptions in places like Iraq, Nigeria, Iran and Venezuela.
The market would not only need to see a significant drop in demand, but also a steep rise in crude oil and products stocks, along with a higher investments in new capacity.

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