Oil Price Movement: The Reason?

I must admit this one topic even had me mesmerized. The Reason was for few months I had heard oil prices falling constantly(it fell from 110$ to 40$ per barrel) & now suddenly the rise. To understand why this is happening the first step will be to understand why the prices fell in the first place. So let's begin...

Many people write off the oil price fluctuations to Dollar fluctuations, that used to be the case earlier. Now however, the scenario has changed. A lot of other things have come into play & I would rather say dollar fluctuations now play a negligible role in oil prices fluctuations. Oil prices depend on 2 factors :

Expectations & Demand-Supply play.

1.Demand-Supply play: First let's analyze demand-supply play because that is the main factor in this falling prices. Previously, US used to import oil from UAE, Iraq & Iran. But recently, US started producing oil itself & stopped importing oil from these countries which led to additional supply of oil to other countries. Add to this, US & Russia also started producing Shale Gas, which is a substitute to oil. This led to the initial slide of oil prices. However, instead of reducing the production of oil, UAE which fulfills 30% of oil demand in the world kept the production constant in a bid that US won't be able to sustain the low prices & thus stop supplying oil & start importing again. This strategy further led to a slide in the prices. Apparently, the UAE can sustain oil supply till prices as low as 10$ per barrel as their cost of production is very low. The cost of production for US for Oil & Shale gas both is high as compared to cost for UAE for producing Oil.

2. Expectation: A person usually invests when there is an upside in the business which he wants to invest in. So, oil companies would invest in increasing the capacity if the prices were supposed to increase. Instead the prices were falling, so no additional capacity was installed. Now when the supply is decreasing & demand remaining constant, the prices have again started rising.

These two factors pretty much explain the reason for the sudden spurt in oil prices & now the decline. This also puts forth the understanding that in economics, all the rise & falls are demand-supply based, just an eye for analysis is needed with a little background.

Cheers!

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