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The simple guide to oil prices.

July 14th, 2008 · Greg Atkinson · No Comments

Recently we have all been hearing about the price of oil and the various reasons why oil should either be trading higher of lower. So in an effort to simplify the whole debate here is my quick summary of some of the key points often raised when oil prices are discussed.

Peak Oil: This refers to the theory that at some point we will be pumping as much oil as there will ever be pumped and from that point onwards, oil availability will steadily decline. Many experts believe we are either at that point now or will soon be. If we assume that the demand for oil will keep growing then Peak Oil theory means oil prices are on a steady path upwards.

Peak Demand: Recently I read an interesting article from the team at GaveKal Research about a theory called Peak Demand. This theory basically says that as oil prices creep higher the world economy will reduce demand by finding alternatives and using more fuel efficient technologies etc. I also wrote about how higher oil prices reduces demand in my earlier blog: “Are higher oil prices a bad thing?”

Geopolitical Risks: At the moment the main issues here are related to supply disruptions from Iraq and Iran. If things take a nasty turn again in Iraq and the situation regarding Iran’s nuclear program becomes nastier then oil prices will head skywards. Nobody can really predict how these issues will play out so you might as well accept the fact that oil prices could spike at very short notice.

Global Demand: At the moment it seems most people are confident that the U.S economy is slowing as it is much of the Eurozone. In theory this means the demand for oil from these regions should drop and this should ease the global demand for oil. However this drop may be negated by the increasing demand from the emerging markets. I have no idea how this will all play out in the short to medium term, however over the longer term I think we will see oil demand in developed nations gradually decline and this will probably also take place in many emerging markets as well.

Speculative Trading: Much focus has been placed on how oil options are traded and this has been blamed for some of the increase in oil prices. This may or may not be true, but over the longer term oil prices will be driven by supply and demand fundamentals as in the case for other commodities such as gold and wheat.

I hope my simple summary helps clarify things a little. There are of course many other issues working to determine at what price oil trades (such as storms, new oil field discoveries etc) but at the end of the day it all comes back to supply and demand.

Anyway I took my own little step to reduce oil demand, I no longer have a car!

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