Oil Barrel Price- How is the oil barrel price determined?

oil-wellHow is the oil barrel price determined?  A lot of factors, many far too complicated for the beginner to understand, but we’re going to take a look at some the basic factors. 

 

First, as a matter of disclosure, I made a fair amount of money playing the movements of oil although I am no longer invested in oil.  If you read our recent article about disclosure, you know that the author’s motivation can be important to know. 

 

 The stock market offers a new kind of investment product (products are called instruments in the finance world) known as an ETF or Exchange Traded Fund.  These ETFs are offered in a variety of different forms.  I purchased an ETF that went up in price when oil went up.  Then, I purchased a similar ETF that went up in price when the price of oil went down. (Called an inverse or short fund)  If you are looking to profit when the oil barrel price goes up (or down) this is one way.

 

I will give you the “tip of the iceberg” explanation of how the oil barrel price is determined but as we said earlier, it’s much too complicated for the layperson to understand and frankly, not overly important to the beginner.  The price of oil is controlled by futures contracts.  A futures contract is a promise to deliver a certain amount of oil or pay (settle) the contract in a specified month.  Most futures contracts result in no delivery of oil.  Instead, it is an investment product designed to make investors money.

 

When the combined resources of commercial investors come together, the price of oil can be moved in ways that don’t coincide with supply and demand.  For example, when the Florida orange crop is damaged by unseasonably cold temperatures, the price of orange juice concentrate (which is also traded as a futures contract) goes up because the supply is lower and the demand is unchanged. 

 

Oil doesn’t always follow this traditional logic and many have asked why.  Most now agree (and a federal study proved) that the price of oil has been artificially moved by investors rather than fundamental supply and demand in the past.  There is a new push to prevent this but faces significant headwinds.

 

No matter what the experts believe about how the market needs more oversight, “the market” always has a way of correcting artificial price levels. (sometimes call a bubble)  We have seen the price of oil come back down to levels that are arguably just as artificial as when they were high.  During the summer of 2008 the oil barrel price was at its high and then only a few months later, it was at its low,

 

The experts have held on to the idea that the correct price based on supply and demand, transit costs, and research and development costs, is about $100 per barrel.  So what happens if we average the highest and lowest price of oil?  We come up with a price of $93.

 

What does oil barrel price have to do with us?  Gasoline is sold in futures contracts of its own but it roughly coincides with oil prices.

 

How can you make money in oil?  Unless you have really large tanks or really deep pockets, you can’t make money on oil directly but read about ETFs and how to trade oil as a stock. 

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