Oil, when all is said and done, demand and supply are the biggest determiners of its price

Oil, which way is it going to go, seems to be the one of the biggest and most disputed questions in today’s marketplace. Opinions seem to change day to day, and even different analysts from the same source have different opinions.

What to make of all of this and why are there so many different opinions on the medium term direction on the price of oil. The conspiracy theorists amongst us might suspect that those with real knowledge of what’s likely to happen are deliberately obfuscating us mere mortal investors. The fact is, however, that the price of Oil is subject to a lot of variables and trying to predict which direction it’s going in the short and medium term is downright difficult. Unforeseen things happen in the world all the time, and some of these geopolitical events can have a big impact. Countries who are major oil producing countries such as the US, Brazil and Russia and especially OPEC as an organisation, each of these entities policies, in addition to the individual companies from those countries own policies have an impact. Any stable agreement between these entities also will have a profound impact.

So what has driven the price of oil down over the last 9 months?

In simplest terms, it’s market basics in play, i.e. demand versus supply. Oil prices reached record levels of $115 a barrel for Brent Crude in June 2014 and indeed had been high since the start of the decade. These high prices encouraged US and Canadian companies to go after less conventional ways of extracting oil, in particular extracting oil from shale formations. Furthermore countries like Russia (driven by war and sanctions) and Venezuela in desperate need of revenue, are producing more oil than ever.

In addition, OPEC not wanting to lose its market share, refused to decrease supply. Along with this increased supply, we had weak economic outlook in the EU, slowing down in the largest world economy of China, countries becoming more efficient in their use of oil.

The strong dollar also has been a factor in the fall of the price of oil, seeing as oil is traded in dollars, as a strong dollar makes it relatively more expensive to European and Asian economies.

However in the last week the dollar has weakened against most major currencies, especially the Euro. A more recent positive outlook for the Euro economies in general, is also further positive news for oil companies, and oil has rebounded somewhat in the past two months. However, the price of Oil seems to be on shaky ground.

There are huge amounts of oil currently in storage, and if companies reach the limit of their storage capacity there could be a flood of cheap oil on the market. World politics is a big factor in the oil market. Iran, currently one of the largest producers of Oil, hit by sanctions over its nuclear program has huge reserves of oil ready to hit the market should a deal be done on its nuclear program, clearing the way for sanctions to be lifted and thus for its oil to hit the global market once again.

Right now, it’s clear there are many geopolitical and economic factors which are likely to maintain a big supply of oil over the coming months and perhaps even the next few years. Potential for increased demand seems to be at best limited, so on balance in the short term the recent gains in Oil we think are temporary, and we expect it to continue its decline. However, in the medium term, this low price of oil, is simply not good in economic terms for the oil producing countries and the incentive to cooperate and reach some sort of agreement to limit production, even though some of these countries could be described at best as not being on friendly terms with each other, is likely to become too great.

However, until such an agreement is reached between OPEC and the other major oil producing countries, of all the factors that influence the price of oil, the one that is paramount is demand and supply. All the other subtle factors which come into play, the demand and supply dynamic gives enough cause to suggest that there is sufficient pressure to have a renewed and continued decline in the price of oil in the short term. Just how long that short term is, is pretty much dependent on when a binding international level agreement can be reached on limiting production. Until such a time, we can be sure that the price of oil will not come anywhere close to its previous heights again.

Although, it’s far from certain, we at investing.co.uk are not going to sit on the fence, we put a negative outlook on oil over the proceeding months.