EBF 301
Global Finance for the Earth, Energy, and Materials Industries

Factors Influencing Crude Oil Price


Many, many factors can influence the price of crude oil either directly or indirectly. Some of the major factors influencing US crude oil prices are:

  • US weather – mostly winter, as the demand for heating oil impacts crude oil prices. The Northeastern part of the US is the world's single largest consumer of heating oil.
  • Geopolitical events - in any oil-producing region of the world where conflicts exist that could potentially interrupt supply.
  • US dollar vs. foreign currencies - as mentioned previously, a devalued US dollar gives foreign investors more money to buy crude oil contracts and, vice versa, a stronger US dollar discourages foreign investment in crude oil contracts.
  • US economy - strength or weakness directly impacts the perception of energy consumption. Several economic indicators are released weekly.
  • World economy - as stated in the introduction, we are now in a truly global economy and what happens in one country can affect all others.
  • Production & imports vs. demand - reports on domestic oil production & imports vs. consumption can cause prices to vary greatly. Some of the reports/statistics are listed below:
    • Baker Hughes Drilling Report of active rigs - this oilfield service company keeps track of the total number of rigs actively drilling for oil and gas, and they report the statistics weekly. A rise in rigs means more potential supply coming-on down-the-road. A drop in the rig count could mean less supply down the road.
    • West Texas Intermediate (WTI) crude vs. Brent North Sea crude - Brent crude oil is presently the global standard and trades in London. Its prices reflect demand in continental Europe, which can influence the price of imported crude here in the US.
    • Weekly Crude Oil & Distillates Inventory Report (Energy Information Agency) - The Department of Energy releases a report every week that gives the current amount of crude oil and distillates in the nation's storage facilities. (Distillates include heating oil, diesel, gasoline, etc.) Increases in the inventory are viewed as an increase in supply, while decreases are seen as an indicator of increased demand. Another key piece of information presented is that of "refinery utilization". The higher the utilization percentage, the higher the demand for crude and vice versa.
    • OPEC - The Organization of the Petroleum Exporting Countries, OPEC, was formed in 1960 by the first five members including Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela and has 14 members as of May 2017. OPEC members control about 73% of the world's total proved oil reserves and produced 44% of the world's total crude oil in 2016. OPEC has a significant impact on the oil market, managing the oil production, and oil price.
  • Cross-commodity markets – as we will see in future lessons, most fuels, such as gasoline, diesel fuel, heating oil, and jet fuel, are all produced from crude oil. The demand shift for these commodities, such as travel season and weather change, will also impact the demand of crude oil. The EIA Weekly Crude Oil & Distillates Inventory Report also lists inventory changes for these commodities.

The following videos go into greater detail about the factors which can influence crude oil prices. Please note that some of the statistics might be a bit out of date, but please do not worry about that. These are just examples and are meant to teach you about how the various factors influence the market. You will not be responsible for the example details.

(The lecture notes can be found in the Lesson 2 module in Canvas (Lesson 2: Supply/Demand Fundamentals for Natural Gas & Crude Oil.)

Fundamental Factors Part 1: Weather and the US Economy

(9:04 minutes)

EBF 301 Factors Influencing Crude Oil Price Part 1
Click for a transcript.

Farid Tayari: In this video and following videos, I'm going to explain the factors that are influencing the crude oil price. So there are many factors that can have an impact on crude oil price that we can name some of them as weather, US economy, international economy, US dollar exchange rate comparing to other foreign currencies, geopolitical events, supply and demand statistics, and crude oil and petroleum distillates inventory.

First, US weather-- heating oil is a refined distillate of crude oil. And it is being used by 5.7 million-- around 6 million households-- in the United States for space heating and warming of the water. Around 80% of those six million households are living in Northeast part of the country.

So if there is a cold winter, if there is a cold wave hitting this part of the country, we're expecting to have higher demand for heating oil. And it could be a good signal for price of oil being potentially increased.

I put a link here and this is slide to EIA website-- Energy Information Administration-- that includes the heating oil prices. So in addition to looking for data such as temperature or having a potential prediction of wind chill, there's also another indicator called HDD or Heating Degree Days. It's a good sign for energy demand.

So HDD represents the amount of energy being used to heat the space inside the building to reach 65 degrees, Fahrenheit. The lower outside temperature, it means that more energy has to be used for space heating. So historical and forecasted issues can be found at this link. It takes you to the National Oceanic and Atmospheric Administration. It can be a good metric for expected demand of heating oil and eventually, crude oil.

So one thing that we have to note that HDD is always positive-- there's no negative-- in case for the summer, the outside temperature is higher than 65, and then energy has to be used to cool down the space to the 65. We use this metric called CDD, or Cooling Degree Days. It's a measure for the amount of energy that needs to be used to cool down the building.

The other weather event that could potentially affect the crude oil price is a hurricane. According to EIA-- Energy Information Administration-- around 23% of the offshore oil production and 45% of the US oil refining capacity is around the Gulf of Mexico. And this is the section that in case of hurricane, that could potentially be affected and the supply can be interrupted.

So around 24 hours before the hurricane, the site-- which is a production site or drilling site-- has to be evacuated. And after the hurricane, it takes around at least 72 hours to reman the facility and start production.

In case of hurricane, there are two possible things that can happen, the interruption in the production because the site has to be evacuated. Or if the hurricane is severe, it can also damage the facility. For example, two cases-- Hurricane Katrina in 2005, 12 rigs and 30 platforms were damaged. And 18 of those platforms were completely destroyed.

Hurricane Ivan in 2004 damaged seven rigs and destroyed two rigs, and seven platforms destroyed. And it had consequences-- flooding and so on and so forth. And this can cause the supply interruption or the prediction of supply interruption. So when there is an interruption in supply, price can potentially increase.

I put a link here and it takes you to National Hurricane Center. It is a good resource for getting information of hurricane events. The official hurricane season begins on June 1st and it goes to November 3rd with a peak around mid-September. During this time, Weather Channel provides information through tropical update report.

The other factor that fixed the price of oil is the economy. Oil is a global commodity and the United States economy and other major countries in terms of economy. They can potentially influence the price of crude oil.

In this video, I'm going to explain the effect of US economy and crude oil. And in the following videos, I'm going to focus on international aspects of the economy and factors that are affecting crude oil price.

So energy runs the economy. And every aspect of economy can potentially influence the crude oil price. If economy is doing good, if economy is growing, it means there will be higher demand in future. Demand will be increasing. Strength and weakness of domestic economy directly impacts their prices, and also the perception of prices change and the prediction of the demand and eventually, the price predictions and the reaction of the traders to the price.

One of the most obvious and most frequently reported indications of economic health is stock market. Dow- Jones Industrial Index, S&P 500, and NASDAQ are daily reports that indicate the performance of the stock market. If these metrics are showing a good performance for the stock market, it means that economy is growing. And it could go up.

There are also weekly, monthly, quarterly economic reports that can have immediate impact on the price perception. Unemployment rate and reports being published by US Department of Labor-- this report is published every Friday. Institute of Supply Management Index report published monthly. Inflation rate, which is calculated from the CPI, Consumer Price Index, is being reported by US Bureau of Labor Statistics. It's a monthly report. GDP, US Gross Domestic Product, which also being published by Bureau of Economic Analysis and it's being published quarterly.

Also, US Department of Commerce's Economic and Statistics Administration has number of economic indicators that include data from US Census Bureau and US Bureau of Economic Analysis. These economic metrics are including construction spending, housing starts, housing sales, US international trade, monthly wholesale trade, manufacturing and trade, sales for retail and food services, personal income, and personal spending.

Also, quarterly earning reports from US companies-- these are the report metrics in economic parameters that can help us predict the future demand.

The next video-- so I'm going to explain the other factors that can influence crude oil price.

Credit: Farid Tayari:

Fundamental Factors Part 2: International Economy, US Exchange Rate and Geopolitical Events

(9:29 minutes)

EBF 301 Factors Influencing Crude Oil Price Part 2
Click for a transcript.

Farid Tayari: Following the previous videos, in this video, I'm going to continue explaining the factors that are affecting crude oil price. In this video, I will start with international economy. As we learned previously, crude oil is an international commodity. It's a global commodity. It's being traded everywhere in the world. Every part of the world economy can have impact on the crude oil price. Some countries that are contributing to biggest portion of crude oil consumption, their economy can potentially have a big impact on crude oil price.

So when trading starts early in the morning on the exchange in New York, Asian market is already closed and European market is at midday. So the behavior of the market, the signs of how market will behave, they are already known.

And probably the most watched nation these days outside of the US is China. China is contributing to around 15% of the world GDP. And China is, after the United States, the second-largest consumer of crude oil.

After China, Japan used to be the third-largest consumer of crude oil. After the Fukushima nuclear disaster, Japan's imports of fossil fuel increased. But at the moment, India is in the third place, taking Japan's place in oil consumption of the world. Also, the European Union and Europe region is consuming around 22% of world crude oil, and this data is from 2013.

So economic growth in these regions that are large consumers of crude oil can influence the crude oil. If the economy is doing good, if growth rate-- economic growth rate-- is high, it gives the signal that the demand in the future-- there will be high demand for crude oil in the future. And if the economy is slowing down, it means that the expected demand will not be as high as before. The increasing demand will be not as high as before, and it is going to potentially affect the price of crude oil.

The other factor that can potentially influence the crude oil price is the United States exchange rate. As you know, crude oil is globally being traded in US dollar. So the fluctuation of exchange rate, US dollar compared to other currencies, can potentially affect the crude oil price.

Why? Because there are many traders outside of the United States, and they are trading the crude oil which is being traded in US dollar. So if the dollar value decreases-- if US dollar loses its value-- it means that those traders living outside of the United States will have higher buying power. So they can buy more crude oil futures contracts. It means that there will be higher demand from outside of the United States. It will increase the demand of crude oil and can potentially increase the price.

So usually, there is a strong correlation, negative correlation, between the United States US dollar value and crude oil price. During the periods of a strong US dollar, foreign traders, investors try to sell their future contracts. And when the US dollar loses its value, they tend to buy more contracts.

The other factor that can impact the price of oil is geopolitical events, especially in the regions that are big producers of oil. Any conflict or potential conflict can impact the prices. Any news that can give the sense of potential interruption in supply can increase the price.

Please note that it doesn't necessarily need something to happen that interrupts the supply. Traders are also humans. They behave emotionally. They can react to the news in an emotional way. So if news says some potential conflicts in the region where large producing countries are located, it can potentially affect the perception of the supply in the future. It could potentially interrupt the supply, or it can influence the perception of the supply in the future and can have a significant impact on the crude oil prices.

For example, in mid-June 2014, WTI-- West Texas Intermediate-- crude oil price was about $107 per barrel. And at the end of that year, it went down to around $54 per barrel. We can explain this price behavior into two major factors that influence the price. First, the increased supplies of oil in the United States, mostly coming from unconventional reservoirs, shale and tight sands, because the price of oil was high. And at this price, at around $100, it's totally economically feasible to produce oil from costly unconventional reserves.

Around this time, Saudi Arabia-- that is, one of the largest producers and exporters of crude oil-- tried to maintain the market share by flooding the market with cheap oil, but this strategy caused excess supply and price to drop substantially. Low price of oil can have a large impact on oil-producing countries that are highly dependent on the revenue from oil. Also, in the United States, the companies who are working on the exploration and production section of oil, they will have to cut back on exploration and drilling activities, too, because they lose their revenue. And potentially, if the price is too low, they can potentially-- the small companies-- they can go bankrupt.

The other major player in the oil global market is OPEC, or the Organization of Petroleum Exporting Countries. OPEC was formed in 1960 by the first five members, including Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. And right now, at the moment, 2017, it has 14 members. OPEC produced around 43% of the world's total crude oil in 2015, and OPEC members control about 73% of the world's total crude oil reserves. So every decision that OPEC members-- every agreement or even the meetings that don't come to an agreement can potentially affect the price of crude oil.

For example, if OPEC members come to an agreement and they cut back to production, it can cause the supply-- the world's total supply-- to decrease and eventually cause price increase. And if in their meetings, let's say there's time and there's a conflict-- politics is always involved in the decisions. If there is a period that prices are going down and they cannot come into an agreement for cutting back the production, then it can potentially affect market prices and potentially cannot stop the price decrease.

Credit: Farid Tayari

Fundamental Factors Part 3: Supply & Demand Statistics

(3:45 minutes)

EBF 301 Factors Influencing Crude Oil Price Part 3
Click for a transcript.

Farid Tayari: Following the previous videos, in this video, I'm going to explain the factors that can influence the crude oil price.

The last factor that I'm going to explain is supply and demand statistics. Any informational report that can give some information about the production or consumption of crude oil and, also, its distillates products can cause an impact, can cause a price change.

There are a variety of reports being published by governmental entities, both US and international, as well as industry associations. And these reports are good sources to predict the behavior of the crude oil price.

EIA, Energy Information Administration, from the US Department of Energy, issues a report on the status of country's inventory of crude oil, and its various distillates. This report is being published every Wednesday at 9:30 AM, and it has several pieces of key supply and demand statistics.

I'm going to explain some of the items that are included in this report. First, a refinery utilization, the percentage of total US refinery capacity that is running indicates both demand for crude oil as well as production of gasoline.

And, two, is an import report, both raw crude oil and refined products, such as gasoline. They are imported and volumes are compared to last year, which could be indicators of improving or worsening the balance.

The other part of the report includes commercial crude oil inventory. The change in inventory from one week to the next week has a profound impact on crude oil prices from a trading standpoint.

Analysts provide forecasts for the change in inventory ahead of the actual report. And financial and energy commodity traders react to the difference between the forecasted and actual report.

The other piece of information that is included in the report is gasoline inventories. Total gasoline products, as well as, breakdown between finished gasoline and blending products, gives a picture of supply and demand for gasoline. A decrease in total products could mean more demand for refinery feedstocks. Surplus could mean just opposite.

If there is an inventory, it means that there will be more supply to the market, and price won't go up, then they potentially could go down.

Information about distillate fuel is also included in EIA Inventory report which, in this category, is mainly about heating oil. And as I explained earlier, the cold winter-- the cold weather, or low temperature, means higher demand for heating oil.

And if there is low inventory, if there is low storage, it can be translated to low shortage of supply and higher prices in the cold days.

Optional Video: Exchange Rate Example

Click here for a transcript of the Factors Influencing Crude Oil Part 2 Exchange rate example video.

So as I explained in previous video, value of the US dollar or US dollar exchange rate versus foreign currencies is one of the factors that affects the crude oil price. As we know, crude oil is a global commodity that is traded globally, but in US dollars. So any fluctuations in the exchange rate between US dollar and foreign currencies can affect the crude oil price.

I'm going to explain that in a very simple example. Let's assume there are two traders who trade crude oil futures contracts. So one is Trader A is in the United States and Trader B is in Europe. Trader A has $1,000, and Trader B has 1,000 euros.

So first, let's assume that the exchange rate between US dollar and euro is 1-to-1 so meaning that $1 is equivalent to 1 euro. And let's assume that crude oil price is $50 per barrel. OK, let's see what happens for Trader A.

Trader A has $1,000 and can buy 20 barrels of crude oil or can buy futures contract equivalent to 20 barrels of crude oil. So $1,000 divided by 50 leaves 20 barrels of crude oil.

Let's see what happens to the trader in Europe. So Trader B has 1,000 euros. The first thing that Trader B has to do is going to the exchange and convert the 1,000 euros to the equivalent dollar amount, which is $1,000. Then with that amount, Trader B can buy crude oil. So Trader B can also buy 20 barrels of crude oil.

So the total demand will be 20 from inside the United States and 20 internationally, assuming there only two traders. So there will be 40 barrels of crude oil demand, total demand.

OK, now let's assume the case that US dollar loses its value. So again, same traders, two traders, Trader A is located in the United States and has $1,000. Trader B is in Europe and has 1,000 euros.

And now let's assume US dollar has lost its value. Now $1 is equivalent to 0.8 euros. Or with 1 euro, you can get $1.25. And let's assume the crude oil price has stayed the same, $50 per barrel. And let's see what happens.

OK, trader A still has $1,000. Crude oil price is still $50 per barrel. So Trader A inside the United States can still get that 20 barrels of crude oil.

And let's see what happens to Trader B. Trader B has 1,000 euros. Trader B has to go and exchange that 1,000 euros to equivalent dollar. And as we can see, because dollar has lost its value, that 1,000 euros will be converted to $1,250 because, with 1 euros, Trader B will get $1.25. So Trader B has $1,250, which can buy five more contracts. So Trader B would end up buying 25 barrels of crude oil or futures contract equivalent to 25 barrels of crude oil.

So 20 barrels demand from Trader A inside the United States and 25 barrels of crude oil demand from Trader B outside the United States-- so total demand will be 20 plus 25, 45 barrels. So we can see the demand increase from 40 barrels to 45 barrels when the dollar has lost its value. So it means that demand has increased. So demand curve shifted to the left-hand side, which changes the market equilibrium price for crude oil. And it potentially increases the crude oil price.