Oil price fluctuation is a major source of uncertainty for businesses and consumers. When prices rise, people spend less on other things, and that can slow economic growth. When prices fall, companies benefit and stock markets usually rise.
Oil is a global commodity, and its price depends on thousands of transactions that take place simultaneously at all points in the world’s oil supply chain. Those transactions are driven by a combination of fundamental factors and speculative demand.
The fundamental factors are shocks to the actual flow supply of crude oil (such as OPEC production decisions or the disruption of production capacity by natural disasters), and shifts in expected future flows of oil demanded by forward-looking traders. Recent research shows that shocks to the actual flow supply of oil have had little impact on real oil prices since 1973, while shocks to expected future demands caused by speculative supply shocks played an important role in price fluctuations in the period from 1979 to 2008, notably following the collapse of OPEC and the Iraq war.
Other factors influencing the price of oil include seasonal demands, such as winter home heating oil, which increases prices in the Northeast U.S.; and transportation costs, which increase when the price of oil goes up, since deliveries from the Gulf Coast or Europe have to travel long distances across harsh climates. In addition, countries that are heavily dependent on petroleum exports tend to have large reserves of oil that can be used to reduce the impact of high prices.
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