Oil Markets and Price Movements: A Survey of Determinants

Abstract

The complexity of the world oil market has increased dramatically in recent years and new approaches are needed to understand, model, and forecast oil prices today. In addition to the commencement of the financialization era in oil markets, there have been structural changes in the global oil market. Financial instruments are communicating information about future conditions much more rapidly than in the past. Prices from long and short duration contracts have started moving more together. Sudden supply and demand adjustments, such as the financial crisis of 2008-2009, faster Chinese economic growth, the Libyan uprising, the Iranian nuclear standstill or the deepwater horizon oil spill, change expectations and current prices.

The daily Brent spot price fluctuated between $30 and above $140 per barrel since the beginning of 2004. Both fundamental and financial explanations have been offered as explanatory factors. This paper selectively reviews the voluminous literature on oil price determinants since the early 1970s. It concludes that most researchers attribute the long-run oil price path to fundamental factors such as economic growth, resource depletion, technical advancements in both oil supply and demand, and the market organization of major oil petroleum exporting countries (OPEC). Short-run price movements are more difficult to explain. Many researchers attribute short-run price movements to fundamental supply and demand factors in a market with very little quantity response to price changes. Nevertheless, there appears to be some evidence of occasional financial bubbles particularly in months leading up to the financial collapse in 2008. These conflicting stories will not be properly integrated without a meeting of the minds between financial and energy economists.

Keywords: oil prices, supply and demand analysis, financial markets

JEL Classification: D4, E3