The political situation in the Middle East is extremely volatile. The political situation in the Middle East can have a dramatic impact on oil supplies. However, threats to the oil supply are beginning to emerge outside of the region as well. For instance, there are political situation beginning to arise in Russia, Venezuela, and Nigeria (Federal Reserve, 2004). Political instability can disrupt the supply of oil from a particular region.
Weather can also take a toll on the production and distribution of oil and oil products. For instance, hurricane Katrina disrupted oil production in the Gulf of Mexico. This caused a temporary shortage until the services could be restored. There are other external factors that can effect oil prices that are beyond the control of the companies.
Oil futures represent clamed to oil to be delivered at a specified price and at a specified date and location. If the price of oil rises above the price specified on the contract, the purchaser will be able to sell their claims to the oil at a profit. Buying oil futures requires a high degree of speculation on the part of the futures broker. The general consensus among speculators is that oil shortages will worsen in the future as demand continues to climb.
There is also room for artificial manipulation on the part of oil speculators. It oil futures are high, than oil producers will hold back oil from today's market, waiting for a better time to buy (Federal Reserve, 2004). When oil speculators hold back waiting for higher prices in the future, it causes an artificial drop in supply. This is another way in which companies can manipulate oil prices. When speculators hold back massive quantities for future purchase, it creases a temporary shortage in supply (Federal Reserve, 2004). This is a key reason for spikes in oil prices. The oil needed to meet demand is available, but it is not being released. Investors are not concerned about temporary spikes due to anticipated high futures prices.
Spikes in price are a key disadvantage in oil speculation and cause the practice to have a negative connotation (Harrison, 2006). Oil Speculators are often blamed for oil prices, when in fact the rise stems from another factor. However, oil speculation has one positive benefit. It assures that there is a future supply of oil available should natural disruptions in the supply occur (Federal Reserve, 2004). Oil speculation can boost current production of oil, as producers attempt to fill the temporary shortages and receive a premium price for their product (Harrison, 2006). Oil speculation assures that there will be a supply available when it is needed.
One of the difficulties that the layman has is how to determine whether the rise in price is temporary or long-term. There are several key indicators that can help to determine if a spike in price is the result of speculation or whether it represents a downward trend. The first way to determine if prices are a speculative move is if the daily oil price is highly reactive to news about future supply and demand. A second indicator that an oil price rise is the result of speculative training is that we should see speculative traders holding large amounts of oil for future delivery (Federal Reserve, 2004). This information is not always readily available to the general public. A third indicator that a rise in oil price is due to speculation is the accumulation of significant increases in inventory being held for future use (Federal Reserve, 2004). When one begins to see these three conditions being met, then a rise in price is more likely to be speculative and represents s short-term rise that will come back down quickly.
However, if one begins to see a rise in oil prices without the presence of inventory build up, then it may be that this represents a more permanent rise in oil prices (Kilian, Revucci, and Spatafora, 2007). It may mean a new high for oil prices that will be sustainable in the future. Historical data is usually used to determine if surpluses are being held for the future (Federal Reserve, 2004). Decreases or increases from the previous year are a good indicator as to the direction that futures prices will take. However, this method is not perfect, unless one takes into account rises in demand into the equation.
Inflationary Adjustments in Oil Prices
Aside from supply and demand, oil also adjusts just like any other commodity in relation to inflationary forces. Inflationary rises are often difficult to spot because they happen more slowly. They are more gradual than spikes caused by futures speculation. One of the key indications that a rise in oil price is the result of inflation that oil prices are rising at the sale rate as other commodities. Oil prices typically adjust more quickly than other commodities....
Therefore, adjustments in monetary policy will first show up in commodities that adjust more rapidly to changes in monetary policy (Federal Reserve, 2004). However, many analysts do not find oil prices to be a reliable instrument for setting monetary policy (Federal Reserve, 2004).
Using oil prices to set monetary policies would work if oil prices reacted reliably to adjustments in inflation. However, there are many other factors that can effect oil prices, such as geopolitical upheaval, the weather and other less predictable factors. Therefore the consensus is that oil prices can be affected by inflation, but that this is not a reliable means to determine the direction of oil prices in the future. When a certain commodity rises more rapidly than other commodities, it is more likely to be a temporary rise in price (Federal Reserve, 2004).The commodity that overshoots the inflationary index will be more likely to adjust back down to levels that are more in line with other commodities. However, before one uses this as a rule to determine if the current rise in oil prices is temporary or long-term, it is important to consider the complexities of the oil market. One must determine if other factors are at play in the high prices.
Determining the Best Method for Predicting Oil Prices
This research discussed the complexities of the oil market and examined three factors that can help to predict future trends. In this analysis, no single factor emerged as the best way to predict oil prices in the future. All of these factors help to determine oil prices. It is important to understand that they work in conjunction with one another. To complicate matters further, any one or a combination of these factors can emerge as the predominant factor in any trend. For instance, if OPEC decides to cut production and all other factors are in balance, then supply decisions by OPEC take precedence over the other factors. However, inflationary forces, as well as speculative forces might also be working together to produce a particular trend.
Currently, oil prices are at a historically high trend that has been building for approximately three years. This represents a long-term trend, rather than a temporary spike. However, the most important question is not what oil prices have done to reach this new high, but rather whether they will stay at this level for the long haul. The question weighing on everyone's mind is whether they will continue to climb higher. If they do climb higher they will begin to have a negative impact on the economy, particularly that of the United States. The United States and other highly industrialized nations are more susceptible to economic turmoil due to high oil prices than non-industrialized nations. Oil is more highly imbedded in the economies of industrialized nations as it is used the transportation that is necessary to make the economy function.
As far as future demand is concerned, it is likely that the demand for oil will continue to rise on a global level. As an increasing number of industrialized nations rises to the ranks of industrialized nations, their dependence on oil will increase as well. This will have a significant impact on the demand for oil in the future.
Oil usage differs among industrialized nations. For example, Japan uses almost one-third the amount of oil as the United States (Federal Reserve, 2004). There are also differences in the efficiencies with which nations use their oil reserves. For instance, Chinas uses its oil much less efficiently than other nations. This partly due to the underdeveloped electrical grid in China and their heavy dependency on diesel powered generators (Federal Reserve, 2004). China is a recent player as far as industrialized nations are concerned. However, they will continue to develop their grid and improve in their usage of natural resources. Energy demand will increase, but so will the efficient use of China's resources.
On the demand side, energy use from all sources will continue to increase. The challenge will be meeting the needs of an increasing demand under the current constraints of production limitations.…
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