How is the Price of Oil Determined?

Crude oil prices are nearing record highs, when adjusted for inflation, but history has shown that the cost of the energy resource is subject to wide variations depending upon market conditions. In inflation adjusted dollars, the record price for crude oil is about $110 per barrel, a level reached in 1979. According to WTRG Economics, the price of crude oil has been subject to significant government regulation that has kept the commodity at levels below those found in the rest of the world.

The price of crude oil is determined by many factors. According to the peak oil theory, the earth only holds a finite supply of oil, and as a result the production of the commodity will peak at some point and then decline. However, since more than three-quarters of the world has yet to be subjected to oil exploration, there is some time before crude oil supplies are exhausted.

A fact sheet published by oil-gas-consulting.com argues that while both economic and political events are factors in determining the price of crude oil, the former affects long-term pricing while the latter, particularly in the Middle East and Arabian Gulf area, has a more immediate effect in the short-term. The fact sheet says that political events have differing impacts, depending upon whether they are expected or unexpected. Expected events tend to be factored into pricing by traders in spot and futures markets while unexpected events that result in political instability in oil producing regions tend to cause price spikes and wide fluctuations.

A crude oil price history available from the New York Stock Exchange reveals that between December 31, 2005 and December 31, 2007 oil prices fluctuated from a beginning level of $61.04 to an ending level for the period of $95.98. The price of a barrel of crude oil broke the $100 threshold on January 2, 2008. In the New York Stock Exchange's history of crude oil prices, the lowest level during the evaluated period occurred on January 19, 2007 when the price for a barrel of oil was $51.99. From then until the end of the year, the price of crude oil per barrel rose sharply to finish the month of December just under $96 per barrel. The price history provided by the New York Stock Exchange reflected prices per barrel for light sweet crude oil for future delivery.

Political instability has been responsible for much of the recent increase, with damage to Nigerian infrastructure, international tensions regarding Iran's pursuit of nuclear technology, and the ongoing war in Iraq. A calming of the situation between Iran and the international community and continued security improvements in Iraq could mean that oil prices will begin to come down in the near-term.

Sources: WTRG Economics web site, Peak Oil News web site, Oil-Gas-Consulting.com web site, New York Stock Exchange TV web site