Price of OilOne of the common questions that I get asked about on numerous occasions tends to be around what actually causes the price of petrol to increase or decrease in price?

It's a fair question and the first part of the answer is to always link it back to the cost of the commodity that is used as the raw material to produce petrol; the cost of a barrel of oil. So now we need to look at this in more detail and what are the factors that cause the cost of a barrel of oil to increase or decrease in price?

The most obvious answer and the one that all economists like to use is SUPPLY and DEMAND. What this effectively means is how much oil is actually being pumped from the ground and offered for sale, whilst also how many people are actually wanting to buy those barrels of oil that are sitting there waiting for a buyer. In an ideal world you want to have enough supply to meet demand as this will always keep the price constant, however this is business and oil is a great commodity which can make a country rich.

If a country was to cut the supply of oil, eg; pump less oil out of the ground, so have less barrels of oil to sell - what would you expect to happen to the price of each barrel of oil if the level of demand was to stay the same? The price should increase, because you have more customers wanting to buy and less items on the shelve for them to buy. This means that the shop (oil producing countries) can increase the price of each barrel as if the customer really wants that barrel of oil, they will pay more for it.

This is a tactic that is used by many businesses, as cutting supply of your product or just controlling the supply of your product is a great tactic in being able to increase the selling price (sales revenue) and the gross profit margin that you make on each item you sell. This however only works when demand is higher than supply and tends to work in markets where the customer has no "substitute" items to choose from. A substitute in terms of business means an alternative item that the customer could choose, eg; Pepsi is a substitute for Coke Cola

The level of demand also has an impact on the price that we pay for a product or service. If there is an increase in the number of people trying to get their hands on the product or service, then unless supply increases you again get the situation where you have more customers wanting to get their hands on something that does not have enough supply to meet demand. This means that if a customer really wants it, then they will have to be willing to pay more to get their hands on it. In a business sense demand can be increased through the use of marketing, just like Apple does when it creates hype at the launch of their new iPhone. However demand for oil tends to increase when economies are growing, as consumers have more money to spend on items that are produced using this commodity as a raw material, whilst businesses start increasing economic output which tends to see an increase in the use of energy.

 

In an ideal business world an organisation would want to try and increase the level of demand for a product / service, whilst at the same time reducing supply. At the current time the main reason that the price of oil is falling is due to a reduction in demand, whilst supply of oil has remained the same. If the oil producers wanted to increase the price then they could reduce supply. The problem with doing this is that demand for oil tends only to increase when economies are growing, however increasing the price of oil is unlikely to help this to happen as quickly as low oil prices will do.

This is why many people feel that the current low prices or oil are only a short term measure as once economies around the world start to grow again and demand for oil increases, the price will start to increase once again. This increase in demand will once again suit the oil producers. This is a basic overview of how the price of oil is influenced by supply and demand.