What Factors cause an increase in the Price of Oil?
Increasing demand will push up price of oil. A short term rise in demand could lead to a significant increase in price, because supply is quite inelastic. The main reason for the rising price of oil is the increased demand that we are seeing, especially in the developing world. Countries such as China and India are experiencing rapid rates of economic growth. Because their population is so large ( a combined population of over 2.5billion) this rapid economic expansion, combined with large population is causing an unprecedented rise in demand for oil. Demand for oil tends to be income elastic. For example, the growing middle class in China have aspirations to own a car, therefore the increase in income can cause a proportionately bigger % increase in demand.
With many goods higher prices lead to lower demand as people switch to alternatives. However, demand for oil is notoriously inelastic because of the lack of available substitutes. In the long term, demand may become less inelastic because substitutes develop; but, at the moment we still search for those elusive alternatives. This means as price rises, demand doesn’t drop off. People just pay the higher prices.
Disappointing yields from known suppliers
Many countries have struggled to increase supply as much as they like. US, UK, Russia and even many Arab countries have found it difficult to meet the rising demand. Their is still plentiful oil supplies (although there is a significant debate about the true extent). However, as more oil is extracted, it becomes increasingly expensive and difficult to extract oil. Certainly now that oil is over $140 a barrel it will encourage oil exploration in less accessible areas such as Siberia and the Antarctic. But, even it if is possible to increase supply from these areas, it will take time for these extra supplies to come on track.
The price of oil does not just depend on economic fundamentals. There is also an element of speculation with investors predicting oil prices will keep rising, therefore, they are buying oil futures pushing prices up.