What factors cause an increase in the price of oil?

What Factors cause an increase in the Price of Oil?
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Rising Demand

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.

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Inelastic 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.

Speculation

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.

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2 thoughts on “What factors cause an increase in the price of oil?

  1. Price of probably has increased because of the set number of oil wholesalers and access to oil. Unlike many other industries not everyone can be a seller of oil therefore as you rightly pointed out the burden increases on the set number of oil extractors, wholesalers and ditributors therefore passing the cost onto the end customer.

    Also there is the element of what they can get away with charging since the demand for oil has not declined.

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