The Oil Market and The Financial Crisis Part I

The oil market and the financial crisis 1

The causes of the financial crisis of recent years will probably be discussed among historians and economists for a long time. So far, the debate has revolved around imbalances in the world economy, according to, the deficit in the US foreign economy and China’s surpluses, the deficits in the state budget in the US and the UK and failing regulation in both countries by financial institutions. However, there is also reason to look at the oil market in connection with the financial crisis and the financial institutions’ dispositions.

  • What has happened to the oil price in recent years?
  • What distinguishes the oil market?
  • What are the main factors affecting the price of oil?
  • How heavy is the oil bill in the countries’ economies?

A first assumption is that the rise in oil prices in the 2000s has to a large extent been caused by financial actors (investment banks and funds, hedge funds, etc.) who wanted to position themselves (speculate or secure values), more than by the real relationship between supply and demand. demand in the oil market (whether there is balance or imbalance in this ratio).

A second assumption is that the sharp rise in oil prices – especially from 2007 to 2008 – contributed to exacerbating an economic downturn that was already under way, primarily in the United States.

2: Commercial and financial actors

Fluctuations in the oil price (Brent) from $ 51 / barrel ($ 51 per barrel) in January 2007 to $ 142 / barrel in July 2008 to $ 34 / barrel in January 2009 show the sensitivity of the oil market to changes in both the immediate, actual balance between supply and demand , and expectations of future balance . Of particular importance are the level of activity in the world economy, which drives demand, and notions of political risk, which can affect supply.

The demand for oil is essentially determined by consumer income. In the short term, the price is less important because the alternatives are usually more expensive and because not using oil can lead to a loss of income. In the longer term, price is more important because consumers’ expectations of the price of energy are an important factor in their investment decisions. This can be, for example, when buying a new car or insulating homes.

At the same time, a sharp rise in oil prices can lead to reduced real income and thus indirectly affect demand. Therefore, demand for oil is sensitive to changes in employment and income, as in the United States in recent times.

Somewhat simplified, the price formation of oil can be presented as driven on three levels:

  • The balance in physical volume between supply and demand, where the building up and downsizing of stocks of crude oil and oil products is of crucial importance:
  • Risk assessments with significance for inventory management and for the desire to enter into agreements in the long-term real market (forward)
  • Financial players operating in the long-term paper market for oil (futures – futures)

Financial players entered the oil market in earnest after the second oil price jump in 1979–80, and the paper market developed rapidly. Venture capital was given better opportunities to participate in the oil market. During the Gulf crisis in 1990–91, the paper market was able to anticipate developments in the real market . In August 1990, oil prices more than doubled after Iraq occupied Kuwait, with no physical shortages . In January 1991, the price of oil fell on the same day as the war to expel Iraq began, without the supply of oil having increased.

Later, the paper market has been the most important driving force for oil prices, but will sooner or later be overtaken by the balance in the real market. In the 1980s, the expectation was that the paper market would contribute to stabilizing the oil price by taking an advance on future developments in the real market. In retrospect, however, the paper market seems to have helped to destabilize the oil price by reducing the immediate significance of the real market. The extraction costs have become even less important for the oil price, so that the element ground rent, extra profit, has become greater, and the oil price even less anchored in actual costsby production and distribution. In the paper market, there are tendencies towards herd behavior. Financiers can outbid each other and drive up the oil price, and they can follow each other out and drive down the oil price sharply.

3: Oil supply and price movement

The supply of oil is determined to a certain extent by the Organization of Petroleum Exporting Countries

OPEC. Where is Saudi Arabia the country that carries the most weight. In general, however, the country – the world’s largest oil exporter – has only a limited capacity to regulate volume in order to influence oil prices. Other important oil-exporting countries are Canada, Mexico, Norway and Russia, and soon Brazil. OPEC has recently shown a relatively good ability to reduce oil production (volume) to justify oil prices, but high spare capacity also entails a risk of falling prices. Speculation in the markets can contribute to sudden changes in oil prices.

In addition, political risk , primarily related to conflicts in the Middle East, sometimes has a major impact on oil prices. Historically, jumps in oil prices have been caused by sudden cuts in oil supplies , or credible threats of disruption, linked to political events, primarily in the Middle East, such as in 1973-74, 1979-80 and 1990-91. Expectations of scarce supplies drive up oil prices. This time, in 2007–08, the course of events and the causal factors have been different.

The oil market and the financial crisis 1