What Determines Oil and Gas Prices

As the years pass by, oil and gas seem to play an even bigger role in the world. Drilling to find oil in the early days was considered somewhat of a nuisance as the intentions of the drill was to in fact find water or salt. It wasn’t until the 1850’s that oil was commercialised, and we started to drill for oil.

The early demand for oil, however, was for oil lamps and kerosene, not as we know it today. In 1901, the first commercial oil well that was capable of mass production was drilled producing more than 10,000 barrels a day. With this new discovery, it was soon to be the worlds primary fuel source, replacing coal.

Gas and oil are very much a commodity today and continues to be in high demand across the globe but how exactly are oil and gas prices determined?

There are two main factors that impact oil and gas prices including supply and demand and market sentiment.

Supply and demand are a pretty easy concept to understand. When demand increases the price generally goes up and as demand decreases the price will go down. This works in the same way with supply. If supply increases prices go down and if it decreases, then prices go up. Simple right?

Not exactly. The price of oil isn’t determined on supply and demand alone but is also set by the oil futures market which is a binding contract agreement that gives someone the right to purchase oil by the barrel and a set price on a set date in the future. Under this contract, both the buyer and seller are obligated to fulfil their side of the contract on the date specified.

From the basic supply and demand theory, it seems logical that if we produce more oil and gas the cheaper, we can sell it for. Supply has actually increased, but that doesn’t mean to say that prices are going to fall. Although producing more, distribution and refinement can’t keep up. So why not increase this right? There are in fact fewer refineries than before with many now closed. Refineries also only operate at 62% of their capacity due to needing the excess capacity to meet future demands.

So, in hindsight unlike a lot of products, the price of oil and gas cannot be solely determined on supply, demand and market sentiment. However, they can be used to determine oil futures contracts. Regardless of how the price is determined it is obvious that oil and gas will still be in high demand for the foreseeable future due to its use in fuels and countless consumer goods.