Oil is a consequential commodity that plays a much greater role in the global economy. With the travel and energy industry at the heart of human activities, oil demand will always be there. It is a high-demand commodity partly because of its use in fuels that power most systems at the human race center. Likewise, it is commonly referred to as black gold, given its importance in fuelling the global economy.
Sudden price spikes are known to have a ripple effect on various sectors of the global economy and, in some cases, can send the global financial market into a meltdown. Many factors are known to influence oil prices, news cycles, and policy changes as well economic cycles tend to have a significant impact on oil prices.
However, production, which affects supply, remains the key driver of oil prices in the market.
How Production Affects Oil prices
For a better understanding of the oil price fluctuations, a trader betting on the commodity should always monitor the factors we will be looking at below.
The supply factor
Since 2014, oil prices have been on a downward trajectory attributed to a glut in supply due to increased production. While prices did bounce above the $50 a barrel level, a plunge to the negative territory at the peak of the COVID-19 pandemic in early 2020 underscored the negative impact of higher production amid lower demand.
The plunge in oil prices to below the zero marks came as major oil producers continued to produce oil, even on-demand tanking to record lows. Countries worldwide imposing lockdown restrictions and travel restrictions all but led to an influx in oil inventories with nowhere to dispose amid a plunge in demand.
The events of 2020 all but affirmed how demand goes a long way in influencing oil prices. As demand plunged and oil majors continued to produce, a glut in supply came into play, conversely leading to a crash in oil prices.
The production factor
Oil is a commodity mined beneath the earth’s surface. Likewise, there are several countries with millions of oil reserves that they mine daily. The major oil producers are under the Organization of Petroleum Exporting Countries. As it is commonly known, OPEC is the body tasked with regulating oil production from 13 countries.
The fact that OPEC nations control almost 80% of the total world’s supply is one reason why the body has a big influence on any prevailing oil prices in the market. The consortium regulates oil prices by setting production levels.
OPEC’s production levels are designed to ensure only supply that meets global demand finds its way into the market. Therefore, the body can increase the production limit if there is pent-up demand or decrease the production limit whenever demand is low.
OPEC had initially promised to keep oil prices above $100 a barrel level by regulating production by member countries. Its refusal to trim production in 2014 triggered one of the biggest plunges as oil prices plunged from above the $1,000 a barrel level to less than $30 a barrel.
The shale boom in the US between 2011 and 2014 resulted in the US producing around $4.8 million barrels a day, resulting in a global market glut. Amid the increased production, oil prices plunged to $27 a barrel in 2016
Production costs and storage
In addition to production levels, production cost and storage cost influence oil prices. For instance, oil in the Arab countries is relatively cheap to produce compared to oil in Canada. Similarly, whenever there is more oil supply from Arab countries, prices tend to be lower given the lower production costs that don’t affect prices much.
However, whenever the market has to contend with oil supply from North America, prices can increase significantly as producers factor in the high cost of producing the same oil.
US Production also influences oil prices significantly. The US is one of the biggest consumers of black gold. Likewise, whenever production in the US fails to meet demand, the country is forced to import in bulk, which often causes prices to edge higher on supply from the other countries remaining constant.
Pre COVID-19, the US produced an average of 12.7 million barrels of oil. As oil producers shut operations in the aftermath of the pandemic, oil prices started ticking higher as demand improved and average production remained low.
Production cut wars
The free-fall in oil prices in 2020 at the height of the COVID-19 pandemic came on Saudi Arabia and Russia disagreeing on production levels. The result was a plunge in oil prices in response to a glut in supply amid weak demand.
OPEC and its allies were forced to carry out the biggest production cut in the history of 9.7 million barrels a day for two months. Starting July 1, 2020, OPEC members agreed to limit production to 7.7 million a day. The cut had a significant impact as oil prices started rallying from the negative territory to above the $50 a barrel level as of the end of the year.
Likewise, OPEC failure to impose strict production levels, especially in crisis times, has proved to be detrimental to oil prices. Increased supply amid lower demand has always triggered a decline in oil prices most of the time.
Supply and demand
Oil prices fluctuate in response to changes in supply and demand. As is the case with any commodity, oil prices will always slump whenever supply exceeds demand. Similarly, prices will always rise whenever demand outpaces supply.
For this reason, it is the role of the major oil-producing countries to regulate the production, as a whole, at any given time to ensure it matches the prevailing demand.
While oil prices are influenced by bets placed by traders in the futures market, it’s been proven over and over again that production remains a key factor. Factoring in the forces of supply and demand, production affects supply, which in return affects prices.