The political situation in the Middle East can have a dramatic impact on oil supplies. However, threats to the oil supply are beginning to emerge outside of the region as well. For instance, there are political situation beginning to arise in Russia, Venezuela, and Nigeria (Federal Reserve, 2004). Political instability can disrupt the supply of oil from a particular region.
Weather can also take a toll on the production and distribution of oil and oil products. For instance, hurricane Katrina disrupted oil production in the Gulf of Mexico. This caused a temporary shortage until the services could be restored. There are other external factors that can effect oil prices that are beyond the control of the companies.
Oil futures represent clamed to oil to be delivered at a specified price and at a specified date and location. If the price of oil rises above the price specified on the contract, the purchaser will be able to sell their claims to the oil at a profit. Buying oil futures requires a high degree of speculation on the part of the futures broker. The general consensus among speculators is that oil shortages will worsen in the future as demand continues to climb.
There is also room for artificial manipulation on the part of oil speculators. It oil futures are high, than oil producers will hold back oil from today's market, waiting for a better time to buy (Federal Reserve, 2004). When oil speculators hold back waiting for higher prices in the future, it causes an artificial drop in supply. This is another way in which companies can manipulate oil prices. When speculators hold back massive quantities for future purchase, it creases a temporary shortage in supply (Federal Reserve, 2004). This is a key reason for spikes in oil prices. The oil needed to meet demand is available, but it is not being released. Investors are not concerned about temporary spikes due to anticipated high futures prices.
Spikes in price are a key disadvantage in oil speculation and cause the practice to have a negative connotation (Harrison, 2006). Oil Speculators are often blamed for oil prices, when in fact the rise stems from another factor. However, oil speculation has one positive benefit. It assures that there is a future supply of oil available should natural disruptions in the supply occur (Federal Reserve, 2004). Oil speculation can boost current production of oil, as producers attempt to fill the temporary shortages and receive a premium price for their product (Harrison, 2006). Oil speculation assures that there will be a supply available when it is needed.
One of the difficulties that the layman has is how to determine whether the rise in price is temporary or long-term. There are several key indicators that can help to determine if a spike in price is the result of speculation or whether it represents a downward trend. The first way to determine if prices are a speculative move is if the daily oil price is highly reactive to news about future supply and demand. A second indicator that an oil price rise is the result of speculative training is that we should see speculative traders holding large amounts of oil for future delivery (Federal Reserve, 2004). This information is not always readily available to the general public. A third indicator that a rise in oil price is due to speculation is the accumulation of significant increases in inventory being held for future use (Federal Reserve, 2004). When one begins to see these three conditions being met, then a rise in price is more likely to be speculative and represents s short-term rise that will come back down quickly.
However, if one begins to see a rise in oil prices without the presence of inventory build up, then it may be that this represents a more permanent rise in oil prices (Kilian, Revucci, and Spatafora, 2007). It may mean a new high for oil prices that will be sustainable in the future. Historical data is usually used to determine if surpluses are being held for the future (Federal Reserve, 2004). Decreases or increases from the previous year are a good indicator as to the direction that futures prices will take. However, this method is not perfect, unless one takes into account rises in demand into the equation.
Inflationary Adjustments in Oil Prices
Aside from supply and demand, oil also adjusts just like any other commodity in relation to inflationary forces. Inflationary rises are often difficult to spot because they happen more slowly. They are more gradual than spikes caused by futures speculation....
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