The price of oil, Russia and gasoline (expensive?)

In the weekly “Price Forecast” section, we usually look on Monday at the expected price development of various investments, including oil. Since today is Easter and European stock exchanges are closed, our price forecast will appear tomorrow (on Tuesday). Instead, today in the Beyond Price Forecasts section, we discuss how the price of oil is determined. We also discuss to what extent the price of oil determines the price of gasoline.

In this article we will discuss how the price of oil is determined, the factors that determine the price of oil and what is the relationship between the price of oil and oil prices.

How is the price of oil determined?

There are several ways to trade oil. These are important because the price of oil is set differently for those categories. The three main methods are: spot price, options and futures. We briefly discuss the different categories of oil prices and the way the oil price is set for each category.

Spot oil price

The spot price of oil is the price determined by the market at a particular moment, and therefore by direct factors that determine the market price of oil (discussed below). The price is set per barrel.

Oil futures price

If you want to invest in oil as a private individual, of course it is not meant to have a backyard full of barrels of oil after purchase. It will also not be practical if you want to make several transactions in a day as it is very busy on the street. This is the reason why many individuals trade oil futures contracts. This allows you to speculate on the price of oil over a certain period, for example a week or a month. If you think the price of oil is going down, you trade and place oil futures contracts. These give the right to sell (barrels) of oil on the agreed date at a certain price. If you think the price of oil is going up, you are trading a call for oil futures. These give the right to buy (barrels) of oil on the agreed date at a fixed price. If the market goes up, you can sell it back at a higher price. With futures contracts, you are obligated to execute the transaction at the agreed upon time.

Since you don’t have to buy oil at the time of buying the futures contract, you only pay a premium at the close of the future. In addition, you must have collateral to allow the transaction to continue. In practice, this often means settling the profit or loss balance on the due date.

Oil options price

Oil options are largely comparable to oil futures. However, there is one distinct difference. As the name suggests, this form of trading is an option. So you can choose whether you want to execute the transaction on the agreed due date (also called execution date) or not. Of course, only do this if you can make a profit from the deal on the execution date. Here you also pay a premium. If you can’t make a profit, don’t execute the deal. You will lose your premium of course.

What are the factors that determine the price of oil?

As always, price is determined by the law of supply and demand. The higher the demand or the lower the supply, the higher the price and vice versa. There are 4 factors that structurally affect the supply and demand for oil. here they are:

  • Economic activity: the stronger the economy grows, the greater the demand for oil;
  • Organization of Petroleum Exporting Countries (OPEC): Many oil-producing countries are consulting here about production in the short and long term. This largely determines the width. Another major oil exporter, America, is not a member of OPEC. America can also influence the price by exporting more or less;
  • Alternative Energy Sources: The more energy that can be obtained at a good price from other energy sources such as wind, sun and water, the lower will be the demand for oil;
  • Oil supply: If one produces more oil than required, it is stored in storage tanks. This limits the impact on price, unless there is excess capacity that also makes storage locations full. In this case, there is a very large inventory, which can lead to a rapid drop in prices. In addition, of course, there is the absolute oil supply. If less oil can be extracted due to unavailability of oil fields, this will cause the price of oil to rise.

What is the impact of the war in Ukraine on oil prices?

Because of the war in Ukraine, oil is less available. This is partly because Ukraine, as well as Russia itself, is consuming more oil. In addition, attacks on oil refineries and transportation routes make transportation more difficult. The third factor is that many countries impose sanctions on Russia, which makes it more difficult to buy Russian oil. Of course, this also reduces the width. In addition, investors are concerned about possible further sanctions that would make Russian oil less available.

This turmoil is clearly reflected in the chart below, which shows the development of the oil price.

Historical oil price
Historical development of oil prices. Tradingview.com

However, we also see something amazing. If we zoom in on the development of oil futures prices in 2022, it is noticeable that the return during the period from January 1 to now is +40.71%, but the return over the past month is “only” 5.53% and even the week recorded a loss of 1.05%. This has to do with the new Corona wave in China, as a result of which production there has fallen sharply and therefore there is (a lot) less demand for oil.

The relationship between the price of oil and gasoline

Of course, the price of oil affects the price of gasoline. If you follow the news, they can’t escape your noticing that there’s no fun at the pump. However, things are different here too.

How much is the real increase in gasoline prices in 2022 so far?

According to figures from Statistics Netherlands, a liter of gasoline (95 euros) at the pump cost 1,974 euros at the pump on January 1. If we then look at the evolution of the Euro95 price in 2022, we see that the most recent price per liter 95 euros is 2,084 euros (measured on April 10). This represents an increase of 5.57% (while the increase in oil futures contracts so far is 40.71%). Of course we have to take into account the excise tax reimbursement from the government which took effect on 1 April. That’s why we looked at the highest price per liter of €95 this year so far. This was recorded on March 10 this year and amounted to €2,383 (or +20.72% increase compared to the price of gasoline on January 1).

This indicates that there is a difference between the evolution of oil prices and the evolution of oil prices. This can be explained by the fact that, according to Shell, only 21% of the price of a liter of gasoline at the pump is determined by the price of crude oil. The rest of the price consists of refining costs (2%), storage and transportation costs (3%), production charges (45.6%), operating costs (11%), and 21% levied on this total. This directly explains why, despite the same price of oil, refueling in Germany or Belgium is still often cheaper.

We hope this post provides more ideas if you want to do your own research into investing in oil. You can read more basic information about investing in the “Beyond Price Forecasts” section. If you are interested in the expected development of the price, you can, of course, always study the weekly price forecast.

Note: We never provide financial advice, so you cannot interpret our contributions in this way. Always do your research and make rational decisions about whether to invest and when, what and how much to invest.

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Behind price predictions: the price of oil, Russia and (expensive?) gasoline

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