Understanding the Oil Market in Uncertain Times

October 26, 2023 23:28

Despite the global transition to cleaner energy, the truth is that crude oil still plays an enormous role in our lives. It permeates every inch of the global economy and is a key factor in the production and distribution of the vast majority of goods and services in the world.  

Consequently, changes in oil prices often have ripple effects throughout the economy. This has been particularly evident over the last couple of years, as high oil prices have played a significant role in pushing up inflation around the world. Understanding the oil market, then, is not just important for oil traders, but can also help observers digest what is happening in the wider economy.

What Drives Oil Prices?

As with any commodity the price of oil is dictated by levels of supply and demand in the global market. However, in reality, it’s actually far more nuanced than that.

Rather than being driven solely by the actual levels of supply and demand at a particular point in time, often, oil prices are driven by speculation over what might happen to supply and demand. This means that movements in price often precede actual events taking place.

All commodities are sensitive to geopolitical events but this is particularly true of oil. As we have seen all too well over the last couple of years, the price of oil can behave quite erratically when geopolitical tensions simmer, particularly when oil producing nations are involved.

Besides geopolitical events, oil prices can be reactionary to changes in economic health. Growing economies tend to consume more oil than stagnant or shrinking ones, meaning that in times of economic boom oil demand grows. On the other hand, in times of economic gloom, the outlook for oil often follows suit.

What’s Currently Moving Oil Prices

So, what’s moving oil prices at the moment? In the following sections, we will take a look at factors which oil traders should bear in mind whilst navigating the market in the current climate.

Tension in the Middle East

In February 2022, we saw what happens to oil prices when conflict arises involving an oil producing nation. Less than two weeks after Russia, a major oil producer, invaded its neighbour, Brent crude prices jumped more than 30%.

Unfortunately, at the beginning of this month, we witnessed a repetition of this grim phenomenon, this time in the Middle East.

As markets reopened the week following Hamas’ attack on Israel, Brent crude prices spiked more than 4% in one day. In the ten days that followed, prices rose a further 5%. These increases were sparked by fears of an imminent conflict spilling over to neighbouring countries in a region which supplies much of the world’s oil.

However, a flurry of diplomatic manoeuvring and a subsequent delay in the anticipated Israeli invasion appear to have eased fears of contagion in the region. However, this situation seems far from resolved and is certainly something to remain conscious of.

Weak Economic Outlook

The correlation between oil prices and economic health is fairly easy to understand. When the global economy is growing, demand for oil tends to increase. Of course, the opposite also tends to be true, and this is one of the factors which has weighed on oil prices in recent months.

Firstly, China, which is the second largest oil consumer in the world, has churned out a slew of underwhelming economic data since the post-Covid reopening of its economy. Consequently, Chinese economic growth is forecast to slow significantly this year, and even further next year.

More recently, earlier this week, oil markets were knocked by weak business activity data coming from both the eurozone and the UK. The bloc’s largest economy, Germany, is already in recession, and this latest data has prompted fears that the wider bloc, a key source of oil demand, may also enter recession.

Higher Interest Rates

Whilst central banks appear to be nearing the end of their rate hiking cycles, the expectation is that rates will remain higher for longer. Although there may not be a direct link between rising interest rates and oil, it can indirectly add downward pressure to oil prices.

In order to tame high inflation, central banks around the world have hiked interest rates. However, as well as bringing inflation to heel, higher interest rates can stifle economic growth which, in turn, can lead to a decline in demand for oil.

Trading Oil – Understanding the Current Climate

As with any asset, it is important to be aware of the risks involved when trading oil and to have a carefully considered risk management plan in place. Commodity prices have a tendency to be particularly volatile, which can significantly increase the risks involved in trading.

It is also important to understand the current climate and to be aware of the geopolitical events and economic announcements that could impact oil prices. A good way of keeping on top of the latter of these is by using an economic calendar, which allows you to keep track of important economic updates.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

Roberto Rivero
Roberto Rivero Financial Writer, Admirals, London

Roberto spent 11 years designing trading and decision-making systems for traders and fund managers and a further 13 years at S&P, working with professional investors. He has a BSc in Economics and an MBA and has been an active investor since the mid-1990s