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oil
it's the fuel of our economies
despite efforts to leave it behind
demand for crude is on the rise and
worldwide nearly 100 million barrels are
guzzled every single day
its price is notoriously volatile
just over the past few years oil prices
have swung dramatically the price of oil
has collapsed to a record low as demand
dries up and storage runs out crude oil
prices have risen to levels not seen in
a decade
continuing a decades-long cycle of boom
and bust
here at capital.com we recently covered
the price fluctuations of natural gas
you can watch that video by clicking up
here
but oil is a unique commodity so why are
oil prices so volatile and where could
they go from here
like other commodities oil is bought and
sold in something like a global auction
and the highest bidder
wins in terms of price everybody's in
the same boat
bob mcnally is a former top energy
advisor to president george w bush he
knows the ins and outs and the ups and
downs of the oil market
he even wrote a book about it oil is
widely traded priced in global markets
and more or less fungible everybody pays
the same price
what determines that price
it comes back to a familiar economic
principle
supply and demand
oil prices are extraordinarily volatile
because supply and demand for oil
are inelastic
meaning they're unresponsive to changes
in price
that's because unlike most other
commodities oil is integral to the
functioning of the economy there's only
one way to transport stuff on the world
and that's oil
and 95 of the vehicles on the planet run
on oil
so on the demand side when prices rise
consumers have little choice but to pay
up
so that's what inelastic or unresponsive
means even if the price changes
a lot your consumption won't change
and on the supply side it's slow and
expensive to ramp up oil production to
meet spikes in demand
so when you have a commodity for which
demand is
very inelastic and supply is inelastic
whenever you have an imbalance between
supply and demand you need huge price
swings to effectuate just small changes
in consumption
and production so the only way to tame
oil price volatility is to try to make
supply more flexible
and the only way to do that is through
something called spare capacity
oil production is an expensive venture
so it makes sense that after all that
upfront investment a producer will want
to extract and sell as much oil as
possible to maximize revenue
you're going to maximize that's that
system you're not going to hold any oil
back if the oil price goes up
can you increase production probably not
and that's where spare capacity comes in
that is oil production
capability that is not being used when
an oil producer has spare capacity it
means they're holding back and could
pump more oil on short notice if needed
it comes at a cost less oil means less
revenue but it leaves a buffer against
supply disruptions and spikes in demand
history has shown the only successful
way
to tame oil price volatility is to
introduce
flexible supply and that comes from
spare production capacity
the crucial role of spare capacity comes
into focus when you look at the history
of oil prices and see that they haven't
always been so turbulent
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new super shell motor oil from 1932 to
1972 was by far the most stable
period uh in oil market history
why were prices so stable
you guessed it spare capacity
during that period producers in texas
dominated global oil supply
they were heavily regulated and they
pumped far less oil than they could have
the great texas oil industry has a hard
fisted history of companies one-third
of total global oil production was being
held off the market just to keep prices
stable but by the 1970s demand for oil
was beginning to outstrip supply to keep
up texan producers used up all of their
spare capacity and the u.s began
importing more oil from the middle east
losing control of global oil supply
in short the market was ripe for a
shake-up
and then in 1973
everything changed
the yom kippur war between israel and
several arab states disrupted the power
balance of global oil supply
1973 dramatized u.s dependence on
foreign oil after the war a coalition of
arab oil-producing countries imposed an
embargo on the u.s and some of its
allies for the support of israel the
embargo triggered panic buying and
caused the first so-called oil shock
and prices quadrupled within a year
it was clear that the u.s was no longer
in control and that power over oil
prices had shifted to a group of
countries centered in the middle east
and an organization called opec
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the organization of the petroleum
exporting countries remained dominant
for more than three decades
even today the cartel controls 80
percent of the world's oil reserves and
exports more than half of all the
petroleum traded globally
and opec has often maintained the most
spare capacity giving them control of
the oil market
opec takes over from
1973 till according to my sense um 2008.
from the 1970s opec began carefully
controlling production ramping up or
cutting back to influence prices and
maximize revenue the opec era saw some
massive price swings
by early afternoon the demonstrators
were out in their thousands
in 1978 revolution erupted in iran
opec's second biggest oil producer
leading to strikes at large refineries
and sending oil prices booming to
historic highs amidst fears of supply
shortages
but with oil prices all booms go bust
the killer of all price booms and oil
are recessions
and that's exactly what happened in the
early 1980s
since oil is used in so many products
and is so integral to transportation and
shipping its price reverberates
throughout the economy so it's closely
linked to inflation and by extension
recessions
not all recessions were caused by oil
price increases but all oil price spikes
end with recessions and that then causes
the price of oil to fall very sharply
another boom came in the mid-2000s as
demand surged in emerging economies
especially china to meet the rising
demand opec members tapped into their
spare production losing leverage and
their dominance in the market and the
oil price boom had to end as they all do
with a recession what you've seen since
then is that opec has been unable to
act to stabilize the price of oil
in 2014 a surplus of oil supply led to a
price bust
and then emerged a new contender for the
top spot
opec plus
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in 2016 opec's member countries allied
with 10 other major oil producers
including russia forming opec plus which
has effectively become the new reigning
master of global oil prices
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opec plus holds the keys to most of the
world's spare capacity and now as the
market teeters on the edge of an
historic oil supply crisis pressure is
mounting for them to use it
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russia's invasion of ukraine sent shocks
throughout the world prompting a wave of
unprecedented sanctions and a rapid
spike in the price of oil russia's
decision to invade ukraine
poses one of the biggest oil supply
interruption risks since the 1970s
especially when you compare it to how
much
spare production capacity is available
russia is the world's largest oil
exporter and the only countries with the
spare capacity to help offset a russian
oil embargo are saudi arabia and the
united arab emirates both key members of
opec
but despite international pressure to
boost production neither seemed willing
to budge insisting that it wouldn't be
enough
so we don't have enough spare to offset
the loss of a russian oil if that loss
materializes this looming supply crisis
has spurred some countries to tap into
their emergency oil stocks which can
help alleviate price spikes in the short
term but they're finite and have a
limited long-term effect
so what happens to oil prices if nothing
can offset the lost supply
the only other way mathematically that
the market can balance and the market
must balance is for consumption to go
down you need big increases in price
to obtain even small declines in
consumption
and if history teaches us anything here
it's that big spikes in oil prices tend
to precede recessions
russia's invasion of ukraine poses not
only an oil price spike
but also the risk of a
collapse
if the spike contributes or causes a
recession
the world may be turning away from oil
in the long run but as demand continues
to rise peak oil remains a pipe dream
and amidst so much geopolitical
uncertainty its price will likely
continue to be volatile
the biggest question is whether opec
plus can pull together to tame prices in
the long run
a critical question for
oil price stability is whether opec plus
will be one of those temporary failed
swing producer groups or
whether it will succeed over the years
and decades at keeping oil prices
relatively stable i think it's the most
important question not only for oil
price stability but for macro economic
stability and geopolitical
risk thanks so much for watching you can
read more about oil markets on our
website capital.com
also check out our recent film exploring
what affects the price of natural gas if
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you