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(Update) Why Oil Prices Change – Part III
And Seven Reasons Why They Don't
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Special Series
Why Oil Prices Change
For more reading on why oil prices change -- and why they don't, please read all parts of the series.
Part I, Part II, Part III
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Editor's Note: Originally posted on May 7, 2008, this story has been updated to address current market activity.
It's easy to write a "Why Oil Prices Change" headline, but it takes some reading and research to deliver on the headline's promise. I found that, for the most part, my research time proved an exercise in myth busting – which is to say, I realized that I needed to explain what does not change oil prices before I could explain what does.
Oil is by far the world's most heavily analyzed commodity, and the data is both voluminous and reliable. The Energy Information Administration (www.eia.doe.gov) is the best one-stop data source, for oil and all other major energy sources. Its charts are among the several I include below; as you'll see, the visuals alone are an education in oil and oil prices. Let's begin with the most-often repeated myths about why oil prices change, or more to the point, why they've been going higher in recent years. (Click on the thumbnails to view the charts.)
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It's OPEC's Fault – That can't be true, since non-OPEC states produce more crude oil than does OPEC. |
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The World is Running Out of Oil – More nonsense, of the "Peak Oil" variety; the world's proven crude reserves are growing. |
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Surplus Crude Oil Production Capacity is Too Low – Capacity is only slightly below the historical norm; it actually increased in 2006 and 2007. |
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Consumers and Industry Use Too Much Oil – Actually, they're learning how to make energy go a lot further. |
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Countries Like China Are Driving Up Demand – Look carefully at this chart: year-to-year consumption has seen marginal gains, but the rate declined. |
There's A Supply/Demand Imbalance – This is nonsense. Total world supply and demand have grown at the same constant pace since the mid-1980s. And by definition, two constant factors cannot account for wide fluctuations in the outcome (namely price) of a transaction.
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It's the Weather – This myth goes back to Hurricane Katrina, which to this day is said to have "caused" shortages and a huge increase in oil prices. Katrina came ashore in Louisiana on August 29, 2005; not only did prices not go up, they actually declined 19% in the three months that followed, as the chart plainly shows. |
Mind you, all sorts of other myths surround the oil and energy markets these days. Take the "Biofuels will save us" idea. Here's a few remarks from The Wall Street Journal about how the biofuels experiment is going.
"Corn ethanol can now join the scare over silicone breast implants and the pesticide Alar as among the greatest scams of the age.... it's worth recounting how much damage this ethanol political machine is doing.
"To create just one gallon of fuel, ethanol slurps up 1,700 gallons of water... The record 30 million acres the U.S. will devote to ethanol production this year will consume almost a third of America's corn crop while yielding fuel amounting to less than 3% of petroleum consumption."
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Oil Up When Stocks Down – Until this past summer, the media's favorite financial mantra was "Stocks Go Down When Oil Goes Up." I invite you to print this chart, keep it in your pocket, and pull it out next time that particular myth assaults your ears. |
So: What is the answer to "Why Oil Prices Change"?
Prices in a freely traded market are always a function of what the seller asks and what the buyer bids. Innumerable factors will affect the psychology of the buyer and seller – yet when their minds meet, you get a price. And make no mistake: that meeting of those minds is, above all, psychological.
That psychology unfolds in recognizable patterns. Elliott Wave International's Energy analyst Steve Craig was NOT thinking about "supply worries" in his commentary for the Global Market Perspective in March 2007 – which was the last time crude oil was anywhere near $50 per barrel. Instead, he was thinking about what really matters, namely the psychology of the market as reflected by the price patterns. He said, “Given the depth of the decline from last summer’s record high, an impulse wave into record territory would fit the… advance.”
What about the more recent decline in crude from $140 to $70 per barrel? Well, that decline began in mid-July. And soon after the trend turned, Steve Craig presented Global Market Perspective subscribers with a labeled chart, showing a reversal in crude oil at four degrees of trend. His forecast was: "Oil's mid-July peak should mark a signicant top and the beginning of a multi-month countertrend retracement" (GMP, August 1).
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