Oil Prices Jump, But What Is The Real Reason

The price of West Texas Crude jumped to its highest level on Wednesday, one day after President Trump announced that the U.S. was pulling out of the Iran Nuclear Deal. The president has been talking about pulling out of the deal since he got elected, so I’m not really sure why it should be viewed as a big surprise and cause oil to jump by over 2.8%.

While there are other factors at work, this seems like a ploy by oil companies and OPEC to drive the price up. Sure oil has been rallying since reaching $30 a barrel in 2016 and the rally kind of ramped up last summer, but overall demand for oil seems to be topping out a little.

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Various alternative energy sources are becoming more and more viable. Hybrid and electric cars are becoming more popular. But the demand curve for oil is relatively inelastic. What I mean by that is that it takes the price of oil reaching a certain level for consumers to make a change. We can’t just change our driving habits in a day or two. We have to change over time.

For instance, I have a lease on an SUV that ends in July. If oil prices stay high or continue to rise, I will likely look at a smaller SUV that gets better gas mileage than my current one. That is how the demand for gas and oil changes, it doesn’t change quickly the way it might for other goods.

Because the demand for oil is rather inelastic, it is more likely to shift than it is to remain on the same curve. I have included a basic chart that you might see in an economics textbook.

The steepness of the curve is indicative of inelastic demand. There isn’t a readily available substitute. If we go to the store and the price of beef has jumped sharply, we have substitutes right there in front of us. We can choose pork, chicken, or fish instead of beef. There isn’t such a thing for gas. That is why prices have to rise to extreme levels or stay elevated for a prolonged period. That is when we see the demand curve shift to the left.

The recent rally seems to be being fueled by lower production in Venezuela and now traders expect a decline in Iranian production. But the demand for oil is flattening out. We see on the chart how the demand appears to be peaking.

The table shows global oil demand, but oil consumption in the United States, Europe and Japan has been declining for approximately 10 years now. Ever since the huge spike in oil prices in 2008 the demand in more developed countries has been on the decline.

Personally I don’t see oil prices going much higher. I think they likely peak around the $75 a barrel level. If the price stays up or becomes range bound between $65 and $75 a barrel, it would likely cause another demand shift and that would be bad for the OPEC countries long term.

Once consumers shift away from oil consumption for alternative energy sources, I don’t really seem them shifting back. If the current oil price is being manipulated by OPEC and the oil companies, they would be wise to not push the price too high or to keep it this high for very long.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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