Six Key Variables Driving Oil Prices

oil etfsDan Hassey: You hear it in the news all the time: Oil traded higher, oil went down, oil moved sideways. What drives this movement?

Like other commodities, the price of oil is a complex mixture of supply and demand factors. Some are obvious, others more subtle. Today I’ll show you the six key variables that determine oil prices.

Variable # 1: Production Costs

Producing oil is expensive. Costs like leases, royalties, equipment, materials, labor, environmental, regulatory costs and debt service have been steadily going up. I think they will go up more — especially leases.

When I started analyzing oil companies in 2004, the average finding and development (“F & D”) cost was about $6 a barrel. F&D costs almost quadrupled in less than a decade to about $22.80 in 2011.

Oil prices are likewise higher. In 2004 crude was around $30. Now Brent crude is about $110. The numbers are bigger, but the proportions are about the same.

Variable # 2: Oil is a Global Commodity

The cable financial news mistakenly focuses on energy dynamics and U.S. energy data. Serious oil analysts understand that oil is a global commodity.

The table below shows U.S. history and 2012 supply and demand forecast:

Click on the chart to see full 2004-’12 data

Notice that oil production for 2012 was 5.74 million barrels per day, and demand was 18.96 million. That means we had to import about 13 million barrels per day to meet demand. That’s why we need to look at global supply and demand data and not just focus on the U.S.

Notice also that consumption peaked in 2005, declined for several years, then began rising again.

The U.S. has about 2% of global “proved reserves,” but consumes about 22%.

Oil is an essential, depleting global commodity …  but in one sense it’s not a commodity at all.

Most commodities can be grown, repaired, refurbished, salvaged or replenished. When we burn a gallon of oil or gasoline, it is gone forever. This is what I mean by “depleting.”

But one thing that isn’t shrinking is demand …

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