Investors of oil futures contracts took necessary profits Friday as the market cooled off from the best weekly oil rally for nine months. This following months of extreme uncertainty of global economics centered on the U.S. and European debt crisis. According to this Bloomberg article by Moming Zhou, crude oil prices increased 4.2 percent on Thursday due to the report that economic growth has accelerated at the highest rate in the past year, and “European leaders agreed on a plan to curb the region’s debt crisis” (Zhou, 2011).
Though we are not extremely happy when fuel prices increase from $3.00 to $4.00 per gallon, this is a great sign that consumer spending has increased, causing a greater demand for oil and consequently, increasing oil prices. Where the U.S. has had a more difficult time drilling for oil because of administration regulations and offshore drilling issues over the past couple of years, there has been only a slight incline in the supply of oil produced in the U.S.
Big moves in commodity markets are driven highly off of speculation and reported news. For example, if I hear news that the demand for oil has drastically inclined because Japan is back on track after the quake, this will drive up prices as investors buy up oil contracts anticipating the big move. Due to increased contract buying volume, the contract prices will increase at a rapid rate. Oil will eventually reach natural equilibrium as the demand curve shifts to the new demand for oil. Sadly, Zhou's article also describes the contrary status of Japan, markets cooled off on Friday because Japan is still not doing so well economically following the quake, this lowering demand for oil.
According to this article by Ron Cooke on the Energy Bulletin in 2007, “oil demand … has been relatively inelastic since 1982” (Cooke, 2007), meaning that these big price swings do not effect crude barrel purchasers greatly, mostly due to the fact that these prices will eventually be passed through production and manufacturing to us as the consumer, and we as the consumer, use a lot of oil, and will unhappily pay the price.
So next time you fill up at the pump and notice that fuel prices have increased yet once again, remember that it may be due to the fact that our local and global economy may be improving.
Please see the market for Crude Oil on the CME here.