Oil Market Drivers

Oil Market Drivers

The price of oil can be influenced by a wide range of factors:

Supply and Demand

Oil is a tangible and in-demand commodity. The largest consumer and importer of oil in the world is the United States, followed by China and Japan. Anything that disrupts the supply of oil is guaranteed to influence its price. Factors such as extreme weather, war, terrorism, political unrest, and OPEC production decisions have the potential to push the price of oil up and down.

Since oil is used in the manufacture of many different consumer products, from gasoline and heating oil to fertiliser and cosmetics, the demand for these products can also have an effect on the value of crude oil. When consumption falls in these products, the demand for crude oil also falls, and this can have a negative effect on prices.

Inventory numbers, sales figures and the EIA petroleum status reports all serve to shed light on the difficult task of measuring overall oil consumption. Traders can look to these reports and announcements to better understand the factors influencing the consumption of oil. 

Seasonal Factors 

The seasonal consumption pattern can also have an effect on the price of crude. During cold-weather months, more heating oil is consumed than in warmer months. In contrast, the "summer driving season" in the US frequently sees a rise in the price of gasoline, in reaction to increased demand. The hurricane season in the Gulf Coast of the United States also has potential to influence the price of oil, since hurricanes pose a threat to refineries located in the Gulf of Mexico. Speculators are aware of these patterns and their sentiment may influence their trading decisions.

Speculation 

Recently brought to the forefront of the global oil debate, thanks to the extreme price-spike in the summer of 2008, is the role of speculators in determining the price of oil. While speculators do serve to provide liquidity to a market, the fact that traders without the need for physical delivery of the commodity have the ability to significantly move the price of oil has raised eyebrows around the world. The most fundamental fact regarding speculators' presence in the market is that traders' sentiment may not be strictly supply and demand based, and as such the expected influence of supply and demand on prices may not always be as important as the overall market sentiment towards the direction of oil prices.

Currencies 

Since oil is quoted in U.S. Dollars, many of the factors influencing the dollar can carry over into the oil markets. In a general way, the direction of oil prices is regarded as being opposite to the direction of dollar strength. A stronger dollar means that it takes fewer dollars to purchase a barrel of oil. This is typically good for consumers. Inter-currency relationships then come into play, since a barrel of oil worth $100 is good for producers (and bad for consumers) when the dollar is strong relative to other currencies. However, if $100 only translates to 64 Euros (a weak dollar), high oil prices might not mean as much to producers, since their profits in dollars would not be worth as much.

Market Size and Liquidity

Unlike other financial markets like the New York Stock Exchange, the forex spot market has neither a physical location nor a central exchange.

The forex market is considered an Over-the-Counter (OTC), or "Interbank", market due to the fact that the entire market is run electronically, within a network of banks, continuously over a 24-hour period.

This means that the spot forex market is spread all over the globe with no central location. They can take place anywhere, even at the top of Mt. Fiji!

The forex OTC market is by far the biggest and most popular financial market in the world, traded globally by a large number of individuals and organizations.

In the OTC market, participants determine who they want to trade with depending on trading conditions, attractiveness of prices, and reputation of the trading counterpart.

The chart below shows the ten most actively traded currencies.

The dollar is the most traded currency, taking up 84.9% of all transactions. The euro's share is second at 39.1%, while that of the yen is third at 19.0%. As you can see, most of the major currencies are hogging the top spots on this list!

*Because two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%

The chart above shows just how often the U.S. dollar is traded in the forex market. It is on one side of a ridiculous 84.9% of all reported transactions!

The Dollar is King

You've probably noticed how often we keep mentioning the U.S. dollar (USD). If the USD is one half of every major currency pair, and the majors comprise 75% of all trades, then it's a must to pay attention to the U.S. dollar. The USD is king!

In fact, according to the International Monetary Fund (IMF), the U.S. dollar comprises almost 62% of the world's official foreign exchange reserves! Because almost every investor, business, and central bank own it, they pay attention to the U.S. dollar.


There are also other significant reasons why the U.S. dollar plays a central role in the forex market:

• The United States economy is the LARGEST economy in the world.
• The U.S. dollar is the reserve currency of the world.
• The United States has the largest and most liquid financial markets in the world.
• The United States has a super stable political system.
• The United States is the world's sole military superpower.
• The U.S. dollar is the medium of exchange for many cross-border transactions. For example, oil is priced in U.S. dollars. So if Mexico wants to buy oil from Saudi Arabia, it can only be bought with U.S. dollar. If Mexico doesn't have any dollars, it has to sell its pesos first and buy U.S. dollars.

Speculation

One important thing to note about the forex market is that while commercial and financial transactions are part of trading volume, most currency trading is based on speculation.
In other words, most trading volume comes from traders that buy and sell based on intraday price movements.
The trading volume brought about by speculators is estimated to be more than 90%!
The scale of the forex speculative market means that liquidity - the amount of buying and selling volume happening at any given time - is extremely high.
This makes it very easy for anyone to buy and sell currencies.
From the perspective of an investor, liquidity is very important because it determines how easily price can change over a given time period. A liquid market environment like forex enables huge trading volumes to happen with very little effect on price, or price action.
While the forex market is relatively very liquid, the market depth could change depending on the currency pair and time of day.
In our trading sessions part of the school, we'll tell you how the time of your trades can affect the pair you're trading.
In the meantime, here are a few tricks on how you can trade currencies in gazillion ways. We even narrowed it down to four!