March 2001 - Article - Price determination in international oil markets
G N Farrell, B Kahn and F J Visser
Last Modified Date:
2020-10-01, 09:31 PM
Quarterly Bulletins > Articles and Notes
After falling at the end of 1998 to levels last seen before the oil crises of the 1970s, oil prices in late 2000 rose to their highest levels since the Gulf War. They remained high despite repeated sets of co-ordinated production increases by the Organisation of Petroleum Exporting Countries (OPEC). There were indications, however, that these increases had resulted in an oversupply that was not immediately reflected in prices, and by December 2000 it appeared that the oil price was returning to the target range set by OPEC. The intention in this paper is to provide a brief analysis of the functioning of the world oil market. Particular attention will be paid to the interaction among world supply and demand, and the spot, term and futures markets which together determine oil prices. This analysis supplies the background to a discussion of the current situation in world oil markets, and the future prospects for oil prices. Since the late 1980s, world oil prices have been set by a market-related pricing system which links oil prices to the ‘market price’ of a particular reference crude (such as Brent, West Texas Intermediate or Dubai). A brief review of recent price trends is provided in Section 2. A fundamental determinant of these prices is the balance between supply and demand in the various markets. This supply-demand balance is in turn influenced by a complex set of factors which have undergone significant changes in the past 25 years. The factors influencing the supply of and demand for crude oil in world markets are reviewed in Sections 3 and 4, respectively. In addition to these fundamental determinants, oil prices are the result of a complex interaction of relatively thin spot markets, a more liquid forward market (for Brent), and two very liquid futures markets. These more liquid futures markets play an important role in the price discovery process which is analysed in Section 5. The current situation in world oil markets is discussed in Section 6, focusing on the interaction among supply and demand factors and the role of inventories. Section 7 concludes by reporting some current medium-term forecasts for oil prices.