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Determinants of Oil Price Volatility

The Commodity

Oil grades: Crude oil all over the globe varies in availability and quality. These two factors determining the pricing as the better quality oil is priced relatively higher than any other. The non-homogeneity of both physical and geological properties of oil is a necessary in economic pricing.

The availability of substitutes such as synthetic fuel and bio fuels influence oil prices and cause the downward adjustment of those prices Simmons (2005).

Reserves

The demand for oil and development of suitable extraction mechanisms began at around the 19th century. As the demand for oil increases over the years, the discovery of new reserves is however slowing as most of the major reserves have been discovered and utilized Simmons (2005). Moreover, the reserves being discovered right now are found in the deep seas and only produce unconventional oil types that are difficult to process.

The availability and size of the reserves is naturally an important factor in the determination of oil prices and the valuation of the oil companies. For instance, oil is sometimes allocated higher prices to cover for the costly extraction of the crude oil in reserves that are difficult to reach.

Being that reserves are unevenly distributed in the world, the countries that own large fields equate this to political power. They even ration production and distribution of such resources such that they are a great influence in the pricing of oil in the globe.