Page last updated at 13:39 GMT, Tuesday, 22 July 2008 14:39 UK

Why have oil prices been falling?

New York oil traders
Oil traders are considered to be particularly susceptible to rumours

Oil prices have risen to record levels in recent weeks, with traders in London and New York paying more than $147 a barrel for crude oil at its peak on 11 July.

But since then, prices have fallen on both sides of the Atlantic, dipping almost 13% to a low of $128.23 for a barrel for US light sweet crude on 18 July, and down 10% to $129.66 for Brent crude.

Crude oil prices affect the wholesale cost of the petrol and diesel paid for by the major retailers. A number of those firms have passed on the lower prices to motorists at their forecourts.

Why did oil prices fall last week?

The perception last week that the slowing US economy could trigger a worldwide economic slowdown had clear implications on the expected demand for oil.

Countries such as India and China depend on the US, Europe and Japan as major markets for their manufactured goods and services.

If demand for their goods declines, as is expected, so too will their thirst for the oil and fuel needed to produce the products.

The fundamentals of the oil market don't change every minute
Dr Manouchehr Takin, Centre for Global Energy Studies

Another factor helping to cut oil prices was on the supply side, where there were indications that tensions were easing between oil-producer Iran and the US over its nuclear programme.

This reduced fears that the supply of crude oil from Iran could be interrupted.

Traders also pointed to news that a Chevron oil pipeline in Nigeria had reopened following an attack on it in June.

Are these the only factors that determine oil prices?

No. The price of oil on the international markets is determined by a combination of forces.

There are the so-called fundamental factors of supply and demand which are expected to keep prices high in the longer term.

On the demand side there is the rising need for oil from the ever-expanding economies of India and China, which need more fuel oil to run their factories and more petrol for a growing number of motor vehicles.

On the supply side, there are concerns that it is taking longer than before to develop new oil fields, an average of at least 10 years, so it is difficult to increase output quickly to meet increasing demand.

This is exacerbated by critical shortages of skilled oil engineers, and the limited investments made by many state-owned oil companies who control the vast majority of the world's oil production.

In the even longer term, there are worries that we may be reaching the limits of the world's finite oil resources and that production could begin to fall in the decades to come.

Can these explain the sudden changes in oil prices?

Not really, and crude oil is something of a special case.

Oil is traded on futures markets, making it more vulnerable to the kind of speculation that can move prices by as much as $5 a barrel in a single day.

We've had a correction, but I expect a resurgence in prices in the near-term
Victor Shum, Purvin & Gertz

According to Dr Manouchehr Takin of the Centre for Global Energy Studies this volatility is caused by oil traders.

He says that oil traders are making decisions to buy or sell oil on a minute-by-minute basis, and are much more influenced by rumours and stories than their counterparts trading shares on stock markets.

"Perception is the key word here," he said. "Because the fundamentals of the oil market don't change every minute".

It is the perception of changes in either the demand or supply of oil that drives and fans market rumours.

What's the link between crude costs and pump prices?

The price of crude oil is a significant factor determining the price that retailers pay for their fuel.

As well as the cost of the raw material, the cost of refining the oil also needs to be factored in, as well as the level of demand for the refined product.

According to industry experts Platt's, the wholesale price of fuel also fell substantially last week.

The price of refined diesel, for example, has fallen by 8.3% since it reached an all-time high on 11 July of $1,241 per metric tonne, according to Platt's data .

Is the sudden drop in prices going to keep going?

Well, crude oil prices have been on the way up again this week after traders suggested that Tropical Storm Dolly could affect oil production in the Gulf of Mexico.

Dolly was cited as the primary reason for a $1 rise in the price of a barrel of oil on Tuesday, as oil producers began evacuating some of their staff from facilities that could be in the storm's path.

Tensions between Iran and the international community were also deemed to be rising, dispelling last week's optimism.

And as for one of the key fundamentals of the oil market - demand from China - government figures showed that its imports of crude oil were 3.2% higher in June than a year earlier.

This combination of factors led some to suggest last week's fall in oil prices was only a temporary situation.

"There's been no slowdown in Chinese demand growth, and the Iran situation remains fluid," said energy analyst Victor Shum from Purvin & Gertz.

"We've had a correction, but I expect a resurgence in prices in the near-term."


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