Are real world oil prices really based on supply & demand?

I ask because oil prices have fallen over 50% and yet (so far as I can tell) in looking at local driving habits people have not curtailed their fuel usage anywhere close to this amount. So the conclusion is either we were somehow getting gouged before, and this is normal or … what? How can such a basic commodity fluctuate so greatly in price, it makes you wonder about the blind faith we put in the free hand of supply and demand driving price in a nominally capitalist market.

I don’t know about driving, but air travel is way, way down.


Presumably a significant factor in the high price of oil was speculation, which is a natural part of a free market / capitalistic economy.

Did the oil price crash take the wind out of their sails? Is price speculation acting to depress prices now?

I’m guessing that the existence of big oil cartels also changes the price dynamic considerably.

You seem to be looking at it from the demand side only. If demand stays static but supply increases then theoretically you’ll see a drop in prices.

Worlds oil supply is flat to rising, global demand forcast has been cut by 700Kbbl/day for 2009.
So with supply up and demand down you would expect to see a price drop.
Remember also that a 50% drop in price does not equate to 50% drop in demand.
Consider the converse situation, if supply is slightly under demand, you will see people bid more and more money for those last few barrels leading to a price rise as they all need the oil, this price rise will be out of proportion to the mismatch in supply and demand.

An analogy would be people selling tickets outside a football game, if it is a big game that is sold out, people will bid up the price of the tickets to the point of paying crazy prices for the last few tickets. The majority of the tickets have been sold at a different price, and demand only needs to exceed supply by only a small amount to get a big price swing.
On the flip side, if supply exceeds demand for a less popular game you would expect to see the price drop significantly as the ticket touts try to recover some money, probably selling the tickets at a lower price than people bought them on line several weeks before.

Commodity prices are based on the supply and demand of buyers and sellers of the commodity, not the supply and demand of end users. Of course end use ultimately drives the commodity trades themselves, but many other factors enter in. Demand may drop significantly if future end-use projections are down, traders loads on a sell side all at once, suppliers change their base prices, and on and on. The price at a given moment is going to be much more volatile than the actual current consumption, even though consumption is a key factor in the longer term variability.

Another good point to remember, (though you do seem to be getting close to it,) is that the economics concepts of ‘demand’ and ‘supply’ do not really boil down to simple numbers on either side, but are functions seeking to explain the probably behaviour of lots of participants and various differerent price points - demand and supply curves. In general, those curves will tend to coexist at one point of supply/demand equilibrium, which gives you a stable price.