Oil pricing, like other risk-driven activities, can be wrong, depending on the expectations involved.
A Market Driven by the News
Al Hegburg is a senior fellow for the Energy and National Security Program at the Center for Strategic and International Studies.
Updated March 9, 2011, 11:28 AM
Commodity prices are based on replacement costs, not production costs.
Oil and natural gas are commodities. Market expectations for oil indicate that it is a commodity that will become more expensive over time. That market expectation is probably driven by investors and traders concerned about the political activity in the main oil producing countries in the Arabian Gulf.
The oil market is event driven and reports and interpretations of these events can be dramatic, leading to over interpretation of the future. Likewise, the episodes can be downplayed by market participants, leading to moderate interpretations of potential events.
Future oil prices are one means to interpret the value of the commodity, albeit perhaps incorrectly. These prices reflect an effort to price future risk and like all risk-driven activities the outcome can either be accurate or overestimated, driven by political and economic expectations.