The factors that lead to affect the demand for oil include the cyclical demand, the prices of the substitutes, changes in climate and the market speculation. When there is an increase in the prices of oil the demand remains constant. A very large change in the price of oil leads to a very minute impact on the demand and therefore the short-term demand curve is shown like this:
The supply of the conventional oil is relatively inelastic. This is so because the actual total cost of pumping the marginal barrel of the oil is comparatively low, once all capital expenses of building and prospecting an oil rig has been established. The oilfield will always cost the same roughly to operate whether producing at full capacity or at 50 percent capacity but in most cases the producers try their best to produce at the maximum sustainable rate. The short-run supply of oil is affected by the profit motive, spare capacity, stocks available for the immediate supply especially from the oil refineries and the external shocks (Zucchetto, 2006, p.45). The result of the demand and supply trends is that the oil market is affected and operates at a point where the small changes either to the supply curve or to the demand curve usually causes very large changes in the clearing price.
The high demand of oil matched against the inelastic oil short run supply drive the market prices higher as depicted by the diagram below. A rise in demand causes a decrease in oil stocks at the main global refineries and forces the prices higher. It acts as an indicator to suppliers to increase production. There are time lags amid a change in price and the extra supply coming on stream. The demand for the oil is price inelastic. The combination of an inelastic supply and demand helps to clarify some of the instability in world oil prices (The Economist Newspaper Ltd, 2004, pp.8378-8381).
Adding new capacity is expensive and time-consuming. Over time, both the businesses and the individuals have their ways of cutting back the oil consumption due to the high prices; this promotes new investments in production and the discovery of new sources of the market. This gradually restores the supply-demand balance. Changes in the supply curve can be caused by some restrictions on the supply made by the sellers' cartels. An example is the oil shocks of 1973 where OPEC announced that it would not sell any more oil to the US and would limit the overall oil output. This in turn meant that for a given price level, the oil supplied would be less because the supply curve shifts upwards. The changes on the supply caused by natural factors like the Hurricane Katrina which totally knocked out the production of oil in the Gulf of Mexico. The supply curve is shifted to the left and therefore the prices rise. An increase in the market due to some emerging markets causes the demand curve to move to the right such that for any level of price given, the more the oil is demanded.
In the long run the demand and the supply of oil is remarkably elastic, there is no over supply or under supply it is only the price at which the market clears. A high oil price in the long run encourages the consumers