You are correct in that the free market sets the price of oil, but external forces weigh heavily mostly driven by fear mongers. Threats of Iran closing the Straight of Hormuz, Nigerian rebels stopping the flow of oil from there, Middle East tensions, etc. does more to drive the price higher than economics, at least for the time being.
There was a time when Saudi Arabia had a lot of spare capacity because they weren’t producing all that they’re capable of producing so that they could increase their output, flood the market and that would bring prices down, or alternatively they could shut down some of their production and that would boost prices. But in fact, most countries now with prices as high as they are, including Saudi Arabia, are producing as much as they can to benefit from high prices. So the notion that Saudi Arabia and OPEC can do anything to influence prices is a thing of the past, and act more like a shock absorber, increaing or decreasing supply to maintain pricing rather than controlling it.
OPEC' latest annual report cut its medium-term and long-term global oil demand forecast. Meanwhile, the organization also lowered its forecast for global oil demand in 2013 in a monthly report last Friday. The global economic weakness, together with the European debt crises and slowdown in China's economy are reducing the world oil demand expectation, OPEC said in its latest report.
Weaker economics, increasing supply will lead overall to lower prices, as most analysts have forecast for 2013. EIA projects the price of Brent crude oil will average $112 per barrel in 2012 and $103 per barrel in 2013, EIA expects the WTI price to average $89 per barrel in the fourth quarter of 2012, about $4 lower than last month's Outlook and to mostly remain at this level throughout the forecast period averaging $88 per barrel in 2013. After increasing to $22 per barrel in October of this year, the WTI crude oil spot price discount to the Brent crude oil spot price will average $20 per barrel in the fourth quarter of 2012 before falling to $11 per barrel by the end of 2013, according to EIA.
Last month, Goldman slashed it's forecasts for 2013. Wall Street giant Goldman Sachs , one of the biggest banks in commodity trading, slashed its oil price forecast following years of super-bullish recommendations as it said oil output was soaring in the United States and Canada.
Goldman, which up until now had the highest oil price prediction among major forecasters, said on Thursday it cut its 2013 Brent crude oil price forecast to $110 a barrel from the previous $130 per barrel.
Like anything else, supply will be a factor of price. If WTI falls much below $70, production will slow across the US from Bakken and other basins. Producers will be forced to continue production from wells already drilled and fracked, but new wells would be curtailed until the price rises. Wells returning an IRR of 50% at $95 oil don't seen so attractive at $75 oil, but companies with high debt loads (KOG, for instance) will have to continue producing just to pay down the debt, and forecast of returing to positive cash flow in 2013 would be pushed down the road. Again, as long as oil stays where it is, no issue.