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Contents
The Determinants of Oil Prices......................................................................................................4
Market Forces Impacting Oil Prices:.............................................................................................7
Probably the single biggest influencer of oil prices is OPEC, made up of 15 countries (Algeria,
Angola, Ecuador, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Republic of
Congo, Saudi Arabia, United Arab Emirates, and Venezuela); collectively, OPEC controls 40
percent of the world's supply of oil....................................................................................................7
Supply and Demand Impact:..........................................................................................................9
Natural Disasters and Politics Weigh:..........................................................................................11
Impact of production costs and storage:......................................................................................11
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ACKNOWLEDGMENT:
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The U.S. was the world's dominant oil producer at that time. It regulated
prices. Domestic oil was plentiful. Cheap oil and gas made the expansion of
interstate highways, interstate trucking, and auto ownership part of
the American Dream.
INTRODUCTION
Crude oil, is an invaluable source of energy all over the world as it affects the
development and activities of almost all governments and its people. The
energy, industrial, domestic, transportation and economic sectors heavily
depend on crude oil. According to the BP statistical review of world energy in
June 2016, oil remained the world’s leading fuel, accounting for 32.9% of
global energy consumption This ever increasing demand and emergence of
crude oil as a highly sought after global commodity after its commercial
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inception in the 1860s has accounted for its market complexity and price
volatility. Various factors such as oil production and demand, government
decisions and activities, multinational oil companies, geopolitical conflicts and
economic activities and entities such as the Organisation of Petroleum
Exporting Countries (OPEC), have been identified as contributors in the
determination of oil prices. Because crude oil plays a major role in almost all
modern day activities there is the need to identify and understand the factors
influencing its pricing as this can aid in governmental, organisational and
individual decision making, planning and forecasting.
With each passing year, oil seems to play an even greater role in the global
economy. In the early days, finding oil during a drill was considered somewhat
of a nuisance as the intended treasures were normally water or salt. It wasn't
until 1857 that the first commercial oil well was drilled in Romania. The U.S.
petroleum industry was born two years later with an intentional drilling in
Titusville, Pa.
While much of the early demand for oil was for kerosene and oil lamps, it
wasn't until 1901 that the first commercial well capable of mass production was
drilled at a site known as Spindletop in south-eastern Texas. This site produced
more than 10,000 barrels of oil per day, more than all the other oil-producing
wells in the United States combined. Many would argue that the modern oil era
was born that day in 1901, as oil was soon to replace coal as the world's primary
fuel source. Oil's use in fuels continues to be the primary factor in making it a
high-demand commodity around the globe
Crude oil, or “black gold,” is one of the world's most precious commodities: Its
price affects the economic ecosystem at every level, from family budgets
to corporate earnings to the nation's GDP.
The term Crude Oil refers to a naturally occurring, unrefined flammable liquid
composed predominantly of hydrocarbons and found in oil reservoirs primarily
associated with sedimentary rocks. This resource is limited and non-renewable,
also known as fossil fuel, thus it cannot be replaced naturally after consumption
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The oil market consists of a complex range of industries all performing a wide
variety of activities from the upstream through the mid-stream to the
downstream of the petroleum sector. Crude oil resides mostly in underground
reserves that are difficult to reach and whose ownership is highly sought after.
The crude oil is extracted by either a national company or a private company
after the right and necessary petroleum arrangements have been established.
Crude oil after its extraction is separated from natural gas, water and other side
products such as harmful gases, organometallic compounds and basic sediment
and water (BSW). It is then sold and transported to refiners around the world by
tanker ships, oil pipelines etc. The oil at refineries then undergo various
chemical and physical processes such as atmospheric distillation, hydrocracking
and blending to transform them into useful products which are sold on further
markets to industrial users and retailers. The end products of oil reach
consumption in the form of transportation fuel such as gasoline and diesel,
asphalt for road construction, electricity, plastics, petrochemicals
Not quite. The price of oil as we know it is actually set in the oil futures market.
An oil futures contract is a binding agreement that gives one the right to
purchase oil by the barrel at a predefined price on a predefined date in the
future. Under a futures contract, both the buyer and the seller are obligated to
fulfil their side of the transaction on the specified date.
Commodity Pricing:
content also represents the amount of sulphur present in the oil expressed in
percentage by weight in crude. Crudes with negligible amount of sulphur are
termed sweet crude whilst sour crudes have significant sulphur content.
The API gravity of crude oils vary from 5 oAPI to 55 oAPI. Average crudes
have a 25 oAPI to 35 oAPI range, whilst light crudes range from 35to 45 oAPI
and heavy oils below 25 oAPI . Light and sweet crude oils are more desirable
and usually priced higher than heavy, sour crude oils. This is because gasoline
and diesel fuel which typically sell at a premium to residual fuel oil or other
“bottom of the barrel” products, can usually be produced easily and cheaply
using light sweet crude oil and these crudes require far less sophisticated and
energy intensive processes. Sour crudes are corrosive and require extra treating
costs
.
The amount of entrained water and salt content in crudes also influence the
price refineries are willing to pay for each barrel of crude oil, regardless of
where in the world it is produced
Oil suppliers and buyers meet on commodity exchanges to trade these various
blends of oil. Commodity exchanges trade in options, futures and physical
delivery of crude oil and various oil products. Some of the major exchanges in
which oil is traded are; The New York Mercantile Exchange(NYMEX) in New
York City and the Intercontinental Exchange (ICE) in London and Atlanta
hedgers
speculators
The other key factor in determining oil prices is sentiment. The mere belief that
oil demand will increase dramatically at some point in the future can result in a
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dramatic increase in oil prices in the present as speculators and hedgers alike
snap up oil futures contracts. Of course, the opposite is also true. The mere
belief that oil demand will decrease at some point in the future can result in a
dramatic decrease in prices in the present as oil futures contracts are sold
(possibly sold short as well), which means that prices can hinge on little more
than market psychology at times
Factors Affecting Oil Prices:
Market Forces Impacting Oil Prices:
While the consortium has vowed to keep the price of oil above $100 a barrel for
the foreseeable future, in mid-2014, it refused to cut oil production, even as
prices began to tumble. As a result, the cost of crude fell from a peak of above
$100 a barrel to below $50 a barrel. As of February 2018, oil prices are
hovering slightly below $62.
Exchange value of dollar:
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Crude oil is traded globally in, US Dollars while consumers use local currencies
to buy petroleum products. When the US dollar depreciates against other
currencies, countries with non-dollar appreciating currencies enjoy cheap oil,
while consumers in US Dollar-pegged countries pay a higher price for the same
barrel of oil. Changes in the US Dollar will therefore affect world oil demand.
Depreciation of the US Dollar versus the appreciation of other currencies will
decrease the cost of buying a dollar. This will increase the demand for crude oil,
in other currencies than the US Dollar which consequently leads to increases in
prices. A negative relationship between the US Dollar exchange rate and the
crude oil price changes is thus expected[14]
.Geopolitics:
The war in Yemen is a geopolitical conflict with the potential to impact the
crude oil price in the short to medium term, for two reasons.
Firstly, Yemen itself borders a key transport route for crude oil. Some 5 million
barrels of crude oil pass through its Bab Al Mandab every day. Recently, the
area has been drawn into the conflict. A worst case scenario for the conflict is a
further escalation which closes the Bab Al Mandab for commercial shipping
entirely, forcing crude oil transports from the Middle East to Europe and the
Americas to take the much longer route around the Cape of Good Hope instead
of through the Suez Canal.
Secondly, behind the war in Yemen is a conflict between Saudi Arabia and Iran.
It is not impossible for the war in Yemen to spill over into other areas of the
Middle East, which, at 31 million barrels per day, is home to around 35 percent
of global crude oil production.
Other geopolitical events with a more remote likelihood of impacting the global
oil markets are Iraq, in particular the battle for Mosulwhich is of course a key
oil producing area, and the battle against ISIS, in particular in Libya where the
group has been threatening the major oilfields
Consumption:
Crude oil consumption is driven by the demand for refined oil products. There
are large regional differences in consumption rates, with the developed OECD
countries such as (Denmark, Germany, Luxembourg and the United Kingdom)
representing about 50 % of world demand. Demand for crude comes also from
many sources, but two main sectors: transportation and industry cover about 85
% of the total globally with residential, commercial, electric power generation
and heating representing the remaining. It is notable that industries use may be
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OPEC vowed to keep the price of oil above $100 a barrel for the foreseeable
future, but in mid-2014, the price of oil began to tumble. It fell from a peak of
above $100 a barrel to below $50 a barrel. OPEC was the major cause of cheap
oil, as it refused to cut oil production, leading to the tumble in prices.
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While supply and demand impact oil prices, it is actually oil futures that set the
price of oil. A futures contract for oil is a binding agreement that gives a buyer
the right to buy a barrel of oil at a set price in the future. As spelled out in the
contact, the buyer and seller of the oil are required to complete the transaction
on a specific date.
Supply.
For several decades, the Organization of Petroleum Exporting Countries
(OPEC) has been the elephant on the world's trading floors, with its oil-
producing member nations working together to determine prices by boosting or
reducing crude oil production. While OPEC's grip on the market has loosened
some in past years, its decisions continue to play a dominant role. OPEC's every
move is watched closely by governments, oil companies, speculators, hedgers,
investors, traders, policymakers and consumers.
The supply crude oil is also determined by external factors, which might include
weather patterns, exploration and production (E&P) costs, investments, and
innovations.
Demand:
Strong economic growth and industrial production tend to boost the demand for
oil — as reflected in changing demand patterns by non-OECD nations, which
have grown rapidly in recent years. According to the U.S. Energy Information
Administration, “oil consumption in the Organization for Economic
Cooperation and Development (OECD) countries declined between 2000 and
2010, [while] non-OECD oil consumption increased more than 40 percent.
China, India and Saudi Arabia had the largest growth in oil consumption among
the countries in the non-OECD during this period.”
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increases during travel season and in the winters when more heating fuel is
consumed.
Economic factors:
Like many other commodities, oil prices are linked to the economic activities of
most countries. Demand and consumption of oil by all sectors increases with
economic, industrial and population growth and decreases when there is
economic recession.Oil importing countries, such as the US and China, will
increase their oil demand as a result of economic growth eventually leading to
higher oil prices. Oil exporting countries, gain maximum oil profit and
economic wealth as a result of higher prices from these increasing demands. If
oil prices remain at high levels, economic growth in importing nations might
decline, causing a decline in oil demand and prices. High prices will also lead
to increases in petroleum investments, exploration and development budgets
leading to new oil discoveries and increased supply which over time will cause
prices to decline
Production costs can cause oil prices to rise or fall as well. While oil in the
Middle East is relatively cheap to extract, oil in Canada in Alberta’s oil sands is
more costly. Once the supply of cheap oil is exhausted, the price could
conceivably rise if the only remaining oil is in the tar sands.
U.S. production also directly affects the price of oil. With so much oversupply
in the industry, a decline in production decreases overall supply and increases
prices. The U.S. has an average daily production level of 9 million barrels of oil,
and that average production, while volatile, has been trending downward.
Consistent weekly drops put upward pressure on oil prices as a result.
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There are also ongoing concerns that oil storage is running low, which impacts
the level of investments moving into the oil industry. Oil diverted into storage
has grown exponentially, and key hubs have seen their storage tanks filling up
rather quickly. More than 77% of storage capacity is being used in Cushing,
Okla., one of these hubs. However, slowing production and pipeline network
improvements will reduce the chance that oil storage will reach its limits, which
helps investors shed their fears of too much supply and a rise in oil prices
Before the 1970’s the oil business was dominated by seven western companies,
“Seven Sisters”. These companies operated around the world and were
responsible for significant oil field developments. The Seven Sisters comprised
of the Anglo-Persian Oil Company, Gulf Oil, Standard Oil of California,
Texaco, Royal Dutch Shell, Standard Oil of New Jersey and Standard Oil
Company of New York [8]. After the oil crisis in the 1970’s and following
political developments, oil production around the world became nationalized to
a large extent. Today multinational companies control only about 5 % of global
oil reserves, but have remained as important partners in the oil market and
development of the petroleum industry.
The largest oil producers are roughly the countries with the largest reserves as
in the case of the Middle Eastern producing countries. Some developed
economies have however, managed to utilize their reserves more effectively and
have a lower reserve-to-production ratio whilst others that produced at higher
rates are experiencing production decline due to depleting reserves. It is notable
that especially Russia and the United States produce at a very high rate despite
their relatively lower reserves.
Refinery capacity:
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While views are mixed, the reality is that oil prices and interest rates have
some correlation between their movements, but are not correlated exclusively.
In truth, many factors affect the direction of both interest rates and oil prices.
Sometimes those factors are related, sometimes they affect each other, and
sometimes there's no rhyme or reason to what happens.
One of the basic theories stipulates that increasing interest rates raise
consumers' and manufacturers' costs, which reduces the amount of time and
money people spend driving. Fewer people on the road translates to less
demand for oil, which can cause oil prices to drop. In this instance, we'd call
this an inverse correlation.
By this same theory, when interest rates drop, consumers and companies are
able to borrow and spend money more freely, which drives up demand for oil.
The greater the usage of oil, which has OPEC-imposed limits on production
amounts, the more consumers bid up the price.
Future market:
The price of oil as we know it is actually set in the oil futures market. An oil
futures contract is a binding agreement that gives one the right to purchase oil
by the barrel at a predefined price and date in the future and clients purchase
futures to hedge against crude price fluctuations that adversely affects
profitability Futures prices above spot prices that lead to expectations of higher
prices in the future can influence oil producers withhold their oil in order to sell
it at latter date for higher profits. This can reduce current supply of oil and
substantially affect prices
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Weather:
Cold weather can also affect oil production negatively if temperatures drop
low enough. Crude oil has a freezing point of between -40 and -60 degrees
Fahrenheit. If temperatures drop to these depths, the supply side of oil and
gas prices will be affected
Broadly speaking, crude oil and other energy sources such as renewables,
natural gas and hydroelectric are used to satisfy different parts of global energy
requirements. While crude remains the largest primary source of energy, it is
generally used in the production of transportation fuels whilst renewable energy
is primarily used to generate power (electricity).
Thus crude oil does not have direct substitutes, and therefore when the prices of
one energy supply increases, the demand for the other does not always
increase. The exception to this comparison is liquid transport bio-fuels e.g. bio-
diesel, bio-jet fuel and bio-ethanol which directly compete with crude oil
products. The price of crude can thus be influenced by increasing popularity of
bio-fuels
Natural gas and crude oil are also close substitutes for each other in regions
where both are supported by technology, infrastructure and markets. Advances
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in technology now allow end consumers to switch between fuels. If the price of
one energy source rises significantly, consumers move to other energy source.
This increases demand for the second energy source and its price then also
increases
The chief executive officer of OPEC is its secretary general. His Excellency
Mohammad Sanusi Barkindo of Nigeria was appointed to the position for a
three-year term of office on August 1, 2016, and was re-elected to another
three-year term on July 2, 2019.
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2019. They are, in order of joining, Qatar (1961), Indonesia (1962), Libya
(1962), the United Arab Emirates (1967), Algeria (1969), Nigeria (1971),
Ecuador (1973), Gabon (1975), Angola (2007), Equatorial Guinea (2017), and
Congo (2018). However, Qatar terminated its membership on Jan. 1, 2019, and
Indonesia suspended its membership on Nov. 30, 2016, so as of 2019 the
organization consists of 14 states.
OPEC’s influence on the market has been widely criticized. Because its member
countries hold the vast majority of crude oil reserves (79.4%, according to the
OPEC website), the organization has considerable power in these markets. As a
cartel, OPEC members have a strong incentive to keep oil prices as high as
possible while maintaining their shares of the global market.
The advent of new technology, especially fracking in the United States, has had
a major effect on worldwide oil prices and has lessened OPEC’s influence on
the markets. As a result, worldwide oil production has increased and prices have
dropped significantly, leaving OPEC in a delicate position. As late as June
2016, OPEC decided to maintain high production levels, and consequently low
prices, in an attempt to push higher-cost producers out of the market and regain
market share. However, starting in January 2019, OPEC reduced output by 1.2
million barrels a day for six months due to a concern that an economic
slowdown would create a supply glut, extending the agreement for an additional
nine months in July 2019.
Reasons for dropped in crude oil prices in 2015:
The oil industry is full of booms and busts. Prices typically rise during periods
of global economic strength and as demand outpaces supply. Crude oil will fall
when the reverse is true, and demand cannot keep up with growing supplies.
Meanwhile, supply and demand are driven by a number of factors:
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West Texas Intermediate comes from the United States and is the benchmark
for U.S. oil prices. Brent North Sea oil comes from Northwest Europe and is the
benchmark for global oil prices.
U.S. sanctions against Venezuela and Iran have decimated these two countries’
oil production but have failed to push prices higher, the head of the International
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Energy Agency, Fatih Birol, said at the Baker Hughes AM2020 conference
earlier this week. So have the attacks on Saudi oil infrastructure that cost 5.7
million bpd in temporarily lost production capacity and the U.S. assassination of
Iranian General Qassem Soleimani.
Demand;
OPEC estimates suggest that there will lower oil demand in 2019 due to various
factors. In its most recent Monthly Oil report, the cartel revised its demand
growth forecast down by 100,000 bpd. Goldman Sachs has also “slashed its oil
price forecast” due to concerns regarding oversupply and relatively weaker
demand. If these predictions are accurate then falling demand growth will likely
impact prices throughout the year.
China’s economic health:
It may not be possible to win a trade war, but one party can suffer more than
the other. This seems to be the case with China as manufacturing slows and
GDP growth forecasts look bleak. The Chinese stock market gained the title of
worst-performing stock market of 2018, largely due to the trade war. Recently
released inflation data, which measures the Consumer Price Inflation (CPI), was
lower than what observers had expected; rising 1.9 percent against an estimated
2.1 percent. Producer inflation also looks worrying for China, rising only 0.9
percent against expectations of 1.6 percent growth. Should the world’s most
important consumer see an economic slowdown in 2019, the global economy
and oil markets would both be hit hard.
Global Recession and Financial turmoil:
We are currently in the longest bull market in history, a fact that may be seen as
a cause for worry as we enter 2019. 2018 saw multiple sell-offs in the U.S.
stock market driven by fear of a financial crisis, slow growth and the trade war.
In 2019 the observers should continue tracking the health of the global economy
closely. The U.S. yield curve, a time tested measure of prognosticating a
recession, has once again inverted. An inverted yield curve augurs ill for both
the global economy and the oil market.
2020 Maritime Regulations:
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While this list is far from exhaustive, it contains the most significant oil price
catalysts to watch in 2019. The interplay between these factors is likely to play
a large role in influencing the oil market narrative for the year to come.
Conclusion:
This report considered the oil industry and the extraction process of crude oil. It
further highlighted on crude oil properties and characteristics and how they
affect the quality and consequently the pricing of the various crude oil
benchmarks. From the review, it can be established that these individual factors
or a combination of some of these factors can cause oil price volatility. Excess
production of crude oil can lead to surplus and price reduction whilst excess
consumption can also drive prices up. Increasing popularity of other energy
sources can also lead to a reduction in oil as well as its price. The atmosphere of
geopolitical tensions and instability is mostly associated with higher oil prices.
Other factors such as the value of the dollar, government decisions in
producing and consuming nations and futures market are also contributory
facors in oil price determination.
Global crude oil prices thus change overtime and cannot be attributed to one
single market. It is a highly complicated market system dependent on several
variables
Reference:
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Energy Journal 2016, 65thed., pp. 1 – 43.
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Books, Tulsa, Oklahoma, 2nd ed., pp. 1-10.
[3] Happonen, J. (2009), “A Review of Factors Determining Crude Oil Prices”,
Unpublished MSc Thesis Report, Helsinki School of Economics, Finland, pp. 1
– 24.
[4] Mian, M. A. (2011), Project Economics and Decision Analysis:
Deterministic Models, PennWell Books, Tulsa Oklahoma, Vol. 1, pp. 1 – 160.
[5] Energy Information Administration (2012), “Crude oils have different
quality characteristics”, U.S. Energy Information Administration webpage,
https://www.eia.gov/todayinenergy/
.php?id=7110. Accessed: February 2, 2017.
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[6] Energy Information Administration (2016), “What drives crude oil prices?”,
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https://www.eia.gov/finance/Markets/reports_
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[7] Seth, S. (2015), “Do Oil and Natural Gas Prices Rise and Fall Together”,
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trading/032515/do-oil-and-natural-gas-prices-riseand-fall-together.asp.
Accessed: February 2, 2017.
[8] Yergin, D. (1991), The Prize: The Epic Quest for Oil, Money & Power,
Simon & Schuster, New York, pp. 1 – 78.
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Accessed: February 3, 2017, pp. 1 .01
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