Take your time and read. This Column will teach you everything you need to know about Oil Market.
The word Petroleum originates from the Greek words for rock and oil, Petra and Elaion.
Oil has become a product that the modern developed societies rely upon to function.
Crude oil once refined can be used to fire our power stations so as to give us electricity that lights our homes, schools, hospitals and street lights.
Without crude oil, the home appliances that we have become dependent on such as the television, telephone, refrigerator and heating would not function as other stores of energy be it coal and natural gas are not sufficient to make up the shortfall if crude oil fields stopped pumping tomorrow.
Green energy such as the wind, tidal and solar do show promise but the technology has not progressed sufficiently to replace crude oil.
The excitement of splitting the atom and satisfying the words energy needs has diminished due to the safety concerns that surround the operating of such plants and the cost and complexity of deactivating nuclear plants that have come to the end of their operating life.
What defines the Type of Oils?
All Crude Oil contains Sulfur. This sulfur content can be used to determine the quality of the extracted product.
The general rule of thumb is the lower the sulfur level, the sweeter the crude.
Due to the low sulfur content, refineries have a preference for Light Sweet Crude as higher yields on premium products such as gasoline, diesel, heating oil and jet fuel can be extracted.
Light Sweet Crude as designated by the New York Mercantile Exchange to contain less than 0.42% of sulfur.
3 types of major crude oil products
- West Texas Intermediate
- Also known as Texas light Sweet is extracted from Texas and North Dakota. WTI contains 0.24% of sulfur.
- Brent Crude
- Brent took its name from the Brent oilfield that is located in the East Shetland Basin of the North Sea between Scotland and Norway. Brent contains a 0.37% sulfur level.
- Other major crude products
- OPEC Reference Basket, Dubai Crude, Oman Crude, Ural.
2 types of Oils that you invest online
The pricing of West Texas Intermediate is used as the benchmark for the global oil market.
WTI is traded on the New York Mercantile Exchange as the underlying commodity for the future contract.
Brent is traded electronically on the Intercontinental Exchange.
Brent is a major indicator for the pricing crude oil.
The reason for this is that two-thirds of all contracts transacted globally use Brent as their benchmark.
14 Reasons of the fall in the price of crude
1. Demand and supply
The demand for oil following the years since the great recession of 2008 has decreased.
Although the price of oil did rebound from the lows it reached in February 2009, increased supply that was spurred on by the cheap credit allowed for an expansion of United States shale oil field production.
This, in turn, led to an oil glut and the downward spiral in crude that August 2014.
2. Strong US Dollar
The strong U.S. Dollar has been the main driver for the price decline of crude oil over the last few years.
In fact, the dollar is currently at a 12-year high against the euro, leading to an appreciation in the U.S. dollar index and a reduction in oil prices.
Commodities and the US Dollar have an inverse relationship.
This is because commodities such as crude oil is priced in US Dollars.
Therefore, when the value of the US Dollar weakens it will take more US Dollars to buy the same barrel of crude.
Whereas the surge in the US dollar in the second half of 2014 caused a sharp fall in the leading commodity indexes and the price of Oil as fewer Dollars are needed for their purchase.
The Chinese economy has experienced stellar growth over the past two decades.
This growth transformed the world’s most populous country into the global factory of the world.
An economic miracle that took less than three decades turned a once backward economy into a country that now produces everything from the IPhone in your back pocket to the train that you take on your way to work.
However in recent years, the credit-fuelled bubble created overcapacity and this combined with a decrease in global demand have meant Chinese demand for Oil has also declined.
4. EU and the Eurozone
The European Union has struggled to grow its constituent economies since the great recession of 2008.
Economies that are contracting have meant the demand for crude has also contracted.
5. The global economy
The global economy has the struggle to grow since the great recession of 2008 with inflation and wage growth remaining at low levels.
The effect of this lack of growth has been to dampen the demand for manufactured goods which in turn depresses the demand for oil.
6. Emerging and developing markets
Weaker economies in the emerging and developing marker have meant the demand for domestic production has declined and this has had a relative impact on the price of oil.
7. Wage inflation
Although the United States economy is reaching levels close to full employment, there are continued concerns over the pace of wage growth.
With average earnings continuing to be depressed, the US consumer has been unable to fully take part in what has been an anaemic recovery.
This lack of spending leads to low consumption of products and, in turn, leads to lower demand for oil.
There has been a stream of lower price forecasts which have been published by major investment banks.
These lower forecasts have had an effect of depressing a crude market that is under stress.
OPEC is not an organization that includes all the major oil producers.
Notable high volume producers of Oil that are not in OPEC are Canada, USA, and Russia. OPEC and, in particular, Saudi Arabia has refused to introduce production quotas.
The decision not to limit production is for two reasons.
By keeping production high, the cost of oil will fall.
As lower oil prices penalize high-cost producers such as US Shale, the Saudi’s envisage that many of the highly leveraged shale oil extraction companies will be forced into bankruptcy.
Furthermore, Saudi Arabia is concerned that the US Shale industry will sever the geopolitical link that the USA has to the Middle East.
A reliance on Middle East oil will reconnect this link.
The successful conclusion to P5+1 negotiations has opened up global new commercial opportunities to Iranian Government and business interests.
This positive news for the Iranian economy will also benefit the oil industry.
Over the past few months, the market began to price in the possibility that an agreement would be reached.
It was not a surprise therefore when news broke that negotiations had been successfully concluded.
On the news, that agreement had been reached and with sanctions lifted Iran announced that it would immediately increase crude production.
To further add to the downward pressure on Oil prices, Iran has announced that a further 500,000 barrels will be produced daily as a when the infrastructure is in place.
Indonesia has recently re-joined OPEC. With this status, Indonesia could if it wished to attract more investment to its crude industry and therefore in the future increase its oil output.
12. Refinery downtime
U.S. refineries are in need of major maintenance at least once a year.
This maintenance usually occurs in the autumn following the height of the summer driving season.
With refineries unable to refine any product, crude that is extract has to be placed into storage or sold at a discount.
13. The weather
The recent good weather in the Northern Hemisphere, which on the whole has seen warmer than average winter temperatures, has led to a consumer needing to use less heating.
In turn, the reduced demand for heating has led to a reduced demand for power station electricity and, therefore, crude oil.
14. New technology
Over time, technology enhancements have allowed for increased efficiencies and cost savings.
This is true for the oil industry and especially for Saudi Arabia, the Gulf States and Iran who already benefit from low extraction costs.
Who are the Winners and Losers?
The Russian Government loses US$2 billion in budgetary revenue every time the price of crude drops by one US Dollar.
According to the World Bank, the Russian economy shrunk my 0.7% in 2015 with a further contraction expected in 2016.
Russia cannot simply turn off the taps due to technical reasons and also due to the need to maintain its market share.
The fear being that a pullback of Russian production would lead to the slack being taken up by other countries.
Venezuela is a major exporter of crude.
However due to Government mismanagement, this Latin American nation is finding it difficult to balance its budget.
For many OPEC means Saudi Arabia. This Arabian Peninsula nation is the world biggest exporter of crude oil.
With huge funds in reserve, the Saudi Government has embarked on a policy of forcing the price of crude ever lower so as force the closure of competitors and increase its own market share.
Its main target being the higher cost of production US Shale producers and to some degree Iran and Russia which it views as geopolitical foes.
US Shale Producers
The United States shale industry has taken off in recent years.
The volume of extraction from shale fields means that the USA is no longer dependent from foreign imports and has effectively severed the geopolitical link with the Middle East.
However, Saudi Arabia sees the introduction of shale oil as a major player in the global crude picture as a threat to its market hegemony.
Therefore, the deliberate policy to inflate production has had the effect of placing highly leveraged shale companies under financial stress.
The rest of the world
On the whole, falling crude prices have been welcomed by consumers be it households or producers.
There have been tangible benefits for Europe, China, Japan and Asia however, there are fears that that the declining price of oil will derail the Eurozone’s and UK’s inflation targeting.
Furthermore, the drop off in the pace of Chinese growth is offsetting the dividend that the lower crude price gives.
What to expect from Oil Price?
Demand and supply will always dictate the price of any product and this applies to the price of crude oil.
The glut of crude that is pumped from the ground will continue to place downward pressure on prices.
At some point in the future, crude will begin to find a level and form a base from where it edge higher.
Where this drop will stop is difficult to tell with analysts making calls of US25, 20, 15 and 10.
What will be the trigger if oil is to find demand?
The end game most probably is when the huge credit bubble in the US shale sector finally bursts.
With these producers out of the picture, crude could once again begin to edge higher.