Special Topics in Economics Econ. 491 Chapter 8: Oil Industry; Facts and Pricing.

Special Topics in Economics Special Topics in Economics Econ. 491Econ. 491

Chapter 8:Chapter 8:

Oil Industry; Facts and PricingOil Industry; Facts and Pricing

I. Oil Market OverviewI. Oil Market Overview Historically, the international oil market was Historically, the international oil market was

dominated by the “Seven Sisters” multinational dominated by the “Seven Sisters” multinational companies or world cartel("British Petroleum", companies or world cartel("British Petroleum", "Chevron", "Exxon", "Gulf, "Mobil", "Royal Dutch "Chevron", "Exxon", "Gulf, "Mobil", "Royal Dutch Shell", "Texaco“). Shell", "Texaco“).

These companies, had control over refining of crude These companies, had control over refining of crude oil and distribution of the oil products all over the oil and distribution of the oil products all over the world.world.

These companies meant to keep purchasing prices for These companies meant to keep purchasing prices for oil down unilaterally, on the basis of which they paid oil down unilaterally, on the basis of which they paid income taxes and royalty (rental payment) to oil income taxes and royalty (rental payment) to oil countriescountries.

Main Oil producers felt the unfairness of such actions Main Oil producers felt the unfairness of such actions by these companies.by these companies.

As a result, Organization of Petroleum Exporting As a result, Organization of Petroleum Exporting Countries (OPEC) was established by five oil-Countries (OPEC) was established by five oil-producing developing countries (Iran, Iraq, Kuwait, producing developing countries (Iran, Iraq, Kuwait, Saudi Arabia and Venezuela) in Baghdad in Saudi Arabia and Venezuela) in Baghdad in September 1960 September 1960 .

OPEC's objective is to co-ordinate and unify OPEC's objective is to co-ordinate and unify petroleum policies among Member Countries, in order petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum to secure fair and stable prices for petroleum producers.producers.

Now OPEC consists of twelve members twelve members countries; Qatar (1961), Libya (1962), the United Arab Emirate Qatar (1961), Libya (1962), the United Arab Emirate (1967), Algeria (1969), Nigeria (1971), Angola (1967), Algeria (1969), Nigeria (1971), Angola (2007), Ecuador (2007).(2007), Ecuador (2007).

OPEC has twelve member countries: six in the Middle OPEC has twelve member countries: six in the Middle East, four in Africa, and two in South America.East, four in Africa, and two in South America.

Currently, there are 115 countries whose are producing oil worldwide.

OPEC produces around 40% of the world oil production.

OPEC Production of Oil :OPEC Production of Oil :Rank Country Production( bbl/day)

33,327,700 1 Algeria 2,125,000

2 Angola 1,948,000

3 Ecuador 485,700

4 Iran 4,172,000

5 Iraq 3,200,000

6 Kuwait 2,494,000

7 Libya 2,210,000

8 Nigeria 2,211,000

9 Qatar 1,213,000

10 Saudi Arabia 8,800,000

11United Arab

Emirates2,798,000

12 Venezuela 2,472,000

II. Oil Pricing Strategy II. Oil Pricing Strategy OPEC avoids the unusual increases in oil OPEC avoids the unusual increases in oil

prices, to limit the efforts for investing in prices, to limit the efforts for investing in alternative energy sources.alternative energy sources.

Oil consuming countries increase prices of the Oil consuming countries increase prices of the petrochemical products to limit the petrochemical products to limit the dependence on petroleum as the only energy dependence on petroleum as the only energy source, this is through:source, this is through: Imposing taxes on gasolineImposing taxes on gasoline Imposing carbon tax on oil importing companiesImposing carbon tax on oil importing companies Spreading the awareness of oil consumption efficiency.Spreading the awareness of oil consumption efficiency.

The cost of producing petroleum differs from country The cost of producing petroleum differs from country to another .to another .

The cost of producing the shale oil ranges from 40-The cost of producing the shale oil ranges from 40-70$ per barrel.70$ per barrel.

The cheapest cost of oil production is in the middle The cheapest cost of oil production is in the middle east region.east region.

For Kuwait, Saudi Arabia and Iraq, the cost is ranging For Kuwait, Saudi Arabia and Iraq, the cost is ranging from 0.8-1$ per barrel.from 0.8-1$ per barrel.

For other Middle Eastern countries,, the cost is For other Middle Eastern countries,, the cost is ranging from 2 - 4.5$ per barrel.ranging from 2 - 4.5$ per barrel.

Mexico (6-7$) , Brazil (10$), & Venezuela(7-10 $).Mexico (6-7$) , Brazil (10$), & Venezuela(7-10 $).

Lifting Costs“costs to operate and maintain oil

and gas wells and related equipment and facilities to bring oil

and gas to the surface”

Finding Costs“costs of exploring for and developing

reserves of oil and gas and the costs to purchase properties or acquire leases that might contain oil and gas reserves”

Total Upstream

Costs

United States – Average

12.18$ 21.58$ 33.76$

All Other Countries –

Average9.95$ 15.13$ 25.08$

Canada 12.69$ 12.07$ 24.76$

Africa 10.31$ 35.01$ 45.32$

Middle East 9.89$ 6.99$ 16.88$

Central & South

America6.21$ 20.43$ 26.64$

Costs for Producing Crude Oil and Natural Gas, 2007–2009

III. Oil Future ContractsIII. Oil Future Contracts Oil is marketed among other products in commodity Oil is marketed among other products in commodity

markets. Widely traded oil futures, and related natural markets. Widely traded oil futures, and related natural gas futures.gas futures.

Because of its excellent liquidity and price Because of its excellent liquidity and price transparency, the contract is used as a principal transparency, the contract is used as a principal international pricing benchmark.international pricing benchmark.

The first futures contracts on crude oil were traded in The first futures contracts on crude oil were traded in 1983. 1983.

Crude oil became the world's most actively traded Crude oil became the world's most actively traded commodity.commodity.

The largest markets are in London, New York and The largest markets are in London, New York and Singapore but crude oil and refined products - such as Singapore but crude oil and refined products - such as gasoline (petrol) and heating oil - are bought and sold gasoline (petrol) and heating oil - are bought and sold all over the world. all over the world.

Crude oil became the world's most actively traded Crude oil became the world's most actively traded commodity.commodity.

IV. Benchmark PriceIV. Benchmark Price A benchmark crude or marker crude is a crude oil that A benchmark crude or marker crude is a crude oil that

serves as a reference point for the many other crudes serves as a reference point for the many other crudes available.available.

There are three primary benchmarks, West Texas There are three primary benchmarks, West Texas Intermediate (WTI), Brent Blend, and Dubai/Oman. Intermediate (WTI), Brent Blend, and Dubai/Oman.

Other well-known blends include the OPEC basket Other well-known blends include the OPEC basket used by OPEC, Tapis Crude which is traded in used by OPEC, Tapis Crude which is traded in Singapore, Bonny Light used in Nigeria and Mexico's Singapore, Bonny Light used in Nigeria and Mexico's Isthmus. Isthmus.

Benchmarks are used because there are many different Benchmarks are used because there are many different varieties and grades of crude oil.varieties and grades of crude oil.

Using benchmarks makes referencing types of oil easier Using benchmarks makes referencing types of oil easier for sellers and buyers.for sellers and buyers.

There is always a spread between prices of these There is always a spread between prices of these Benchmarks due to the transportation cost.Benchmarks due to the transportation cost.

1- West Texas Intermediate )WTI(1- West Texas Intermediate )WTI(

The The price of petroleum as quoted in news in North as quoted in news in North America generally refers to the West Texas Intermediate America generally refers to the West Texas Intermediate (WTI).(WTI).

WTI is a type of crude oil used as a benchmark in oil WTI is a type of crude oil used as a benchmark in oil pricing and the underlying commodity of New York pricing and the underlying commodity of New York Mercantile Exchange's oil futures contracts.Mercantile Exchange's oil futures contracts.

WTI also is known as Texas Light Sweet.WTI also is known as Texas Light Sweet. The high quality sweet crude oil is a type of oil that The high quality sweet crude oil is a type of oil that

refineries need to meet stringent environmental refineries need to meet stringent environmental requirements adopted in many countries.requirements adopted in many countries.

WTI is a light crude oil, lighter than Brent Crude WTI is a light crude oil, lighter than Brent Crude oiloil..

In the United States, the benchmark is West Texas In the United States, the benchmark is West Texas Intermediate (WTI). Intermediate (WTI).

This means that crude oil sales into the US are usually This means that crude oil sales into the US are usually priced in relation to WTI. priced in relation to WTI.

This may be any of a number of US domestic or foreign This may be any of a number of US domestic or foreign crudes but all will have a specific gravity and sulphur crudes but all will have a specific gravity and sulphur content within a certain range. content within a certain range.

'Sweet' crude is defined as having a sulphur content of 'Sweet' crude is defined as having a sulphur content of less than 0.5%. less than 0.5%.

Oil containing more than 0.5% sulphur by weight is said Oil containing more than 0.5% sulphur by weight is said to be 'sour'. to be 'sour'.

This makes it ideal for producing products like low-sulfur This makes it ideal for producing products like low-sulfur gasoline and low-sulfur dieselgasoline and low-sulfur diesel

2- Brent Crude 2- Brent Crude

Brent Crude is used primarily in Europe and the OPEC Brent Crude is used primarily in Europe and the OPEC market basket, used around the world. market basket, used around the world.

The Brent Crude benchmark is a mix of crude oil from 15 The Brent Crude benchmark is a mix of crude oil from 15 different oil fields in the North Sea.different oil fields in the North Sea.

Brent is generally accepted to be the world benchmark, Brent is generally accepted to be the world benchmark, although sales volumes of Brent itself are far below those although sales volumes of Brent itself are far below those of, for example, some Saudi Arabian crude oils. of, for example, some Saudi Arabian crude oils.

Brent is used to price two thirds of the world's Brent is used to price two thirds of the world's internationally traded crude oil supplies. internationally traded crude oil supplies.

Brent is not as light or as sweet as WTI but it is still a Brent is not as light or as sweet as WTI but it is still a high-grade crude.high-grade crude.

3- Dubai and Oman3- Dubai and Oman

Dubai Crude is also known as Fateh, and it is produced in Dubai Crude is also known as Fateh, and it is produced in Dubai (UAE). Dubai (UAE).

Previously, Middle Eastern oil producers have taken the Previously, Middle Eastern oil producers have taken the monthly spot price average of Dubai and Oman as the monthly spot price average of Dubai and Oman as the benchmark for their oil sales to the Far East.benchmark for their oil sales to the Far East.

Whereas, WTI and Brent futures prices are used for Whereas, WTI and Brent futures prices are used for exports to the Atlantic Basin. exports to the Atlantic Basin.

4- OPEC Basket4- OPEC Basket

OPEC - a cartel of some of the world's leading producers OPEC - a cartel of some of the world's leading producers - has its own reference. - has its own reference.

It is known as the OPEC basket price which consists of It is known as the OPEC basket price which consists of the average of 15 different crudes (oils of OPEC the average of 15 different crudes (oils of OPEC members).members).

In practice, the price differences between Brent, WTI and In practice, the price differences between Brent, WTI and the OPEC basket are not large. Crude prices also correlate the OPEC basket are not large. Crude prices also correlate closely with each other.closely with each other.

The OPEC basket is slightly heavier and sourer than The OPEC basket is slightly heavier and sourer than Brent. As a result of these gravity and sulfur differences, Brent. As a result of these gravity and sulfur differences, WTI typically trades at a dollar or two premium to Brent WTI typically trades at a dollar or two premium to Brent and another dollar or two premium to the OPEC basket.and another dollar or two premium to the OPEC basket.

IV. Fundamental Factors Affecting Oil IV. Fundamental Factors Affecting Oil PricesPrices

Oil prices are determined by the demand and Oil prices are determined by the demand and supply of oil.supply of oil.

Therefore the supply and demand market Therefore the supply and demand market sentiment affects the oil prices.(Go Back to sentiment affects the oil prices.(Go Back to Principles)Principles)

Decisions Announced by OPEC. Decisions Announced by OPEC. HOW!!HOW!!

Oil Supply from outside OPEC .Oil Supply from outside OPEC . HOW !! HOW !!

Weather ConditionsWeather Conditions. HOW. HOW

Exchange Value Rate of the US dollar. Exchange Value Rate of the US dollar. HOW!!HOW!! Expectations . Expectations . HOW !!HOW !! US Oil Reserves.US Oil Reserves. HOW !! HOW !! US Oil Refinery Reserves.US Oil Refinery Reserves. HOW !! HOW !! Oil Demand in OECD Countries .Oil Demand in OECD Countries . HOW !! HOW !! Future Oil Market.Future Oil Market. HOW !! HOW !! Political Instability. Political Instability. HOW !!HOW !! Developments in Oil Alternative Resources. Developments in Oil Alternative Resources.

HOW !!HOW !! Investment in Oil Exploration & Development. Investment in Oil Exploration & Development.

HOW !!HOW !!