Definition - Prices and supply of Crude oil plays a vital role in major economies of the world. Every day we hear / see some or other news about crude oil. However, maximum of lay man does not understand the economies behind crude oil, pricing structure and their impact on economies when prices are falling or rising.
What is crude oil - Crude oil is a
naturally occurring, unrefined petroleum product composed of hydrocarbon
deposits and other organic materials. A type of fossil fuel, crude oil can be
refined to
produce usable products such as gasoline,
diesel, and various other forms of petrochemicals.
Uses of Crude Oil - Many products can
be manufactured from Crude oil which form part of our day to day life. Few of
them are - 1) Liquefied Petroleum Gas (LPG) 2) Bitumen. 3) Kerosene. 4)Diesel
5)
Gasoline 6) Diesel 7) Lubricants 8) Paint etc.
Quantification – Crude oil is
generally quantified into Barrels. One barrel is equal to 158.99 liters.
Why Barrels - One of the most basic questions to
ask is why oil is measured in barrels and why is it priced in US dollars? No
one actually buys a barrel of oil; it’s not even transported in barrels. The
main reason is that the US measures it in
barrels (one barrel is the equivalent of 42 gallons) and that has become the
“normal” way that oil is talked about. To understand its origins we need to
look back to the 1860’s early oil fields in Pennsylvania USA. The first oil
that was pumped wasn’t stored in barrels. As the oil industry grew during the 19th
Century explorers needed to find a way to transport it around the country.
Inspiration came from the whiskey industry. It transported the golden liquid in
wooden barrels of a standard size, 40 gallons.
Largest oil producing country – US is the largest
oil producing country in the world followed by Saudi Arabia and Russia. US and Russia
both are not part of OPEC (will discuss on later part of this article about
OPEC). Hence, we generally see price war between US, OPEC countries and Russia.
Below is the list of largest oil production country.
Country
|
Oil Production (Million
BBL)
|
World
Production
|
89.59
|
United
States
|
15.04
|
Saudi
Arabia (OPEC)
|
12.00
|
Russia
|
10.80
|
Iraq
(OPEC)
|
4.45
|
Iran
(OPEC)
|
3.99
|
China
|
3.98
|
Canada
|
3.66
|
United
Arab Emirates (OPEC)
|
3.11
|
Kuwait
(OPEC)
|
2.92
|
Brazil
|
2.52
|
Venezuela
(OPEC)
|
2.28
|
Mexico
|
2.19
|
Top crude oil importing countries – India is third largest importer of crude oil in the world. It is interesting to know that despite being the largest oil producer in the world, the United States imports oil to meet its energy needs. In 2018, the US exported ~2.8 billion barrels of crude oil and petroleum products.
At the same time, it imported ~3.6 billion
barrels of crude oil and products during the year. So, it imported net ~0.9
billion barrels, or ~2.3 million bpd (barrels per day), of crude oil and
petroleum products in 2018. India also produce crude oil however it not enough
for domestic consumption.
·
China: US$239.2 billion (20.2% of total
crude oil imports)
·
United States: $163.1 billion (13.8%)
·
India: $114.5 billion (9.7%)
·
Japan: $80.6 billion (6.8%)
·
South Korea: $80.4 billion (6.8%)
·
Netherlands: $48.8 billion (4.1%)
·
Germany: $45.1 billion (3.8%)
·
Spain: $34.2 billion (2.9%)
·
Italy: $32.6 billion (2.8%)
Difference between Bren Crude and WTI - There are two benchmark
indices for crude oil – Brent Crude and West Texas Intermediate (WTI). Brent crude
is extracted from the North Sea and WTI is usually extracted from US oil fields
in Texas, Louisiana, and North Dakota. Brent crude price is the international benchmark
price used by the OPEC, while WTI crude price is a benchmark for US oil prices.
Since India imports primarily from OPEC countries, Brent is the benchmark for
oil prices in India.
Most of the
oil produced in Europe, Africa and the Middle East is priced according to the
cost of Brent crude. Brent futures are primarily traded on the Intercontinental
Exchange (ICE) in London, while WTI is the underlying asset for oil futures on
the New York Mercantile Exchange (NYMEX). Other benchmarks are Dubai Crude,
Canadian Crude, Urals (For Russia) etc. What is OPEC and Why it is formed? - The Organization of the Petroleum Exporting Countries (OPEC) is a permanent, intergovernmental Organization, created at the Baghdad Conference on September 1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. The five Founding Members were later joined by: Qatar (1961; Indonesia (1962) Libya (1962); United Arab Emirates (1967); Algeria (1969); Nigeria (1971); Gabon (1975) - terminated its membership in January 1995 but rejoined in July 2016; Equatorial Guinea (2017); and Congo (2018). OPEC had its headquarters in Geneva, Switzerland, in the first five years of its existence. This was moved to Vienna, Austria, on September 1, 1965.
OPEC’s objective is to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry. Currently, the Organization has a total of 13 Member Countries.
How long will the world’s oil reserves last? - It is believed that global oil reserves (1.67 trillion barrels of oil globally) will be exhausted sometime between 2050 and 2060. This assumes that global consumption (currently 92 million barrels per day) will increase over the next few decades.
The Determinants of Oil Prices - he two primary factors that impact the price of oil are: 1) Supply and demand 2) Market sentiment
The concept of supply and demand is fairly straight forward. As demand increases (or supply decreases) the price should go up. As demand decreases (or supply increases) the price should go down. Sounds simple? 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 fulfill their side of the transaction on the specified date
Price History of Crude Oil – Below is the price history of crude oil. There were many ups and downs in prices of crude oil. In month of April 2020, first time in world history prices of crude oil (WTI) gone below zero (April Expiry) i.e. suppliers are forced to sell crude by paying money or at zero oil as they did not have capacity to store the oil. However, prices of Brent Crude cannot go to negative since OPEC countries have sufficient storage facility and facilitate deliveries in cash. However, in case of WTI at end of expiry, trader either have to take physical delivery or can roll over the position for next month.
Price of crude oil always depends on demand and supply. OPEC countries mostly do focus on supply cut which helps them to maintain prices at optimum level. However, US and Russia was always a biggest challenge as one of them any time focus on exports of oil at lower prices and which leads to drop in oil prices of OPEC countries also. As of 2019, OPEC controlled roughly 75% of the world’s total crude oil reserves and produced 42% of the world’s total crude oil output.
However, the U.S. was the world’s largest oil-producing country in 2019 with more than 12 million barrels per day. Although OPEC still has the ability to drive prices, the U.S. has limited the cartel’s pricing power by ramping up production whenever OPEC cuts its output.
In past 5 years, countries whose 90% of economy depended on crude oil came to standstill such as Saudi Arabia, Qatar, Kuwait etc. If UAE had not focused on tourism, it will also the worst hit country from price fall. Economic crisis and recession was already started in these countries. These countries had enjoyed huge amount of profits and monopoly during 2008-2009 when prices soars highest at $140 per barrel.
Top Oil and Gas Companies in the World – We have always heard about Saudi Aramco as biggest oil company in the world however it is myth in current scenario. Sinopec group from China is biggest oil and gas company with total revenue of $414 billion in 2018 followed by Royal Dutch Shell – $388.37bn, China National Petroleum Corp (CNPC) – $346bn and Saudi Aramco – $ 355 bn. Saudi Aramco was biggest oil company till 2017 however revenue dropped drastically due to oil cut on other side China had good control over domestic oil prices.
Article Credit: CA.Shubham Bahety
Reference: E-Newsletter Vaisai Branch of WIRC of ICAI
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