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Crude Oil pricing?

May 2018

— This article is aimed at demystifying the history of crude oil and what makes the basis for pricing of crude oil. The different types of crude oil, the correlation and there demand across the globe. How does the price movement effect the economic and financial development of the countries across the globe?

From the middle of twentieth century, due to exceptional importance of the crude oil in the supply of the world’s energy demands, it had become one of the major indicators of economic activities of the world. Even after the appearance of alternate forms of energy like solar power, water and wind, the importance of crude oil as the main source of energy still cannot be denied. The sharp increase in the world oil prices and the volatile exchange rates are generally regarded as the factors of discouraging economic growth.

The exchange rate volatility and oil price fluctuations have considerable consequences on real economic activities. The impact of oil price fluctuation is expected to be different between the oil exporting and the oil importing countries. An oil price increase should be considered as bad news for oil importing countries and good news for oil exporting countries. While the reverse should be expected when the oil price decreases. Through demand and supply transmission mechanism, oil prices impacts the real economic activity.

The March 1999 spikes were experienced due to the restriction of crude oil production and cooperation among OPEC member states, the growth of oil demand in Asia that signified its recovery following the Asian financial crisis and decreased production from non-OPEC countries. The world market reacted with a sharp rise in prices with the increase in crude oil going beyond 30USD/barrel in the last quarter of 2000. OPEC countries tried to stabilize prices through the increase or reduction in production to a range of 22USD per barrel to 28USD per barrel.

The overall world crude oil demand grew at an average of 1.76% per year from 1994 to 2005, with a high of 3.4% in 2003-2004 and is projected to increase 37% over 2008 levels by 2030 (118  million barrels per day from 86 million barrels), and the largest part of increase in demand would come from the transportation sector. Most of the experts say that increased crude oil markets and price volatility can be due to unanticipated economic developments besides the Chinese and Indian unforeseen heavy energy demand.

Today, petroleum derivatives cover around 34% of the energy consumed in the world, according to the US Energy Information Administration. This simple fact explains why the oil market is of such an importance to the world. For an average reader, the feeling that the global oil trade involves a single type of crude oil found in underground deposits. In reality oils come with different densities (API gravity) and sulfur content which makes consuming nations and businesses. Hence different oil end up with different market values. Prices of crude oil are also determined by the dynamics of global supply and demand as well as regional geopolitical and economic conditions. To reflect all these considerations, traders use reference baskets of oils also called as benchmarks. There are over 160 different benchmarks around the world.

A benchmark crude is a crude oil that serves as a reference price for buyers and sellers of crude oil. There are three primary benchmarks, West Texas Intermediate (STI), Brent Blend, and Dubai Crude. Other well-known blends include the OPEC Reference Basket used by OPEC, Tapis Crude which is traded in Singapore, Bonny Light used in Nigeria, Urals oil used in Russia and Mexico’s Isthmus. Benchmarks are used because there are many different varieties and grade of crude oil. Benchmarking makes referencing types of oil easier for sellers and buyers. There is always a spread between WTI, Brent (shown in the charts) and other blends due to the relative volatility (high American Petroleum Institute – API gravity is more valuable), sweetness/sourness (low sulfur is more valuable) and transportation cost. This is the price that controls the world oil market price.

West Texas Intermediate (WTI): It primarily comes from Southwestern U.S. It is light (API gravity of 39.6 degrees & a specific gravity of 0.827, which means that at 60 degrees Fahrenheit, WTI is only 8/10 as heavy as water) and sweet (low- sulfur containing only 0.24%) thus making it ideal for producing products like low-sulfur gasoline and low-sulfur diesel and is refined in the Midwest. Today it is highly in demand and is bench marked for the other crude oil grades.

                                                       WTI crude oil price movement from 1971 to 2017/18

Brent Crude: Brent Crude, is a mix of crude oil from 15 different oil fields in the North Sea. It is a light, sweet crude with an API gravity of 38.06 and a specific gravity of 0.835, making it slightly heavier than West Texas Intermediate. The sulfur content is 0.37%. The price of Brent Crude is used to set prices for roughly 2/3 of the world’s oil. It is mostly refined in Northwest Europe and is also called Brent Blend, London Brent and Brent petroleum. The Brent field is located in the East Shetland Basin, halfway between Scotland and Norway. Brent is not as light or as sweet as WTI but it is still a high-grade crude.

                                                     Brent Crude Oil price from 1971 to 2017/18

Dubai and Oman: Dubai Crude, also known as Fateh, is a heavy sour crude oil extracted from Dubai. It is produced in the Emirate of Dubai, part of the UAE.  Dubai’s refinery, at Jebel Ali, takes condensates as feedstocks, and therefore all of Dubai’s crude production is exported. The API gravity is 31 degrees and a specific gravity of 0.871. Its sulfur content is 2%, making it 6 times more sour than Brent Crude and 8 times more sour than Wet Texas Intermediate. It is generally used for pricing oil that comes from the Persian Gulf.

OPEC Reference Basket (ORB): This is not a specific crude, but rather is a weighted average of petroleum that come from OPEC countries, the world’s oil cartel. There are currently 12 different oils combined into the ORB. It is calculated by the OPEC Secretariat in Vienna and reflects the output and exports of each state. It averages an API gravity, with the present combination, of 32.7 degrees and has a sulfur content of 1.77%. I t was recently changed to reflect the average quality of crude oil in OPEC Member Countries. The OPEC countries oils include Saharan Blend (Algeria), Girassol (Angola), Oriente (Ecuador), Iran Heavy (Iran), Basra Light (Iraq), Kuwait Export (Kuwait), Es Sider (Libya), Bonny Light (Nigeria), Qatar Marine (Qatar), Arab Light (Saudi Arabia), Murban (UAE) and Merey (Venezuela). The OPEC basket is slightly heavier and more sour than Brent.

Minas: Minas oil is also referred to as Sumatran Light and comes from the island of Sumatra. It is a light, sweet crude. The API gravity is approximately 35 and the specific gravity is 0.8498. It has a sulfur content of only 0.08%.

Canadian Crude: Edmonton Par and Western Canadian Select (WCS) are benchmarks crude oils for the Canadian market. The API gravity levels is around 40 degrees. The Canadian Crude Index (CCI) serves as a benchmark for oil produced in Canada. It allows investors to track the price, risk and volatility of the Canadian commodity.

Contracts: The first futures contracts on crude oil were traded in 1983, with the Chicago Board of Trade (CBOT) and the New York Mercantile Exchange (NYMEX). The NYMEX Division light crude oil futures contract is the most liquid form for crude oil trading, as well as the world’s largest-volume futures contract trading on a physical commodity. The contract provides for delivery of several grades of domestic and internationally traded foreign crudes, and serves the diverse needs of the physical market.

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