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Business dynamics of the crude oil market

Published on 3rd Mar, Edition 9, 2014

 

Crude oil determines inflation and also determines the GDP of an oil exporting nation. In more advance economics as discussed earlier, oil is used for investments i.e. trading of commodity futures. Irrespective of the current market price, futures are locked at a higher price being traded on the New York Mercantile Exchange (or NYMEX), as well as the International Petroleum Exchange. Speculation that who trade large volumes can easily swing the price higher. This gives an indication to the oil exporting nations where the price of oil should be, hence cuts current supplies and for future sale to obtain a higher price. This is also an indication that trades would not want the price to drop from current levels. When investments are pulled in oil futures, it gives a signal to the market that oil prices will increase, which influences the price of oil. Crude at the end of the day is a commodity and those operating their businesses around commodity keep a close eye on the price of crude. Just as any commodity, the price of crude fluctuates, however, has little to do with demand and supply and more to do with decisions undertaken by OPEC to determine the international price. OPEC is an open cartel which identifies the price of Crude. The demand and supply factors rarely come into play with the price of crude. Oil prices tend to fluctuate with major macro-economic issues, however, it is also important to know that crude has an inelastic demand, which means revenue of oil exporting countries will increase if the price increases since crude will always be demanded.

This is also the reason why OPEC knows that reducing the price of oil will only hamper their own GDP, which they are not willing to compromise on and no exporting nation ever will. There are 42 gallons or 159 liters in one barrel of oil as the size of a single barrel remains same internationally, however, the price at which the barrel is sold changes. The only way the demand of crude will decrease is with alternate fuels, wind and solar energy. No one is sure how much oil is available in the world. Major corporations such as Shell, Chevron, BP constantly invest to find new sources of oil around the world.

Brent Crude is a major trading classification of sweet light crude oil that serves as a major benchmark price for purchases of oil worldwide. Brent Crude is sourced from the North Sea.

Oil is made of compressed hydrocarbons, the remains of prehistoric animals and plants placed under extreme pressures and temperatures in the Earth’s crust. Hydrocarbons take many forms, including coal, natural gas, crude oil and even diamonds. These oil sources can be found anywhere in the world with the Middle East and Saudi Arabia being the most abundant sources of oil. North America is the second largest producer of oil in the world with reserves found in Texas. OPEC has significant control over the price of oil and dictates production, supply, embargos and the price which becomes the benchmark for the world.

Once again, since oil exports constitute to higher GDP for exporting nations, the price is expected to remain above US$100 per barrel and the higher it goes the better. Oil is also non-renewable source of energy, which means that the reserves will come to an end at some point in the future.

With the price of oil, there is increased focus on alternate fuels which is expected to substitute the demand for oil in the future. Looking at the international trends, there are few developments in the world, which may affect the price of oil. US is in cross roads whether to refine and use the oil it produces internally or export. Ethiopia is in the lime light and is considered to show highest reserves in the African region. Morocco and Western Sahara have also shown oil deposits and are making efforts to refine the oil. Iran talks potential nuclear-oil swap with Russia where Russia is considering the construction of a second nuclear reactor at Iran’s Bushehr nuclear plant in exchange for Iranian oil. Saudi Arabia has oil reserves of 267 billion barrels, which only falls second to Venezuela with reserves of 297 billion barrels. More than 40% of the land in Saudi Arabia consists of oil reserves. There are more than 100 oil fields in Saudi Arabia with the Ghawar field the largest in the world with 70 billion barrels. OPEC has 1,200 billion barrels of oil whereas Non OPEC nations control 277 billion barrels. More than 66 percent of all OPEC reserves fall in Middle East. Based on ranking, Venezuela manages 24.8 percent of all oil supplies, Saudi Arabia with 22.1 percent of oil supplies and Iran with 13.1 percent of oil supplies.

It is also important to know the forecast of oil in the future. Upto year 2015, it is unlikely that oil will drop below US dollar 100 per barrel, which is currently averaging US dollar 108 per barrel to US dollar 112 per barrel since June 2013. It is expected that the refining in the US leading to excess supply just may reduce the price by 20 percent from current levels; it is unlikely that the oil will be exported than meet domestic production. There remains high uncertainty when it comes to projections. No one is for sure where the prices will be, however, prices will be higher than current levels. Oil prices will most definitely affect inflation and increase cost of living and cost of manufacturing.

According to International Energy Agency, OPEC will sustain its production to 30 million barrels per day whereas the demand is expected to increase. This means inflationary pressures will exist. Demand in developing world is expected to be slow whereas advanced economies such as China and the Western markets are expected to drive demand.

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