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

I. Oil Market Overview  Historically, the international oil market was dominated by the “Seven Sisters” multinational companies or world cartel("British Petroleum", "Chevron", "Exxon", "Gulf, "Mobil", "Royal Dutch Shell", "Texaco“).  These companies, had control over refining of crude oil and distribution of the oil products all over the world.  These companies meant to keep purchasing prices for oil down unilaterally, on the basis of which they paid income taxes and royalty (rental payment) to oil countries  These companies meant to keep purchasing prices for oil down unilaterally, on the basis of which they paid income taxes and royalty (rental payment) to oil countries.

 Main Oil producers felt the unfairness of such actions by these companies.  As a result, Organization of Petroleum Exporting Countries (OPEC) was established by five oil- producing developing countries (Iran, Iraq, Kuwait, Saudi Arabia and Venezuela) in Baghdad in September 1960  As a result, Organization of Petroleum Exporting Countries (OPEC) was established by five oil- producing developing countries (Iran, Iraq, Kuwait, Saudi Arabia and Venezuela) in Baghdad in September  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.

 twelve members Qatar (1961), Libya (1962), the United Arab Emirate (1967), Algeria (1969), Nigeria (1971), Angola (2007), Ecuador (2007).  Now OPEC consists of twelve members countries; Qatar (1961), Libya (1962), the United Arab Emirate (1967), Algeria (1969), Nigeria (1971), Angola (2007), Ecuador (2007).  OPEC has twelve member countries: six in the Middle 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 : Rank CountryProduction (bbl/day)bbl/day 33,327,700 1 Algeria2,125,000 2 Angola1,948,000 3 Ecuador485,700 4 Iran4,172,000 5 Iraq3,200,000 6 Kuwait2,494,000 7 Libya2,210,000 8 Nigeria2,211,000 9 Qatar1,213, Saudi Arabia8,800, United Arab Emirates 2,798,000 12Venezuela2,472,000

II. Oil Pricing Strategy  OPEC avoids the unusual increases in oil prices, to limit the efforts for investing in alternative energy sources.  Oil consuming countries increase prices of the petrochemical products to limit the dependence on petroleum as the only energy source, this is through:  Imposing taxes on gasoline  Imposing carbon tax on oil importing companies  Spreading the awareness of oil consumption efficiency.

 The cost of producing petroleum differs from country to another.  The cost of producing the shale oil ranges from $ per barrel.  The cheapest cost of oil production is in the middle east region.  For Kuwait, Saudi Arabia and Iraq, the cost is ranging from 0.8-1$ per barrel.  For other Middle Eastern countries,, the cost is ranging from $ per barrel.  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 – Average $9.95$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 America $6.21$20.43$26.64 Costs for Producing Crude Oil and Natural Gas, 2007–2009

III. Oil Future Contracts  Oil is marketed among other products in commodity markets. Widely traded oil futures, and related natural gas futures.  Because of its excellent liquidity and price transparency, the contract is used as a principal international pricing benchmark.  The first futures contracts on crude oil were traded in  Crude oil became the world's most actively traded commodity.

 The largest markets are in London, New York and Singapore but crude oil and refined products - such as gasoline (petrol) and heating oil - are bought and sold all over the world.  Crude oil became the world's most actively traded commodity.

IV. Benchmark Price  A benchmark crude or marker crude is a crude oil that serves as a reference point for the many other crudes available.  There are three primary benchmarks, West Texas Intermediate (WTI), Brent Blend, and Dubai/Oman.  Other well-known blends include the OPEC basket used by OPEC, Tapis Crude which is traded in Singapore, Bonny Light used in Nigeria and Mexico's Isthmus.

 Benchmarks are used because there are many different varieties and grades of crude oil.  Using benchmarks makes referencing types of oil easier for sellers and buyers.  There is always a spread between prices of these Benchmarks due to the transportation cost.

1- West Texas Intermediate (WTI)  The as quoted in news in North America generally refers to the West Texas Intermediate (WTI).  The price of petroleum as quoted in news in North America generally refers to the West Texas Intermediate (WTI).  WTI is a type of crude oil used as a benchmark in oil pricing and the underlying commodity of New York Mercantile Exchange's oil futures contracts.  WTI also is known as Texas Light Sweet.  The high quality sweet crude oil is a type of oil that refineries need to meet stringent environmental requirements adopted in many countries.  WTI is a light crude oil, lighter than Brent Crude oil.

 In the United States, the benchmark is West Texas Intermediate (WTI).  This means that crude oil sales into the US are usually priced in relation to WTI.  This may be any of a number of US domestic or foreign crudes but all will have a specific gravity and sulphur content within a certain range.  'Sweet' crude is defined as having a sulphur content of less than 0.5%.  Oil containing more than 0.5% sulphur by weight is said to be 'sour'.  This makes it ideal for producing products like low-sulfur gasoline and low-sulfur diesel

2- Brent Crude  Brent Crude is used primarily in Europe and the OPEC market basket, used around the world.  The Brent Crude benchmark is a mix of crude oil from 15 different oil fields in the North Sea.  Brent is generally accepted to be the world benchmark, although sales volumes of Brent itself are far below those of, for example, some Saudi Arabian crude oils.  Brent is used to price two thirds of the world's internationally traded crude oil supplies.  Brent is not as light or as sweet as WTI but it is still a high-grade crude.

3- Dubai and Oman  Dubai Crude is also known as Fateh, and it is produced in Dubai (UAE).  Previously, Middle Eastern oil producers have taken the monthly spot price average of Dubai and Oman as the benchmark for their oil sales to the Far East.  Whereas, WTI and Brent futures prices are used for exports to the Atlantic Basin.

4- OPEC Basket  OPEC - a cartel of some of the world's leading producers - has its own reference.  It is known as the OPEC basket price which consists of the average of 15 different crudes (oils of OPEC members).  In practice, the price differences between Brent, WTI and the OPEC basket are not large. Crude prices also correlate closely with each other.  The OPEC basket is slightly heavier and sourer than Brent. As a result of these gravity and sulfur differences, WTI typically trades at a dollar or two premium to Brent and another dollar or two premium to the OPEC basket.

IV. Fundamental Factors Affecting Oil Prices  Oil prices are determined by the demand and supply of oil.  Therefore the supply and demand market sentiment affects the oil prices.(Go Back to Principles)  Decisions Announced by OPEC. HOW!!  Oil Supply from outside OPEC. HOW !!  Weather Conditions. HOW

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