International Finance
Economy

Functioning of World Oil Markets

Crude oil is arguably the world’s most important and most actively traded commodity. 16th August 2013 On Friday, the U.S. Energy Information Administration forecast said China would be the world’s largest oil importer by the end of the year. Demand is expected to grow 13 percent from 2011 to 2014, as factory output in China increased to 9.7 percent. On the New York Mercantile Exchange...

Crude oil is arguably the world’s most important and most actively traded commodity.

16th August 2013

On Friday, the U.S. Energy Information Administration forecast said China would be the world’s largest oil importer by the end of the year. Demand is expected to grow 13 percent from 2011 to 2014, as factory output in China increased to 9.7 percent. On the New York Mercantile Exchange (NYME), West Texas Intermediate crude oil added $ 2.70 to $ 106.10 per barrel. Reformulated blendstone gasoline gained 5.05 cents to reach $ 2. 9081 per gallon. Home heating oil added 3.75 cents to reach $ 2.9949 per gallon. Taking these details into consideration, one might wonder how international crude oil prices are measured, traded and calculated. International Finance Magazine, goes into the details of the NYMEX, how world oil markets work and other details of the crude oil industry.

Several key factors influence the global oil market, including the types of crude oil, players in the oil market, supply and demand of crude oil and the price of oil. These factors have a direct impact on the prices consumers pay for diesel, gasoline and other oil based products.

 U.S. Benchmarking Index

Crude oil is arguably the world’s most important and most actively traded commodity. As there are many varieties and grades of crude oil, buyers and sellers have found it easier to refer a limited number of crude oils as a benchmarking reference.  Other varieties are then priced at a discount or premium, according to how their quality compares to that of the benchmark. In the U.S., the benchmark is West Texas Intermediate (WTI), this means the crude oil sales into the U.S. are usually priced in relation to the WTI, and this is the price that is quoted in the newspapers. There is another category of oil known as “light, sweet crude” which is traded in the New York Mercantile Exchange, this consists of a number of U.S. domestic or foreign crudes but will have a specific gravity and sulphur content within a specific range. Sweet crude is defined as having a sulphur content of less than 0.5 percent, oil containing sulphur of more than 0.5 percent is considered to be “sour”.

World Benchmark

Brent is generally accepted as the world benchmark, although sales volumes of Brent itself are far below compared to Saudi Arabian crude oils. According to International Petroleum Exchange (IPE), Brent is used to price two thirds of the world’s internationally traded crude oil supplies.

Gulf Region

In the Gulf, Dubai crude is used as a benchmark to price sales of regional crudes into Asia.

OPEC Basket

Known as the OPEC basket price, this is an average of 15 different crudes which includes oils from Saharan Blend from Algeria, Girassol from Angola, Minas from Indonesia, Oriente from Ecuador, Basra Light from Iraq, Iran heavy, Kuwait Export, Es Side from Libya, Bonny Light from Nigeria, Qatar Marine, Murban from the Emirates, Saudi Arabia’s Arab Light and BCF 17 Venezuela. OPEC takes control of the oil pumped into the marketplace and aims to keep the basket price with a predetermined range, the price differences between the WTI, Brent and OPEC correlate with each other very closely.

Crude oil comes in many varieties and qualities, depending on its specific gravity and sulphur content which depend on where it has been pumped from. If no other information is given, an oil price appearing in UK and other media reports will refer to the price of a barrel of Brent blend crude oil from the North Sea sold at London’s International Petroleum Exchange (IPE).

Demand and Supply

The price of oil is ruled by the general economic principle of demand and supply, when there is more supply in the market than consumers want, they can shop for the most competitive prices leading to lower prices. If demand is higher than the amount available, consumers will compete with each other, bidding for the supplies they need leading to a hike in prices. However, this not the only balance which drives demand and supply of the oil prices, buyers and sellers also factor in what they expect will happen to the prices in future. If buyers think the supply might be lower due to economic consequences or other reasons, they will stockpile, even if it means buying at a premium to protect against a higher price. (Since it is bought in huge volumes). Buyers will also delay their purchases if they observe a drop in international crude prices.

Crude Oil Prices

As explained in the earlier paragraphs the prices of crude oil is set against various indexes followed by countries worldwide. If there is a shortage oil in one part of the world, prices will raise in that market to attract supplies from other market until the forces of supply and demand fall in place, if there is a surplus in a region and the prices drop, buyers will be soon drawn into the market.

Trading

Along with all of the actual barrels of oil that are traded, there is a secondary market that trades in “paper” barrels. This simply indicates that oil is traded on “paper” based on a perceived monetary value of oil and not usually a physical exchange of the product. The two key markets where paper barrels of oil are bought and sold are in New York, on the New York Mercantile Exchange and in London, on the International Petroleum Exchange (IPE). There are two different kinds of buying mechanisms:

Future Contracts: In this type of a transaction, the buyer agrees to take delivery and the seller agrees to provide a fixed amount of oil at pre-arranged prices at a specified location. Future contracts are traded only on regulated exchanges and settled daily based on their current prices value in the market place, the minimum purchase in 1,000 barrels.

Spot Market: In the spot market, oil is bought and sold for cash and delivered immediately. The current spot price of cash is influenced by the futures market price, since the futures price represents the market’s collective view, at a given point of time, where prices may be headed.

The buyers in the futures market protect themselves from price volatility by their costs and revenue, the second group of investors make money by predicting the crude oil prices correctly.

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