For my first commodities coverage series, I’ve decided to choose crude oil, which happens to be one of the most active commodity markets. Before getting into crude oil futures, which will be covered in the following articles, let’s first seek to understand the basic format of the crude oil market by stating the world’s biggest oil consumers, what is crude oil, it’s different types, the market for crude, it’s price influencers, how it’s formed and how crude is extracted.
Worldwide crude oil production is approximately 92.6 million barrels per day. Roughly 39.5 million of these barrels are produced by OPEC countries. While the United States just recently surpassed Saudi Arabia and Russia as the world’s largest crude oil producer.
* OPEC member countries: Algeria, Angola, Congo, Ecuador, Equatorial Guinea, Gabon, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, UAE and Venezuela
Also, below I’ve provided a chart from the U.S. Energy Information Administration (EIA) highlighting the current world’s top 10 largest total oil consumers. For more information on energy statistics I suggest you check out the EIA website https://www.eia.gov. Also, please note that total oil includes consumption of crude oil, all other petroleum liquids and biofuels.
Now that the producers of crude oil and consumers of total oil have been stated, let’s seek to define what is crude oil? Oilprice.com (https://oilprice.com) defines the commodity as “Crude oil, commonly known as petroleum, is a liquid found within the Earth composed of hydrocarbons, organic compounds and small amounts of metal. While hydrocarbons are usually the primary component of crude oil, their composition can vary from 50%-97% depending on the type of crude oil and how it is extracted. Organic compounds like nitrogen, oxygen, and sulfur typically make-up between 6%-10% of crude oil while metals such as copper, nickel, vanadium and iron account for less than 1% of the total composition.”
Two qualities or properties that define the type of crude are the sulfur content and API gravity. Light Sweet Crude Oil or West Texas Intermediate (WTI) contains sulfur contents below 0.5%, hence the name sweet, and has a API gravity of around 39.6. Brent Crude Oil (Brent) is a heavier oil with a higher sulphur content percentage than WTI and has an API gravity of around 38.08. Also crudes from Nigeria have even lower sulfur of around 0.1% or less. Meanwhile crude produced from Saudi Arabia contain sulfur levels in excess of 2% while crude out of Iraq has a sulfur level of nearly 3%.
The reason for why whether crude is light or heavy matters, is due to the costs associated with refining it. Light crude contains more of an important material called naphtha which can be refined into gasoline while also containing jet fuel and diesel fuel. Heavier crudes on the other hand contain more of what’s called vacuum gas oil and residual fuel. Hence, heavier oils can require more refining which can be a more expensive process. Essentially, there are four characteristics that define the quality or type of oil.
- Light — oil with a low density viscosity
- Heavy — oil with a higher density viscosity
- Sweet — oil with less sulfur
- Sour — oil with excessive sulfur
Now that crude oil has been defined and the differences described, let’s move onto understanding the market for crude oil. There are three main benchmarks for crudes on the world. Dubai Crude, also known as Fateh, serves as the benchmark crude for the Middle East. Brent crude is the North Sea crude marker and West Texas Intermediate (WTI) is the marker crude for the Western Hemisphere. West Texas Intermediate (WTI) is the crude price typically covered in the news and when a headline states or someone says “The price of oil dropped this month to $50 per barrel” they are referring to WTI.
The second part of understanding the market for crude oil is to define who sets crude prices. These benchmark crude prices are influenced by oil traders, refiners, producers, hedge funds, pension funds, speculators and all individuals with a position in mostly NYMEX Crude. More on what NYMEX Crude is later in my next article, but to further understand market price influencers I’ve included descriptions of four important price influencers provided by Smart Touch Energy.
- Current supply and output. Until recent years, Organization of Petroleum Exporting Countries (OPEC) often set supply through a quota system. However, American shale oil production doubled between 2011 and 2014, driving down the price. OPEC’s response has been to increase supply and drive down the cost per barrel, which is cutting into the affordability of U.S. shale production. All of this means you’re likely going to see lower home heating oil prices relative to the late 2000s.
- Future supply and reserves. Large oil-producing and oil-consuming countries tend to have reserves of crude oil to keep their economies going in the event that oil prices spike. Oil is stockpiled when the price is low and then spread through the economy to keep prices down when the resource becomes scarce. The U.S. has its Strategic Petroleum Reserve that can be tapped easily, while oil-related allies such as Saudi Arabia also have large reserves that can be tapped.
- Demand from major countries. The price of crude oil jumps when there is a larger demand, and that tends to happen at the beginning, middle and end of the year. Winter — covering the beginning and end of years — can see oil prices climbing as consumers demand more oil for heating their homes and businesses. Summer will also drive up oil prices as more Americans take to the roads for vacation.
- Political events and crises. War, natural disasters, political upheaval and new government leaders are all factors influencing crude oil pricing. For example, the “Arab Spring” unrest in 2011 pushed oil prices to a peak of $113 a barrel as unrest and protests rocked Egypt, Libya and Tunisia. They then returned to under $100 per barrel as things calmed down in June. Hurricane Katrina caused a large price increase in 2005 when it destroyed hundreds of oil and gas platforms and pipelines.
With the general outline of the crude oil market and it’s price influencers understood, let’s focus on how crude oil is formed and how it’s extracted. To better understand how crude oil is formed I’ve provided another passage from Oilprice.com which states that “Crude oil is created through the heating and compression of organic materials over a long period of time. Most of the oil we extract today comes from the remains of prehistoric algae and zooplankton whose remains settled on the bottom of an Ocean or Lake. Over time this organic material combined with mud and was then heated to high temperatures from the pressure created by heavy layers of sediment. This process, known as diagenesis, changes the chemical composition first into a waxy compound called kerogen and then, with increased heat, into a liquid through a process called catagenesis.”
To extract crude oil, the common method is drilling. Now in order to know where to drill, geologists will use satellite imagery, gravity meters, magnetometers and other methods. The common or basic drill is often associated with the image of an oil well. One drive along the highways in West Texas will reveal more oil wells than you can count, but with advances in oil extraction the methods have become today anything but simple.
The first two methods of extracting crude oil are referred to as primary and secondary recovery. Adventures in Energy describes primary recovery as “reliant on underground pressure to drive fluids to the surface. When the pressure falls, artificial lift technologies, such as pumps, are used help bring more fluids to the surface. In some situations, natural gas is pumped back down the well underneath the oil. The gas expands, pushing the oil to the surface. Gas lift technology is often used in offshore facilities. Primary recovery often taps only 10 percent of the oil in a deposit.” Also, they describe secondary recovery as “ the most widely applied enhanced recovery technique. Water that is produced and separated from the oil in the initial phase of drilling is injected back into the oil-bearing formation to bring more oil to the surface. In addition to boosting oil recovery, it also disposes of the wastewater, putting it back where it came from. This can bring an additional 20 percent of the oil in place to the surface.”
In addition to primary and secondary recovery, there are three enhanced techniques that are used to extract up to 60% of oil reserve.
- Thermal recovery entails injecting steam into the formation. The heat from the steam makes the oil flow more easily, and the increased pressure forces it to the surface.
- Gas injection uses either miscible or immiscible gases. Miscible gasses dissolve CO2, propane, methane or other gasses in the oil to lower its viscosity and increase flow. Immiscible gasses do not mix with the oil, but increase pressure in the “gas cap” in a reservoir to drive additional oil to the well bore.
- Chemical flooding involves mixing dense, water-soluble polymers with water and injecting the mixture into the field. The water pushes the oil out of the formation and into the well bore.
To wrap up, I’ve stated and defined the world’s biggest oil consumers, what is crude oil, it’s different types, the market for crude, it’s price influencers, how it’s formed and how crude is extracted. Now that the basic understanding of the crude oil market has been laid out, it’s time to move on to crude oil futures, oil trading and market complexities which will be covered in the upcoming commodity coverage series article.