Crude Petroleum.docx

Crude Petroleum  Crude Petroleum is the 9th most traded product and the 1060th most complex product according to the Product Complexity Index (PCI).  The top exporters of Crude Petroleum are Russia ($73.7B), Canada ($39.5B), Norway ($22.8B), Kazakhstan ($19.4B) and Mexico ($15.5B). The top importers are China ($116B), the United States ($108B), India ($60.7B), Japan ($50.8B) and South Korea ($44.3B).  Top export of Russia, Norway, Kazakhstan, Colombia, Oman and Ecuador.  Top import of Japan, the Netherlands, South Korea, Belgium, Poland, Romania, Finland, Greece, Bulgaria and Lithuania.  Also known as oil, bituminous, diesel, gasoline, fuel.  Is a 4 digit HS92 product.  One of the better commodities to trade. It is a very active market and it is well known to investors around the world. There is usually no shortage of news to cause the price of oil to move from day to day. This presents many good trading opportunities, whether you focus on day trading futures or you are a longer-term trader or investor.  One of the most actively traded commodities in the world. With steadily rising crude oil prices in India, why should a trader add the commodity to his portfolio? 

India is world's 4th largest crude oil consumer with consumption at 3.1 million barrels per day. India imports almost 70% of its total consumption. Crude oil is the biggest component of India's import basket and its price affects overall economy. Rapid economic development is expected to further increase its consumption. Indian commodity market is growing and crude oil is one of the most traded commodities on domestic bourses.

Trading opportunities may not always be presented directly in crude oil commodity market. For example, there could be some fundamental change brewing in crude oil, it may not manifest into a trade in crude oil directly, but instead a trade opportunity may come about in the downstream companies. The oil and gas industry can be segregated into three sections – 1. The upstream industry 2. The downstream industry 3. The midstream industry Upstream companies 

Do the dirty work – they take on geological surveys, dig up bore wells to get a sense of what’s in the ground underneath, and if they find oil reserves, they then begin the drilling and extraction of crude oil.

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It takes many years for upstream companies to identify an asset (potential oil well) and convert it into a fully functional, profitable oil well. Upstream companies manufacture and store crude oil in barrels (millions of barrels are produced everyday). These companies do R&D and engineering, and are asset heavy. Therefore, they end up spending a lot of money (read as capital expenditure) to extract oil. However, the price at which they can sell this oil in the open market is not really in their control. The price is determined by the markets in which market participants participate and influence the international oil price. Every upstream company has a breakeven point – defined as the cost of producing one barrel of oil. The breakeven point is also referred to as the ‘full cycle cost’. Naturally, these companies would strive hard to keep their costs low and bring down the full cycle cost.

Companies such as ONGC, Carin India, Reliance Industries, Oil India are some of the Indian upstream companies. Internationally companies such as Shell, BP, Chevron etc., fall in this category. Low oil prices do not really favor upstream companies in general, especially the ones which have high economies of scale (the ones which have high full cost cycle). Obviously, higher oil price is good for these companies as their efforts to extract oil remain the same, but margins improve drastically. Downstream companies  

Purchase the crude oil from upstream companies and refine the crude oil to various forms such as – petrol, diesel, aviation fuel, marine oil, kerosene, lubricants, waxes, asphalts, liquefied petroleum gas etc.,. Companies in this sector also go the extent of distributing these products across the value chain, right from business to business (B2B distribution) to business to consumer (B2C) distribution.

Companies that successfully combine upstream and downstream operations are often referred to as the ‘Super Major’. Classic example of this is the US based ‘Exxon Mobil Corp’. So, if the oil prices fall, then it implies that the downstream companies can buy oil at cheaper prices from the upstream company (which is not so good for upstream companies as their efforts to produce oil is still the same). However, the benefit of lower oil price is not passed on to the end user, but in developed countries like US and UK, this benefit is passed on to the end users quite quickly.. Midstream companies  

Act as a courier between the upstream and downstream companies. Responsible for the transport of oil from the oil well to the refineries. They do this via pipelines, road transportation (oil takers), and by ocean shipments.

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Since midstream companies deal with both up and downstream companies, they are kind of caught in the middle, they neither want oil prices to increase or decrease, but seek stability in oil prices.

Brent crude is the benchmark for International crude oil pricing. o o o

Upstream and downstream companies share a see-saw relationship Low oil prices, is bad for the upstream but good for the downstream Higher oil price is good for upstream but bad for downstream

What Three Factors Do Traders Use To Set Oil Prices? 1. Current supply in terms of output. Since 1973, OPEC has limited supply of 61 percent of the world's oil exports. But U.S. shale oil production doubled between 2011 and 2014. That created an oil glut (surplus). Traders bid the price down to $45 per barrel in 2014. Prices fell again in December 2015 to $36.87 a barrel. OPEC would normally cut supply to keep oil at its target of $70 a barrel. This time, it allowed prices to fall since it wouldn't lose money until oil is $20 a barrel. Shale producers need $40-$50 a barrel to pay the high-yield bonds they used for financing. OPEC bet that the shale oil producers would go out of business. This would allow it to keep its dominant market share. That started to occur in 2016.

2. Access to future supply. That depends on oil reserves. It includes what's available in U.S. refineries as well as in the Strategic Petroleum Reserves. These reserves can be accessed very easily to increase oil supply if prices get too high. Saudi Arabia can also tap into its large reserve capacity. 3. Oil demand, particularly from the United States. These estimates are provided monthly by the Energy Information Agency. Demand rises during the summer vacation driving season. To predict demand, forecasts for travel from AAA are used to determine potential gasoline use. During the winter, weather forecasts are used to determine potential home heating oil use.

How World Crises Impact Oil Prices: Potential world crises in oil-producing countries dramatically increase oil prices. That's because traders worry the crisis will limit supply. That happened in January 2012 after inspectors found more proof that Iran was closer to building nuclear weapons capabilities. The United States and the European Union began financial sanctions. Iran threatened to close the Strait of Hormuz. The United States responded with a promise to reopen the Strait with military force if necessary. The possibility of an Israeli strike was also a concern. As a result, oil prices bounced around $95 to $100 a barrel from November through January. In mid-February, oil broke above $100 a barrel and stayed there. Gas prices also went to $3.50 a gallon. Forecasts were that gas would be at least $4 a gallon through the summer driving season. (Source: “Iran News,” New York Times. “Cushing WTI Spot Price,” Energy Information Administration.) World unrest also caused high oil prices in the spring of 2011. In March 2011, investors became concerned about unrest in Libya, Egypt and Tunisia in what became known as the Arab Spring. Oil prices rose above $100 a barrel in early March and reached its peak of $113 a barrel in late April. The Arab Spring revolts lasted through the summer and resulted in an overturn of dictators in those countries. At first, commodities traders were worried that the Arab Spring would disrupt oil supplies. But when that didn't happen, the price of oil returned to below $100 a barrel by midJune. Oil prices also increased $10 a barrel in July 2006 when the Israel-Lebanon war raised fears of a potential threat of war with Iran. Oil rose from its target of $70 a barrel in May to a record-high of $77 a barrel by late July.

Effect of Disasters on Oil Prices: Natural and man-made disasters can drive up oil prices if they are dramatic enough. Hurricane Katrina caused oil prices to rise $3 a barrel and gas prices to reach $5 a gallon in 2005. Katrina affected 19 percent of the nation's oil production. It came on the heels of Hurricane Rita. Between these two, 113 offshore oil and gas platforms were destroyed and 457 oil and gas pipelines were damaged. On the other hand, the Exxon-Valdez oil spill did not cause oil prices to rise. One reason was because oil prices in 1989 were only around $20 a barrel. The other was that only 250,000 barrels were spilled. Although this had a devastating impact on the Alaskan coastline, it didn't really threaten world supply. The Determinants of Oil Prices With oil's stature as a high-demand global commodity comes the possibility that major fluctuations in price can have a significant economic impact. The two primary factors that impact the price of oil are:  

supply and demand market sentiment

The concept of supply and demand is fairly straightforward. As demand increases (or supply decreases) the price should go up. As demand decreases (or supply increases) the price should go down. Sound simple? (For background reading, see Economics Basics: Demand And Supply.) Not quite. The price of oil as we know it is actually set in the oil futures market. An oil futures contract is a binding agreement that gives one the right to purchase oil by the barrel at a predefined price on a predefined date in the future. Under a futures contract, both the buyer and the seller are obligated to fulfill their side of the transaction on the specified date. The following are two types of futures traders:  

hedgers speculators

An example of a hedger would be an airline buying oil futures to guard against potential rising prices. An example of a speculator would be someone who is just guessing the price direction and has no intention of actually buying the product. According to the Chicago Mercantile Exchange (CME), the majority of futures trading is done by speculators as less than 3% of transactions actually result in the purchaser of a futures contract taking possession of the commodity being traded. The other key factor in determining oil prices is sentiment. The mere belief that oil demand will increase dramatically at some point in the future can result in a dramatic increase in oil prices in the present as speculators and hedgers alike snap up oil futures contracts. Of course, the opposite is also true. The mere belief that oil demand will decrease at

some point in the future can result in a dramatic decrease in prices in the present as oil futures contracts are sold (possibly sold short as well).