Understanding Crude Oil Prices (original) (raw)

Oil prices: The role of renery utilization, futures markets and non-linearities

This article appeared in a journal published by Elsevier. The attached copy is furnished to the author for internal non-commercial research and education use, including for instruction at the authors institution and sharing with colleagues. Other uses, including reproduction and distribution, or selling or licensing copies, or posting to personal, institutional or third party websites are prohibited. In most cases authors are permitted to post their version of the article (e.g. in Word or Tex form) to their personal website or institutional repository. Authors requiring further information regarding Elsevier's archiving and manuscript policies are encouraged to visit: http://www.elsevier.com/copyright We test the hypothesis that real oil prices are determined in part by renery capacity, non-linearities in supply conditions, and/or expectations and that observed changes in these variables can account for the rise in prices between 2004 and 2006. Results indicate that the rening sector plays an important role in the recent price increase, but not in the way described by many analysts. The relationship is negative such that higher renery utilization rates reduce crude oil prices. This effect is associated with shifts in the production of heavy and light grades of crude oil and price spreads between them. Non-linear relationships between OPEC capacity and oil prices as well as conditions on the futures markets also account for changes in real oil prices. Together, these factors allow the model to generate a one-step ahead out-of-sample forecast that performs as well as forecasts implied by far-month contracts on the New York Mercantile Exchange and is able to account for much of the $27 rise in crude oil prices between 2004 and 2006.

Oil Markets and Price Movements: A Survey of Determinants

The complexity of the world oil market has increased dramatically in recent years and new approaches are needed to understand, model, and forecast oil prices today. In addition to the commencement of the financialization era in oil markets, there have been structural changes in the global oil market. Financial instruments are communicating information about future conditions much more rapidly than in the past. Prices from long and short duration contracts have started moving more together. Sudden supply and demand adjustments, such as the financial crisis of 2008-2009, faster Chinese economic growth, the Libyan uprising, the Iranian nuclear standstill or the deepwater horizon oil spill, change expectations and current prices. The daily Brent spot price fluctuated between 30andabove30 and above 30andabove140 per barrel since the beginning of 2004. Both fundamental and financial explanations have been offered as explanatory factors. This paper selectively reviews the voluminous literature on oil price determinants since the early 1970s. It concludes that most researchers attribute the long-run oil price path to fundamental factors such as economic growth, resource depletion, technical advancements in both oil supply and demand, and the market organization of major oil petroleum exporting countries (OPEC). Short-run price movements are more difficult to explain. Many researchers attribute short-run price movements to fundamental supply and demand factors in a market with very little quantity response to price changes. Nevertheless, there appears to be some evidence of occasional financial bubbles particularly in months leading up to the financial collapse in 2008. These conflicting stories will not be properly integrated without a meeting of the minds between financial and energy economists.

Oil Prices and the Hydrocarbon Markets: A Review

Energies

In this paper, we review the literature that investigates the impact of oil price shocks on the selected hydrocarbon prices. First, we present the empirical studies that presume, due to the global nature of the crude oil market, that the world oil price is an exogenous determining variable to the evolution of the local hydrocarbon markets such as natural gas or natural gas liquids (NGLs). Then, we present recent empirical studies that have improved our understanding of the source of oil price changes. They treat the real price of oil as an endogenous variable, identify the causes underlying oil price shocks, and then evaluate the impact of structural supply and demand shocks on the other hydrocarbon prices. The first strand of studies does not represent a consensus on the relationship between crude oil and other hydrocarbon prices—some demonstrate stable and asymmetric relationships, and some find no relationship or a very weak relationship. The second strand of studies shows that o...

An Anatomy of the Crude Oil Pricing System

Bassam Fattouh , it is possible to draw the following conclusions:  Markets with relatively low volumes of production such as WTI, Brent, and Dubai-Oman set the price for markets with higher volumes of production elsewhere in the world but with fewer or none of the commonly accepted conditions to achieve an acceptable „benchmark‟ status. So far the low and continuous decline in the physical base of existing benchmarks has been counteracted by including additional crude streams in an assessed benchmark. Such short-term solutions though successful in alleviating the problem of squeezes should not distract observers from some key questions: What are the conditions necessary for the emergence of successful benchmarks in the most liquid market? Would a shift to assessing price to these markets improve the price discovery process? Such key questions remain heavily under-researched in the energy literature and do not feature in the producer-consumer dialogue. The emergence of the non-OECD as the main source of growth in global oil demand will only increase the importance of such questions. Doubts about the suitability of Dubai as an appropriate benchmark for pricing crude oil exports to Asia have been raised in the past (Horsnell and Mabro, 1993). This raises the question of whether new benchmarks are needed to reflect more accurately the recent shift in trade flows and the rise in importance of the Asian consumer.  PRAs play an important role in assessing the price of the key international benchmarks. These assessed prices are central to the oil pricing system and are used by oil companies and traders to price cargoes under long-term contracts or in spot market transactions; by futures exchanges for the settlement of their financial contracts; by banks and companies for the settlement of derivative instruments such as swap contracts; and by governments for taxation purposes. PRAs do not only act as „a mirror to the trade‟. In their attempt to identify the price, PRAs enter into the decision-making territory. The decisions they make are influenced by market participants and market structure while at the same time these decisions influence the trading strategies of the various participants. New markets and contracts may emerge to hedge the risks that emerge from some of the decisions that PRAs make. The accuracy of price assessments heavily depends on a large number of factors including the quality of information obtained by the RPA, the internal procedures applied by the PRAs and the methodologies used in price assessment.  The assumption that the process of identifying the price of benchmarks in the current oil pricing system can be isolated from financial layers is rather simplistic. The analysis in this report shows that the different layers of the oil market are highly interconnected and form a complex web of links, all of which play a role in the price discovery process. The information derived from financial layers is essential for identifying the price level of the benchmark. One could argue that without these financial layers it would not be possible to „discover‟ or „identify‟ oil prices in the current oil pricing system. In effect, crude oil prices are jointly co-determined and identified in both layers, depending on differences in timing, location and quality.  Since physical benchmarks constitute the basis of the large majority of physical transactions, some observers claim that derivatives instruments such as futures, forwards, options and swaps derive their value from the price of these physical benchmarks i.e. the prices of these physical benchmark drive the prices in paper markets. However, this is a gross over-simplification and does not accurately reflect the process of crude oil price formation. The issue of whether the paper market drives the physical or the other way around is difficult to construct theoretically and test empirically in the context of the oil market. 79  The report also calls for broadening the empirical research to include the trading strategies of physical players. The fact remains though that the participants in many of the OTC markets such as forward markets and CFDs which are central to the price discovery process are mainly „physical‟ and include entities such as refineries, oil companies, downstream consumers, physical traders, and market makers. Financial players such as pension funds and index investors have limited presence in many of these markets. Thus, any analysis limited to non-commercial participants in the futures market and their role in the oil price formation process is incomplete.  The analysis in this report emphasises the distinction between trade in price differentials and trade in price levels. We postulate that the level of the price of the main benchmarks is set in the futures markets; the financial layers such as swaps and forwards set the price differentials depending on quality, location and timing. These differentials are then used by oil reporting agencies to identify the price level of a physical benchmark. If the price in the futures market becomes detached from the underlying benchmark, the differentials adjust to correct for this divergence through a web of highly interlinked and efficient markets. Thus, our analysis reveals that the level of oil price, which consumers, producers and their governments are most concerned with, is not the most relevant feature in the current pricing system. Instead, the identification of price differentials and the adjustments in these differentials in the various layers underlie the basis of the current oil pricing system. By trading differentials, market participants limit their exposure to risks of time, location grade and volume. Unfortunately, this fact has received little attention and the issue of whether price differentials between different markets showed strong signs of adjustment in the 2008-2009 price cycle has not yet received its due attention in the empirical literature.  But this leaves us with a fundamental question: what factors determine the price level of an oil benchmark in the first place? The crude oil pricing system and its components such as the PRAs reflect how the oil market functions: if oil price levels are set in the futures market and if participants in these markets attach more weight to future fundamentals rather than current fundamentals and/or if market participants expect limited feedbacks from both the supply and demand side in response to oil price changes, these expectations will be reflected in the different layers and will ultimately be reflected in the assessed price. The adjustments in differentials are likely to ensure that these expectations remain anchored in the physical dimension of the market.  Transparency in oil markets has more than one dimension. Although improving transparency in the physical dimension of the market is key to understanding oil market dynamics and enhancing the price discovery function, our analysis shows that transparency in the financial layers surrounding the physical benchmarks is as important. In this regards, it is important to emphasize three dimensions to the transparency issue. First, obtaining regular and accurate information on key markets is not straightforward and depends largely on the willingness of PRAs to release or share information. Second, the degree of transparency varies considerably within the different layers in the Brent, WTI and Dubai-Oman complexes as well as across benchmarks. The third dimension of transparency relates to the extent assessed prices are accurate and are reached through a transparent and efficient process. There are two aspects to this issue. The first aspect relates to the structural features of the oil market trading which impose certain constraints on these agencies‟ efforts to report deals and identify the oil price. The second aspect is linked to the internal operations of PRAs. Thus, the degree of price transparency is very much interlinked to the activities of PRAs and the reporting standards and other procedures that they internally set and enforce. The current oil pricing system has now survived for almost a quarter of a century, longer than the OPEC administered system did. While some of the details have changed, such as Saudi Arabia‟s decision to replace Dated Brent with Brent futures price in pricing its exports to Europe and the more recent move to replace WTI with Argus Sour Crude Index (ASCI) in pricing its exports to the US, these changes are

Oil and its markets

PSL Quarterly Review, 2015

Oil markets are extremely complex, characterized by an interplay of economic, political, technological and ecological issues. The paper begins by pointing to the high ratio between fixed and variable costs as a characteristic of the oil sector in all its production stages. Then the story of the sector is sketched, since the expansion of Rockefeller's Standard Oil Trust in the late Nineteenth century. Anti-trust intervention and collusion characterize the first part of the story; the notion of "trilateral oligopoly" (oil companies, producing and consuming countries) is then utilized in interpreting the developments since the Second World War. An illustration and a critique of the role played by financial markets in the determination of oil prices is accompanied by a critique of the theories interpreting oil prices as determined by its nature as a scarce natural resource. Recent trends in the oil sector, with the development of shale oil, are briefly considered.