Oil is constantly in the news, be it the security of its supply with geopolitical risks, the fluctuation of the price, or the reliance companies and countries have on it. This month, we seek to investigate why oil is so important, what factors affect it, and the news surrounding it today.
On the FTSE 100, oil and gas companies occupy three out of the top ten by market capitalisation. The economic impact of the industry is significant. According to Petrobas, the Brazilian oil and gas company, the sector has reached 13% of GDP, up from 3% in 2000. A report conducted by PWC in 2011 stated that the industry employed just under 10million people or 5.6% of US total.
What Affects Supply?
OPEC (Organisation of Petroleum Exporting Countries) is an organisation of twelve countries which produce around half the world’s daily oil production. It was founded in 1960 as an alliance or quazi trade union to regulate the supply of oil and has a major influence on the price of oil. This collaboration was drawn out of necessity to reduce competition. If they competed with each other, the price of oil would be constantly low, ensuring a high demand and running out of the resource swiftly. OPEC’s current goal is to keep the price of oil at around $100 per barrel. A high price for oil allows companies to justify spending significant CAPEX to conduct exploration and production. This is the incentive OPEC has to keep a high price as they want a constant and significant revenue stream.
If there is an oversupply in the market, OPEC will decide who will cut production in order to keep prices high. Recently, Saudi Arabia cut production by 400,000 barrels a day after prices dropped below $105 a barrel.
The U.S. has a storage capacity of over 700 million barrels of oil, known as the Strategic Petroleum Reserves. It came into existence due to the oil embargo crisis in the 1970s as a means to protect the US from any further supply disruptions. It is rumoured that the Chinese have a similar storage capacity, however this is still unproven.
What Affects Demand?
In terms of consumption, the U.S. uses 21% of the world’s oil. The European Union is the next biggest user at 15% of the world’s oil production with China using just 11%.
Two-thirds of oil usage is for transportation. This includes petrol, diesel, and kerosene or jet fuel. The other demands are industrial, which equate to about a quarter of consumption which is the heavier users such as heavy goods vehicles, air transport and shipping. Several surprising places we find oil products are in aspirin, crayons, chewing gum, lipstick, and, ironically, solar panels.
A third and very deadly reason for price volatility is speculation. This is the same speculation that brought upon the housing crisis in 2008.Oil futures, or futures contracts, are the same as any other commodity futures markets. Contracts to buy or sell oil at a specific date in the future at a specific price. Traders have the ability to drive the price of oil significantly if they are bullish on the global economy, driving the price of oil up several months or years out has ramifications to the end users of oil, such as petrol prices now on average 120p a litre.
The Current Status of Oil
Russian sanctions are unfortunately, likely to hurt western oil companies. All the majors such as Exxon Mobil, Shell Oil, and BP have joint ventures or significant shareholding in Russian oil infrastructure. Although there will be no immediate risk, the long term impact of continued investments will be in decline the most.
China, the rising consumer of oil, has a vast impact on the price. On the news that China’s manufacturing output grew the weakest since the financial crisis has added to the price of oil collapsing. The Chinese data “is one of the main weak sides of the market,” Andy Sommer, an analyst at Axpo Trading AG in Dietikon, Switzerland. “This weak data can mean the certainty, or confidence, in their expected growth is declining more and more. Currently the market is on the bearish side.” Added with Libyan oil production increasing steadily, the market is still oversupplied and demand is weakening.
The ex CEO of BP, Tony Hayward, has voiced his concerns on the current price of oil. “The world has been lulled into a false sense of security because of what’s going on in the US,” Hayward said in an interview with the Financial Times. His concerns came from why the market is crashing despite all the tension, where he believes the price would be closer to $150 a barrel if the US oil revolution wasn’t a factor, “When US supply peaks, where will the new supply come from?”