3. Crude oil, commonly known as petroleum, is a liquid
found within the Earth comprised of hydrocarbons,
organic compounds and small amounts of metal. Crude
oil is refined into diesel, gasoline, heating oil, jet fuel,
kerosene, etc.
Classification by:
• Origin (e.g., West Texas Intermediate, WTI or Brent)
• Weight (light, intermediate or heavy)
• Sulfur content (sweet /sour).Crude oil production:
• Extraction/ drilling from oil reserves.
• About 80% of the world's readily accessible reserves are located in
the Middle East.
• Top 5 oil producing countries: Saudi Arabia, Russia, United States,
Iran, and China.
What is crude oil?
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4. Types of Transaction
Spot Transaction
Futures Contract
Major Trading Platform:
Intercontinental Exchange (ICE)
New York Mercantile Exchange (NYMEX)
Major Oil Price Benchmark
London-based Brent
US-based West Texas Intermediate (WTI)
OPEC Contract
Trading of Crude Oil
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6. Oil Supply
OPEC
•!Cartel of 12 countries : Algeria,
Angola, Ecuador, Iran, Iraq,
Kuwait, Libya, Nigeria, Qatar,
Saudi Arabia, UAE, Venezuela
•!To regulate supply and price of oil
•!Produced 42% of the world's oil
production
•!Account for 78% of world’s proven
oil reserve
•!OPEC Production Allocation
Oil Producers
•!Russia and Saudi Arabia produced
25% of world’s oil production
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9. Oil Demand
Factors affecting Demand
GDP growth
Seasons of the Year
Demand for Petroleum-based product (e.g. Heating oil, Gasoline)
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10. Oil Demand
World GDP
0.7166
Developed GDP
0.6757
Developing GDP
0.7617
Emerging market GDP
0.7770
World Production
0.5646
Opec Production
0.5384
Non-Opec Production
0.5319
World Consumption
0.5815
OECD Consumption
0.3489
Non OECD Consumption
0.7229
World Reserves
0.5184
OPEC Reserves
0.3367
World Inventories (Year end)
0.6299
Average Inventories
0.6224
GDP
•!Strong positive correlation (r =0.71) between World
GDP and oil price
•!Emerging countries has a higher correlation, r = 0.78
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12. •!GDP!
•!Unemployment rate!
•!National debt!
•!Interest rate!
•!Inflation rate!
•!Trade!
Dollar Value Determinants
US Dollar Strength
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13. - Increased 1.6% in Q2!
- 9.6% in Sep 2010!
- Over $13 trillion!
- 89% of GDP in Q1!
US Economic Growth
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14. US Economic Growth
- Benchmark interest rate: 0.25%!
- Inflation rate last reported at
1.1% in Aug 2010, down from a
peak of 5.6% in Jul 2008!
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16. US Trade
- Increased to $123 billion in Q2
from $109 billion in Q1!
-!Trade deficit dropped 14% to $42.8
billion in July 2010!
-!Total July exports rose 1.8% to $153.3
billion!
- Total Imports fell 2.1% to $196.1
billion!
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17. Expansionary monetary policy results in an economy based largely on debt
Increase in money supply leads to dollar decline
To bring trade imbalance under control
Leads to higher commodity prices
Recent Federal Reserve rate cuts to boost US economy accelerated dollar devaluation
Investors move capital out to avoid losses leading to further dollar decline
Recent FOMC meeting: Fed may add new stimulus measures to boost sluggish
economy (quantitative easing)
High unemployment rate at 9.6%
Weak housing market
US Monetary Policy
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18. •Heavy reliance on fiscal policy during latest recession
•Huge stimulus bill: American Recovery & Reinvestment Act (2009)
•$787 billion in personal & corporate tax cuts
•Increased federal aid & direct federal spending
•Federal revenues falling due to recession & ARRA tax cuts
•Increased fiscal deficits associated with depreciating exchange rate
US Fiscal Policy
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20. Impact of Dollar Devaluation
I/ SHORT TERM IMPACT
•Increased speculation and investment in oil futures:
•Hedge against weakening dollar
•High profit potential
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21. Impact of Dollar Devaluation
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II.! LONG TERM IMPACT!
Reduces purchasing
power and
increases domestic
inflation!
Reduce real income!
Lesser investment
in additional
capacity and
maintenance!
Reduced oil
production!
Varying impact on OPEC members!
•!Countries that import more from US stand to lose less!
Cheaper oil in
countries with
appreciating
currencies!
Higher demand for
gasoline in US due to
reduced number of US
tourists abroad!
Increased oil demand!
22. Impact of Dollar Devaluation
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EFFECTS OF SUPPLY & DEMAND!
Reduced oil supply!
Increased oil demand!
Increase in oil prices!
Higher oil
prices!
Higher US
trade deficits!
Weaker
dollar!
25. ICEemployed partial electronic trading on November 1, 2004
and shifted its benchmark ICE Brent crude to an all-electronic format on April 7, 2005
NYMEX started electronic WTI futures in 2006
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Oil Futures Contracts
30. !"#$%&'()%"*
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•Oct 5, 1973: Yom Kippur War started. The United States and many western
countries showed support for Israel
•Embargo on the countries supporting Israel curtailed production by 5 million
barrels per day
•Other countries were able to increase production by a million barrels Net loss
of 4 million barrels per day extended through Mar 1974 and represented 7%
of the free world production.
•The market price for oil immediately rose substantially, from $3 a barrel to
$12.
•The extreme sensitivity of prices to supply shortages became all too apparent.
Any doubt the ability to control crude oil prices had passed from the United
States to OPEC was removed during the Arab Oil Embargo.
Arab Oil Embargo – 1973 Oil crisis
31. •In 1979 and 1980, events in Iran and Iraq led to another round of crude oil price
increases.
•Iranian revolution resulted in the loss of 2 to 2.5 million barrels per day of oil
production between Nov1978 and Jun 1979. At one point production almost
halted.
•Sep1980, Iran was invaded by Iraq. By Nov, the combined production of both
countries was 6.5 million barrels per day less than a year before.
•Consequently worldwide crude oil production was 10% lower than in 1979.
•The combination of the Iranian revolution and the Iraq-Iran War cause crude oil
prices to more than double (from $14 in 1978 to $35 per barrel in 1981).
1979 Energy Crisis
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32. •Declining world oil demand and increasing non-OPEC production OPEC cut
output significantly in the first half of the 1980s to defend its official price
•Saudi Arabia bore most of the production cuts (from over 10 million barrels
per day for the period Oct 1980 through Aug 1981 to just 2.3 million by
Aug 1985)
•Late 1985, Saudi Arabia increased production, and aggressively moved to
increase market share.
•In response, other OPEC members also increased production and offered
netback-pricing arrangements to maintain market share and to offset
declining revenues.
•These actions resulted in a glut of crude oil in world markets, and crude oil
prices fell sharply in early 1986.
1986 Oil Price Collapse
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33. •Iraqi invasion of Kuwait
•Followed 6 months of extreme turbulence in world oil markets.
•3-year peaks in Jan1990 and then plunged to levels comparable to their 1986 lows by Jun (primary
cause: overproduction by Kuwait and the UAE)
•Gulf war
•Waged by a UN-authorized coalition force from 34 nations led by the US and UK, against Iraq.
•6/Aug/1990: UN imposed an immediate and nearly total embargo on oil exports from Iraq and Kuwait,
which Iraq had by then absorbed removed almost 5 million barrels a day from the world market.
•Government’s Reaction:
•Emergency Programs failed
•Market interference drove prices even higher.
•Prices rose from $21 per barrel at the end of July to $28 on August 6, reaching $46 by mid-October.
Gulf War - 1990 Oil Crisis
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34. •OPEC 10% increase in production quota coupled with Asian currency crisis which
reduced demand low point of oil price in 1999
•9/11 attack had no major effect on oil price
•2005: Damages by Hurricane Katrina led to sudden drop in oil supplies and sent oil
price to a high.
•Financial crisis 2008 and the ensuing economic recession held down demand
Other events
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40. One-year Forecast
Alquist and Kilian (2010) found that no change forecast is
more accurate than most forecasting models.
Random Walk Model
y(t)=y(t-1) +ε(t)
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41. “Changes in the spot price are unpredictable, so the best
forecast of the future spot price of the crude oil is simply the
current spot price.”
Price volatility: SD = 17.67
Price Range: $47.72 - $118.40
Price:
$83.06
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42. “It’s an ideal situation we are in now,” says Ali Naimi, Saudi oil
minister. “Consumers are happy, producers are happy.
Companies are investing.”
"Energy developments in
2009 were dominated by a
global recession and, later in
the year, a tentative recovery
and we can't know how
durable this recovery will
be," said Tony Hayward, BP's
embattled chief executive
Voser warned of a
challenging year ahead. ‘So
far in 2010, oil prices have
remained firm, and demand
for petrochemicals has
increased, but refining
margins, oil products demand
and spot gas prices all remain
under pressure,’ he said.
Société Générale SA cut its oil price forecast $88 a barrel for 2011
to $85 as demand growth slows and production outside OPEC
expands.
44. •Oil prices are highly volatile and are affected by supply & demand, dollar
strength, oil speculation and risk premium
•Oil is politically driven as it is an essential commodity and it is unequally
distributed in the world
•Oil has emerged as a separate asset class due to its negative correlation with
the dollar and stock markets
•In recent years, oil prices are becoming more “forward looking” as speculators
increased their share of trading dramatically
Key takeaways
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