Understanding Oil Prices E-Book

Salvatore Carollo

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Series
• Sprache: Englisch

Seitenzahl: 272

Veröffentlichungsjahr: 2011

Beschreibung

It's a fair bet that most of what you think you know about oil prices is wrong. Despite the massive price fluctuations of the past decade, the received wisdom on the subject has remained fundamentally unchanged since the 1970s. When asked, most people - including politicians, financial analysts and pundits - will respond with a tired litany of reasons ranging from increased Chinese and Indian competition for diminishing resources and tensions in the Middle East, to manipulation by OPEC and exorbitant petrol taxes in the EU. Yet the facts belie these explanations. For instance, what really happened in late 2008 when, in just a few weeks, oil prices plummeted from $144 dollars to $37 dollars a barrel? Did Chinese and Indian demand suddenly dry up? Did Middle East conflicts magically resolve themselves? Did OPEC flood the market with crude? In each case the answer is a definitive no - quite the opposite in fact. Industry expert Salvatore Carollo explains that the truth behind today's increasingly volatile oil market is that over the past two decades oil prices have come untethered from all classical notions of supply and demand and have transcended any country's, consortium's, cartel's, or corporate entity's powers to control them. At play is a subtler, more complex game than most analysts realise (or are unwilling to admit to), a very dangerous game involving runaway financial speculation, self-defeating government policymaking and a concerted disinvestment in refinery capacity among the oil majors. In Understanding Oil Prices Carollo identifies the key players in this dangerous game, exploring their competing interests and motivations, their moves and countermoves. Beginning with the 1976 oil embargo and moving through the 1986 Chernobyl incident, the implementation of the US Clean Air Act Amendments of 1990, and the precipitous expansion of the oil futures market since the turn of the century, he traces the vast structural changes which have occurred within the oil industry over the past four decades, identifying their economic, social and geopolitical drivers, and analysing their fallout in the global economy. He explores the oil industry's decision to scale down refining capacity in the face of increasing demand and the effects of global shortages of petrol, diesel, jet fuel, fuel oil, chemical feedstocks, lubricants and other essential finished products, and describes how, beginning in the year 2000, the oil futures market detached itself almost completely from the crude market, leading to the assetization of oil, and the crippling impact reckless speculation in oil futures has had on the global economy. Finally he proposes new, more sophisticated models that economists and financial analysts can use to make sense of today's oil market, while offering industry leaders and government policymakers prescriptions for stabilising the market to ensure a relatively steady flow of affordable oil. A concise, authoritative guide to understanding the complex, oft misunderstood oil markets, Understanding Oil Prices is an important resource for energy market participants, commodity traders and investors, as well as business journalists and government policymakers alike.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Dedication

Epigraph

Foreword

Preface

Quick Reference Guide

List of Figures

List of Tables

List of Boxes

Chapter 1: The World Crude Oil Paradoxes

Chapter 2: The Market Events from 2008 to 2011

WORLD ENERGY POLICY

THE FINANCIAL CRISIS AND THE OIL MARKET

DEMAND/SUPPLY OF GASOLINE AND GASOIL

WTI – BRENT DIFFERENTIAL

Chapter 3: Evolution of the Price of Crude Oil from the 1960s up to 1999

1960–1980: THE OIL MONOPOLY AND THE TWO CRISES IN THE 1970S

THE 1980S: THE GRADUAL DISAPPEARANCE OF OPEC

THE PRICE WAR

1985–2000: FROM THE INTRODUCTION OF BRENT AS AN INTERNATIONAL BENCHMARK TO THE CLEAN AIR ACT

THE SUICIDE OF OPEC

THE START OF THE FREE MARKET

THE CONSEQUENCES OF THE ENVIRONMENTAL TURNAROUND

Chapter 4: Changes in the Market for Automotive Fuels

EVOLUTION OF ENVIRONMENTAL DEMAND

GASOLINE AND ITS COMPONENTS

REFINERS WALK THE TIGHTROPE

THE FISCAL POLICY OF THE INDUSTRIALIZED COUNTRIES REGARDING FUELS

Chapter 5: World Oil Flow

TRANSFORMATIONS IN THE DOWNSTREAM

WORLD SUPPLY STRUCTURE

Chapter 6: The Classical Model of the International Oil Market

Chapter 7: The Short-term Model of the International Oil Market

Chapter 8: The Brent Market

THE SALE AND PURCHASE CONTRACT

THE FORWARD MARKET FOR BRENT (15 DAY BRENT CONTRACT)

THE IPE BRENT MARKET

THE DIVORCE BETWEEN OIL PRICE AND OIL

Chapter 9: Principal Uses of the Forward and Futures Markets

TAX SPINNING

BENCHMARKING

HEDGING THE PRICE RISKS

SPECULATIONS ON OPERATIONAL FLEXIBILITIES AT LOADING

MARKET STRUCTURE: CONTANGO AND BACKWARDATION

PROCEDURES AT THE LOADING TERMINALS

Chapter 10: Problems of the Brent Forward Market

Chapter 11: The European Refinery Crisis

Chapter 12: Conclusions: We are Ourselves OPEC

Bibliography

Index

For other titles in the Wiley Finance series

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This edition first published 2012 © 2012 Salvatore Carollo

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Library of Congress Cataloging-in-Publication Data

Carollo, Salvatore. Understanding oil prices : a guide to what drives the price of oil in today’s markets / Salvatore Carollo. p. cm.—(The wiley finance series) Includes bibliographical references and index. ISBN 978-1-119-96272-4 (hardback) 1. Petroleum products—Prices. 2. Petroleum industry and trade—History. I. Title. HD9560.4.C37 2012 338.2′3282—dc23 2011039266

A catalogue record for this book is available from the British Library.

ISBN 978-1-119-96272-4 (hardback) ISBN 978-1-119-96289-2 (ebk) ISBN 978-1-119-96290-8 (ebk) ISBN 978-1-119-96291-5 (ebk)

A Sofia e Riccardo

Parmi d'aver per lunghe esperienze osservato tale essere la condizione umana intorno alle cose intellettuali, che quanto altri meno ne intende e ne sa, tanto più risolutamente voglia discorrerne; e che, all'incontro, la moltitudine delle cose conosciute ed intese renda più lento e irresoluto al sentenziare circa qualche novità.

It seems to me, after long experience in observing the human condition as regards intellectual matters, that some persons, the less they understand and know, all the more forcibly wish to hold forth; and that, when we encounter something new, the myriad things known and understood

Foreword

This book was conceived after a critical re-reading of the lectures I gave at the Eni Corporate University (ECU) for the Master MEDEA and for the Annual Seminar on oil marketing.

It is therefore the result not only of my elaborations and market models developed over the years to interpret the international oil market, but also of the discussions in the lecture hall with the students of the Master MEDEA and with the representatives of those producing countries who have taken part in the various editions of the Annual Seminar.

My thanks are due above all to these persons.

I also wish to thank Prof. Enzo Di Giulio, president of ECU, who desired to be present in these lectures and encouraged me to put the content of my presentations in book form.

Finally, I owe particular thanks to Dr Caterina Marmorato who, apart from helping me with notable professional commitment in the delivery of the lectures for the Master course, dedicated a good part of her free time for several months in preparing the technical annexes and in the task of editing.

Preface

The title of the book you are holding – Understanding Oil Prices: A Guide to What Drives Oil Prices in Today's Markets – brings to mind the telling of a story. Now, we know that for a story to be a good story it should meet three conditions: a) there are certain events to relate; b) these events run in order, that is, their sequence has some sense and, if possible, succeeds in holding the attention of the reader; c) there is a voice that narrates the story effectively and clearly. We feel that Salvatore Carollo's book satisfies all three of these conditions, and it tells a story of great interest to all of us.

The world of oil seems to be cloaked by a form of disparity in comprehension. Without oil, our entire existence – as we know it today – would not be possible. Despite the countless discussions regarding the oil peak and the end of the oil era, this fuel still represents, by far, the primary energy source. According to the last World Energy Outlook of the IEA, the proportion of oil as a source of energy stands at 34% against the 26% of coal and 21% of gas. According to the IMF's World Economic Outlook (WEO) reference scenario, in 2030 it will still be the primary source: 30% as against the 29% of coal and 22% of gas. Oil has, and continues to have, a profound influence on the lives of westerners and perhaps even more so on that of the peoples of the east. Certainly, it is a non-renewable source and this means that its days, in the long term, are numbered. But that is not the point here: the heart of the matter is that we are dealing with a material that shapes, changes, models, directs and configures the history of the world. And this is destined to carry on for a long time – true even when the lusty flames of oil, ephemeral like all the things in this world, fade away in the great emptiness of time. Just as the Hellenistic or Roman worlds still influence our lives despite their decline – consider for a moment our language – in the same way, oil has given the world a development and geopolitical model, which is destined to last for the coming centuries. But this is the future. Today, rather, we are in the midst of the oil era. And yet, as we said earlier, there is a depressingly inadequate awareness of the significance of this essential source. This very book has come to your hands, reader, thanks to oil. Here we are not talking about a technical knowledge of the complex work of exploration, or oilfield production, or of the transport of crude oil across the oceans of the globe. Rather, we refer to those three words that millions, if not billions, of times stand out in the media: the ‘price of oil’. This expression, the content of which has such a powerful influence on our lives, is the synthesis of immense forces – costs, decisions regarding investments and expenses, use of reserves, operations to cover risks, speculations, transactions, the policies of contracting companies, the policies of nations, oil companies and so on – that interact to form it. At the same time, from the price itself stem innumerable chains of actions that influence variables of fundamental importance for the entire economy: the quotations of the dollar and the euro, the balance of payments, the price of gasoline and gasoil, the cost of electricity, the rate of inflation, employment and so on. Thus, the price of oil has a vast and forceful impact on our existence. And despite all this, the issue is not adequately discussed. Rather, it is mentioned, hinted at and at times journalists try to explain it; but beyond the inner circle of specialists no one talks much about it. And this circle, to tell the truth, is very restricted. This is a destiny that oil shares, unfortunately, with all the sources of energy. Just reflect on the scarce availability of courses in energy economics in universities across the world. A similar reflection applies to books on energy economics that are a rara avis on this planet, particularly if we compare them with the plethora of texts on environmental economics. Paradoxically, energy – which represents perhaps the central axle around which the entire economy rotates – is almost never an issue to dissect in our degree courses, in particular those regarding economics. Thus, tethered within the strict boundaries of a territory for specialists, the price of oil remains an abstruse, esoteric matter. When an attempt is made to pass from the esoteric to the exoteric, it is often done in a misguided, amateurish way. The media advances information that evokes horrific scenarios – until last year some were predicting a price of around $200 per barrel – they talk of an oil peak and the end of oil. Alternatively, OPEC is indicted as being responsible for the high prices, inflating its role disproportionately. In this way, public opinion tends to form biased opinions based on explanations that draw attention to just one main force, as the only one responsible for what happens.

This book by Salvatore Carollo speaks of all this. It tells a story, as we said, and it does so starting from the end, namely the crude oil price collapse of last year from almost $150 to under $40 per barrel. Why did this happen? To what extent can the fundamentals explain it? Starting from these questions, the book offers an examination of the phenomenon that takes us nimbly through the essential phases of the evolution of crude oil price. The volume deals with relevant aspects – some quite technical – such as purchase contracts, the structure of world supply, the evolution of environmental regulations and, naturally, the refining process for crude oil. But at its core remains the key question of the price and its formation. The various issues discussed serve as fodder for the exploration of the primary question, as if they were pieces of a jigsaw to be completed. Certainly, as regards the role of the various forces that drive prices up or down, the book offers a very clear explanation. In one sense, it tracks down some of those guilty. We will not reveal them here, so as not to deprive the readers of the pleasure of discovering them in due course. We will only declare that the text materializes from the vast experiences of the author. As we read, we hear the voice of a professional, namely a man who works in the oil arena and whose main task is, for his part, to contribute towards the formation of prices, and not explain them. And yet, the author belongs to that class of professionals that master, thanks to their deliberation, whatever they do, in this way succeeding to unify thought with action. Unfortunately, their class is very rare: it is hard to say whether it is more or less rare than that of the academic who follows the inverse route, passing from theory to practice. What is certain is that the marriage of practice and reflection has produced a stimulating and enjoyable book. Some readers will appreciate its structure, which alternates the narration with the technical aspects, others the voice, still others will find it an interesting and nimble introduction to the world of oil, and others, finally, may see it as a sort of text book. Some will agree with its propositions, others not: we can be certain of that. But the function of a book is precisely this: to stimulate reflection and nurture knowledge with thought. To quote the celebrated words of a troubled writer of the 1900s, Franz Kafka – as troubled as the oil market! – ‘a book must be a pickaxe for the frozen sea that resides within us’. And the frozen sea is not only the existential and interior one as navigated by the writer from Prague. Often, the ice on the sea is created by prejudices, the knowledge fossilized inside us and never seen again, by the ready-made explanations, by their nebulosity which is never questioned. This book has the honour and duty to be a robust pickaxe.

Enzo Di Giulio President, Scuola Enrico Mattei

Quick Reference Guide

To assist the reader a glossary of the technical terms that have been only briefly considered in the text has been added. Other terms have been described in some detail in the pertinent chapters.

ASSESSMENT: this term is used in the text to mean estimate and/or valuation.AUTHOR'S SOURCE: when this reference is indicated, the source of data and graphs should be intended as a personal elaboration of data available in the market and from public sources.BENCHMARK: in the crude oil sector, a benchmark provides a reference parameter based on which other crudes are evaluated or priced. Some benchmarks are localized in specific geographic areas (e.g. Dubai in the Middle East or Tapis in the Asia-Pacific area) while others have global application, e.g. Brent Dated.BLENDING of GASOLINES: final operations in a refinery for mixing semi-finished products arriving from various plants. Actually, with very few exceptions, for technical/economic reasons, gasoline as a finished product is not directly obtained in a refinery from one sole plant, but usually through mixing various components.DOWNSTREAM/UPSTREAM: downstream is the part of the oil cycle that embraces transport, refining and marketing. The preceding operations, i.e. exploration and production of crude, represent the upstream.DRIVING SEASON: this term indicates the season for gasoline in America. Normally this phase starts in late May and continues for the entire summer season; in other words, as a result of summer travel, it is the period of greatest gasoline consumption in the USA.ICE: acronym for the Intercontinental Exchange, previously known as the International Petroleum Exchange (IPE), one of the major exchange markets for physical products and their derivates. The contracts dealt with on ICE include the following products: exchange rates, stocks and shares, crude and refined products, natural gas, coffee, cotton, sugar and so on. When reference is made to ICE futures, this signifies the futures contract for ICE Brent, dealt with in Europe on the London Exchange.IEA: Acronym for the International Energy Agency, an international organization founded by the Organization for Economic Cooperation and Development (OECD) with headquarters in Paris.JET-FUEL or JET-KERO: aviation fuel.JOINT VENTURE: a contract between organizations for the implementation of a project that involves notable technical and financial risks. The obligations and responsibilities of each partner are shared proportionately on the basis of each partner's participation quota in the project. Joint ventures between oil companies occur frequently in the exploration and exploitation of oilfields (in particular offshore ones).OCTANE NUMBER: the index of resistance to detonation of a fuel. If the octane number is too low the speed of combustion of the gasoline is too high and this causes shock waves in the combustion chamber of the engine (‘pinking’) and dispersion of energy.NYMEX: acronym for the New York Mercantile Exchange, one of the biggest commodity markets. Founded in 1872 for trading eggs, butter and cheese, it is now the reference bourse for oil. When the text refers to NYMEX futures this means the WTI futures contract.OPEC: acronym for the Organization of the Petroleum Exporting Countries.OPEN INTEREST/OPEN POSITIONS: in the futures market, this indicates the aggregate of the purchase and sale operations that have not been closed by operations in the opposite side.TERMINAL OPERATOR: the body that manages and administers a production terminal for crude oil (loading tankers, administration of production data, allocation of barrels). Normally this body coincides with the partner that has a majority shareholding in the project.OSP: Acronym for Official Selling Price. This provides one of the many ways for determining crude prices. The OSPs are normally fixed unilaterally and published by the producing countries.SPARE CAPACITY: in general, this refers to the unused capacity of a refinery (namely the capacity to produce greater quantities of refined products as compared with those already in production), or the unused production capacity of an oilfield (namely the capacity to produce greater quantities of crude oil as compared with those already in production).SWING PRODUCER: a producing country or association of such countries likely to adjust its offer of crude to the demand so as to control price movements.ARMS-LENGTH TRANSACTIONS: those between related parties but whose contractual terms reflect market conditions between independent and unrelated parties.WTI: acronym for West Texas Intermediate, also called Texas Light Sweet. This crude is used as a benchmark throughout America. The WTI derived contract is traded on the NYMEX.

List of Tables

Table 2.1 Comparative analysis of the value of NYMEX and Brent in the financial and physical markets

Table 2.2 Total production costs by region

Table 2.3 Demand of oil products in OECD Europe and in the USA

Table 4.1 Evolution of gasoline specifications

Table 4.2 Evolution of gasoil specifications

Table 4.3 World crude oil demand

Table 4.4 Gasoline in Europe and the USA: list price and price at the pump

Table 4.5 Price of gasoline and diesel fuel in some European countries

Table 5.1 Italian refineries

Table 6.1 Global oil demand and supply

Table 9.1 Correlation index between Brent and other international crudes

Table 11.1 EUROPE: surplus/deficit in capacity, refining margins and demand

Table 11.2 USA: surplus/deficit in capacity, refining margins and demand

List of Boxes

Box 2.1 Cost of the Marginal Barrel

Box 2.2 Jet Fuel and Gasoil Market

Box 3.1 The Netback Value System

Box 6.1 Variations in Estimated IEA Stocks

Box 8.1 The Principal Clauses in a Sale and Purchase Contract

Box 8.2 The Daisy Chain

Box 8.3 15 day Brent Contract

Box 8.4 The Price Risk in the 15 day Brent Contract

Box 9.1 First Example of Hedging

Box 9.2 Second Example of Hedging

Box 9.3 Example of Synergies Between Operational Flexibilities and Hedging

Box 9.4 Floating Storages

Box 10.1 Market Squeeze

Box 10.2 Assessment of Brent Dated (Platts’ Methodology)

Box 11.1 Trends in Agricultural Products and Oil Prices

1

The World Crude Oil Paradoxes

For some years now, the price of oil has been out of control. None of the great names of the industry, the production cycle or the oil market is able to intervene to decide its level or guide its progress. The oil companies, the OPEC producing countries as well as the non-OPEC, the consuming countries, the consumers: not one of these has this capability.

The price of oil, in the imagination of western consumers, is still linked to the equilibrium developed during the 1970s and 1980s, with the emerging of the Persian Gulf countries and the OPEC nations.

It is still a popular belief that the cartel of the largest oil producing countries in the world is capable of regulating the volume of production and using this key raw material to achieve political aims.

Even today, when the price of oil rises beyond any level considered critical, the vast majority of the oil market analysts turn their eyes towards Vienna, where the oil ministers of the OPEC countries meet, imagining, hoping for and analysing decisions which either will not be taken or, if taken, will turn out to be completely ineffective. Lately, in some market reports, more sophisticated analyses are merely focused on the availability of OPEC countries’ spare capacity; linking to this factor the dynamics of the oil price. When we look at the graph of the price of crude oil in Figure 1.1 we do not see the result of market forces, but rather a design traced by the hand of a powerful invisible architect who, following his own purposes, has established a course along which the price of oil should travel.

Figure 1.1 Brent Dated 1970–2010 and main historical events

Since the end of 1998 analysts, oil companies and producing countries have mistaken every forecast of the price of oil, clearly showing not only that they no longer control the fundamental market mechanisms, but that they are not even able to comprehend its real dynamics – it is as if the invisible architect had lost his pencil.

If we take our memory back to December 1998, when the price of crude oil fell to $9 per barrel, all the respected names of the oil industry, bar none, forecast that the price would stay for at least one or two decades under $15 per barrel. It is enough to glance at the investment budgets of all the oil companies or the financial programmes of the producing countries to confirm that only the most optimistic among them estimated maximum price levels between $14 and $15 per barrel in the long run. Some oil companies, based on this view, hedged their production at this level of prices and went bankrupt. Yet only a few months later, in the summer of 2000, the price had already reached $35 per barrel, taking everyone – market analysts, oil companies, producing countries, economists, politicians and consumers – by surprise. Rivers of ink were consumed to explain the nature of this event through analysis where the causes were sought in transient factors; a sudden storm, nervousness between two OPEC countries, political uncertainties and so on.

The years of the energy crises were far away and deeply buried in the collective subconscious. The reappearance of such a thorny question was regarded, before it raised any anxiety, as almost a nuisance. Still today, after a decade of price hikes for crude from $9 to more than $140 and then down to $37 and once again above $120 per barrel, most people limit themselves to reciting a series of clichés to try to find justifications for an incomprehensible phenomenon:

Limited supply from the producing countries, apparently inadequate to satisfy the growing demand for oil.Unexpected growth in the demand for oil by China and India, apparently upsetting the stability of the oil market.Tensions in the Middle East.The prospect of a decrease in the crude reserves/crude production ratio and therefore the availability of spare capacity.The excessive taxes on petroleum products (gasoline, diesel, LPG etc.) imposed by European governments.

This type of analysis has the advantage of being simple and easily presentable to the public at large, without, however, explaining what has really happened or is happening. Nevertheless, this approach has enabled some commentators to exaggerate on the contentious issues regarding the excessive power of the OPEC countries and the ways to bring them to reason.

The problem which all serious analysts have to face up to is actually quite simple. The essence is to explain oil price movements by use of the classic model of economics, which assumes that price is a function of the relationship between demand and supply:

This principle of economics seems too valid to allow any space for querying it. Notwithstanding this, the fundamental classic method applied tout-court to the oil market does not work. Yes, it is correct to say that the price is linked to the supply and demand balance, but of which good? We need to find out the merchandise or commodity whose supply and demand is determining the dynamics of oil price. For sure, it is not the physical crude oil.

OPEC has programmed and put into effect increases or cuts in production on numerous occasions, but always with scarce results. To every public announcement of increased production by the OPEC countries, the markets have responded with an increase in the crude oil price by at least a couple of dollars per barrel – and vice versa, when they announced cuts (Figure 1.2).

Figure 1.2 OPEC production versus Brent

Source: International Energy Agency

It is therefore reasonable to question whether the economic model utilized really works or if it is applied in an incorrect way to the oil market. Or, rather, that the technological complexity of this market does not allow it to be modelled on the simple relationship between demand and supply at a global level. The internal dynamics of this particular market require a much more detailed and complex model, capable of describing some of the fundamental dynamics of the system.

Unfortunately, the majority of analysts in this field have exclusively economic backgrounds and tend to apply general or econometric models to the crude oil, which are suitable for other commodities (coffee, copper, gold etc.), where the production and technological transformation processes are less complex.

Figure 1.3 Complexity and interdependence in the oil market

One starting point should be the recognition that what is commonly called the oil market is actually the conjunction and interaction of different markets which operate separately and independently but which are linked by certain complex forms of correlation and dynamics (Figure 1.3).

We refer now to the crude oil market (raw material), to the finished products market (gasoline, diesel, jet fuel, fuel oil, chemical feedstocks, lubricants) and to the financial market for crude and finished products (futures). We should always remember that in our cars and in airplanes we do not use crude oil, but finished products, which are increasingly difficult to produce. We cannot also neglect the dramatic developments of the futures market and its predominant role in the world economy.

Each and all these markets respond to different behavioural patterns and they are operated by bodies with differing interests, culture and business objectives. A model that does not take into account the inter-relations between these markets and their individual dynamics is incapable of describing what happens to oil prices.

When the analyst is confronted by the unequivocal event of a price variation, and having only the classic model of the global demand/supply, he can only create a scenario of probable events (input to the model), which, when processed, might generate the variation in price which actually took place. If the price rises it is clear that there must have been an increase in demand or a reduction in supply. Therefore, one looks for all the clues which might prove that something like this has taken place. In the absence of reliable and prompt information there is more than enough space for these concoctions. It is thus very easy to reach the mistaken conclusion that China and India (the distant enemy, the invisible tartars) are becoming the critical factors for our planet. And that certainly OPEC (the conflict of civilizations) is yet again, for political and ideological reasons, not producing enough crude. Unquestionably there is no need to verify the production data of Venezuela under Chavez, or Iran under Ahmadinejad. It seems highly likely that both would wish to create problems for the west by raising prices.

The economic and strategic importance of the themes related to the price of crude oil would require a far more detailed technical analysis.