Global oil markets can be among the most tumultuous to follow, thanks to the world’s fierce dependence on the finite fuel for everything from powering our cars to heating our homes. Crude oil is the source of nearly half of the energy used worldwide, and once it is processed it can be transformed into literally thousands of products, from lubricants to plastics to synthetic fibers. Thanks to this intense and constant demand, oil markets can be a roller coaster ride: after Iraq’s August 1990 invasion of Kuwait, U.S. oil prices shot past $40 a barrel, but just eight years later they had dipped to less than a fourth of that price, thanks to a glut of oil in world markets. In early 2003, oil again flirted with the $40 mark on concerns that a U.S.-led invasion of Iraq would disrupt Middle Eastern oil supplies.
Crude oil is found throughout the world, but large deposits are concentrated in the Gulf of Mexico, the Middle East, the North Sea and Africa. In a number of countries, the exploration, production and sale of oil remain firmly in the control of the government, which often oversees the industry through a state-run oil company, such as Venezuela’s Petroleos de Venezuela (PDVSA) or Saudi Arabia’s Saudi Aramco. In territories where the industry has been opened to the private sector, firms like ExxonMobil, the world’s biggest oil company, explore for, pump and sell the oil.
The world’s biggest oil producer by a long shot is Saudi Arabia, which is sitting on proven oil reserves more than double those of its closet rival. Other major producing countries include Iran, Venezuela, Russia, Mexico, Kuwait and the United States, although the latter, the world’s largest energy consumer, has to import about half its oil needs. The largest private sector oil companies, known as the oil majors, include BP Amoco, the Royal Dutch/Shell Group and ChevronTexaco.
Oil is measured in barrels and the production of a company or country is quoted in barrels per day, abbreviated as bpd. One barrel equals 42 U.S. gallons or 159 liters. The commodity trades primarily in London on the International Petroleum Exchange (IPE) and in New York on the NYMEX exchange. The benchmark grades, or those that see enough trading to serve as reference points for buyer and sellers, include Brent crude and West Texas Intermediate, or WTI. Brent contracts trade in London and WTI trades in New York. These grades, as well as a host of other kinds of oil, can trade in the form of spot, or short-term, contracts, and futures contracts, an agreement to buy or sell oil at a later date. Futures contracts allow buyers and sellers to hedge, or take out an insurance policy on the risk of potential price swings down the road. Besides the basic oil contracts, investors trade scores of oil products such as heating oil and gasoline, which, like oil, can move wildly on news headlines.
Oil comes in a variety of grades, which are classified based on weight and sulfur content. When measured by weight, crude can be classified as light, intermediate and heavy, and the lighter the oil, the easier it is to refine in oil refineries and the more valuable it is. Consequently, light crudes usually sell at a higher price, or a premium, to heavier grades. The weight, or density, of oil is measured by the API reading adopted by the industry group American Petroleum Institute (API). There is no official cutoff for when a grade is classified as heavy or light, but in general an API number in the low 20s or below is considered heavy and a number in the 30s or higher is light, with the intermediate grades falling in between.
Sulfur is also an important consideration in the classification of crude because its presence in oil makes gasoline more polluting and corrodes car engines -- it must therefore be removed from the crude. Oil containing a lot of sulfur is called sour, while crude with low sulfur content is characterized as sweet.
Supply and Demand
The chief reason behind the often-massive swings in oil prices is a change in supply or demand. A myriad of factors can affect either side of the equation, but simply put, any jump - or at least an expected jump - in the world’s oil supplies can push prices lower, while the prospect of reduced supplies can lead prices higher. The same goes for demand: an increase in the world’s oil needs, whether real or perceived, can lift prices, while a slackening of demand can sink them.
On the supply side, among the factors that are closely watched by investors and traders are sizable new oil deposits and the timing of when these discoveries will begin producing, or come on line. A country’s decision to increase its crude production and/or its exports to world markets also garners a lot of scrutiny in the markets, as does a reduction in output due to the drying up of oil deposits or declining productivity levels at oil wells.
Temporary supply disruptions can also play a critical role. A reduction or halt in the flow of oil, whether at the production wells themselves or in the process of transporting the crude, by a major oil supplier can have an explosive effect on the markets. A hurricane in the Gulf of Mexico, for example, can threaten the vast web of offshore oil platforms, forcing evacuations and the temporary shutdown of a key source of the United States’ oil. In Colombia, guerrillas routinely blow up oil pipelines as part of their ongoing civil war against the government, and while Colombia does not rank among the world’s major oil suppliers, such events can be of interest to the markets. Social unrest can also spell disaster for oil production, something seen in December of 2002 and January of 2003 when a two-month general strike in Venezuela strangled the nation’s oil production and exports and helped send global oil prices soaring. Ethnic conflict in Nigeria in 2003 also caused price rises as the tensions cut off some 40 percent of the nation’s production. In some cases, like in Venezuela, the disruption can be severe enough to force the country or company to declare a force majeure, which is effectively an inability to deliver on oil promised to customers because of a so-called act of God.
Another part of the supply picture that must be monitored is industry and government data on U.S. crude oil stocks. The U.S. Energy Information Administration (EIA) and the American Petroleum Institute (API) publish weekly reports on stocks and an unexpected buildup of supplies can sink prices, while a decline can do the opposite. In the United States, another potential market mover is the Strategic Petroleum Reserve (SPR), an oil stockpile created for supply emergencies like the disruption of oil imports. If the government decides to utilize some of the SPR or increase its size - as of the end of the first quarter the level was 599 million barrels - prices can move accordingly.
While much of the news affecting oil prices is found at the production level, known in oil parlance as upstream, the processing and refining of crude - or downstream - is also closely watched. A fire at a refinery, for example, can cause delays in the processing of crude, which in turn means consumers could face shortages of heating oil or gasoline.
On the demand side, a sharp change in the use of oil is also something closely watched. A fast-growing economy, for example, will require more oil than a more stagnant one to keep industries humming, and this is something investors will take into account in their daily calculation of whether to buy or sell oil. Weather, too, is a factor: a particularly warm winter in the Northern Hemisphere can keep oil stocks high, depressing prices, while a severely arctic winter can erode stocks and push prices higher.
OPEC
Since its creation in 1960, the Organization of Petroleum Exporting Countries has been at the center stage in international oil circles, thanks to its control of a sizable chunk of world oil production. Most recently, the group has been in the spotlight through its efforts to keep oil prices “stable,” or in the target range of $22 to $28 a barrel for a basket of selected OPEC crude grades. OPEC, headquartered in Vienna, is comprised of 11 developing countries and dominated by the Arab oil producers like Saudi Arabia, but it also includes Venezuela, the top oil exporter in the Americas. OPEC says it produces about 40 percent of the world’s oil and exports around 55 percent of total shipments.
OPEC has long been a fractious organization known more for its infighting than its cooperation among members. But after global oil prices dipped below $10 a barrel in 1998, Saudi Arabia, Venezuela and Mexico - not a member of OPEC but a country that has cooperated with the organization - spearheaded a plan to rein in output in order to boost the sagging prices. The countries agreed to observe quotas on production, or in some cases on exports, and while the nations routinely cheat on these supply limits, the plan has kept a lid on oil supplies and helped lift prices.
OPEC holds two ordinary meetings a year in March and September and other extraordinary meetings to discuss supply and demand and determine whether the quotas should be maintained, reduced or increased based on the outlook for supply and demand. The summits are a feeding frenzy for journalists, who go to extreme lengths to gleam information on which way the organization may be leaning before it puts out its official statement at the meeting’s end. In recent years, for example, a host of journalists have tagged along on the Saudi oil minister’s early morning run through the city - even in the frigid Vienna winter - to gain insights into OPEC’s view of world markets.
Because of OPEC’s increased weight on the oil stage, the comments of the organization’s secretary-general, president or other oil ministers are of vital importance at any time of the year, and journalists can spend hours “doorstopping”-or waiting - in hotel lobbies or at meeting sites to catch one of these officials. Their views are often cryptic and difficult to interpret but they can fire up or sink prices in seconds, although the comments’ impact depends heavily on the market’s mood and sensitivity at the time. If the market feels there is plenty of supply, for example, an OPEC Secretary General’s comment that a shortage is imminent can send prices racing higher. But the same comment made at a time when the market is expecting short supplies could be shrugged off as little more than a confirmation of the obvious.
Natural Gas and Electricity
Natural gas is an emerging focal point for markets, governments and companies alike because it burns cleanly and efficiently. Natural gas already accounts for some 20 percent of the world’s energy use and it is expected to see fast-paced growth in coming years as the fuel heats and cools more and more homes and powers an increasing number of electricity generators, among other uses.
Natural gas can be found along with oil or separately, and once it is removed from the ground it is usually transported by pipeline - often over great distances. The United States, for example, imports the fuel from remote places in Canada to meet its growing domestic needs. A natural gas reserve is typically measured in cubic feet or cubic meters and production is quoted in cubic feet per day (cfd) or cubic meters per day - figures that are regularly in the millions or even billions.
Natural gas is traded mainly on the spot and futures market on New York’s NYMEX exchange. An increasing number of gas players are using the market to hedge against price movements, but because gas trades are somewhat local - the fuel cannot be shipped all over the world like oil - the natural gas market is not scrutinized as heavily as crude. The benchmark contract is Henry Hub natural gas, or gas that is priced at Henry Hub, Louisiana and prices are quoted in million British thermal units (mmBtu), which refers to the amount of heat needed to raise one pound of water one degree Fahrenheit.
Among the world’s major producers of natural gas are Russia, the United States, Canada, and Algeria. But there are a number of countries - like Bolivia - with vast, largely untapped reserves of natural gas and scarce domestic demand. This has given rise to a flurry of projects to bring liquefied natural gas, or natural gas in a highly compressed, super-cold form that can be transported in special tankers much like crude, to parts of the world where demand is strong. It has yet to be seen, however, whether these liquefied natural gas (LNG) plans will become a reality, given the sluggish world economy of the early 21st century and the projects’ price tags in the hundreds of millions of dollars.
The electricity sector also falls into the world of energy. Again, electricity generation, transmission and distribution do not receive the same attention as oil, but the industry can be a source of big news. In 2000-2001, for example, California was slammed by electricity shortages, which led to blackouts and surging power prices. The crisis spurred an investigation by U.S. regulators, who have charged some power companies with trying to manipulate the electricity market to drive prices higher.
Mergers, Acquisitions and Reforms
In recent years, the oil industry has seen a steady stream of mergers and acquisitions as companies coped with the rock-bottom oil prices of the late 1990s and the rising costs of drilling in hard-to-reach places. This wave of consolidations produced oil monoliths like ExxonMobil and BP Amoco, among others.
These consolidations are typically of more interest to investors holding the companies’ shares, which can make dizzying moves upward on the news of a merger or an acquisition, than to the oil market. But the resulting shifts in corporate strategy, like a decision to ratchet up the search for oil in a particular region, can ultimately play a role in oil price movements.
A country’s decision to open its energy industry, or a piece of it, to the private sector can also be important news. In Mexico, for example, a host of foreign companies have been eagerly following the government’s efforts to reform the bloated, state-run industry in the hopes of gaining entry to an energy market almost untouched by the private sector. The reform, a touchy political subject because the population equates a Mexican-run oil industry with national sovereignty, also has repercussions for the citizens. Without outside investment in the electricity industry, for example, the country could face electricity blackouts in a couple of years.
The Environment
Oil spills and other environmental damage are not usually market-moving events because the amount of oil spilled is rarely enough to cause supply disruptions, but they can still be big news for the populations affected and the companies or parties deemed responsible.
The Exxon Valdez spill off the Alaska coast in 1989, for one, spread oil over some 1,200 miles of shore, decimating wildlife and beaches. The cleanup cost Exxon more than $2 billion and the spill unleashed billions of dollars in lawsuits and years of litigation. In November 2002, the oil tanker Prestige split in two off the coast of Spain, spreading oil across the nation’s shoreline and decimating its fishing industry. The case has prompted the European Union to push for a ban on some old tankers in an effort to avoid similar disasters.
Sourcing and Tips for Reporters
Because an infinite combination of events and players can influence the oil market, energy can be a real challenge to grasp, let alone cover. It requires creativity, persistence and excessive patience - particularly in developing countries, where the government’s oil policies can literally change by the day.
Covering energy also means reporters must cast their nets wide when cultivating contacts. At the country level, it is important to have contacts at levels far above the spokespeople at the Energy Ministry, or whatever its equivalent may be, because they are often the last people to know about market moving events. (In fact, do not be surprised if you inform them of an event or rumors). The Energy Minister is obviously the best source on national energy policies and decisions, but deputy ministers, advisers, company officials, potential investors and analysts can all have the inside story on energy sector developments.
At the market level, it is crucial to know good energy traders on the exchange trading floors or at brokerages because they can tip you off to rumors of supply disruptions, what the market sees OPEC doing at its next meeting, refinery fires and so on. Bear in mind, however, that traders are usually not quoted by name and to do so can get them in trouble or even fired - bad for the trader and bad for you, since you no longer have a source. Analysts, meanwhile, can often be quoted and they are great for perspective, background and a quote about “what it all means,” although they may not know the day-to-day gyrations of the market as well as traders. Investment banks usually have oil sector analysts and there are a number of oil industry groups with country- and sector-specific analysts. A few suggestions to start with are Cambridge Energy Research Associates, the Petroleum Finance Co and Wood MacKenzie.
From there, it is also important to cultivate officials in the major companies operating in your area. Companies handling exploration and production, commonly known as E&P, are a key place to start, but it is also important to know people at the refining, transportation and shipping firms. A good source of contacts can also be a country’s ports, since they know about shipping disruptions quite literally by looking out the window.
To take an example: Imagine there are rumors in the market that a rebel group has attacked a nation’s major oil pipeline. How do you determine whether the story is true, how much supply has been disrupted and whether exports will be hurt? Good places to start are the rebel group itself and the government, although it is important to be skeptical about their statements -- it is probably in the group’s interest to magnify the damage done while the government will likely want to play down the damage. Other sources might be the municipal government of a town or village near the pipeline - perhaps someone can tell you what they see. It would also be good to call the ports to check if they have seen oil shipments drop, and by how much, and you might also call the buyers of the nation’s oil to determine whether they have been told their oil is coming late or not coming. Finally, you should probably check in with the government’s budget office or finance ministry or whoever handles the big picture financial questions for the government. A number of countries rely heavily on oil for government revenues, so it is always good to have some background information on what a prolonged supply halt would mean for the country’s growth rates and its budget - the nation may, for example, have to cut spending or its outlook for expansion if oil income takes a dive.
What reporters need to look for:
- Are benchmark oil prices making a large, sustained movement in a particular direction, or are they merely see-sawing with no particular gains either way? Is the trading volume large or small?
- If the price movement is sizable, can market players like traders attribute the movement to one event or one new piece of information?
- If a country, company or OPEC is moving the market, can they officially confirm or deny the rumors? If they refuse to confirm or deny the speculation, is it possible to confirm or deny through other (and possibly off-the-record) sources, such as deputy ministers or lower level officials in OPEC or in a company? Are there any oil industry sources with first-hand knowledge of the event who can be called?
- If the market is moving on weather or social unrest, are there any witnesses at the scene who can confirm how events are unfolding?
- Once the initial market rumor is confirmed, can the story be taken a step further to discuss what it might mean for the market over the longer term?
- What kind of implications does the event have for the finances of a country or company? Will the event affect the reputation or standing of a country, company or organization like OPEC?
- If there is a sustained increase or decrease in output, will it prompt a policy shift from OPEC, the U.S. government or another group?
- Will the event have implications for other markets?
Corporate Governance Glossary
API is the measurement system adopted by industry group American Petroleum Institute used to gauge the weight of oil; an API reading in the 30s or higher, for example, generally signifies light crude.
Barrel per day (bpd) is the standard measurement used in oil production and export; one barrel is equivalent to 42 U.S. gallons or 159 liters.
British thermal units (mmBtu) is the unit of measurement used in the quotes of natural gas contracts; refers to the amount of heat needed to raise one pound of water one degree Fahrenheit.
Come on line is the term used when a company begins operations at an oil field or other energy project.
Cubic feet per day (cfd) is the unit of measurement used in the production and export of natural gas (cubic meters per day, or cmd, can also be used for natural gas).
Downstream is the segment of the oil industry encompassing refining and processing of oil.
Force majeure is a declaration by an oil company or oil producing country that it cannot deliver oil it has promised; the basis for such a declation is normally a so-called act of God, like a hurricane or other unforeseen event.
Futures contract is an agreement to buy or sell oil (or other products) at a later date.
Heavy crude is an oil grade with a relatively high density compared to other grades; heavy crude is more difficult than light grades to refine in oil refineries
Hedging is a term describing the use of futures contracts or other kinds of contracts to offset potential losses.
Light crude is an oil grade with a relatively low density compared to other grades; light crude is easier to refine.
Oil majors are the world’s largest crude oil companies.
OPEC, or the Organization of the Petroleum Exporting Countries, is a powerful group of 11 developing countries who supply about 40 percent of the world’s oil output.
Sour crude is crude oil containing a relatively high sulfur content; sour oil grades require more processing than sweet grades.
Spot contract is an agreement to buy or sell oil (or other products) in the short-term.
Sweet crude is crude oil containing a low sulfur content.
Upstream is the segment of the oil industry pertaining to oil exploration and production.
Links
OPEC
http://www.opec.org
U.S. Department of Energy
http://www.energy.gov
U.S. Energy Information Administration
http://www.eia.doe.gov
International Energy Agency
http://www.iea.org
ExxonMobil
http://www.exxonmobil.com
Saudi Aramco
http://www.saudiaramco.com
PDVSA
http://www.pdv.com/pdvsa/pdvsa.html
Royal/Dutch Shell
http://www.shell.com
BP Amoco
http://www.bp.com
Energy Intelligence
http://www.energyintel.com
