Crude Oil Price
To understand the importance of the crude oil price per barrell, one needs to consider its relationship with oil’s products…
One month, the cost of regular-grade gasoline is $2 per gallon, the next month it is over $3! Diesel fuel prices are less than gasoline one day, and gasoline is cheaper the next day! Electricity rates, generated from natural gas combustion, are stable all winter, but you can’t afford to heat your home with heating oil because of higher prices (click to see current oil prices) . What’s the deal?
The deal is, hydrocarbon (crude oil and natural gas) is a global commodity. Its refined products are the backbone of business and industry around the globe.
Supply and demand principles apply to oil produced in the Middle East, Asia, Europe, North America and everywhere else – regardless of whether a society embraces socialist or democratic doctrines.
International demand for oil has risen. Consequently, excess capacity is lean. Supply hiccups due to production/shipping/refining bottlenecks and revolutions and rumors of war, can and do cause oil and gas prices to spike. In one violent act, Mother Nature can wreak havoc on operations, critically damaging infrastructure on a regional level, and preventing crude deliveries.
High oil prices cause a ripple effect on downstream, refined products, and global financial markets which recognize its importance.
But, operational constraints, acts of God, and malfunctions are not the only cause of oil price spikes. Oil producing governments and cartels, like OPEC, have artificially curtailed production supply in the past to affect oil prices in their favor.
The public has often accused independent oil companies, oil speculators, and refineries of underhanded dealings too, reducing supply to artificially inflate prices. This is an easy assumption to make when oil companies report record profits during times of limited supply. However, what is not often discussed is the role federal and local governments play in pricing and market requirements.
Crude oil is often refined in localities near their intended market. This is because local agencies have established their own standards for gasoline and other refined products in response to federal mandates and requirements. Reformulated gas, MTBE additives, ethanol use, and minimum Reid Vapor Pressures (RVP) requirements, amongst others add to local complexities.
What are acceptable characteristics and contents for gasoline in Chicago, Illinois may not be acceptable in San Francisco, California. Folks in New England often count on heating oil to heat their homes in winter, while the residents of southwestern United States typically use electricity and natural gas for the same purpose.
This variation in local market requirements can often lead to price spikes when problems arise, which can originate anywhere in the process, from an oil field to a refinery – some scheduled, and some not.
Oil companies, both independent and country-run, are in the business to make profits for themselves and their shareholders. As a result, the costs of exploring, developing, producing, refining and transporting the oil in its raw state to its ultimate refined output is included in the cost of each gallon of gasoline or other such product sold.
In addition, governments can and do levy taxes on oil products, increasing the burden on the individual and corporate consumer.
So, how does oil pricing work?
Crude oil’s value is based on its refined use. The primary use dictated by current global demand is for fuels like gasoline, diesel, heating oil, and jet fuel to run the equipment that support our ways of life. The various characteristics/properties of crude from around the world – referred to euphemistically in industry jargon as light, sweet, intermediate, sour, heavy, etc. – contain differing amounts of the various hydrocarbons and impurities. Their locations around the globe also speak to the costs of getting the oil to local refineries and markets – thereby establishing their relative value for the products in demand.
So, with all the different combinations of crude, how does anyone keep the relative ratings straight? Is Kern River crude more valuable than Nigeria’s Bonny Light? Well, that depends on the end product that is desired, where it is to be refined, and…the market price (see current prices). To ease comparisons, the two predominant crude oil exchanges: The New York Mercantile Exchange (NYMEX) and The International Petroleum Exchange (IPE), based in London, England, have established benchmark crudes from which other crudes are compared. In New York, the benchmark is West Texas Intermediate (WTI) crude oil, while in London it is the North Sea’s Brent crude.
The price of crude oil for immediate delivery (spot price) is set by the transactions that occur at the exchanges (essentially at NYMEX and IPE) throughout the day. The transactions are made based on the sellers’ and purchasers’ assessments of supply and demand.
Kern River crude’s value comparison with WTI or Brent and likewise, Nigeria’s comparison with WTI or Brent allows a buyer to purchase the best valued crude. Along with the benchmark, the benchmark crude oil’s delivery terms are also specified with the exchanges. For example, the spot price for WTI is in Cushing, Oklahoma; for natural gas, it is at Henry’s Hub in Erath, Louisiana; and for gasoline and heating oil it is at New York Harbor.