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A study on Crude Oil
1. MITTAL SCHOOL OF BUSINESS
FIN-210
CA-1
Name of Faculty: Mr. Vishal Goyal
Submission Date: 21/03/20
Submitted by: Amal Varayil
Registration no.: 11710974
2. CRUDE OIL
INTRODUCTION
Crude Oil is often referred to as the blood that flows through the veins of the world. It is a
fundamental source of energy for the world’s economy. Crude oil is a naturally occurring,
unrefined petroleum product composed of hydrocarbon deposits in natural underground
pools or reservoirs and remains liquid at atmospheric pressure and temperature. Although it
is often called "black gold". It can be refined to produce usable products such as gasoline,
diesel and various forms of petrochemicals.
The majority of oil reserves in the world is in the Middle East, at 48 per cent of the known
and identified reserves. This is followed by North America, Africa, Central and South
America, Eurasia, Asia and Oceania, and Europe.
There are over 160 different types of crude oil traded on the market. Six primary oils, which
are considered the world’s most important oil benchmarks and draw the most serious
attention among investors and analysts are:
• West Texas Intermediate (WTI)
• Brent Crude
• OPEC Reference Basket
• Dubai Crude
• Bonny Light
• Urals
OPEC controls almost 40 per cent of the world's crude oil, accounts for about 75 per cent of
the world's proven oil reserves, and exports 55 per cent of the oil traded internationally.
3. USES OF CRUDE OIL
Crude oil and other liquids produced from fossil fuels are refined into petroleum products
that people use for many different purposes. Petroleum is the world’s largest energy source.
It is used to propel vehicles, to heat buildings, and to produce electricity. In the industrial
sector, the petrochemical industry uses petroleum as a raw material to make products such
as plastics, polyurethane, solvents, and hundreds of other intermediate and end-user goods.
Petroleum consumption by sector and share of total in 2018.
Various uses of crude oil are:
Plastic
This is probably the most widespread use of oil. Plastic is used in just about everything that
you can find in a store. If an item doesn’t contain plastic, then it is probably stored or
packaged in the oil based polymer.
Clothing
Petroleum is used to help make clothing non-flammable and colorful. It is used in the
production of rayon, nylon, polyester, and even artificial furs. Also, hangers are
strengthened by petroleum-based resins.
Furniture
Couch cushions are often filled with durable, lightweight polyurethane foam. It is also used
in the manufacturing of carpet or linoleum flooring. Thus, making crude oil an important
element in the household industry.
4. Insulation
The insulation that we find in our home which keeps unwanted heat from escaping or
entering is a petroleum-based product. This means that we depend on crude oil to regulate
the temperature in our homes in more ways than we realize.
Kitchen Items
There are a number of items in the kitchen that rely on petroleum as a part of their
production. For refrigerator, the molded interior panels, door liners, and even the foam
insulation are all manufactured using crude oil. Many stoves function by using natural gas.
Cars
High performance plastics have replaced heavier materials throughout the average vehicle –
from the interior to the engine block reducing weight and improving fuel economy, and
enhancing safety. Crude oil is also important in the production of car’s hoses, wiring, and
many fluids.
Food
Fertilizer is something that relies on petroleum; thus, when the price of oil goes up, it gets
more expensive to grow food. Many of the food items are stored and or packaged in plastics
as well; meaning that crude oil plays a large part in the production of your food.
5. FACTORS AFFECTING THE PRICE OF CRUDE OIL
Crude oil, or “black gold,” is one of the world's most precious commodities. Price changes in
the commodity can affect the economic ecosystem at every level, from family budgets to
corporate earnings to the nation's GDP. Crude oil prices change quickly in response to news
cycles, policy changes, and fluctuations in the world's markets. Since 2014, oil prices have
experienced a downward journey, falling from highs of around $105 per barrel. In February
and March of 2020, crude prices accelerated their decline in reaction to the coronavirus
pandemic and an expected sharp drop in demand for oil. The factors that affect oil prices
are as follows:
OPEC
OPEC, the Organization of Petroleum Exporting Countries, is a cartel made up of 14
countries who export petroleum. Cartel in this instance means that the countries within
OPEC have come together to regulate the price of oil by controlling supply. OPEC have done
this because although oil is a finite resource, many countries have access to their own oil
fields and means of production. PEC was formed to regulate oil production via quotas, which
ensures members get a good price for their oil even if this means producing less in the short
term. OPEC used to hold considerable influence over the price and supply of oil.
Non-OPEC oil producing countries
Outside of OPEC, the world’s biggest oil producing countries are the USA, Canada and China.
In terms of single oil producing countries, the USA is the world’s leader with 13 million
barrels a day being produced in 2017.
There is also the OECD, the Organisation for Economic Cooperation and Development,
whose members produce around 24 million barrels per day. As a whole, non-OPEC nations
produce somewhere in the region of 53 million barrels of crude oil a day.
Exogenous shocks
Events that economics cannot explain or control, such as natural disasters, war and
geopolitical instability can all impact the price of oil. For example, when Hurricane Katrina hit
the east coast of America in 2005, it damaged vital oil supply lines, causing an oil crisis in America. As
6. a result, between 29 August and 5 September 2005, prices for fuel rose more than half a dollar in
some parts of the country. This resulted in the release of 30 million gallons of fuel from American
strategic reserves in an attempt to prevent fuel prices escalating further by the then POTUS.
Global economic performance
The strength of the economies and global economic performance can therefore affect the price of oil
significantly. The 2008 financial crash, for instance, brought about a slowdown in industry which in
turn lowered the need for oil. Without a similar drop in oil supply, the price of Brent Crude declined
by over $100 in a five-month period. Currently, the world consumes around 98 million barrels of
crude oil per day. There is speculation over whether the demand for oil will remain this high in the
coming years, due in part, to the development of renewable sources of energy.
Alternative energy sources
An increased awareness of the benefits of renewable energy sources such as solar and wind could
see a decline in the world’s reliance on oil. Electric cars are also responsible, as are pledges by
various governments to ban the production of new petrol and diesel cars in the years ahead.
This could see oil prices fall as supply may remain high. However, in the event of dwindling demand,
it is also likely that OPEC and other oil-producing parts of the world will reduce their supply to keep
prices at a profitable level.
Strength of the US dollar
the value of the dollar has a major impact on the price of oil. If the dollar becomes stronger, for
instance, the price of oil will tend to drop – at least nominally – assuming that all other factors
remain constant. Conversely, if the dollar is weak then prices of crude oil will tend to rise.
7. RELATIONSHIP BETWEEN CRUDE OIL PRICE AND RUPEE-
DOLLAR EXCHANGE RATE
Crude Oil in Indian Market
India is the fourth largest oil importer in the world. It imports in excess of 3 million barrels of
petroleum per day. From the fiscal year 2005-2006 to 2010-2011, on average, the import of
crude oil has been equivalenting to about 40% of the country’s total export. In the fiscal
year, 2011-2012, it increased to over 53% of the total export worth $160 billion in monetary
value. One of the obvious reason for this increase is the upsurge in the use of modern
technology in production in both agricultural as well as non-agricultural sectors, including a
phenomenal rise in the use of the modern mode of transport such as automobiles,
motorbikes, which is associated with the growth rate of the economy.
Exchange Rate and Crude Oil Price
Investment decisions of oil derivative investors determine the futures prices of oil. They
speculate price changes and take investment decisions. The financial market decisions drive
the real market prices. Research suggests that the import of crude oil continues to rise up
when the crude oil future price increases. The oil imports thus became a substantial source
of demand for dollar in India’s foreign exchange market. This strong demand contributes to
strengthen the dollar against Indian rupee, among the other factors.
If examined the effects of oil price on exchange rate of Indian rupee against dollar using
time series data from 1972-73 to 2012-13. Oil price and imports are rising continuously. This
pushes up the demand for dollar which strengthens the dollar against rupee and Indian
rupee is continuously depreciating. This erodes purchasing power of Indian currency in the
international market. The domestic oil supply growth and control over oil demand seems to
be viable policy option to overcome exchange rate depreciation and its consequences.
8. AFFECT OF GEOPOLITICAL EVENTS ON CRUDE OIL PRICE
Geopolitical events and severe weather that disrupt the supply of crude oil and petroleum
products to market can affect crude oil and petroleum product prices. These events may
create uncertainty about future supply or demand, which can lead to higher volatility in
prices. The volatility of oil prices is tied to the low responsiveness, or inelasticity, of supply
and demand to price changes in the short term. Most of the crude oil reserves in the world
are located in regions that have been prone to political upheaval or in regions that have had
oil production disruptions because of political events. Several major oil price shocks have
occurred at the same time that political events caused supply disruptions. In recent years,
conflicts and political events in the Middle East, the Persian Gulf, Libya, and Venezuela have
contributed to world oil supply disruptions and increases in oil prices.
Given the history of oil supply disruptions caused by political events, market participants
constantly assess the possibility of future disruptions. In addition to the size and duration of
a potential disruption, market participants also consider the availability of crude oil stocks
and the ability of other producers to offset a potential supply loss. When spare capacity and
inventories are low, a potential supply disruption may have a greater impact on prices than
might be expected if only current demand and supply were considered.
Some Notable events in this matter are:
1. Yemen Crisis: Since 2015, Yemen has been the site of a proxy war between Iran and
Saudi Arabia. Among the key targets that the Iran-aligned rebels have been attacking
are the Saudi Aramco oil facilities and Saudi oil tankers. In addition to these risks, all
of which directly affect Saudi oil production, is that Yemen is located along another
major supply chokepoint–the Red Sea–through which millions of barrels are
transported daily from the Suez Canal to Europe.
2. Iran and the Strait of Hormuz: In 2011, Iran threatened to block the Strait of Hormuz,
sending the price of Brent soaring. In anticipation of these type of situations, the US
does maintain a strong naval presence in the region, but the 2011 scenario is a
reminder of the ways that the politics of this region can affect global oil prices.
9. WEATHER AND CRUDE OIL PRICES
Weather also plays a significant role in the supply of crude oil. Hurricanes in the Gulf of
Mexico can affect oil production and refinery operations in the Gulf region. As a result, U.S.
petroleum product prices may increase sharply as supplies from the Gulf to other regions
drop. Severe cold weather can also strain product markets as producers attempt to supply
enough product, such as heating oil, to consumers in a short amount of time. This seasonal
demand can also result in higher prices.
A harsh winter or a relatively temperate winter can affect the demand for oil and gas.
Weather is considered to be a demand-side factor affecting prices, because weather can
alter the way people use gas and oil. When a winter is abnormally cold, the demand for oil
increases because homes need to use more natural gas to maintain their internal
temperatures. If a winter is abnormally warm, as it may be for 2015 in the United States,
then the demand for heating will decrease and less gas will be needed to heat homes.
Cold weather can also affect oil production negatively if wintry conditions cause disruptions
in oil production activities. If the temperatures drop low enough, operations cannot produce
at full capacity. Poor traffic conditions caused by snow can also disrupt the transportation of
oil products to storage facilities and to consumers. Crude oil has a freezing point of between
-40 and -60 degrees Fahrenheit. If temperatures drop to these depths, the supply side of oil
and gas prices will be affected.
10. ARBITRAGE OPPORTUNITIES IN CRUDE OIL
Arbitrage is the purchase and sale of an asset in order to profit from a difference in the
asset's price between markets. It is a trade that profits by exploiting the price differences of
identical or similar financial instruments on different markets or in different forms. There
may be opportunity for netting more profits in crude oil futures.
The Brent/WTI arbitrage is a fairly popular trading technique within the energy sector and
its aim is to profit from price discrepancies. The strategy is reasonably simple and it consists
of contemporarily selling the WTI and buying the Brent or selling the Brent and buying the
WTI.
Indian companies, with an arm in Dubai, can use arbitrage between Mumbai-based MCX
and Dubai Gold and Commodities Exchange. Crude is also the most popular contract on
MCX. More than 29,000 lots of the June contract were traded, with the gold June contract a
distant second at 18,533 lots. Indian companies that are trading on MCX and have a
subsidiary that trades on DGCX can use the slight price difference in crude oil contracts on
the two exchanges, which is created largely by the dollar-rupee exchange rate, to make risk-
free profits at the end of day.
11. CURRENT SCENERIO IN CRUDE OIL MARKET
The price of crude oil is plunging into ground since Saudi Arabia, the chair of OPEC started a
price war with Russia. They slashed the official cost of crude oil to the kingdom’s buyers by
the most in more than 30 years. The price of Brent Crude (one of the main benchmarks for
oil prices) has fallen from close to $52 per barrel on 6 March to $31.49 per barrel on 8
March. On 11 March, the price had recovered to $36.4 per barrel. he world’s top oil
exporter is trying to destroy the shale oil industry in the US, which isn’t viable at sub-$50 per
barrel and create some trouble for the Russian oil industry as well.
In 2017, China overtook the US to become the largest oil importer in the world. In 2019,
China imported close to 10 mbd. With the coronavirus outbreak shutting down economic
activity in the country, imports are expected to fall in 2020. In order to counter this, Saudi
Arabia wanted Opec + to cut output by around 1.5 mbd. This cut amounts to around 1.5% of
the total global supply of 100.89 mbd. But the Russians did not agree. With Russia refusing
to play ball when it comes to production cuts, the Saudis decided to go exactly the opposite
way and decided to increase oil production. Thus, starting a PRICE WAR.
Indian Scenario
The sharp decline in global crude oil price has opened up an unexpected revenue stream for
the Indian administration struggling to find resources during an economic slowdown. The
government has raised excise duty on petrol and diesel by ₹3 each to boost revenue
collections taking advantage of the declining global crude oil price.
India has also decided to take advantage of the low oil prices in major producing centres in
Saudi Arabia and the UAE to top up its strategic oil reserves. The government has decided to
buy oil worth $670 million at the current price of around $30 a barrel for deliveries starting
in April-May. These purchases will help fill up three petroleum reserve caverns with a
capacity of 5.33 million tonnes of oil created by the India Strategic Petroleum Reserves Ltd.
12. GLOBAL OUTLOOK ON CRUDE OIL MARKET
Global oil demand has been hit hard by the novel coronavirus (Covid-19) and the
widespread shutdown of China’s economy. The novel coronavirus (Covid-19) is a major
global public health emergency that has brought tragedy to many lives. Its impact is still
unfolding globally. There is already a major slowdown in oil consumption and the wider
economy in China. The impact of Covid-19 for oil prices have been sharp: Brent values fell by
about $10/bbl, or 20%, to below $55/bbl. Before Covid-19 came along, the market was
already nervous in anticipation of a supply overhang of 1 mb/d in the first half of 2020 due
to continued expansion in the US, Brazil, Canada, and Norway.
From the point of view of the producers, before the Covid-19 crisis the market was expected
to move towards balance in the second half of 2020 due to a combination of the production
cuts implemented at the start of the year, stronger demand and a tailing off of non-OPEC
supply growth. Lower oil prices, if sustained, are also bad news for highly responsive US oil
companies, but we are unlikely to see an impact on output growth until later in the year.
The effect of the Covid-19 crisis on the wider economy means that it will be difficult for
consumers to feel the benefit of lower oil prices.