The World Oil Market

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The World Oil Market

• One of the most important global markets is the
  market for oil. This week we will discuss some
  oil market basics and important facts
• "petroleum" comes from the Latin words petra, or
  rock, and oleum, oil.

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There are many good sources on the world oil
market these include

• The International Energy Agency (IEA)
• Energy Information Administration (US govt)
• The Society for Peak Oil
• OPEC (least reliable)
• Lectures will follow the tutorial on oil market
  basics at the AIE website
• http//www.eia.doe.gov/pub/oil_gas/petroleum/analy
  sis_publications/oil_market_basics/intro.htm

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Oil and Energy

• The age of industrialization has been the age of
  energy use-basically burn fuel to create
  mechanical force
• Since the beginnings of the industrial revolution
  energy use by human societies has increased
  steadily
• Energy is generated in a lot of ways but burning
  fossil fuels is by far the most important
• Until the middle of the 20th century most
  economies supplied their own energy (self
  sufficiency in energy) but this changed
  dramatically after World War II
• The market for oil is a global market and one of
  the major distinguishing characteristics of the
  modern world economyit is also very important
  politically

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World energy consumption totals and per capita
industrial countries use a lot of energy
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Another way to look at energy is a share of GDP
it has been falling but currently each dollar of
GDP uses just under 8 cents worth of energy
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Oil is only one of the major energy sources but
an important one
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Some supply basics

• Oil is compressed hydrocarbons formed millions of
  years ago and now stored deep in the ground in
  natural reservoirs in sedimentary rock
• In some places it is easy to get at these
  reservoirs (middle east) in other cases a lot
  harder (offshore)
• Geologists and petroleum engineers estimate what
  we currently know about the reservoirs that can
  be accessed

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Vertical organization of industry

• Industry organized in various stages
• Exploration
• Extraction of crude from ground (oil rigs)
• Transportation of crude(tankers and pipelines
• Storage
• Refining-gas, heating oil, jet fuel etc
• More storage of final product
• Shipping to final consumers
• Consumption-fill er up

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Stocks versus flows

• In economics it is very important to distinguish
  for any commodity which can be stored over time,
  like oil, stock versus flow measures
• Think of filling a bathtub the stock is the
  total amount of water in the bathtub
• Water flows into the bathtub from the tap and out
  of the bathtub through the drain
• Flows always have a time dimension eg so many
  gallons per minute while stocks have no time
  dimension (eg. The bathtub holds so many gallons)

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Measuring Oil

• The basic unit in the oil market is a barrel of
  oil (the price of which is reported everyday in
  newspapers and on the news) currently over 60 US
• However in most studies we use measures of stocks
  by millions of barrels
• Flows are usually measured per day (millions of
  barrels per day or MBD) although some times you
  will see annual flows measures
• Following is a graph depicting worlds stock of
  reserves and annual production flows (white box
  in top left of each square)

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Finding oil

• Exploration for new sources of oil is what makes
  it in many ways different than most other goods
  which are produced
• Oil is a non-producible raw material
• Economic incentives to find new oil are driven by
  the prospect of profits and the simple fact that
  energy is a necessary input to production and
  thus human well-being
• New technology has had a major impact on the
  discovery process for new oil reserves
• The first major supply crisis occurred in the
  1970s and led to very high prices (see next
  graph) which in turn stimulated a great deal of
  exploration for new oil

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Supply reserves versus production

• We always need to distinguish changes in current
  annual supply or production from changes in
  proven reserves or the stock
• For eg. If you look at Saudi Arabia you will
  notice there have been large increases in their
  annual production
• Proven reserves change due to new oil finds or
  new technology but estimates are subject to a
  considerable diversity of views

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Proven reserves

• "Proved reserves" are estimates of the amount of
  oil recoverable from known reservoirs under
  current economic and operating conditions.  
• Total global proved reserves have been estimated
  at approximately 1 trillion barrels since the
  late 1980's, because additions to reserves from
  new discoveries and from revisions to previous
  estimates have approximately matched the annual
  volume of oil produced (or withdrawn). 
• A lot of the increase in proven reserves has come
  from getting more oil using new technology out of
  previously discovered reservoirs

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Demand for oil

• Demand for oil is driven primarily by two
  factors-income and substitution effects
• As income rises demand for oil goes upon average
  it seems the increase in demand for oil is
  greater than the increase in GDP or economic
  growth Why? Most probable reason is found in
  cars and transport as incomes rise people spend
  a larger fraction of their income on cars and
  therefore gasoline

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Substitution effects the price of oil

• The other factor driving changes in demand for
  oil is the possibility of substituting between
  oil intensive activities and those which are less
  intensive in oil usesubstitutes are everywhere
• Thus as oil prices rise people move to smaller
  cars, turn down the heat, and use less
  electricity the opposite happens when prices
  fall
• In the short run when prices rise it is often
  difficult for people to find substitutes but over
  the longer run a very powerful influence on the
  level of demand

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Oil Demand about 84 MBD in world in 2005
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Where is oil used? Mostly in transport, followed
by industry then residential use, then electrical
generation
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From raw material (crude oil ) to final consumer

• Oil market very complex market
• Oil comes out of the ground as , is shipped to
  refineries either by tanker (ocean) or pipeline,
  or even truck or rail
• Refineries turn crude into final user
  product-gasoline, heating oil, jet fuel,

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Seasonal factors important in oil demand

• The United States and Canada use oil more for
  transportation than for heat and power, but the
  opposite pattern holds for most of the rest of
  the world  most regions use more oil for heat
  and power than for transportation.  As a result,
  global demand for oil is highest in the Northern
  Hemisphere's cold months.  There is a swing of
  3-4 million barrels per day (some 5 percent)
  between the 4th quarter of the year, when demand
  is highest, to the 3rd quarter, when it is
  lowest.  (The precise amount varies from
  year-to-year, depending on weather, economic
  activity and other factors.)  While the 4th
  quarter is not the coldest in any region,
  estimated demand calculations are swollen by the
  traditional stock building that occurs during the
  period.    

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Calculating a hard or objective supply estimate
very difficult

• Refinery production (output)
• plus imports of the product
• plus or minus the change in inventory
• plus or minus shipments from other domestic
  regions
• minus exports
• equals Product Supplied in a particular
  national market
• In practice very easy for bottlenecks to develop
  in chain linking supply of crude to final users

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Trade in oil

• oil is the worlds single most important traded
  commodity either by value or volume
• Distance is important-oil tends to move from
  suppliers to the nearest demanders
• Nearest measured in timeimports to US from
  Mexico and Venezuela take about a week
• Oil going to East Asia, Japan from Middle East
  takes about 30 days
• Regional crises such as wars or port blockages
  can causes big shifts in patterns of trade
• Middle East has been dominant producer and swing
  supplier for most importing regions

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Here are the regional supply demand differences
which in turn lead to either imports(demandgtsupply
) or exports(supplygtdemand)
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Import Dependency

• For much of the world-North America, Europe and
  Asia a substantial part of demand is met by
  importsthis creates what is called import
  dependency
• Germany, Japan import about 90 percent of
  consumption, US near 50 percent
• Because middle east is major supplier and given
  instability in that region substantial concern
  about security of foreign supply
• Countries now engaged in attempts to secure more
  secure sources of oil supply and to build
  strategic reserves
• Much of this is high costeg offshore or tar
  sands (Alberta) and has triggered search for oil
  in more politically stable regions

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Bottlenecks in the chain linking supply to demand

• Because of long complex chain from upstream
  suppliers to downstream users very complex
  logistical issues in oil market
• Bottlenecks (short term restrictions in supply)
  can occur for a variety of reasons
• A) crude source (eg war in middle east)
• B) in transportation phase (tanker or shortage)
  (terrorist attacks issue here)
• C) refining stagelimited refining capacity

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Next lecture Refining, stocks, and oil prices
and Hubberts Peak