“Formula for success: rise early, work hard, strike oil.”
— J. Paul Getty
Since the Global Financial crisis (2007-2008), market developments in the Oil industry have made a significant impact around the world. The changes have not gone unnoticed. Print media, televisions, social networks and other platforms have been discussing oil issues over the years.
Thanks to the overwhelming use of oil in multitudinous applications: making gasoline, kerosene, tar, paraffin wax, etc., the precious energy resource has emerged as a key factor in making and breaking economies. Today, understanding of the present economy is incomplete without the understanding of the Oil Industry.
This article focuses on the rapid change in Oil Industry and the emergence of the “New Oil Order”. This New Oil Order lead to a situation where the new ‘shale’ oil producers (US) have been fighting for market share, and the older producers (OPEC) have been fighting for sustenance in the Industry. This tussle between producer countries has ensued fluctuations in prices, leading to wide-ranging impacts.
As the whole discussion of recent years arises due to the distinction between two types of oil, we will try to unravel the complicated mystery step by step. The first step is to introduce the crude oil before the story unravels.
Crude oil is a type of fossil fuel. This is a mixture of hydrocarbons. This unrefined petroleum is available in different forms, each form signifies its particular properties and the regions that it is sourced from.
Light crude oil is a low-density liquid petroleum. It flows freely at room temperature. As it produces a higher percentage of gasoline and diesel than heavy crude oil(which is highly viscous and cannot easily flow into production wells in normal conditions), light crude oil receives a higher price on commodity markets. The American Petroleum Institute (API) uses gravity to measure the density of crude oil.
Sweet crude oil is a type of petroleum with less than 0.42% sulfur. It is termed as ‘sweet crude oil’ as a low level of sulfur provides the oil with a mildly sweet taste. Generally, the low-sulfur crude oil is preferred over the others for processing it into gasoline due to its desirable properties.
The petroleum containing higher levels of sulfur is called sour crude oil.
We move further to the benchmarks of crude oil. As crude oil is available in different grades and varieties, there are certain benchmarks that serve as reference prices in a marketplace. Primarily, there are three benchmarks of crude oil; Brent crude, Dubai crude and West Texas Intermediate (WTI). Let us delve briefly into each of these benchmarks.
Brent Crude: Also known as Brent Blend, Brent Crude is a sweet light crude oil extracted from the North Sea. It is sourced primarily from European countries. This is the most popular benchmark.
Dubai Crude: Also known as Fateh, Dubai Crude is a medium sour crude oil extracted from Dubai. This is mainly exported to Asia.
West Texas Intermediate (WTI): WTI is a light sweet crude oil. It is lighter and sweeter than the other two major oil benchmarks. Because of its high quality and sweet, it is easily refined. This crude oil is produced, refined and consumed in North America region.
Now that we know about types of crude, we need to understand the way things unfolded. Initially, there was Crude Oil supplied by a group of countries called the OPEC. OPEC in earlier days had the pricing power and flexibility to ‘swing’ its crude oil production according to the market demand.
OPEC (Organization of the Petroleum Exporting Countries):
Formed in 1960, OPEC is an intergovernmental organization of (currently) 14 petroleum exporting nations. It accounts for nearly 44% of global oil production and also accounts for 73% of world’s “proven” oil reserves. This has given OPEC an influential position on global oil prices. Today, almost 66% of OPEC’s oil reserves and production are in its six Middle East countries. These countries surround the oil-rich Persian Gulf. Saudi Arabia comes out as the de- facto (or assumed) leader of the fourteen nations.
OPEC uses the OPEC Reference Basket (ORB). ORB is a weighted average of prices for petroleum blends produced by OPEC members. ORB is an important benchmark for crude oil prices. The OPEC Basket is heavier than both Brent Crude oil, and West Texas intermediate crude oil.
The primary objective of OPEC is to coordinate and unify petroleum policies among Member Countries and secure fair and stable prices for petroleum producers.
For an economist: OPEC is a classic example of a cartel. The term ‘cartel’ refers to a group of producers who formally come together to regulate demand to control prices in a goods or services market.
How OPEC dominated the Market?
Formation of OPEC took place at a time of a huge transition in the economic and political landscape. It all started with five oil-producing countries. This was the time of decolonization and formation of newly independent countries. In those days, the oil market was dominated by the “Seven Sister” countries.
Within ten years, OPEC was gaining tremendous prominence. The member countries were controlling the domestic petroleum markets and had already started having a say in the crude oil prices. Slowly, more countries started joining OPEC.
Since that time, OPEC has been trying out different strategies to control and stabilize the crude oil market. The oil prices could be controlled by the member countries which were ‘swing producers’- as these countries could change their supplies according to the market demand- the role of swing producer was mostly fulfilled by Saudi Arabia.
However, things have changed with shale oil gaining strength.
Growing Shale oil in the US: The Shale Revolution
A decade ago, with growing demand, many observers expected a steadily global shortage of crude oil. But it did not happen, because of a new phenomenon; the growing production of shale oil in the US. The rising petroleum costs at the turn of the 21st century had lead to the development.
This was the beginning of the Shale Revolution in the United States. A “New Oil Order” had started taking shape. With the help of companies like Shell, the US had started exploring the options with Oil Shale rock.
Shale oil: It is produced from oil shale rock fragments by converting the organic matter within the rock into oil and gas using technological advances in drilling.
Though the extraction operations of oil shale had commenced, had been explored, or had been renewed in the United States, China, Australia and Jordan, high scale production could be achieved only in the US. Why?
Before the early 2000s, extraction of shale oil was highly cost ineffective. The companies started looking for the technology to ‘make it work’ in the US, as it had plenty of skilled labor and technology. Due to the same constraints of labor and suitable drilling rigs, other countries were unable to replicate the US.
The New Oil Order was established as the production of Shale in the US increased 130% in 9 years. Production grew from about 0.4 million barrels a day in 2007 to more than 4 million barrels a day in 2014. Since 2009, oil production and WTI (see crude oil types for reference) oil prices have been negatively correlated, oil production increased preceding a decrease in WTI oil prices, because of shale oil boom in the United States. This resulted in WTI price of oil to fall below Brent price.
How has the boom in US oil production impacted the OPEC countries? Why did the prices of oil fall, for the past two consecutive years, and rose suddenly this year?
Price Free Fall: OPEC vs the US
Between 2010-2014, the demand for oil soared with countries coming out of the financial crisis. This lead to high oil prices (around 100$ per barrel). The US-based companies used these prices to innovate “hydraulic fracturing and drilling techniques” and unlocked vast shale reserves in Texas and North Dakota. The US started increasing their production at a very fast rate. With time, supply surpassed demand. Then things crashed.
By 2014, the global demand had started to slow down. The European countries were stumbling due to the eurozone mess. The Chinese Economy was not faring well either. But the US kept on producing more and more. Countries like Iraq and Libya had also started increasing their production too. This lead to a fall in the price of oil to $70 per barrel.
Surprisingly, Saudi Arabia didn’t swing it’s production this time. Instead, it increased production to capture market share and crush the US producers. But things only got worse, the US producers were quite adaptable…
Since this decision, the prices of oil kept tumbling to $50 per barrel, $40 per barrel… $30 per barrel due to supply exceeding demand.
Impact on Economies: This turned out to be beneficial to most of the oil consuming countries. Most of the people had more money to spare as their gasoline cost less. Some countries earned by keeping their petroleum rates fixed and earning more on taxes. Countries like India made strategic oil reserves to leverage advantages of low pricing.
The Crude Oil exporting countries like Russia and Saudi Arabia, on the other hand, were negatively impacted due to fewer oil prices in the global markets.
On November 30, OPEC and allied oil-producing nations including Russia agreed to extend curbing oil production throughout 2018 by about 1.8 million barrels per day (bpd) in an effort to boost oil prices. As soon the decision was made, oil prices rise above $60 per barrel. As the US is not participating in the deal, the alliance stated that it is ready to revisit this move, if U.S. shale operators increase their production with the surging oil prices.
On the other hand, with leveraging shale oil, U.S. crude oil production already has grown by 15 percent since last year to nearly 10 million barrels per day, just behind Russia and Saudi Arabia. The International Energy Agency(IEA) expects the United States to become the biggest net exporter by the end of the 2020s.
The trend makes the future difficult to comprehend. Let’s follow this from now to see what happens next in the disruption…
Categories: Story Of The Week