-Theme song to The Beverly Hillbillies
In order to understand what is happening in one’s stock portfolio, it is necessary to have a grasp on what impacts markets. The price of oil is important because it is both a reflection of the global economy and a determinant of the global economy.(Yes, you read that correctly.) It connects geopolitics with economics, trade and military issues, how you spend your next holiday and the price of a cup of coffee. The price of oil is a nexus, or connecting point, of everything that is happening in the world.
First things first. When people talk about the price of oil, what does this mean exactly? The price of oil refers to the spot price of a barrel of crude oil. In the oil business, one barrel is equivalent to 158.987 litres or 42 U.S. gallons. A spot price refers to the current market price of a tradable security. Crude oil refers to petroleum – the unrefined yellow-to-black liquid that is extracted from beneath the surface of the earth.
There are several types of crude oil, ranging in quality determined by the ease with which they can be refined into a usable product. These include:
West Texas Intermediate: WTI is the highest quality crude oil– light and low in sulphur. It comes mostly from the Midwest and Gulf Coast of the U.S.A. It is light weight and easiest to refine into gasoline, making it the benchmark for oil prices in North America.
Brent Blend: This type of oil is medium in quality – although still excellent for gasoline – and refers to oil that is produced from the 15 oil fields in the North Sea. It is named from its first extraction point, the Brent Oilfield, offshore from Scotland. It is also a mnemonic for oil field foundation layers: Broom, Rannoch, Etive, Ness and Tarbert.
Shale Oil: This is in effect a substitute for crude oil. Organic matter called kerogen lies within the layers of fine-grained sedimentary rock. It is extracted from the ground using a process known as fracking and then converted into a synthetic oil product.
OIL PRICES
There are three prices that are important for investors to be familiar with. Other oil prices are quoted in relative terms to these benchmarks.
WEST TEXAS INTERMEDIATE
WTI is the benchmark for oil prices in the United States. WTI is the spot price, and it is what NYMEX oil future prices are based on. NYMEX, the New York Mercantile Exchange, is a commodities and futures exchange. The NYMEX oil price refers to what 1,000 barrels of oil are priced at for delivery at an agreed upon time in the future. Futures prices for commodities are usually leading indicators of prices for goods, but the oil market is reactive to disruptions so the futures prices are often lead by the spot price. (Oil traders are not sensitive types.)
BRENT BLEND
As the price of 2/3’s of the oil traded internationally, this is considered to be the true crude oil benchmark. WTI is quoted as trading at a discount to Brent, and it serves as the benchmark price for most crude oil in Europe and Africa.
OPEC
The Organization of Petroleum Exporting Countries is an intergovernmental organization of 15 countries. The original 5 include Iran, Iraq, Saudi Arabia, Kuwait and Venezuela. Newer members include Qatar, Indonesia, Libya, the UAE, Algeria, Nigeria, Ecuador, Gabon, Angola, Equatorial Guinea and Congo. The OPEC basket price is a weighted average of petroleum from the member countries. The basket is a mixture of prices for light and heavy crude, and is on average heavier and therefore lower quality than Brent or WTI oil. OPEC is an important benchmark for crude oil prices since it reflects a large number of producers who actively and collectively increase and decrease production to keep worldwide oil prices trading within a stable range.
All oil trades in U.S. Dollars. We will examine the economic impact of changes in oil prices in future posts. The price of oil effects most aspects of modern day life and is a major determinant of inflation.
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