Understanding the Crude Oil Market

What is Petroleum?

Many of you are familiar with crude oil, also called “Black Gold” and even “Texas Tea.” This is that hot commodity that actually comes out of the ground… petroleum. Petroleum is comprised of carbon, hydrogen, sulfur and actually originate from fossilized plants and animal remains believed to have existed millions of years ago. These fossil fuels are a nonrenewable energy source and once they are gone that will be it. Hence the short science lesson, it’s ironic but in its natural and purest form crude oil has little to no use to anyone. In order to get gasoline, or kerosene, or diesel fuels crude oil must be refined.

 

How do Commodities Interact in the Market?

A commodity starts out generally the same across the board, regardless of who produces it. A barrel of oil is a barrel of oil, who produced it does not make it better or worse, it is still a barrel of oil. Commodities are most often used as inputs in the production of other goods and services. Commodities tend to fluxuate in cost due to their supply and demand. The supply in demand particularly in petroleum is one that is viewed worldwide, and one that none of us could imagine existing without. Events also tend to affect commodities. As an example, let’s say that there was an explosion at an oil refinery that actually compromised the production of crude oil for even so little time as a day. The news alone would send prices shooting up, mainly in anticipation of being unable to meet the daily production required to be able to supply the current day’s demands.

A second player in the pricing game, having heard the same report would be the hedge investors who study not only market itself but the trends of the market and its investments. These investors bet daily on how much crude oil will increase or decrease over time. Their speculation feeds both the investor and the producer, questioning the anticipated need as well as the ability for it to be met. Their opinion alone can sway the market in increasing and decreasing a commodities worth respectively.

 

Let’s talk Gasoline.

Did you know it takes 42 gallons of crude oil to make one barrel? One gallon of crude oil can produce .47gallons of actual gasoline, so in essence one barrel of crude makes about 20 gallons of actual gas.

There are four main factors that ultimately dictate the cost of our gasoline. They are supply, consumption, the financial market, and governmentpolicies. Taking a look at each factors part one can assume that most investors invest looking at what they think petroleum will cost later and how the consumers will react to that cost. In turn they also have to consider what other’s think oil should cost and how much actual product petroleum companies will actually release into our market. It’s also important to note that the four main factors act and react with each other.

 

What Part does our Government Play?

Our government’s part in our gas prices is varied. They often create rules that actually inhibit how much crude oil can be produced and then they also negate the amount of taxes that will be paid to produce the crude oil, sell the crude oil and even buy the end product. One could say they really affect all aspects as the repercussions of their involvement are felt by the drillers, refiners, middle men and consumers. Even as the government allows for or explores and invests in alternate energy resources itself, such as wind, solar or alternate fuels, can even affect our costs. As alternates become closer to actual fruition they will impact costs on the theory their success will lower crude oil’s actual demand.

Another area that government passively participates in that also affects costs is its reaction, or lack thereof, to volatile situations in other oil producing countries. While we all know you can be damned if you do or if you don’t the West often suffers regardless of its positions.

 

Location, Location, Location.

Oil supplies vary by their location and we all know there are certainly some places that it’s much more abundant than others. Saudi Arabia, Iraq and Iran are the leading oil exporters worldwide.In the last fifty years the USA has really stepped up thanks to Texas and its production making the USA the 2nd largest producer of crude oil. Russia and Venezuela are participants too.

Important to note, that many Middle Eastern partners own issues and volatilityof their own countries really affect pricing too. Realizing the part they do play they formed OPEC (Organization of Petroleum Exporting Countries) to monitor the supply of their oil as a whole, the amount they are getting per barrel, and also how much oil they are allowing into the system making them another key player in the costs.

Reflecting back to the 70’s when the USA experienced a horrible gas crisis, where there often was no gas and if there was it was so expensive and limited many peoplecould not even get.Many felt this was a direct result of the West being punished for supporting Israel. This wakeup call proved to be the push we needed here in the US, resultingin the Texas boom we are fortunate enough to maintain today.

 

Futures… and I don’t mean tomorrow.

Let’s look at the “futures,” this is what they refer to in investing when considering whether a commodity will increase or decrease in price later. Future contracts ensure the Buyer they will get the commodity they purchase at a certain rate regardless of the market activity, good or bad. When large future blocks are bought on the market it also affects pricing because they are able to keep the cost of the commodity more stable, and in their attempts to provide the commodity to their contracts and not lose money they horde the product.  That said, investing in the futures market is the safest way for anyone to invest in petroleum and in the big picture maintain a modest return.

 

With so many factors influencing crude oil, this investment should be looked at long term. Changes in the market can mean the loss or gain of millions overnight. Understanding your investment market, researching it as a whole can lead to smarter investing and better returns, just by doing your homework. Crude oil remains a very lucrative return for those who not only havethe means to play but have the ability to ride the wave through.

 

 

 

Randy Johnson
 

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