1.

INTRODUCTION

Crude oil or petroleum is a black (sometimes red or green) viscous liquid mixture of
naturally occurring hydrocarbons, well known for its high capacity to burn and release
energy. This added to a wide range of ever increasing uses has made it globally, the
important energy source.

Crude oil prices references vary depending on its quality, with API (American Petroleum
Institute) index, Sulfur content as some of its major determining factors. Price
references are Brent (from UK continental Shelf) and WTI (West Texas intermediate
from Texas) (Crude Awakening, 2010).

During the last century and in recent decades, the crude oil market has seen a
continuous change in the price and availability of this very essential commodity
(commonly referred to as “black gold”). For example, from 2002 – 2006, prices have
risen over 3 times, form US $21.13/bl in January 2, 2002 to US $ 73.76/bl on July 7,
2006 (Askari,Hossein, 2008). The economic crisis of 2008 saw an even greater
volatility. With the current crude oil price at about 82 –US $85/bl (CNN.com, 2010), it is
quite obvious that stability may not be achieved anytime soon.

The factors that have resulted in these ever constant changes vary widely, with volatility
of producing areas, dynamics of market and price not being least.

This report aims at providing an insight into the crude oil market, investigating major
issues and factors affecting the market, forecasting its future and the effects that these
sometimes sporadic changes will have on the market, as well as development of the
industry. Finally, it aims at suggesting methods for stabilising the market as well as the
energy needs of the world.

2. BRIEF HISTORY OF CRUDE OIL MARKET WITH PRICE CHANGES

Though crude oil was discovered in the 19 th century, its major exploration began
in the early 20th century. From the early periods of the 20th century until the early 1970s,
crude oil prices were determined using a basis known as “Posted Price” (Mabro,R,
1986). Prices were basically controlled by the industrial sector which had its main
players as the large multinational companies basically comprising of the “Seven
sisters”( Standard oil of New Jersey, Standard Oil Company of New York(Presently
Exxon Mobil); Standard Oil of California, Gulf Oil and Texaco (presently Chevron);
Royal Dutch Shell, and Anglo-Persian Oil Company (Presently BP) (Fattouh,B. 2007).

By late 1950s, changes began to occur with the introduction of independent oil
companies into the system and the arrival of crude oil from the former USSR started to
challenge the dominance of the “Seven Sisters”. However, neither these new
companies nor OPEC (founded in 1960) was strong enough to significantly alter the
existing pricing, and thus status quo remained in the upstream and downstream sector
of the industry for most of the 1960s (WILSON,C. 1970).
However, with the 1970s came major changes that saw the movement of price, setting
power off the “Seven Sisters” towards OPEC. This shift was mainly powered by the stiff
supply-demand conditions that prevailed during this period (early 1970s). Increased
crude oil demand was met by OPEC countries, hence enhancing the power of the
OPEC nations relative to that of the multinational companies. In October, 1973, after
negotiations with multinational companies failed, six Gulf members of the OPEC
announced an immediate increase in the posted price of Arab Crude from $3.65 to
$5.12 and in December, OPEC raised the posted price of Arab light further to $11.65.
This is the basis of a remarkable change in pricing system and power (Fattouh,B.
2007).

The 1980s saw a great integration of non OPEC countries, who taking advantage of the
higher oil prices as incentives increased their share of world total oil production from
48% to 71%(from 1975 – 1985) with the most of these coming from Mexico, North Sea
and the Soviet Union (Fattouh,B. 2007). The OPEC(particularly Saudi Arabia, its
highest producer) adopted the “netback pricing system” in a bid to reclaim its “stake” in
1986 (Mabro, 1986). This resulted in the 1986 price collapse from $ 26/bl in 1985 to
less than $10/bl in the mid 1986. Out of this fall came the current “market-related” oil
pricing regime. In this regime, despite the fact that OPEC has a major impact in the
price control, other market forces, as well as Non OPEC countries also influence prices.

Figure 1: Graph showing regimes of oil market control and prices

Source: Crude Oil History, 2007

3. FACTORS AFFECTING CRUDE OIL PRICES

A number of factors tend to exert both negative and positive impacts on crude oil and its
pricing. Some of the major factors include
 3.1 Oil Production Peak (Demand & Available):

Oil production peak basically describes a period during which the maximum pace
of global petroleum exploration is achieved, after which the rate of production assumes
a downward and terminal trend. This concept, developed by M. King Hubbert is based
on observed production rates of wells (Campbell, 2000). Accepting this theory inevitably
brings to light the question of the global peak period. While some have argued that this
period has passed and that production is on a decline, some others have argued that
the peak date is yet to come. Hubbert, applying his theory, predicted the peak
production date of the US between 1966 and 1970 and that of the world to be
2007( Sorrell,S. 2010).

Obviously, there is enormous difficulty in predicting the oil peaks in any area of the
world, and this is probably due to lack of insight, transparency in accounting of global
resources, and even major oil companies have sometimes been known to be reluctant
in releasing reserve figures or even falsifying them. Some scientists and researchers
from Oxford University argue that official figures are overblown due to the fact that
OPEC over-estimated reserves during the 1980s when competing for global market
share (telegraph.co.uk, 2010).

The inability to accurately determine oil peak and decline rate has lead to many price
changes, due to the forces of demand, availability and speculative expectations.

Like with every other commodity, crude oil prices are primarily determined by the forces
of demand, availability and speculative expectations. In essence, it is safe to say that
every other determinant factor actually manipulates these primary factors (directly or
indirectly) to produce its effects.

When crude oil was first discovered, its demand was relatively low (mainly for heating)
and so, the prices where moderate and easily controlled. Since the 20th and 21st
century, where technological advancement and significant population increase have
made crude oil the main source of energy, it has become increasing difficult to match
demand with a steady supply. The result then becomes an ever fluctuating crude oil
price (averagely on the increase).

Reports suggest that supply and demand forces are likely exert even more upward
pressure on the prices of crude oil. Francisco Bland of Bank of America Merrill believes
that global demand is set to increase by 1.4m bpd as the growth in demand from
developing countries offsets a decline in demand from rich countries(who are gradually
shifting to other sources), as a result, he expects price to hit $100 pbl in 2010 and to
average $90 in 2011 (Crude Awakening, 2010).

3.2 Alternative Energy Sources

Alternative energy sources to crude oil are many and vary widely, but the main
sources are Natural gas, Coal, biofuels and renewable energy.
Natural gas which has methane as its main component, as well as other hydrocarbons
and impurities (sulfur, water vapour, Nitrogen) is primarily found in reserves where
crude oil exist (associated gas). It is also found existing alone (gas wells) and can also
be produced by other natural and artificial means.

Natural gas can be used in power generation, domestic use as well as in transportation
where it can replace crude oil (and its products). Its main advantages over Petroleum
are its relatively higher abundance, lower level of CO2 emission (cleanest fossil fuel) as
well as its relatively low market price current price at about $3.86/ million BTUs
(CNN.com, 2010). Natural gas if well exploited is capable of being a replacement to
crude oil

As the name implies, biofuels are energy sources that are derived from biological
origins. Their sources vary widely, but the most common ones include plant sources
(starch plants) and animal sources (animal fats).

Bio fuels have had considerable effects of the prices of crude oil. Analysis showed that
in 2007, introduction of biofuels reduced international fuel prices by between 1.07 and
1.10%, it also reduced the quantity of fossil fuels consumed by importing countries to
between 0.3% and 0.7% (Hochman,G. 2010). Biofuels production also reduced CO2
emission by 16.55 -18.55 million tons of CO2 (Hochman,G. 2010)

The most common sources of renewable energy are wind, water(hydro) and solar.
Despite the high initial cost of investment, these energy forms (often called the cleanest
forms) have gained prominence due to the ever increasing price of crude oil,
environmental issues, as well as reducing crude oil reserves.

With the information above, it is obvious that these other energy sources provide more
environmentally friendly avenues of reducing crude oil reliance and thereby curtailing
volatile price changes and so production is forecasted to be on the increase

Figure 2: Graph Showing World Marketed Energy use by Energy Type 1980-2030
Source: History: Energy Information Administration (EIA)www.eia.doe.gov/iea.projections
Projections: EIA, systems for the Analysis of Global Energy Markets

3.3 OPEC Roles and Influences

The Organisation of Petroleum exporting countries, OPEC is a cartel of major 12

oil exporters (Saudi Arabia, Nigeria, Algeria, Iraq, Ecuador, Iran, Kuwait, Libya, Qatar,
Angola, UAE and Venezuela), formed to control the supply of oil (Salisbury,Peter 2010).
Founded in September, 1960, its main objectives are

• Management of oil price and thereby ensuring final long term value of the resource
• Influencing of prices by the control of supply of its reserve capacity into the market
• Releasing and withholding reserves to lower or reduce prices when the situation
demands (Salisbury,Peter 2010).

OPEC supplies over 40% of the world’s oil and also controls 50-75%. Its revenues are
expected to reach $ 625B, says the centre for global energy studies (Crude Awakening,
2010).

With its figures and reserves, it is obvious that OPEC plays a major part in the
determination and manipulation of oil prices. For example, earlier in 2009, OPEC cut
production by over 12% to support prices, which had fallen from $147 pbl in 2008 to just
$33 (Crude Awakening, 2010).

Arguments though have maintained that OPEC is actually more interested in

maintaining very elevated crude oil prices, rather than stabilising prices. This is thought
to be very well against sustained economic growth. This said to be achieved by
perpetuating phoney theories of scarcity and thereby achieving price increases via the
previously discussed forces of supply demand and speculation.

3.4 Non OPEC Crude Oil Producers and Influence

The US energy information agency (EIA) released that 7 of the world’s 15

largest crude oil producers do not belong to the OPEC. These counties which include
United States, China, Russia, Mexico, Canada, Norway and Brasil are said to be the
major non OPEC producers who exert considerable influence on crude oil prices.
Britain used to be a part of this group in 2004, but fell out after its production rate
continued to decline (www.eia.doe.gov, 2010).

In 2007, generally, non OPEC nations produced about 48mbpd which is about 60% of
total production that year. Though there has been a decrease in the US, Mexico and
Norway’s reserves, Non OPEC productions have been compensated by the increase in
production from brasil, Russia and Canada (www.eia.doe.gov, 2010)

Recent price has been one of the major incentives for a partial shift in source of crude
oil from the OPEC to non OPEC producing nations.

Due to the capacity of their reserves, it is easy to understand why the non OPEC
countries would have very reasonable impact on the crude oil market and its prices.
This is not to say that their impact overshadows that of the OPEC. This is probably due
to the fact that the lack of an official union within the non OPEC countries considerably
reduces their impact on the crude oil market (as opposed to what is available in the
OPEC)

OPEC countries also have indirect effects. For example, in 1986, then vice president
George H. W. Bush travelled to the Persian Gulf to urge the regions oil producers to
rein oil production. Oil prices were low(under $10pbl) and the economies of Louisiana,
Texas and Oklahoma were hurting badly. His actions resulted in an increase in oil
prices to over $ 22pbl by July 1987 (BERGMAN,E. 1985).

Table 1.0: Table showing the world’s top 15 Oil crude producers (, 000 bpd)

Source: US Energy Information Administration http://tonto.eia.doe.gov/country/index

3.5 Other Factors

Other factors that have been known to have considerable effect on oil prices
include, tax increase and decreases, inflation, the recently fluctuating state of the stock
market as well as the shaky condition of the US dollars which many countries argue
should no more be used as a basis for oil pricing.

10 CONCLUSION

It is quite obvious that the world’s energy need is always on the increase and Crude Oil
is bound to be in contention for quite a long while. Hence it would be very advisable to
strategically manage both its production, pricing and use in the most transparent and
informed way, so as to curb the many adverse effects of price fluctuations.

In conclusion, alternative energy sources have a major part to play in the stabilisation of
oil prices (as is of primary concern here) and also ensures that cleaner and more
reliable sources of energy are there to replace crude oil whose reserves are finite.
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