Oil Pricing and Profit

How Oil Prices Are Determined

Commodity traders bid on oil futures contracts and thus are responsible for oil pricing. Some of the factors they look at when bidding include production quotas set by OPEC, current output supply, oil reserves, and oil demand. High quality oil, or “sweet” oil, is one that is lightweight and contains minimum amounts of sulphur. Because of these properties, it is ideal to use for gasoline. From West Texas Intermediate, this oil is the benchmark for America. It is priced at approximately $5-6 per barrel. Brent Blend is also a high quality fuel that is ideal for gasoline use. This oil is usually priced at about $4 per barrel.

The OPEC basket price is an average of prices combined from countries such as Algeria, Indonesia, Saudi Arabia, Nigeria, Dubai, Mexico, and Venezuela. This price is used to monitor world oil trends. Oil from some of these countries has a higher sulphur content, which makes it less desirable, and known as “sour oil,” for gasoline use, so the OPEC prices are usually lower. Higher crude oil pricing directly affects the U.S. economy because it impacts gasoline costs as well as home heating costs, electric power generation, and manufacturing. This also increases inflation, which, in turn, increases the cost of everything Americans purchase while depressing the stock market.

According to the EIA, West Texas Intermediate crude oil pricing was at an all-time high in 2008 with a cost of $99.62 per barrel. Also in 2008, oil use was divided into 96% for transportation, 43% for industrial products, 21% for residential and commercial use, and 3% for electric power. Currently, 55% of crude oil is accounted for in the price of gasoline with 45% in distribution and taxes. (See EIA, http://www.eia.doe.gov/basics/energybasics101.html)

Heating Oil Pricing

Heating oil pricing impacts nearly 107 million Americans each year with 8.1 million households using it as their main heating source. Heating oil is seasonal with the Northeast using most of the production during the months of October – March. Most heating oil users try to fill their tanks during the summer months while heating oil pricing is still relatively low; however, many of these people do not have large enough storage tanks. The possibility of increased heating oil pricing makes some homeowners weary because they will have to fill their tanks 4-5 times during the winter months.

Refineries produce “distillate fuel oil” which is commonly used in heating oil and diesel fuel. This oil is shipped throughout the U.S. via pipelines, barges, tanks, trucks, and rail. There is such a high demand for heating oil in the winter months that these refiners produce oil in the summer and store it for the upcoming high demand.
Crude oil pricing directly affects heating oil pricing because it is a core component of heating oil. Heating oil pricing fluctuates based on factors such as the season and the demand, changes in crude oil pricing, local competition, and regional operating costs. Heating oil consumers in the Northeast account for between 78% and 82% of use. Annual sales of heating oil are divided with the Northeast at 82%, Midwest using 9%, Southeast with 6%, West Coast using 3%, and the Rocky Mountains using 0%. (See EIA, http://www.eia.doe.gov/pub/oil_gas/petroleum/
analysis_publications/heating_brochure/heatbro.htm)

Surges in heating oil pricing can occur for several reasons, which may include rapid changes in cold weather that impact supply and demand, available heating oil storage, and prices of other heating fuels.

Crude Oil & NYMEX

Crude oil is the most traded commodity throughout the world. The NYMEX futures contract for sweet crude oil is the largest volume contract trading that exists on physical commodities. It is used as a pricing benchmark because of the crude oil pricing transparency and its liquidity. Opportunities through the futures contract include calendar spread options and crack spread options on pricing differentials of heating oil futures, crude oil futures, and gasoline futures as well as average oil pricing options.

The contract is listed for 72 months and is traded in 1,000-barrel units. Designed for investment portfolios, the NYMEX miNY™ is equal to 500 barrels of crude oil, which is 50% of the size of a standard futures contract. The CME Globex® electronic trading platform offers the contract, and it can be cleared through the NYMEX clearinghouse.

Also available from NYMEX is a Brend Blend/West Texas Intermediate spread. The Brent Blend futures contract is based on sweet crude oil from the North Sea and trades as a differential to the NYMEX division futures contract. Significant amounts of the crude oil are found in the areas of the U.S. Gulf and East Coasts, but it is also refined in Northwest Europe. (See NYMEX, http://www.nymex.com/cp_produc.aspx)

Gulf Region Oil

The Gulf Region is the largest crude oil source in the world. Major oil companies working in the Gulf Region include the Bahrain National Oil Company in Bahrain, National Iranian Oil Company in Iran, Iraq National Oil Company in Iraq, Kuwait Oil Company in Kuwait, Petroleum Development Oman Ltd. in Oman, Qatar General Oil Corporation in Qatar, and Saudi Aramco in Saudi Arabia. Some foreign companies already working or interested in working in the Gulf Region are Shell, Chevron, Petro Canada, BP, Texaco, and Mobil.
It is predicted that by the year 2015, oil production in the Gulf Region will be increased by 10 million barrels per day because of large investments in the region's oil industry. 300 active projects are currently ongoing in the region, and this expectancy is based on these projects meeting their goals. Saudi Arabia will be contributing more than half the total crude oil production followed by the United Arab Emirates. Following these two countries are Qatar, Bahrain, Kuwait, and Oman. In total, 8 Gulf Region oil companies are shaping the world's oil pricing market. It has been estimated that approximately $500 billion is needed in investment by the year 2030 to enable the region to produce 35 million barrels per day.