How is the price of a barrel of crude oil set?
The different oils that can be traded on the stock exchange are listed according to their level of quality compared to the so-called benchmark oils, which are of course North Sea Brent crude oil and US WTI or West Texas Intermediate. In fact, more than half of the oil produced on the planet has its price indexed to these two reference crude oils. For each oil, a premium or discount is thus associated with the price of the reference oil and is supposed to reflect the difference in quality between it and its reference.
But who is responsible for determining the price of a barrel of oil? In reality, only a few dozen players are in charge of setting oil prices. They are mainly the oil and gas groups, representatives of the OPEC oil countries, European and American hydrocarbon traders, and a few banks that specialise in crude oil trading.
It is therefore very difficult to understand how the actual process of setting the price of a barrel of oil works, as it is so complex and depends on many successive rules that have been imposed over time by agencies such as Platts and Argus Media, also known as Petroleum Argus. It is indeed these agencies that are in charge of establishing the quotation of the reference oils and with the aim of making this process as little subject to manipulation as possible.
As we will see below and in detail, there are of course many external factors that influence the setting of oil prices, including of course the strength of supply and demand, but also other more contextual elements. These include national and sometimes even regional legal contexts, announcements or denials of new oil discoveries around the world, geostrategic risks as oil is a natural resource whose price can change rapidly in response to international tensions and conflicts and more generally international news or political decisions by producing countries including OPEC countries, the investment costs which are increasingly important due to the depletion of easily accessible resources and the obligation for operators to invest more funds in order to search for, exploit and process non-conventional oil, which is often dirtier and is found in great depths, particularly at sea. The advent of alternative energy supplies and the carbon market are also other contextual elements that can influence these prices.
Cases of crude oil price manipulation:
In the past, crude oil prices have also been manipulated, despite the mistrust and scrutiny of the agencies responsible for determining its price. Various cases of fraudulent transactions or price manipulation have been made public in recent years. Here are a few examples that you should be aware of before beginning to analyze this value.
- Especially in 2013 and with regard to the price of North Sea Brent oil, a suspicion of abuse of a dominant position by some industrial groups, including the Equinor group, has been brought to light by the European Commission. The latter has indeed opened an investigation whose main purpose was to determine whether certain oil and gas groups could have agreed on prices with the Platts agency we mentioned earlier, with the aim of modifying the figures at the close of the market. This suspected manipulation could have started in 2002 according to sources close to the investigation. These groups have thus violated the rules of competition and have also indirectly manipulated the world price, which is aligned for almost half of the price of Brent oil. Among the companies that collaborated in the investigation and were therefore directly targeted by these accusations are Royal Dutch Shell, BP, Equinor and Platts.
- A year later, in 2014, another case of oil price manipulation was uncovered, this time in the US. Indeed, during this year, a US Senate committee revealed the practices of certain banks including JP Morgan Chase, Goldman Sachs and Morgan Stanley on the commodity markets, including the copper and oil markets. The latter are accused of having manipulated the markets to their advantage by stockpiling large quantities of these commodities that did not correspond to any useful production operations.
Elements influencing the evolution of crude oil prices :
Now that we have reviewed the contextual elements and particularities that can change the price of crude oil, we propose to learn a little more about the recurring elements that are used by investors to predict the next price variations of this commodity.
These factors are essential to analyse since oil, like any other raw material or financial asset, is above all influenced by the phenomenon of supply and demand and more specifically by the relationship between these two factors.
We know that oil is an indispensable raw material in the world and that it is used both as a raw material and as a fuel, to make plastics, pharmaceuticals and many other products. This is why the demand for oil remains strong and why the health of these industries will determine most of the world's oil demand. Indeed, if demand from these industries increases while production stagnates, it will logically lead to higher oil prices. Conversely, of course, when these industries are in a recessionary phase, their oil requirements will be lower and therefore demand will fall. In this case and if production remains stable or increases, this will logically lead to a drop in the price of a barrel of crude oil.
As you will have understood, it is above all by analysing the difference between supply and demand that you will be able to determine how the price or rate of crude oil will evolve.
It should also be noted that this analysis is now a little more complex than before. Until a few years ago, it was quite simple to understand how these prices would behave. At that time, the USA was the main consumer of crude oil. On the other hand, and in terms of production, OPEC was the main supplier to the market. But over time and over the years, this situation has become more complex and confusing. One explanation for this phenomenon is that oil drilling technologies have been greatly improved and have led to improved supply. In addition, we have seen the emergence of alternative solutions to this production. Finally, new players have also entered the equation, including China, which has become a major oil consumer in the world.
Below, we will take a closer look at the factors that modify the supply or demand of oil and that will therefore contribute to the evolution of the price and the price of this raw material.
What are the elements that influence the supply of oil :
Let's start by looking at the world's oil supply. There are various factors that have a direct or indirect effect on the amount of oil available on the market, which we invite you to find out more about here.
First of all, it is particularly important to follow OPEC news closely. OPEC stands for Organisation of Petroleum Exporting Countries. This organisation is in charge of publishing a report that defines the production volume of each of its members. The organisation is made up of 14 countries which alone produce nearly 40% of the world's oil each year. Thus, OPEC reports have a very important influence on the world's supply of black gold and can help to determine it relatively accurately. Among the elements that will need to be monitored, particularly with regard to OPEC, are the most influential OPEC meetings. It is at these meetings that future production levels are determined and discussed. When the various members of this OPEC organisation agree on the production levels to be set, this will have a direct and significant influence on the price of a barrel of crude oil. It should be noted, however, that geopolitical elements can make this consensus among OPEC members more difficult to achieve. This was particularly the case in 2014, when OPEC countries failed to find common ground on freezing oil production in order to counter the slowdown in Chinese growth and the rise of the US shale. Following this event, there was a rise in supply that far exceeded demand and thus a fall in crude oil prices.
Of course, OPEC is not the only player that plays an important role in the world's oil supply. Indeed, other oil-producing countries that are not members of this organisation should also be taken into consideration, such as Russia, Saudi Arabia and the United States, which have been the world's three largest oil producers for many years. Today, Saudi Arabia has joined OPEC, but the role of the US and Russia in the adjustment of oil prices will be taken into account and their influence remains very important. However, since no unified report currently exists, it remains complicated to reliably monitor the production levels of these countries.
Finally, and still in the context of the analysis of oil supply, we will monitor what are known as "supply shocks". We know that a large part of the world's oil is produced in the Middle East. As a result, military conflicts and terrorism can have a strong impact on world oil production. In the 2000s, for example, there was a loss of growth in world oil production due to the war in Iraq. Other elements such as specific climatic conditions can also have an important influence on oil production and thus on oil supply. This was seen recently with Hurricane Katrina, which caused a rise in the price per barrel after the destruction of a major pipeline.
What influences the demand for oil?
Let us now turn to the elements that will have a more or less strong influence on the demand for oil.
- In particular, the data from the United States will be closely followed, as oil consumption in that country has been falling for several years. Chinese economic growth has notably led to a recovery in the price of oil after the 2008 recession, while American demand was falling. But the USA remains the largest oil-consuming country at present. This is why reports from the Energy Information Administration (EIA) on the country's crude oil reserves are a prime indicator for assessing demand.
- We will also keep an eye on global economic data, especially China, which has become the world's second largest oil consumer but does not yet provide reliable statistics on its consumption. However, it is possible to analyse the economic publications from this country which will indicate the level of Chinese growth and make it possible to anticipate demand.
- The development of alternative energies is also an influential factor, since the better the technology improves, the lower the world's dependence on oil, thanks to the implementation of more viable alternative solutions. For example, an increase in renewable energy can lead to a decrease in the demand for oil.
- Finally, another very important element to be taken into consideration when anticipating the demand for crude oil in the world concerns the US dollar. Indeed, we know that the price of raw materials is most often fixed in US dollars. This means that the price of crude oil can be influenced by the rate of this currency. A weak dollar on the foreign exchange market will indeed make investment in oil more attractive and will therefore increase demand.
Technical analysis to anticipate the evolution of oil prices :
We have just explained to you in detail the factors that influence the supply and demand of oil and thus the evolution of the price of this raw material. But you should also take into account the technical analysis before taking a position on this asset.
To carry out this analysis, you simply use a customisable graph such as those offered by online brokers and display various trend and volatility indicators. Only when the signals from technical and fundamental analysis are in agreement will the forecasts on this evolution be the most reliable and you will be able to optimise your positions on this stock.