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''This article describes forces that affect oil prices in general. For specific commodities, see the articles on [[Light Crude Prices]], [[Brent Crude Prices]], [[Heating Oil Prices]], or [[Gasoline Prices]]. ''This article describes forces that affect oil prices in general. For specific commodities, see the articles on [[Light Crude Prices]], [[Brent Crude Prices]], [[Heating Oil Prices]], or [[Gasoline Prices]].
 +''Also see article on [[iPath S&P GSCI Crude Oil Total Return ETF (OIL)]]
Few inputs impact the world economy like the price of oil. Oil powers cars, trucks, boats, airplanes, and even power plants that make up the backbone of the global economy. As oil prices rise, costs go up for transportation companies, squeezing their profit margins and forcing them to raise prices, similarly affecting all the other companies that rely on them to transport products and people. By contrast, most [[energy]] companies benefit from higher oil prices, either from higher revenues for oil, or because of increased demand for substitute energy sources such as [[ethanol]] and [[natural gas]]. 2007 and the first half of 2008 were good times for many energy companies; futures prices rose tremendously, peaking on July 3rd, 2008, at a record high of $145.85<ref>[http://www.voanews.com/english/2008-07-03-voa33.cfm VOA News: "Oil Prices Soar to Record High of Nearly $146 a Barrel"]</ref>. Since then, however, futures prices have plummeted (dropping below $50 per barrel by early December<ref>[http://www.ft.com/cms/s/0/b44eaf80-c0dc-11dd-b0a8-000077b07658.html Financial Times: "Crude oil prices tumble $100 in five months"]</ref>), mostly in response to the [[recession]] caused by the [[2007 Credit Crunch]] and [[2008 Financial Crisis]]. The extreme volatility of this important economic input has piqued interest in issues like [[peak oil]], speculation, and the world's rising [[energy appetite]], and is leading to greater investment in [[renewable energy]]. Few inputs impact the world economy like the price of oil. Oil powers cars, trucks, boats, airplanes, and even power plants that make up the backbone of the global economy. As oil prices rise, costs go up for transportation companies, squeezing their profit margins and forcing them to raise prices, similarly affecting all the other companies that rely on them to transport products and people. By contrast, most [[energy]] companies benefit from higher oil prices, either from higher revenues for oil, or because of increased demand for substitute energy sources such as [[ethanol]] and [[natural gas]]. 2007 and the first half of 2008 were good times for many energy companies; futures prices rose tremendously, peaking on July 3rd, 2008, at a record high of $145.85<ref>[http://www.voanews.com/english/2008-07-03-voa33.cfm VOA News: "Oil Prices Soar to Record High of Nearly $146 a Barrel"]</ref>. Since then, however, futures prices have plummeted (dropping below $50 per barrel by early December<ref>[http://www.ft.com/cms/s/0/b44eaf80-c0dc-11dd-b0a8-000077b07658.html Financial Times: "Crude oil prices tumble $100 in five months"]</ref>), mostly in response to the [[recession]] caused by the [[2007 Credit Crunch]] and [[2008 Financial Crisis]]. The extreme volatility of this important economic input has piqued interest in issues like [[peak oil]], speculation, and the world's rising [[energy appetite]], and is leading to greater investment in [[renewable energy]].

Revision as of 22:12, February 13, 2009

This article describes forces that affect oil prices in general. For specific commodities, see the articles on Light Crude Prices, Brent Crude Prices, Heating Oil Prices, or Gasoline Prices. Also see article on iPath S&P GSCI Crude Oil Total Return ETF (OIL)

Few inputs impact the world economy like the price of oil. Oil powers cars, trucks, boats, airplanes, and even power plants that make up the backbone of the global economy. As oil prices rise, costs go up for transportation companies, squeezing their profit margins and forcing them to raise prices, similarly affecting all the other companies that rely on them to transport products and people. By contrast, most energy companies benefit from higher oil prices, either from higher revenues for oil, or because of increased demand for substitute energy sources such as ethanol and natural gas. 2007 and the first half of 2008 were good times for many energy companies; futures prices rose tremendously, peaking on July 3rd, 2008, at a record high of $145.85[1]. Since then, however, futures prices have plummeted (dropping below $50 per barrel by early December[2]), mostly in response to the recession caused by the 2007 Credit Crunch and 2008 Financial Crisis. The extreme volatility of this important economic input has piqued interest in issues like peak oil, speculation, and the world's rising energy appetite, and is leading to greater investment in renewable energy.

Prices

Light sweet crude oil futures (US$/barrel) with a March, 2009 delivery date:



Brent crude oil futures (US$/barrel) with a March, 2009 delivery date:



Heating oil futures (US$/gallon) with a February, 2009 delivery date.



RBOB Gasoline futures (US$/gal) with a March, 2009 delivery date.

Who Benefits from Rising Oil Prices and Loses from Falling Oil Prices

  • Coal companies like Peabody Energy, Arch Coal, CONSOL Energy, and Massey Energy Company see sales growth, as rising oil prices cause consumers to demand more local sources of energy; the U.S. is the world's second largest coal producer, after China, and there are estimates stating that U.S. coal deposits have more energy than the world's remaining oil reserves.[3]
  • Independent Oil & Gas companies benefit the most from high oil prices, as they can extract crude at a relatively constant cost from a reserve, but sell it at higher and higher prices. The higher the price of oil, the larger an E&P company's margins.
  • Oilfield services see dayrates (and, thus, margins) skyrocket, as upstream oil companies scramble to increase production, causing demand for drilling rigs and other oilfield services go through the roof. Machine tools & accessories companies also benefit, as they sell individual parts to oilfield services companies that build, retrofit, and repair rigs.
  • The oil majors are the very largest of the non-national oil companies, and are vertically integrated. These companies explore for and produce crude oil and natural gas; they transport it by pipeline and tanker; they refine crude oil into finished petroleum products; and they also market crude oil, natural gas, and refined petroleum products to industrial users and retail consumers. The majors get most of their money from selling refined petroleum goods; vertical integration allows them to sell high-priced crude to themselves at production costs, causing the margins on these goods to go through the roof. Often, however, they must buy crude to supplement their own production, as their refining capacities are greater than their upstream production capacities. This offsets some of their profitability.
  • Industrial gases vendors such as Praxair (PX) benefit from high prices because they sell hydrogen, which is necessary for the extraction of heavy and non-conventional oil (i.e. tar sands, shale oil), and production of these types of oil increases as prices rise.
  • With the price of oil having been above $100 per barrel, the world's waste management companies (like Waste Management (WMI)) are considering "landfill mining", as high-quality polyethylene prices have doubled since the summer of 2007[6], making the world's trash landfill operators' treasure.

Who Loses from Rising Oil Prices and Wins from Falling Oil Prices

Rising oil prices pose challenges for many companies as well as consumers, which is why rising oil prices are often seen as damaging to the economy.

  1. Rising oil prices increase costs for many companies. These costs may be difficult to pass on to customers, who are loathe to pay more for the same goods, thereby eroding profit margins.
  2. Rising oil prices reduce consumer demand for products that consume oil.
  3. Rising oil prices make travel and shipping more expensive.
  • Oil & Gas Refining & Marketing companies buy crude oil, process it, and sell the processed product to the end market. Companies like Sunoco, Valero, and Western Refining are all prolific U.S. refiners. When these companies must purchase crude oil at a higher price, they then have to sell the refined product (gasoline, jet fuel, diesel, etc.) at a higher price, which then causes demand to drop as people travel less. Furthermore, refined goods prices rise by a smaller amount than crude price. At the end of the 1990s, oil traded below $20/barrel[7], while gasoline cost under $1.50[8]. In June 2008, crude traded at around $121 (after rising to over $135)[9], while gasoline averaged $4.10[10]. Oil prices rose by a factor of six, while gasoline prices rose by less than a factor of three. The clear losers, in this case, are the companies that make and sell gasoline, though when oil prices fall, they fall further than gasoline prices, making refiners the winners.
  • Shipping companies are harmed by higher oil prices because oil is necessary to operate the planes, trucks, and ships that transport goods around the globe. These companies include brand-name shipping companies like FedEx and UPS, industrial shipping companies like TNT and Con-Way Trucking, and international shipping companies like Teekay Shipping and Frontline. LTL trucking companies, however, are relatively shielded from fluctuations in diesel fuel prices, as the industry generally passes on fuel price surcharges to its customers like Wal-Mart Stores (WMT). Also, aircraft leasing companies such as Aircastle (AYR) are hurt by rising oil prices.
  • Airlines like Delta, Northwest, United, and American Airlines are harmed by rising oil prices; in the past, jet fuel has accounted for 10-15% of an airline's cost, but by mid-2008 they made up 30-50% of costs[11], albeit before the price collapsed below $50/barrel.
  • The lodging industry sees declines in occupancy rates and revenues when oil prices rise, as higher travel prices cause fewer consumers to take vacations.
  • Other vacation and travel alternatives (e.g. cruise lines like Royal Caribbean Cruises and Carnival) see higher fuel costs, forcing them to raise prices and drive potential customers away.
  • The Chemical industry is harmed by higher oil prices because petroleum is a key ingredient in plastics. As the price of oil rises, plastics become more expensive to produce, causing margins to shrink.
  • The retail industry is harmed by rising oil prices because shipping companies charge higher prices, making it more difficult for retailers to get their products to market and forcing them to raise prices. Discount retailers, including Family Dollar Stores, Dollar Tree Stores, Big Lots, Wal-Mart, Target and Dollar General are especially exposed as their consumers generally have lower incomes, making them more sensitive to rising energy prices.
  • Online retailers that subsidize the cost of shipping, like Amazon.com and Overstock.com, are forced to pay part of the shipping price increases, causing margins to shrink.
  • Automotive retailers like AutoNation and CARMAX depend on replacement demand for new cars due to wear-and-tear, which decreases as fewer people drive.
  • Chinese manufacturers lose their low-cost production advantage, as rising oil prices cause the prices of whatever is being shipped from China to be artificially inflated. Lower oil prices, at around $20/barrel, were equivalent to low tariff rates (about 3%). With the oil that was being used in shipping during the 2nd quarter of 2008, the equivalent tariff rate was around 9% and rising (until the bubble burst).[12]

Crude Oil Classifications

Oil is generally classified based on its weight and sulfur content

Weight

  • Light crude has low density (there are no exact numbers assigned to this, because the classification is more practical and theoretical), making it easier to transport and refine. Light crude is more expensive.[13]
  • Heavy crude has high density, making it more difficult to transport and refine. Heavy crude is cheaper to buy and usually cheaper to extract[14], though heavy crude produced from tar sands can cost twice as much as conventional drilling.[15]

Sulfur Content

  • Sweet crude has a sulfur content less than 0.5% by weight, making it much easier to refine in a way that would meet environmental standards in developed countries - and making it more expensive.[16]
  • Sour crude has a sulfur content above 0.5% by weight, making it more expensive to refine, and therefore worth less per barrel.[17]

Crude Oil Benchmark Blends

Crude oil is priced in terms of regional blends, each with different characteristics. Of these, certain blends are followed by traders, as they most reflect the overall value of oil, and therefore affect the way different blends are priced. These are essentially like a Consumer Price Index for different types of oil. There are about 161 different types of crude that are traded around the world; the four primary benchmarks, of which these are priced internationally, are Brent Crude, West Texas Intermediate, Dubai, and the OPEC Basket.[18]

  • Brent Blend: Based on the prices of Brent crude, which is a light, sweet crude, from 15 different oil fields in the North Sea.[19]
  • West Texas Intermediate (WTI): The benchmark for oil prices in the US based on light, low sulfur WTI crude[20]. WTI remains the benchmark for oil prices in the US despite the fact that its production has been falling for years.[21]
  • Dubai: Dubai crude, from Dubai, is a benchmark for Persian Gulf crudes, and is light yet sour.[22]
  • OPEC Basket: The OPEC crude basket is OPEC's benchmark, and is made up of 13 different regional oils: Algeria's Saharan Blend, Angola's Girassol Ecuador's Oriente, Indonesia's Minas, Iran's Iran Heavy, Iraq's Basra Light, Kuwait's Kuwait Export, Libya's Es Sider, Nigeria's Bonny Light, Qatar's Qatar Marine, Saudi Arabia's Arab Light, the United Arab Emirates' Murban, and Venezuela's BCF 17.[23]

Spot Prices versus Futures Prices

Spot prices are the prices paid for oil here and now - as in, the amount of money you would hand a producer in exchange for their tossing a barrel of oil into the back of your truck. Futures prices, on the other hand, are the prices paid for contracts promising the delivery of oil at a future date. Whether or not the prices of oil futures affect spot prices is one of energy economics' most prevalent modern debates.

Moreover, there really is no "true" spot market for oil, in the sense of that there is a "true" spot market for stock or other financial assets.[citation needed] A "true" spot market requires, as described above, the actual physical transfer of the goods, to the purchaser, directly at the time of purchase, and there simply are no large scale sellers of crude oil, that operate in such a fashion. The "spot" prices that are quoted, involve the transfer of 1000 barrels of crude oil, not one or two.[citation needed] That would require literally 5 of 6 tractor-trailer rigs to carry off back to your house: the transportation costs would approach the value of the oil itself.[citation needed] When one speaks of a "spot" price for crude oil, one is meaning the current trading price, of the next future contract that will come due.

Those that claim that futures prices (and, therefore, speculation) do not affect spot prices argue that people who purchase futures contracts do not actually purchase any real oil. When a fund purchases a futures contract and that contract comes due, it must sell the oil to someone who will actually use it, because that fund has no way of actually keeping the physical product. This means the oil must come to market - no matter what the price. If a firm buys a $150/barrel futures contract in June for July and the spot price in July is $140, the firm must buy the oil at $140, and then it MUST sell the oil at $140 as well, because it can't actually hold the oil. This means there is no accumulation of oil - firms can't hoard oil, so they can't actually affect the present market. Therefore, it is argued, the prices of futures contracts have no affect on spot prices.

Those that believe futures speculation has an effect on spot prices (at least, those with a sound understanding of economics) argue that when oil futures are traded, oil purchasers, like refiners, try to buy oil at prices that will benefit their margins in both the short and long term. If it is believed that oil prices will rise in the future (indicated by futures prices being higher than present prices), purchasers will want to stock up on oil at lower prices today and put it in inventory; this drives up demand for crude in the present, forcing oil prices up in the present. Thus, it is argued, high prices for oil futures leads to high prices for oil in the present.

Analysis of Events Affecting Oil Prices

  • July 14th, 2008: After oil prices reached new highs of $147 the week before, U.S. President George W. Bush lifted the Executive Ban on Offshore Drilling in an effort to expand domestic oil supplies; because offshore reserves will take years to start producing, however, oil futures fell marginally, settling over $145 per barrel.
  • July 15th, 2008: After Ben Bernanke told Congress that high energy prices were creating an inflationary environment, worries about how high energy prices were affecting the economy caused a run on August futures, plummeting the price of oil by 4%, to $138.74 - the greatest single-day drop in 20 years.[24]
  • July 30th, 2008: Reports of low consumer demand for gasoline causing suppliers to cut stocks by 3.5 million barrels drive oil prices up by $4.39, to $127.10.[25]
  • August 13th, 2008: Crude futures settle at $113.77 on worries about a strengthening dollar and declining demand in industrial nations.[26]
  • September 2nd, 2008: Oil prices drop to just over $105 per barrel after Hurricane Gustav doesn't do nearly as much damage to oil production as expected.[27]
  • September 9th, 2008: Oil prices fell to $103.26, as forecasts of impending Hurricane Ike project it to hit land south of major Texas refineries.[28]
  • September 15th, 2008: Oil prices fell below $97 during early trading.[29] Causes speculated on range from lower-than-expected damage from Hurricane Ike to the deepening economic crisis in the U.S., fueled by the collapses of Freddie Mac, Fannie Mae, and Lehman Brothers, the crumbling of other major banks like Wachovia and Washington Mutual, and the growing consolidation of the industry as seen in the acquisition of Merrill Lynch by Bank of America.
  • October 10th, 2008: Oil prices slide all week, closing at $77.70 on the NYMEX, as fears over global recession lead to panic in the market.[30]
  • October 13th, 2008: Oil prices rebound on fickle investor sentiment, rising back above $80 to $81.19. Goldman, however, revises its projections for year-end oil prices down to $70 from $115.[31]
  • November 18th, 2008: NYMEX WTI December contracts fell below $55/barrel, to $54.50, on continued investor worries that the global economy is entering a prolonged recession.
  • December 2nd, 2008: Prices drop to $47.36[32] after the National Bureau of Economic Research announced that the U.S. is officially in a recession.
  • December 10th, 2008: Crude Oil is at $43.25
  • January 6th, 2009: As Israel's invasion of Gaza and it's fighting with Hamas escalates, crude prices shoot up, with February Brent crude futures rising $2.71 to $49.62 per barrel.[33]
  • January 8th, 2009: U.S. government reports of increased crude and gas inventories forces NYMEX WTI February contracts down by $3.24, to $45.34.[34]

Why Oil Prices Rise or Fall

Demand Growth Forces Prices Up

Demand for oil, as well as demand for energy in general, is closely tied to the global economic cycle. In periods of economic growth, new factories consume energy, shipping companies transport more goods and consumers take more trips. This demand for energy—or even news suggesting the economy is heating up—pushes up energy prices. For example, the five major central banks announced in December 2007 that they would pump money into the world economy to help mitigate the possibility of a recession; immediately, the price of oil jumped over $4 at speculation that energy demand would increase.[35] Conversely, during periods of economic contraction such as recessions, demand for oil and other types of energy tends to fall, leading to reductions in price. In China, for example, manufacturing fell during July and August 2008, and oil prices followed.[36]

The Recent Drop In Oil Prices Due To Demand Destruction

Demand destruction - primarily in the United States - is likely responsible for most of the drop in oil prices that occured during the third quarter of 2008[37]. According to an Energy Information Administration(EIA) report, gasoline consumption in 2008 is expected to drop 3.4 percent, or 320,00 bpd, from its 2007 levels and continue to decline 0.6 percent during 2009.[38] Furthermore, in the first quarter of 2008, trucking industry analyst Donald Broughton estimated that 42,000 trucks, over 2% of the United States' fleet, came off the nation's highways. With nearly 1,000 trucking companies filing for bankruptcy, the demand for diesel fuel has been slashed.

Much of this demand destruction is likely rooted in the 2007 Credit Crunch, the 2008 Financial Crisis, and the resulting recession; when unemployment rises, people stop spending and start saving. When people stop spending, companies stop producing. When companies stop producing, demand for energy falls. When demand for energy falls, the price of oil falls. Hence, it is likely that oil prices will remain down until the world economy recovers from its recession.

Supply Shocks

Production Cuts

The global oil supply is dependent on the ability of oil companies to produce and the willingness of oil-exporting countries to export. Historically, periods of oil price spikes have been caused by oil-exporting countries placing embargoes on certain countries. In 1973, for example, the world's largest oil cartel, OPEC, placed an embargo on oil exports to the Netherlands and the United States, in response to the countries' support of Israel in the Yom Kippur War; the price of oil acquired by refiners increased by approximately 100%, and the U.S. experienced widespread shortages.[39] In 2007, however, despite a 57% increase in prices, the amount of oil exported by the world's top exporters fell 2.5%. Demand for oil in the world's six largest exporters (Saudi Arabia, United Arab Emirates, Iran, Kuwait, Iraq and Qatar) increased by more than 300,000 barrels, while their exports fell by over half a million barrels.[40] In this case, growing demand in each company acted as a natural embargo, forcing them to meet their own needs before exporting to the rest of the world.

The Financial Crisis of 2008 has laid waste to oil prices, by causing a recession so deep even expectations of large supply cuts can't force prices up. In December 2008, OPEC announced a production cut of 2.2 million barrels - it's largest ever - and oil futures actually fell, as traders ignored decreasing supply and focused on decreasing demand.[41]

Violence Against Producers

Since then, oil prices have been volatile because of geopolitical events affecting the ability of upstream oil companies to produce. Terrorist and political attacks can damage drilling rigs or the transportation and refining networks -- including pipelines, shipping facilities, and refineries -- that bring oil from where it is extracted to the consumer. During the spring of 2008, for example, Nigerian rebels initiated attacks on the oil majors' pipelines and deepwater drilling rigs in the country. Despite the fact that OPEC's lead producer, Saudi Arabia, announced it would increase production by 2%, a rebel attack on one of Shell's deepwater rigs sent prices to $136.[42]

Weather

Strong hurricane seasons can damage offshore oil platforms, reducing the amount of oil produced. Supply can also be artificially reduced or increased by government taxes or subsidies on oil production.

Transportation Bottlenecks

When there are problems with the pipelines that transport oil, it can't get to market; this effectively reduces the supply of crude oil to the world's refiners, causing the supply of refined products to fall. When supplies fall, prices rise. On March 28th, 2008, the day after the bombing of one of Iraq's primary export charges, Brent crude rose on the London exchange by $1.01.[43]

Peak Oil and Declining Production

Peak oil theory presents an idea on how the declining supply of oil, a non-renewable resource, will affect its price over time. Since oil is a limited resource that takes millions of years to form, when we extract it from the ground, its supply constantly declines without being replenished. Peak oil theory states that as reserve extraction approaches a halfway point, production increases, and at the halfway point, prices are lowest and production volumes are highest. Once the halfway point has been passed, production begins to fall and prices begin to rise. Many analysts believe oil production is at or past peak oil already, since prices are now at record highs and, for the first time since 2002, global oil production fell.[44] Even OPEC production is thought to be declining; satellite photos of Saudi Arabian oilfields show more pressure-pumping (an expensive way to get oil out of the bottom of a maturing well) occurring in the last year, indicating that the country is working much harder to keep production up.[45]

Theories that opening the Arctic National Wildlife Refuge and offshore drilling sites in the U.S. to development would alleviate gasoline prices are likely misguided; Jim Sweeney, director of the Precourt Institute for Energy Efficiency at Stanford University, says that offshore U.S. reserves would account for just 1% of worldwide consumption, but wouldn't be productive for 10-15 years.[46]

U.S. Dollar Value Fluctuations Cause Positive Feedback on the Price of Oil

The United States imports much of its oil, and that oil is purchased abroad in U.S. dollars. The price of oil, in fact, is pegged to the dollar. The changing value of the dollar in comparison to other currencies impacts the price paid by end users. A strong dollar means a lower price, in dollars, for oil, and a weak dollar means more dollars must be spent to purchase the same amount of oil. Currency fluctuations are complex (for a more complete discussion see currency fluctuations) but the value of a currency is impacted by the relative value of goods imported and exported by an economy (known as the trade balance), its interest rates, the size of its national debt, and its economic growth.

Speculation

Some analysts believe that oil prices are at record highs because of speculation about the future value of oil. Specifically, these analysts claim that the belief that oil supply is lower than it is and the belief that future oil supply will be just as low has led traders to inflate the prices of oil futures. When oil futures are traded, oil purchasers, like refiners, try to buy oil at prices that will benefit their margins in both the short and long term. If it is believed that oil prices will rise in the future (indicated by futures prices being higher than present prices), purchasers will want to stock up on oil at lower prices today and put it in inventory; this drives up demand for crude in the present, forcing oil prices up in the present. Thus, high prices for oil futures leads to high prices for oil in the present.

OPEC, believes that record fuel prices are not a function of supply and demand, but a function of Western government policy and rampant speculation, and has used this belief as an excuse not to raise production by the amounts demanded by the West.[47] While much of the data shows that production has been slowing, it's likely that speculation could account for some of the present price spikes.

When oil prices closed at record highs for five days in a row during the week of May 5th, 2008, a House of Representatives committee announced an investigation regarding the role of hedge funds and investment banks in pushing up prices. In June 2008, the U.S. commodities futures regulator announced new rules requiring daily large trader reports, and position and accountability limits for foreign crude contracts traded in the U.S.[48]


Negative Feedback on Rising Prices Offsets Some of the Increases

Rising oil prices can force major purchasers of oil to turn to other fuel types. The U.S. Military, for example, in May of 2008 tested a jet that broke the sound barrier using synthetic fuel. The military is the largest single consumer of oil in the U.S., at 1.5% the country's total, and rising oil prices drove the Defense Department's energy bill up 25% in 2007. Since estimates stated that commercial-scale synthetic-fuel refineries could sell the fuel at just $55 a barrel, the military has started pushing away from oil - which could actually drive oil prices down.[49]

The Chinese government was also forced to act on rising global oil prices. On June 20th, China announced that it had raised diesel prices by 18% and gasoline prices by 16%; oil prices on world futures markets immediately fell by $4, as higher prices in China were expected to lead to decreased demand in China, thereby leading to decreased world demand.[50]

Even regular consumers were forced by soaring fuel prices to change their habits, turning to gas-efficient cars or simply driving less; gasoline demand in the U.S. fell at the beginning of June 2008 by 3.8% from the year before, while consumption fell 1.9%.[51]

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Oil Price per Barrel since 1997
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World Oil Production


Investment Strategies: Ways To Invest in Oil

1) Buy some dirt and drill a well

The "beauty" and ease of purchasing securities online to invest in lucrative commercial endeavors like oil production is best put into perspective by considering the history of the oil business and the extreme difficulty and risk of actually "investing" the time and effort to buy your own dirt and drill a well like the oldtimers did. The 2007 dramatic film "There Will Be Blood" by Paul Thomas Anderson gave modern day audiences and online investors alike a sense of the difficulty and risk involved in speculative oil drilling ventures[1].--PGSanalyst 16:12, January 28, 2009 (PST)

2) Private Placement

Investing in publicly traded energy industry securities, including oil and gas securities and related services companies, represents only a part of the total global investments made.

Arguably, the most lucrative way to invest in oil and gas is through a "private placement," [2].

The general public does not receive information about private placements because these are a type of securities that carry a much higher degree of risk than publicly traded securities like ExxonMobil and the like. The securities laws, both federal and state, prohibit what is known as a "general solicitation" in private placements. This means that PP's cannot be advertised, including any website open to the public, and, a telemarketing campaign cannot be utilized except to screened lists of qualified investors.

After the lessons learned from the stock market crash of the 1930's, the US government enacted various legislation that attempted to protect unsophisticated layperson "investors" from investments that carry inordinate risk. The Securities Acts of 1933 and 1934 created these protections.

Private Placements are unregistered securities that qualify for an exemption from registration.

Private Placements in oil and gas investment partnerships are only available to "accredited investors," a legal term carefully defined by the SEC.

Although there are a series of specific rules[3][4], generally, a person must have made verifiable income of at least $200,000.00 USD in the most recent two years and have a reasonable expectation to earn at least that amount in the current year. For married couples the "rule" is $300,000.00 USD between both spouses incomes (could be a $175k/ 125k split or any other percentage split).

Private Placement investments in oil and gas drilling ventures carry a very high degree of risk, so the investor must have the financial means to withstand the complete loss of the investment without sustaining undue hardship.

These strict rules cut out approximately 91.53% or so of potential US investors, thus making the world of private placements very elite by nature. Also, the SEC has proposed new, more strict rules regarding hedge funds and accredited investors. The new rule would require that investors in hedge funds be not only accredited, but also would have to meet the requirements of the Investment Company Act section 3 (c) (7) and hold at least $2.5 million USD in investments on the date of investment. This would set an extremely high bar over which to qualify and thus theoretically protect less sophisticated investors from the significantly higher risks associated with hedge funds.[5].--PGSanalyst 00:33, January 29, 2009 (PST)

Historically, private placements in oil and gas drilling and production ventures utilized a "one third for one quarter" type investment strategy. This meant that the investment partnership organizer would draft contracts that specified that 3 investors would each put in one third of the total investment. In 2008/ 2009 investment for drilling one typical well is about $2.5 to $4.0 Million dollars. The investors each put up one third of the money but get only one fourth of the "rights" to any oil or gas found and or produced. The remaining one fourth is kept by the organizer of the investment as compensation for arranging the drilling, completion of the well, production of the oil and gas and so forth.

Investors choosing to purchase securities in the form of capital stock issued by oil and gas industry companies would be wise to understand and consider the big picture and the fact that the most lucrative oil and gas ventures are often in private placements not available to the public.--PGSanalyst 18:22, January 27, 2009 (PST)

3) Purchase Securities in Publicly Traded Oil Industry Companies

Purchasing securities issued by publicly traded oil companies like ExxonMobil (XOM) is probably the simplest and least risk strategy to participate in the potential advantages of investing in the oil industry.--PGSanalyst 16:12, January 28, 2009 (PST)

4) Oil-Related ETFs

Stock investors can buy or short-sell oil-related ETFs. Two of the most traded ETFs are USO and OIL. Also consider DCR, UCR and DUG. In addition, there are two recently added double leveraged ETF's based on Crude Oil Futures rather than oil stocks, UCO is ultra long crude oil and SCO, ulta short crude oil. These stocks are now trading at a brisk pace and are quite liquid.

References

  1. VOA News: "Oil Prices Soar to Record High of Nearly $146 a Barrel"
  2. Financial Times: "Crude oil prices tumble $100 in five months"
  3. Fast Facts About Coal
  4. RigZone: Offshore Rig Day Rates Page, Accessed May 05, 2008
  5. Energy Current: "Deepwater rig day rates hit new high", November 9th, 2007
  6. IHT: "Landfill sites are being viewed as mines with buried riches"
  7. zFacts: "Crude Oil Prices Drive up Cost of U.S. Addiction"
  8. zFacts: "Current Gas Prices and Price History"
  9. BBC News: " Oil dips to $121 as reserves grow"
  10. zFacts: "Current Gas Prices and Price History"
  11. Kiplinger: "Southwest Airlines: Best of the Worst"
  12. Research and Recap: "High Oil Prices Eroding Asian Manufacturing Advantage"
  13. Cheaper Petrol Party: Glossary
  14. Cheaper Petrol Party: Glossary
  15. Energy Bulletin: "Shell, Exxon tap expensive oil sands & gas, oil reserves dwindle."
  16. BBC: " Oil markets explained"
  17. BBC: " Oil markets explained"
  18. Ezine Articles: "The Changing Meaning Of Oil Price Benchmarks"
  19. Wikipedia: Brent Crude
  20. Wikipedia: West Texas Intermediate
  21. Ezine Articles: "The Changing Meaning Of Oil Price Benchmarks"
  22. Wikipedia: Dubai Crude"
  23. OPEC: Basket
  24. Axcess News: "Crude oil prices plunge, biggest drop in 17 years"
  25. Reuters: Oil jumps more than $4 after gasoline stock draw"
  26. Reuters: "Oil falls below $114 on global demand worries"
  27. IHT: "Oil companies 'dodged the bullet' Gustav aimed at them"
  28. MarketWatch: "Energy stocks slide as oil retraces near $100 a barrel"
  29. MSNBC: "Oil slides below $97 on Ike's light damage toll"
  30. MarketWatch: "Energy stocks endure another grueling session"
  31. MarketWatch: "Oil, gas sector leads record day for the Dow "
  32. Financial Times: "Crude oil prices tumble $100 in five months"
  33. FT: "Escalating violence pushes oil price higher"
  34. FT: "Jump in crude supplies drags oil price lower"
  35. Reuters: "Oil jumps $4 on central bank move, U.S. stock draw"
  36. Seeking Alpha: "Thank China and Gustav for Lower Oil"
  37. IU: "Crude Oil Prices: Are "Oily Characters" Behind the Move?"
  38. EIA: The Decline in Motor Gasoline Consumption: A Replay of the Early 1980s?
  39. Wikipedia: "1973 oil crisis"
  40. The Wall Street Journal: "Oil Exporters Are Unable To Keep Up With Demand"
  41. SeekingAlpha: "OPEC's Power to Influence Oil Price Slips Away"
  42. The Independent: "Oil continues to rise as Nigerian rebels attack Shell platform 120 miles offshore"
  43. BBC: " Oil hits $108 on pipeline blast"
  44. The Press Association: "World oil production falls"
  45. Forbes" "Economic Consequences Of Sky-Rocketing Oil"
  46. MarketWatch: "Is offshore drilling a viable solution to energy needs?"
  47. The Independent: "Saudi King: 'We will pump more oil'"
  48. WSJ: "Limits Put on Some Oil Contracts On ICE Amid Outcry Over Prices"
  49. The Wall Street Journal: "U.S. Military Launches Alternative-Fuel Push"
  50. The New York Times: "China Sharply Raises Energy Prices"
  51. Reuters: "Retail gasoline demand down vs year ago: MasterCard"
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