So far 2008 has been a significant year for the oil industry:
- Shell, the Anglo-Dutch oil giant, recently announced the highest ever profit for a UK company (and a European company for that matter) of £13.9bn.
- Exxon Mobil, produced the highest profit for any company anywhere - $40.6bn.
- The oil price peaked at an all-time high of $100 a barrel.
These events follow hot on the heels of PetroChina - the state-sponsored Chinese oil company - becoming the largest company in the world measured by market capitalisation - and the first to be worth $1 trillion - and BP, the largest British company by market capitalisation ousting its long-term CEO, John Browne.
The rising price of oil has been cited as the major cause of cost inflation throughout the world - requiring Central Banks to raise interest rates as an antidote right at the time when there is demand for them to be lowered to reinvigorate the economy in the wake of the credit crunch.
And concerns over the security of oil have been cited as the true reason for war in Iraq - the Americans invading to protect their supply.
Oil is literally the fuel for the world economy and therefore has a major bearing on the climate for the City, and, in turn, graduate recruitment.
So why are oil prices currently so high?
Prices have always been known to fluctuate- typically between $30 and $60 a barrel during the post-war era. Yet the last decade has demonstrated a steady rise in crude oil prices. Over the last two years this trend has be exacerbated with prices doubling in dollar terms since 2006.
The reason behind this historical anomaly can be whittled down to simple economics: increasing demand and decreasing supply equals high prices.
Demand Factors - Oil's Well
Demand for oil has never been so high.
Much of this increased demand is linked to the growing needs for energy from the developing world.
The last two decades have witnessed the economic em ergence of previously under-industrialised nations. The rapid industrialisation of countries such as China and India is a necessary step if these nations are to catch up with their western counterparts on an economic level but is only made possible when fuelled by the necessary commodities: metals, gas, minerals and oil.
Nowhere is this more evident than in China whose oil consumption doubled between 1996 and 2006 as it undergoes a period of aggressive economic and industrial growth.
Having been a largely self-sustaining economy up until the end of the last century with little need for importing commodities, China now finds itself as the second largest consumer of oil in global terms, consuming almost twice the amount of oil it is able to produce (see Charts A and B).
Though the United States is still a long way ahead in its consumption - devouring 25% of all oil produced around the globe to China's 8.5% - the gap is steadily narrowing as China's industry develops and increasing numbers of its 1.4 billion citizens look to adopt a 'western' lifestyle- driving cars, heating their homes and travelling by aircraft.
Such is the rise of the developing world that economists predict that worldwide demand will increase by a further 37% by 2030.
Supply Factors - Oil Barren?
But, worryingly, supply is struggling to keep up with such voracious demand. While oil reserves are far from running out, the greater majority oil producing nations are thought to have surpassed their point of 'peak production'(see Chart C), meaning that the number of barrels of oil produced per day is only set to decrease as time goes on.
Furthermore, in many cases it is becoming increasingly difficult and less economical to extract and produce crude oil. Many of the world's known reserves, particularly those in Russia and Canada, lie in areas which are largely inaccessible due to geographical conditions and harsh climate which combine to render the process of extracting oil and transporting it difficult and expensive.
As such, Shell's increased profitability over 2007 can be counterbalanced by the fact that during the same 12 months its production levels fell by 4.5%.
BP, the World's fourth largest oil company, saw its profits fall by 22% during the same period, largely due to the rising cost of production.
Whilst new sources of oil continue to be found and previously low-scale producers such as Nigeria and Angola have dramatically increased levels of production in recent years, various factors have contributed to crude oil becoming an increasingly scarce and hence valuable commodity.
The amount of oil available on the market is strictly controlled by governments and international agencies, amongst them OPEC, a collaboration of Middle Eastern, African and South American oil producing nations who look to safeguard their future income from oil production by limiting the supply made available to consuming nations.
Fundamentals vs Speculation
The forces described above are real - ie they represent fundamentals - real demand and real supply of actual oil stocks. However, there is a second array of forces - speculation by traders - which also have a major bearing on oil prices.
Traders anticipate fundamentals and anticipate other traders' actions too. They exploit imbalances between different prices and forecast where they think the oil price will be in the future.
If they think the market price of oil will rise in the future, they will take a position - buying actual stocks or more likely a futures or options contract.
The volume of speculation in world markets has a huge bearing on the price of oil paid by manufacturers and consumers.
Political Factors: There has been Blood
Political factors are also having an increasingly significant factor in the rising price of oil. Major events such as the Iraq war, political instability and humanitarian crises have all had an influence on prices over the years, creating nervousness over the level of production and driving up costs. The correlation between political troubles and oil prices has been well document.
Twice during the course of the 1970's, for example, the price of crude oil reached an 'all-time high'- first in 1973 when the then predominantly Arabic members of OPEC ceased all supply to the US and Western Europe in protest over their support of Israel in the Yom Kippur War (Israel's conflict with Syria and Egypt); and again in 1979 when prices rose from $15 to $39 per barrel within the space of twelve months following the onset of the Iranian revolution.
Recent troubles in many oil-producing nations in Africa the Middle East has provoked similar fears over future level of production. Events such as the assassination of former Pakistani Prime Minister Benazir Bhutto, outbreaks of violence in Nigeria and Algeria, and western suspicion towards Iran have sent ripples of uncertainty across the globe, creating anxiety amongst financial analysts as to future supply. The end result of this has been inflated oil prices.
Outlook for the future
However, much of this anxiety may be speculative. Saudi Arabia, like Iran, is an Islamic theocracy regarded with suspicion by Western nations, and having remained a stable environment for oil production since the discovery of reserves in 1938 continues to rank as the world's largest producer.
Whether the world is truly undergoing a genuine 'oil crisis' comparable to those of the 1970s is subjective.
Oil is a volatile and unpredictable commodity, as susceptible to economic and political changes as it is a contributor to them. Previous decades have experienced far greater shortages and with it inflated prices, only for these to return to more constant levels.
One, more optimistic view is that the opposing forces of supply and demand should be enough to prevent prices from spiralling out of control if they haven't done so already. The members of OPEC, through limiting supply have undoubtedly benefiting economically from robust prices, yet they are equally wary not to let oil prices rises to a level where they would provoke a major global recession which in turn would lower demand and prices, halting growth.
As such, many economists predict that oil prices will recede to more sustainable levels both as supply is increased and alternative sources of energy such as bio-fuels become more widely available, reducing the West's dependence on foreign oil production.
Nevertheless, fear and speculation over the state of oil supply is one factor that can always be counted on. As long as world population growth shows no sign of slowing down and poorer nations seek to develop there will be demand for energy and for oil. How long the planet can keep producing oil at the levels required, however, is anyone's guess.
The Language of Oil
OPEC - formed in 1960 - the Organization of the Petroleum Exporting Countries. Made up of Algeria, Angola, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, Venezuela, and Ecuador.
WTI - (West Texas Intermediate) - a type of crude oil used as a benchmark in oil pricing and the underlying commodity of New York Mercantile Exchange's oil futures contracts.
Brent Crude - Brent Crude is one of the major classifications of oil consisting of Brent Crude, Brent Sweet Light Crude, Oseberg and Forties. Brent Crude is sourced from the North Sea and is an inferior grade to WTI.
"Upstream" - the upstream oil sector is a term commonly used to refer to the searching for and the recovery and production of crude oil and natural gas.
"Downstream" - the downstream sector includes oil refineries, petrochemical plants, petroleum product distribution, retail outlets and natural gas distribution companies. The downstream industry touches consumers through thousands of products such as gasoline, diesel, jet fuel, heating oil, asphalt, lubricants, synthetic rubber, plastics, fertilizers, antifreeze, pesticides, pharmaceuticals, natural gas and propane.
Oil discovery peaked in the 1960s - today we use 4 barrels of oil for every one we find.
One barrel of oil is the result of 20,000 man hours of labour.
Oil demand increases by 2% a year, doubling total global consumption every 35 years.
More oil has been used in the last 35 years than in the rest of human history before it.
The United States is estimated to have reached its point of 'peak' oil production in 1970, some 38 years ago!
Oil Companies in the Spotlight
- worth $220 billion. Recently announced record profits for a European company, but had to revalue its reserves. Ango-Dutch conglomerate.
- worth $480 billion. The most profitable company ever. Operates under the brand 'Esso' in the UK - a throwback to the founding of Standard Oil ie "S.O.".
- worth $205 billion. Recently announced a 22% drop in profits. Ousted long-term CEO John Browne in 2007 after a sex scandal, appointing Tony Hayward to succeed him.
- the state-sponsored oil and gas company of Russia. Alleged to be involved in a wider political game for control of European energy, and of using its economic power to exert Russian political influence.
- the largest company in the world, measured by market capitalisation, worth over $1 trillion, although only 15% of its shares are floated on the (overvalued?) Chinese stock exchange.
Chart A - Top Oil Producers
Barrels produced per day
1 Saudi Arabia 9,475,000
2 Russia 9,400,000
3 United States 7,610,000
4 Iran 3,979,000
5 China 3,631,000
6 Mexico 3,420,000
7 Norway 3,220,000
8 Canada 3,135,000
9 Venezuela 3,081,000
10 UAE 2,540,000
Chart B - Top Oil Consumers
Barrels consumed per day
1 United States 20,730,000
2 China 6,534,000
3 Japan 5,578,000
4 Germany 2,650,000
5 Russia 2,500,000
6 India 2,450,000
7 Canada 2,294,000
8 Korea, South 2,149,000
9 Brazil 2,100,000
10 France 1,970,000
Chart C - Year of Peak Oil Production
Saudi Arabia 2014
How do you value an oil company?
What factors drive the oil price?
What is the difference between fundamental and technical trends in charting the oil price?
What is the importance of oil in the global economy?
Why did Shell and BP recently announce widely different financial results?
What is the outlook for oil?
Why aren't oil companies even more profitable, given the sky-high price of oil?
What is the difference between "upstream" and "downstream"?
How has Gazprom used its economic power for political ends?
- Why could it be argued that PetroChina is overvalued?
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