When mentioning of oil market, why do we refer to the WTI Crude Price (NYMEX)

The West Texas Intermediate (WTI) crude is traded at the US’s NYMEX, which is considered to be the Futures Market. It is the world’s most liquid market and the largest futures market. The WTI crude price is quoted as the benchmark for many types of crude trading in the North America. 

Usually the prices of Brent crude, which are trade in European and African countries, and the Dubai crude, which is referred in the Middle Eastern and Asian countries, are aligned to the WTI prices. The Brent crude is cheaper than the WTI by USD 1-2 per barrel. Meanwhile, the Dubai crude has the lowest prices, or USD 2-3 cheaper than the WTI prices, since it has the lowest quality due to its high density and large proportion of fuel oil. However, sometimes WTI can be cheaper than Brent or Dubai crude if there is fluctuation of demand/supply in each region.

Why do we have to monitor the US economy and how it is affecting the oil prices?

Basically, crude oil prices are set by supply/demand in fundamentals. If the demand rises, the prices will be high. On the other hand, if there is a growth of supply, the prices will be decreased. The economic numbers is also another indicator for demand in the future. In other words, if the economic numbers show good signal it means that the economy is expanding. Therefore, the oil demand will rise. Usually, when the USA declares that the economic numbers are improved, the oil prices usually rise in the same day.

The numbers that are significant and have much effect on the crude prices include Gross Domestic Product (GDP), unemployment rate, retail sales, industrial production index, consumer confidence index as well as real estate index such as new housing development rate, etc.

Which factors are influential to the global oil price?

Factors that have effect on the oil prices can be categorized into 3 factors as follows:

1. Fundamentals which are demand and supply
1.1 Demand is the demand for crude (refineries) and demand for oil products (consumers). Normally the demand that is forecasted is the demand for oil products. The supply will align with the oil prices. Therefore, the price will be higher if the demand rises. When considering if the demand will rise or not, we consider from economic growth. The oil usage tends to rise when the economy is expanding. When the economy shrank, oil demand tends to drop accordingly.

1.2 Supply is quantity of oil including crude quantity (from oil fields) and quantity of oil products (refinery products). When declaring the oil supply, it refers to crude supply. The supply tends to contradict to the oil prices; the prices rise when the supply is decreased. To forecast the oil supply, it should be considered from oil production of the two major producers which are OPEC and Non-OPEC. Normally, the OPEC producer supply 35% of the global production capacity. The OPEC creates the balance between demand and supply in the market. For example, if there is a growth of crude supply of Non-OPEC producers, the OPEC producers will decrease their production capacity in order to prevent over-supply in the market, causing oil prices to drop.

Since the OPEC has important role in balancing quantity of crude in the market, therefore, the OPEC meetings, which are held in Vienna, Austria, are given much attention. In the meeting, the OPEC members make decision on crude production quota. The OPEC uses this opportunity to adjust the crude pricing to be at reasonable rate. For example, when the crude prices sharply dropped in the second half of 2008, in order to lower its over supply from the market OPEC decided to reduce its capacity for several times, resulting the decrease of 4.2 million barrels per day in total from its highest capacity in September 2008. The decreasing production quota significantly maintained the crude price at that moment.

1.3 Oil Inventories include crude oil inventories and petroleum product inventories. The US inventories are declared by the U.S. Energy Information Administration (EIA) every Wednesday directly influences the WTI crude prices. In addition, the European, Japanese and Singaporean inventories, which are large ones, also have effect on the crude prices and petroleum product prices in each region.

2. Financial/Investment flows: Financial/Investment flows are related to the global oil markets since nowadays oil trading are more like investment. Investors decide to invest in the markets that provide the highest return and sell or withdraw money from the market that gives lower return.

2.1 financial markets: Normally crude prices moves in the opposite direction to the US dollars. In other words, the crude prices rise when the US dollar is weakened. Factors influencing the weakening of US dollar can be analyzed as follows:
(1) Capital flow: Investors choose to invest in the markets they will gain highest return. Therefore, when the economy is in good condition, investors prefer to invest in high-risk assets for higher returns by selling US dollar since it is low risk asset and moving the investment to higher risk assets such as equity and oil. Consequently, the stock prices and oil prices are raised while the US dollars is weakened.
(2) Inflation risk management: Since the key factor leads to inflation growth is energy cost, mostly oil pricing, investors choose to invest in oil markets because they will gain more or as much as inflation. Thus, investment in oil then works as hedge against loss while investing in other assets when there is inflation growth might gives loss to net income.
(3) Producers’ point of view: Since the US dollars is the main currency for oil trading, when the dollar is weakened, oil producers will gain less from the same quantity of the trading. Therefore, they are willing to sell crude oil at higher prices to gain back the return, resulting the oil prices to be raised.
(4) Consumer’s point of view: Since the US dollars is the main currency in oil trading, if the dollar is weakened, consumers pay less for oil at the same amount. Therefore, the oil consumption will rise and the price is increased as a consequent.

2.2 Investment market: Usually crude prices go in the same direction with equity market (the major US equity market is Dow Jones Indexes). Since stock and oil are considered to be high-risk assets that give high return when economy is in excellence condition, when investors are confident in the economic growth they invest in high-risk assets more. Stock and oil trading gives higher return than other investment such as buying US dollar or government bond. In addition, energy shares are the majority in the equity market. When the crude price is increased, the energy stocks also rises along with the stock indexes.


3. Sentiment of the market: Nowadays, financial and investment flows are related to oil markets since oil is traded for investment more. Investors decide to invest at the markets that give the highest return by selling or withdrawing from the market that gives lower return.

The market sentiment or what we called psychological factors is another main factors affecting oil prices, especially in the past 1-2 years. Investors’ sentiment toward news or incidents as well as forecast of economic outlook, oil demand in the future, oil production for the market and conflicts between crude oil producer countries that might affect on oil production. These issues crucially have psychological effect on investors, causing them to invest more in order to speculate prices. Investors might be afraid that the issue will cause the oil prices to go up, consequently, they purchase oil in advance in order to sell when the prices rise later. As a result, the price is increased due to higher purchase power. On the other hand, if they issues are considered to cause supply more than demand, investors might sell oil because they believe that the prices will drop in the future so they immediately sell, resulting the prices to decrease. For example, in the world’s economic crisis in 2008, the oil prices significantly drop because investors worried that the global economic shrinkage would caused lower demand for oil. Therefore, they sold oil. However, in Q2 of 2009, the oil prices began to increase after the US economic number signal positivity. Investors then forecasted that the oil demand would grow since the US economy was improved (even though oil consumption of US was not in good condition at that time). Another example is when Iran threatened to fire missile or the US added more measures for boycotting Iran. This also suggested that Iran’s crude production would be affected from more severe conflict (even though Iran’s production capacity was at normal level at the moment).
Which institution declares the US oil inventories and how is it affect crude prices?

The US Energy Information Association (EIA), the US Department of Energy declares oil inventories as well as consumption rate, production, import/export rates of crude, gasoline, diesel, jet fuel and fuel oil of the US every Wednesday. In addition, the American Petroleum Institute (API) also announces inventory indexes every Tuesday evening after the NYMEX closes. Therefore, there will be no effect of closing prices of WTI crude price on Tuesday.

Reuters also gets views from analysts from various institutions every week and put all the information together to find the mean for crude, benzene and diesel. If the inventories declared by EIA are not the same number that is predicted, it will significantly affect on the crude prices. The more different they are, the more effect it will have on the prices. This is because the market has received information on the crude inventories forecast 1-2 days before the confirmed numbers are announced. Usually when the inventories are decreased, the prices will go up since the market concerns that there will be not enough supply for the demand. On the other hand, if the inventories are increased the oil price will drop since the market considers that there is over supply while the demand is decreased.

Sometimes we find that inventories of each type of oil are different. For example, when crude inventory increases more than it has been expected, normally the prices will drop. However, diesel inventor decreases more than it has been expected, the prices will be increased. In the case that there are differences in oil inventories, the prices will be up to investors’ decision based on what oil prices they put weight on. For example, in winter they gives attention to diesel inventory since there is high demand for diesel while there is high demand of gasoline in summer.
Which organizations play significant role in global oil market?

The US Energy Information Administration (EIA) is founded by Congress in 1977. It is an independent organization under the US Department of Energy. EIA’s key function is to collect data on energy, including demand, supply, distribution, prices, technology as well as economic and financial outlook. Its objectives are to forecast, analyze and suggests suitable energy policies as well as offering energy literacy and energy’s effect on economy and environment. It also publishes short-term and long-term oil market outlook report on the second Tuesday of every month. The report includes the global demand for oil and crude production number.
The International Energy Agency (IEA) was founded in 1974. Its headquarter is in Paris, France. It is the organization under the Organization for Economic Co-operation and Development (OECD). Initially, it was founded to prevent oil shortage for its members and offer statistics on oil and energy market. In addition IEA also works as consultant for its 28 member countries and non-members, especially China, India and Russia. The energy policies focus on energy security, economic development and environment conservation. IEA puts much attention on global warming issue, renewable energy and international technology collaboration.

Organization of Petroleum Exporting Countries (OPEC) is founded in 1960 by its 5 founding members including Saudi Arabia, Iraq, Iran, Kuwait and Venezuela. Later, 8 more countries joining the OPEC are United Arab Emirates, Qatar, Nigeria, Algeria, Libya, Indonesia, Ecuador and Angola. Currently there are total 12 member countries. OPEC headquarter is situated in Vienna, Austria. However, (Indonesia has left its member place in 2008 after it has changed its position form oil exporter to importer.) OPEC has crude production capacity of 29-30 million barrels per day (if excluding Iraq 0r OPEC-11, it produces 26.5 million barrels per day) or 35% of the global oil production capacity.

OPEC is founded to collaborate and unite international oil policy between its member countries. It focuses on maintaining the stability of oil prices for producing countries and supplying the consuming countries continually as well as maintain justified benefits for investors in oil business. Usually the meetings of OPEC leaders are held twice a year and the member countries must accept the resolution at the meeting.