Decoding The Myth Of Oil Pricing - With An Indian Perspective

Today, Oil has become a ‘Global’ commodity. The pricing of oil is critical to the world economy simply because it has a direct impact on the cost of transportation, cost of goods, essential commodities and services. A slight increase in price of Oil has a direct impact on all the related services and sectors and result in higher Inflation.

Is the pricing of oil simply determined by Supply - Demand factors and the rising cost price? What are the factors that determine the pricing of Oil?

Spot Prices, futures Market and Sentiments/Speculations

The price of the oil is actually set in the ‘oil futures market’. A ‘futures contract’ is basically established when a buyer purchases a ‘barrel’ of oil at a ‘predefined/ fixed’ price on a particular date. It is a contract between a buyer and a seller. The ‘spot price’ will be its value in US dollars at any given time in the market.

Speculators on the other hand would be just betting on the direction in which the prices would move. Market sentiments and speculation today play a vital role in the pricing of oil today. The latest speculation that the oil supplies through ‘Suez Canal’ might be disrupted due to the ongoing political unrest in ‘Egypt’ (Egypt controls the Suez Canal which connects Europe and Asia) has cause the oil prices to head north. WTI (Western Texas Intermediate) crude oil, the US benchmark crude has surged above $100 per barrel for the first time since April 2012.

Although there have been no signs of supply disruptions in Egypt, the
oil prices have increased based on such ‘speculations’.


Crude quality / type

The price may also vary based on the crude quality depending on factors such as API gravity and sulphur content.

Western Texas Intermediate is light crude (API gravity of 39.6) that is traded in New York Mercantile Exchange (NYMEX) and is one of the benchmark crudes that we have today.

Brent is also light sweet crude and is a combination of oils from 15 fields of Scottish Brent and Ninian Oil fields in the east Shetland basin of the North Sea.
Brent is considered a preferred ‘benchmark’ for oil prices when compared to WTI.

According the
OPEC monthly oil report, in 2012, the monthly trading volumes at ICE (Inter Continental Exchange)-Brent had been constantly above those of NYMEX –WTI and so the price of Brent over WTI.

OPEC Reference Basket (ORB) is a weighted average of prices of the different blends produced by the OPEC member countries.
The OPEC regulates the prices of ORB by varying its production levels.

Source: Monthly oil market report, OPEC

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