United States: How Are Oil Prices Set And Why Are They Falling Fast?

Last Updated: February 20 2015
Article by Karen J. Anspaugh

The price point at which crude oil is traded internationally is fixed predominantly by the Brent Crude Oil, West Texas Intermediate Crude Oil and Dubai/Oman Crude Oil benchmarks. As of December 15, 2014, rates are as follows:

  • Brent Crude Oil $61.85
  • West Texas Intermediate Crude Oil $57.81
  • Dubai/Oman Crude Oil $60.19

Source: http://www.businessinsider.com/oil-price-charts-2014-12

The Brent Crude Oil standard is used in Europe, the Mediterranean, Africa, Australia and some areas of Asia and is the most common global price index. This benchmark relates to light, sweet crude generated from 15 oil fields located in the North Sea.

The West Texas Intermediate Crude Oil standard is used in the United States and also relates to light, sweet crude; however, it is lighter and of higher quality than Brent Crude Oil. The West Texas Intermediate Crude Oil price is set in Cushing, Oklahoma, which has the largest storage capacity in the country and serves as the point of delivery of New York Mercantile Exchange futures contracts. This benchmark is also applied to crude oil imported into the United States from Canada, Mexico, and South America.

The Dubai/Oman Crude Oil standard is used by Saudi Aramco, Saudi Arabia's state-owned oil company, and relates to medium and sour crude produced in the Middle East. This benchmark is applied to crude oil exported from the Middle East to China and Asia.

What Drives Oil Prices?

Source: http://www.bloombergview.com/quicktake/oil-prices

#1) Supply and Demand:

Global crude oil demand trends are driven largely by economics. Economic downturns around the world result in reduced oil consumption, which causes crude oil benchmarks to fall. Global crude oil supply trends were historically dominated by the Organization of Petroleum Exporting Countries (OPEC), which was founded in 1960 by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. These initial member countries were later joined by Algeria, Angola, Ecuador, Libya, Nigeria, Qatar and the United Arab Emirates. OPEC meets in March and September annually to evaluate global economics and crude oil demand and to set their price and production levels in accordance.

Price point dynamics have recently been altered by increased production in the United States. According to the U.S. Energy Information Administration (EIA), the United States is the world's largest producer of natural gas and produces more oil than any other country except Saudi Arabia. The chart below compares oil production in the United States, Russia and Saudi Arabia from 2009 to 2013.

Source: http://www.eia.gov/countries/cab.cfm?fips=SA

At a conference held on November 27, 2014, OPEC voted not to reduce oil production levels generated by member countries despite an already significant drop in crude oil benchmark prices. OPEC states on its website that increased production by non-OPEC countries was a causal factor (http://www.opec.org/opec_web/en/press_room/2938.htm):

The Conference reviewed the oil market outlook, as presented by the Secretary General, in particular supply/demand projections for the first, second, third and fourth quarters of 2015, with emphasis on the first half of the year. The Conference also considered forecasts for the world economic outlook and noted that the global economic recovery was continuing, albeit very slowly and unevenly spread, with growth forecast at 3.2% for 2014 and 3.6% for 2015. The Conference also noted, importantly, that, although world oil demand is forecast to increase during the year 2015, this will, yet again, be offset by the projected increase of 1.36 mb/d in non-OPEC supply.

#2) Technological Advances:

Utilizing recent technological and engineering advances, oil producers in the United States have successfully combined multilateral horizontal drilling techniques with high pressure, high volume, multi-stage, slick-water fracking to recover resources from geologic formations known as "unconventional resources" that were formerly uneconomic. Unconventional resources are characterized by low shale and rock porosity. Few connected pathways exist, causing low permeability and low flow rates. Fracking connects existing porous spaces and fissures to allow the migration of oil and gas to the wellbore.

Further, depths that were previously out of reach are now in production, as wells reaching 10,000 feet and greater are routinely drilled. The multilateral horizontal wellbore illustration below depicts a wellbore that "kicks out" at the "heel" of the well to allow the majority of the wellbore to run horizontally through the producing layer. This technological advance increases contact with the payzone and thereby increases production.

Source: http://images.pennwellnet.com/ogj/images/ogj2/9611jta02.gif

Two thirds of global oil and gas reserves yet to be drilled are located in unconventional resources while conventional oil and gas comprise only 31% of global supply.

Source: http://www.cgg.com/default.aspx?cid=3501

#3) Futures:

As a method to mitigate the detrimental impact of benchmark price fluctuations, oil producers frequently participate in contracts that set the purchase price applicable to future production. If the Brent, West Texas Intermediate or Dubai/Oman benchmark standards drop below the price agreed upon in the futures contract, producers respond by withholding production from the market. Decreasing the crude oil supply eventually depletes inventories and benchmark prices thereafter rebound.

#4) Politics:

An example of the impact of politics upon the price of oil is OPEC's embargo against the United States in 1973, which was driven by our support of Israel. The ensuing lack of supply caused a significant rise in oil prices. At present, energy analysts speculate that Saudi Arabia's move to cut oil prices rather than to decrease production was intended to damage its competitors and adversaries such as Russia, Iran and the United States' booming shale oil industry.

What are the Ramifications of Dropping Oil Prices?

Ambrose Evans-Pritchard states in an article published in The Telegraph on December 9, 2014, ( http://www.telegraph.co.uk/finance/oilprices/11283875/Bank-of-America-sees-50-oil-as-Opec-dies.html) that OPEC's vote on November 27, 2014, reflects their weakened position:

The OPEC oil cartel no longer exists in any meaningful sense and crude prices will slump to $50 a barrel over the coming months as market forces shake out the weakest producers, Bank of America has warned.

Francisco Blanch, the bank's commodity chief, said OPEC is "effectively dissolved" after it failed to stabilize prices at its last meeting. "The consequences are profound and long-lasting."

The free market will now set the global cost of oil, leading to a new era of wild price swings and disorderly trading that benefits only the Mid-East petro-states with [the] deepest pockets such as Saudi Arabia. If so, the weaker peripheral members such as Venezuela and Nigeria are being thrown to the wolves.

The bank said in its year-end report that at least 15% of US shale producers are losing money at current prices, and more than half will be under water if US crude falls below $55.

It will take six months or so to whittle away the 1 [million] barrels a day of excess oil on the market – with US crude falling to $50 - given that supply and demand are both "inelastic" in the short-run. That will create the beginnings of the next shortage. "We expect a pretty sharp rebound to the high $80s or even $90 in the second half of next year," said Sabine Schels, the bank's energy expert.

John Kehoe states in an article published in The Financial Review on December 2, 2014, (http://www.afr.com/p/markets/citi_calls_bottom_on_oil_price_collapse_FWNyXRiYLzgEBtrsyof2WL) that Citigroup analyst Tom Fitzpatrick concluded that oil producers in the United States can tolerate a drop in crude prices as low as $50 per barrel before ceasing production. Kehoe references "revolutionary new fracking and horizontal drilling techniques" that have "unleashed a wave of new oil on to the energy market" and further states:

The US pumped out 8.8 million barrels of oil per day in September, 56 percent higher than in 2011. At the same time, the traditional suppliers of oil in the Middle East have maintained pumping too. The Organization of the Petroleum Exporting Countries surprised markets last week when it refused to cut production to support prices. In previous price troughs, Saudi Arabia has stabilized prices by trimming production. By keeping up supply, Saudi Arabia is believed to be trying to eliminate higher-cost US producers in the Bakken shale area in North Dakota and oil fields in Texas.

In summary, the ability of the United States to increase oil production by tapping unconventional resources has influenced crude oil benchmark prices as well as national and worldwide markets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.