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
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Goldin Peiser & Peiser, LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Goldin Peiser & Peiser, LLP
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions