Lecture Notes 3: Oil and Gas Marketing PDF

Lecture Notes 3: Oil and Gas Marketing Dr Jonathan Atuquaye Quaye Department of Petroleum Engineering College of Engineering KNUST, Kumasi. Email: [email protected]  Oil and Gas Marketing ❑ Marketing is the most complex sector of the world oil industry. ❑ Oil marketing...

Lecture Notes 3: Oil and Gas Marketing Dr Jonathan Atuquaye Quaye Department of Petroleum Engineering College of Engineering KNUST, Kumasi. Email: [email protected]  Oil and Gas Marketing ❑ Marketing is the most complex sector of the world oil industry. ❑ Oil marketing may be viewed in many ways, including wholesale markets, in which large sales are made to sellers of small volumes, and versus retail markets, which sell to final consumers. ❑ Sometimes sales are on a spot or single-sale basis and sometimes on short- or long-term contracts. ❑ There are also differences between crude oil and oil product markets.  Oil and Gas Marketing ❑ Historically, until the early 1970s, crude oil was marketed through integrated company systems. ❑ Sometimes producing/refining companies would exchange oil, usually on a barrel-for-barrel basis. ❑ Some crude oil, around 5 per cent, was sold by producers through spot markets to refiners. ❑ This situation is now changed. Most of the world’s equity crude has disappeared from the market, largely as a result of the nationalization of the assets of most major oil producers.  Oil and Gas Marketing ❑ Although the traditional concessionary companies have retained preferred access to crude oil through service contracts, the amount of oil traded on a spot basis has increased to above 50 per cent. ❑ This trend has been accentuated by the development of formal oil exchange markets such as New York, London, Hong Kong, and Dubai. ❑ In recent years oil exchange markets allow for movement away from physical crude oil markets to paper markets which consist of futures, Options, and forwards.  Oil and Gas Marketing ❑ Such movement has increased market speculation and price volatility rather than the fundamentals of the supply and demand forces. ❑ Marketing was relatively simple for oil products in the past. There were essentially three main products: motor gasoline, heating oil, and heavy oil. ❑ Motor gasoline markets were, and remain, the most fragmented among the world’s oil products. ❑ In the United States, which consumes about half of the world’s gasoline supply, private service stations tend to be the main marketing distributors.  Oil and Gas Marketing ❑ In the rest of the world, major private or government companies own the outlets. ❑ However, company- or government-owned service stations tend not to compete on a price basis, but on advertising and locational advantages. ❑ For the middle distillates, mainly heating oil, diesel fuel, and aviation jet fuel, the situation is more complex. ❑ For heating oil, competition is less among suppliers, which implies less emphasis on advertising and brand identification.  Oil and Gas Marketing ❑ Diesel fuel sale, however, is mostly for trucks and other heavy equipment such as railroad engines, construction equipment, and marine diesel engines. ❑ Because sales tend to be in larger volume than for motor gasoline, marketing relies on price differentials. ❑ Aviation fuel tends to be an especially profitable marketing area. *This is due to the large volume involved and requirements for high-quality product. ❑ Heavy fuel oil is mainly used for electric power generation.  Oil and Gas Marketing ❑ It is always sold on a wholesale basis, often under long-term contracts, with prices related to the prices of coal and natural gas. ❑ Oil product pricing generally depends on crude oil price and the quality of crude in terms of sulfur content and density. ❑ The high quality of crude yields higher-value products which increases the refinery margins given the refinery process and configuration. ❑ However, beyond supply and demand, product pricing is affected by the degree of market competition, the way oil products are traded in the financial markets, and the government’s regulations.  Oil and Gas Market Structures ❑ Here we provide a general review of the industrial structure of world oil and gas markets to explain the forces that shape the oil and gas industry and influence pricing. Structure of the Oil Industry ❑ Before World War I, the world oil market was dominated by four major international oil companies: Shell, Standard Oil, Nobel, and Rothschild. ❑ The latter two companies were in Russia and were liquidated as private companies by the 1917 Russian Revolution.  Oil and Gas Market Structures ❑ Another major company, founded by the British government, was the Anglo-Persian Company (now British Petroleum) ❑ In the 1920s, the oil market was essentially controlled by these three companies. In the 1930s, new major oil companies developed as offshoots ❑ of the old Standard Oil Company. They were Gulf, Texaco, Standard of California, Sohio, and Mobil. ❑ With these new entrants, the degree of competition in the world oil market increased, but only to a certain extent.  Oil and Gas Market Structures ❑ In the 1940s and 1950s, the seven sisters (Gulf, Texaco, Standard of California, Sohio, Mobil, British Petroleum, and Shell) had balanced the supply and demand mainly by market-sharing and joint producing agreements. ❑ To some extent, these agreements distorted world market competition, resulting in an oligopoly market structure characterized by substantial differences between production cost and market price. ❑ The deviation of oil prices from production costs allowed for vertical integration and controlling the market all the way from exploration to marketing.  Oil and Gas Market Structures ❑ The share of the major oil companies in world oil production refining and marketing was about 60 per cent. ❑ This concentration ratio, which indicates the degree of competition in the world oil market, has declined dramatically, especially in the production sector. ❑ This is due to the increased participation of oil-producing countries in production and to the evolution of the national oil companies. ❑ It is clear that the market power of the majors has reduced, yet they still control around 25 percent of world oil refining and about 35 percent of marketing activity.  Oil and Gas Market Structures ❑ In the early 1980s, spot and future markets were widely used at the same time. This led OPEC members to follow market-based pricing systems. ❑ In February 1987, OPEC effectively terminated market-priced sales, and oil prices tended to stabilize around a target price of $18/bbl as OPEC’s reference basket price or oil-pricing benchmark. ❑ The market-based pricing system was enhanced by the development of derivative instruments such as forwards, futures options, and swaps. ❑ Trading oil became either through paper markets, where deals are futures and swaps, or physical oil trading through spot market and long-term contracts, where the price of a cargo in long-term contracts is linked to spot price.  Oil and Gas Market Structures Oil Products Pricing ❑ In principle and to a large extent, prices for oil products can be regarded as reflecting the economic value added in the chain from production to marketing. ❑ Product prices are linked to crude prices through the full-barrel refiner’s margin, which can be considered as value added in the processing of crude oil.  Oil and Gas Market Structures ❑ There have been at least three markets for oil products: spot sales, term contracts, and wholesale transactions. ❑ In oil surplus situations, which characterize the world oil market except for supply crises of 1972–1974 and 1978–1981, spot sales tend to command the lowest markup over crude oil costs and wholesale transactions the highest. ❑ Term contract sales, however, justify some discounting for outlet security, and therefore fall between wholesale and spot sales.  Oil and Gas Market Structures ❑ Individual product value-added in refining varies among different products. It also varies among market areas and over time. ❑ These variations require refiners to be competitive even during periods of supply surplus. ❑ Government regulations and different oil product pricing schemes in different countries are affecting the oil products market. ❑ As far as the market structure is concerned, spot and futures markets have been widely developed for oil product trading and transactions.  Oil and Gas Market Structures Structure of the Gas Industry ❑ In the United States, the gas industry has been regulated since the beginning of gas discovery. ❑ From time to time, such regulation created a supply shortage. However, in competitive markets, the price of natural gas reflects the interaction between the demand and supply, which are inelastic with respect to price in the short run. *Inelastic refers to the static quantity of a good or service when its price changes. Inelastic demand means that when the price of a good or service goes up, consumers' buying habits stay about the same, and when the price goes down, consumers' buying habits also remain unchanged.  Oil and Gas Market Structures ❑ This market structure was enhanced by the drop in natural gas prices because of the decline in demand for natural gas as a result of the 1970s energy crisis and energy conservation policies. ❑ This allowed for direct deals between suppliers and buyers, which opened the door for natural gas spot markets. ❑ With more fluctuations in natural gas prices, the futures market for natural gas has developed. ❑ The New York Mercantile Exchange (NYMEX) became the trading floor for short- and long-term futures contracts.  Oil and Gas Market Structures Summary and Conclusion ❑ The main sectors of the oil industry have been reviewed and it has been shown that high oil prices stimulate more investment in exploration. ❑ The exploration and development stage has been shown to be part of the overall production operation in the oil industry. ❑ Because of the high fixed cost of exploration and development, the oil industry tends to be a increasing cost industry. ❑ Crude oil has to go through refining processes to convert it into a useful finished product. Refining facilities are located mainly near the consuming areas.  Oil and Gas Market Structures ❑ Crude oil and oil products have in the past been marketed quite differently than they are today. ❑ With the increased fragmentation of the oil industry, crude oil marketing is becoming more like product marketing of the past. ❑ This has been encouraged by the emergence of official exchanges in major oil trading centers. ❑ Until the early 1970s, the world oil market was controlled by the major international oil companies.  Oil and Gas Market Structures ❑ Oil producers’ participation in the world oil industry started with the formation of OPEC in 1960, and oil pricing mechanisms have changed accordingly. ❑ Oil prices were previously posted by the majors, but after 1973 official OPEC prices emerged. ❑ In the early 1980s, spot and future markets were widely used in the face of price volatility. ❑ Natural gas consumption has increased over the past 30 years as a result of its economic and environmental advantages.  Oil and Gas Market Structures ❑ The natural gas industry has been regulated in the United States except for periods when the demand is low, which allows for spot and futures market deals. ❑ Outside the United States, natural gas prices are linked to oil prices through long-term contracts.