Understanding oil prices

DPI, Guyana, Sunday January 18, 2020

Oil prices across the globe are unpredictable as it is prone to wild “boom and bust” swings.  With Guyana being a new comer on the petroleum market, it is imperative to know and understand the way the markets work and what influences the fluctuation in prices.

As such, the Centre for Local Business Development has launched a “Join the Conversation” series which is designed to provide local access to leading experts and international perspectives on the oil & gas industry. On Thursday, the centre’s inaugural session hosted world-renown author and energy markets expert, Robert McNally.

McNally has over 29 years in the petroleum industry. He has served on the White House staff as Special Assistant to President George W. Bush on the National Economic Council and Senior Director for International Energy on the National Security Council and is founder and president of the Rapidan Energy Group. The energy expert recently authored the award-winning book Crude Volatility: The History and the Future of Boom-Bust Oil Prices (2017).

According to McNally, oil is considered to be the “lifeblood of modern civilisation.”

“Oil will remain the primary fuel for powering the movement of people and goods on the ground, in the air, and at sea for the foreseeable future. Along with its other crucial uses, including heating, power generation, and as a feedstock for petrochemicals,” the oil expert wrote in his discussion paper January 2020, “The Challenge of Managing Boom and Bust Oil Prices in the Global Oil Market”.

He notes that one of the two major circumstances which influence the industry is the new era of price volatility that stems from the lack of swing producer who can help manage supply and demand imbalances. This means, there is a lack of oil producing nations capable of offsetting possible global shortage of oil supplies in the world’s growing demand for energy. Currently, the kingdom of Saudi Arabia is the only swing producer that has the spare capacity to stabilize oil markets.

With Guyana being one of the newest oil producers, it has already registered on the Organization of the Petroleum Exporting Countries (OPEC) market screen as a potential swing producer.

OPEC is an intergovernmental Organization, formed in Baghdad in September, 1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Its headquarters is in Vienna, Austria. The objective is to co-ordinate and unify petroleum policies among Member Countries, in order “to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.”

Price Stability

McNally described the fluctuation of oil prices as a rollercoaster ride and in his discussion paper, he attributes this to the destabilisation of investment planning which contributes to economic uncertainty.

According to him, history has shown that to limit this cycled is through a “swing producer who is able and willing to adjust production quickly and, if necessary, for a long period of time to prevent supply-demand imbalances that would otherwise trigger harmful price instability.”

He opined in this regard, OPEC Plus (a selection of other oil-producing countries such as Russia that have agreed to coordinate production with OPEC), “plays a good role in the economy.”

“The only thing worse than OPEC Plus managing the oil market, is OPEC Plus not managing the oil market because then, you get these wild swings in crude oil prices,” the oil expert stated during the media engagement. As such, Guyana will have an interest in OPEC Plus succeeding.

“Broadly speaking, if OPEC Plus succeeds year after year after year at managing the oil market, the we can be reasonability confident that oil prices will maybe range between $50 USD and $70 USD. There will always be an occasional spike because of a war or recession but everybody meaning the oil companies, the Guyanese Finance ministry can expect that the price of oil with be somehow stable then we can base our revenues.”

Price Determination

Unlike the majority of consumer products, crude prices are not solely determined by supply and demand. While it is also determined base future supply and demand trends and the geopolitical influences which contributes to this, like any product, it is determined by the quality of the crude.

McNally explained that in the industry, there are many different grades of crude. These are characterised by their weight (heavy and light) and by their sulphur content.  Generally, heavier crude oil has a higher sulphur content and is less valuable.

This is because the sulphur components which exist are unfavourable in the refining process. It can also cause erosion problems in the pipelines, pumping, and refining equipment.

“When you put that (heavy crude) through a refinery, you get less valuable products like asphalt and until recently, marine fuel for the big ocean going ships,” the oil expert described.

As such, the more valuable crudes are those that are lighter (medium to light) which have a lower sulphur component.

Another influencing factor in determining the price of crude is how hard is it to produce. For example, neighbouring Venezuela, there is a manufacturing process of extracting crude from mud by “steaming the oil out of it and cleaning it up”.  Where as Liza-1, Guyana’s first operational well, the process is much simpler. The oil is extracted from the ground with the use of the Floating Production, Storage and Offloading (FPSO) vessel, the Liza Destiny and is loaded on to tankers once it is sold.

McNally remarked that “Guyana is enormously fortunate not only that is has found an enormous quantity of crude but the quality is superb.”  He highlighted that presently and, in the future, the most valuable crude is “medium grade”.

‘Guyana’s crude is medium…medium grades tend to produce some very valuable products what we call middle distillates.”  These include jet fuel, heating kerosene, and gas and diesel oils. Due to new international marine laws, ships are required to use marine gas oil which are cleaner and lighter.

“Guyanese oil is not only a middle rich crude, but it is naturally low sulphur,” which means the value of Guyanese crude will be relatively higher as it does not require a complex refining process.