- Alternative
fuel. News from the area of renewable energy sources impacts the oil
market. Not only are the Governments looking to reduce their dependency on
non-renewable resources, but the consumers are also increasingly adopting
environment friendly options, such as solar energy, on the back of
technological advancement and government incentives. Greater acceptance for
other forms of fuel or development of more energy efficient equipment will
indeed reduce the demand for oil in the medium to long term.
Derivatives
The prices we see in the international markets are set on
the basis of crude oil futures. Different grades of crude oil are
differentiated by their sulfur content. Brent Crude and West Texas Intermediate
(WTI), both low sulfur grades, are the two international benchmarks denominated
in USD per barrel. The above demand/supply factors influence traders’ views on
potential future price movements and the market activity is directed
accordingly. However, not all futures trades are hedging transactions. Since
the market is largely controlled by big banks and hedge funds, industry
watchers believe that the bigger portion of it is speculation.
Brent
Extracted in the North Sea, Brent Crude is used as a pricing
base by most countries. It usually leads WTI and OPEC basket price, though the
gap has narrowed significantly over years. Before 2005, Brent was traded on the
International Petroleum Exchange, London through an open-outcry floor. These
days it trades electronically on Intercontinental Exchange (ICE), also in
London.
West Texas Intermediate
WTI is the benchmark for U.S. oil prices. Though it is
lighter than Brent, it is extracted from land sites and therefore more
expensive to transport. WTI is traded on New York Mercantile Exchange (NYMEX)
in Manhattan, which converted to electronic trading in 2006.
The Real-World Prices
When the near-term demand shows a potential to increase, the
big traders begin taking long (buy) positions in expectation of future price
increases, pushing the futures prices higher. As discussed above, these prices
are used to set the current rates. Therefore, any expected change in the demand
and supply has a magnified impact on the market, which is far from what is
warranted. Major institutions and oil producers, including OPEC, have admitted
that speculation is playing havoc with oil rates. The hedge funds and banks are
happier when volatility increases because that is how they book profits. According
to OPEC, “The stability that OPEC and other energy stakeholders seek is of no
help to them and severely limits their scope for gain.” An IMF Working Paper,
Oil Price Volatility and the Role of Speculation (2014), estimates that speculative
demand increase oil volatility by 10-35% in the short-term
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