15 July 2015
If you’re new to the CSS Investments blog, please make sure you read our introduction post here to find out how this blog will help you become a better informed investor or trader.
The purpose of this blog is to introduce crude oil to you, all the basic need to know information, also to explain the concept of crude oil as a traded commodity and how it impacts companies share prices in the energy sector.
To warm us up I’d like to start off with an Interesting fact, Petroleum quite literally means rock oil from Medieval Latin. That should be a clue as to where crude oil comes from…
Crude Oil is a natural raw material that is found hundreds of feet beneath the surface of the earth in certain rock formations. This raw material is extracted from the earth via many techniques such as fracking, which is known to be extremely costly for oil mining companies. Not the most sustainable method, which adds pressure on oil mining companies.
The most common technique for extracting crude oil is using drilling wells into an underground reservoir. If you have seen the film ‘There will be blood’ with Daniel Day-Lewis, you should have a pretty good idea of what an oil well looks like.
Once it’s obtained the crude oil is refined into petroleum products; I’ll give you some examples of these products later on. According to the International Energy Agency the top producers of crude oil are the United States, Saudi Arabia and Russia, with the United Kingdom ranked 23rd on this list.
The top 10 producers of oil account for over 60% of the world’s oil production.
Crude Oil is typically refined into Petrol, Liquefied Petroleum Gas, Kerosene, Naphtha and Gas Oil. It is important to note at this point that there are different types of crude oil, such as light, heavy, sweet and sour. The preferred crude oil type is light sweet oil; it’s less dense and faster to process into petroleum products.
Crude oil is a commodity, so arguably the main factor that impacts the price of crude oil is supply and demand. Economics 101! If there is an oversupply of crude oil and less demand the price will decrease. This will have a direct effect on the price of the petrol that you pump into your cars as it’s a byproduct of crude oil.
Unfortunately it’s not as simple as only looking at supply and demand, crude oil can spike up in price off the back of multiple factors. Examples include political news, any unrest in oil producing regions such as the Middle East. Arab’s are one of the main oil producers in world. Other factors can be economic growth in developing countries, such as China’s manufacturing growth.
Several factors affect the price of oil, which investors could consider when looking at companies. Such as supply and demand, political news, territorial conflicts, economic and manufacturing growth and levels of consumption.
The most important report that affects the price is the Crude Oil Inventories Report that is released at 3:30pm every Wednesday. This tells the world the change in the number of barrels of crude oil held in inventory by commercial firms during the past week in America.
This number influences the price of petroleum products which affects inflation, but also impacts growth as many industries rely on oil to produce goods.
Economists tend to say that oil demand is firm, this means that a small drop in production can cause price to skyrocket. Indeed, in the 1970’s‘oil shock’, a production drop of 25% caused oil price to jump 400%. So clearly peak oil spells trouble for the world’s economy. History tends to repeat itself, so should we watch this space?!
Crude oil is sold per barrel:
You will notice that more litres have been produced from the 159 litres of crude oil per barrel. This difference is due to the processing of crude oil into products which, in total, have a lower specific gravity than the crude oil processed.
Scientists and oilmen are concerned about the amount of crude oil produced over time and the amount of crude oil still in the ground, that can potentially be extracted in the future. The Peak Theory discusses this and potential dramatic outcomes to production levels and price over the next 50 years.
The cost of production would begin to go up as crude oil becomes scarcer, at the same time the world’s population is continuing to grow thus requiring even more crude oil.
I cannot stress this enough, any price increase of crude oil is not a guarantee that oil company shares will also rise. There have been many occasions in the past that have seen the price of crude oil increase. Some oil shares have enjoyed a positive correlation with this, while others have failed to benefit immediately from the increase..
For example BP has had a 11.7% rise in share price to 426.85 since January 15th when it was valued at 382.15. Suggesting that the UK100’s oil majors are benefiting from the crude come back. However this hasn’t helped Royal Dutch Shell whose share price has stalled in recent months.
Both producers have been hit hard by last year’s halving of the oil price, with Q1 revenues down 57% and 56% respectively.
The one thing that is agreed upon in almost every brokerage firm is that there will be an increasing demand for commodities as they become more and more scarce in the future and the populations grow. This will be seen in changes in price of everything from crude oil to the coffee in your Starbucks.
The importance of understanding the intricate details as to why these two oil companies have fared differently I leave up to your stockbroker and your own due diligence.
I hope this brief overview on crude oil has helped you understand the basics and how the price can potentially be a factor when investing into individual energy companies. It is always important to consider what is happening to crude oil, the supply and demand situation and future potential factors that could affect this.
Especially as many companies success and profits have a relationship with the price of crude oil.
Do note that the higher the prices of crude oil the higher the prices of petroleum products become as a general rule which will increase oil company’s revenue.
Many believe crude oil will be replaced by an alternative energy source as crude oil is not a sustainable energy. We are already adapting to this eventuality. Seen in terms of the way in which we are investing into new technologies, such as the electric car and solar energy. We certainly have a long way to go but we find ourselves in an interesting time.
If you’re new to the CSS Investments blog, please make sure you read our introduction post here to find out how this blog will help you become a better informed investor or trader.