Crude, Cutthroat Competition

What is crude oil? Crude oil is a raw, natural, unrefined petroleum made up of hydrocarbon deposits and organic materials. It’s used as a base for diesel, petrol, and other petrochemicals that you may see at your local gas station.

There are many ways for producers to differentiate themselves from one another. Usually, the method of competition is chosen based on what the good or service is in question and what type of market it’s sold in (e.g. perfect competition). There’s also non-price competition where producers compete with one another by promoting what distinguishes their product from their competitor’s. 

Price-competition is distinctive of goods that are similar if not the same. Since there’s no “distinguishing” characteristic of crude oil (i.e. quality, workmanship), the best way to become a market leader (in terms of revenue/sales) is to push price as far down as possible to attract all buyers, leaving your competitors with zero. 

With high barriers to enter and therefore a small number of players, an oligopolistic market is an archetypal byproduct of a good like crude oil. There are three types of ‘companies’ that generate the global supply of crude oil: governmental oil companies that operate as an extension of the government, governmental oil companies with strategic and operational independence, and international oil companies that are investor-owned. 

Dutch Royal Shell and BP are two well-known examples of public, international oil companies. Saudi Aramco and Pemex are traditional governmental oil companies with no operational independence, in fact the smallest proportion of national companies are those with operational independence. OPEC is a special case under the former category as it groups up 13 governmental petroleum companies into a legal cartel of sorts. OPEC allows some international oil companies to operate within their market borders of the 13 countries that make it up. 

OPEC is one of the most powerful market players within the oil industry as it dominates supply (aggregating to over one third of global supply) and can therefore control or induce price fluctuations. It is important to note that, in general, oil is one of the most volatile goods that exist. Volatility is inherent to raw goods – however, crude oil takes a special precedence. This is because of the inelasticity of its nature, on both the demand and supply side. Due to it being relatively irreplaceable (therefore demand is often predictable and does not easily shift to a substitute), and difficult to organically increase supply in a small amount of time (artificially, however, these companies can reduce supply to increase price), price fluctuations are large. As crude oil is a raw material, it also has second-hand ripple effects on direct byproducts i.e. petroleum, diesel, and other petrochemical products. Given the same logic, it is used for many, many businesses globally, crude oil price volatility affects their production costs and businesses. 

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In fact, in 1973 when oil prices rose sharply from 20$ per barrel to 60$ per barrel and then, subsequently in 1982, to 128$ per barrel (real dollars), the US unemployment doubled. This was followed by a worldwide recession. These price rises were caused by embargos placed on oil exports, targeting nations supporting Israel during the Yom Kippur War. 

Price competition can be viscous, especially in this market as either company can compromise and share demand for oil by keeping prices capped at a certain decided price or one can alter this balance by undercutting, generating a price-war where suppliers begin to retaliate. Of course, this is pure theory as real-life includes contracts and legal binding effects between suppliers and buyers, and of course how the price of oil rarely changes drastically from one supplier to the other.  

The market of crude oil is heavily influenced by futures and hedging. Daily trading of these futures, speculation and noise, and counterparties hedging their risks in the oil market create new buzzes of information and data every day that dictate price changes. The price of oil, as dictated on the futures market, is found through the difference of the futures (delivery of this good in the future) and spot price (delivery of this good today). Historically, the price of oil has always been positive except on the 20th of April 2020 when the price of oil, for the first time in history, went negative up until -$37.63 (barrel of West Texas Intermediate). This was the result of multiple, consecutive and subsequent events: 1) the May futures for crude oil were about to expire on 21st of April and the large panic due to 90% of the world being under lockdown and sluggish economic recovery; 2) COVID-19 speculation, uncertainty, and fear; 3) virtually absent demand for oil.

A close up of a barrel

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To sum up, the oil market is intense to say the least. Made up of an oligopolistic market with high price competition, trust is key to shared success among privately-owned companies but also countries. The price for oil is the most volatile variable in the real and financial economy. This is due to how interlinked geopolitical events and financial markets are (futures on oil dictate the price). The most recent oil market crash, April 2020, showed the world that oil price can become negative when subjected to extreme pressure like oversupplying, lack-of-demand, and a global pandemic with no known cure. Although it is difficult to predict, it’s safe to say that traders and the rest of the financial world have learned their lessons due to more than a few reasons. Firstly, due to production cutbacks and increased lifting of lockdowns, in between the months of July to November, confidence in the US oil storage facilities has returned. Secondly, there have been new, structural changes made to prevent the exclusive holding of oil futures for the next month, traders now know to spread their buys over a period much larger (6+ months). Lastly, as this was not a “win-lose” event, in the sense that literally not one group of people stood to benefit from this (except maybe news reporters as they had something other than COVID-19 to report on), it is very unlikely that the future of oil prices sees a repeat event.

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