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Crude Oil

Discussion Materials
February 2011
Table of Contents

Section 1 Energy Statistics: World & US

Section 2 Crude Oil Statistics : World & US

Section 3 Crude Oil: Production

Section 4 Crude Oil: Demand

Section 5 Inventories

Section 6 Miscellaneous

Appendix A Section Title

Appendix B Section Title

Appendix C Section Title

2
Section 1

Energy Statistics: World & US

3
World Energy Consumption
120 500
United States Europe Eurasia Middle East China India Africa World

450

100
400

350
80

300

60 250

200

40
150

100
20

50

0 0
1980 1985 1990 1995 2000 2005

A BTU is defined as the amount of heat required to raise the temperature of one pound of water by one degree Fahrenheit.
143 BTU is required to melt a pound of ice. 4
World Energy Consumption

A BTU is defined as the amount of heat required to raise the temperature of one pound of water by one degree Fahrenheit.
143 BTU is required to melt a pound of ice.

5
US Energy Production
Primary Energy Production

80
Coal Natural Gas Crude Oil Nuclear Total

70

60

50

40

30

20

10

0
1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009P
Quadrillion Btu

Source: Annual Energy Review, EIA 6


US Energy Consumption
Primary Energy Consumption

120
Coal Natural Gas Petroleum Nuclear Total

100

80

60

40

20

0
1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009P
Quadrillion Btu

Source: Annual Energy Review, EIA


7
Section 2

Crude Oil: World & US

8
What do we do with crude oil?

Avg. Refined Product Revenues

Raw material acquisition costs


Refined product purchases
Energy costs
Marketing Costs
Environmental Costs
Other refining costs

Net Refining margin

Source: EIA
Source: www.wikipedia.org

9
A barrel of crude oil…..
50 35

48 30

25
46
20
44
15
42
Gasoline (LHS) Distillates 10
40 5

38 0

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10
May-03
Sep-03

May-04
Sep-04

May-05
Sep-05

May-06
Sep-06

May-07
Sep-07

May-08
Sep-08

May-09
Sep-09

May-10
Sep-10
1985 1995 2004 2005 R/P ratio Share of total
USA 36.4 29.8 29.3 29.3 11.8 2.4%
North America 101.5 89.0 60.6 59.5 11.9 5.0%
Venezuela 54.5 66.3 79.7 79.7 72.6 6.6%
• About 62% of proven reserves are in politically sensitive S. & Cent. America 62.9 83.8 103.0 103.5 40.7 8.6%
Middle East Kazakhstan n/a n/a 39.6 39.6 79.6 3.3%
Europe & Eurasia 78.6 81.5 138.7 140.5 22.0 11.7%
Iran 59.0 93.7 132.7 137.5 93.0 11.5%
• World production is heavily dependent on Middle East Saudi Arabia 171.5 261.5 264.3 264.2 65.6 22.0%
with Reserves/Production ratio at 81, implying ample Middle East 431.3 661.5 738.2 742.7 81.0 61.9%
untapped reserves with the region. Africa 57.0 72.0 113.8 114.3 31.8 9.5%
Brunei 1.4 1.1 1.1 1.1 14.9 0.1%
China 17.1 16.3 16.0 16.0 12.1 1.3%
India 3.8 5.5 5.6 5.9 20.7 0.5%
• Russian politics to dictate crude oil prices in Euro zone,
Asia Pacific 39.1 39.2 39.8 40.2 13.8 3.4%
which could prove impactful for Brent crude. TOTAL WORLD 770.4 1027.0 1194.1 1200.7 40.6 100.0%

10
Section 3

Crude Oil: Production

11
World- Production

World Production - 2009


Source: Annual Energy Review, EIA
90,000

USA OPEC Rest of the World


OPEC controls 40% of 80,000
oil production.

US production on 70,000
decline.
60,000

50,000

40,000

30,000

20,000

10,000

0
1970 1975 1980 1985 1990 1995 2000 2005
thousand barrels/day

12
OPEC – Production
35,000
Algeria Qatar Angola
4% 2% 1%
Libya
30,000
7%

25,000
Iraq
9% Saudi Arabia
39%
20,000
Thousand
barrels/day
Emirates
15,000
7%

10,000

Nigeria
8% 5,000

OPEC- Production Saudi Arabia


0
Iran 1980 1985 1990 1995 2000 2005
Venezuela Kuwait
7%
9% 7%
Angola
Qatar 6%
Algeria 3%
Saudi Arabia
5%
29%

Libya
6%
Source: EIA, OPEC
Iraq
8%
Saudi Arabia accounts for close to 30% of OPEC production

OPEC divided on its relations with US Emirates


8% Iran
13%
Venezuela, Iran, Nigeria account for another 30% production of OPEC.
Nigeria
6%
Venezuela Kuwait
8% 8%

13
PADD

Field Name Year Location


Prudhoe Bay 1967 Alaska
Yates 1926 Texas
East Texas 1930 Texas
Wasson 1911 Texas
Percentage of US total
Source: US Crude Oil, Natural Gas Reserves,
American Petroleum Institute, Volume 34, June
1980.

Estimated prod volume


Production of crude oil in US is about 1,907 million barrels i.e. Field Name Year Location (mln barrels)
5.2 million barrels/day Prudhoe Bay 1967 Alaska 118.9
Wasson 1954 Texas 56.2
Kuparuk River 1969 Alaska 47.7
Belridge South 1911 California 37.4
Percentage of US total 13.63%
Source: US Crude Oil, Natural Gas Reserves 2005 Annual Report

14
Oil Wells Productivity

8,000 700

7,000 600

6,000
500

5,000
400
Rig count follows the price action
4,000
300
3,000

200
2,000
Average Productivity Producing Wells
1,000 100 5000 80

0 0 4500
70
1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005
4000
barrels/well thousands 60
3500

50
Source: EIA Annual Energy Review 2005 3000

2500 40

Productivity of oil wells in the US is on the decline. 2000


30

1500
No. of Rigs USD/bbl
Baker Hughes Rig count 20
Producing wells in operation are also on the decline 1000
Source: Bloomberg
10
500
The Alaskan share of the oil being pumped is about 20%. 0
Rig count Crude Oil Price - WTI
0
Dec-73 Aug-76 May-79 Feb-82 Nov-84 Aug-87 May-90 Jan-93 Oct-95 Jul-98 Apr-01 Jan-04 Oct-06

15
Section 4

Crude Oil: Demand

16
World - Demand
World Demand for Crude Oil

• World consumption of 90,000

crude oil on the rise.

• 22% of world demand 85,000


comes from United
States

• 58% crude oil demand 80,000

from OECD countries

• Percentage based on 75,000


Q3, 2009

70,000

65,000
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
thousand barrels/day

Source: EIA, OECD

17
US - Demand

US Petroleum consumption

25 80
Transportation Residential Industrial Electric Power Commercial Transportation share

70

20
60

50
15

40

10
30

20
5

10

0 0
1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009
million barrels/day % share of transportation
Source: EIA
18
US Crude Oil imports
U.S. Crude Oil Imports
12

10

US imports have
2 been on the rise

0
1981 1986 1991 1996 2001 2006
million barrels/day

Source: EIA

Average imports of crude oil in the US range from 10.2 million


barrels/day in Oct 2006, having dropped to 9.85 mb/d in Nov.
Major trading partners are Canada, Mexico, Saudi Arabia,
Venezuela and Nigeria.
Geopolitical tensions and unrest in Nigeria, Saudi Arabia.
Chavez’s conflict of interest with the US.

19
Section 5

Inventories

20
EIA – Crude Oil Stocks (excluding SPR)

160

390

140

370
120

350
100

330
80

310
60

290
40

270 20

Crude Oil Stocks Crude Oil Prices

250 0
Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11
million barrels USD/bbl

Inventories may help in


Intraday trades
But not much relation in
medium term. 21
EIA – Gasoline Stocks

270 160

140
250

120

230
100

210 80

60
190

40

170
20

Gasoline Stocks Crude Oil Prices


150 0
Period Stocks Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11
USD/bbl
Feb - Mar peak million barrels

Sept-Oct trough
Seasonality
Driving Season: April – September
Hurricane Season: June - November
22
Winter Season: October - March
EIA – Distillate stocks
200 160

140
180

120

160
100

140 80

60
120

40

100
20

Distillate Stocks Crude Oil Prices


80 0
Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11
million barrels USD/bbl

Period Stocks
Feb - Mar peak
Sept-Oct trough US follows the summer-peaking stock cycle
Seasonality US refinery maintenance is scheduled for winter or early fall.
Asian refiners have peak output in winter.
23
Trends in Refining capacity
20.00 100.00
United States China India World Total

18.00 90.00
Refinery capacity(million
Country barrels/calendar day) 16.00 80.00

United States 17.67 14.00 70.00

China 6.45
12.00 60.00

Russia 5.42
10.00 50.00

Japan 4.69
8.00 40.00
Korea, South 2.61
6.00 30.00
Germany4 2.42
4.00 20.00
Italy 2.34
2.00 10.00
India 2.26
0.00 0.00
Saudi Arabia 2.10 1970 1975 1980 1985 1990 1995 2000 2005
million barrels/calendar day million barrels/calendar day for world
Canada 2.04

Source: Refinery report, EIA.

.
Total world refining capacity = 85.9 million barrels/calendar day
US refining capacity is 20% of world total.
US demand for crude is about 20 million barrel/day
Refining is a constraint in the US.
Product prices could drive up crude oil prices.

24
Hurricane impact analysis – another Katrina!!

Gulf of Mexico Oil - Impact of Hurricane in Gulf of Mexico

% from
Gulf of Gulf of
Mexico Total U.S. Mexico

Oil (million barrels per day)


Federal Offshore
Crude Oil
Production (4/05) 1.562 5.488 28.50%

Total Gulf Coast


Region Refinery
Capacity 8.068 17.006 47.40%
Total Gulf Coast
Region Crude Oil
Imports 6.49 10.753 60.40%
- of which into
ports in LA, MS and
AL 2.524 10.753 23.50%

- of which into
LOOP 0.906 10.753 8.50%

This component was


disarmed during the
hurricane season. Source: EIA Hurricane report, June 2005.

25
Section 6

Miscellaneous

26
Carbon Emissions

27
Use of Alternative fuels
Electricity
9%
Liquefied
Petroleum Gases
(LPG)
Share of LPG drops from Ethanol, 85 32%
Percent (E85)
2004 to 2008 38%

Compressed
Natural Gas
AFV (CNG)
21%
900000 Liquefied Natural
Gas (LNG)
800000 0%

700000

600000
Electricity Liquefied
500000 7% Petroleum Gases
(LPG)
400000 19%

300000 Compressed
Natural Gas
200000 (CNG)
15%
100000
AFV
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
# of vehicles
Year

Liquefied Natural
Source: Alternative Fuel, DOE Gas (LNG)
Ethanol, 85
Percent (E85) 0%
59%

28
World Demand- Supply Forecast

World Demand World Supply

2002 77.8 77

2003 79.4 79.6

2004 82.5 82.9

2005 83.9 84.2

2006 84.9 84.4

2007 86 84.8

2008 85.7 85.98

2009 84.33 84.39 (million barrels/day)


Source: OPEC
2010E 85.15 85.17

• World demand expected to increase to 85.6 million barrels/day

• OPEC supply to be at around 28.3 million barrels/day

• OPEC supply can be tweaked subject to strategies adopted by the cartel.

• Demand and supply scenario roughly balanced.

29
Bullish vs Bearish

Bullish factors Bearish factors

Industrial production re-emerges with US


housing market turning around.

Energy policy favouring renewable energy, if


World GDP growth higher than expectations introduced by Democrats
i.e. demand – supply mismatch.

Loss of bargaining power of OPEC


Price support mechanisms from cartels

Favourable weather
Hurricanes/ weather related change

Double dip recession across the globe


Hedge fund/ETF participation

Strategic loans/sales by countries


Supply disruption due to political tensions

Refinery outages

Strategic purchases by countries

30
Exploring Arbitrage opportunities
A study in Crude Oil

31
Table of Contents
Section 1 Exchange Contract Specifications
Section 2 Spot Markets of Crude Oil
Section 3 Distribution & Price Model
Section 4 Bringing the pieces together

32
Section 1
Exchange Contract Specifications

33
Contract Specification - NYMEX

Contract Month & Expiry February 2009 (20 Jan) Delivery allocation : (21 Jan) Actual Delivery: (1-28 Feb)
March 2009 (20 Feb) Delivery allocation : (23 Feb) Actual Delivery: (1 -31 Mar)

Trading Unit 1000 barrels (42,000 gallons)

Quotation USD per barrel

Tick Size 1 cent/bbl

Delivery Centre Cushing, Oklahoma

Initial Margin ~5 – 6%

Quality Specification Light Sweet Crude Oil conforming to the following quality:
Sulfur 0.42% by weight or less,
API Gravity: Between 37 degree - 42 degree
All volumes are defined at 60 degree Fahrenheit

Deliverable crude streams U.K.: Brent Blend (for which seller shall be paid a 30 cent per barrel discount below the last
settlement price)
Nigeria: Bonny Light (for which seller shall be paid a 15 cent per barrel premium above the
last settlement price)
Nigeria: Qua Iboe (for which seller shall be paid a 15 cent per barrel premium above the last
settlement price)
Norway: Oseberg Blend (for which seller shall be paid a 55 cent per barrel discount below
the last settlement price)
Colombia: Cusiana (for which seller shall be paid 15 cent per barrel premium above the last
settlement price)

34
Contract Specification – BRENT (ICE)

Contract Month & Expiry Feb 09; Last Trading Day: 15 Jan 09
Mar 09; Last Trading Day: 12 Feb 09

Trading Unit 1,000 barrels (42,000 gallon)

Quotation USD/bbl

Tick Size 1 cent/bbl

Delivery Centre Sullom Voe

Initial Margin USD 9,250/bbl (span – based)

Quality Specification Brent Crude (export quality blend). The ICE Brent Crude futures contract is a
deliverable contract based on EFP delivery with an option to cash settle. An
EFP can be posted up to 1 hour after the relevant time of cessation of trading
of the last day of trading on the ICE platform.

Cessation of trading Trading ceases on the business day preceding the 15th day prior to first day of
the delivery month. (If holiday, then a day before).

35
Section 2
Spot Markets in Crude Oil

36
Brent – The market structure

Brent market is interrelation of 4 sub-markets

1. An OTC market for “15-day” Brent which, in 2002, changed to OTC market for “21 day”
Brent

2. The spot market for “Dated Brent” (unregulated)

3. The Brent futures market

4. An OTC market for Brent- based derivatives

37
21 Day Brent

1. The terminal for delivery of Brent is Sullom Voe.

2. Producers tell the operator (Royal Dutch/Shell) well in advance about how much crude oil,
they wish to deliver.

3. Producers/sellers have to tell the counter party 21 days in advance when cargo will be loaded.

4. Though producer may know anywhere from 6 weeks in advance regarding loading of cargo,
but the purchaser may be informed no later than 21 days in advance.

5. Market for 15 day and 21 day Brent contracts has been limited to major oil companies and
traders.

38
Dated Brent

1. Brent crude oil bought and sold in the spot market is known as “Dated Brent”.

2. The notice period of 21 days for a 21- day Brent has expired and now the crude cargo is dated
Brent.

3. Disseminated by Platts and Petroleum Argus

4. It is used as benchmark for spot transactions.

39
Contracts for Differences

1. The price of cargo of Brent at expiry of a futures contract is fixed from two to six weeks in
advance of the time when the oil underlying the contract is actually loaded for delivery.

2. The time gap between the expiry of a future contract and when the barrel is loaded at the
Sullom Voe terminal, hence significant price moves can be observed during this time gap.

3. To hedge this risk, CFDs (“Contracts for differences”) are contracts for difference between
price of dated Brent and the price of 21 day Brent.

40
Section 3
Distribution & Price Model

41
Primary Distribution System

Source: Gallagher, Savant Measurement Corp.

•Major crude oil pipelines (trunk lines) links import points to storage tanks and refineries.

42
The Pricing Model

WTI is a blend of several crudes extracted from wells in the southern part of the US and more
specifically from Texas, New Mexico, Oklahoma and Kansas.

F = S * (1+C) + ST + TR + INS + Taxes + Losses

F: Futures price of WTI


S: Spot price of WTI
C: interest costs
ST: Storage costs
TR: Transportation costs to the delivery point (eg: Cushing, Oklahoma in case of NYMEX WTI)
INS: Insurance costs
Taxes: import fees/state taxes/federal taxes
Losses: storage/transportation losses in crude

Source: Alizadeh et al, (2004).

43
Storage Costs

Galbraith Ltd.(ship broker) stated that supertanker storage/floating storage would cost approximately
90 cents/bbl

The cost of storage of crude at Cushing (NYMEX contract delivery point) would be about 35
cents/bbl. (Lipow & Associates)

Source: Kaminska (2008), www. ft.com/alphaville

Source: US Senate Committee on Government Affairs, 2003.

44
Transportation Costs

• Shipping costs are as per Worldscale or Worldwide Tanker Nominal Freight Scale (WS100, implying
100% of freight cost)

• “Worldscales” are the joint endeavour of two non-profit making organisations know as Worldscale
Association (London) Limited and Worldscale Association (NYC) Inc.

• Indicative freight costs are available from Argus Media/ Platts Oilgram.

• General freight costs range between USD 0.917/bbl to USD 1.5/bbl

• Heavy dependency of freight costs are dependent on crude prices and economic activity level.

Source: Alizadeh, et al. (2004)

45
Pipeline Transport Costs

• USA’s crude oil distribution system comprises of networks of terminals, refineries, other storage
facilities, pipelines, tankers, barges, rail tank cars and tank trucks.

• Trunk lines link gathering systems and import points to storage terminals.

• Locations of hubs:
•Midland and Odessa, Western Texas
•Cushing, Oklahoma
•Fort Laramie and Guernsey, Wyoming
•Clovelly and St. James, Louisiana
•Patoka, Illinois

• Cost for pipeline transport from Texas to Cushing: USD 1.1280/bbl

Source: Plains Pipeline L.P.

46
Losses in storage/transportation

1. Vapour loss due to evaporation during cargo operations and transportation

2. Evaporative loss from a 250,000 tonne dwt VLCC voyage Persian Gulf to Northern Europe of
0.13% of cargo volume.

3. Losses should be much lower on short North Sea voyages.

4. Vapour emission from shore tankage is 0.14%.

Source: Bhatia et al. (2004)

Deduction for incremental


API Gravity, Degrees Evaporation and Shrinkage
45.0 through 54.9 0.50%
55.0 through 64.9 1.00%
65.0 through 74.9 1.50%
75.0 and above 2.00%

Source: Supplement No. 2 to F.E.R.C. No.2 (Plains Pipeline LP) Effective January 2006

47
Section 4
Bringing the pieces together

48
The puzzle as it unfolds
WTI – WTI Spread arbitrage

Near Month Contract 40.44 Arbitrage Spread 12.31


Far month Contract 52.75
Months 11.00

Costs - USD/bbl
Shipping 1.50 Freight Rate (per bbl) 1.5
Storage 9.90 Storage costs(per bbl, 0.9
Pipe Transportation 1.13 per month)
Losses 0.16 Losses Parameter 0.40%
Total 12.69

Profit/Loss in USD/bbl -0.38

ROI -0.89%

49
Crude Oil

The anomalous behaviour of spreads

August 2007

50
Heterogeneous crude types – Homogeneous Price action

90
WT I Cushing Maya Dated Brent Dubai
80

70

60
Brent - WTI Correlation (2005): 0.968
50

40

30

20
10

0
Aug-01

Aug-02

Aug-03

Aug-04

Aug-05

Aug-06
Feb-02

Feb-03

Feb-04

Feb-05

Feb-06

Feb-07
May-01

Nov-01

May-02

Nov-02

May-03

Nov-03

May-04

Nov-04

May-05

Nov-05

May-06

Nov-06

May-07
WTI WTI WTS ANS Eugene Dated
Cushing Midland Midland USWC Island HLS LLS Poseidon Maya Brent Dubai Tapis
Date
WTI Cushing 1.000
WTI Midland 1.000 1.000
WTS Midland 0.997 0.997 1.000
ANS USWC 0.996 0.996 0.996 1.000
Eugene Island 0.994 0.994 0.995 0.996 1.000
HLS 0.996 0.996 0.995 0.995 0.998 1.000
LLS 0.998 0.998 0.996 0.996 0.998 0.999 1.000
Poseidon 0.995 0.995 0.998 0.996 0.998 0.996 0.997 1.000
Maya 0.983 0.983 0.987 0.992 0.991 0.989 0.988 0.989 1.000
Dated Brent 0.995 0.995 0.995 0.995 0.998 0.998 0.998 0.996 0.989 1.000
Dubai 0.984 0.985 0.987 0.988 0.992 0.990 0.989 0.989 0.988 0.992 1.000
Tapis 0.991 0.991 0.989 0.991 0.993 0.993 0.994 0.990 0.985 0.995 0.991 1.000

51
WTI – Brent spreads getting anomalous!

52
Historical Base

Median spread
for a decade:
USD 1.38/bbl

53
How did spreads fair this year?

10 90
HLS LLS Dated Brent Dubai WTI - Prices
8 80
6 70
4
60
2
50
0
40
-2
30
-4
-6 20

-8 10

-10 0
Jan-07 Feb-07 M ar-07 Apr-07 M ay-07 Jun-07 Jul-07 Aug-07

Date: July 27, 2007 – US Q2 GDP results in a spurt in WTI.

54
Spread – deviating from the norm!

55
Forward curves – does it have the clue!

56
WTI – Forward Curve

57
Brent Crude Oil – Forward curve

58
Seasonality in Forward Curves

59
How does the world react to this?

60
Transatlantic Arbitrage – when spreads turn favourable!

61
Crack spreads – Lets crack them!

62
What are crack spreads?

Refiners’ profits are attached to the spread or difference between crude oil and refined products.

Refining margins

Total Costs Receipts


of Refinery

Sale of refined products


Costs of operating
Crude Oil Prices
refinery

: Uncertain

1994: NYMEX launches 3-2-1 crack spread


The 3-2-1 ratio approximates the real-world ratio of refinery output—2 barrels of unleaded gasoline
and 1 barrel of heating oil from 3 barrels of crude oil.
OTC contracts available for individual refiners (customised contracts).

63
Seasonality in Gasoline stocks

64
Crack Spread Activity – What happened?

65
Why did it happen?

May 15, 2007:

Memorial day approaches……May 28.

Lower refinery runs

Crude inventories at Cushing (Oklahoma) at 27.35 million barrel

Yearly high at Cushing at 28 million barrel

Upcoming rise in gasoline demand

66
Future work

Causality test for gasoline and crude oil prices

Details on possibilities of vessel arbitrage and impact on prices

Freight rates and impact on economy and energy prices

Weather related issues and impacts.

Dynamics of natural gas and its causality with crude oil

67
THANK YOU

68