The recent spurt in the crude oil prices, and a temporary respite in the form of stabilization of the same, prodded me to dive deep into the magical barrel, which is capable of such immense fluctuation. All said and done, what exactly causes such crests and troughs of gigantic proportions? This post is just to refresh myself with my notes from the ‘ET- In the classroom’ article on Global Oil prices which had appeared a long time back.
The organization of petroleum exporting countries or OPEC, is an association formed of Iran, Iraq, Kuwait, Saudi Arabia, Venezuela in Baghdad in 1960. It controls more than 45% of the international crude oil trade. The objectives are to co-ordinate and unify petroleum policies among its member countries in order to secure fair and stable prices for petroleum producers. It also ensures a regular and economic supply of petroleum to consuming nations. One more responsibility is to ensure a fair return on capital to those investing in the industry. Over the years OPEC has grown to include new full time members: Qatar, Algeria, Nigeria, Indonesia, Libya, Abu-Dhabi, apart from the five founding members. Among the OPEC countries Saudi Arabia is the highest producer with nearly 8 mbpd (million barrels per day).
How does OPEC control the global Oil prices?
This is done by agreeing to reduce production. For instance, at one point of time Saudi Arabia had asked nine other OPEC countries to restrict their production by 4 mbpd such that the total production is kept at 24 mbpd from a high of 29 mbpd. If all the members comply with such guidelines, prices will rise to the desired levels.
What is the OPEC basket Price?
The OPEC basket of crude oil is widely known in the world market for reference pricing. The basket consists of Algeria’s Saharan Crude, Indonesia’s Minas, Saudi Arabia’s Arab Light, Nigeria’s Bonny Light, Mexico’s Isthmus, Venezuela’s Tia Juana, and the UAE’s Dubai Blend. Basket Price is the average price of these grades on the reference date.
How is the selling price decided?
The Basket prices are just references, an average of price of each of the components within the basket. They are largely theoretical and are used as a barometer to measure how the industry is faring. Actual Selling Prices are generally the week’s average price of each nation’s free on board (FOB) prices for the date of reference. For instance, for any loading day the selling price will be the average price for the two working days before and after that particular day. The provisional prices are always set for the buyers reference at the time of loading. The final prices, however will be decided by the buyer and seller as per terms and conditions in the sale purchase agreement (SPA), based on cost, insurance and freight (CIF). For long term contracts, the prices are generally the monthly average of loading prices.
As a rule the pricing mechanism is generally decided by the buyer and not the seller. For a buyer like India, the reference price is the Platt’s weekly and monthly average for spot or contract cargoes. Platt’s is an agency which reports international prices. Pricing invariably depends on the sale-purchase agreement between the buyer and the seller. For India, the delivery period ranges between four and six days, both on the east and west coast.
Besides, secure hedging mechanism is not developed in the country and provisional prices are more or less the final prices- the Platt’s CIF prices in Arab Gulf for reference loading dates and the Platt’s Singapore prices for the same deliveries from the Far-east. Generally, each country within the OPEC also has its own official selling price (OSP), which is the reference price for both spot and contract deliveries for its crude exports.
Different grades within a particular country’s production programme will attract different premiums or discounts depending upon market conditions and other factors. The actual crude pricing follows complex arithmetic powered by simulation by the central agency of that country incorporating several factors such as market conditions and the buyer’s interest.
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