Crude Oil

Introduction

Crude oil is a naturally occurring, flammable liquid consisting of a complex mixture of hydrocarbons of various molecular weights, and other organic compounds, that are found in geologic formations beneath the earth's surface.

Crude oil varies greatly in appearance depending on its composition. It is usually black or dark brown (although it may be yellowish or even greenish). In the reservoir it is usually found in association with natural gas, which being lighter forms a gas cap over the petroleum, and saline water which, being heavier than most forms of crude oil, generally sinks beneath it. Petroleum is used mostly, by volume, for producing fuel oil and gasoline (petrol), both important "primary energy" sources.

84% by volume of the hydrocarbons present in petroleum is converted into energy-rich fuels (petroleum-based fuels), including gasoline, diesel, jet, heating, and other fuel oils and liquefied petroleum gas. The lighter grades of crude oil produce the best yields of these products, but as the world's reserves of light and medium oil are depleted, oil refineries increasingly have to process heavy oil and bitumen, and use more complex and expensive methods to produce the products required.

The petroleum industry is involved in the global processes of exploration, extraction, refining, transporting (often with oil tankers and pipelines), and marketing petroleum products. The largest volume products of the industry are fuel oil and gasoline (petrol). Petroleum is also the raw material for many chemical products, including pharmaceuticals, solvents, fertilizers, pesticides, and plastics. The industry is usually divided into three major components: upstream, midstream and downstream.

Indian Scenario

India is a net importer of crude oil. Indian demand has picked up in the last few years owing to increased consumption of petrol and diesel. Industrial demand has also picked up thus increasing demand for furnace oil and other mid-distillates. Indian supply remains more-or-less constant at approximately 0.77 mn bbls per day which is around 27% of demand. The rest of the demand is met through imports, mainly from the middle-east. India imports Dubai-Oman crude and Brent crude in the proportion of 62.3:37.7

The country produces only 27% of its total consumption, which means the country is a net buyer international market price. Since we are automatically exposed to international price fluctuations, the same affects our balance of trade. On the other hand, Indian petroleum industry is partially administered by the government. Owing to large volatility on the procurement price and fixed price from the sales side, refiners are exposed to price risk.

Factors influencing Crude Oil prices

The pricing markers are Brent, WTI, and Dubai/Oman. Crude oil is one of the most volatile commodities traded chiefly because the way it affects the global economy as well as our dependency on its derivative products like gasoline, heating oil, furnace oil, etc. With growing demand comes another great concern of resource depletion
Crude oil availability across the world is limited and is not recyclable. In addition to this, the producers of oil invest heavily in finding newer oil wells despite resources being limited; giving rise to diminishing returns per unit invested
At a larger scale, we see the Organization of Petroleum Exporting Countries (OPEC – a group of major oil producers) trying to control prices through production refinements; while non-OPEC countries like Russia finding newer reserves to gain market share. Owing to the complexities of each price determining factor – including reserves, global demand, geo-politics and currency fluctuations, and the random effect of each on prices, we can only conclude that price risk management is inevitable for entities in this value chain
Refiners face risk from both procurement and sales sides. On the purchase side, fluctuating oil prices affect the raw material cost and the administered price mechanism restricts linking the sale prices to international price thereby having a bearing on the refining margins
End consumers of furnace oil and other mid-distillates, whose prices are not fixed, are exposed to global price fluctuation. For the same, users of these petroleum products for their industries/facilities, face risk of price changes thus affecting their production planning and future cash flows

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Crude Oil