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How oil and gasoline prices are set
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What factors determine oil and gasoline prices? This question has taken on increased interest to the general public as the price they pay to heat their homes and at the pump for gasoline has sharply declined.[1]
Up until the early 1960s, the major oil companies set the prices. Since the late 1980s, however, oil prices are determined in various ways, including, for instance, through open, public exchange on the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE).
Factors affecting the price of oil include the intense competition emerging through the use of new means of discovering and extracting oil, particularly hydraulic fracturing, also known as fracking.[2][3]
How oil prices have been set historically
Until the late 1950s and early 1960s, oil prices were mostly set by large, multinational corporations. These corporations controlled both the upstream (oil and gas extraction and production) and downstream (refining and transportation) operations and could control the supply of oil on the market and to some extent the prices. During this time, governments were not involved in setting the price of oil; instead, governmental involvement in oil and gas finances was generally limited to the fees charged to drill wells and the collection of royalties or taxes.
OPEC
Some oil exporting countries desired a change and colluded to alter this pricing system. Thus, in September 1960, the Organization of the Petroleum Exporting Countries (OPEC) was formed as an intergovernmental organization of oil exporting countries that could collectively agree to certain crude oil policies to influence the global price of oil. OPEC formed at the same time as global oil demand increased, and its member countries were able to feed this increased demand and control a large share of the global oil market. The formation of OPEC led to a period from 1973 to 1988 during which OPEC set oil prices by having member countries agree to certain production targets.[4]
Beginning in the late 1970s, however, the pricing system created by OPEC became too ineffective to meet global demand and multinational corporations began to fill the gap. Then, in the mid-1980s, a global recession decreased the demand for oil and prices fell. In response, Saudi Arabia (the most prominent member of OPEC) cut oil production in an attempt to increase oil prices, but prices stayed low and Saudi Arabia lost part of its share of the global oil market. Overall, OPEC's share of the oil market decreased from 51 percent in 1973 to 28 percent in 1983. In 1986, the national oil company of Mexico, PEMEX, shifted to market-based pricing system and many countries followed suit.[4][5][1][6][7]
Financial market exchange
Since 1988, oil prices mostly have been set through market forces like changes in supply and demand. As OPEC’s share of the oil market decreased, the number of oil suppliers and buyers increased, leading to the bifurcation of the oil market into a market for physical oil and another market specializing in the trading in financial products tied to the oil market. The "'financialization'" of oil markets involves the use of financial tools including swaps, futures, and options. Futures and options are openly traded on regulated financial markets like the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange, Inc. (ICE). These financial tools are used by a wide variety of participants including oil and gas producers to hedge against the volatility of the global oil market and traders (including hedge funds and pension traders) that use arbitrage to make a profit. The financial markets have therefore become an important source of information about the physical oil market itself.[4][8]
Fracking and oil prices
- See also: fracking and horizontal drilling
Fracking has introduced increased North American competition into the global market. The use of fracking and horizontal drilling has increased the domestic production of crude oil since 2008 to the extent that the United States had altered an industry previously dominated by oil-rich countries in the Middle East. A 2015 study by the American Petroleum Institute, an oil and natural gas industry group, found that Texas, Pennsylvania, and North Dakota rivaled major energy-producing countries. "U.S. imports of oil went from greater than 60 percent down to lower than 40 percent. So we cut out a good 20 percent of all the oil that we used," said Ryan Sitton (R), one of three members on the Texas Railroad Commission, which regulates oil and gas production in Texas. "We changed from net imports to now using that 20 percent here that we produce in the United States. And that brought a lot of stability to the markets."[9][3]
According to a July 2016 article in The Telegraph, North American fracking endeavors have been able to cut costs and produce oil at prices far below global averages, notwithstanding what it says was an attempt in the previous two years by Saudi Arabia to push for oil policies designed to lower the global price of oil to, what the article report, "break the back of the US shale industry."[2] Saudi Arabia, the largest and most influential member of OPEC, was pushing the organization to keep production elevated in order to drive down prices, presumably to prevent an influx of U.S. oil from entering the global market.[10][11][12]
According to a source in the story, increased improvements, however, "have changed the cost calculus faster than almost anybody thought possible." For one company mentioned in the piece, fracking "is now so efficient that it is already adding five new rigs" despite the lowered price of oil on the market, something ostensibly affecting the decision to produce more oil in the first place.[2] Writing in July, "North America oil rigs has risen for seven out of the last eight weeks to 374."[2] Longer term, innovations in fracking have the ability to sustain competition with OPEC countries, through the rapidity with which rigs to extract oil can be readied. The Telegraph reported one company being able to ready a rig "135 days flat, a dramatic contrast to deep-water mega-projects that can take seven to 10 years."[2]
Energy policy in the 50 states
Click on a state below to read more about that state's energy policy.
See also
Footnotes
- ↑ 1.0 1.1 Vox, "Why crude oil prices keep falling and falling, in one simple chart," February 8, 2016
- ↑ 2.0 2.1 2.2 2.3 2.4 The Telegraph, "Texas shale oil has fought Saudi Arabia to a standstill," July 31, 2016
- ↑ 3.0 3.1 American Petroleum Institute, "States compete among top energy producing nations," May 28, 2015
- ↑ 4.0 4.1 4.2 The Oxford Institute for Energy Studies, "An Anatomy of the Crude Oil Pricing System," January 2011
- ↑ Vox, "Why oil prices keep falling — and throwing the world into turmoil," January 23, 2015
- ↑ U.S. Energy Information Administration, "Supply: OPEC," April 12, 2016
- ↑ U.S. Energy Information Administration, "Glossary - O," accessed April 17, 2016
- ↑ Investopedia, "Over-The-Counter Market," accessed September 16, 2016
- ↑ Ballotpedia Senior Writer Brittany Clingen, "Interview with Ryan Sitton," May 29, 2015
- ↑ Fox News, "Falling oil prices could hurt US producers, fracking industry," December 16, 2014
- ↑ The New York Times, "Gas, Still Not as Cheap as It Used to Be," January 27, 2015
- ↑ CNN, "Cheap gas could kill U.S. oil export ban," December 12, 2014
