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How World Oil Markets Work

The world oil market has a direct impact on the amount you pay for gasoline and diesel at the pump. Four major factors play a role:

Factor 1: Crude oil types

Among the varieties and grades of crude oil, some are known as benchmarks in the world oil market. The type of crude oil that is used as a benchmark in North America is West Texas Intermediate (WTI) oil, which is a light, sweet (low-sulphur) crude. The price for WTI is usually quoted in newspaper articles. Light sweet crudes sell at higher prices than heavy sour crudes, which are more difficult and expensive to refine and produce less of the more valuable oil products such as gasoline and jet fuel.

Factor 2: Oil producers

The world oil industry is managed by a small group of companies: just ten companies control 68% of the world's proven oil reserves. The largest oil producers are state-owned national oil companies (NOCs) and large private sector energy companies. Eight of the ten largest oil producers in the world are NOCs. Furthermore, nine of the ten biggest oil reserve holders in the world are NOCs. Many of these were formerly private sector companies that were nationalized in the 1970s.

In September 1960, four Persian Gulf nations (Iran, Iraq, Kuwait and Saudi Arabia) and Venezuela formed the Organization of Petroleum Exporting Countries (OPEC) to obtain stable prices for crude oil. By 1973, eight other major oil producing nations had joined the organization.  OPEC members set their production levels which influences world crude oil prices.

In 2004, OPEC produced about 33 million barrels per day (MMB/D) of crude oil and natural gas liquids, or about 40% of the world's supply of oil. Most of the world's proven oil reserves (69.3%) are controlled by OPEC member countries.

Factor 3: Oil production and consumption

• Production – Oil is transported via tankers, pipelines, trains, trucks and barges to refiners as raw material; it is then processed into fuel products such as gasoline, heating oil and jet fuel. The price of crude oil is reflected in the price of these refined products. At the same time, fuel prices are affected by other factors, such as the cost to refine oil, marketing costs, taxes, transportation costs and local/regional market conditions and competition. In turn, fuel prices and pressures feed back into crude oil prices. In 2004, world oil production was 83.1 MMB/D, with about 48.1 MMB/D of this oil exported to various countries around the world.
  
  
• Consumption – The main consumers of oil continue to be the industrialized countries, particularly the United States, Europe and Japan, which together consume about half of the world's annual oil production. However, consumption in countries such as China and India is expanding at a rapid pace as these countries grow rapidly and their demand for energy for transportation, industry and homeowners increases. Transportation accounts for about two-thirds of the oil consumed in the United States and around half of the oil used in the world.

Factor 4: Crude oil prices

The price of oil is set in the global marketplace. The two key markets where oil is bought and sold are in New York and London. Prices are determined daily at the NYMEX (New York Mercantile Exchange), based on contracts between buyers and sellers of oil. In the NYMEX and London's IPE (International Petroleum Exchange), about 200 million paper barrels of oil are traded per day.

There are two types of oil buyers: those that are buying oil to be made into fuel products, and those who buy what are called “oil futures” as an investment, without any intention of ever taking possession of the actual crude oil. Interestingly, there is more oil traded than there is actual oil being pumped out of the ground. About 95% of oil traded on the NYMEX never shows up as physical product. This means that oil prices reflect investors’ expectations about future supplies and their potential impact on prices.

Historical Comparison: Gasoline and Crude Oil Prices in Canada (in 2006 $)

In the last two years the price of WTI crude oil has doubled from US$30 a barrel in the third quarter of 2003 to over $70 in the second quarter of 2006. Commercial oil traders have been concerned with a variety of issues such as the amount of oil produced by OPEC nations, increased demand in China, the amount of oil that can be refined, and hurricane and terrorist activity. Speculation, pessimism and geopolitical concerns about major oil producers including Saudi Arabia, Iraq, Iran, Nigeria, Russia and Venezuela also have contributed to the rise in prices. A large increase in investor trading has corresponded with the rising price of oil. It is fair to say that geopolitical concerns along with trading by investors have had a role in upward pressure on oil prices.

No one knows if $70 oil represents a one-time occurrence or a lasting trend. But oil markets and prices have always been cyclical, and today's higher prices could decrease if global uncertainty about the oil market eased. On the other hand, prices could remain higher since oil demand and global economic growth have remained relatively strong despite higher prices.