What Drives the Oil Price?

1. What Drives theOil Price? Dr. Behrooz Abdolvand

2. The RiseAnd Fall ofOil Prices

3. Common Explanationsforthe High Oil Price • 1. Demand sidearguments • Imbalanceofsupplyanddemand • Increaseddemand due toemergingmarkets (China, India) • Therefore OPEC hastoincreaseproduction • Peak Oil (demandoutweighssupply) • Scarcereserves • 2. Supplysidearguments • Hoardingby OECD countries • Speculation • Dollar devaluation

4. IncreasingEnergyCommodity Prices

5. Parallel increaseofsupplyanddemand

6. Parallel development of production and consumption

7. OPEC - Productioncapacity

8. Increasing Prices – GrowingReserves

9. Hoardingcanbeoneofthereasonsforpriceincreases

10. US oilstocks(´000 bbl)

11. Number of ships used for oil storage

12. Future ContractsandtheOil Price

13. Intensecorrelationbetweenoilpriceandfutures

14. Oil: Price development and number of traded contracts

15. Trade volume by now 2000 times higher than the production amount

16. General Trend ofCommodity Investments

17. Thistrendisapparent in all naturalresoures

18. S&P GSCI breakdown by sector – the most popular commodity index is energy-dominated

19. ETF-Securities: Amount of capital held by oil funds

20. The development of the oil price and the capital influx into the ETFS-Oil-Funds

21. ETF-Securities: Amount of capital held by oil funds

22. Historiccorrelationbetweenthe „New Economy“ bubbleandtheoilbubble

23. Negative correlationbetweenoilandthe USD

24. Euro/Dollar Exchange Rate andOil Price Growth

25. Illustration ofcorrelation not only in theoilsector, but also commodities in general

26. MonetaryPolicycauses Dollar Devaluation

27. Historical Processof Dollar Devaluation

28. CalculationofcumulativeinflationillustratesthecurrentvalueofthedollarCalculationofcumulativeinflationillustratesthecurrentvalueofthedollar

29. Nominal and Real Price ofCrude 2008

30. Nominal and Real Price ofCrude2007 Nominal price 2007: ca. 93 $ Nominal price 2007: ca. 93 $

31. Nominal Oil Price 2006 Nominal price 2006: ca. 88 $ Nominal price 2006: ca. 88 $

32. List Price (Posted Price) • From a historical perspective, multinational oil companies dominated the industrial promotion of energy resources in the Middle East and South America up until the 1950’s. Until the early 1970’s, the trade of oil was based on the “Posted Price”, which large mineral oil corporations collectively set; the fees exacted from this “Posted Price” ultimately determined the size of the state budget of the respective countries. As the oil-producing nations increasingly realized how high the profits were from the contributions of the shareholders, they demanded and even higher percentage. The oil corporations, in turn, attempted to decrease the “Posted Price” in order to protect themselves from the consequences of higher demands and to secure their own revenues.

33. The establisment of OPEC • In response, OPEC was founded by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela in 1960, which later expanded to include Algeria, Libya, Nigeria, Indonesia, Qatar, and the United Arab Emirates. OPEC was initially founded in order to unify and coordinate members' petroleum policies and to protect against oil price declines and decreases in oil revenues.

34. GovernmentSelling Price/ Official Selling Price • Consequently, OPEC controlled the oil market and price formation from 1973 until the beginning of the 1980’s. The “Posted Price” was initially replaced by the “Government Selling Price”, which was set by the governments of oil producing states. Later, it was substituted by the “Official Selling Price”, whose price was determined by national oil companies.

35. Net back • In light of the decrease in oil demand during the mid 1980’s, many OPEC countries were guaranteed a fixed margin of payment in order to secure oil sales; this fixed margin would then have to be transferred to the oil refineries. The price risk was assumed by the so-called “Net back” conditions of oil producing states. The producer states provided the refineries with crude oil and received a percentage of the profits derived from the sale of refined oil minus a margin of profit that remained for the refineries.

36. Price decline as a consequence of „Net Back“ • This process, which removes the price risk from the producer and guarantees a margin of profit, led the refineries to increase production levels. This, in turn, tightened competition. Consequently, the price of products declined and the price of crude oil sank to about $10 a barrel within a very short period of time.

37. Quota regulation/Price increase • This induced the OPEC states to introduce production quotas. They curtailed the oil supply and divided the oil output among the member states in order to achieve price stability.

38. Futuresmarket • The oil trade had to re-structure itself. Initially, the trade was handled through spot markets. Later ensued-as a reaction to the oil price fluctuations caused by the limited quota discipline of OPEC-the futures market. The oil futures trade served to limit price risks for oil dealers, but also drew the participation of new groups to the international oil futures market.

39. Formula pricing • Under this system, the price of the delivered petroleum (for instance West Texas Intermediate (WTI), Brent or Dubai-Oman) orients itself toward the average price of futures markets of the previous month. The WTI generally serves as the benchmark for oil that is sold to North America, Brent Oil for the sale to Europe and Africa and Dubai-Oman for petroleum that is sold in the Asian-Pacific market.

40. Concluding remarks • Based on this mechanism, there will surely be attempts made by OPEC to regulate prices. A triangle will remain between the futures markets, the consumers and OPEC in the future. • The future oil market will not be a producer market, but rather, a consumer market.

41. Thankyou! • Questions?