Economics Essay Example: Oil Prices of the Primary Benchmarks

There are many different oil benchmarks recognized according to the crude oil from the particular part of the world. But the prices of oil are given according to the three most important primary benchmarks:

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Brent Blend is the most widely used marker as it makes up two-thirds of all crude contracts in the globe. Brent refers to four distinct oil fields in the North Sea: Brent, Forties, Osberg and Ekofisk. Crude from this region is the ideal for refining diesel, gasoline, and high-demand products. This Region is found in the sea hence making it easy transport the crude to distant locations.

West Texas Intermediate (WTI) this marker refers to crude oil extracted from the U.S. and sent to Cushing, Oklahoma. One major hindrance of WTI is transportation; transported on land via pipeline hence making it expensive to ship. West Texas crude is light and very sweet hence easy to refine gasoline. WTI is the dominant marker for oil used in America.

Dubai also known as Oman, this is used to refer to Middle Eastern crude, and it is useful to refer to crude oil of lower grade than Brent of WTI. Oil from this grade is heavier and has higher sulfur content hence referred as Sour oil. Dubai is the primary marker for Persian Gulf oil.

The latest price for Brent Blend is USD 64.08 per barrel in the month of May 2015 while as the most recent price of WTI crude is USD 59.26 per barrel also in May 2015.

The economic aspect

Deepwater rigs are gravely affected by the drop in oil prices, and some old rigs are facing the possibility of being demolished. The low prices and the emergence of new, efficient drilling rigs and productive drilling operations created an oversupply of the commodity. The daily income of some rigs dropped by more than 50% for example rigs that commanded a day rate of USD 650,000 goes for USD 250,000. More efficient drilling equipment are reducing the operation cost and drilling time of deepwater rigs. The drilling time has improved from 20% to 35% in the last few years. International oil companies are making more profits and able to fund deepwater megaprojects. The difference is showing between new technology vendors; there is pressure on those selling new offshore technology to keep improving. On the other hand, there is little pressure on those dealing with onshore technology to improve. The pressure to improve is because companies are not worried about the cost and are ready to invest if the likelihood of making good returns is big. Productivity is the third aspect that has made significant improvements. Productivity has improved mainly due to a complete understanding of organization details, reducing overbuilt systems that were a product of uncertainty about the size of the reservoir. Hence reducing the costs of production and improving productivity.

Economic evaluation.

Economic evaluation is the process of systematic identification, quantification, and assessment of inputs and outcomes of two alternate activities and their comparative analysis. Economic evaluation in offshore and land drilling would be essential to establish why oil prices are falling. This type of assessment can help in stabilizing oil prices. Drilling rigs are always the target for cost cuts to steady the prices of oil. For lasting, cost control producers are expected to reconsider how the drilling rigs operate to eliminate ineffective methods that add unnecessary cost to the already expensive process. We have witnessed a decrease in onshore exploration budgets while offshore funds keep increasing. Application of new technology in offshore rigs would help to make the process cheap and more efficient just as it has happened in the offshore drilling.

Productivity and the cost of production also require evaluation, this is because a more detailed comprehension of the formation makeup and history could lead to more productive and cost-effective developments. Rigs should be built by a team which is in communication with the exploration team so as to avoid expensive overbuilt systems that overestimate the size of the reservoir. To resolve the problem companies have created joint ventures that perform a variety of tasks with an aim for better-synchronized tasks. For example, the oneSubsea founded in Cameron International and Schlumberger in 2013, Baker Hughes merged with Aker Solution with the same purpose. Even though these mergers have not been around for an extended period to ascertain the long-term benefits and disadvantages, the early results are positive. Some projects cost has been reduced 10% to 20% mainly because these partnerships have been able to complete tasks in less time and with innovative methods. (Rassenfoss 2015).

Supply market.

Supply market involves observation and analysis of trends in the marketplace in which the providers of the commodity (Suppliers) conduct their business. This view begins with the understanding of global markets and gaining enough knowledge on the main players in that particular market. Observation of supply market involves defined steps as developing a commodity profile, understanding the size and organization of the supply market, evaluation of major players and lastly the study of industry trends and forces. In the oil market, the prices are mainly controlled by the Organization of Petroleum Exporting Countries (OPEC) that is made up of most oil-rich countries. United States also has a significant influence on the global price of oil, and this is because up to Mid-20th century the United States was the largest oil producer in the world. Other factors that influence the supply market are capable drilling rigs and new technologies which have created an oversupply of the commodity in the market. This oversupply has also reduced contracts in this rigs, and they are making less income as oil companies are renegotiating reduced contracts. Drilling new rigs are easier and have gotten more efficient and the costs, days and the day rate has gone down hence suppliers are making more money from their investments. Oil companies are also merging with exploration companies, for example, the OneSubsea for the purpose of eliminating overbuilt Drilling rigs and Refineries. These mergers have produced positive results in cutting the cost of production and supply. Suppliers are now working on ways to reduce the duration between discovery and first oil production. Usually, it has been taking seven years, but smaller projects for example in the Gulf of Mexico are operational in 3 years hence indicating the gap can be reduced. If the gap is reduced the supply will significantly increase, and the prices of the Petroleum will decrease. (Rassenfoss 2015).

Demand market.

Demand market the total quantity demanded by all consumers for a particular product at a specific period. There two types of demand: primary demand and secondary demand. Primary demand is the total demand for all brands of a particular product or service for example computers, cars or mobile phones. While as selective demand refers to the demand of a specific brand of product or services, for example, Toyota or Volvo for cars, Android or iPhone for phones, Dell or Acer for computers. Demand market is a major indicator of consumer willingness and ability, competitiveness of the market and the likelihood of a company to survive in a new, competitive market. In most cases, if the demand market is little the company may terminate their services or product, relocate or restructure to appeal more and new consumers. In the oil, market demand also follows the concept of supply and demand which states that as demand decreases or supply increases the price of that particular commodity drops. But for oil, it is quite different as oil future market controls the prices of oil. Oil Future Contract is an agreement that gives buyers the right to buy oil by barrel which had an already determined price on a future date. Under this contracts, the seller and the buyer are obliged to fulfill part of their agreement and conduct the transactions on the predetermined date. Consumers can buy oil futures to protect them against the future potential rising of the price. Others referred to as spectators keep on guessing the future prices of oil with no intention of buying the commodity. Also, oil demand can be determined by speculations where a mere belief that oil demand will increase in the future can result in an increase in oil prices in the present as buyers try to buy oil futures. The vice versa is also true, as prices may drop if oil prices in the future are expected to decrease in comparison to the present prices.

Time value of money

The time value of money is the concept that money available now is more worthy than the same amount in the future mainly because of its potential earning capacity. A major principle in finance states that money can generate interest and that any amount of money is more worth the quicker it is received. Most investors prefer to receive money as sooner as they apply or create it than receiving it in the future due to the money growth potential to grow in value during a given period. This increasing ability is referred to as the compounding value of money, ability to generate interest or dividend payments. In the article Offshore Operators shed costs, but can they keep them off? By Stephen Rassenfoss in the JPT. The time value of money concept favors oil companies as poor oil prices have battered rig drillers. Companies are in a better position to renegotiate contracts hence making money. Experts believe that this low-cost environment will linger up to 2018 when the oversupply passes and the rate of offshore services will rise again. The surplus money made by the companies has been used to invest in new and more efficient technologies which have eliminated inefficient methods that add to the cost of operation. Companies are also investing this surplus capital by creating joint ventures that can perform a broad range of tasks through better coordination and communication. This coordination is mainly to eradicate the probability of building ineffective overbuilt or underbuilt systems due to conflicting evaluations of reservoir size.

Those selling new technologies to these companies are also benefiting from the time value of money. Especially those dealing with offshore operations are coming up with new advanced ideas and are always under pressure to come up with this new technologies. Most companies are trying to make more money and invest more so as to keep up with the cash flow; as a result, they invest heavily in new technologies to reduce the cost of exploration, drilling and also operating a rig. The companies and the innovators are presently making more money which they busy investing in other ventures. As a result of using the concept of time value of money to their advantage. (Rassenfoss 2015).

References

Rassenfoss s, (2015). Offshore Operators Shed Costs, But Can They Keep Them Off. Journal Of Petroleum Technology. Vol 67. I 7. Page 42-44.