Crude oil: The market and its players

4.4

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In the previous chapter, we read all about the interesting history of crude oil, and other basic information related to this commodity. In this one, however, we will be dealing with the key players involved in the crude oil market. This will allow you to gain a better understanding of how the crude oil market functions and how a change in the price of the commodity affects the players within the commodity market.

So, without any further delay, let’s just jump right in.

Crude oil: The key players

Extracting and refining crude oil into the various petroleum products that we know and use is not an easy task. It requires exceptional amounts of investment and is a very intensive process.

The process of transforming crude oil into viable fuels and other petrochemical products requires the involvement of three different types of companies - upstream companies, midstream companies, and downstream companies. Here’s a quick look at each one of them.

Upstream companies

Finding the right spot to extract crude oil is not as easy as just simply drilling a hole into the ground. It involves careful monitoring, geological surveys, seismic surveys, and inspection of samples, among others. And once the presence of an oil well is identified, then the drilling and the setting up of an oil rig starts.

Exploration, identification, and extraction of crude oil from an oil well takes years to materialize. Companies that are involved in these activities are commonly referred to as upstream companies. Since this process is extremely capital intensive, upstream companies are generally very asset-heavy and have a huge capital expenditure budget. Reliance Industries, ONGC, and Cairn India are a few examples of upstream companies in India.

For upstream companies, high crude oil prices work in their favour, since they can sell their barrelled crude oil to downstream companies at a higher price, which would effectively increase their profit margins. As the crude oil prices get lower, upstream companies will start to feel the pinch. This is because each company has a breakeven point of their own and when the price of oil dips below that point, they start making losses.

Midstream companies

The midstream companies are the ones involved in storage of the crude oil extracted by the upstream companies, and in the transportation of that oil to the downstream companies for further processing and refinement. The transportation happens via three primary channels - pipeline, oil tankers, and ships.

Since the midstream companies are the link between extraction and refinement, they neither prefer high nor low oil prices. Instead, stability in crude oil pricing is what they are after. If either upstream or downstream companies get affected due to the oil pricing, the midstream companies invariably get to bear the brunt as well.

Downstream companies

You must have already gotten a fair idea about downstream companies by now. Companies that are involved in refining the raw crude oil into various petrochemical products are commonly referred to as downstream companies.

Many downstream companies don’t just stop with simply refining crude oil. They get involved in the marketing and distribution of their products to other businesses and individuals as well. BPCL, HPCL, and Indian Oil are a few examples of Indian downstream companies. If you take a good look at them, you can easily figure out that these companies not only refine crude oil, but also sell the byproducts such as petrol, diesel, liquified petroleum gas (LPG) to consumers.

These companies tend to benefit a lot from low crude oil prices since it would mean that they can buy the oil for cheap from the upstream companies. And, the benefit of low oil prices is usually not passed on to the consumers quickly, allowing downstream companies to elevate their profit margins.

Crude oil: The different variants in the commodity market

The characteristics of crude oil such as the viscosity, colour, thickness, and volatility tends to vary quite a lot depending on the oil well’s location and geographical conditions. While some variants of crude oil look thick and black, others tend to be thinner and slightly yellow in colour.

The crude oil market consists of two primary variants - Brent Crude and West Texas Intermediate (WTI). These two are the ones that are traded on the exchange through derivative contracts. Let’s take a look at the differences between the both of them.

Brent Crude

Brent Crude is essentially a blend of different crude oils from multiple oil wells. It has low sulphur content (around 0.37%) and an API Gravity level of 38.06. An API Gravity level of more than 10 means that the oil is light and can float on water. As you can see, the API Gravity level of Brent is more than 10, which makes it light enough to float on water.

The crude oil derivative contract that you see on the MCX website is based on the Brent Crude since it is widely considered to be the international benchmark for crude oil.

West Texas Intermediate (WTI)

The characteristics of the WTI are much better than Brent Crude. It has a far lower sulphur content (only around 0.26%) and has an API Gravity level of 39.6. This makes WTI a far superior crude oil variant to Brent Crude. The WTI is extracted from oil wells in the U.S.A., which is quite evident from the name itself. It is traded exclusively on U.S. exchanges and is not available in India.

Wrapping up

With this, we’ve come to the end of another chapter on crude oil. This should have given you a good idea of the structure of the crude oil market. In the next chapter, we’ll finally be moving onto the part where we dissect the crude oil derivative contract. Till then, stay tuned!

A quick recap

  • The process of transforming crude oil into viable fuels and other petrochemical products requires the involvement of three different types of companies - upstream companies, midstream companies, and downstream companies. 
  • Exploration, identification, and extraction of crude oil from an oil well takes years to materialize. Companies that are involved in these activities are commonly referred to as upstream companies.
  • The midstream companies are the ones involved in storage of the crude oil extracted by the upstream companies, and in the transportation of that oil to the downstream companies for further processing and refinement. 
  • Companies that are involved in refining the raw crude oil into various petrochemical products are commonly referred to as downstream companies. 
  • The crude oil market consists of two primary variants - Brent Crude and West Texas Intermediate (WTI). These two are the ones that are traded on the exchange through derivative contracts. 
  • The crude oil derivative contract that you see on the MCX website is based on the Brent Crude since it is widely considered to be the international benchmark for crude oil. 
  • The WTI is extracted from oil wells in the U.S.A., which is quite evident from the name itself. It is traded exclusively on U.S. exchanges and is not available in India.
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