If you are thinking of investing in oil and gas or an AIM listed oil and gas company, this article aims to give you some background information before making an investment decision.
It looks at the factors affecting oil prices; the impact of US shale on supply; the different ways of investing in oil, including oil futures; and how the crude oil markets work.
The oil and gas industry
Oil and gas exploration currently generate total revenue of around $2 trillion a year. It employs almost 4.2 million people involved in activities such as exploring and drilling for oil, the production of crude petroleum and natural gas, and the recovery of a wide range of hydrocarbons.
What are the factors that influence oil prices?
As oil is such a crucial commodity, fluctuations in oil prices have a significant economic impact globally. Prices are affected by several factors including:
Demand:
Demand is driven by increased demand for transport and continued economic growth, the demand for oil and gas shows little sign of abating despite the rise in renewable energy sources.
Supply:
OPEC continues to have a significant impact on prices by restricting supplies. While this has been countered by increased output from the US, OPEC is now working closely with Russia to strengthen its grip on controlling world supply.
Non-OPEC supply:
Supplies from other sources such as US shale oil and gas has a downward pressure on oil prices restricting the ability of OPEC to maintain high oil prices.
Weather and climate:
Climate change and local weather have a significant impact on demand and, to a lesser degree, on supply.
US dollar:
The value of the US dollar has a complicated relationship with oil prices. While a declining dollar can lower prices, it can also dis-incentivise increased output which can lead to higher prices. Furthermore, declining oil revenues can depress dollar values.
International conflict:
Geopolitical issues can have a significant effect on prices. Examples of global conflict include the Suez crisis, the Gulf War and the Arab Spring unrest.
Stock levels:
The level of oil held in reserves can impact oil prices, pushing it higher as stock levels decline.
Speculation:
Investors taking a view on the oil futures market has an impact on prices as it can influence the quantity of oil producers release.
Government regulation:
Increasing concern around emissions such as the Clean Air act increase demand for low sulphur content crudes (sweet crude oil) raising prices.
What is the impact of US shale oil production?
The US government has continually challenged the ability of OPEC to maintain artificially high oil prices, especially as US oil production had been in decline since the 1970s, up until 2009. At that point, fracking (the process of extracting oil and gas from shale reserves) became a game changer for the US economy.
By 2014, the US was able to reduce its foreign petroleum imports by 40% compared to its 2006 levels. The availability of shale oil had a considerable effect on global oil prices, which served to limit the influence of OPEC.
Investing in oil and gas?
There are several ways of investing in oil and gas:
- Integrated oil companies: usually more diversified, midstream and downstream, Big Oil companies, such as Royal Dutch Shell
- Independent Exploration and Production (E&P) companies: usually upstream, market minnows, listed on the Alternative Investment Market (AIM)
- Exchange-Traded Funds (ETFs): buying into a basket of oil and gas focused companies, can mitigate risk as ETFs give diversified exposure to several oil companies
- Futures Contracts: these are aimed at experienced or professional investors. While this type of product can be lucrative, they are also risky, and many expire with zero value.
How does the crude oil market work?
Before the oil crisis of 1979, most crude oils were traded short term so that OPEC producers could benefit from volatile and lucrative spot prices. While this was good for producers, it was terrible for oil companies, refiners, and government buyers.
However, after the crisis, non-OPEC production rose rapidly as new fields were opened, creating forward markets for Brent Crude.
In 1983, NYMEX (New York Mercantile Exchange) commenced trading oil futures. The NYMEX platform can be used for buying and selling crude oil future contracts from one month in advance to eight and a half years forward.
Future markets (along with other financial instruments) allow organisations to hedge price volatility. The other major oil futures exchange is the Intercontinental Exchange (ICE).
What are oil futures contracts?
Oil futures contracts are standardised financial instruments which are traded through regulated futures exchanges. For example, a crude oil futures contract can be purchased on NYMEX.
A single contract or lot consists of 1,000 barrels of oil; the terms specify the quantity and quality of oil covered by the contract; the delivery location and the date of delivery.
These contracts cannot be modified, are financial in nature and are settled in cash rather than through the physical delivery of oil.
Where are the best quality oil deposits located?
The highest quality crude oil occurs in Malaysia. It is known as Tapis and is the most expensive oil in the world. The reserve, however, is relatively small. The second, third and fourth highest quality crudes are also from Malaysia, known respectively as Kikeh, Miri Light and Kimanis.
Some of the lightest crudes are Brent from the North Sea, Saudi Arabia’s Arab Extra Light, Bonny Light from Nigeria, and Saharan BIend from Algeria all of which have APIs greater than 37.
To learn more about the density and sulphur content of selected crude oils please click here.
Which countries are the leading oil producers?
The table below lists the top ten oil-producing countries indicating their daily outputs and share of the world’s total oil production.
| Country | Million barrels per day | Share l |
| United States | 15.65 | 16% |
| Saudi Arabia | 12.09 | 12% |
| Russia | 11.21 | 11% |
| Canada | 4.96 | 5% |
| China | 4.78 | 5% |
| Iran | 4.69 | 5% |
| Iraq | 4.45 | 5% |
| United Arab Emirates | 3.72 | 4% |
| Brazil | 3.36 | 3% |
| Kuwait | 2.82 | 3% |
The Oil and Gas Industry
To learn more about the Oil and Gas industry please click here.
