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Understanding Oil Prices: A Guide to What Drives the Price of Oil in Today's Markets


It’s a fair bet that most of what you think you know about oil prices is wrong. Despite the massive price fluctuations of the past decade, the received wisdom on the subject has remained fundamentally unchanged since the 1970s. When asked, most people – including politicians, financial analysts and pundits – will respond with a tired litany of reasons ranging from increased Chinese and Indian competition for diminishing resources and tensions in the Middle East, to manipulation by OPEC and exorbitant petrol taxes in the EU. Yet the facts belie these explanations. For instance, what really happened in late 2008 when, in just a few weeks, oil prices plummeted from $144 dollars to $37 dollars a barrel? Did Chinese and Indian demand suddenly dry up? Did Middle East conflicts magically resolve themselves? Did OPEC flood the market with crude? In each case the answer is a definitive no – quite the opposite in fact.

Industry expert Salvatore Carollo explains that the truth behind today’s increasingly volatile oil market is that over the past two decades oil prices have come untethered from all classical notions of supply and demand and have transcended any country’s, consortium’s, cartel’s, or corporate entity’s powers to control them. At play is a subtler, more complex game than most analysts realise (or are unwilling to admit to), a very dangerous game involving runaway financial speculation, self-defeating government policymaking and a concerted disinvestment in refinery capacity among the oil majors.

In Understanding Oil Prices Carollo identifies the key players in this dangerous game, exploring their competing interests and motivations, their moves and countermoves. Beginning with the1976 oil embargo and moving through the 1986 Chernobyl incident, the implementation of the US Clean Air Act Amendments of 1990, and the precipitous expansion of the oil futures market since the turn of the century, he traces the vast structural changes which have occurred within the oil industry over the past four decades, identifying their economic, social and geopolitical drivers, and analysing their fallout in the global economy. He explores the oil industry’s decision to scale down refining capacity in the face of increasing demand and the effects of global shortages of petrol, diesel, jet fuel, fuel oil, chemical feedstocks, lubricants and other essential finished products, and describes how, beginning in the year 2000, the oil futures market detached itself almost completely from the crude market, leading to the assetization of oil, and the crippling impact reckless speculation in oil futures has had on the global economy. Finally he proposes new, more sophisticated models that economists and financial analysts can use to make sense of today’s oil market, while offering industry leaders and government policymakers prescriptions for stabilising the market to ensure a relatively steady flow of affordable oil.

A concise, authoritative guide to understanding the complex, oft misunderstood oil markets, Understanding Oil Prices is an important resource for energy market participants, commodity traders and investors, as well as business journalists and government policymakers alike.

SALVATORE CAROLLO graduated in engineering from the University of Palermo, where he also served as a lecturer and researcher. In 1975 he began working at eni; both in Italy and abroad where he was active in various sectors of the petroleum downstream, refining, market research, supply and trading of crude oil. Since 1995 he has been based first in Amsterdam and then in London as the manager of the Upstream Marketing Department, where he is responsible for the commercial relations with several producing countries and eni partners in various joint ventures. Within this area he provides support to eni corporate university, through teaching activities at the Mater MEDEA and organising the annual Oil Market and Commercialization of Crude Oil seminar. He is often called in as an expert by various institutions in the oil sector to provide his own analysis on the dynamics of oil prices.
Foreword xiii

Preface xv

Quick Reference Guide xix

List of Figures xxiii

List of Tables xxvii

List of Boxes xxix

1 TheWorld Crude Oil Paradoxes 1

2 The Market Events from 2008 to 2011 7

World Energy Policy 8

The Financial Crisis and the Oil Market 10

Fundamentals or Financial Speculation? 17

Demand/Supply of Gasoline and Gasoil 21

WTI – Brent Differential 24

3 Evolution of the Price of Crude Oil from the 1960s up to 1999 29

1960–1980: The Oil Monopoly and the Two Crises in the 1970s 30

The 1980s: The Gradual Disappearance of OPEC 33

The Price War 35

1985–2000: From the Introduction of Brent as an International Benchmark to the Clean Air Act 37

The Suicide of OPEC 40

The Start of the Free Market 41

The Consequences of the Environmental Turnaround 44

4 Changes in the Market for Automotive Fuels 45

Evolution of Environmental Demand 45

Gasoline and its Components 50

Reforming 51

Cracking 52

Alkylation 53

Isomerization 53

Refiners Walk the Tightrope 53

The Fiscal Policy of the Industrialized Countries Regarding Fuels 55

5 World Oil Flow 63

Transformations in the Downstream 66

World Supply Structure 70

6 The Classical Model of the International Oil Market 73

7 The Short-term Model of the International Oil Market 81

8 The Brent Market 89

The Sale and Purchase Contract 90

The Forward Market for Brent (15 day Brent Contract) 94

The IPE Brent Market 100

The Divorce Between Oil Price and Oil 102

9 Principal Uses of the Forward and Futures Markets 105

Tax Spinning 105

Benchmarking 105

Hedging the Price Risks 106

Speculations on Operational Flexibilities at Loading 114

Market Structure: Contango and Backwardation 117

Procedures at the Loading Terminals 119

10 Problems of the Brent Forward Market 123

11 The European Refinery Crisis 131

12 Conclusions:We are Ourselves OPEC 155

Bibliography 163

Index 165