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Benchmark Oil and Oil Characteristic
Oil has reached three years high at USD 72 per barrel due to the geopolitical tension in the Middle East.
Besides West Texas Intermediate (WTI) and Brent, the other major benchmark crude oil in the world is Dubai Oil and Shanghai Oil. Shanghai Oil is a Futures product launched two weeks ago and it aims to provide a much more accurate pricing for Asia oil market.
The grade and varieties of crude oil are measured by API Gravity and Sulphur Content.
API Gravity is a measure of how heavy the oil is compared to water. The Greater the number of API, the lighter the oil is. Heavier crude is harder to be refined into petroleum
Sulphur Content is the impurities found in the crude oil. If the sulphur level is higher than 0.5%, the oil is considered sour. Impurities need to be removed before the sour oil can be refined into petroleum.
Due to the different characteristics of oil, Malaysia Tapis is usually traded at a premium of around USD 4 per barrel to Brent while Alberta Oil Sand is traded at a discount of USD 30 per barrel to WTI.
However, investors should understand that although WTI has been trading at a discount against Brent, WTI is a higher quality oil. The reason for the trading discount is due to the oversupply of oil in US and the higher demand for oil in Asia. (Oil field that produces Brent Oil is nearer to Asia)
Oil Investment Cycle
Historically speaking, the oil & gas sector goes through long, 30-year investment cycles driven by the market’s risk appetite for long-term investments. Here are some insights on the oil & gas investment cycles.
Oil Investment cycle is long
Since 2014 we’ve been in the Contraction phase of the cycle, as the market absorbed the oversupply generated by the 2003-2013 Expansionary phase. The costs to drill a barrel of oil is now 50% lower, making new investments profitable once again.
EV is making the oil supply market tighter
The focus on the electric vehicle is dis-incentivizing investments in long-cycle capacity. While shale provides enough short-cycle production to prevent the market from running into shortages, the lack of long-term investment keeps the physical markets tight. Concerns about EV demand displacement is taking more future supply off the market through lack of financing. Decarbonization is actually having a net tightening effect on the oil market.
Oilfield Service Provider benefits the most
Cost tends to rise in the Expansion phase of the oil investment cycle, led by perceived future supply shortages, easy credit, market fragmentation and rising inefficiencies. Cost inflation compounded at 10% per year in the 2003-13 period, destroying the producers’ returns and only partially benefitting oil services.
In contrast, during the Contraction phase, returns improve slowly but consistently, led by an oligopolistic market structure, better management of the supply chain, and advantaged resource access.