In mid-2008, crude oil shocked energy markets as it reached an all-time High of $147/barrel (Bbl.) on the New York Mercantile Exchange. (See Figure 1 below.) Within four months, prices had sunk to $50 per barrel. Then, again in 2014, prices hit a High of about $100/Bbl in June only to fall to under $50/Bbl by December. How could this happen and what were the factors causing this level of price volatility? We will be exploring these questions in Lesson 2.
At the successful completion of this lesson, students should be able to:
This lesson will take us one week to complete. There are a number of required activities in this module. The chart below provides an overview of the activities for Lesson 2. For assignment details, refer to the location noted.
All assignments will be due Sunday, 11:59 p.m. Eastern Time.
REQUIREMENT | LOCATION | SUBMITTING YOUR WORK |
---|---|---|
Reading Assignment: Oil & Gas Basics Video Viewing Assignment: Understanding the Drilling Process Reading Assignment: Fracturing Operations |
Lesson 2 Reading Assignment page | No submission |
Lesson 2 Activity: "Fundamental" Factors exercise | Lesson 2 Activity page | Submit through Canvas |
Lesson 2 Quiz | Summary and Final tasks page | Submit through Canvas |
If you have any questions, please post them to our General Course Questions discussion forum (not e-mail), located under Modules in Canvas. The TA and I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.
Before we begin our discussion of the logistics and value chain for natural gas and crude oil, we need to have at least a cursory understanding of the “upstream” processes for the exploration, drilling, fracturing, and production of these fossil fuels. The following readings and video support this learning.
Oil and Gas Basics
Go to the PetroStrategies web site [1], click on the section marked "Oil and Gas Basics" and read the following sections:
Understanding the Drilling Process
The focus of this course involves the sectors of the oil and gas industry known as “midstream” and “downstream.” These occur after the exploration and production, or “upstream” processes. In these videos, you will view this aspect of the energy industry and see how the drilling, completion and production of an oil and/or gas well is accomplished from start to finish. This will give you a cursory understanding of how oil and gas is developed. The midstream and downstream activities start once the oil and gas has risen to the top of the well and is ready to be produced.
Fracturing Operations
Go to the PetroStrategies web site [2], click on the section marked "Fracturing Operations" and read the following sections:
Economists have long recognized that we are truly a global society and all of our economies were intrinsically tied-together. Growth or recession in one region of the world could have a ripple effect on other regions. China and India were emerging as large-scale industrial countries with vast exports of manufactured goods. Both were consuming new, higher levels of energy, and most specifically, crude oil. News of increasing crude imports by both countries sparked buying of the financial commodity contracts.
The so-called “speculators” were blamed for a lot of the price increase that year, but there was a whole new set of players who greatly influenced the market. Investment funds and private investors, both domestic and international, saw the crude market as a “safe harbor” from the ups-and-downs of the stock market and the US dollar. When the stock market fell, they bought crude oil contracts. And when it rose, they sold those same contracts. The dollar is a little more complicated. When the value of the US dollar falls relative to foreign currency, overseas investors have more “buying power,” that is, they can buy more crude with their currency than those holding US dollars. So to some extent, it is true that “traders” had a major influence on oil prices that year. But the definition of “trader” had changed from the stereotypical “day trader,” who wreaks havoc on markets, to sophisticated investors and real demand from emerging nations.
Today, the economic health of various countries still impacts the volatility in oil prices, and the US dollar and crude prices have a very high but inverse correlation. Concerns over the stability of Portugal, Ireland, Spain, and Greece (not so politely known as the “PIGS”) impact the perception of world demand for oil on a daily basis as the collapse of even one of them could create a “domino effect” across other economies. Various economic reports on growth, manufacturing, etc. are monitored continuously.
And, geopolitical conflicts involving oil-producing countries and regions always cause concern over potential supply disruptions.
US oil production has risen steadily over the past (10) years and currently stands at about 9.0 million Bbl. per day. This represents a +13% increase from 2013 to 2014 alone and now stands at a 30 year high. Production for 2015 & 2016 is forecasted to remain slightly over 9.0 million Bbl/d. Current production represents only about 53% of consumption, with the remainder coming in the form of imports. However, as Figure 2 shows, imports continue to decline as domestic crude supplies increase.
The rise in domestic oil production is mostly attributed to the new, “unconventional”, sources found in shale formations. Advances in seismology (“3-D”), directional drilling (“horizontal”) and, fracturing methods (“fracking”), have made this once inaccessible resource common place today. Contrary to some beliefs, the number one source of imported crude oil in the US is not the Middle East but, Canada. Oil from tar sands in their Western Provinces is shipped via pipeline into the US.
Figure 1 shows the upward trend in oil production over the past (6) years with projections to 2016. (Based upon the latest completed study by the Energy Information Agency of the US Department of Energy.) Figure 2 shows the downward trend in oil imports for the same time period.
Many, many factors can influence the price of crude oil either directly or, indirectly. Some of the major factors influencing US crude oil prices are:
The following video goes into greater detail for the factors which can influence crude oil prices. (The lecture notes can be found in Modules under Lesson 2: Supply/Demand Fundamentals for Natural Gas & Crude Oil in Canvas.)
In contrast to crude oil, natural gas is almost strictly a domestic North American commodity* whose price is more influenced by weather and the health of the US economy. Other factors, such as the level of US natural gas inventory, impact prices on a weekly basis. While US economic indicators, such as the stock market, employment figures, housing and, manufacturing indexes, are deemed to be indicative of demand for natural gas, global economies and the US dollar do not have much affect on pricing in this country.
Natural gas is used in more than 50% of US homes for space heating and hot water. In addition, it is the second largest source of energy for electrical generation behind coal (Figure 1) and is widely used in commercial and industrial industries. Figure 2 illustrates the break-down by consuming sector.
The main sources of natural gas supply in the US are domestic production, imports and, Liquefied Natural Gas (LNG). Canada again represents the largest source of imported natural gas, with Mexico contributing a minor amount. Additionally, there are export points into Canada and Mexico. The map below indicates the major import/export and, LNG import points in the US.
Domestic production in the US has grown dramatically in recent years due to the same advanced technologies that have allowed crude oil production to increase: “3-D” seismology, horizontal drilling and new “fracking” methods. All contribute to successful recoveries from hard formations such as the new “shales.” Figure 7 illustrates the growth in production of the currently active shale basins in the US.
Among the major factors influencing US natural gas prices are:
The following video goes into greater detail for the factors which can influence natural gas prices.(The lecture notes can be found in the Modules under Lesson 2: Supply/Demand Fundamentals for Natural Gas & Crude Oil in Canvas.)
As we explore pricing for crude oil and natural gas in a later lesson, we will consider the major influential factors for each and define their individual impact. We will also have a weekly activity about the market prices for crude oil and natural gas and the factors we believe affect them.
*In a future lesson, we will discuss the plans for exporting natural gas in the form of LNG. That will make North American natural gas a global commodity similar to crude.
You may wish to print this page to circle each corresponding decision (bearish, bullish, neutral) as you work through the scenarios.
Read each of the factor examples and scenarios given below for crude oil and then for natural gas. For each scenario, determine whether it could have a “bearish” (lower prices), “bullish” (raise prices), or neutral impact on the commodity price. When you are finished with the scenarios, synthesize them in your own mind to generate a recommendation to buy or sell the commodity.
Keep in mind, these are actual energy commodity contracts and not "stocks". So, you are buying or selling the actual commodity using the financial contracts. These decisions are also about trading for a profit. That is, if you think prices are going to rise, you want to buy contracts now and sell them later when prices do rise to make a profit. Conversely, if you think prices are going to fall, you would sell contracts now and buy them back later when prices do fall to make a profit. Buying or selling a commodity contract now is called "taking a position" and then offsetting that with a sell or a buy at a later date is called "closing a position." In the Fundamental Factors activities that follow in the weeks ahead you will be asked to take and close a position in crude oil and natural gas each week. For this week, however, we will warm up by focusing on understanding the various factors influencing crude oil and natural gas prices.
Read through these factor examples to help you with the scenarios that follow.
Determine whether each scenario could have a “bearish” (lower prices), “bullish” (raise prices), or neutral impact on the commodity price.
Given all of these, would you Buy crude oil contracts (you think prices will rise, i.e., "Bullish") or Sell crude oil contracts (you think prices will fall, i.e., "Bearish")?
Read through these factor examples to help you with the scenarios that follow.
Determine whether each scenario could have a “bearish” (lower prices), “bullish” (raise prices), or neutral impact on the commodity price.
Given all of these, would you Buy natural gas contracts (you think prices will rise, i.e., "Bullish") or Sell natural gas contracts (you think prices will fall, i.e., "Bearish")?
Please answer the following two questions:
This Fundamental Factors activity will be worth 30 points, as per the EBF 301 grading scale described in the syllabus. You will earn two points for each of the crude oil and natural gas factors that you interpret, and 2 points for each buy/sell recommendation that you include and explain in your response. Each factor has to be explained individually, how it is going to affect the market and prices. You will also earn two points for each of the trading questions that you answer correctly and completely. Your trading suggestion should be based on the overall evaluation.
Submit a single word processed document with your responses to the Crude Oil/Natural Gas Scenarios and the Trading questions to the Lesson 2 Fundamental Factors Activity in Canvas.
Now that we have examined production and consumption in the United States as well as the energy “mix,” we will focus on the fuel sources that comprise over 57% of the energy used in this country. Crude oil, with refined products, and natural gas and related natural gas liquids (NGLs) make-up this large sector.
Complete the Lesson 2 Quiz
You have reached the end of Lesson 2. Double-check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there before beginning the next lesson.
Links
[1] https://web.archive.org/web/20150930155519/http://www.petrostrategies.org/Learning_Center/oil_and_gas_basics.htm#What%20are%20Crude%20Oil%20and%20Natural%20Gas?
[2] https://web.archive.org/web/20150930215323/http://www.petrostrategies.org/Learning_Center/fracturing_operations.htm
[3] http://www.eia.gov