The cost of producing gasoline starts with exploration to find oil, and after its discovery, the development necessary to recover it. Oil companies hope to recover these costs over the life of a given oil field.
- Profitable companies must get paid more for their oil than its costs to pump it out of the well and pay for exploration and development. However, as the search for oil goes on, its future price is unknown.
- Because oil is so widely traded, prices around the world become related.
- Different crude oils have different properties and these affect their values.
Different 'kinds' of crude oil
Refiners use computer models trying to optimize the financial return from their facilities. The yields in terms of volumes and current market values are calculated for different crude oils. For example, when a particular crude oil rises in price relative to the overall market, these computer models help determine the most financially advantageous oil to refine.
News reports in North America of the price of oil quote the price of a particular kind of crude, known as West Texas Intermediate (or WTI), delivered in a specific place – Cushing, Oklahoma.
Few refiners use this crude, but it is a 'benchmark' against which other crudes and their prices are compared. The prices of other crudes delivered in other places will be different. Furthermore, because different crudes yield different amounts of the various petroleum products, their prices are not directly comparable. Still, while differences vary over time, they are relatively consistent among the crudes.
You can track the prices of some of the crudes that are processed by Canadian refineries by visiting Natural Resources Canada’s “Fuel Focus Report” website.
Oil markets are not completely free. The Organization of Petroleum Exporting Countries (OPEC) attempts to influence the price of oil by controlling production levels.
Influences on the crude oil market
OPEC’s share of world production, at around 43%, gives it considerable but not absolute influence over prices. When prices rose to record levels in mid-2008, the OPEC countries, with the possible exception of Saudi Arabia, had little spare capacity. With the economic downturn later in the year, OPEC countries were reluctant to cut volumes and reduce their revenues.
Oil on the market trades freely. Trading occurs in several financial centres, including New York, Rotterdam and Singapore. These exchanges trade refined products, too. They deal in 'spot markets' and 'futures.' In a futures contract, a buyer agrees to buy a specified amount of crude oil at an agreed price at a future date. Many of these contracts are traded by speculators who typically sell the contract before the delivery date.
The United States is the world's largest consumer of oil, with a demand of more than 20 million barrels per day out of world consumption of 82 million barrels per day. Events in the United States strongly influence oil prices. The U.S. Government's Energy Information Agency publishes energy statistics. Every Wednesday, its report and analysis of inventory levels, significantly influences short-term oil prices.
Even though Canada is a net exporter of crude oil, our refiners pay the world price for their supplies because our oil producers are free to sell oil to the highest bidder, domestic and foreign. In fact, trade agreements prevent discrimination against foreign buyers.
What about crude oil price speculation?
Controvery exists about the influence of speculation on record prices in mid-2008. In the long run, prices will be more affected by the balance between supply and demand, but, in the short run, speculators, reacting to events such as reports of low inventories or political unrest in producing areas, can significantly influence prices.
Impact of a crude oil price change
The cost of crude oil is the largest single cost in delivering gasoline to motorists, and, over time, changes in crude oil costs influence retail prices. (Yet, costs are not the only influence on prices.)
A change of US$1 per barrel in the price of crude oil affects the cost of gasoline by about 0.63 cents a litre if the dollar is at par. If this cost change passed fully to consumers, the price would move by 0.66 cents per litre, with about 0.03 cents attributable to the GST. When the value of Canada's dollar drops below the U.S. dollar, Canadian oil (and gasoline) prices rise, because oil prices are quoted in U.S. dollars.
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