3 - The underlying Flashcards
Define a derivative
A financial security whose payoff depends on other, more fundamental, variables such as a stock price, an exchange rate, a commodity price, an interest rate
Why is oil a good commodity?
578 kWh of electricity can be produced from 1 barrel of oil
1kWh will power a 40 watt lightbulb for 25 hours
Oil is high-quality energy
Liquid and easy to transport around the world
Oil production improves overall global wealth
Improves quality of life
What is the law of demand?
When the price of a good rises, the amount demanded falls, and when the price falls, the amount demanded rises
What is the law of supply?
The quantity of a good supplied rises as the market price rises and falls as the price falls
What is market equilibrium?
The supply and demand curves will operate to find an equilibrium
If the determinants of demand change and demand increases how will this affect market equilibrium price and quantity
They will both increase too
If the determinants of demand change and demand decreases how will this affect market equilibrium price and quantity?
They will both decrease too
If the determinants of supply change and supply increases how will this affect the market equilibrium price and quantity?
The market equilibrium price will decrease and quantity will increase
If the determinants of supply change and supply decreases how will this affect the market equilibrium price and quantity?
The market equilibrium price will increase and quantity will decrease
What are non-price determinants?
Are the factors that change supply or demand irrespective of the commodities price
what are the non-price determinants of demand?
Income
Taste and Preference
Complementary goods
Substitutes
Buyers
Buyers price expectations
Availability of information
What are non-price determinants of supply?
Production costs
Core resource demand
Changes in technology
Future price expectations
Number of sellers
Production time
What are the 7 factors that influence oil markets? (drivers of price on supply side)
Non-OPEC
Balance
Non-OECD
Spot prices
OPEC
Financial markets
OECD
who is involved in global oil markets?
Policy makers
Producers
Consumers
Traders, hedgers, speculators and investors
What are the 3 main ‘marker crude’ used to value oil?
1) Brent Blend: 2/3 of all crude contracts reference Brent. Light and sweet, ideal
for diesel, gasoline etc.. and waterborne so easy to move!
2) West Texas Intermediate (WTI) Refers to U.S. wells. Light and sweet, but
landlocked so expensive to ship elsewhere.
3) Dubai/Oman – Middle Eastern oil – slightly lower grade than Brent/WTI –
heavier and more sulphur (sour)
What is a NOCs organisation ?
Government owned national oil companies. National oil companies control the worlds oil reserves and production.
What is a NOCs organisation with autonomy?
NOCs that operate autonomously (will consider state objectives
What is an IOCs organisation?
International oil companies operate in the interest of the company and its shareholders. Although these producers are affected by the laws of the countries in which they produce oil, decisions may not be in the interest of a gov.t
The supply of oil is is considered in terms of which two principal constituents?
Non-OPEC Suppliers
POEC Suppliers
What drives crude oil prices - Non OPEC?
»Production is based on independent/economic decision criteria and operate to a close to maximum capacity
»Tend to be price-takers – cannot/do not attempt to influence prices by varying
production
» Generally, only have access to oil in areas where Exploration & Production
(E&P) Costs are high.
» While increases in non-OPEC supply contribute to lower oil prices, disruptions
of non-OPEC production reduce global oil supply and can lead to higher oil
prices.
What drives crude oil prices - OPEC?
» Generally, OPEC attempts to influence/maintain stable/profitable prices.
» It does this by exercising its market influence through its application or
otherwise of it spare capacity.
» OPEC attempts to manage this by setting production quotas for each of its
members
What are some of the external influences on OPECs ability to influence oil prices?
a) Underlying demand for oil
b) How competitive non-OPEC oil producers are as Oil Prices ↑ (e.g. US)
c) The relative efficiency of OPEC compared to non-OPEC producers
Demand for oil in the OECD?
Oil demand is less prone to variation and is less price sensitive in OECD countries:
Economies tend to be more service orientated so growth does not demand oil
Policies to promote mass transit and oil efficiency of transport systems
Oil price subsidies are lower so consumers are more directly affected by
price variation. However, the ability to reduce consumption is limited in
the short term
Demand for oil in the Non-OECD?
Oil demand is strongly linked to the economic growth or slowdown
observed in these countries. This is because:
» Many manufacturing processes require oil so economic growth and
increased manufacturing capacity create demand for oil.
» Oil is an important fuel for power generation
» The non-OECD countries have seen strong population growth
» As economic wealth has increased the demand for transportation has
increased leading to an increased demand for oil
