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Trading Oil Futures

If you are going to be successful in trading oil futures then you need to understand the role that OPEC plays ( whether overtly or covertly) in the control and management of international oil markets, and hence the prices of crude oil. To simply call it a cartel, is in my view too simplistic, although according to it’s statutes one of it’s principle goals is ” the co-ordination and unification of petroleum policies of the member countries and the determination of the best means for safeguarding the Organisation’s interests both individually and collectively”, which I guess comes fairly close! It goes on to say “The Organisation shall devise ways and means of ensuring the stabilization of prices in international oil markets with a view to eliminating harmful and unnecessary fluctuations.”

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Created with just 5 founding members in 1960, OPEC now has 12 member countries¬† including relative newcomers such as Angola and Ecuador. Above is a table showing the current members and some of the basic facts regarding each which I hope will give you some idea of the power that OPEC wields in the market, although as we will see shortly, this has waned since the early 1980’s. Three things should become instantly apparent from the above figures. Firstly the importance of Iraq and Iran, secondly the refining capacity of Saudi Arabia compared to other states, and finally the lack of exports from Iraq and Iran compared to other much smaller member states. It makes interesting reading, but even so, let me put this into context for you – current estimates put the reserves of the recently discovered Alberta sands oil fields of Northern Canada, at a conservative 2 trillion barrels ( eight times the size of the Saudi’s reserves ), and as the technology and extraction techniques improve, these estimates are likely to increase.
Trading Oil – How OPEC Works

Each member country selects representatives, who in turn choose a governor for their country, who attends the two meetings held each year. The governors also choose the chairman. The meetings are held to set prices of oil and oil products in order to keep the price and supply stable with fair returns to investors. To increase oil prices OPEC decreases production and to reduce prices it increases overall supply. In addition to increasing and decreasing supply for price reasons, this also occurs for political reasons, either to highlight an issue or to obtain support from a larger neighbour.

OPEC’s years of dominance were essentially in the late 1960’s to the early 1980’s where much of the world’s oil supply was controlled by member states, and it is generally considered that OPEC’s response to any crisis is generally weak at best, and often hopelessly ineffectual.¬† With the growth of new markets such as Russia, the Gulf of Mexico and Northern Canada, their power has been slowly waning, and their long term future and power will ( I believe ) depend on three factors. Firstly the oil requirements of member states themselves, secondly the future oil demands of the world economies, and finally the increase in alternative energy sources. T Boone Pickens, an energy consultant and seasoned oil trader, suggests that daily demand for crude oil is currently averaging around 86.4 million barrels a day, with current production around 85.0 million barrels a day – he suggest that prices will keep on rising until demand is driven down to meet ongoing supply, assuming no new major supplies of oil appear. In other words, as I said on page one, economies will eventually adapt and the weaker will be forced out of the market through an inability to pay ever higher prices. I will cover this in more detail when we look at supply and demand.

At the current rate of production and usage OPEC has around 80 years of reserves left – at that point their power will cease in all senses of the word! Ironically however, it is not supply that is the key issue in the next few decades but that of refining. As we saw in the above table, many of the major producers have limited refining capability, and the US has not built a new oil refinery in over thirty years so it is questionable whether the world could cope with a sudden increased in demand for refined products anyway. It’s one thing to extract, but a very different business to refine.

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You may be wondering how OPEC arrives at a “world” oil price¬† – the answer is the price basket which is ( as the name suggests ) a “basket” of crude oils which are then averaged ( we will look at the principle types of oil extracted, exported and traded on the markets shortly).

From 1st of January 1987 to the 15th June 2005, the average price was based on seven crude oil streams and blends from members such as Saudi, Venezuela, Algeria and Indonesia amongst others. Since then, and in order to reflect a more representative market this has been increased to eleven oil streams From 2000 onwards, these average basket prices have been as shown alongside. To track the daily and other time frame basket prices please just follow the link here – OPEC basket prices.