I am a gasoline head. In Dubai, I drive an Australian-built, American-badged, 6.0-liter V-8 muscle car. I turn the key, and the eight cylinders immediately burble into life, making that sound only a V-8 can make. The red dash lights automatically illuminate, my eyes roll to the back of my head and I floor it. For the record, I don’t speed as a rule, but I most certainly get to the speed limit as quickly as I can! In Australia, I have a 25-year-old German-built cruise mobile. It is also a hefty V-8. My green credentials are sadly lacking. Neither car is particularly fuel efficient, I admit. When I fill up in Dubai, it costs me about 120 dirhams. When I fill up in Australia, there is no change out of $110 Aussie dollars. If we convert this to USD, in Dubai a tank of gas costs me about $30. The same tank of gas in Australia costs me $100. Now, I know Australia has direct tax, while Dubai does not, but a 300% price difference? So it made me wonder, where does the global oil price come from?
The main oil exporters are Saudi Arabia and Russia, accounting for a combined 40% of the global export market, with the next six producers making up another 40% of this market. None of these producers include the United States or Britain. Yet when we see the oil price, it is almost always quoted as WTI or Brent. WTI is West Texas Intermediate, while Brent refers to the Brent Sea, off the North coast of Scotland. Neither blend of crude is exported or produced in any great quantity, yet they are the global benchmark. Both are priced in U.S. dollars of course.
Despite the fact we have a “global oil price,” the oil market remains highly fragmented and opaque. There are many reasons for this, none of which are particularly convincing, but on average oil is traded twenty-six times in its various forms between producer and end user. It is mostly traded between the same players, as most big producers are vertically integrated operations, meaning they dig the wells, strike oil, transport it, refine it, transport it again and sell to you as gas for your car. Yet it still trades on average 26 times.
The next big oil producer will be Iraq. It is the next great frontier market. The war in Iraq is not just about oil, it is about which economic model will be deployed there: capitalist, communist, Islamic, or Western (a discussion for a later column). Iraq has some of the biggest, most accessible, best quality crude reserves on the planet. In terms of production, Iraq should become the world’s single biggest producer and exporter within the next ten years, with daily production targets of around 14 million barrels per day. Russia and Saudi Arabia each produce approximately 10 million barrels per day.
Oil is currently priced against WTI and Brent, whose prices are largely derived from speculators in New York and London. These speculators watch weather reports to see if a hurricane is approaching the Gulf of Mexico, and might affect production there. The fact that two-thirds of the world’s daily oil passes through the Strait of Hormuz between Iran and the United Arab Emirates seems to be less important. It is less important to the price of WTI because WTI does not pass anywhere near the Strait of Hormuz. And there lies the problem with how we price oil globally. We do not. We price it regionally using speculators and then try to put square pegs in round holes in order to get a global oil price. The price of oil from Russia or Saudi Arabia similarly should not be affected by weather reports in the Gulf of Mexico, but it is because WTI is used as the benchmark to price oil. In today’s world of instant information delivery, it is an ironic situation to say the least.
The actual oil demand and supply equation plays a distant back seat to the fear and greed equation. It is mostly oil price speculation via non-deliverable futures contracts which give us the oil price that we see flashed on our TV screens today. Oil exploration and production is a long term game with huge infrastructure costs associated, but it was speculation not demand or supply which took oil to USD $145 in 2007 and back to USD $25 in 2008 to today’s current level of USD $80.
So despite all these facts, figures and speculation, I am far from clear why my V-8 in Australia costs me three times as much to fill the tank as my V-8 in Dubai. What does seem to be a bit clearer is that how we price oil globally is very unclear and that needs to change. In the meantime, I better start saving for my next driving holiday in Australia.
Global Markets are anything but integrated. What if we had a paradigm shift in the way we think, the way we actually do business with each other, between nations. Balanced global trade can only occur if we have transparent, accessible, efficient markets, with standardized contracts and on a standardized platform of global exchange. We are on the cusp of achieving this, although most people cannot see it. Sam’s Exchange aims to give its readers a clearer view and a platform for discussion. Markets, trade and economics are in fact nothing more than the result of our thoughts and actions expressed in numbers, not the reverse.
Sam Barden is CEO of SBI Markets General Trading LLC, a Dubai-registered trading and advisory company. Barden, 39, has worked in the global financial markets for more than 17 years in Europe, Russia and the Middle East. He has advised and executed strategic transactions for both the government and private sector, in particular in energy and commodity markets, advising various energy producing nations on their strategic market developments and interaction. He holds a degree in economics and finance from Victoria University, Melbourne, Australia.