Marketing

Once refined, oil products enter the complex and dynamic global market. The oil market extends world-wide. Market balance for one product is also connected to the market balance for another. These region-by-region and product-by-product supply and demand patterns interact to establish the price level for crude oil and its products.  The interaction is constant and usually invisible to anyone not directly involved in the oil industry. As a general rule, the thousands of transactions that take place simultaneously on the oil market are completed without fanfare. The price fluctuations are small, and of interest only to the buyers and sellers within the industry.

However, at times, oil market stability can be, and has been, disrupted by a number of factors, suddenly bringing oil prices to the headlines.  Demand surges, refinery outages, and supply cutbacks can all cause price run-ups. Some, like refinery outages, logistics snags or demand surges in a cold snap, cause a price spike -- prices shoot up initially and then recede again when the supply and demand balance has been re-established. After others, like the crude oil price declines experienced during 1998 or the crude oil price increases experienced during 2000, it takes longer to return to the underlying price trend.

How Oil Markets Function

Oil markets are essentially a global auction -- the highest bidder will win the supply. Like any auction, however, the bidder doesn't want to pay too much. When markets are "strong" (when demand is high and/or supply is low), the bidder must be willing to pay a higher premium to capture the supply. When markets are "weak" (demand low and/or supply high), a bidder may choose not to outbid competitors, waiting instead for later, possibly lower priced, supplies.Contract (or "term") arrangements in the oil market cover most of the oil that changes hands.  Oil is also sold in "spot" transactions, that is, cargo-by-cargo, transaction-by-transaction arrangements.  In addition, oil is traded in futures markets. Futures markets are a mechanism designed to distribute risk among participants on different sides (such as buyers versus sellers) or with different expectations of the market, but not generally to supply physical volumes of oil.  Both spot markets and futures markets provide critical price information for contract markets.

Prices in spot markets send a clear signal about the supply/demand balance. Rising prices indicate that more supply is needed, and falling prices indicate that there is too much supply for the prevailing demand level.  Furthermore, while most oil flows under contract, its price varies with spot markets.  Futures markets also provide information about the physical supply/demand balance as well as the market's expectations.