Who are the buyers, who are the sellers | Oil Trading 101

0:00 oil markets oil prices where do they come from who sets them who are the buyers who are the sellers that's what we're going to talk about today this is very 101 okay but there are some little keywords in here i want you to pick up on because they're very important and hopefully we will kind of wind down some of our political chatter because we'll recognize the political chatter at times was written by people like me 13 years ago all right futures contracts the oil markets are in the futures market we do not speculate in options there are differences between options and futures but the fundamental one of the fundamental differences with an option when you buy a when you buy a call option or a put option or sell a call in

0:45 a put option if you buy a long call today on exxon at ninety dollars for june 2022 you have purchased the right but not the obligation to buy a hundred shares of exxon at that stock price on that expiration date the futures contracts are binding agreements they're different the buyer and seller are obligated to make that purchase now there are two types of people who trade oil and i'm not talking about you i'm not talking about me i'm not talking about what my wife does the primary people who are doing this are hedgers and speculators oh and let me answer that question for you options

1:35 profit calculator all right so hedging is designed to protect yourself obviously right you want to if you have a hundred shares of um of apple stock at 165 and you own it for the long haul but you're worried about a significant downturn you might buy a put on apple at 150 and if the stock falls below 50 you have the right but not the obligation to sell your stock at 150 on or before that that uh strike date hedgers do something very similar they are effectively using futures contracts in order to hedge against volatile price movements very relatively simple so

2:23 if you are an oil producer and you are producing oil at 100 a barrel today but there are concerns that the market might go down over the next 12 months you would potentially hedge by maybe selling some of your contracts at 95.95 maybe you go up the ladder maybe you you looked for contracts at 105. or their speculation oil is going to go from 100 to 150 maybe you sell it 120 yet oil goes all the way back you're using it to hedge and a lot of this is much easier in the oil markets than it is in the agricultural markets because agriculture takes longer to produce obviously you're growing in the fields where oil you're pulling it out of the ground and then moving it oil hedging is a little bit easier and a

3:10 little bit less volatile speculators are doing what we do right we speculate on the on the potential price movement of something at a later date and at the same time you know a company that is going to purchase a uh purchase fuel purchase oil for maybe refining or maybe uh for uh you know potential to develop plastics or whatever it is that they need it for they will speculate on prices as well they will use hedging as a way to ensure that they lock in a price that they want at a specific level but then they will speculate elsewhere and look for opportunities to bring in at a lower price where the producers will speculate on prices and try to get higher prices uh where they can so those are the two mechanisms of the market

3:56 everybody following me eric does that make sense i understand everything you're saying and i'm loving it all right so let's talk about this there are three primary benchmarks in the world there is west texas intermediate that is u.s oil that is the u.s u.s markets i'm going to pull this up real quick and i'm going to show you because we talk about it every day over here on finviz you see crude oil wti that is the u.s benchmark that is priced in new york at the nymex crude oil brent that is a second benchmark this is the global benchmark it is priced in the north sea north of scotland that is where brent the uh where the royal dutch cell shell and that production really had kicked off that is the global

4:44 benchmark but there's a third one now and that is dubai dubai has its own benchmark as well that really covers the middle eastern now those three benchmarks we talk about wti and brent crude the most because brent crude and wti dominate the market dubai has its local market it's very important and it's going to be even more important in the decades ahead but i want to point this out there are hundreds of different types of crude around the world there there are multiple types of crude in saudi arabia there are multiple types of crude here in the united states there are multiple types of crude in south america what matters at the end of the day is and is sulfur content and location

5:29 so in the united states the united states has very low levels wti crude is known as a quote unquote sweet crude that means it has less sulfur content it is easier to process it is easier to refine dubai crude is medium crude but medium light medium sweet a little bit more sulfur brent crude is heavy it is it requires far more refining and what's interesting about this is that brent crude for a long time traded under wti for a long time and it was because wti was more desired by refiners it's cheaper to refine

6:15 rent crude higher sulfur now some places in in the middle east have extraordinarily high levels of sulfur so you'll hear a lot about refining networks we're going to talk a little bit about refining networks and what they mean it's very important but just for now know we talk about west texas intermediate and brent all the time this is the global benchmark brent wti is the u.s benchmark dubai crude in a couple of years maybe ten years from now five to ten years it will show up on cnbc's ticker and we will talk about it because it is going to be very important to the india and the chinese markets in the future who buys crude the united states buys more crew than anybody else hands down we buy we use 18.2 million

7:02 barrels per day in 2020. we produced 11.3 million per day now that does not mean barrels of oil equivalent that means barrels of oil and i'm going to get into the difference between that china uses two 12.7 million per day that is 50 but their average consumer uses 50 percent less oil than the us consumer so when somebody says that the us consumer is going to increase its use of oil by 2.5 percent next year in order for china to match that the average consumer would effectively need to increase their produce consumption by 5 as they're already consuming well less than us so you can see on this chart the united states is about 25 percent of

7:47 global purchases china's about eight japan's about six and the eu is 18. who sells the most oil okay the united states is technically still the largest producer in the world we're doing about 11 12 billion per per day saudi arabia russia second and third and canada is fourth however opec is critical opec is the world's largest global oil cartel they own the bulk of the reserves in the world and they work together in order to manage the production of their member states so let me take you through opec real quick opec is was founded in 1960 they have 13 member nations it

8:33 is a cartel if you've ever seen a beautiful mind john nash he created uh effectively the game theory of of cartels and that cooperation is better than competition so if these countries were pulling oil out of the ground and trying to sell it on the open market there would be a free for all because they'd be producing as much as they possibly could in order to get as much as they possibly can for their oil what this group did they banded together and then they set production targets for each nation in order to maximize profitability they all work together in order to reduce their production to it reduce the amount of available oil on the global markets and by doing that it drives up the price now not to be undone the united states

9:19 dramatically increased its production in 2008 thanks to the shale revolution we became the largest producer in the world we were reliant on opec right well opec went and started to band with a handful of other nations that in a group that is called opec plus and opec plus consists of russia mexico uh kazakhstan south sudan sudan oman brunei bahrain and uh as a azerbaijan i can never can never pronounce that no matter how many times i try so you have nations like venezuela you have saudi arabia you have the uae and kuwait and libya and nigeria and everything of these every single one of these countries has different break-even points every single one of these countries wants higher energy prices because every single one of these

10:05 countries heavily relies on oil in order to finance their state governments and all of their welfare programs so a country like saudi arabia that just came out of this crisis that has expanded its debt balance sheet that is working to increase the amount of things that it can provide for its citizens they want higher oil prices they are not going to take they are going to keep their foot off the gas as much as they possibly can because they want oil prices to get to a hundred dollars per barrel however sometimes opec messes up sometimes opec makes a huge mistake where they don't cut production because they don't foresee that global demand may potentially fall that happened last year at the onset of

10:51 the 2020 crisis that also happened back in around 2011 through 2013 when oil prices were up around 100 bucks they did not cut production and as a result of that oil prices fell to 40. so opec is the most important component of the global energy sector they have roughly 79.4 of the proven oil reserves in the world and they account for i believe anywhere between 40 and 45 of global output that number actually might be low on my estimate um i have not looked at the eia number lately that opens the question of who sets the price well the price is set by you and me it's set by oil traders refiners producers hedge funds pension funds speculators your grandmother if she's taking a

11:37 long-term or short-term position on the nymex crude but i point this out supply-wise opec plus is the biggest driver of supply in the market it heavily dictates the price on the supply side of the quote-unquote supply and demand curve demand heavily obviously in the united states even though we do a lot of production of our own but china is increasingly increasing its energy demand and as a result of that china is also getting closer with a lot of those nations in the middle east so they are effectively trying to drive more of that production to them and that creates issues of energy security for the united states which opens up this question

12:22 we've talked about this we've gotten into this in the chat we've talked about energy independence okay energy independence what is that well it's the idea that the united states would be able to produce all the energy and live off of it and we would not need anybody else okay energy independence is a political term and i know it because i know the person who wrote it i worked in a group i worked at a a political shop in 2009 2010 one of my one of my big clients was the american petroleum institute in the wake of the bp oil spill so i know how the sausage is made on language around this the more important term is called self-sustaining that is the economic term energy independence sounds really patriotic right

13:09 well self-sustaining is the real term and that is the ability to produce enough of the energy that it meets local demand this is a term that agricultural economists use on a regular basis we'll talk about how the united states is self-sufficient in corn the united states produces way more corn than it could ever eat that's important but the more important component of quote-unquote independence and and self-sustainability is security energy security and the united states does not have energy security we are reliant on canada we are reliant on other exports keep in mind the united states is massive i believe something like 80 percent of our population lives within 100 miles of the ocean i have to go back and look at that but that's a

13:54 that's a seems like an arbitrary enough statistic that i would know um our refinery networks are in the southeast our people live primarily on the coasts um we move things across pipelines but even then that's not the most secure way to do things we move a lot of things by rail we have to import import into the gulf coast in order to produce and move things through our refinery networks and that's really really critical so while we might have had quote-unquote we might have produced more energy than we did for the first time in 1957 and 2019 it doesn't necessarily mean that we are self-sustaining because you have to be able to get the crude and all of the other uh different types of energy to everyone in the nation and we are very good at getting

14:40 it to the people in the northeast we're pretty good at getting it to people in texas but on the west coast in certain areas some of these kind of expanding places around the country we're not as good and you can see that in uh in the fluctuations in oil prices that are dependent or in gasoline prices that are dependent of policy like tax policies in different states there are three components to the energy sector in the united states there is the upstream and these are the energy exploration and production companies think of a company like diamondback or eog resources which is part of the money morning live portfolio these companies pull oil out of the ground now i'm going to talk about chevron and exxon in a moment but i want you to just think of the pure play emp

15:26 companies that's what we call them diamondback they're in they're in the permian basin they just pull oil out of the ground and they sell it and these companies typically use the futures markets to hedge they'll speculate a little bit when trying to sell things they'll keep things in order but remember things typically operate on the futures market if uh things need to go to a spot market those spot markets exist where you can purchase fuel it uh you know whatever the current price of today is remember the futures go out a few months i believe we're on the january con maybe the december contract right now so that's very very important delivery is always typically through cushing oklahoma that's the the primary primary point but again it doesn't have to go there at the end of the day because we are not operating like a 1920s chicago

16:12 futures market anymore where you deliver the cattle to the to the feed lots and then people pick them up all right so the benefits of investing in the upstream components of the oil markets are when the oil prices rise those stocks go higher these companies typically have a good access to capital markets they're able to drill usually you know before uh before we got into the big climate change debate uh this was um or at least within the within the bond markets with esg um this was a relatively stable industry for lending uh these companies would go out get money expand build their reserves and as oil prices rise and fall these companies can go higher or lower so if we predict that oil prices are going to go to 120 a company like eog resources or

16:59 diamondback which is f-a-n-g they're going to do a lot better the second component is the midstream and we talk about this on a regular basis and remember you are absolutely right we are lng rich we're going to talk about that in a moment these companies generate revenue through the center of the supply chain so they do storage of oil and gas and gasoline and oil and gas let's stick there oil and natural gas pull it out of the ground put it into pipelines put it into storage put it into places where you're going to generate capital like you're charging rent so these typically have very strong reliable cash flow and it doesn't matter what the price of oil is because you still have to move it through the supply chain every single day so they're charging rent it's like trying to cross

17:45 a bridge from one side to the other they operate the bridge and what's interesting about this is the tax structure in the united states allows for what are known as master limited partnerships because the companies generate 90 of their revenue from the assets which are pipelines or their storage facilities they are able to skip one round uh they can skip corporate uh corporate taxes they are structured differently and because of that they pass on their profits roughly 90 of their of their cash flow directly to their to their uh shareholders so enter enterprise product partners enter energy transfer they operate under those environments and that's why you can see a six percent to 10 dividend with potential appreciation upside as they

18:31 expand their businesses across the country the last part of this is the downstream and the downstream are the companies that refine and process crude into products right so you're turning oil into gas or plastics or jet fuel these companies tend to be a little bit more speculative on their trades they don't want to have to lock in you know too far into the future unless they know that it is going to be beneficial for their profit margins they can struggle when oil prices rise because they operate under tighter margins and one of the things that's extraordinarily confusing about what's happening right now the us government is going to release they're going to double down on the idea that oil prices are going to go lower they're going to release oil from the strategic reserve and as a result of that refineries that want to

19:18 rev have to avoid uh filling refilling the spr at higher prices at a later point they're going to have to be forced to buy the 2022 oil futures contracts or opt out of this exchange with the white house entirely as a result oil prices are probably going to go higher so this is going to be a very short term thing here you might see a little bit of a bump in these companies like valero because the lower oil prices coming from the strategic reserve could easily help their profit margins for a short period of time but you got to keep in mind the spr has to be refilled it'll be refilled at higher prices and as a result you may very well see uh higher oil prices in 2022 and that's one of the reasons why guys like kyle bass who's a hedge fund manager came out and said this is the stupidest thing they could possibly do oil prices are

20:05 most likely heading to 120 next year refineries one of the more important things that people need to know refineries typically never operate above 90 capacity so there's a reason why we're not flush with cheap gasoline all the time it's because our refineries we have we don't build a lot of them here in the united states we typically our network is along the gulf coast here in the united states down where i am places like california are trying to shut down the refineries because of their their climate policies but these refineries typically never run above 90 because they need to have excess capacity in case of of uh greater demand and ken pointed out that last point you're absolutely right opec is planning to respond to this coordinated uh effort because they might just not increase

20:50 their production for the year ahead and that would be relatively bad now real quick question what do you think the difference is between the united states and the other nations this is in uh this is in a place that i've traveled to nigeria this is flaring at night this is effectively where your refineries you just burn everything because you can't uh you can't uh get rid of all of your crude or you can't get rid of all your natural gas you think we do this here in the united states chat i would say it is not a good idea to invest in valero right now so flaring yeah we do it and we do it heavily up in the bakken i read it i read an article earlier that we might at times burn upwards of 19 of the natural

21:36 gas they pull out of the ground at the place where they're pulling it out because they don't know where to put it they have to straight up burn it into the sky so that is a serious issue and moving forward we're going to be uh there's going to be laws that are likely going to impact that that will impact producers how much crude and natural gas they pull out of the ground so a recap this is what the supply chain looks like offshore and onshore pumping platforms processing storing pipeline transfer distribution purification and ultimately selling it to the people um but reality this is really what it looks like there is the upstream the midstream the downstream and then back to the midstream because once you refine it turn it into gasoline you have to store it again you got to transport it again and then it ends up in your home heating products propane things like that so

22:21 that is it that is the global oil market in 20 minutes what do you think eric i think you did a great job breaking that down garrett i'm glad i'm glad you enjoyed it i hope that everybody's on i hope everybody's thoroughly confused no i'm kidding