Appendix A The Crude Oil Market

The free market for crude oil is more mature than that for natural gas, but still only dates back to about the mid-1970's. With the myriad of refined products which emanate from crude oil (including heating oil, jet fuel, propane and gasoline) few corners of our industrial and commercial marketplaces are untouched by price and supply fluctuations in crude oil.

Because of its unique transportation method (pipelines instead of barges) pipeline disruptions are a major factor contributing to the volatility of the WTI contract. With few exceptions, US legal restrictions prohibit the export of domestic crudes except in the form of refined products.²⁸ However, on November 28, 1995, President Clinton signed into law a bill which will lift the 22-year-old ban on oil exports, allowing exports of Alaska North Slope crude oil by June 1996. The effect of this new law is unclear, though analysts expect it to have little impact on world oil prices.²⁹

Bans on crude exports have meant that US crude is not internationally tradable and thus it is possible for the relationship between WTI and other benchmark crudes to become severed in times of international upheaval, such as occurred during the Gulf crisis. At that time, the price differential between Brent (the major benchmark crude outside the US) and WTI crudes got as high as $3/barrel³⁰ (Brent over WTI) largely because WTI crude essentially could not be exported to meet international demand imbalances. As a point of reference, this relationship histori­cally trades at approximately $1.50.

Crude oil presently accounts for approximately 40% of world energy supply and is the world's most actively traded commodity.³¹ Outside of the US, Brent crude is actively traded on the International Petroleum Exchange (IPE) in London as well as the Singapore International Monetary Exchange (SIMEX) as of June 1995. On September 8, 1995, the NYMEX linked their electronic ACCESS^SM system with the Sydney Futures Exchange's (SFE) Sycom electronic trading system. This link allows SFE members to trade NYMEX energy products during the lengthy ACCESS^SM trading hours. The success of this link will depend on the success of hedging Tapis (that region's benchmark crude oil) with WTI crude which is not the customary pricing mechanism in the region.³²

Oil is denominated in US dollars internationally. This factor has caused chagrin among OPEC (and other interna­tional) producers during times of dollar weakness. Exhibit 9 plots the price of the front month crude oil future rel­ative to the US Dollar Index during the period 2/1/95 through 8/21/95. While numerous other factors impact the price of crude oil, it can be seen that dollar weakness is often accompanied by an increase in the price of crude oil.

Exhibit 9

Crude Oil vs. US Dollar Index

Feb. 1 through Aug. 21, 1995

Date

— Dollar Index —Crude

During the Gulf War of 1991, the last major disruption in world crude prices, both the NYMEX and the IPE market were closed at the time of the initial confrontation, leaving the cash WTI and the forward Brent markets as the only open trading vehicles. Prices gyrated wildly during the night that US forces began their attack on Baghdad, with price swings moving as much as $14/barrel.³³ With the addition of the NYMEX ACCESS^SM and the SIMEX Brent contract, however, accessing reasonably liquid crude markets around the clock is very plausible. Thus, even during an event of extreme uncertainty, the ability of so many market participants to transact virtually around-the-clock would probably serve to stem volatility.