Changes in the Market Structure

No longer is there a market structure in the oil industry based on rigid long-term, commercial arrangements. It has been replaced by a more efficient one. Now the buyers and sellers have greater flexibility in establishing commercial relationships that better meet their respective needs. The market structures are transforming. The global oil industry has seen a transformation in the contractual structures used to purchase and sell crude oil over the last 25 years.

Transactions which involve the near-term purchase and sale of a commodity, such as crude oil and refined products are called “spot markets”. Spot contracts typically involve delivery of crude over the coming month. Since they entail the buying and selling of physical volumes, spot markets are also referred to as the “physical market”. Refiners, traders, producers, and transporters all buy and sell these markets. The benefit of allowing buyers and sellers to more easily adjust their crude supplies is achieved depending on the near-term supply and the demand conditions in both the product markets and the crude oil markets.

In contrast to a spot transaction, a futures contract concerns the future purchase or sale of crude oil or petroleum products.
Specifically, it is a contract that carries the obligation for delivery of a given quantity of crude in the future. The contract specifies the volume, type or grade of crude oil, the price, the future time in which the crude is bought or sold, and the particular location to which it is to be delivered. The buying and selling of futures contracts occurs on organized exchanges.

The futures market is often referred to as the “financial market.” The crudes underlying futures contracts are often called “marker” or “benchmark” crudes. Thousands of independent traders, including both commercial as well as financial institutions get involved in competitive organized exchanges. The prices in the spot market transactions are often tied to prices for crude oil on organized exchanges. Price adjustments account for differences in the quality of the crude oil being traded; plus the location of the spot market transaction is considered. The oil industry uses various types of contractual structures and financial instruments. The trade press most commonly reports the prices of futures contracts which are watched by the public.

Futures markets bring a number of benefits to the global oil market. Crude oil futures markets provide information about future expectations regarding supply and demand conditions. To manage risk facilitated, crude oil producers, marketers, and refiners are able to use the financial contracts on the exchanges. This trading process becomes beneficial to those who can respond to this information. It provides the economic incentive to build inventories if the higher futures prices will cover the cost of storage.

Future markets bring together valuable information about the market’s expectations about future supply and demand conditions in the physical market – conditions that will ultimately determine the price for oil. Oil companies like Triple Diamond Energy Corporation use the future markets to gauge their supply capacity and to make business transactions.