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Crude Oil Overview

Crude oil is an important global energy source

What is Crude Oil?

Crude oil is a naturally occurring mixture of hydrocarbons found underground. It can be in the range of a highly viscous liquid to a thick tar-like substance. The color of crude oil can also range from light yellow to dark brown, or black. This substance is one of the most widely used fuel sources around the world, and oil, as well as oil derivatives, are globally traded in oil markets. Crude oil can also be referred to as just crude or oil. This fuel source must be refined before it can be used and once refined, it falls under the category of petroleum products.

 

Crude Oil Pumps

 

Quick Summary of Points

  • Crude oil is one of the most important energy sources used globally
  • Due to the importance of this energy source, a vast market which includes physical trading, as well as derivative trading, exists for crude oil
  • Crude can be classified based on density into a light, medium, heavy, and extra heavy category
  • Crude can be classified based on sulfur content into a sour and sweet category

 

Why is Crude Oil Important?

Globally, crude oil is one of the most important fuel sources and historically has contributed to over a third of the world’s energy consumption. The process of discovering, shipping, and refining crude is a long process, and the infrastructure needed to support the processes must be in place. This involves thousands of miles of oil pipelines across countries, storage facilities in major oil trading hubs, and multiple refineries. In aggregate, the global oil industry is a multi-trillion dollar industry.

This energy source is especially important to businesses that heavily rely on fuel, such as airlines, plastic producers, and agricultural businesses. Being such an important source of energy, crude is a major import and export of numerous countries. Many industries, such as the aforementioned ones are affected by the fluctuating price of oil. The importance of this commodity creates a vast oil market. Here, not only physical crude oil is traded, but oil derivatives such as futures, forwards, and options exist as well.

 

How is Crude Oil Classified?

When crude is discovered, there is no one single variety found. It exists in a number of varying forms, and the composition it is found in will determine how it is transported and refined. To make it easier to compare all these varying crude oils, they are classified by physical and chemical characteristics.

Crude oil can be referred to as either light, medium, or heavy based on the density. The American Petroleum Institute gravity, commonly shortened to API gravity compares the density of crude to water. An API gravity higher than 10 degrees means the oil is less dense than water and will float on it. An API gravity lower than 10 degrees means the oil is denser than water and will sink in it. When referring to oil, an API gravity greater than 31.1 degrees would be considered light. An API gravity between 22.3 degrees and 31.1 degrees would be considered medium. An API gravity between 10.0 degrees and 22.3 degrees would be considered heavy. Finally, an API gravity of less than 10.0 degrees would be considered extra heavy.

The following shows the classifications for crude oil density:

 

Crude Oil Density Classifications

 

Crude oil can also be referred to as sour, or sweet based on the sulfur content of the unrefined oil. Determining the sulfur content in crude oil is an important assessment of quality. Sulfur must be removed when refining crude. If it is not, when released into the atmosphere, it can cause pollution and acid rain. Furthermore, high sulfur content can lead to the degradation of metals used in the refining process. When working with crude that contains hydrogen sulfide, it can also be dangerous as it poses a breathing hazard. Crude oil with a sulfur content greater than 0.5% is considered sour, and less than 0.5% sweet.

The following shows the classifications for crude oil sulfur content:

 

Crude Oil Classification by sulfur content

 

What Determines Crude Oil Prices?

Crude oil prices depend heavily on the two aforementioned classifications. Light crude is easier to refine and produces higher quantities of high-quality gasoline and diesel fuel. It also flows freely at room temperature. The heavier and denser the oil is, the harder it is to transport. Crude classified as extra heavy can also be referred to as bitumen. It is so thick that it must be diluted to transport.

Sulfur content is also very important in determining the quality and thus the price of the crude. As mentioned above, sulfur must be removed during the refining process. High quantities of sulfur also create problems related to transporting and working with the crude.  For these reasons, sweet oil is generally priced higher relative to sour oil.

In general, light, sweet crude oil is the most desirable; however, there is one other very important factor that is priced into crude – the location of extraction. If crude is extracted near the coast, it is much easier to transport globally. When it is extracted further inland, it must be transported via pipeline systems to refineries and eventually the coast if it is to be transported globally.

When determining the price of crude oil, oil benchmarks are used as a pricing tool. There are various benchmark prices that correspond to specific oils, each with a distinct density and API gravity. The most commonly used benchmarks are the West Texas Intermediate as well as the Brent benchmark. Having an accessible price that corresponds to a specific geographical location, density, and gravity allows analysts to compare and determine the prices of different crude oils.

 

Additional Resources

Thank you for reading CFI’s article on crude oil. If you would like to learn about related concepts, check out CFI’s other resources:

  • Financial Modeling Oil & Gas
  • Derivatives
  • Commodities
  • Commodity-Linked Securities

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