17 March 2022

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How global oil production works, and how it affects your business.

The global oil industry – and therefore fuel prices – are likely to remain in the news for some time and will directly affect the finances of your business if you run petrol and diesel vehicles.

So here’s everything you need to know about the sector, worth $3.3 trillion annually

UK consumption

In the UK we consumed more than 120 million tonnes of oil in 2020, with all forms of transport accounting for around 40 million tonnes - a third of that total - although overall demand was down around 30% due to the effects of the pandemic. Petrol accounted for 9 million tonnes and road diesel 19 million tonnes.

Energy provision

Oil and gas are part of the UK energy need, but there is much talk about energy provision and security. Ultimately that means being able to source enough supply from other countries, or produce it yourself.

The UK is now a net importer of oil (and gas, which comes along with the drilling of oil) with the Netherlands, as the main European trading hub, the largest source of transport fuel.

Thanks to the North Sea oilfields, the UK became, in general, a net exporter between 1981 and 2004, with production peaking in 1999. However, by 2020 28% of all energy used in the UK was imported.

The dependency on oil has reduced in the last 20 years though: consumption of oil has dropped by 40 million tonnes a year, while energy from low carbon sources, due to a focus on renewable sources such as wind and solar, has doubled to contribute 20% of overall energy supply needs.

How global oil production works

There are three inter-linked sectors in the global oil business, and they can be characterised as upstream, midstream, and downstream.

  • Upstream

    Exploration and production (E&P) firms are those working in the upstream sector, looking for reservoirs and drilling to extract from them. They are closely linked to governments and the oil cartels because of geopolitics and the high levels of investment (and risk) involved.
  • Midstream

    Midstream organisations transport oil, on tankers, trucks and by pipeline.
  • Downstream

    Downstream firms take the oil supply from midstream partners and refine it into useable products.

What’s in a barrel of oil?

There is a lot of talk about production of barrels of oil, but what actually is a barrel, and what is really in it? One barrel of oil, which holds 35 UK gallons (about the same as a beer barrel), will have many different destinations, and includes approximately the following, although it can change depending on region, demand and season:

45% Petrol

Petrol accounts for just under half of a barrel of oil. Once refined, it is then blended with biofuels and other additives before it reaches the forecourt.

25% Ultra-Low Sulphur Diesel (ULSD)/Heating Oil

Diesel and heating oil (which are chemically identical at this stage) make up the second largest share. Diesel for road transport use is blended with biofuels too.

9% Kerosene/Jet Fuel

Kerosene is a light petroleum for heaters, lamps, cooking stoves, and water heaters.

4% Hydrocarbon Gas Liquids

These ‘gas liquids’ are used as feedstock to make various chemicals, plastic products and synthetic rubber.

The price of oil

Content and quality of oil can change hugely depending on the reservoir, and where in the world it has been drilled.

As a result, in order to try and create some clarity around pricing, oil barrel prices are usually referred to by two main benchmark types (although there are many more): West Texas Intermediate (WTI) and Brent Crude.

WTI refers to the type of oil produced and traded in North America. It’s a lighter oil than Brent Crude, which is the European standard.

As well as the geopolitical issues pushing up prices, there are other reasons for the record levels, because oil prices have been this high before. One reason, for example, is the added cost from the increasing proportion of biofuel, as stipulated by the Renewable Transport Fuel Obligation (RTFO).

The biofuel is called FAME (fatty acid methyl ester) and is nearly three times as expensive as standard diesel. From January 2022, the biofuel element in diesel rose from 9.93% to 11.72%.

So, 88.28% of regular diesel plus 11.72% of FAME meant that the price of a litre of diesel overnight went up by approximately 1.9ppl (excluding VAT), on January 1, 2022. And each year until 2032, the biofuel element – and therefore cost - is due to rise.

Crude oil prices are extremely reactive and therefore volatile. While it may take time for the price of fuel at the forecourt to adjust because of the various stages of the supply chain between extracted barrel and pump, traders buy and sell all the time, based on numerous factors, such as perceived supply and demand.

But because oil is traded as a commodity, rather than an end-use product, the price rarely reflects accurately the need on the ground at any time. Future risk to supply, or concerns about reduced demand, are reflected in the day-to-day barrel price.

One of the major influencers of oil prices is OPEC, made up of 13 countries: Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, the United Arab Emirates and Venezuela.

OPEC controls 40% of the world's supply of oil and so can adjust production to suit its aims. In 2021, it produced nearly 32 million barrels per day.

Alongside OPEC (of which Saudi Arabia is the second largest producer on its own with 10.8mn, but the largest holder of surplus stocks), the USA is the largest with just over 11mn although it has stated this will increase to more than 12mn in 2023), and Russia third with 10.5mn. However, with the war in Ukraine, this is likely to change.

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