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Brent Crude

  • February 10, 2021
  • Team Kalkine

What is Brent Crude?

Brent crude or Brent blend is among the two most significant crude oil benchmarks used globally for trading. Sometimes, it is also known as Brent oil or London Brent. It is referred to as sweet because of its low Sulphur content and light because of its low relative density. Brent crude is used to price around seventy-five per cent of the globally traded oil supplies.

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Insights about Brent Crude

To understand Brent crude's insights, one must first understand the basic extraction process related to oil exploration. Oil is explored from the subsurface reservoirs using the drilling technique. A hole is drilled into the reservoir's depth to puncture it and extract all the deposited crude oil with a pipeline to the surface. The extracted oil is not present in its purest form and needs to go through various stages of refining for further use as an end product.

The amount of impurities present in crude oil is directly related to the age of maturation, depth, type of source material, and reservoir rocks. With a higher level of impurities, the crude oil becomes sour; however, it becomes sweet in case of fewer impurities. Sour oil corrodes the equipment, storage tanks and pipeline through which it comes in contact during transportation and storage. Sweet oil has a higher commercial value as compared to the sour oil.

Brent oil is extricated from the oilfields present in the North Sea between UK and Norway. The name “Brent” comes from Brent oil fields which ultimately follows the naming convention of Shell UK division, which named all of its fields after birds like Brent Goose in case of Brent.

When was Brent crude first discovered?

Brent crude was first discovered in 1859 in Atlantic Ocean’s North Sea. The commercial exploration was started in 1966, which was further developed in the early 1970s to ramp up the exploration activities. After the oil pipeline construction in 1975,  Brent crude oil began to be transported to the Saloomwoo oil terminal in Britain for refining.

Which are the other key crude oil benchmarks?

There are two more types of crude oil benchmarks widely used: West Texas Intermediate (WTI) and OPEC Reference Basket.

Mostly produced in Texas, US, WTI is the lightest form of crude oil and is best for gasoline production. On the other hand, the OPEC Reference Basket is the average price index formed by the average crude oil price of 12 OPEC member countries.

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Brent Vs WTI

The significant contrast between Brent and WTI is the source from where they begin. Brent crude is produced near the sea, hence accounts for relatively fewer transportation costs. WTI, on the other hand, is sourced from oil fields in the US. Apart from this, another major difference between both the benchmarks is their prices. WTI witnesses a lower impact of geopolitical issues in its prices because of the landlocked location of exploration. In addition to that, the price of WTI crude remains slightly lesser than the Brent crude due to the recent technological advancements in the exploration of US shale oil.

However, the price trend used to be opposite before the US shale oil revolution, the prices of WTI used to be higher than Brent crude.

Brent Crude Trading

The crude oil commodities begin trading in futures after the 1970 OPEC crisis. Brent futures are traded on the New York Mercantile Exchange (NYMEX) and Intercontinental Exchange (ICE). One contract of Brent futures contains 1,000 barrels of oil.

What are the Factors of Production? Production of anything requires inputs to produce an output, and the inputs used in the production are known as factors of production. Alternatively, these are resources used in the production of goods and services.  Factors of production are also critical to economic growth given the economic growth requires expansion in output/national income or total production. Factors are a class of productive elements, which individually are known as units.  Units are interchangeable and homogenous, moreover, they are perfect substitutes for each other. Factors, which constitute a group of units, are not a perfect substitute for each other. Modern economists prefer using ‘inputs’ instead of conventional factors of production: land, labour, capital and entrepreneurship.  Classification of Factors of production Land Land includes all the natural resources available such as water and air. It constitutes a natural resource that yields income and is exchangeable for a consideration. In the absence of land, water and sun, a farmer cannot produce crops.  Every commodity traded in the world can be traced back to land directly or indirectly. Such as gold is extracted from mines, crude oil is explored and extracted from oil fields, grains are produced in agricultural land. Moreover, the land is arguably the ultimate origination of commodities.  Meanwhile, the quantity and quality of land are vital to yield an acceptable utility for the user. But the availability of land does not guarantee economic growth because the ability to use resource determines the optimal use of the resource.  Land can be further classified as renewable and non-renewable. Renewable resources can be used again and again in the production like an agricultural land used year after year for the cultivation of food, grains etc.  Non-renewable land is not usable again and again and is exhausted as the consumption increases. A gold mine may not yield additional income for a business when ore reserves are exhausted. And a new discovery would provide additional resource.    Land, as a blessing of nature, is fixed in supply. Whether the demand increases or decreases, the supply of land will remain the same. As a result, it is not dependent on the price, therefore supply of land is perfectly inelastic.  Labour Labour does include not only physical but also mental abilities that are done by humans for a monetary benefit. The contribution of labour depends on the size and quality of labour.  For instance, Japan has been successful in the production of small and compact cars, while the US producers were efficient in slightly heavy cars.  Higher productivity of labour will likely deliver favourable benefits. As a human factor, labour cannot be exchanged for value, unlike land and capital. Labour is used with land and capital and cannot be separated. Labour is available in return of wages and is not a saleable commodity. While one cannot store labour for future use, the supply of labour is dependent on the need for production. Labour supply is elastic, and it takes time to develop overall supply. Division of labour emphasises on the speciality of labour in a particular work. Every labour group in an organisation is further classified into various divisions, depending on the quality, skills, knowledge and demand.  Capital  Capital is a critical factor of production and largely means wealth, which includes stock of raw material, machinery, tools, building etc. It is also the money available for productive and investment purposes.  Capital also extends to physical assets such as machinery, raw material that are directly used in the production. Securities such as shares and bonds are not classified because they are not used in production, thus not the factor of production.  It is largely classified into fixed capital and working capital. Fixed capital is used in the production continuously and incur wear and tear. Fixed capital does not mean it is immovable, but the essence of fixed is the cost incurred, which largely remains fixed over the period of production.  The cost incurred in working capital is, however, recovered when the product is sold. Such as the cost of raw material, along with other inputs, is a component of the total cost of the good. Capital also includes human capital.  Human capital is also a vital unit of production and means the education, skills, and health of people. It is essential for the improvement in productivity. It is now understood that investments in human capital provide favourable growth.   Entrepreneurship Entrepreneurship is vital to confluence the factors of production and manages risk & uncertainty associated with the production. Now it is understood that production is a function of land, labour, capital, and entrepreneurship.  Entrepreneurship is more concerned with the incorporation of production, rather business affairs, which are managed by other people working on wages. Therefore, an entrepreneur takes the risk and uncertainty associated with production.  An entrepreneur is responsible for initiating a business enterprise and is engaged in assembling the factors of production, including land, labour, capital and entrepreneurship. Innovation and development are also associated with entrepreneurship.  Entrepreneurs undertake crucial decision of capital allocation, which may include setting up new factors, purchasing machinery, upgrading skills of human capital, innovating units of production etc.  Elon Musk is an entrepreneur aspiring to reach mars, produce e-vehicles, launch space travel. He is effectively managing and bringing about the factor of production to achieve results.  

What is backward integration? Backward integration is a form of vertical integration which involves companies acquiring or creating processes enabling the company to produce its own inputs. These processes are those which the company had previously assigned to other companies up the supply chain. Complete vertical integration is achieved when a company is involved in all the stages of the production process. This can be achieved by the firm either by mergers and acquisitions with the companies in the supply chain, or by starting its own subsidiary to perform the tasks which had formerly been assigned to these companies. Copyright © 2021 Kalkine Media Pty Ltd Backward integration is a form of vertical integration used to make the business more competitive. What are some examples of vertical integration? Vertical integration can be better understood with an example. Consider an oil refining company like Marathon Petroleum Corporation that depends on another firm for providing it with crude oil. Marathon refinery purchases raw oil from other oil exploration companies and is only engaged in refining the oil and selling it. However, if Marathon were to acquire or merge with these oil exploration companies then it would be called a backward integration for Marathon. Consider a restaurant engaged in the production of wheat and potato-based products. The firm usually acquires these products through long-term contracts with farmers or wholesale grocery suppliers. If the firm now decided to start its own plantation growing wheat and potatoes, then it would be a backward integration. Here the firm has chosen to create its own production process without having to merge with or acquire any other company. This gives the firm endless possibilities to change how these inputs are processed. For instance, the firm can choose to opt for organic farming, which it could then advertise to its customers. How is backward integration different from forward integration? A company’s supply chain refers to the different stages involved in achieving the final good. The processes lying upwards in the chain are the initial stages while the processes lying further down are the final stages including the sale of the product or service.  Backward integration involves integrating those production processes into the company’s operation that lie on the upper side of the supply chain. Whereas forward integration involves the integration of those processes into the firm’s operation that lie on the lower end of the supply chain. Forward integration involves companies acquiring or merging with those firms that are engaged in the distribution or in the retailing process of the product. For example, consider a cheese processing company that sells its product to a retailer for resale. If the company decides to set up its own retail chain, or its own digital platform to sell its cheese then it would be forward integration.  What are the advantages of backward integration? Higher control: Integrating upper-level supply chain processes into a firm’s operation gives it higher level of control over how the final good turns out. This also allows companies to conduct their supply chain management more efficiently. Thus, there can be higher level of differentiation in the final goods as compared to other competitors. Additionally, the company would have a fixed supply of input when the subsidiary is engaged in raw material production. Competitive Advantage and Barriers to Entry: Acquiring a company through backward integration can allow access to exclusivity of the supplier. Other companies may no longer approach the supplier once the firm acquires or merges with it. This adds a competitive advantage to the firm and creates barriers to entry for other companies. Cost Cutting: When a raw material producer supplies it to companies lying lower on the supply chain, it would charge a mark-up over the actual cost of production to gain profits. However, if a firm were to become its own input supplier, then there would be no mark-up costs involved for it as it is producing for itself. What are the challenges with backward integration? Copyright © 2021 Kalkine Media Pty Ltd Lack of competitiveness: Removing competition by acquiring the supplier could sometimes have more adverse effects than benefits. Reduced competition could make a firm less competitive and hence less efficient. This could reduce the innovation in the firm and cause it to produce poorer quality products. Financial requirement: To acquire with a full-fledged supplier, firms must have adequate capital. Thus, backward integration can be a huge investment for firms. Many companies may consider debt financing which could end up hurting their balance sheet.

What are Capital Markets? Capital markets are the lifeline of an economy that facilitates funding for Government, corporations, and other institutions. Moreover, capital markets are funding infrastructure for the economy, therefore lifeline.  Savings and investments are channelised to those in need of funding in capital markets. Investors and savers can include households and institutions, while capital seekers primarily include Governments, corporations, and institutions.  Capital markets are the place where securities are exchanged between two parties. These securities incorporate equity, bonds, preferred shares, derivatives, commodities etc. Almost all financial instruments are traded in capital markets.   Kalkine image Primary Market Vs Secondary Market  Primary market is only concerned with the new issuance of securities. The moment security is exchanged between two parties after the initial issue, it happens in the secondary market. A company’s going public move is started through a primary market, where it directly sells securities to specific investors whereas once a company is public, it sells its securities (shares, bonds etc) to a large number of investors through the secondary market.  Investment banks provide primary market services to capital seekers. A firm selling a bond goes to investment banks for underwriting, pricing, and listing of the security. Likewise, an initial public offering is also facilitated by investment banks for privately held enterprises looking for multiples.  Market makers, brokers and dealers facilitate the secondary market for securities. Mostly these market participants are investment banks, but there are plenty of individual companies too providing secondary market services. Kalkine Image What are the types of capital markets? Stock market Also known as equity market, the stock market is the most popular capital market due to accessibility of investments. The liquidity levels in stock market are usually high, given the scale of market participants.  Equity as an asset class has never faded for investors seeking capital appreciation. Stocks represent an ownership stake in the company, and stockholders have voting right on the decisions of the firm. A considerable portion of investors also includes households.  Bond market Debt market provides large scale funding sources to an economy and is very crucial for economic development. Countries issue bonds in the debt market to fund their ambitions, while corporations and institutions have a similar intent.  Bonds as an asset class is considered as safe because of regular interest payments on the principal amount as well as repayment of principal at the time of maturity. The risk of non-repayment of interest and principal is always present.  Government bonds are considered as safest investments in the debt market, and yields on Government bonds depict the risk-free rate at a given point in time. Corporate debt is second to sovereign debt and is relatively riskier than the latter, therefore carries a higher interest rate.   Commodity market Commodities are crucial for the global economy and have been factors of production in many industries. Unlike debt or equity, commodities have a movable presence and are traded extensively across global markets.  As a resource, commodities have tangible demand and supply dynamic and are priced through these two market forces. While there are several types of publicly traded commodities, the popular ones include gold, silver, iron ore, coal, barley, grain, crude oil, platinum etc.  Foreign exchange (FX) market The FX market is an essential part of capital markets, facilitating global trade and cross-currency flows across jurisdictions. Currencies and associated products are traded in the FX market.  This market determines the exchange rate between the currencies of two countries. FX rate or exchange rate is evaluated based on the cross-comparison of various variables of two nations, including purchase power parity, the balance of payments, interest rates, inflation, GDP growth etc.   Derivative market A derivative is a contract between two parties with an underlying asset, which would be exchanged on a specified future date at a pre-determined price.  The value of a derivative contract changes consistently with the change in the value of the underlying asset. But the magnitude of change in the value of the derivative contract would be in multiples compared to change in the value of an underlying asset. The underlying asset to a derivative could be equity, bonds, commodity etc. Derivative also include structured products like total return swap, interest rate swap, swaptions, options, FX swaps etc.  Private market  A private market is a place where securities are exchanged privately between parties. Companies, before going public, trade in private markets. Private markets remain crucial for the development of new businesses and entrepreneurs.  Businesses may experience significant capital activity in the private market. Private equity and venture capital are the prime examples of private market investors, seeking to invest in start-ups, ideas, and budding stories.  Public market Public market is extremely transparent than the private market. In the public market, the investor base is large, and the information flow is extensive. All markets discussed above, except the private market, falls under the public market. 

Risk-adjusted return is typically defined as the return provided by an asset in excess of a benchmark with the same risk factor. For example, if crude oil is a benchmark for measuring the performance of oil stocks and it provides 10 per cent return on YTD basis, and an oil-related stock provides 12 per cent return on YTD basis, the remaining 2 per cent return would be the risk-adjusted return provided that the oil-stock and crude oil contains similar quantifiable risk factors.

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