In the oil and gas industry, one of the most commonly used terms is commodity prices. While this term extends beyond the crude oil and gas industry, its implications are very important for this particular industry. It can be the deciding factor for profit and loss. Especially for the different parties involved in the extraction and sale of minerals.
Someone who works in the industry or buys and sells oil and gas royalties should know its meaning. So first, let’s quickly discuss the literal meaning of it.
Commodity Prices Definition
Commodity prices reflect the price in real-time of a commodity.
A commodity, as defined by Investopedia, is any good or material in commerce that is interchangeable with a similar good or material. There’s not much difference between the same commodity or goods coming from different producers.
Examples of commodities are crude oil, gas, grains, gold, metals, and beef.
With the advancement of the finance sector and technology, the term ‘commodity’ now even applies to bandwidth or foreign currency.
In simpler words, commodity prices are the rate a commodity (exchangeable good) is sold or bought.
These prices play a very big role in both economics and finance. As commodities are used to produce goods and services. So the commodity prices ultimately define the prices of goods and services. Normally, these prices are dependent on demand and supply.
Commodity Prices in Oil and Gas
In the oil and natural gas industries, the prices of oil and gas are also referred to as commodity prices, as crude oil, shale oil, and natural gas all are commodities. The commodity prices for oil and gas are referred to as the wellhead price. These prices are calculated using an oil and gas pricing index.
To understand commodity-prices meaning in the context of oil and natural gas, it’s fundamental to understand wellhead price.
Wellhead price is the price of oil or gas at the mouth of the well when it has not been adjusted for treatment, transportation, or distribution.
Mineral owners typically receive the wellhead price for the minerals (commodities) extracted from the well to which they have mineral rights.
What Determines Commodity Prices?
In general, are important for determining the prices of many things we use daily. So a common question is who or what determines those prices.
Generally, these prices depend on demand and supply. The more demand there is for a particular commodity, the higher the price is. Conversely, the lower the demand or higher the supply, the lower the price is.
In the oil and gas industry, the commodity prices for natural gas or crude oil also mainly follow the general demand and supply phenomenon.
It’s important to note that commodities are also exchanged in markets called commodity markets. There are over 20 major commodity markets around the world that have a big impact on the prices of different commodities traded. That eventually also influences the price for gas you add to your car or the cup of coffee you purchase at a cafe.
These prices are not set by a single entity, rather a number of factors are at play. Economic factors play a vital role in the fluctuating prices we see every day.
For instance, a major political event or a natural disaster can dramatically fluctuate the prices of oil and gas and really any kind of commodity.
When it comes to oil prices, there’s another thing that ultimately decides the price. The price of oil is largely determined by the oil futures market.
Commodity Price Cycles
In economics, there’s also a thing called the commodity price cycle which states that the these prices have a cycle over a certain period of time. This is purely based on historical data that shows oil prices peaking at close intervals.
Cycles are just guidelines essentially and don’t have a big say in the oil pricing. Market trends, sentiments, and futures play a bigger role.
Big players in the oil market can also influence the prices. It’s typically countries with leverage over oil production. For instance, OPEC, which comprises 13 oil and natural gas producing countries often influences oil prices by controlling production.
Similarly, other self-sufficient oil producers like the US, China, Russia, and Canada also have an influence on the oil market, and consequently, the oil prices.
Why is Commodity Prices Important For Oil and Gas Royalties?
Commodity prices, in this case, oil prices or gas lease prices, play an important role in determining oil and gas royalties. However, it’s important to note that there are other dedication factors as well. The royalties also depend on how much value is a certain factor has, which can vary by agreement.
While royalties ultimately depend on the royalty percentage, which can vary from state to state. Generally speaking, if the commodity prices for oil or gas are higher, the royalties will be higher as well.
Again, the royalties depend on how much oil or natural gas the well produces, so even if these prices are trending upward, the royalties can be low if the oil well production is low.
The royalties may also be influenced by the potential of the well or land. For example, the total acreage of the field or the total amount of minerals in the field.
For anyone buying or selling royalties, it’s important to keep an eye on the commodity indexes and commodity prices, in general, to see where the prices are heading. This is why using a professional with the right expertise is crucial when it comes to buying or selling oil and gas royalties.
Now that you understand commodity prices meaning, you can understand the meaning of the term in contracts or in the news. There’s not one but many factors that influence the prices of commodities, including oil and gas which are still pretty high-demand commodities.
The prices can fluctuate greatly at times due to socioeconomic factors. Nevertheless, oil and gas royalties can sustain those fluctuations easily as commodity price is only one determinant.