A selective history of financial energy markets

Oil and gas markets as we know them today are far younger than many realize, and financial energy markets are positively immature. Yet even in that short time, financial energy markets — particularly oil markets — have seen several distinct structural “eras” of price behavior that are important to understanding how today’s markets behave.

US oil prices were not fully deregulated until the early 1980s, and it was not until then that spot markets grew; the benchmark West Texas Intermediate futures contract didn’t launch until 1983. European benchmark Brent was discovered in the early 1960s, North Sea crudes became commercial in the late 1970s, and Brent futures were introduced in 1988. US natural gas prices, meanwhile, weren’t fully deregulated until the early 1990s ( and in fact transport and distribution pricing is still regulated) and Henry Hub futures started trading in 1990. Financial markets for international gas are, by comparison, still in their infancy.

A highly abridged version of the pre-financial era

After World War II, the United States was the dominant producer of oil in the world. But shortly thereafter US net imports of crude started to grow, forcing the US to look abroad. Development of non-US oil by the so-called “Seven Sisters” — five American and two Western European oil companies — increased. Even so, until 1970 the Texas Railroad Commission effectively played the role that OPEC plays now, by limiting or “prorating” Texan production to manage prices. By 1971 Texas no longer had any spare capacity, and lost pricing power as a result.

OPEC formed in 1960 in part as a general nationalist reaction of producer country governments to the out-sized influence of the foreign oil companies, and more specifically in response to receiving sharply lower prices for their crude oil production because of a global supply glut. OPEC really didn’t get its mojo, though, until the US pricing power evaporated in the early 1970s and the 1973 Yom Kippur War / Oil Embargo led to dramatic price spikes. In response to the price spikes, the US instituted price controls, which lowered prices to consumers but also led to shortages during supply disruptions, because neither US consumers nor producers got a “true” price signal that would have led to the types of behavior changes required to balance the market.

Globally, price spikes led to lower demand and higher competition among producers. OPEC discipline was poor; prices fell though did not collapse in the first half of the 1980s as Saudi Arabia (at times with help from other producers) attempted to keep the market from going off the rails at the expense of its own market share. By 1985 Saudi Arabia was no longer willing to prop the market single-handedly and this policy change took the form of “netback pricing” which exacerbated the subsequent price collapse. Netback pricing gave buyers of Saudi crude a guaranteed refining netback. In other words, the price refiners paid for crude was a function of the prices they received for refined products. For a comprehensive explanation and analysis of netback pricing,