Hi! Thanks for such an interesting question!
The markets of these three commodities are usually affected by
geographical, technical and political forces. This is the reason why
this is interesting and it is not easy to pinpoint a single source of
observation for pricing and profit movements.
I will try to answer your question by providing the market background
and forces for each of the commodity you mentioned. I will provide
small snippets from the articles I will cite but I highly recommend
that you read them in their entirety so as to get a better grasp of
the topic.
OIL MARKET:
a.) Production Background:
?The Middle East is a region that exhibits both favorable
characteristics -- the petroleum traps are large and numerous, and the
reservoir rock holds the oil in substantial pools. This region?s
dominance in world oil supply is the clear result. Other regions,
however, also have large oil deposits, even if the oil is more
difficult to identify and more expensive to produce.?
?After these exploratory tests, companies must then drill to confirm
the presence of oil or gas. A "dry hole" is an unsuccessful well, one
where the drilling did not find oil or gas, or not enough to be
economically worth producing. A successful well may contain either
oil or gas, and often both, because the gas is dissolved in the oil.
When gas is present in oil, it is extracted from the liquid at the
surface in a process separate from oil production.?
?Historically, drilling a "wildcat" well -- searching for oil in a
field where it had not yet been discovered -- had a low chance of
success. Only one out of five wildcat wells found oil or gas. The
rest were dry holes. Better information, especially from seismic
technology, has improved the success rate to one out of three and,
according to some, one in two. REDUCING THE MONEY WASTED ON DRY HOLES
IS ONE OF THE ASPECTS OF UPSTREAM ACTIVITY THAT HAS ALLOWED THE
INDUSTRY TO FIND AND PRODUCE OIL AT THE PRICES PREVAILING OVER MUCH OF
THE 1990'S.? [Emphasis Mine]
?Supply?
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/Supply_text.htm#Where%20Oil%20Comes%20From
?Technology's contribution to finding oil is huge. It cannot change
geology, but by revolutionizing the information available on the
features of a geologic structure, it has enhanced the likelihood of
success. A primary benefit is the ability to eliminate poor
prospects, thus wasted expenditure on dry holes. In addition,
drilling and production technologies have made it possible to exploit
reservoirs that would have formerly been too costly to put into
production and, as described above, to increase the recovery from
existing reservoirs.?
?Upstream Technology?
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/Supply_technology.htm
b.) Global Oil Demand:
?The industrialized countries are the largest consumers of oil but
until 1998 had not been the most important growth markets for some
years. The countries of the Organization for Economic Cooperation and
Development (OECD), for instance, account for almost 2/3 of worldwide
daily oil consumption. In contrast, however, oil demand in the OECD
grew by some 11 percent over the 1991-97 period, while demand outside
the OECD (excluding the Former Soviet Union) grew by 35 percent. The
Former Soviet Union presents a special case. The collapse of the
Russian economy that accompanied the collapse of Communism led to a
decline in oil consumption of more than 50 percent over the 1991-98
period.?
?The developed economies use oil much more intensively than the
developing economies, and Canada and the United States stand almost
alone in their consumption of oil per capita (see graph). For
instance, oil consumption in the United States and Canada equals
almost 3 gallons per day per capita.?
?In the years since the Arab Oil Embargo of 1973/74, transportation
has become a more important component of oil demand, as price and
policy encouraged the substitution where possible of other fuels for
oil. In non-transportation or "stationary" uses -- burning oil for
space heating in buildings, such as homes, apartment buildings,
stores, and schools, and burning oil for power to run factory
equipment, or to generate electricity -- substitution of other energy
sources for oil was possible, some of it immediately and some with the
turnover of equipment. In transportation uses, in contrast, there is
little fuel substitution possible in the short term and only limited
potential in the longer term, given current technology.?
?Demand?
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/Demand_text.htm
d.) Other production related price determinants:
Refining:
?The quality of the crude oil dictates the level of processing and
re-processing necessary to achieve the optimal mix of product output.
Hence, price and price differentials between crude oils also reflect
the relative ease of refining.?
?Broadly speaking, refining developed in consuming areas, because it
was cheaper to move crude oil than to move product. Furthermore, the
proximity to consuming markets made it easier to respond to
weather-induced spikes in demand or to gauge seasonal shifts. Thus,
while the Mideast is the largest producing region, the bulk of
refining takes place in the United States, Europe or Asia. ?
?In general, refining has been significantly less profitable than
other industry segments during the 1990's, as shown in the
accompanying graph. Gross refinery margins -- the difference between
the cost of the input and the price of the output -- have been
squeezed at the same time that operating costs and the need for
additional investment to meet environmental mandates has grown, thus
reducing the net margin even further.?
?Refining?
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/Refining_text.htm
Stocking:
?Holding inventory costs money. How much it costs varies, depending
on the type of oil being stored, how much storage is available,
whether the storage is owned or has to be rented, the price of the
oil, and the cost of borrowing money. In all cases, the cost of
holding inventory can rapidly become significant compared to the
average margins achieved by refiners, marketers, distributors, and
other oil industry participants that might need or want to hold
inventory. Based on average prices in the first half of the 1990?s,
holding crude oil for a year would cost a company about $1.50/barrel
if it had its own storage and $4/barrel if it had to rent storage tank
space. For gasoline, the corresponding costs would be $2 and
$6/barrel. Thus, storing gasoline in rented tank space costs roughly
1 cent per gallon per month. Companies, therefore, try to operate
their supply and distribution systems in ways that keep their
inventories as efficient as possible.?
?Stocks?
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/Stocks_Text.htm
e.) The Oil Trade: (Very Important for Pricing determinants)
?There is more trade internationally in oil than in anything else.
This is true whether one measures trade by how much of a good is moved
(volume), by its value, or by the carrying capacity needed to move it.
All measures are important and for different reasons. Volume
provides insights about whether markets are over-or under-supplied and
whether the infrastructure is adequate to accommodate the required
flow. Value allows governments and economists to assess patterns of
international trade and balance of trade and balance of payments.?
?Generally, crude oil and petroleum products flow to the markets that
provide the highest value to the supplier. Everything else being
equal, oil moves to the nearest market first, because that has the
lowest transportation cost and therefore provides the supplier with
the highest net revenue, or in oil market terminology, the highest
netback. If this market cannot absorb all the oil, the balance moves
to the next closest one, and the next and so on, incurring
progressively higher transportation costs, until all the oil is
placed.?
?In practice, trade flows do not always follow the simple "nearest
first" pattern. Refinery configurations, product demand mix, product
quality specifications ?- all three of which tie into quality -- and
politics can all change the rankings.
Different markets frequently place different values on particular
grades of oil. Thus, a low sulfur diesel is worth more in the United
States, where the maximum allowable sulfur is 0.05 percent by weight,
than in Africa, where the maximum can be 10 to 20 times higher.
Similarly, African crudes -- low in sulfur -- are worth relatively
more in Asia, where they may allow a refiner to meet tighter sulfur
limits in the region without investing in refinery upgrades. Such
differences in valuing quality can be sufficient to overcome
transportation cost disadvantages, as the relatively recent
establishment of a significant trade in long-distance African crudes
to Asia shows. ?
?Trade?
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/Trade_text.htm
f.) Pricing:
?Contract arrangements in the oil market in fact cover most oil that
changes hands. Oil is also sold in "spot transactions," that is,
cargo-by-cargo, transaction-by-transaction arrangements. In addition,
oil is traded in futures markets. Futures markets are a mechanism
designed to distribute risk among participants on different sides
(such as buyers versus sellers) or with different expectations of the
market, but not generally to supply physical volumes of oil. Both
spot markets and futures markets provide critical price information
for contract markets.?
?Seasonal swings are also an important underlying influence in the
supply/demand balance, and hence in price fluctuations. Other things
being equal, crude oil markets would tend to be stronger in the fourth
quarter (the high demand quarter on a global basis, where demand is
boosted both by cold weather and by stock building) and weaker in the
late winter as global demand falls with warmer weather.?
?Prices?
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/Price_text.htm
Further Readings:
?Oil markets explained?
http://news.bbc.co.uk/1/hi/business/904748.stm
?Oil Market Basics?
http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/default.htm
OPEC
http://www.opec.org/
-----------------------------------
DIAMONDS:
The diamond market is probably one of the most puzzling and
controversial market out there. Coupled with allegation of world
monopoly and overall sophistication of the product, this market is a
story in itself.
a.) The Diamond Pipeline:
?The "pipeline" starts with the rough diamonds at the mines. On a
worldwide basis, diamond mining takes place in nations across 4
continents with diverse political, economic, and cultural ideologies.
Diamonds are found in Australia, Botswana, Canada, Namibia, Russia,
Sierra Leone, South Africa, Brazil, Venezuela, China, India,
Indonesia, the Central African Republic, D.R. Congo, Guyana, Ghana,
Guinea, the Ivory Coast, Liberia, Tanzania, and Zimbabwe.?
?Once the rough diamonds leave the mines, they are distributed through
the DTC to their sightholders, or sold via the rough dealers in
Antwerp (the major rough diamond market) to the diamond manufacturers
at the various cutting centers.?
?In the past few years, new sources of rough, from Australia, Russia,
Canada, and parts of Africa, considerably changed the controlled
single market system in a number of ways.?
?After the rough is polished, it is sold by the
manufacturers/exporters, brokers, or dealers to loose diamond buyers:
jewelry manufacturers, jewelry and watch designers, diamond
wholesalers, retail jewelry stores, catalogue showrooms, etc.?
?The final destination of the polished diamonds and diamond jewelry
being the consumer.?
?The Diamond Pipeline - from the Rough to the Polished?
http://www.keyguide.net/rough/
?The diamond market has been controlled by a well-known cartel for
many years, with the mine owners exercising control over distribution
of raw diamonds to cutters and thence to jewelers.?
?Their position is strengthened by the prohibitive cost of developing
a new mine, and the regulations controlling the sale of mining rights.
These effectively combined to prevent new players from entering the
sector, but during the last decade the booming financial markets and
laissez-faire attitude of governments has finally allowed several new
exploration companies to enter the sector.?
?As excitement mounts about the opportunities brought about by
deregulation, one company (let?s call it Global Digging) discovers
huge new diamond reserves deep beneath Siberia. These diamonds have
the potential to revolutionize the industry by reducing the cost of
production by an order of magnitude, and increasing the supply by a
corresponding amount. The only problem is that it will cost several
billion dollars to develop the mine.?
?Global Digging then approaches the diamond cartel with an offer they
cannot refuse. GD will be able to bring its mine into production more
quickly than the cartel would be able to develop a rival source, so
they would be better off getting their supply of diamonds from GD.?
?Diamonds may be forever, but debts must be dealt with: an overview of
the backbone market?
http://www.analysys.com/default_acl.asp?Mode=article&iLeftArticle=1017&m=&n=
b.) Evolution of the Diamond Industry:
I know that you are not interested in the history of the industry but
in the case with diamonds a historical face will provide a much
clearer picture on how the market has developed into today?s industry.
?In 1946 the entire world production of mined natural diamond was
about 5,300,000 carats. It was not long until world economies were
starting to demand more diamond than was then available. Prior to
W.W.II, production of industrial diamond had been far greater than
usage, and the price of industrial diamond collapsed. Boart had
dropped to $0.50 per carat from earlier prices of $3.00 -$4.00 per
carat. By 1950, although world production had increased to
approximately 12,600,000 carats, natural sources were unable to
adequately fill all demands. Then, as now, mining of diamonds was
primarily to satisfy the demand for gemstones; but the by-product of
the world?s most desired gemstones, industrial grade diamond, was fast
becoming the world?s most desired and essential abrasive and tooling
raw material. It is interesting to note that, although only 15% by
weight of mined diamonds is of gem quality, this represents
approximately 85% of the value of all diamonds mined. The balance of
the carats mined, 85%, are crushed, treated or sorted into the
multitudes of types of diamonds industry requires.?
?Throughout the decade of the1950?s, two important factors emerged out
of the need for more industrial diamonds. First, better mining
techniques were developed and new mines were continuously opening.
That expanded volume entering the market gave users confidence there
would be a plentiful supply of mined diamonds. Second, synthetic
diamond became available on a large scale. At the same time, the
technology for producing and using synthetic diamond improved rapidly
to the point where products became commercial viable.?
?By the early 1980?s, many new factors began to affect the supply and
demand of natural diamond. Diamond was now being mined at record
levels. New mines in Australia and Russia, as well as increased
production from Africa and South America, brought to market an
increasing flow of rough diamonds. Competition for many of the
traditional industrial materials emerged as India more and more became
the center for polishing small and inexpensive diamonds.?
?Evolution of the Natural Diamond Industry?
http://www.landssuperabrasives.com/evolution.pdf
c.) Market Background:
?The rough (uncut) diamond market consists of three very different
segments - 'gem', 'near-gem' and 'industrial'. Gem and near-gem
diamonds are used in jewellery and can vary in colour from pure
blue-white, through pale yellow and brown, to the rarest pink or blue
diamonds. Industrial diamonds, because of their inferior quality or
undesirable colour, are used in industry for cutting, grinding,
polishing, drilling and other technical and scientific applications.?
?Approximately 75 per cent of the world's annual production of rough
diamonds is marketed through the De Beers-controlled Diamond Trading
Company (DTC) which markets all De Beers production as well as
production bought from other mines both on long term contracts and on
the open market.?
?As a result, the diamond market has been less prone to the cyclical
price fluctuations typical of many commodities. Rough diamond prices
increased at an average annual rate of approximately 5 per cent
between 1985 and 2000, and substantially outperformed oil, gold and
the Economist commodity price index over that period.?
?The Diamond Business?
http://www.firestonediamonds.com/diamond.htm
d.) Pricing and Profit Factors:
?The diamond pipeline follows the flow of goods from mine to consumer.
At a cost of $1.5 billion, rough diamonds valued at $6.8 billion were
produced last year. The latter figure is an estimate. A noted Belgian
geologist puts the figure at $7.2 billion as he has a different
appreciation of mostly the Congo production. This $6.8 billion goes
through the pipeline to end up becoming $13 billion in polished
diamonds at polished wholesale prices.?
?The rough distribution system is in the process of change and of
streamlining. The graph outlines the domestic requirements of rough in
the cutting centers. The world produces some 125 million carats
annually. Belgium imports and exports double that figure in rough. In
Israel and India, the rough imports exceed their domestic needs.?
?The greatest value addition takes place between diamond jewelry
manufacturing and diamond jewelry retail sales. Incidentally as rule
of thumb, and there is considerable research to support this, on a
worldwide basis the diamond content (in polished wholesale prices)
represents 23 percent in the value of the total product. The other 77
percent represents gold, design value, retailer overhead, profits,
etc. De Beers has made a calculation as to the actual difference
between the cost of diamond jewelry manufacturing and the retail price
of such jewelry. The mark-up is some 100 percent.?
?There is one more aspect relevant to all phases in the pipeline. The
"Just-in-Time" supply method, production efficiencies and faster store
turnovers are making the pipeline less heavy. Traditionally, the
length of the pipeline is measured in time?So, if annual polished
demand (at wholesale polished prices) is about $12 billion, the entire
pipeline was believed to contain two and a half times that amount,
i.e. $30 billion. That seems not to be true anymore. Some researchers
put the length of the pipeline now at 24 or 25 months. In terms of
value, that would come to about $22-25 billion. Others feel it is even
shorter.?
?Global Overview of the Diamond Industry Pipeline Today & Tomorrow?
http://www.diamondsview.com/ed_18_june.htm
Further Readings:
?THE 2002 DIAMOND PIPELINE?
http://www.diamondintelligence.com/Research_Materials_Full.asp?id=52395
?2002 DIAMOND PIPELINE? (Chart)
http://www.diamondintelligence.com/Files/pipeline%202002.pdf
?THE PIPELINE: INVENTORIES SHIFT TO RETAIL TRADE Ripple Effect will
affect Rough Offtake in 2001?
http://www.diamondintelligence.com/Research_Materials_Full.asp?id=51765
-----------------------------
GOLD:
The expensive nature of Gold is of no mystery but the complexity of
its effects to the economy puts one in wonder.
a.) Mine Production:
?Exploring for gold today is very different from in the the past. It
involves the very latest technology, sometimes beginning with infrared
photographs of the earth taken from space satellites. The U.S.
Geological Survey makes these maps available to geologists who
specialize in looking for anomalies in the earth's surface that
indicate gold might be present below the surface.?
?The drills bring up samples of rock which are carefully examined to
see if they contain gold, at what depth, and of what quality or grade.
The samples are chemically analyzed in a laboratory.?
?Then they decide which would be the best kind of mine to design for
this location. They take many things into account, including the depth
of the gold deposits, the surrounding terrain, potential difficulties
in reaching and bringing out the gold, the presence of water, where to
put in roads and buildings, and - among the most important of today's
considerations - the potential impact on wildlife and the
environment.?
?Once the mine has been designed and built, holes are drilled for
blasting, and samples of ore are examined to determine grade and
metallurgical characteristics. The broken rock is marked by type for
efficient processing?
?Refining is the separation and purification of gold from other
metals, as distinct from smelting which is the separation of gold from
mineral impurities. Gold going though refineries may either be
recycled scrap being purified and upgraded or on the final stage of
its transformation from ore in the mine to bullion bars.?
?GOLD MINING?
http://www.goldinstitute.org/mining/mining.html
b.) The Global Gold Industry:
?The dominant producing country for much of the 20th century was South
Africa, which in the early 1970s was producing 1,000 tonnes per annum,
or over 70% of the world total at that time. This position has been
eroded in the past two decades, however, as South African production
has dropped (due in part to ageing mines and reduced flexibility),
while other nations have expanded their output considerably.?
?Nonetheless, in 2002 South Africa remained the world?s largest
producing nation, with just under 394 tonnes and 16% of the total, but
the US was not far behind with almost 299 tonnes (13%), followed by
Australia with 266 tonnes. The most spectacular rises in output over
the past decade have come from Indonesia, which in 1992 produced just
two tonnes of gold and in 2002 produced almost 159 tonnes??
c.) Pricing and Profit Factors:
?Some mining companies refer to their output in terms of ounces, and
their ore grades in terms of ounces per tonne (or in some cases in
North America, per short ton).?
?Grades vary enormously with ore bodies. Generally, the largest South
African underground operations run at between eight and ten grammes
per tonne (i.e. eight to ten parts per million), with more marginal
South African operations grading between four and six grammes per
tonne. At a grade of 10 grammes/tonne, therefore, it takes more than
three tonnes of ore to produce one ounce of gold.?
?Production costs vary widely, according to the nature of the mine, be
it open pit or underground and at what depth, the nature and
distribution of the ore-body (and by implication the metallurgy which
affects processing techniques) and the grade. Average quoted cash
costs for those commercial scale mining companies in the western world
were, in the second quarter of 2003, in the region of US$218/ounce; by
the time additional costs such as depreciation and amortisation,
administration, exploration and other miscellaneous costs are
included, the total is closer to $260/ounce.?
?Mine Production?
http://www.gold.org/value/markets/supply_demand/mine_production.html
d.) Gold Market Dynamics:
An interesting article on gold analyzes that it is a different kind of
commodity because of its three attributes of being homogenous,
indestructible and inventory is large relative to flow in demand.
?One consequence of these attributes is a dramatic reduction in
gestation lags, given low search costs and the well-developed leasing
market. One would expect that the time required to convert bullion
into producer inventory is short, relative to other commodities which
may be less liquid and less homogenous than gold and may require
longer time scales to extract and be converted into usable producer
inventory, making them more vulnerable to cyclical price volatility.
Of course, because of the variability of demand, the price
responsiveness of each commodity will depend in part on precautionary
inventory holdings?
?Finally, there is low to negative correlation between returns on gold
and those on stock markets, whereas it is well known that stock and
bond market returns are highly correlated with GDP. This is because,
generally speaking, GDP is a leading indicator of productivity: during
a boom, dividends can be expected to rise. On the other hand, the
increased demand for credit, counter-cyclical monetary policy and
higher expected inflation that characterize booms typically depress
bond prices.?
?The fundamental differences between gold and other financial assets
and commodities give rise to the following ?hard line? hypothesis: the
impact of cyclical demand ? using as proxies GDP, inflation, nominal
and real interest rates, and the term structure of interest rates ? on
returns on gold, is negligible, in contrast to the impact of cyclical
demand on other commodities and financial assets.?
?Why is gold different from other assets? An empirical investigation.?
http://www.gold.org/value/stats/research/pdf/C%20Lawrence.pdf
?The global trade in gold consists of Over the Counter (OTC)
transactions in spot, forwards, and options and other more exotic
derivatives, together with exchange-traded futures and options. This
section covers only Over the Counter (OTC) transactions? Over the
Counter transactions take place between principals, not through
exchanges. The flexibility of the OTC market, in contrast to the
relative rigidity of transactions on the exchanges, means that OTC
trading accounts for by far the greater portion of the global trading
in gold, unlike the situation in other commodities where exchanges
tend to dominate.?
?In general, mining companies and central banks tend to transact their
business through London and New York. The New York market also
services manufacturers of jewellery and industrial products, and
investment and speculative business; Zurich specializes in supplying
physical gold to manufacturers of jewellery and industrial products.?
?Trading in spot, forwards, options and other derivatives is offered
on a continuous basis. Business is generally conducted over the phone
and over the electronic dealing system.?
?Market Overview?
http://www.gold.org/value/markets/supply_demand/index.html#4
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