Oil Prices and Big Oil – Myth versus Reality

Posted: May 12th, 2008 by: h2

Oil prices are of course directly related to the cost of their primary raw material, crude oil. And crude oil prices are hitting record high after record high (aproaching $126 bbl for June futures). The rise in crude oil prices has at least 3 separate causes:

  1. The rapid devaluation of the US dollar. It has gone from about .85 to the Euro to up to 1.60 to the Euro, a collapse of about 45% in 10 years. So every barrel of oil now costs that much more to sell. That is the fault of the current debt hungry Republican administration, and republican admistrations going back to Ronald Reagan’s. So all you ‘personal responsibility loving republican’s out there, now you know where to start the blame game, right in your own house.
  2. Global supplies peaking while demand is rising. All you free market loving people, this is what you wanted, a free commodity market, and this is what you get. When demand exceeds supply, prices rise.
  3. And a bit added on the top, speculation in commodities, turning the right to buy commodities into a commodity itself, which is also in shorter supply, thus, again, the price rises to meet demand.

However, if you graph all of these, you’ll find that the primary driver is the supply/demand curve, not the ongoing collapse of the US dollar. Oil is currently at about 6-12 times 1998 prices, but the dollar lost less than half its value, so hopefully even the most math challenged among you can work out the difference, which is too much demand for too little supply.

The Problem: We are Running Out of Easy to Find and Drill Oil

The price of oil is rising not because of the so called ‘oil companies’, who currently control only about 20% of the globally produced oil, but because global supply has been plateaued now for about 3 years, while demand has been rising. And that plateaued production is not composed of the same crude oil type mix that it was decades ago. Most newly added oil is of the heavy or tar sand type. That’s what Saudi Arabia’s alleged extra capacity is, it’s what Venezuela is producing in its Orinoco fields, it’s what Canadian tar sands are. Such heavy oils are much harder to extract and process, and require more energy to handle.

In other words, if you take tar sand bitumen, and refine it into usable oil, there is a serious energy cost to that process, about 1 barrel for every 6 refined, so the cheaper price vanishes since you need to use more energy to refine it than you would need with the light sweet crudes we built our current industrial systems around.

And the energy costs of finding then extracting the latest deep water fields like the ones Brazil is trying to exploit now are in the same area, about 1 barrel to produce 5 barrels. And the costs in both cases are massive.

Big Oil is Not Actually Nearly As Big As You Believe

This process has almost NOTHING to do with big oil companies, in fact, big oil rarely is even involved in most large developments, except in the USA and Canada, where the concept that the civic body, the people, should own their resources, aka resource nationalism, has not yet found a place in the political sphere. The companies that are at the cutting edge of oil production are big oil service companies like Halliburton, Schlumberger, etc, as well as the companies we think of as ‘big oil’.

As you can see in this list of the worlds largest oil companies, by size of reserves, the companies you think of aren’t even in the top 12 (numbers in billions of barrels of stated reserves).

List of petroleum companies, wikipedia

(Note: most if not all OPEC stated reserves are wildly exagerated, at least double what the numbers most probably actually are due to unexplained increases of OPEC reserve numbers.)

You have to go pretty far down the list before you hit a single company you would recognize as ‘big oil’:

[ranking: company: liquids: natural gas: Total Reserves in Oil Equivalent Barrels,
Million Barrels]
17 ExxonMobil Corporation (United States) 8,194 32,480 13,746
20 Chevron Corporation (United States) 7,806 22,894 11,720
21 ConocoPhillips (United States) 6,696 26,835 11,283
25 Royal Dutch/Shell (Netherlands) 3,270 30,058 8,408
Worlds Largest Oil and Gas Companies, www.petrostrategies.org

And these reserves are dwindling rapidly, and are not being replaced, which means current discoveries are only about half of what is being produced. And many of those additions are actually just buyouts of other oil companies.

Shell Oil Begins to Tell At Least Some of the Truth About Global Oil Production

Some companies, such as Shell, actually admitted to the same type of reserve inflation that the Saudis for example are still pretending didn’t happen. Shell, of all the majors, in fact, seems to be taking the position of truthfulness more than most. Their CEO has been on a basically non-stop speaking tour warning the world that oil production is going to peak very soon. Considering that it’s most likely already peaked, that’s a bit late, but better late than never.

In a rare moment of candor, Jeroen van der Veer, the chief executive of Royal Dutch Shell, acknowledged what many have long considered a forgone conclusion: the end of the oil era is almost upon us, and sooner than you might think. The The Oil Drum retrieved an e-mail sent to all Shell employees in which the CEO admitted the obvious:

“Regardless of which route we choose, the world’s current predicament limits our maneuvering room. We are experiencing a step-change in the growth rate of energy demand due to population growth and economic development, and Shell estimates that after 2015 supplies of easy-to-access oil and gas will no longer keep up with demand.”

He went on to criticize the sluggish response by policymakers to the coming energy crisis:

“Taking the path of least resistance, policymakers pay little attention to curbing energy consumption – until supplies run short. Likewise, despite much rhetoric, greenhouse gas emissions are not seriously addressed until major shocks trigger political reactions. Since these responses are overdue, they are severe and lead to energy price spikes and volatility.
Jeroen van der Veer, the chief executive of Royal Dutch Shell

Why Big Oil is Making So Much Money Now, and Why Refining is Not the Problem

The reason big oil makes so much money is because it controls oil reserves, and is profiting from the per barrel price rises just like the oil producing nations are. The actual refining margins are at the lowest levels they’ve been at for years, around 8% now, down from about 25% some years ago.

The quarterly survey of six analysts put the consensus forecast for U.S. Gulf margins in 2008 at an average $12.67 a barrel, a fall from the average $16.60 for 2007.

“Refining margins are currently near their historical lows relative to the crude price. Our worst case scenario assumes that refining margins continue to decouple from crude prices and fall to the lows of 2002,” Goldman said in its research note.
Tue Mar 4, 2008, Reuters

And another article on refining margins from kiplingers.com:

From the start of 2004 through the end of 2007, the gap between the cost of crude and the price of refined products was wide. During that period, the gap — called a “crack spread” in the trade — peaked at $28 a barrel in May 2007 for the spread between Brent crude and unleaded gasoline. In some locations, the spread reached $40. The normal historical spread is about $20. Shares of Tesoro soared nearly nine-fold from the start of 2004 through October 2007.

But starting in the spring of 2007 the crack spread started to narrow. It disappeared altogether this past winter, before recovering in March. Valero says its spread averaged $8.50 in the first quarter of 2008, a weak showing.
Oil Refiners: Cheap for a Reason, kiplinger.com

This means that the cost you pay at the pump would actually be higher if ‘big oil’ were actually doing what you think they are doing.

The Solution You Will NOT See Discussed: Nationalization In the Name of National Security

The actual solution to big oil profits, which you will not see discussed in the US, is nationalization of oil. Just like Russia, China, Indonesia, Venezuela, Saudi Arabia, and most other oil producing nations have done. But that won’t happen here, don’t worry, we will not do more than talk, given the size of the campaign contributions (nifty oil company donation calculator) big oil makes, you can rest absolutely assured that they will keep pulling in record profits, with only superficial, and purely cosmetic, adjustments made along the way.

During the time that Bush and Cheney, both of whom are former oil executives, have been in the White House, the oil and gas industry has spent $393.2 million on lobbying the federal government. This places the industry among the top nine in lobbying expenditures. The industry has also contributed a substantial $82.1 million to federal candidates, parties and political action committees, according to the Center for Responsive Politics. 80 percent of the industry’s contributions have gone to Republicans.
This support has not gone unrewarded. In 2005, Bush, who has received more from the oil and gas industry than any other politician, signed an energy bill from the Republican-controlled Congress that gave $14.5 billion in tax breaks for oil, gas, nuclear power and coal companies. The Energy Policy Act of 2005, which was based on recommendations by Cheney’s energy task force, also rolled back regulations the oil industry considered burdensome, including exemptions from some clean water laws. All of this transpired only one year after Congress passed a bill that included a tax cut for domestic manufacturing that was expected to save energy companies at least $3.6 billion over a decade.
Big Oil, Big Influence, pbs.org

There is no way the US political system is going to voluntarily withdraw the teat of oil money itself, that will have to be forced on it from the outside, by the ‘people’ that is. How that might come about is a mystery to me, I see no signs yet pointing to any such social movement, but sometimes change happens in very fast, and very unexpected ways.

This process of record oil / crude based profits is all just temporary anyway, because big oil is unable to refill its dwindling reserves, just like the rest of the world, only more so. They are essentially cashing out now.

Update: the US media comments on this story

Today, I saw a few articles in the more or less mainstream media touching on this topic:

No industrialized economy is as reliant on oil, or as obsessed with gasoline prices, as the United States, the biggest consumer of oil in the world. But the oil market is largely immune to Washington’s machinations, and prices have more than quadrupled over the last six years for reasons that are increasingly disconnected from what happens in the United States.

The reality is that oil is a globally traded commodity, and Americans must pay international prices to get their share. And those prices reflect the fact that global supplies are stretched and struggling to meet a booming demand that is being driven by growth in developing countries, notably China and India. This has left the world with a very slim cushion of extra production.
Dealing with these complex issues is beyond the scope of the current political debate, which in an election year is focused on the immediate concerns of voters. But, election or not, the nation’s energy debate has rarely resulted in a coherent policy. Oil imports have been rising for the past three decades, for instance, while fuel efficiency standards for cars and trucks are the lowest among industrialized nations. Attempts to develop biofuels are being blamed for higher food prices.

In the long term, there are only two ways to reduce prices: increase supplies or reduce demand. The country’s energy policy does exactly the opposite: it encourages consumption by keeping energy taxes low and discourages exploiting new supplies because of environmental concerns and not-in-my-backyard political objections.

Lawrence Goldstein, an economist at the Energy Policy Research Foundation, estimated that the nation’s oil import bill would probably reach $450 billion this year, up from $120 billion in 2002. “Our energy policy is bankrupt,” he said. “It is not prudent anymore to ignore the supply side of the equation.”
International Herald Tribune, May 11, 2008

It’s especially amusing to see Daniel Yergin, of CERA, trying to now reposition himself and his company in this discussion after being utterly wrong in his predictions on future oil supply and pricing year after year. I resist the urge to quote him here because he is so utterly discredited that whatever he now has to say has to be considered pure opportunism.

The New York Times continues to find itself having a hard time saying the words, while reporting the results, as this article shows.

“The problem is that the market for dollar-denominated assets is orders of magnitude bigger than the oil market,” Mr. Diwan says, so this hedging can have a disproportionate effect on oil prices. “It’s like a lake and a pond, and the lake is overflowing into the pond.”

While it’s hard to pinpoint the impact, it’s clear that money has been pouring into commodities over the last five years. In the first quarter of 2008 alone, commodity assets under management rose $30 billion, to $225 billion, according to estimates by Barclays Capital.
The dollar’s weakness isn’t affecting just oil. Other commodities that are priced in dollars — like wheat, rice and other foodstuffs — are also soaring, with ramifications felt worldwide.

“I don’t think there’s any doubt that the devaluation of the dollar is having an impact on all global commodities, including oil,” says James E. Newsome, president of the New York Mercantile Exchange, where energy and metals are traded.

Based on more traditional fundamentals like the cost of finding, producing and shipping crude, oil should be in the mid-$60s, says William H. Brown III, an independent energy consultant in Chappaqua, N.Y., who monitors investment flows in the energy sector. “I’m not blaming anyone,” he says, “but this price is hard to justify.”
[what about the most basic ‘fundament’: supply and demand? That’s too hard for this author to say out loud though]

The argument over whether traders are to blame for high energy prices has lasted for years, but it has intensified of late. Raising margin requirements — even temporarily — might be worth a try and might at least settle this dispute.
New York Times, May 11, 2008

I for one would love to see such a oil future margin modification happen, just so we can stop hearing people trying to avoid the fact of peak oil as it’s hitting us now. The sooner we face up to reality, the better, and if raising margin requirements to put a hold on oil speculators will help do that, then let’s do it, but it won’t help do anything more than finally convince the denialists that the world is in fact finite, we have in fact really burned about 1/2 the total recoverable oil we will ever find, and that it’s all going to be a very rocky, bumpy, downhill ride from here on in.

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