The Lifecycle of Petroleum

[motoguy128]

My wife was discussing how it's unfair that some folks can no longer afford ot even drive to their minimum wage jobs and that somehow the governement should find a way to help reduce gas prices.

 

I then tried ot explain where oil comes from ahd how it's difficult in a free market economy to "price fix" oil.

 

 

So tell me if I have this correct.

 

1) Most of the major oil companies are vertically integrated so they do the exploration and invest in various technologies to find and harvest oil. They have rights to pump oil from fields, they transport the oil, refine it, then sell it in retial stores. So other than the drilling itself which is often handled by contractors, they control the complete supply chain.

 

2) However, oil that is drilled is sold on the open market. Therefore their refineries are decoupled ot drilling and much buy their oil from the market, meaning that oil trading a oil futures on the commodities exchange set the price of their raw material and likewise determine their profits from oil pumped.

 

3) The refineries sell the gasoline and other petroleum products on the open market.

 

4) Retailers place orders for gasoline and must pay the price that day, unless they've made long term contracts or hedged themselves with oil futures like airlines and most likely bus and rail operators.

 

5) Retailers adjust their price locally based on the competition and a gas price index.

 

 

So to "fix" the price, I figured there are a limited number of options since oil is sold on a world market. The government would need to some how take the prifits from the oil companies and use it to subsidize the price of gasoline, or simiilarly, force the companies ot take the prifits and sell gas at a loss.

 

If that happened, If I was an oil company, I would divest or shut down my refining operations.

 

That does bring up an interesting point. If the profits are in pumping oil itself and not in retail stores or refining, why don't the major oil companies divest their refining operations. that part makes me think there are some shady dealing going on behind the scenes to allow hte oil companies more control and leverage on the market.

 

Perhaps that's the solution. Prevent the oil companies from being vertically integrated. For example, could you imagine if Cargill, ADM and other corn products producers own the majority of all farms? They would give them incredible leverage on the food supply. they could drive down the costs of producing ethanol for example by growing more corn, but the price of wheat and soybeans would skyrocket even futher than they alreay have.

[DiggerJim]

So to "fix" the price, I figured there are a limited number of options since oil is sold on a world market.

We could sue OPEC That'll teach 'em and fix everything

 

I know this is true 'cause our leaders told us it's so.

[velomoto]

First, who ever said life was going to be "fair"?

 

Yes, oil prices (like the rising cost of medical care) hurts the poorest the most. As prices rise the pain spreads next to the middle class and beyond.

 

Unfortunately we (Americans) been programed to believe we are entitled to cheap oil, and why not? We've lived with cheap oil our entire lives. The only solution is to use less oil and this will drive down prices. Perhaps there is more oil to be found but future generations will need fuel so if we drill and tap every available resource to feed our addiction, what will happen ten, twenty of fifty years down the road?

 

If left alone, the markets will stabilize at a price. We may not like the price but there will be oil (and gas), but the markets will be stable. Any attempt by the government to regulate the markets will certainly result in chaos (shortages, long lines, corruption, etc. etc.). If you doubt the government's ability to mismanage things, look at how badly they (we?) mismanaged a "simple" war in Iraq.

[Selden]

Oil is a commodity; its price fluctuates according to supply and demand, with speculation driving the fluctuations beyond what they might be in a "rational" market. The United States hit its oil peak production around 1970. We cannot "drill" our way to oil independence.

 

The major Saudi oil fields have been using water injection since the 1970's to maintain pressure and flow. Overall, the Saudi oil fields, huge as they are, have a finite lifetime, and probably have little or no excess capacity; they have been producing 10 million barrels a day since the 1970's. Producing more than a field will support reduces the amount of oil that is ultimately recoverable, therefore, it is not in their interest to increase production beyond a sustainable level. This is true for all the major oil fields, most of which have already passed their production peaks, and (depending on how they are managed) are slowly or rapidly declining. Are there major fields on the order of magnitude of Ghawar likely to be found? Possibly, but not likely.

 

Finally, the bottom line is that when the energy cost of extracting oil approaches that of the energy value of the oil, a field is dead -- in this way, oil production is not price sensitive, so you can't assume that production will increase forever in reaction to market pressures.

[flars]

Tell me if you think there is potential for abuse/big profit here:

Oil company looks for, finds oil. Writes off cost of exploration.

Oil company drills well, pumps oil, puts into storage. Writes off cost of production, drilling, storage.

Oil company puts oil on open market.

Oil company buys its own oil from the open market at the current market rate through its own brokers, who establish the price based on supply and demand.

Oil company ships oil on tankers it hires from itself. Writes off cost of renting tankers. Writes off cost of operating tankers.

Oil company refines oil. Writes off cost of refinery, repairs, various production costs.

Oil company distributes gasoline in tank trucks it leases. Writes off cost of leasing trucks, including the cost of the gas the trucks use.

At this point the gasoline can be sold at any number of different stores, so the oil company may or may not get the chance to write off the cost of the gas station.

.

.

If I cut down a tree from land that I own to build something, then buy it from myself (or have my wife buy it from me) at whatever the market says I/she should pay for it, then sell it to you at whatever the market says I should sell it for, do you think I will make a small profit?

It ain't Saudi Arabia we should be mad at.

[Bullett]

I agree that new major fields are not likely to be found.

 

But, as the cost of oil rises, fields that were once thought to be economically unfeasible become potentially profitable.

 

The increase in natural gas prices alone has influenced drilling in some rather unlikely places, like my hometown of Fort Worth.

 

There are a lot of relatively small exploration companies that are doing pretty well in today's climate. I purchased some stock in one of them that I felt was well-managed, after "43" was elected. The stock has split twice and is worth 419% more than I originally paid--all because I was pissed off. Unfortunately, I didn't have a lot of cash to invest.

 

It is discouraging to me when I contrast the performance of that oil stock with my investments in alternative energy which have so far, gone nowhere.

[Whip]

I agree that new major fields are not likely to be found.

 

But, as the cost of oil rises, fields that were once thought to be economically unfeasible become potentially profitable.

 

The increase in natural gas prices alone has influenced drilling in some rather unlikely places, like my hometown of Fort Worth.

 

There are a lot of relatively small exploration companies that are doing pretty well in today's climate. I purchased some stock in one of them that I felt was well-managed, after "43" was elected. The stock has split twice and is worth 419% more than I originally paid--all because I was pissed off. Unfortunately, I didn't have a lot of cash to invest.

 

It is discouraging to me when I contrast the performance of that oil stock with my investments in alternative energy which have so far, gone nowhere.

 

 

The post of the year....Thanks Bullet.

 

other than this part........"I agree that new major fields are not likely to be found."

 

They have been found but the idiots won't let us drill.....ANWAR ,the GULF, South/North Dakota, North East Texas, and parts of Colorado have shale deposits just waitin on us to harvest. We could bring down the price of oil all by ourselves if we would let the markets take over.

 

We are dumber than a truck load of hammers.

 

...and I'm not sure I wasn't drivin that truck.

 

Whip

 

[motoguy128]

I think we're smart to not drill more now. Wait for the price to hit $6, and when Asia is hooked on it like crack adicts like we are now.... then drill. I agree with some other assesments that $4 is still pretty cheap gas. We had just gotten used to redicuously cheao $2 and even not so long ago $1 gas due to the greed of the middle east who flooded the market and will find themselves SOL in the near future as they are unable to sustain their current production.

 

I think we needed a kick in our a** to knock us off our addiction. It's never healthy to be so reliant on a single source of energy or any single commodity that's not absolutely nessesary. As a non-renewable resource, that is limited in how much can be recycled, unlike metals, is far more important as a raw material in industry (petrochemicals, plastics, even pharmaceutucals), than it is for energy.

[velomoto]

You're right - higher costs for crude and gas will spur production and alternative energy options.

 

Interestingly the higher crude prices have not caused the collapse of OPEC thru cheating... or perhaps if some members are cheating the small additional oil they are producing is having no effect on the over-all world supply/demand equation.

 

While some would advocate drilling Anwar and suck it dry so we can burn it up in our Hummers and dualies which struggle to get 10 miles out of a gallon, perhaps a more wise solution will be to have and use this fuel in the future when we (America) have a higher value for the fuel? I have no doubt the crude in Anwar will be tapped - so IMO it is not so a question of "if" but rather a question of "when". If this were your oil, would you tap it when prices were $100, $200 or $300 a barrel? People have been whining about this untouched resource long before oil was $100 a barrel - that's just the way some people are.

 

Bottom line is if China is willing, and needs to, spend $150 on a barrel of oil you are going to be fooling yourself if you think these other sources of domestic oil will sell for much less. Companies are in business to make money. It's not evil, it's just business.

 

Good luck with your alternative energy shares - the companies and the technology are young and these investments are speculative. This is not all that different than investing in oil drilling companies in "the early days" before computers came into use for locating potential oil pockets.

[velomoto]

The post of the year....Thanks Bullet.

 

other than this part........"I agree that new major fields are not likely to be found."

 

They have been found but the idiots won't let us drill.....ANWAR ,the GULF, South/North Dakota, North East Texas, and parts of Colorado have shale deposits just waitin on us to harvest. We could bring down the price of oil all by ourselves if we would let the markets take over.

 

We are dumber than a truck load of hammers.

 

...and I'm not sure I wasn't drivin that truck.

 

Whip

I'd love to see your data to support this... The only way we will see prices drop is if world wide supply/demand are significantly affected. For example the potential for war in Nigeria and Iran is very high - a war in either country could disrupt oil supply to a far greater degree than drilling Anwar could offset. Yes, I'm sure this all flies in the face of the teachings from Rush, Shawn and a number of other "experts" but there is plenty of information one can find and the math really isn't that difficult. Remember, these are the same people who told us how the war in Iraq was going to provide the world a greater and more stable oil supply. In case you haven't noticed, this hasn't happened.

[SeanC]

The only way we will see prices drop is if world wide supply/demand are significantly affected.

Well, that's not the only way. I mean, speculators in the oil futures markets are also a factor driving up prices. In theory we could limit the speculation and prices would go down, but in practice it probably wouldn't work. Even if we did impose stricter rules for our exchanges, that wouldn't stop speculators in Asian and European markets.

 

For example the potential for war in Nigeria and Iran is very high - a war in either country could disrupt oil supply to a far greater degree than drilling Anwar could offset.

Um, define "greater degree"... 11 billion barrels? 32 billion? These aren't drop-in-the-bucket type numbers, and it would seem to me that production at those levels would indeed alter world supply to a level that would significantly affect price. Maybe not enough to negate disruption caused by potential wars, but it would certainly offset it.

[exwingnut]

They have been found but the idiots won't let us drill.....ANWAR ,the GULF, South/North Dakota, North East Texas, and parts of Colorado have shale deposits just waitin on us to harvest. We could bring down the price of oil all by ourselves if we would let the markets take over.

 

We are dumber than a truck load of hammers.

 

 

Whip

 

Ahh, but the oil companies are smart...if they hold off exploration in these fields two things happen; One, they get to make a certain percentage profit from oil they have to buy and buying expensive oil makes for more profits(10% of $50/barrel < 10% of $100/barrel) Two, when the expensive oil finally drys up they will be able to extract the oil held back and sell it for even more while making a bigger profit due to the reduced expense of getting it out of the ground here and NOT paying OPEC's markup.

 

Plus, any oil extracted in the US is going to carry the added expense of US scale wages, these guys do not miss a single penny when they are looking to lower costs. In West Texas (Permian Basin), all the major companies left the oil in the ground citing excessive extractions costs.

 

Why wouldn't you buy oil other people extracted and just tack your percentage onto their price knowing that you can come back later and get what you left sitting there when the demand (and price) is higher?

[Mike]

To the OP: I'm not an expert, but I wonder if the industry you describe is truly vertically integrated from the economics viewpoint--if, as you note, there's a loss of control of the product at some point, as occurs when the products (raw and refined oil products)are sold on the open market.

 

Anyway, regardless of how an economist would view it, it does seem that the oil companies largely control the extraction and distribution process from top to bottom, though they may not actually own the oil reserves they're harvesting.

 

I'm among those who believes that the current run-up in oil prices isn't so much the result of a nefarious conspiracy, but, rather, is the result of market forces impacting a dwindling commodity. In my view, we're witnessing the early stages of the decline of a major techno-industrial era, the oil age. It may take several decades for it to play out, but I believe the next century will see the demise of the current paradigms of energy, industry, and transportation. I'm not smart enough to predict with accuracy what will replace those paradigms, but it will be a whole new world by the year 2100. The oil age will be a quaint notion, viewed in the same way we now look at the era of horses and buggies.

[velomoto]

The only way we will see prices drop is if world wide supply/demand are significantly affected.

Well, that's not the only way. I mean, speculators in the oil futures markets are also a factor driving up prices. In theory we could limit the speculation and prices would go down, but in practice it probably wouldn't work. Even if we did impose stricter rules for our exchanges, that wouldn't stop speculators in Asian and European markets.

 

For example the potential for war in Nigeria and Iran is very high - a war in either country could disrupt oil supply to a far greater degree than drilling Anwar could offset.

Um, define "greater degree"... 11 billion barrels? 32 billion? These aren't drop-in-the-bucket type numbers, and it would seem to me that production at those levels would indeed alter world supply to a level that would significantly affect price. Maybe not enough to negate disruption caused by potential wars, but it would certainly offset it.

First, speculators are part of the world supply/demand equation defining the final pricing of oil. If there were large surpluses of oil available speculators would be losing their shirts. Second, because oil is a commodity which for the most part is imported into the US, we are hardly in a position to be imposing rules.

 

Finally, estimates of the oil reserves in the Anway Refuge vary wildly from 4.5 BBL (Billion Barrel) to over 16 BBL (10.3 BBL being the latest estimate from the USGS). With US daily crude usage around 20M barrels, if 5% of the US supply were to come from Anwar then this supply could be gone in as few as 12 years (assuming 4.5BBL) and about 24 years with the USGS estmiated reserve. If the highest estimates are more accurate then the oil lasts 32 years. In any case, if the above estimates are accurate (your crystal ball may show higher/lower numbers) then Anwar equates to a half year to two years of the US total oil consumption. IMO, for all the fuss people are making Anwar just is not a large reserve.

 

[SeanC]

First, speculators are part of the world supply/demand equation defining the final pricing of oil. If there were large surpluses of oil available speculators would be losing their shirts.

Part of the "equation"? Okay, whatever you mean by that, but that's not the comment I was addressing. I was replying to your statement that the "only way" prices will drop is if supply and demand are changed. Speculators don't affect supply and they don't really affect demand any more than bettors at a racetrack affect the number of horses in a race or who the winner will be. They're simply betting that prices will increase, and due to the way exchanges are regulated, they're able to place large bets, i.e., buy large futures contracts, with little money down. But regulations could be changed requiring more money be paid up front, which would decrease the amount of speculation. There's talk of this in Congress right now.

 

But as I mentioned previously, such regulations could only work if all commodities markets adopted them, which I doubt would ever happen. That said, it's still a way to see price drops without significant changes to either supply or demand.

 

Second, because oil is a commodity which for the most part is imported into the US, we are hardly in a position to be imposing rules.

That doesn't really follow. We impose all sorts of rules on commodity trading, whether those commodities are domestic or imported has little to do with it. The key factor isn't where the commodity comes from, but where the trade takes place, and because the oil market is global, these trades could be placed in several countries, all of which would have to agree on restricting speculation for it to work. Probably never happen, but it could in theory.

 

Finally, estimates of the oil reserves in the Anway Refuge vary wildly from 4.5 BBL (Billion Barrel) to over 16 BBL (10.3 BBL being the latest estimate from the USGS).

Actually, 10.6 is the low estimate, 31.5 the high. According to estimates from the State of Alaska and the USGS. Maybe Greenpeace is estimating 4.5, but it's hardly a reliable source on the matter.

[chrisolson]

... They're simply betting that prices will increase, and due to the way exchanges are regulated, they're able to place large bets, i.e., buy large futures contracts, with little money down. But regulations could be changed requiring more money be paid up front, which would decrease the amount of speculation. There's talk of this in Congress right now.

That's the most on-target solution out there because those supply/demand stories just don't explain a 60% increase in one year ... but you're right, chances of it actually happening are slim which is frustrating.

[velomoto]

... Speculators don't affect supply and they don't really affect demand any more than bettors at a racetrack affect the number of horses in a race or who the winner will be. They're simply betting that prices will increase, and due to the way exchanges are regulated, they're able to place large bets, i.e., buy large futures contracts, with little money down....

 

... That said, it's still a way to see price drops without significant changes to either supply or demand.

 

To the extent of that price changes affects demand so do speculators affect demand. In other words, if a slight price change creates a significant change in demand then speculators will have a large affect over demand.

 

The fact that the market seems to have accepted $130/bl oil I'm not holding my breath for a significant price drop any time soon. Blame speculators all you want, the underlying problem is that the world wide consumption of oil is rising.

 

Also note that the price for oil is not necessarily linear with demand. In other words a slight change in demand can result in a much greater percentage change in price. A timely example is the hoarding effect which occurs when people believe a product is becoming scarce or will continue to rise in price. The hoarding increases demand and accelerates the rise in price. The opposite affects happen when people believe there will be surplus and/or significantly lower prices. In practice one sees people filling their fuel tank more often when gas prices are rising - a form of "locking in" the lower price. Similarly when fuel prices decline many people put off filling up their tank to find the best possible deal.

 

That doesn't really follow. We impose all sorts of rules on commodity trading, whether those commodities are domestic or imported has little to do with it. The key factor isn't where the commodity comes from, but where the trade takes place, and because the oil market is global, these trades could be placed in several countries, all of which would have to agree on restricting speculation for it to work. Probably never happen, but it could in theory.

Agreed, but if America over regulates their futures markets the traders can, as you alluded to, move to foreign markets. My point was that if the oil were being exported from America we would have more control of futures as we could control (regulate) the oil companies.

 

 

Actually, 10.6 is the low estimate, 31.5 the high. According to estimates from the State of Alaska and the USGS. Maybe Greenpeace is estimating 4.5, but it's hardly a reliable source on the matter.

The EIA estimate comes in at 10.5 BBL - 'bout the same as the USGS. I looked and couldn't find a source for Greenpeace's estimate... nor your estimate of 31.5. In the end the issue isn't whether the number is 4.5 or 31.5 because we have shown that we can quickly find ways to burn any fuel we have. The only way Americans will value fuel is if it has a high price.

 

[velomoto]

... They're simply betting that prices will increase, and due to the way exchanges are regulated, they're able to place large bets, i.e., buy large futures contracts, with little money down. But regulations could be changed requiring more money be paid up front, which would decrease the amount of speculation. There's talk of this in Congress right now.

That's the most on-target solution out there because those supply/demand stories just don't explain a 60% increase in one year ... but you're right, chances of it actually happening are slim which is frustrating.

Something to ponder... linky

[motoguy128]

I'm among those who believes that the current run-up in oil prices isn't so much the result of a nefarious conspiracy, but, rather, is the result of market forces impacting a dwindling commodity. In my view, we're witnessing the early stages of the decline of a major techno-industrial era, the oil age. It may take several decades for it to play out, but I believe the next century will see the demise of the current paradigms of energy, industry, and transportation. I'm not smart enough to predict with accuracy what will replace those paradigms, but it will be a whole new world by the year 2100. The oil age will be a quaint notion, viewed in the same way we now look at the era of horses and buggies.

 

I tend to agree with this viewpoint. It is pretty amazing to think that humans managed ot burn through a large protion of a relatively abundant resource in only 100 years. Somewhat similar to the logging industry, and somewhat like hte fishing, hunting and trapping industries. Fortuntely their resorces are renewable over a short period. Oil is renewable... but millions of years isn't very practicle.

[chrisolson]

Obviously the weak dollar is a factor, but I still don't see world wide demand (or US demand) increasing dramatically in the last year and the chart doesn't indicate supply dipping significantly within the same time frame to create such a huge a run up in the last 12 months. The truth be told, it's not a simple problem with a one dimensional answer.

[velomoto]

You're right - it's not a simple problem... The instability and volatility in several of the major oil producing nations is pushing companies to be more conservative in their ordering.

 

If the price spike is, as many have claimed due to speculators in the options markets, then there will come a day where supply surpasses demand and the speculators will be "slaughtered on the street" and lose huge sums of money as the crude futures plummet. Time may prove me wrong, but I don't believe this is due to speculators but rather is a sign of the times. For those who forgot what can happen to speculators who "goof", here's a bio of one of the more infamous speculators: Bunky

 

The simple but painful solution is for people to cut back on fuel consumption... which IMO is as good a reason as any to spend more time on the bike(s) and less time in the cage!

[Selden]

I agree that new major fields are not likely to be found.

 

other than this part........"I agree that new major fields are not likely to be found."

 

They have been found but the idiots won't let us drill.....ANWAR ,the GULF, South/North Dakota, North East Texas, and parts of Colorado have shale deposits just waitin on us to harvest. We could bring down the price of oil all by ourselves if we would let the markets take over....

 

Whip

 

Sorry, none of those comes even close to a major oil field on the scale of Ghawar, or even of the lesser Saudi oil fields. I stand by my statement.

 

For greater detail, read Matthew Simmons' "Twilight in the Desert : The Coming Saudi Oil Shock and the World Economy". Published in 2005.