Oil Trends Blog

Several months ago Oil Trends Blog addressed the rapidly rising cost of crude oil. That blog is titled “The Great Oil Shortage Myth“. The conclusions drawn in this discussion were (a) there was no shortage of oil and (b) the increase in the price of oil was not a supply and demand issue, but, was rather the work of greedy speculators operating through the Mercantile Exchange in New York.

With the recent drop in the price of crude oil, it seems appropriate to again review the supply and demand issues affecting the U.S. oil situation. The following graph illustrates the recent decline in crude oil prices.

As you can see crude prices increased about 100% from May 2007 to August 2008. Since August of this year, however, the price has nearly dropped 100%. This rapid decline has resulted in crude oil prices reaching levels that most economists believe represent the true value of the commodity. The driving force behind this rapid decline, if you are to believe the media and so-called oil experts, is the drop in demand for crude oil. We are expected to believe that U.S. stocks (inventory) of crude oil have risen so significantly in the past 2-3 months that the price of the commodity has dropped 100%. While it is true that U.S. consumers have cut back on their driving this in no way accounts for such a radical change in oil prices.

If you look at the following graph you will see that crude oil stocks have remained relatively constant over the past year and are in the middle of the average range expected.

The increase in stocks from August 2008 to present is not unexpected. There has been some conservation exhibited by the public due to the higher prices and we are also out of the summer driving season. However, the rather small increase in U.S. stocks of crude oil can not explain the rapid drop in price. As we have pointed out in the earlier blog mentioned above, supply and demand is not the issue. There are ample supplies of crude oil. The rapid change in price, both up and down, is the direct result of speculation.

The price increase from May 2007 to August 2008 caught the attention of congress and there was considerable discussion about identifying the major speculators and placing restrictions on their activities. It is no wonder that the major players in the speculation game decided to cool their aggressiveness. In our opinion the recent drop in crude oil price is due in large part to a retrenching of speculator activity. Hopefully the crude oil price will remain at a level more consistent with supply and demand issues from this point forward.

All graphs were from the Energy Information Administration.

There has been considerable discussion regarding the supposed lack of refining capacity in this country and the effect this has had on the price of gasoline and distillate as demand increases. Again the uninformed media and administration officials have been the source of these unfounded rumors.

These sources cite their reasons for this interpretation as the rising demand for energy coupled with the fact that there has been no new refinery construction in over three decades. This sounds rather convincing and it is quite true. What you have not been told, however, can be represented by the following information.

In addition to lack of refinery construction in this country the following graph, taken, from the U.S. Energy Information Administration, shows that this situation has been exacerbated by the closure of half of the refineries operating since the early 1980s.

In other words, we have not built a new refinery in thirty years and we have shut down an additional one hundred and fifty. One would surely believe that we are in trouble of reaching a supply and demand upset and the information being propagated by the media and others is right on the money.

So why don’t we build new refineries? A look at the following graph might help answer this question.

This information received through the Energy Information Administration and a report by professor Ken Homa of Georgetown University clearly shows that even with a decline in refining facilities, refining capacity has actually increased from under 16 million barrels per day in the mid 1990s to over 17.5 million barrels per day in 2008, an increase of more than 10%. During this period refineries have been operating at near capacity outputs given downtime for repairs and maintenance as shown below.

The reason new refineries have not been built in recent times is due, in part, to the difficulty in obtaining permits for such facilities. Environmental restrictions make it very difficult for a refiner to build a “grassroots” facility. The time involved in obtaining permits and construction can amount to a decade. It is very difficult for a refiner to economically weigh the investment risk when these time delays in construction are so severe and environmental requirements are rapidly changing. Additionally, refineries are typically built in populated areas and most people now days are reluctant to have a large chemical processing facility near their homes.

What has been happening, and is shown in the above graphs, is that refiners have found it economically viable to expand existing facilities. The permitting is much simpler and they are able to adapt to environmental requirements as they are needed. The main reason for refinery closures over the past thirty years was the inability of old, marginal refineries to upgrade to meet the increasingly harsh environmental demands of higher product quality.

America’s refiners have done a great job of planning for future demand requirements while, at the same time, meeting the EPA standards for increased product quality. It is unfortunate that the uninformed media and the Bush/Cheney administration continually distort the data presented to the public in an effort to promote higher crude oil and product prices. Hopefully, a new administration will not be so dependent on the backing of the oil industry and the need to further the industry’s objectives at the expense of the American people.

As with many other untruths coming from the Bush/Cheney administration and the media, it is not true that we have an oil shortage.

This perception has been encouraged by the administration as a ploy to divert attention away from a number of issues, including the economic debacle in Iraq and the devaluation of the dollar. This was made quite clear to President Bush by the Saudi government when he approached them to increase production in an effort to reduce rising prices. As he was told, there is a surplus of oil available and further increases in production would not affect price. In fact, Iran had to put 30 million barrels of oil in floating storage due to lack of a market. How embarrassing to the US, having a President so out of touch with reality.

In actuality, total world supply and demand for crude oil in the first quarter of 2008, as reported by the International Petroleum Monthly-June 2008, showed world supply at 85,640,000 barrels/day versus demand at 85,430,000 barrels/day or a surplus of 210,000 barrels/day.

A DOE report (#DOE/EIA-0380-2008) projects total US hydrocarbon supply (mainly crude oil) to be 21,230,000 barrels/day by 2011 and total hydrocarbon demand to be 20,900,000 barrels/day or a surplus of 330,000 barrels/day.

Additionally, US crude oil stocks (inventory) for the past year are shown in the graph below:

As you can see, crude stocks in millions of barrels, while dropping in May and June, have continued in the expected range for the year Aug-2007 to June-2008.

If we take the above facts regarding supply and demand into consideration, how can we possibly believe that crude oil prices during the same period have increased as much as shown in the next graph?

Both graphs were obtained from the Energy Information Administration and represent the official energy statistics from the US government. It is clear that in the past year an increase in crude prices of approximately 100% is in no way the result of supply and demand inequities. In fact, based strictly on economic fundamentals, most oil economists believe the present price of oil should be in the $60/barrel to $70/barrel range. It is interesting to note that crude prices were at about this level in August 2007. It must be clear that the constant harangue from media, government, and the oil industry for more drilling and refining simply does not address the present issue. So what is going on?

In an article by Ismael Hossein-za, an economics professor at Drake University, he cites the finding of a number of energy experts that between 30-40% of the increases in oil prices can be attributed to dollar depreciation. This is based on comparing the last five-year discrepancy in the difference between the value of the euro and the dollar. What then accounts for the remaining 60% of the increase? According to F. William Engdahl, an expert in the energy and financial markets, as much as 60% of the crude oil price is pure speculation driven by large trader blocks. It has nothing to do with supply and demand.

Many of these blocks neither own nor use crude oil. Crude oil was made a commodity in the 1970s to allow legitimate oil producers and refiners to “hedge” their risks in drilling costs and raw material costs. However, this concept opened the door for blocks of speculators to enter the markets with very limited control on their behavior. One can enter the crude commodities market by investing in a minimum of one contract, that is, 1000 barrels of light sweet crude oil at Cushing, OK. This individual can either buy a contract (going long) or sell a contract (going short). He is not required to clear this position until the end of the contract period. He can do this by either taking the physical barrel at Cushing or selling a barrel at Cushing. Or, he can simply find an offsetting sell or buy contract and wash the paper transaction out. In most cases this is what happens. In other words, it is usually a paper transaction, played strictly for financial gain with no physical barrel moving to either party. This has resulted in a significant upward pressure on the price of the commodity and a price that is quite arbitrary.

As long as our congress continues to bury its head in the myth that there is and has been a crude and product shortage the American people will suffer needlessly. There are controls that can be placed on the oil commodities market that will greatly mitigate the energy pricing problem. This can probably be done fairly quickly. The only knowledgeable voice I have heard coming from our congress in this regard is that of Senator Byron Dorgan of North Dakota, who presented on the Senate floor very compelling evidence of why we need to control the commodities market.

As Americans we should not continue to let this government’s misinformation program lead us into complacency. Write your congressmen and express your concern over the oil pricing nonsense that is being shoved down our throats.

There has been a good deal of discussion lately with regard to the add campaign being undertaken by T. Boone Pickens concerning the interchangeability of wind power and natural gas usage. It is not clear at this point, however, what his true intentions for this campaign really entail. There has not been enough real information available to intelligently comment on the viability of his general statements. For this reason, I have chosen not to get into the technical details other than to say that wind usage is not a new idea and is rapidly being implemented in states such as Texas, Wyoming, and California. I do wish, however, to comment on character. I have been in the oil business since 1970. During this time I would need less than one hand to count the number of oil producers and investors who were concerned about anything other than their own financial well-being. Don’t get me wrong, the oil industry is a tough business requiring high investment and considerable risk and I do not criticize those who enter this risky game. Most are reputable businessmen who conduct their affairs in a responsible manner. However, there are those who will go to extremes in an effort to promote the industry at the expense of the general good. T. Boone is one of these.

A case in point, during the last presidential campaign, an insidious and unfounded smear campaign was launched against the Democratic candidate for President, John Kerry. The gist of the campaign was to cast dispersions on the awards for valor presented to Kerry during the Vietnam War. So absurd were these allegations that the term “swift boating” is now the generic term for any unfounded smear campaign launched for what ever reason, against anyone running for office. T. Boone was one of the prime movers in this smear campaign. His objective was to insure the re-election of the Bush/Cheney oil monopoly that has run this country since, at least, Bush’s first term and was started by the Cheney secret oil policy meetings of the early 2000s. In fact, T.Boone offered $1,000,000 to anyone who could refute the accuracy of the nebulous campaign allocations. In fact, they were refuted by reputable sources, but since T.Boone was the sole judge, of course the data was found to be irrelevant and payment was not forthcoming. It is producers like T.Boone, who will do and say anything about anyone to promote their interest, regardless of the harm they create, and their motives must be severely questioned. Although, I am an oil man, I am also a retired US Coast Guard Captain. As such, I have a deep regard for the traditions of the military. Particularly, the most sacred tradition of the issuing of awards, particularly those for valor. The military services do not take this responsibility lightly and do not award medals for behavior that have not been thoroughly researched. To challenge the Dept. of the Navy on their evaluation of John Kerry’s service is not only an indication of misunderstanding of the military tradition, but is a slap in the face of all who have been awarded medals for valorous service. Not having served in the military, T. Boone would not understand the disservice he did to our military heritage. In all probability he could have cared less. The point is that T. Boone will take any position, however absurd, to promote his oil agendas and he cannot be relied upon to provide factual information concerning oil issues if they do not promote his agenda. Do not let T. Boone T-Bone (broadside) you regarding the oil industry. Do your own investigation and be skeptical of the oil industry pundits. It is time to stop the oil industry’s control of our government. It has resulted in unprecedented price increases in the past few years, having nothing to do with supply and demand.

OIL INDUSTRY STATUS

In a recent article by the Miami Herald entitled “U.S. trade deficit hits all-time high”, it was mentioned that the chief culprit in forcing the deficit to this level was global oil prices. According to the article the U.S foreign oil bill soared to a record $251.6 billion, up 39.4% from 2004. It also indicated a significant part of this increase was due to loss of Gulf Coast production following Hurricane Katrina. The trade deficit is indeed a significant and complicated problem for our country, particularly considering the high cost of the war in Iraq and the reconstruction costs incurred as a result of the hurricanes. However, we should not be confused by the stories regarding the supply and demand issues on oil confronting our domestic needs. Table 1 below indicates that, despite disruptions in crude supply and spot outages of gasoline and distillate in various areas of the Gulf Coast, there were ample supplies available. In fact, inventories of both crude oil and products actually increased over the last year to-date. This information was obtained from “This Week in Petroleum”, published by the Department of Energy.

As you can see crude oil stocks have been higher than last years average range. Despite increases in inventory (stock) levels, prices of both crude oil and products continued to increase as shown in the Table 2 below.

Table 2

Despite crude oil inventory increases from last year of 26.4 million barrels, prices increased by about $19.00/barrel. In fact from March of 2004 prices have jumped from about $35.00/barrel to over $65.00/barrel in March of 2006. Realistically, one must say that U.S. supply and demand statistics have not strictly followed the principles of basic economics. In fact, I would suggest that the hurricanes, while causing disruptions in some areas, were not responsible for the significant increase in prices. The real driver of price increases results from the fact that crude oil and petroleum products are commodities that are traded daily on the New York Mercantile Exchange (NYMEX). These commodities can be bought and sold in substantial quantities based on the whims of a few large investors. As a result, prices can fluctuate significantly within one trading period and have nothing to do with the supply or demand of the physical barrel. The “rumor mill” provides the somewhat unrealistic and emotional reasons for the changes and these are the reasons given by the news media for fluctuations in price. As an example, one reason given for the strong price footing at the NYMEX beginning the week of 2/6/06 was the concern over Iran’s stand on uranium enrichment, as if this could possibly have an immediate effect on oil prices. NYMEX emotion, combined with OPEC control of significant oil reserves are what control petroleum prices in this county, not hurricanes or suggested lack of refining capacity as we are so often told. There are many problems to be solved with regard to the cost of energy supplies, but the oil industry has done an admirable job of handling domestic supply and demand issues, particularly during disruptions, such as, Katrina.