Oil Trends Blog

There has been much discussion lately regarding the need to increase off-shore drilling. In an earlier blog, The Great Oil Shortage Myth, we discussed the fact that there is no short term oil shortage that allegedly accounted for the rapid price increases this year. However, there will come a time when we will see a decline in total world production of crude oil and there is on going debate as to when this time will be reached.

The debate over “peak oil” has become a political football argued by members of congress who know very little about the complications of oil production. This has been most recently demonstrated by our newest “oil expert” Governor Sarah Palin of Alaska promoting the slogan “drill baby drill”. The fact of the matter is that there exists a “fog of transparency” regarding the information concerning world oil production rates and reserves. Many countries, including the OPEC countries and Russia, keep reserve and production data as state or corporate secrets revising them when it is politically expedient. Additionally, remaining proven reserves are essentially non-scientific guesses based on reservoir simulation models developed without sufficient information and thus are simply educated guesses.

Adding to the confusion is the stark difference between high quality light crudes and heavier oils, such as, tar sands. Light, low sulfur oils yield high levels of gasoline and diesel fuels, while heavier crudes yield more heavy fuel oils and tar. The lighter crudes are environmentally less offensive than the heavier oils and have higher production flow rates; however, they represent a significantly lower percentage of the crude oil being discovered recently. The heavier crudes, such as the Athabasca tar sands in Canada, result in a three fold increase in green house gases when produced and run through refineries.

Finally, there is the problem of production decline and the cost of off-shore drilling. As pointed out by Simmons & Company International in the following graphs, off-shore drilling produces wells with rapid declines in out put. Many of these wells produce at efficient rates lasting only 8-10 years and take nearly 10 years to become productive. The operating costs of these wells alone are staggering. For example, the average operating cost of a 100 ft-water depth well in the Gulf of Mexico increased 100% between 2002 and 2006 from $5,093,200/yr to $10, 258,200/yr. A similar comparison for a 600 ft-water depth well show an increase of 101% during the same time frame from $6, 237,600 to $12,148,800.

So, it is not completely clear that just “drilling” can solve the long term oil supply issue. We are not clear as to when we will start feeling the effects of production decline or what the costs to oil companies and individuals will be. It behooves our elected officials to proceed cautiously in this area and remove oil production from the political arena.

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.