| By Richard Gibson: |
What Things Are Made Of
The story of America's dependency
on mineral commodities (including oil) in everyday life.
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|The price of Crude is up - approaching $100 per barrel. |
This is because worldwide supply is tight and 1) gasoline demand in the US is up despite high prices - 4.3% more than 2003. Americans simply refuse to conserve. This is not trivial considering that the US, with 5% of the world's population, consumes 45% of the gasoline produced on earth. 2) Gasoline demand is surging in China, where crude oil imports increased 30% in 2003.
|Refinery capacity in the US (and in the world) is near its maximum. Hurricanes Katrina and Rita impacted some refineries. Even before Katrina, average US refinery capacity was much less than US gasoline consumption More info. Oil tanker capacity for trans-oceanic shipping is also 100% reserved for the forseeable future, and shipping costs have nearly tripled [more info].|
|The US deficit, around $500 billion in 2004, causes the value of the dollar to decline. Because oil is priced in dollars, no matter where in the world it comes from, producers want higher prices in order to maintain their income.|
|The US Government is buying at these high prices supplies for the strategic petroleum reserve. A minor impact, but some.|
|Local requirements for special gasoline blends to meet environmental regulations result in smaller batches, which are more expensive for refineries to produce. Applies especially to California.|
|Costs reflect distance from refineries (transportation cost). In the US, 50% of gasoline is refined in the Gulf Coast.|
|Variations reflect local taxes. Federal excise tax on gasoline is about 19¢ per gallon; state tax averages about 23¢ per gallon; in California there is an additional 7.5% sales tax.|
|Economic woes in Venezuela are impacting US imports more than problems in the Middle East. US imports from Venezuela were down 19% in 2003, and Venezuela, Mexico, Canada, and Saudi Arabia are the US's main suppliers, normally at about 15% each — but Venezuela in 2003 only provided about 12% of our imports (see table above). • © 2007 Gibson Consulting.|
|Any time there is a problem with a pipeline or refinery, it can impact the supply of gasoline at least in local markets, and the price can spike.|
|Credit card fees paid by retailers amount to about 3.5%, or 7 cents a gallon at $2.00 per gallon. This is more than enough to eliminate all profit for the retailer, and in many cases results in an actual loss of several cents per gallon -- absorbed either through increased pump prices or in other elements of a retailer's business. Retailers with no other sources of profit may go out of business, further restricting ability to deliver gasoline. So don't blame the corner gas station -- even the company-owned ones. The latter may absorb such losses through profits elsewhere in the system, but a loss is still a loss.|
|Even with all of this, the true price of gasoline has fallen more than 40% from its inflation-adjusted price of $3.11 per gallon in 1980-81. And in the US, at $2.50 per gallon (2005), we pay about one-half to one-third of the price western Europeans and others have paid for many years. Icelanders pay about $6.12 per gallon (2004). Much of that cost is in national taxes that support health care and other programs.|
|Although the price of oil is ultimately governed by supply and demand -- with the greatest demand in the US (25% of world oil consumption; 45% of world gasoline consumption) and two-thirds of US demand in the transportation sector -- nervousness on the part of oil traders also impacts the short-term price. For example, in early 2006 real (e.g., Nigeria's shut-in 500,000 barrels per day of production) and perceived possible (e.g., jitters over Iran and political issues in Venezuela and elsewhere) supply problems DO result in increased prices, as buyers are willing to pay higher prices for something that they think may soon be in shorter supply.|
|See also the EIA page, Primer on Gasoline Prices.|
From the 1990s to the present, even OPEC has very little control over prices because there is very little (some say none) excess production capacity anywhere in the world, including Saudi Arabia. Supply cannot be affected, so the price depends on demand. In the long run (months), the price is entirely controlled by the people who consume oil - for the most part that means American drivers.
In the short run, on a daily basis, the price is set by buyers, including market speculators, whose gut reaction to geopolitical, weather, and other impacts on the global market result in their "bets" that supply and demand a month or so out will be such-and-such, and that therefore the price they are willing to pay is this-and-that. There are only three significant oil-trading exchanges in the world: the New York Mercantile Exchange, a similar one in London, and a new smaller one in Dubai. A comment on this topic by Ralph Nader • EIA graphic relating oil price to 74 geopolitical events since 1970
Oil traders are human, and their reasons for being willing to buy oil contracts at any particular price range from scientific to emotional to downright illogical. For example, as the price neared $100 but fluctuated, when prices were as low as $94 or $95, many traders bought at those prices, seeing them as bargains in the face of (likely) impending prices at or over $100. Such buying then drives the price up, almost like a self-fulfilling prophecy.
A (June 2008): Yes, the greater the difference between finding and production cost, and the price of oil, the greater the profit to those who own the oil. For the most part this is nations, like Saudi Arabia, Venezuela, Mexico, Norway, etc. US Oil Companies, for the most part, sell much more oil than they can produce from their "own" wells, so they must buy it on the open market from those countries that own it. If the US Companies actually owned all the oil they sell, their profits would really be astronomical.
Costs to find and produce oil vary significantly around the world. Production costs are called "lifting costs" in the industry. This page has costs per barrel (42 gallons) for locations around the world.
Lifting costs are often combined with finding (exploration) costs. You'll see quite significant variations by region, (finding = $5 to $63 per barrel, lifting incl production taxes = $4 to $14 per barrel) but the world average total finding + lifting + production taxes is something like $17 + $6 + $2 = $25 per barrel. In the US, say, the deepwater Gulf of Mexico, I would expect the finding + production cost to exceed the high end of the averages, i.e., more than $63 + $14 = >$77 per barrel.
The amount of profit US oil companies make is actually just a bit higher than the average for all US industry - about 11 cents per dollar of revenue (US Avg = about 9 cents). They make headline-making absolute $$$ values because they sell (because we consume) so very very very much of their product. If Microsoft, Coca-Cola, or just about any bank or pharmaceutical company could sell as much of their products as oil companies do of theirs, they'd make triple the $$ profits Exxon does.
In the US, companies lease wherever they think the oil is, and wherever they are able to get the lease - that may mean public land of diverse types, or private land. The arrangements (royalties) that they pay are highly variable. It is even more variable in other countries - not too long ago, Angola was charging foreign companies like Exxon, Chevron, BP a "bonus" of $100,000,000 - basically that is the fee they have to pay, just for the right to bid on a concession (a tract where they may explore). It does not guarantee that they will get the concession, and if they do get the concession, there is no certainty that there is any oil there. That also does not include any possible tax the nation may charge - some countries asses a 50% (or greater) tax on oil production - meaning that if, say, Exxon, finds an oil field in nation X, the nation owns half the oil (or Exxon pays the country the value of half the oil) that they produce.
Yes, it is to a US Company's advantage to find and produce oil in the US - they "own" more of it, even after taxes and royalties and the much higher costs. But the simple fact is that there is precious little oil left to find anywhere in the US - and the remaining places where there may be substantial quantities - the deepwater Gulf of Mexico, North Slope Alaska, offshore California, and the complex Bakken horizontal drilling play in North Dakota - are all exceedingly expensive. The US is by far the most drilled place in the world - currently about 510,000 pumping oil wells, in a world that only has around 900,000 altogether. But our per-well average is just 10 barrels per well per day, half of what it was in 1970 - and very unlikely to change, even as new discoveries and big fields are found. They are not keeping pace with the decline of the older wells.
As indicated here, more than two-thirds of the current price of gasoline reflects the price of the oil (and that includes profit to whoever - but of all the oil used in the US, nearly 60% is imported, so those profits are mostly to the nations that own it). 19% is in the total costs AND profit of refining, transportation (tankers, pipelines, trucks), wholesalers, marketers, and retailers - so at $4.00 per gallon, 19% = 76 cents, of which at least half is probably cost, leaving no more than 40 cents profit divided among all those refiners, pipelines, trucks, advertisers, and corner stations. While the big US companies do have their fingers in all of those pies, by no means are they the only ones. The largest refiner in the US, Valero (around 3.3 million b/d of the 20 million that we use) has essentially no production and few retail outlets. Most pipeline companies are not owned by oil companies. Most trucking is not controlled by oil companies. And most retail outlets are barely making a nickel a gallon - and often enough after credit card fees are added, they may be making NO profit on their gasoline; they get that on twinkies and bottled water. Credit card fees are typically percentages, usually around 3% - just 3 cents at $1.00 per gallon, but 12 cents at $4.00 per gallon - and the corner station's profit would be really unlikely to be able to accommodate that much cost.
A (June 2008): Oil companies do work differently to the extent that on the whole, you can set the price of your product. It must reflect your costs, but you must also juggle it so as not to reduce your sales to nothing. Oil companies don't set prices, in any significant way. Back in the 1940s-50s, even into the 1960s, when the US was the world leader in oil production, and when oil companies (be they US or other) much more nearly "owned" the oil they produced (both US and foreign), the oil companies could have a real impact on price by controlling supply. In fact, in the US, the price was largely set through quotas assigned by the Texas Railroad Commission - they did that to try to maintain competition, maximize reservoir longevity, and balance the economic needs of the public. That base price was largely followed in the US.
By the late 1960s and especially into the 1970s, as US imports grew and nations exercised their ownership of oil, OPEC became the determiner of price because OPEC had most of the spare capacity in the world - they could significantly impact prices, either up or down, by "turning on or off" the tap. Over time, into the 1980s, as demand increased, Saudi Arabia became pretty much the sole "swing producer" whose changes in production could affect the world price.
Today there are many who doubt if Saudi Arabia has any excess production. They say they do, but there is no evidence of it. In any case, there is no significant excess capacity in the world, and at best Saudi may have one-haf million to 2 million barrels per day excess, in a world that consumes 85 million barrels per day. It just is not enough to really make a dent in the supply, and therefore it cannot really affect the price significantly.
Today, neither oil companies, nor nations like Saudi Arabia, nor OPEC, nor any government, "sets" the price of oil. It is driven by supply and demand. There is a certain portion of the price -- and the size of that portion is greatly debated -- that relates to investor issues such as buying commodities (gold, silver, diamonds, oil) as a hedge against inflation and the devaluing of the dollar - this affects oil particularly because it is priced in dollars. People holding euros see it as a good deal. Other investor issues include speculators, essentially making bets that the price will be such and such in one month or two months or 8 years. And on a daily basis, jitters on the part of oil traders will send the price up and down by 5% or more - saber rattling in Iran, the winter weather in the US NE, a new hurricane threat, a terrorist attack in Nigeria.
So - some say that the "fundamentals" - supply and demand - should have the price as low as $85 per barrel. Others say only $10 or $20 of the price is the result of speculators and jitters. I have no idea which is correct, nor even how to tell. But I am pretty sure that we have an extremely tight supply for a commodity that is in ever-increasing demand. That world production I mentioned above, 85 million barrels per day, is essentially equal to the demand. In some recent months, demand has outpaced the supply by a half-million barrels per day or more - which means various kinds of juggling, and/or actual shortages in some places. Countries like China, not to mention all Europeans, are very very willing to pay the high prices that we are moaning so much about. Therefore, since the price is really based on what a willing buyer will pay, I can't imagine anything that will reduce the price - short of noteworthy decrease in demand.
So, the price of oil has essentially nothing to do with its cost, and it is not "set" by those who sell it. It is sold in a global marketplace and its price is whatever the traffic will bear. (Incidentally this is the same for things like gold, silver, diamonds, platinum - their prices have nothing to do with the cost of mining them.)
Want to know more?|
Gibson Consulting recommends: Read The Prize, by Daniel Yergin.
©1997-2009 Gibson Consulting
Background image of drilling well in Utah in 1981 © 2000 by Dick Gibson