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April 22, 2006

Why are oil prices so high?

(Posted by John.)

Anyone who's paid attention in the last few years has heard all the stock answers for the price of oil - China, India, Katrina, etc.  Others offer Peak Oil has the explanation (we're pumping out as much oil in a given day as we ever will) and that's why prices are going through the roof - $75/barrel yesterday.

There's another element to pay attention to:  James Fraser points out that production of light sweet crude has been in decline now for a few years.  (Chris Vernon mentioned this last August.)  This has a number of implications for the industry.

The first problem is simply communications.  When the media report "oil prices", they're really reporting the price of a delivery contract - delivery of a particular blend of light sweet crude (West Texas Intermediate, or WTI) on the New York Mercantile Exchange.  The news doesn't often report the average price of a variety of blends, or the price in various countries.  These aren't unimportant details.  When you hear "oil prices are up" what you're really being told is "the price for a delivery contract of WTI blend on the NYMEX is up."

Light sweet crude (oil that flows more easily, and has a lower sulphur content) is the preferred food for refineries.  Most American refineries can handle higher amounts of sulphur, but it makes refining more difficult - sulphur levels are tightly regulated in transport fuels - thus increasing gasoline costs further down the road.  Which is why refineries usually pay a premium for light sweet crude: it lowers their operating costs and increases their profits.

There is, however, a finite amount of light sweet on the market, and that amount is shrinking.  The rest of global demand needs to be made up with heavy sour crude.  This means that the premium refiners pay for a blend like WTI has shot up.  James Fraser in the link above estimates that in some cases the margin between light sweet crude and heavy sour is as much as $16 per barrel.

I haven't seen any analysis on whether the recent decline in light sweet crude production is a short- or long-term problem, but my money's on the latter.  Yes, I do side with those who believe we are right about on top of Peak Oil - I find it very difficult to believe we'll ever get much more then the current 85 million barrels per day of oil we get today.  Certainly, the projections that call for 100+ mbpd are really a form of fantasy, and nothing more.

That said, the current run-up in prices for light sweet crude gives us a small picture of what Peak Oil will look like when it arrives.  Even as demand stays relatively constant (China has recently slowed it's oil consumption growth) the price will increase pretty steadily, and occasionally skyrocket when something upsets the delicate balance - say, an Iranian President threatening to wipe Israel off the map.

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Or a US President threatening to do the same to Iran.

Posted by: Farinata X | Apr 22, 2006 11:50:52 AM

The demand-side and monetary factors of oil prices should not be underestimated. I am told a lot of the most recent run-up is from mutual and pension fund speculation. They are betting, my guess accurately, that Bernanke will continue to increase money supply while moderately increasing interest rates, which will translate to inflation in real estate and commodities. It is not only oil, gold, zinc, copper are at near all-time highs.

The triangle is oil -> Chinese development -> American consumption(GDP growth).

Posted by: bob mcmanus | Apr 22, 2006 4:32:59 PM

Don't know what to believe anymore but the Iran threats from BushCo might possibly be a ploy to drive oil higher and line big oil's pockets...

Posted by: Steve Mudge | Apr 22, 2006 4:56:23 PM

I buy the reason why the price is up. What no one is explaining is the increase in profits?

Posted by: Kevin | Apr 22, 2006 5:32:26 PM

Kevin, the increase in prices means increased profits for anyone who owns an oil well. Companies like Exxon own a lot of oil wells.

Posted by: James B. Shearer | Apr 22, 2006 7:43:24 PM

OPEC says oil supplies not the problem

Three Dog Night Stirling Newberry on inflation (long)

"It isn't an accident that on the day that the Federal Reserve releases minutes that hint that their rate raising campaign is coming to an end that yield curve kinks back towards inversion, the Dow Jones Industrials rally to near an all time high, which is expected to be the start of a world wide rally for equities - and oil and copper hit all time nominal highs, with oil's peak nearing the peaks set the two great inflationary spikes of the 20th century. The September West Texas Intermediate - an important benchmark contract - briefly hit an eyepopping $74.06 a barrel."

"So what is going on?

Why inflation, just not the inflation of the late 1970's. Yet."

When everything (except wages, of course...and consumption goods, of course) is rising in price at the same time, I have a problem believing a particular rise in a particular sector is due to a supply bottleneck, especially when the producers tell me there is no supply bottleneck.

But that is just me, and I am no macro-economist or oil-expert.

Posted by: bob mcmanus | Apr 22, 2006 8:31:22 PM

Boycott Exxon Mobil gas stations. Do not buy gasoline. Do not get your car repaired. Do not buy food or other convenience items at Exxon Mobil gas stations.

Force the Exxon Mobil station owners to lobby their parent company for $1.50 a gallon retail gasoline.

Call your local Exxon/Mobil stations and demand it. Then shift your gasoline buying and car repairs to another station.

http://www.boycott-republicans.com

Posted by: buckfush | Apr 22, 2006 10:14:19 PM

Kevin, the increase in prices means increased profits for anyone who owns an oil well. Companies like Exxon own a lot of oil wells.

But if prices are up because of tight supplies -- then they should have less product to sell. It doesn't explain the increased profits. If I sell three apples for $1 I gross $3. If I sell one apple for $3 the gross is the same. How much less does it cost me to sell 1 apple vs 3? That might be one explanation for the record profits -- but I'm not sure I'm buying that.

Posted by: Kevin | Apr 23, 2006 7:50:46 AM

I think folks need to look at oil prices for the last couple of years. Consider the price of oil has nearly tripled in the last two years. Has demand really increased that much? Also consider that ExxonMobil has had record profits in the last year and are projected to have another record setting quarter. They are merely stacking the deck.

Now... in the companies defense, consumption of petroleum based products, mainly gasoline hasn't slowed much. One could argue they are merely pushing the limits to see what the market will support. Unfortunately a lot of middle class folks and poorer will pay a hefty price in the process. Pay attention to the farmers too. They run farms of gasoline and diesel fuel. Food costs will surely climb too.

Posted by: John Stith | Apr 23, 2006 5:34:15 PM

no one, and i mean, no one can offer a concrete explanation to way the price of oil is so high. i study the energy industry on a daily basis, and the answer is no clearer to me now than it was three years ago. one thing that is largely ignored is the sheer power speculation has over the price. traders on the nymex floor are essentially manipulating the price on reports of geopolitical instability in nigeria, growing demand in china, decreased exploration in the north sea, etc. i am believer in peak oil; that said, there is definitely "enough" oil in the earth to sustain demand for a good few decades. speculators, could drive the price down to $50 next week if they wanted to, or if they received a convincing enough report on global supply. the "light sweet crude" is one of many good *possible* reasons why we're past $70/barrel, but new innovation in technology can easily overcome the challenges of refining heavier oil. it's not common knowledge, but the oil sands of canada contain more recoverable crude than saudi arabia.

Posted by: neal | Apr 23, 2006 10:57:59 PM

i dont get it

Posted by: meme | Mar 19, 2007 12:13:34 PM

Could this just be economic terrorism from OPEC? Perhaps prices going up just because Bush is in office. What a way for the world producers to change policy.

Also it appears that the developed countries are paying for developing countries fuel consumption.

http://money.cnn.com/pf/features/lists/global_gasprices/price.html

Posted by: Jeff | Oct 19, 2007 2:58:20 PM

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Posted by: peterwei | Oct 22, 2007 8:19:19 AM

PEOPLE BETTER HOLD ON TO THEIR MONEY THAT HAVE IT. I AGREE THE OIL PRICES ARE TOO HIGH, IT DOESN,T PUT A HUGE AFFECT ON TRUCKING, BUT I CAN SEE IT PEOPLE ARE OUTRAGED WHEN IT COMES TO PAYING ME FOR THE FUEL SURCHARGE. ITS NOT MY FOUGHT, ITS THE GOVERNMENT DON,T PUT HTE BLAME ON ME, I HAVE A LAWYER I CAN SUE JUST LIKE EVERYONE ELSE. MY NEIGHBOR IS ANGRY AT ME SHE IS POOR, I HAVE MONEY THERE IS NO LAW THAT REQUIRES ME TO HELP HER OUT. I TOLD HER DON,T COME TO ME FOR A HELPING HAND GO TELL IT TO THE GOVERNMENT. IT IS THERE PROBLEM. WHAT IS THE WORLD COMING TO WITH THE HIBH GAS PRICES.

Posted by: MARTINS TRUCKING COMPANY | Nov 9, 2007 11:27:57 PM

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