What’s Behind the Oil Spike to $107 (and Counting…)
Crude oil prices continue to rise, increasing significantly to close yesterday at $106.62 a barrel for West Texas Intermediate (WTI) futures in New York and $117.36 a barrel for Brent in London. Already this morning, WTI hit a new two-and-a-half-year high of $107.83.
The latest rise is not a result of new geopolitical developments – although they do continue to weigh on the market.
Nor is it a result of any short-term inventory problems in either the U.S. or western Europe. In fact, available supply of both crude oil and finished products continues to run considerably above five-year averages. American stockpiles are now at multi-year highs.
This spike is our introduction to a very quickly changing oil sector… one in which demand is coming from new quarters, and concerns are increasing over sufficient balance among regions.
It has been some time since the OECD (Organization for Economic Cooperation and Development) countries – essentially Europe, North America, Australia, Korea, and Japan – have actually controlled this market. Demand now comes from developing, not developed, economies.
And that is prompting a new oil dynamic.
What occurs on a day-to-day basis in the U.S. – still the largest end-user market in the world – has a declining impact on price. This affects both crude oil and finished products such as gasoline, diesel, high-end kerosene (jet fuel), and low-sulfur heating oil.
There is an important point to remember from all of this.
The Global Oil Market Is An Integrated One
Regardless of how much surplus inventory may exist in an individual national economy, prices for gasoline (or diesel or heating oil or jet fuel) are still fundamentally driven by what occurs elsewhere.
Domestic crude is considerably more expensive to extract than oil exported from elsewhere. And since the cost of crude is the single largest component in the cost of refining, having the source closer to home does not translate into less expensive refined products.
Now, if this is a national security argument, pricing considerations take a secondary seat.
Security deals with having supply under control; it does not address price.
If Americans were to accept paying more at the pump (and we are talking way more here – well over $5 a gallon, as we will see in a moment) as a necessary cost of weaning ourselves from Middle East sourcing, then the solution would be simple.
Unfortunately, it is the pricing side that captures the attention.
And if we are concerned with the price of oil and gasoline, diesel, etc., with the net impact of rising oil prices on the U.S. economy and recovery, of jobs, tax base, and industrial infrastructure at risk, then importing from abroad becomes the cheaper option.
The security/pricing tradeoff is both the most all-encompassing and the most politically misused element in the entire energy debate.
Yet it does bring the real issue into focus.
Domestic Production Is Unrealistic
Each one-dollar rise in the price of a barrel of crude oil translates, on average, into a 2.5-cent increase at the pump for a gallon of regular gasoline, and closer to a 3.2-cent increase for a gallon of diesel.
Let me put what this means for American domestic production into perspective.
During the second week of July 2008, when oil prices hit $147.27 a barrel, with gasoline nationwide on average over $4.20 and diesel over $4.60 per gallon, there were more than 360,000 capped wells in west Texas holding, in aggregate, millions of barrels of crude oil.
But even at with oil at $147.27, it was too expensive to open them up. These are “stripper wells,” the source of over 60% of the crude pumped daily in the U.S. Each well provides less than 10 barrels of oil a day but upwards to 200 barrels of water.
And that disproportionately increases the cost of extraction.
At the time, I estimated it would take a price of $183 a barrel to make these wells profitable enough to allow an oil flow. That $35.73 price difference (between the actual $147.27 and the required $183) would have catapulted gasoline prices to an average of $5.09 and diesel to $5.74 per gallon. And that was almost three years ago.
It is little wonder, then, that we are experiencing a rise in imported gasoline and other oil products into the U.S. It is becoming cheaper to refine them abroad.
This is the real reason we will not see new refineries built in the American market.
The actual barriers to new refineries are not environmental regulations or NIMBY (not in my back yard) sentiment. Rather – even forgetting about the billions in expense involved – it would take about a decade to bring a new refinery on-line from scratch. Well before that period expires, the more cost-effective approach is simply to import what additional oil product is needed.
So the current spike in oil prices is not an aberration. It is not because of events in Libya, or Syria or Bahrain or Egypt. It results from the built-in pricing problems of the market itself.
This will guarantee higher oil product prices, supported by a number of the other elements we have been discussing here over the past 15 months.
As another presidential election cycle begins, you need to keep this in mind. Political rhetoric aside, the gasoline pricing issue and the cost of crude are not a result of Democrats, Republicans, Independents, Vegetarians, Reformed Druids, or any other political party or movement. They come from the oil market itself.
We will continue to bounce from crisis to crisis until we recognize this fact… and begin the genuine, difficult, exasperating, long, and incredibly expensive process of moving from a crude-based economy to a more balanced energy model.
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