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What’s Behind the Oil Spike to $107 (and Counting…)

by | published April 1st, 2011

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.

Neither “Drill, baby, drill” nor “Fortress America” will have the impact their proponents anticipate. In fact, the idea that domestic crude can reduce gasoline prices is fundamentally incorrect.

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.

Sincerely,

Kent

P.S. We’re already making strides. In fact, one little American company is pioneering power conversion solutions for the renewable energy markets. Its newest technology is nothing less than a breakthrough that will finally bring solar energy squarely into the power-generation mix. Yet you can still get shares for under $4. I’m currently recommending it to all of my Energy Advantage subscribers. Details here.

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  1. Daniel Smith
    April 1st, 2011 at 11:45 | #1

    I just wanted to let Dr. Moors know of my appreciation for explaining the situation absent any agenda other than the truth. That is truly wonderful to read anything where the writer has no other intention than imparting truth.

  2. Ben Jones
    April 1st, 2011 at 11:55 | #2

    I have always wondered why diesel is more expensive that gasoline. Would you please give an explanation?

    Thanks,
    Ben

  3. April 1st, 2011 at 12:20 | #3

    Our dependence on foriegn oil is about to change dramatically
    in 2012.
    http://www.pemmelectricmotor.com

    Shanghai Haizhou Micro-Motor Manufacture Co. Ltd.

  4. vince nania
    April 1st, 2011 at 12:35 | #4

    dear speed dial, can you just save the fluff and give us some stocks?
    quit the selling stuff links please and give us something we can make money on.

  5. joseph a kolasa
    April 1st, 2011 at 13:11 | #5

    know of any Oil company in Poland

  6. Robert Eastman
    April 1st, 2011 at 13:16 | #6

    The costs of hundreds of thousands of troops occupying the “oil lands” makes $5 per gallon seem cheap. The US Government specializes in “psychological warfare” against its own citizens… conning them on the one hand with “cheap fuel” and “cheap food” while taxing them to death to subsidize the farmers and military industrial complex with the other. Very ineffiecent… economically speaking. Just a big “shell-game.”
    Why isn’t anyone getting serious about processing coal into fuel like Germany and South Africa did/does? (FT process) Supposedly it can stll be done at a cheaper rate than the price of oil per barrel and result in superior products. (I am aware that ExxonMobil have bought up companies in the past that have made a serious attempt at production and basically shut them down.) The amount of fuel that any one of the major airlines uses should be enough to raise financing for the project of building a coal processing to jet fuel plant. I would think that the major coal companies would take this project on themselves… so they can profit by offering “in-demand products” made from their “abundant source” of maligned raw materials… dirty coal.

  7. JERE REID
    April 1st, 2011 at 13:42 | #7

    Dr. Moor Please tell us where the water goes that is used to pump the 10 barrels of oil out of the ground. We live in New Mexico and haven’t seen any water as an after product on the surface. Two hundred
    barrels of water for 10 barrels of oil seems uneconomical as we need the water to exist. Unless it is not potable. Please explain this issue in a future commentary. Thank you for all your expertise and advise. Keep it coming!!!!

  8. April 1st, 2011 at 15:45 | #8

    Diesel fuel is a byproduct of refining. The cost almost nothing as it is not volatile product. It does not require much to produce.
    I paid $.49 a gallon in the 1970′s when gas was selling for $1.50. In the 1980′s diesel cars and pickup trucks became popular the oil companies started to catch on they had a cash cow so they started milking it.
    It put independent Truckers out of business. Now they get a refund on their diesel fuel usage but the general public gets screwed.
    oil companies make millions on Diesel now. I ran my car on Soybean oil for years now it has doubled in price. it more expensive than
    diesel now. Now the consortium of GOVT and the waste oil dealer have just about stopped the flow of waste Restaurant oil to individuals. They have done everything including arresting people for taking waste oil. They are even shaking down restaurant owners trying to stop them from giving the oil to individuals because they get paid to pick it up. I have ways to get around this which I will not reveal.

  9. Ben Greyling
    April 1st, 2011 at 15:50 | #9

    Doing some regression analysis on the WTI price, the % increase from 15 Feb 2010 to 15 Feb 2011 was around 14%. Between 15 Feb 2011 and 31 Mar 2011 the increase was 18% which equates to an annual increase of 145%.

    I fail to see how the demand from other sectors could have increased so significantly in 1.5 months, without acknowledging that speculators are at work.

  10. Jack
    April 1st, 2011 at 16:11 | #10

    Great analysis. Just to go a little farther on the security issue. If we established an “oil bank” of wells drilled, tested and ready to hit the pipelines when needed, then that supply overhanging the market would tend to moderate prices worldwide. Other than that, changeover to natural gas wherever feasible would take some demand out of the market. No other economic alternative now exists except the unpopular nuclear.

  11. scott Brande
    April 1st, 2011 at 16:38 | #11

    Oil is priced in dollars. The dollar is losing value. Dollar down, oil up. Right? Other factors contribute, especially in crisis situations, but isn’t the prime factor determining oil prices the result of the value of the dollar? If not, please explain why. If this is true, what will be the result, the effect on oil prices and prices at the pump when the dollar loses its sole role as the reserve currency of the world?

  12. scott
    April 1st, 2011 at 17:48 | #12

    joseph a kolasa :
    know of any Oil company in Poland

    @Ben Jones

  13. Harold McDuffie
    April 1st, 2011 at 17:54 | #13

    Kent, why does everybody seem to have forgotten that even if we shift entirely to shale gas as the source of energy, the carbon dioxide still gets into the atmosphere. The climbing world temperature remains the big problem. We are not preparing for the continuing climate change.

  14. al loyconer
    April 1st, 2011 at 19:32 | #14

    HI here in oz we are paying 5.67 dollar per gallon,and they tell us it’s good for you.we produce more than 80 percent of our oil,and export lpg to china for next to nixt, and they still tell us it’s good for us.

  15. von Smuts
    April 1st, 2011 at 21:33 | #15

    This is for the benefit of “Jere Reid”. The salt water produced with oil is NOT potable. Produced water is ordinarily routed to a “water disposal well”. If a stripper well produces 5 Bbl/day of oil and 200 Bbl/day of water, the water disposal would cost less than $1.00 per barrel (the highest price I’ve heard of in West Texas). For such a well, assuming $100 per Bbl oil and a 1/8 royalty, the operator would receive a minimum of (7/8)X5X$100 – $200(for disposal) = $237.50 per day (about $7,125 per month) which excedes the operating cost for most wells

  16. kelly cranston
    April 1st, 2011 at 22:22 | #16

    In reply to jerry reid, the water produced during production of oil is generally saline and thus non-potable. The water also carries various other contaminants including hydrocarbon residues and heavy metals. It is re-injected into the ground in either “disposal wells” or through enhanced recovery water flood projects. {Ex-petroleum engineer}

  17. DP
    April 2nd, 2011 at 02:31 | #17

    OK, the domestic production is more expensive and it is clear. But still did not learn any solid reason for the world oil price spike. The production cost has not increased, the supply is well in line with demand, so what are the reasons again? Psychological ones?

  18. william alford
    April 2nd, 2011 at 06:58 | #18

    This is the second post I’ve read this morning and it only tells me that until we get rid of the crooks and thugs in our government and business comunity everything we have or have had will continue to decline.
    All of the stuff is based, not on practicalityand benevolence but on greed in the market place.Men seem to have forgotten what character and morals are. This is why our elected statesmen can’t be relied on to do the right thing anymore.
    If you are really concerned about the status of things in the USA, Check out the elitists in this country and you will beging to get an idea of wht they are doing.
    The Federal reserve would be a great place to start.

  19. April 3rd, 2011 at 12:26 | #19

    Can you please discuss the potential of the Paris Basin shale:
    Its’ extent, its’ potential productivity, and the likelihood that the French government will settle on drilling and development regulations that will make it profitable to proceed there? Also, what is the quality of crude and natural gas that has been sampled to date? It’s great to get information from someone who REALLY KNOWS WHAT HE’S TALKING ABOUT, gets right to the point, and conveys what’s really important. Even when I know a lot of facts, you realy glue them together for me. Thanks for the most educational newsletter EVER!

  20. Sailor Jo
    April 3rd, 2011 at 23:36 | #20

    @Ben Jones
    Wonders me, too. I used to drive Diesel cars and at the time the slogan was: “use less of a cheaper fuel”. My Mercedes 200D got me any place in comfort – no racer. It used about 70 % of the amount of fuel that a 200 gasoline would use.

  21. Sailor Jo
    April 3rd, 2011 at 23:54 | #21

    @Robert Eastman
    Sounds like conspiracy theory. I do not know how expensive the gasoline from coal was that Germany produced during WW II. It must have been expensive because Germany tried to occupy oil fields at the Caspian Sea. And you may know that the Battle in the Ardennes in 1944 was lost by the Germans mainly because of lack of fuel and lack of air cover.

    Politicians are notorious liars and brainwashers. On the other hand, they would not do as they do if their audience wasn’t sheep. They always promise the moon and deliver a piece of coal.

    Personally I would reduce flying dramatically and improve a high speed rail system that makes flying and dealing with TSA ^&**$@ obsolete. Trains, especially electric, are environmentally much better than planes. I bet a high speed train ride from Miami to Washington, DC takes no more time than flying. From Europe I am used to 170 mph train rides in style and comfort.

    What the US needs is an oil belt tightening. Supposedly the oil consumption of Europe increased in the last 20 years by 4% whereas the consumption in the US increased by 25%. Something wrong in this picture! The wasteful attitude has to go!

  22. Ron Estrada
    April 8th, 2011 at 14:39 | #22

    Dear Dr. Moors,

    Thank you very much for sharing your expertise. It is fascinating and enlightening to hear insights not shared by the media. My question centers around small cap land based oil drillers here in America. I understand that now oil demand by developing countries is more important than our own oil demands here in America. It would seem that despite future demand destruction here in the United States that oil prices will more than likely never return again to $30 a barrel. Small cap oil drillers look to be very profitable even while we sadly will see very high prices here at the pump similar to prices in Europe. Thank you again for sharing with all of us as it is much appreciated. sincerely, Ron

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