The Basics of oil pricing and the effect on the price of gas

Detailed analysis of changes in oil price from...

Detailed analysis of changes in oil price from 1970-2007. The graph is based on the nominal, not real, price of oil. (Photo credit: Wikipedia)

There have been a lot of questions asked about why the President of the United States does not do something about the rising price of gasoline. It has also been speculated that by increasing the amount of oil drilling that we would greatly increase the amount of jobs available while reducing the price of oil.

The truth is that no president — whether Democrat or Republican, can do much of anything to affect the short-term price of gasoline. And increasing the amount of oil drilling will do very little to solve the unemployment problem. First let’s talk about the price of gasoline.

Crude oil accounts for about 75% of the cost of a gallon of gas (at current price levels, according to the Energy Information Administration.)

  • taxes account for just 12%
  • refining about 6%
  • distribution and marketing about 6%

The United States consumes about 20 million barrels of oil products per day(bbl/d), according to the Department of Energy

. Of that, almost half is used for motor gasoline. The rest is used for distillate fuel oil, jet fuel, residual fuel and other oils.

Each barrel of oil contains 42 gallons, which yields 19 to 20 gallons of gasoline. So, in the United States, something like 178 million gallons of gasoline is consumed every day.

With those facts in mind, let us take a look at how the oil industry operates.

The overriding factor that determines the price of oil from day to day is the market principle of supply and demand

. It comes down to simple economics: When demand is greater than supplies, prices rise.

The actual price of a barrel of oil is constantly changing, since oil is a commodity that is traded on the futures market. Buying and selling oil futures is called speculating, because you’re making trades based on expectations of future supply and demand. And demand is increasing.

In 2003, 11,000 cars were added to the streets of China each day totaling over four million new cars in that one year alone.  That pace has continued each successive year and it is expected that by 2015, 150 million cars will be traveling on China’s streets.  That is in addition to the estimated 254.4 million registered passenger vehicles in the United States according to the latest 2007 U.S. Department of Transportation study.  With this, anticipated Chinese car ownership, oil consumption is projected to reach 80 million barrels of oil a day above the current world production.

People talk about “oil independence” thinking that if we drill enough oil in the U.S. that we will not have to import oil from other countries.  There are a number of problems with that theory:

  1. All oil, whether domestic or foreign is sold on the open market. The global oil market is massively complex, as is the US’s role in it (for instance, we are both an importer AND an exporter), and it generally doesn’t matter where any particular barrel of oil ends up. All American oil is sold through the Chicago Mercantile Exchange (CME). The CME in turn, brings our oil, an American natural resource, onto the global market to be sold on behalf of the corporation that drilled it. In fact, America has been exporting millions of barrels a day. In 2008 the United States exported 1.7 million barrels, up from 1.048 million in 2004 according to Index Muni. Ultimately, prices and availability (“energy security”), are largely a function of global supply and demand. The oil flowing through a new pipeline would indeed increase global supply and in turn have a moderating influence on global prices and a positive impact on global availability. However, the demand for oil, mostly from China and developing countries that are increasing their use of automobiles and developing industries, is also increasing dramatically on a daily basis and it is that current and projected demand that is raising the price of oil.
  1. Companies that are generally considered a major U.S. Oil Company (Shell, Exxon/Mobil, Chevron/Texaco), are actually multi-national companies with operations throughout the world.  They don’t extract oil and gas just from in the United States; they extract it from operations located around the word.  And the oil that they extract goes into a huge open market where it is sold.  Naturally, it doesn’t make since to physically move a lot of oil from one place to another if it is not necessary.  So in theory, whatever is drilled in the U.S. probably, for the most part, stays in the U.S. But its price is dictated by the total amount of world supply. So although these companies are so-called U.S. companies, all that they really care about is selling oil and they sell it indiscriminately worldwide.
  1. In addition, the so called U.S. oil companies are not the only companies extracting “our” valuable crude. As you know, BP, a British company has a very large presence here along with a company you have probably never heard of…Statoil.   Statoil (a publicly traded company with 67% of its shares owned by the government of Norway) is the fifth-largest acreage holder in the Gulf and plans to drill three deepwater wells here in 2013. Statoil has more than $20 billion worth of oil and gas assets in the U.S. and has bet even more that drilling into America is the company’s best bet for growth. Since the government does not keep records as to the nationality of companies that hold oil and gas leases, it is unknown exactly how many foreign owned companies are extracting our precious resource, but those two are the largest.

So, it would be true to say that aggressive increases in U.S. oil production would bring the global supply a little closer to the demand for oil. Unfortunately, the U.S. is such a small player on the international oil scene — we control only 2 percent of the world’s known oil reserves — and even if we doubled our current production capacity today, we still wouldn’t make much of a dent. It would also take a number of years to assemble the drilling rigs, pipelines and manpower to make that type of production increase, meaning oil prices would be unaffected in the short-term.

The days of “cheap” oil are over. It is widely known that easy to reach oil reserves in the U.S. (and Canada), were drilled years ago. It is partly because of the fact that oil is selling for such a high dollar value today.  And it is because of oil’s high dollar value that companies can afford to go after harder to reach deposits such as those deep down in the waters of the Gulf of Mexico and Arctic, as well as, shale deposits. If the price of one barrel of oil were to drop below $80, than those explorations would not be profitable.  So, as you can see it behooves the oil community to make sure that the commodity does not drop below that level. How do they make sure the price stays high; by continuing to pump less than the demand.

Jobs:

Even if the President were to open up vast acres of land for oil drilling the only rush that you would see from the oil companies would be their private corporate jets, full of lawyers and accountants flying into Washington D.C. to try to tie-up as much of that land as possible before the other guy gets there.

While companies may have identified areas of the country that are likely to have oil deposits, it takes hundreds of millions of dollars just to do the scientific research and drill exploratory wells to find exactly where the oil is located.  And when they do find a deposit, the oil companies are not going to move in overnight, put up a dozen drill rigs and start drilling; for two reasons.

  1. As much as it costs to do the exploration for the oil, it costs ten times that amount to actually tap the oil, extract it, and transport it to be stored and refined. Even if the oil find was a “sure thing” and with as much money as oil companies make, none of them can afford to move into an area and start drilling with more than a few rigs at a time.  What the oil companies will do is explore the oil find, tap it, and then extract the resource over the term of a decade or two, getting the long term benefit of their investment.
  1. Working in an oil field is not only extremely hard work; it is also very dangerous and takes a highly skilled worker to handle all of the jobs.  An oil company is not going to pull a bus up to the local unemployment office, or labor hall, and say “I’ll take the first one-hundred of you now,” and then carry them off to the desert to operate a drill rig.  Experienced oil workers are in high demand and there are very few if any out of work, even in these hard economic times.  It takes years of experience doing grunt work to become a journeyman on a drill rig or oil pipeline.

So, as far as jobs go, the only major employment increase might be in the local housing market to build homes, apartments or perhaps motels where the oil workers (and families), would live during the time they are drilling and building whatever infrastructure in needed.

So what is the answer to rising fuel costs? In reality, we have already started on that path but at the current pace it will take quite a few years before we see positive results.

In short the only true way to become “oil independent” is to reduce the amount of oil that is used in the United States.

Oil use in the U.S. is broken down into four main categories:

  • Transportation 72% (with “Light-duty vehicles making up 45% and trucks/buses making up 17% of that number)
  • Electric Utilities 1%
  • Residential and Commercial 5%
  • Industrial 22%

In response to the energy crisis of the 1970s, Congress passed the Energy Policy and Conservation Act. This legislation had two major objectives: 1) Reduce our overall consumption of petroleum and 2) reduce our dependence on foreign oil (meaning OPEC). The means to accomplish this was by Corporate Average Fuel Economy (CAFE). Under CAFE automobile manufacturers are required to produce cars that averaged 18 miles per gallon. For light trucks the standard is 15.8 MPG. There is some flexibility. Every car (or truck) does not have to meet the standard. However, the average of all models (small, medium, and large) must meet or exceed the standard. Failure to do so would result in a fine of $55 per car for every MPG shortfall. CAFE initially took effect with the 1978 models. The standard was increased in 1985 to 27.5 MPG for cars and to 20.7 MPG for light trucks. The light-truck standard was again increased to 22.2 MPG in 2007.

But fuel economy standards did not stop there. Future standards were developed by DOT’s, National Highway Traffic Safety Administration (NHTSA), and the EPA following an extensive engagement with automakers, the United Auto Workers, consumer groups, environmental and energy experts, states, and the public. And in 2011, thirteen major automakers (which together account for more than 90 percent of all vehicles sold in the United States), announced their support for the new standards.

In August of 2012 The Obama Administration finalized groundbreaking standards that will increase fuel economy to the equivalent of 54.5 mpg for cars and light-duty trucks by Model Year 2025.

In addition, major auto manufacturers are already developing advanced technologies that can significantly reduce fuel use and greenhouse gas emissions beyond the existing model year 2012-2016 standards. They are focusing on a wide range of technologies that are currently available for automakers to meet the new standards, including advanced gasoline engines and transmissions, vehicle weight reduction, lower tire rolling resistance, improvements in aerodynamics, diesel engines, more efficient accessories, and improvements in air conditioning systems. The program also includes targeted incentives to encourage early adoption and introduction into the marketplace of advanced technologies to dramatically improve vehicle performance, including:

  • Incentives for electric vehicles, plug-in hybrid electric vehicles, and fuel cells vehicles;
  • Incentives for hybrid technologies for large pickups and for other technologies that achieve high fuel economy levels on large pickups;
  • Incentives for natural gas vehicles;
  • Credits for technologies with potential to achieve real-world greenhouse gas reductions and fuel economy improvements that are not captured by the standards test procedures.

But as you can see from the categories above, trucks and automobiles are not the only users of oil.  While manufacturers, businesses, and residences do not have to go to the fuel pump to get the energy to run equipment, appliances, lights, air cooling/heating units, etc., they do use oil by way of the electricity they consume.  By cutting back on fossil fuel electric generation and turning to solar, wind, geothermal and other renewable sources of energy, we can cut about 6% of our oil use.  If residences and businesses across the country installed their own solar energy systems it would drive down the demand from public utilities and therefore drive down their use of oil.

So while more drilling for more oil may sound logical and make a great political stump speech, it is not the answer to either oil independence or lowering the price of gasoline.

For insight on how the Oil Sands project in Canada will impact the price of U.S. oil click on this link to The World:

http://www.theworld.org/2012/03/where-would-keystone-xls-canadian-oil-go-and-does-it-matter/

For more information about the current oil reserves I offer the following:

According to the BP Statistical Review of World Energy June 2012, proved oil reserves at the end of 2011 reached 1652.6 billion barrels, sufficient to meet 54.2 years of global production.  That is assuming that world consumption remains at 88 million barrels per day.

The U.S. controls 1.9% of the world’s oil with an estimated 30.9 million barrels of “proven reserves” (including both taped and untapped sources).  In addition, the U.S. produces 8.8% of the world’s oil at 7,841,000 barrels per day but consumes 20.5% of the world’s supply at 18,835,000 barrels of oil per day.

Assuming that BP’s claims are true, and there is 54.2 year of global production at present levels of use, we know that the growing economies of Asia are using more and more energy every day. Increased use will not change how much oil remains at this very moment but it will determine how long any such supply will last.

BP’s estimate is close to projections made by the Society of Petroleum Engineers who estimates that the remaining official world reserves represent 41.6 more years of oil.

A recent Scientific American article states that “A new analysis concludes that easily extracted oil peaked in 2005, suggesting that dirtier fossil fuels will be burned and energy prices will rise.”

In August 2012, the U.S. Congressional Budget Office issued a report on Potential Budgetary Effects of Immediately Opening Most Federal Lands to Oil and Gas Leasing.  It details the amount of land currently under lease, currently available for lease, and future lands that would be available if Congress were to allow said leases.

The Washington Post, on August 25, 2012, ran an article titled; Romney would open federal lands to drilling.  How much oil and gas is there?  The article is based on the report issued by the U.S. Congressional Budget Office (CBO), and “The basic takeaway here is that the vast majority of oil and gas on federal lands is already available for leasing, particularly in the waters off Alaska and the Gulf of Mexico. There’s certainly room to open up further federal lands, but the additional resources appear to be fairly modest in comparison. For instance, opening up the rest of the Outer Continental Shelf to drilling would boost offshore oil and gas production in federal waters by just 3 percent in 2035.”

 

About craigruark

Craig A. Ruark is a freelance writer, journalist, and marketing and PR professional. In 2008, Craig became one of the first non-technical persons to become an Accredited Professional by the U.S. Green Building Council for ‘Leadership in Energy & Environmental Design” (LEED AP). Over the years he has immersed himself in the subject of “sustainability” and by combining this knowledge with his expertise in marketing and advertising, has published a book titled “Marketing Your Green Side,” which is available through Amazon. Craig is an avid fitness participant, sailor, SCUBA diver, enjoys singing Karaoke, listening to jazz, and is working on his next book.
This entry was posted in Business, Globalization, Green Energy, Price of Gas, Price of Oil, Solar Energy and tagged , , , , , . Bookmark the permalink.

2 Responses to The Basics of oil pricing and the effect on the price of gas

  1. Dianah Wylde says:

    Craig, this post makes a lot of sense. I followed your links, added the green button, and bookmarked your sources, especially the article about the XL pipeline on THE WORLD.
    Bottom line? Making oil more accessible is indeed like giving another bottle of whiskey to an alcoholic. Drilling more oil is not a long term solution because one, there’s no guarantee the oil will stay in the US, and two, cheaper oil will only encourage more consumption, increasing the global negative environmental impact.

  2. Great detailed information…too bad opponents of the now re-elected President (yay!) would still see this as completely biased information! They will believe want they want to believe – and that has nothing to do with detailed accurate information and facts.

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