Start the conversation
Comment on This Story
Or to contact Money Morning Customer Service, click here.
Crude oil prices rose for the third straight day yesterday (Thursday) – with more of the same to come.
West Texas Intermediate (WTI) crude for June delivery rose to $111.50 a barrel on the New York Mercantile Exchange, and traded as high as $112.48, the highest intraday price since April 11. Crude prices are up by a full third so far this year.
Brent crude is trading at $123.70 a barrel on the ICE Futures Europe exchange in London.
The latest surge in oil prices is not a result of new geopolitical developments – although they continue to weigh on the market.
Nor is it a result of any short-term inventory problems in either the United States 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.
The New "Oil Dynamic"
It has been some time since the Organization for Economic Cooperation and Development (OECD) countries – essentially Europe, North America, Australia, Korea, and Japan – have actually controlled this market. Demand now comes from developing, not developed, economies.
This has created a new oil dynamic that is playing an increasingly growing role in crude oil prices.
What occurs on a day-to-day basis in the United States – 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 highly integrated.
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 in the world.
Neither "Drill, baby, drill" nor "Fortress America" will have the impact their proponents anticipate. In fact, the idea that domestic crude oil can reduce gasoline prices is fundamentally incorrect.
Domestic crude is considerably more expensive to extract than oil imported from elsewhere. And since the cost of crude oil 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 had been a national-security argument, pricing considerations would take a secondary seat.
If we were talking about a national security strategy, the objective is to bring crude oil supplies under control; price is not a consideration.
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 fuel and other fuels, with the net impact of rising oil prices on the U.S. economic recovery, and the risk that those higher costs pose to U.S. jobs, the American tax base, and the country's industrial infrastructure, 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 Crude Oil Production Is Unrealistic
An important rule of thumb holds that each $1 increase 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 an increase of as much as 3.2 cents for a gallon of diesel.
Let me put into perspective what this means for domestic U.S. production.
During the second week of July 2008, when oil prices hit $147.27 a barrel, with gasoline costing an average of more than $4.20 a gallon nationwide (and diesel more than $4.60 per gallon), there were more than 360,000 capped wells in West Texas. And those wells held, in aggregate, millions of barrels of crude oil.
But even with oil at $147.27, it was too expensive to open them up. These are "stripper wells," the source of more than 60% of the crude pumped daily in the U.S. market. 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 record price of $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 the United States is experiencing a rise in imported gasoline and other oil products. 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 of dollars in expenses 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 over the past 15 months.
A Look Forward
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 oil – is not a result of Democrats, Republicans, Independents, Vegetarians, Reformed Druids, or any other political party or movement.
This comes 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.
On one front, at least, we're already making strides.
Indeed, 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.
But here's the stunner: You can still get shares for less than $4.
Dr. Moors is currently recommending it to all of his Energy Advantage subscribers. To find out more, please click here.]
News and Related Story Links:
- Money Morning "Quarterly Report" Forecast Series:
Oil Prices Look to Top $150 by Midsummer On Resilient Demand and MENA Turmoil. - Money Morning News Archive:
News Articles by Dr. Kent Moors. - MarketWatch.com:
Oil Prices Likely to Keep Rising Until June. - MarketWatch.com:
Oil Turns Higher, Rising Above $111 a Barrel. - Money Morning News Analysis:
The Middle East Crisis: Egypt, Libya and Triple-Digit Oil Prices - Money Morning News Analysis:
U.S. Consumers Get Creative to Handle High Food and Fuel Prices. - Wikipedia:
Drill Baby, Drill. - Wikipedia:
Stripper Well. - MarketWatch.com:
Oil Edges Down After Topping $112 a Barrel. - Wikipedia:
Druids. - Oil & Energy Investor:
The Whole Truth About Rising Oil Inventories - The American Thinker:
Fortress America
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.
Of course oil shall go up but there is a bright side to this because it will encourage new technologies as electric and LPG.Cars need not be converted to LPG if they come off the assembly line alredy designed properly.The engine benefits. Owners I have met were happy.Good enough.
Thanks Dr. Moors for sharing this uncommon knowledge.
I am somewhat confused though. As I watched crude climb throughout 2007-2008, I believed a bubble was forming in crude speculation. I was also certain about the housing bubble. My position was in cash throughout the summer of 2008. Then suddenly, crude dropped from $147/bbl to $108 by the third week of September. At the same time money markets became jeopardized. I also was being told by media experts that oil was then a bargain below $120/bbl. One said that, "The lows are getting higher and the highs are getting higher." This made a great deal of sense. So, believing that oil would soon rise again and that cash was losing value, I moved my position to oil just a couple days prior to the executive order to insure money markets. As you know, by March, 2009, oil plunged to below $35/bbl. I later learned that the primary reason oil fell was due to investment banks had significant holdings in oil and needed to cover their cash positions causing them to abandon oil. I remained in oil till October 2010 believing that our economy was beginning another dip. I also felt that similar conditions to last quarter 2008 were being created in an even weaker economy. For about a weak following the announcement of QE2, the market remained sideways.
Now, as oil climbs again, just as it did the first half of 2008 pressuring our currently weak economy, isn't oil entering yet another bubble funded by QE2 which ends in June? Or am I single handedly controlling the market by being in cash, oil will rise; being in oil, oil will fall?
Finally an article that said what was known by the oil industry for years. Great job of putting it into words for the masses. Foreign Policy magazine has said the same for a very long time but no one seems to be listening.
This is an excellent explanation of the cause of oil prices. It should be read by the politicians from all sides and also the news media including FOX News and O'Reily, who blames on the speculators and refuses to listen to an expert explaining to him. The entire population should understand this and support energy policy that includes gas and nuclear.
Excellent article.Thanks
Aren't you ignoring (or discounting) the rapidly declining value of the U.S. dollar in the pricing mix? QE1 and QE2 money creation exercises have contributed to a 25% drop in the trading value of the dollar over the past 12 months.
It is a surprise to all non Americans, that fuel can be so cheap in the States! Look at Europe –
we all pay there between U$ 9 an 12.- for one Gallon of fuel or petrol. So what is wrong with the USA! The government is subsidizing far too much – this is an competition violation for trade. -American companiers pay so much less for Energy- not allowed by WTO!
If the government would rise the fuel-taxes,- which means – make fair taxes, – the horendous
Debts of the USA would be paid up for in just a few years!
Just bring this message foreward to the lost- wasting – helpless – idiots of a parlament!
It is soooo easy for the USA – just pay up as others do too – and you are no longer a burden to the financial world.
I am a Swiss and I am sure that I would have a cure for all miserable wasting – petrol guzzlers!
They would start reducing the USA deficite – isn't that a hit! ha-ha
Best regards
Theo Müller
From Wounderbound, As long as the oil cartel controls both the source of energy(IE gasoline,
natual gas), and 60 years of technical( mechanical&chemical) proven in your own history making
by way of Shell Oil since the1940s they meaning the cartels are the real masters and captains of every economy and commodity on the planet. I personally would not have the will to change the power structure ( to much fun ) this is a planetary game. Thanks I needed that.
Good article. however, I would point out that if domestic production were completely uneconomical, as you suggest by citing the inefficiencies of stripper wells, we would see no new wells being drilled domestically. But they are being drilled, and not just for fracking, but for extraction of sweet crude in the Bakken reserve. There is crude available in the US that is economical to recover.
Secondly, as another comment suggested, there is a genuine correlation between commodity prices in general and the US dollar, and this correlation is especially strong with regard to oil. My contention is that widespread (globalized) speculation in oil futures (derivatives) is at the heart of both pushing the price of crude up and the pushing of the dollar down. Since they are hedged against each other in the markets, and both (US currency and oil) markets have become hugely inflated through derivative leverage, the market for the underlying commodity has become deformed. I think, even as a political conservative, that the solution is to regulate a limit on leverage itself. This is a simple, original notion that I think would bring sanity and more safety into all of our financial markets. Since small moves in markets would no longer be profittable, the use of derivatives as true tools of financial hedging rather than as speculative bets would occur.
Remember, anyone who loves derivatives and thinks they should not be regulated, that the mispricing of risk is commonplace in these futures markets, and derivatives have the added feature now of causing taxpayer bailouts. Plus, they stop adding liquidity to the markets just when it is needed most, that is when there is a huge downward trend. Buyers stay on the sidelines waiting for prices to bottom out, any time there is an actual panic. Hopefully, food for thought.
A couple of points about this excellent article. Where oil is refined is not very important. If any refinery decided to raise the price of refined product too high, other refiners around the world would quickly gain the market share from that one refiner. I am delighted that refined product is imported. Where the crude originates is a different matter. A few large producers can corner the market and create a temporary squeeze for a few months, or even for the long term.
We have only reached peak oil until the new micro fluidics Coal-to-Liquid process starts to be a big supplier of crude. I see a future of oil refiners accepting both crude oil, and then as much product as CTL can generate at a fair price. No shortage of refined oil product until we run out of coal, and the new CTL process handles the worst in shale and coal, and without pollution or big water usage. And gasoline can return to $1.25 a gallon. This changes everything.
PLEASE SEND ME CRUDE OIL REPORTIN FUTURE