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Oil and Gas Catch 22



March 09, 2012 – Comments (1) | RELATED TICKERS: VDE

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Board: Pro: Philosophy & Strategy

Author: BigOil1


You wrote:

Now here's the problem. We don't burn oil in our cars, we burn gas. It seems the major gasoline refiners have produced more gas than we need because of our cutting back, buying smaller cars, green energy, etc. So this gas supply/demand situation should lead to lower priced gas - yes?

Gas as you called it is actually gasoline which is refined from crude oil. Gas as in natural gas which is used as a source of fuel for domestic heating and cooking, generation of electricity and numerous "synthetic" substances is sometimes a by product of oil production (associated) or sometimes from a natural gas reservoir (non-associated gas).

World crude oil production in October 2011 was 74.3 MMBOPD. US crude oil production was almost 5.8 MMBOPD. (Source: Journal of Petroleum Technology March 2012, published by Society of Petroleum Engineers). The US consumes about 16 MMBOPD. We are a net importer and will be for the foreseeable future. Oil prices are set partially by speculators and partially by demand for the product. Roughly 18 MMBOPD travels through the Straits of Hormuz (roughly 25% of world production) any saber rattling over the Straits has a huge impact on oil prices. Fear and rumors as mentioned in the How-things-work article.

Estimated crude oil production and consumption are roughly in balance with production being about 0.5 MMBOPD greater than consumption (Source US DOE/EIA). Reserve production capacity is probably not much more than 1 to 2% more. Most of this reserve capacity is probably in the Middle East where most of the world's proven developed reserves are located. The number is difficult to estimate because the major National Oil Company producers are opaque about their reserves and production rates. Most drilling today is to keep up with production declines from existing fields. Until the demand curve starts to decline or level out this is not going to get better. Have we reached "peak oil"? Can't answer that question yet. We'll recognize it in the rearview mirror after it has happened.

Okay gasoline or "gas" as you called it is refined from crude oil most of which comes from outside the US (16 MMBOPD -5.8 MMBOPD = 10.2 MMBOPD). Obviously not all this crude oil is refined into gasoline but a good chunk is. Our refineries here in the US have a finite capacity and they typically are run at about 95 - 98% capacity. Because of their design and construction it's technically not feasible to reduce capacity for "indeterminate" periods without mothballing facilities. Therefore, when demand in the US is reduced the major refiners (not just the integrated oil majors) will export gasoline. In reality even when demand is high in the US there are exports and imports of gasoline due to market needs and inefficiencies. However, the major input material for gasoline is crude oil and we (the USA, Exxon-Mobil, Chevron, BP, Shell and anyone else who is called an oil major) do not set the price for the commodity.

Even though US crude oil production has increased over the last three years it is still far below its previous peak and a fraction of our daily consumption.

Yes speculators and hedgers (airlines, refiners, the US military and other big consumers will hedge their fuel requirements) to save a few bucks or to establish a price for future production. The whole process is a lot more complicated than what I've very, very briefly described here. While it's not fair, OPEC has determined a floor price for crude oil (Saudi's think $70ish is okay, Iranians think whatever the market will bear is okay). It does not cost the Saudi's much to produce a barrel of oil. The US is probably the highest cost oil producers, due to low well rates and higher costs.

People have written books on the industry, its flaws and the machinations that influence the price of crude oil. I'm not about to attempt that kind of effort here. It should suffice to say, crude oil is a commodity and we are a marginal producer and don't set the price. Everybody has their own conspiracy theory because it's easier to blame our problems on some "them". As Pogo once famously said " We have met the enemy and they is us".

Want to help lower the price of gasoline? First, ping on your elected representatives and senators for a national energy policy. We don't have a plan and that is no way to address a commodity that is not limitless. Two, conserve energy both liquid and gaseous fuels. Three, develop more alternate energy sources including nuclear power generation and make them economic by raising the cost of cheap crude oil through taxes. All those alternate sources are basically uneconomic without tax subsidies or tax breaks. We must establish a floor price for a MMBTU of energy so that the alternates can compete economically. This is the reason we need a national energy policy. Four, get used to paying more at the pump. The price will fluctuate but the trend will be steadily upward unless we do something different.

Finally, "drill baby drill" will NOT solve the problem. It will be part of the solution but it won't get us there. All of the above is what is needed.



Disclaimer: I own VGLEX (Vanguard Energy Fund) which is similar to VDE. I however, do not own any shares of "Big Oils" directly.

1 Comments – Post Your Own

#1) On March 11, 2012 at 5:38 PM, 5lohands2 (< 20) wrote:

Well, the liberal democrat has beeen heard from.  What a surprise, higher taxes, more governement regulations, intrusion and interference.  Same old song and the beat is down.

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