Wednesday, September 21, 2005

How to jack up oil prices even more

As oil prices soar, so does the worldwide public outcry against Evil Big Oil. Consumers are squeezed dry as Evil Big Oil soaks up the profits. Why don't they flood the markets with oil to give consumers some relief?

Informative article from BusinessWeek. To quote: There's no way the oil majors can flood the markets, for the simple reason that it takes years to find the oil, build the refineries, and construct the pipelines that will turn a shortage into a surplus.

The shortfall in refining capacity is appaling: No new refineries have been built in the U.S. since 1976, because of a combination of regulatory hurdles and local opposition. And the majors still see refining as a poor business, although profits on refining are now very lucrative at $20 per barrel, vs. under $5 per barrel as recently as the fourth quarter of 2004.

Nor is finding the oil a walk in the park: Despite the risks, oil companies have boosted exploration substantially. Norwalk (Conn.)-based consultants John S. Herold Inc. report that 200 oil companies have roughly doubled exploration spending to a combined $180 billion for this year. "They're certainly spending a lot more. Whether or not they are spending enough, that's up for some debate," says research director Nicholas Cacchione. But while they explore more for oil, the oil is harder to find. Companies are being forced to replace their depleted sources of oil and gas in the West with new supplies in politically and geologically more challenging areas, from Russia to the deep water off West Africa. "The companies are making more money, but they have more risks," says J. Robinson West, chairman of Washington-based consultants PFC Energy.

The biggest risk comes from the inability to predict the long term trend of oil prices: Executives need to make multibillion investment decisions without knowing whether oil prices are going to keep rising or plunge to the $20 range that prevailed through the 1990s and inched up gradually until 2004. Now companies are slowly increasing their pricing assumptions. Browne says BP figures prices will remain around $40 per barrel for the next five years. But the industry's leaders, who rose up the ranks in the relatively lean times of the '90s, are still being conservative -- some think obstinately so. No oil executive will cut a deal for five years out assuming that today's spot price of $65 will prevail.

Do you want to make sure that oil will cost over a hundred dollars a barrel? Easy. Compound the uncertainty facing Big Oil by threatening taxes on windfall profits. Send them a signal that whenever it becomes more attractive to invest in oil drilling and expanding refinery capacity, along comes Big Government to take it all away. Since you've pushed the return on investment down, don't be surprised that investment to expand oil supply goes down. Supply stagnates, while demand continues to grow.

It's that simple. Let's give it a try.


Amadeo said...

I'm with you on this. But it sounds too logical. Thus, many would rather play the blame game. After all, big oil continues to show profits.

And what is it? It costs only US$4 to extract oil from the sandy deserts of our MiddleEastern friends? So what is so sweet about sweet crude that's priced at about US60 on the market.

China's burgeoning demands, maybe?

It is ironic for us here in the BayArea of the golden state, because we are surrounded by aging refineries and where Chevron is headquartered. But San Francisco gas is still averaged at US$3/gallon.

The strong presence of environmentalist groups which call this area home, maybe?

Econblogger said...

As explained in the Business Week article, an unanticipated slight increase in demand (China, US, even India) was enough to cause prices to skyrocket. This is what you get when both demand and supply curves are highly inelastic (let me know if the term is unfamiliar.)

When profits are moderate, then you get the investment stagnation talked about in the article. You can only really get the multi-billion dollar risky investments in place when there are high returns in the offing.

In your local case, yeah, some environmental group probably.

f said...

more than a third of the price of gas in the u.s. are accounted for by federal (fix of course across states) and state excise and sales taxes. some states require retailers to add special additives that also add to the cost at the pump. indirectly the environmental lobby might have something to do with it.

Amadeo said...

Taxes (both fed and state) accounted for less than 30% of gas price when crude oil was under US#30 and it accounted for 44% as a price component. Average retail price was then $1.56.

Now, with crude at $60, more or less, taxes must now account for even less of the retail price. But crude oil should account for even more.

f said...

right it does vary and it depends where you live and sometimes what county within the state you live in, some states levy the taxes ad valorem, as a precentage of the value sold. the federal component which is excise of course goes down as a percentage of total price (when prices are rising as you said). if you happen to live in a county that inserts certain excise or additional sales tax (to finance say certain infrastructure, or sometimes expenses by the school board) the tax component of gas prices in your particular county would be different from others. california has very strict environmental standards so the environmental friendly additives they require refineries to add also adds to the price at the pump. counties around washington dc also have notoriously high gas prices because of environmental considerations.