Home » Money » Breaking the Oil Cycles

Breaking the Oil Cycles

News shown out over the highway in big glowing numbers – 3.289, a number lower than anyone had seen in a while.  That was the price per gallon of gasoline the last time the little purple car was filled up and piloted back down the highway.  A few months earlier it was 3.929 at the same station, about 20% higher or $7.68 over a tankful.  How can that possibly be?

Many things go into the price of gasoline, but the most important is the cost for crude oil.  Something around 60% of the cost at the pump is the raw material that fuels our lives, the rest being more or less fixed costs in refining, transportation, taxes, and profit.  It’s the price of oil that is notoriously volatile, driving the changes at the pump.  And something is about to be done about it, too.

As reported here last May, the market for oil is volatile to the point of being dysfunctional.  As shown by the price of West Texas Intermediate (WTI), a benchmark middle-grade oil, since the economic bottom in 2010 it has flopped up and down tremendously:

This chart from the St Louis Federal Reserve shows the problem immediately.  Through this weak recovery WTI has averaged $90 per barrel (42 gallons), but has hit as high as $110 and as low as $75.  It gyrates up and down a stunning 20% above and below its average on an annual basis.  How can this be the case?

At the very least, the futures market is not functioning as it should.  Stable prices for key commodities are what a futures market is supposed to be about, more or less moving stocks forward and backward in time.  It does this by being a place where suppliers can sell their production months or even years in the future, raising quick money to bring more capacity online.  That should bring the price down, and the market should find equilibrium.  But oil does not work that way.

This naturally brings about charges that the failure of the futures market to bring stability comes from its role as a haven for speculation and manipulation.  Joseph P. Kennedy Jr of Citizen’s Energy Corporation points that where 85 million barrels per day is traded in a market that buys and sells a billion barrels a day – meaning each barrel is turned over at least 10 times.

Estimates run between about $0.50 to $1.00 per gallon is paid by consumers to cover the profits made by this excessive trading.  That’s why the Obama administration has been cracking down on speculators to the extent that it can.

But this alone does not explain the volatility in oil.  Part of the problem is that there are dormant wells everywhere, particularly in Texas and Oklahoma, that are not profitable unless oil is at the upper end of its current range.  Oil does not simply bubble out of the ground most of the time – it has to be extracted with pumps, steam, or other methods.  Every well has a price for operating it, and no one is going to pull oil out at a loss.  When the price goes up, production rises – which sends the price down again.  A properly functioning futures market would even this out, but it clearly does not.

Clearly, there are two problems here.  Production costs are uneven and the futures market is run by people who care more about money than oil.  Even without the gaping maws of speculators, the diminishing resource would not trade evenly in the best of circumstances, however.

The only true solution are new sources of fuel.  As written here, cheap natural gas can be made into gasoline by a number of methods – some of which are expensive and difficult.  But the price of oil is high enough, on average, to justify some fairly extreme methods.  What we talked about earlier this year is fast becoming a reality, even without the latest in technology.

This is very important to our economy, and not because it will provide cheaper gasoline.  In fact, it won’t bring the price down as low as many think.  What this does is set a floor in the cost of gasoline probably around $3 per gallon no matter what.  New technologies might bring it lower, but what makes new sources of gasoline from natural gas viable is the high cost overall – driven at least in part by excessive speculation.

Note that it is completely ridiculous to assume that more drilling will solve the problem, especially since most new wells are tapping resources that were deemed too expensive in the past – perhaps because they were deep in the Gulf of Mexico, among many reasons.  The only things that can change this is a crackdown on speculation and new sources of supply.

We will all benefit from stable gasoline prices because costs for everything transported (i.e. absolutely everything) will be more stable.  That’s important.  It may not be as low as some think, but it is likely to drive the speculators out of business even if laws lack the guts to do it.

17 thoughts on “Breaking the Oil Cycles

  1. Yes, gas can of course be liquified. Something to consider is that the carbon/hydrogen ratio of methane (.25) is quite different than that of octane (0.44). (Octane is sort of a placeholder for the complex mixture of stuff making up gasoline.) So to make gasoline out of methane, you have to almost double the carbon content, and that carbon has to come from somewhere. Or, you have to have a lot of hydrogen left over. From a climate-change perspective, it’s the relatively low carbon that makes methane an attractive fuel, and adding carbon to it is a step backward. Greatly increased use of compressed/liquified natural gas in vehicles might make better sense than massive methane liquifaction.

    • It depends on a lot of things. I believe that ultimately we’ll be producing methane from bio sources (as I wrote back in May) and natural gas is just an interim tech, so that would change it. Also, making longer hydrocarbons would have hydrogen as a by-product, which could produce electricity with very high efficiency, so it’s not wasted.
      There are a zillion ways to look at it, but in the very short term a drop-in gasoline is going to be the way to go. And you are right in the long term – something has to give.
      The way the oil market is manipulated is pretty horrible, however. Simply breaking that would get us somewhere good, I think.

  2. Hmmm–using hydrogen is a matter of moving protons in a pipe rather than electrons in a wire. By “very high efficiency” do you mean electrochemical as opposed to thermal processes? That could make sense, I suppose.
    I totally agree about the manipulations of the oil market. I think this has always been true of crude and gas prices and long antedates today’s sophisticated “market” manipulation tools that (may, I’m no expert) effectively deprive people of the legitimate purposes of hedging. If you look, for example, at consumer-level natural gas prices, they’ve been only trivially responsive to a dramatic drop in wholesale prices. For the most part industry players pocket the difference. Xcel reporting an 18 percent profit increase at the moment…. Of course, industrial interests dominate the regulators, such as the Minnesota Public Utilities Commission. It all depends, as you say, on a lot of things. So many that almost any view can be defended…..

    • I’ve never been fond of hydrogen as a fuel because the energy per unit volume is as bad as anything you can imagine! Even batteries are better. So if you have hydrogen (as you would from gas reforming) you really should use it in place, IMHO. I’m thinking of a fuel cell, yes.
      You’re right that oil markets have always been manipulated – it’s almost a tradition at this point. Natural gas is indeed going the same way even as we find more of it all the time (and learn how to use it rather than flare it). I do think that the first policy goal has to be to break these guys one way or the other, but the fact that we’re looking at alternative sources of supply for gasoline-type fuels will help that tremendously.
      Thought of another way to look at this. There are many people who believe that gasoline is as expensive as it is only because of taxes ( though only about $0.50 per gallon, depending where you live). We can be sure that speculation is at least as much as taxes, however. Puts that whole big gumint / big business argument into a different light, eh?

  3. It is insane that this is allowed to continue. What laws we have to write or whatever I can’t say but this is unbelievable. There is a place for futures markets but to turn over each barrel 12 times a day (check your math) has no place in the market. It has to add a lot to the price of oil because they don’t do this just for fun.
    Do you know of any regulations that could change this? Why is this not a campaign issue too?

    • It is close to 12 times a day, yes. I used Kennedy’s assertion of “more than 10”, since I had a link to the article.
      No, they don’t do this just for fun – there is a tiny profit on each trade, which adds up at the end.
      I have no idea how to regulate this out of existence, and neither does Obama (who would really like to). We do need a futures market of some kind and these trades are roughly the same as a real functioning market – how can we differentiate?
      The only thing that would change it is messing up the cozy li’l market they have now. Remember when I described a world currency? Part of the idea is a more open market that had opportunities for stable contracts “on the side” which bypassed the futures market all together. It’s really another idea I have for breaking these.
      To get them to stop will require real pain. Someone would have to go into this market and slam these guys to the point where they lose a ton of money. That would probably break some very big banks, too. I’m starting to think that all these guys should fail and just go away because they are parasites.

  4. I don’t care about the usual excuses like “oh its always been this way” and whatever. This is just wrong. You are telling us that as much as a buck a gallon goes to people who add nothing but cost to gasoline? What if that money was put into roads or, I don’t know, left in the wallets of regular folks for once?
    This makes me mad. The only thing I don’t understand is why we don’t hear about it like Anna said. If I ran for office (which I won’t) I would talk about nothing but this day and night!
    You are sure about this? I can’t believe this happens right under our noses and no one even says anything!

    • I am sure of this. Why it is not talked about and made into a major campaign issue I can’t tell you. I will say that oil lobby generally is more these people than Exxon or even the Koch Brothers, and the Republican “Drill here now!” position is very much a diversion away from the underlying issues at hand.
      It’s really sick stuff, especially since the Democrats don’t try to make more hay out of it.
      Even at $0.50 per gallon, we’re talking $65B per year that can be identified, and it may be twice that. This is about $1,000 per household per year. It’s a lot of money.

  5. It is ridiculous & if the futures market is making things worse it should be totally revamped. A whole lot of new laws would be a disaster but I can’t believe the oil companies put up with this in the first place. If they don’t take the lead on doing something about it they have to be taking their cut.

    • The whole market is completely out of whack, and as oil becomes more precious it will only get worse without some major changes. Since I have no idea how to re-vamp the market, I look to new sources of supply to shake things up. But there may be a way to regulate this without destroying the needed futures market. I do prefer to not regulate unless it has to be done, but in this case I think we should figure out how.

  6. it is all rigged to give fat cats an ez income – they are parasites as you said – too big to fail is an illusion, we are better off if they fail

  7. As you said, “they don’t do it for fun.” Of course they don’t; they (speculators) do it because it is profitable. If it weren’t profitable – just like those expensive dormant wells – then they wouldn’t do it. Why is it profitable? Because the consumer is willing to pay the resultant price. Until/unless you fix that ‘problem’ (in quotes, because that’s one heck of a presumption) then any regulation you add to ‘fix’ it will ultimately only fuel the fire by creating a false scarcity, a la prohibition. “Cracking down on speculators” is misguided – their singular transactions are simply trying to buy low and sell high, just like any other merchant, and unless the price is reliably trending in one direction they must ultimately lose as much as they gain. Summation( all futures speculations between time x and time y) == delta( average price). In order to cause the market price to -always- be increased by $0.5 – $1.0 requires a ‘constant drain’ in the system, which in this case is the “house percentage” of the brokers’ fees; they’re the only part of the equation which represents a “cost” regardless of whether your speculation made a profit or a loss. So what are you going to do, tell the brokers that it is illegal to charge a fee for their service? Tell a merchant that it is illegal to conduct a transaction over a commodity more than N times? How would you enforce it? More importantly, how would you enforce it in a way which didn’t ultimately cost more than the brokers’ fees it is intended to eradicate? …. Your other possibility is that the important speculators have insanely deep pockets, and are speculating with amounts large enough to buy up & sell off at appropriate market flows to profit on both sides of the curve, which doesn’t negate my previous point entirely, but merely provides insight as to why an expected ‘stabilization’ isn’t occurring. Stabilization in a futures market depends on large volume compared to small consumers, and that assumption doesn’t necessarily hold. Which leads toward the ‘big banks need to fail’ option, in which we agree. “Too big to fail” is the most laughable phrase I’ve ever heard; the only way it makes any economic sense is if the speaker really means to say, “I’m too afraid to allow the necessary failure, especially on my watch.” …. there’s probably also a great deal to be said about removing taxes and subsidies so that the price more accurately reflects the cost, which allows consumers (at all levels, including speculators) to make more accurately informed purchasing and preference decisions. Much of that may be ‘post speculation market’ and so may not be entirely applicable here, except insofar as a) it would certainly cause the speculation market to change somewhat, especially if b) it might also spur a great deal of demand for alternative energy sources once the True High Cost of Gasoline is revealed – unless it isn’t so it doesn’t, but in which case it’s still an overall Win.

    • Thanks, Larry! The bottom line is that market forces do work – at least over a very important time frame. I agree, we can’t dismantle the market that does exist. We can stop screwing with it in various ways, and there is certainly a market developing for all kinds of alternatives that are now economical. It will sort out.
      In the meantime, some people are making a lot of money on nothing but trading. I think that this can’t go on forever and that the cost of trade around the globe has to fall. With the cost of capital lower than it ever has been in the petroleum era, the carrying cost of buying a tanker full of oil right at the source is at a low – perhaps the “value” added by traders is much lower as well, and more fixed deals directly from the source might be in order. I wonder what would make that even more palatable in the future? Seems to me that if a barrel of oil trades 12x, with a little vig each time, there has to be some value in an efficient system that allows a barrel to be held all the way to the refinery.
      Just a few more thoughts to add to a great addition, thanks!

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