Reviews of Oil 101

1. A review of Oil 101 just posted by Robert Boyd.

"I am relatively new to the energy business. One of the things I had to do as soon as I started was to take a course given by Baker-Hughes about all the stages of the oil and gas business. It wasn't a bad course, but I now think it would have been better for me just to read Oil 101 by Morgan Downey......Oil 101 is an excellent handbook, and should be on the desk of anyone in the oil (or gas) industry, regardless of where in the value chain you are." (full review here)

2. Another review here.

Escape from Oil ca traz

At an energy conference in a place called "Alcatraz" University near Perugia, Italy over the weekend, I had a conversation with a Swede about the country with the most agressive plan to almost completely phase out oil use.

Supply-Driven Oil Price Rally

Carl Etnier from the Rutland Herald wrote an interesting piece on why oil prices have been rising and to role of speculators. Carl mentioned an article to me that said the rally was due to speculators because oil demand is still weak. My response was:

"The thing that annoys me about those sorts of articles [blaming speculation] is that it says oil demand is down and so price should not be rising. Since the beginning of 2009 demand is down year on year by 2 million barrels per day but supply is down over 3.5 million barrels per day (due to OPEC cuts)."

US Traffic Growth

In April 2009, miles driven by US motorists increased year/year for the first time since late 2007. The US DOT traffic data released today for April is a lagging indicator of oil demand. The average price of crude oil (NYMEX WTI) back in April 2009 was $49.95 per barrel. It will be interesting to see if this traffic recovery continues now that oil is hovering around $70 per barrel. Complicating year/year comparisons this year will that this year's data is being compared to a period when oil prices spiked during 2008 and the credit crisis.

US Inventories & Summer Doldrums

Chart: Crude Oil (NYMEX WTI) Prices Over the Past 8 Days

The oil market has been chopping sideways around $70 over the past few days. Weekly US oil inventory numbers are released by the DOE each Wednesday at 10:30am New York time. This week the data provided little impetus for any price move for the oil complex. Bear is mind that although US data is widely followed, it is the source of less than a quarter of the world's demand. Nonetheless, US data is viewed as a barometer of global supply and demand. I was quoted in the Wall Street Journal today:

The draw in crude stockpiles and the rise in gasoline "offset each other, and the effect on the market was neutral," said Morgan Downey (WSJ)

Crack Attack

Cracks are the spread between the price of a finished product (gasoline, diesel and so on) over* crude oil. A crack is usually quoted in US dollars per barrel. The crack could be thought of as oil refinery's US$ per barrel profit margin before the costs of running the refinery.

Over the past few months we have had very low gasoline inventories (as gasoline demand has recovered from the 2008 oil shock causing inventories to fall) but very high diesel and jet fuel inventory (as commercial activity has not recovered to the same extent as gasoline demand).

In 2009, Gasoline cracks (see chart 1) have been increasing while distillate margins (see chart 2) have been decreasing. The net result is that, in 2009, gasoline prices at the pump have increased more quickly compared with crude oil prices. Diesel and jet fuel prices have increased more slowly than crude oil prices in 2009.

Refineries produce a basket of finished products including gasoline, diesel, heating oil, jet fuel and residual fuel. Net refinery profitability (a proxy is called the 321 spread) has moved sideways as higher gasoline margins are offset by lower diesel and jet fuel margins (see chart 3).

Chart 1: Gasoline Crack
Chart 2: Heating Oil Crack (proxy for diesel and jet fuel)

Chart 3: 321 Crack (proxy for total refinery basket margin)

*Cracks tend to be positive except for residual fuel oil cracks which tend to be negative. See Oil 101 for more.

Iran and Oil

Iran is a strategic pivot point for the oil market. Iran is a large crude oil exporter, it is close to large oil exporting nations and it borders a major oil transit waterway (Strait of Hormuz).

The election result in Iran a few days ago were surprising to some outside of Iran - they shouldn't have been - at least according to Stratfor, a Texas-based private intelligence agency. Stratfor has a summary of how the election resulted in Western Misconceptions Meeting Iranian Reality. Their conclusion:

"For the moment, the election appears to have frozen the status quo in place. Neither the United States nor Iran seem prepared to move significantly, and there are no third parties that want to get involved in the issue beyond the occasional European diplomatic mission or Russian threat to sell something to Iran.(Stratfor)

Plus ça change

How much oil is stored in the European Union (EU)? Official oil inventory reporting in the EU is weak compared to that compiled in the US. Today the EU "overhauled" its reporting mechanism for oil inventories but rejected a proposal to report inventories weekly (as they are in the US). From Reuters:

"Monthly reporting of stock levels is a small change from the current system under which EU states must confirm each month whether they hold 90 days-stocks, but need provide no more detail." (Reuters)

A Market Yen for Kiloliters

As mentioned in Oil 101, oil is traded in US dollars because it most efficient for everyone (consumers and producers) involved. Oil floats freely against the US dollar and all currencies. If the US dollar or other currencies weaken then oil prices rise in all those currencies. There is little economic reason for wholesale markets other than in US dollars.

Every once in while there is a suggestion to trade oil more often in Euro or other currencies. Trading oil in non-USD currencies makes comparing the price of oil across the world more difficult. If oil has risen by US$1 per barrel, how much should it have changed in Japanese Yen per kiloliter (the unit used on Japan's TOCOM exchange)? This may seem trivial but this causes an inefficiency which raises prices for Japanese consumers. The issue was discussed in the Wall Street Journal today:

"One of the reasons why oil around the world is traded not just in barrels, but in U.S. dollars per barrel, is because it allows the least amount of computation from one market to another," said Morgan Downey....author of 'Oil 101,' a book about the oil industry." (WSJ)

Crude above $70

Crude (NYMEX WTI) continues to make new highs for 2009 above $72 per barrel. I was quoted in the Wall Street Journal yesterday:

"Until OPEC increases production or consumers are reluctant to bear high prices we are going to see an increase in the crude price." (WSJ)

OPEC and the Consumer: BFF?

Which one in the consumer?

Today the oil market (NYMEX WTI crude) traded above US$70 per barrel and closed at a high for 2009. If you read this blog you will have been aware of the reasons for this trend since the turn at US$35 per barrel oil. Fundamental oil bulls have been lonely. Total global inventories are falling. OPEC members have removed more oil supplied than demand has fallen.

US$70-US$80 is the sweet spot at which OPEC and the consumer have declared they would both be comfortable for now given the nascent state of economic recovery. OPEC (read: Saudis) know that they can't open the spigot yet. They need to get prices up to US$90 to allow for some slippage. OPEC members know that consumers haven't got the cash to pay the high prices from 2008 and so members are unlikely to allow prices back above US$100 without finding themselves on the receiving end of some serious net consuming country political pressure.

Hey Mister, Spare US$2,240 a Year?

Gasoline prices in the US are around US$2.60 per gallon this week. The American Petroleum Institute (API) mentioned today that proposed US climate change legislation would add 77cents per gallon onto US oil prices. A rough calculation converts this to around US$2,240 out of pocket per US household per year. Gross this number up to pre-tax income and it becomes a whopping big number.

Refiners and Heavy Crude

As you know from Oil 101, OPEC members' marginal production (that which members cut and add to the market) tends to be heavy crude oil. Refineries designed to run on heavy oil are therefore exposed to fluctuations in the price differential between heavy and light crude. When OPEC cut, as they have since the fourth quarter of 2008, heavy crude becomes more scarce and rises in price relative to light crude. This price rise removes some of the advantage which heavy crude refineries paid dearly (with expensive equipment) to have. Here is a Reuters story describing the situation such "complex" refineries face.

Oil Spike in the Works?

The head of Shell warning today that another spike in oil prices is likely given the lack of sufficient new investment.

Crude oil is set to “spike” without new investments and a price surge is in the making, Royal Dutch Shell Plc Chief Executive Officer Joroen van der Veer said. The global energy industry is facing “severe challenges” and the world needs unconventional energy supplies to meet rising demand... (Bloomberg)

Reserves: an Educated Guess or Maybe Not

Resources are an estimate of the total amount of a mineral underground which can technically be removed. Reserves, a subset of resources, are an estimate of what can be removed economically at today's prices. The key word to remember is "estimate."

As you know from Oil 101, there are major issues with commonly stated global oil reserves. Some reserves estimates are no more than wild guesses.

As an example of how mineral reserves estimates can be subject to significant readjustment, the U.S. Geological Survey (USGS) has just completed a survey of an area in which one third of US coal is sourced. As a result of the survey, the USGS is now saying that its estimate of US coal reserves may be significantly overstated.

Sometimes reserves remain unquestioned because the answer may be frightening. Sometimes reserves remain unquestioned because the method used to generate the estimate may be even more frightening. For example, if someone asked, "how does the USGS calculate US coal reserves?":

"Every year, federal employee.....calculates America's vast coal reserves the same way his predecessors have for decades: He looks up the prior year's coal-reserve estimate, subtracts the year's nationwide production and arrives at a new official tally." (Wall Street Journal)

Oil is typically more expensive than coal on a BTU (energy content) basis. As oil is a liquid which can release energy quickly, it is primarily a transport fuel. Oil is only used to generate 7% of global electricity. Coal is an electricity generating fuel used to produce around 40% of global electricity.