FYI: Fuel Prices

[SonomaCat]

Some debate fodder about the nature of sharply rising gas prices around New Orleans:

http://www.reason.com/hitandrun/2005/09 ... tml#010780

[Grizlaw]

The only gouging going on is by Big Oil. The fact that they would jack the price up this much, this fast, is ridiculous and can't even remotely be explained away as "we're just covering our increased costs".

If it's not too complex to explain simply, could you tell us a little bit about the mechanics of how oil gets to the marketplace? Is it traded on the major exchanges like other commodities, or is there another market? (I know oil futures are traded on the Chicago Mercentile Exchange; I assume barrels of crude are traded on a similar market?)

The reason I ask is because it isn't clear to me how much control the oil companies themselves could really have over prices. I don't doubt that they're making a killing right now, but intuitively it would seem to me that market forces would play a bigger role than any action the oil companies could take. Short of outright collusion by the oil companies, I'm not sure I see how they could truly control prices. Could you tell me a little more about this?

--GL

[grizbeer]

The reason I ask is because it isn't clear to me how much control the oil companies themselves could really have over prices. I don't doubt that they're making a killing right now, but intuitively it would seem to me that market forces would play a bigger role than any action the oil companies could take. Short of outright collusion by the oil companies, I'm not sure I see how they could truly control prices. Could you tell me a little more about this?

--GL

By Market forces I assume you mean market speculators and manipulators, not supply and demand? Obviously what is happening right now is a market disruption, but the run up in crude oil prices over the 18 months previous to Katrina had nothing to do with supply and demand - relative worldwide supply and demand had changed little from 2003 levels, and in fact crude was backing up a little because some refineries were mysteriously down for repairs at the same time other refineries were mysteriously delayed in starting back up again, and oil still costs about $5 a bl to drill. So if it isn't increased demand, and it isn't reduced supply, and it isn't increased costs, what does that leave - market manipulation?

The last time was saw a problem like this was the energy crisis in 2000 - remember when all of the sudden California had a shortage because a couple of generation plants had maintenance issues at the same time (very similar to the refinery issues). previous to that there had been no imbalance between supply and demand, but wham we have an energy crisis. Oh sure in the end a few people went to jail for fraud and Enron and a few other energy companies went bankrupt, but the higher energy prices stuck. In the end it was the blueprint for the oil companies and really, after paying $3.50/gallon for a few months won't $2.50 seem like a bargain, especially if all the blame goes to guys like EG that have no control over it instead of market traders who got rich off it?

[SonomaCat]

This is a great conversation, and I hope everybody that has some insight into these markets chimes in loud and strong -- I think most of us can learn a lot from those of you in the know.

Grizbeer -- I like your analysis, and am intrigued by the analogy of the CA energy crisis (especially after watching the Enron documentary, which was very interesting on several levels). However, one thing I'm not clear on is whether the current cost of gas is really tied to current levels of supply and demand, or is it more a function of perceptions of future potential supply shortages? Are people just assuming that the problems in the Gulf (and Iraq and Venezuala) are going to lead to actual future situations where we do, in fact, have a shortages of oil in the US?

In other words, is it possible that the price swings are more a function of speculators buying up oil-related commodities (meaning there could be a great opportunity for people to jump in and short those commodities if we don't believe a real threat of shortages exists, if they have the massive balls to do that sort of thing), or is it more plausible that the price surges are due to market manipulation due to refinery shutdowns (exactly like the Enron manipulation of old)?

I guess this leads me to another question -- is gasoline traded on any kind of commodities market, or is only unrefined oil traded in this way, and gas only bought and sold for real/consumer purposes?

[Grizlaw]

So if it isn't increased demand, and it isn't reduced supply, and it isn't increased costs, what does that leave - market manipulation?

Well, yeah; that's really what I'm asking, though: if the market is being manipulated, then who's doing the manipulating, and how?

It's fine to throw out terms like "market manipulation" in the abstract, but that alone is not very informative. What I'm trying to learn is, exactly who is being accused of what, and why is the market not equipped to deal with it (and thus, what can be done about it)?

EDIT: As a followup -- if the problem is, as grizbeer says, that refineries have gone down (either legitimately or otherwise) and not a lack of supply of crude oil, then what explains the sharp increase in the price of crude oil in the past year? If there were an excess of supply of crude (because of the lack of refinery capacity), then shouldn't the market price of crude be going down instead of up? I'm not disagreeing, by the way; I don't have any specific knowledge of this industry, but it's just not intuitive to me.

[grizbeer]

So if it isn't increased demand, and it isn't reduced supply, and it isn't increased costs, what does that leave - market manipulation?

Well, yeah; that's really what I'm asking, though: if the market is being manipulated, then who's doing the manipulating, and how?

It's fine to throw out terms like "market manipulation" in the abstract, but that alone is not very informative. What I'm trying to learn is, exactly who is being accused of what, and why is the market not equipped to deal with it (and thus, what can be done about it)?

Those are the key questions, and I don't have answers, only suspicions.

BAC I have my doubts that futures are being traded based on some expected future supply disruptions due to the speed at which the price of oil went up. I have heard the argument that increased demand from China and India developing are driving the costs, but that doesn't make a lot of sense, since as I said supply and demand have been in relative balance.

As far as concerns about the Middle East, really should oil have peaked in 2003 when the war started instead of now? OPEC has said that they are near the limit of excess capacity, meaning that they are likely unable to continue to increase supply to meet increasing demand, and this combined with forecast of increasing demand from India/China should lead to higher prices, but this should occur over a longer run, as it should lead to any shortages over the next few years. Also it takes away OPEC largest weapon to control prices - a common misconception is that OPEC primarily controls prices by reducing supply, but this rarely works because reduced supply increases the price (and therefore profits) creating too large of an incentive to cheat on the quotas. OPEC's power lines in it's ability to flood the market with oil, driving prices (and therefore profits) down. Without the ability to increase supply OPEC loses it's ability to control prices for the entire market.

With specific respect to Iraq, they are currently only producing about 70% of the crude they produced before the war, but it is expected within the next decade to more than double production. Unless you had specific knowledge that there was going to o be a supply disruption in Iraq at a certain date you would think the long term influence of Iraq would be to lower prices.

With respect to Venezuela, Chavez hates the US (and specifically George Bush), but would he cut off his nose to spite his face (not to mention hurt the Chinese, Japanese and French) by cutting off oil supply? It doesn't make sense - he might not sell to the US, but that really shouldn't change worldwide supply or price.

So why would traders bid up the price if there is no looming supply/demand situation they are responding to? Well there might be other market signals other than supply or demand - if someone is sending the signal that oil prices will be going up, and has the ability to do that by themselves, eventually the herd mentality of the market will move the price up by itself until the eventual crash (think Internet stock prices circa 1999 - 2000).

Obviously it would take a lot of money, and willingness to lose that money, to manipulate the market. Most people would think the Big Oil companies would be the ones pushing this, but I have a different conspiracy theory as to who it is - here is a hint - he was blames for the Asian flu due to his manipulation of currency trading, he owns an oil company, and he operates out of Curacao, where his activities can't be traced and the money can't be followed.

As far as buying short I pretty much feel that given my stock market performance I could crash the oil price by myself just buy bullishly purchasing a large amount of oil futures. As soon as I buy in the market is sure to crash.

Note that I am really just talking out of my ass, and don't have any real knowledge, proof, or reasonable research, just my own paranoia, so take all of this with a huge grain of salt - it is all just my opinion.

[El_Gato]

Pardon the pun, but I'm out of gas today to offer much more than the following:

1) I do believe there is justification for the increase in crude oil prices over the past 18 months or so. China & India are now "big time" players and their consumption is skyrocketing; if any of us were the Sultan of Saudi Arabia, I'm pretty sure we'd all sell our crude to the highest bidder and now there are more people willing to bid for that supply; thus Economics 101 tells us the price should rise. That I can understand & accept.

HOWEVER

2) What I can't understand right now is that crude has climbed less than 5% this week, yet Big Oil has raised their prices across the nation at more than double that rate. Even in podunk Montana, arguably the most "insulated" area from the effects of Katrina when it comes to petroleum, Conoco & Exxon have raised gasoline 13% and diesel 17% in just 4 days. The simple bottom line here is that those increases are indefensible. The supply & demand issues facing the Gulf Coast will undoubtedly have a "ripple effect" but they really can't explain any increase in their cost of doing business short of an increase of their raw material, in this case crude oil. And the farther you get from the Gulf, the less impact there should be. The people of Montana are being royally screwed by Conoco, Exxon, and Cenex and yes, GL, those 3 are in collusion as they all change their prices at the same rate within 24 hours of each other, regardless of the fact that none of them could possibly show any increase in their costs to justify their increased price.

Just keep in mind one thing: Pay attention to the profit/loss reports the Big Oil companies reveal over the next few quarters and for 2005. Trust me, they will make profit, probably even at record levels. If all they were doing was "covering their costs", that wouldn't be the case, would it?

[El_Gato]

Now, I've got good news and I've got bad news:

The good: Wholesale gasoline prices (we call it the "rack price") did not change today.

The bad: Diesel went up another dime.

The ugly: My disposition. Bartender, make that a double, please!

[Grizlaw]

The people of Montana are being royally screwed by Conoco, Exxon, and Cenex and yes, GL, those 3 are in collusion as they all change their prices at the same rate within 24 hours of each other, regardless of the fact that none of them could possibly show any increase in their costs to justify their increased price.

Ok, that's the answer I was looking for.

Now, the next logical question: if the problem is market collusion between the three largest players (which is plausible; I'm not squabbling with that conclusion, btw), then what is the solution? We have antitrust laws in place to avoid anti-competitive practices; why aren't they being investigated?

(The question is rhetorical, by the way; I think we all know that politics and $$$ are the answers -- I am curious to know whether others who are more knowledgeable than I about the industry have ideas about a solution, though.)

--GL

P.S. By the way, grizbeer -- I've had much to long of a day at work to really wrap my brain around your argument, but it is interesting. I'll try to get back to it later...

[DCC2MSU]

It is my understanding that the biggest influence on the price in recent history has been the increased consumption by India and China, and more importantly the potential future increase by those countries. I also question the $5/bbl drilling costs refered to earlier. Where does that number come from? I'm just interested. I disagree that expenditures for exploration have stayed about the same. The increase in fuel alone increases the cost to drill. I work for a service company and any added costs to us get passed onto the operator (Exxon, Conoco, and such). There was also a shortage of steel as China bought a lot of it recently. This led to a big price jump in casing for the wells. A typical well in the big play in Eastern Montana (Bakken Dolomite) is anywhere from $2.5 - $3 million to get it online. That is before you are able to sell any oil. Once they start producing you will lose roughly 12 - 16% (depends when you leased) revenue off the top to lease owner royalties. Then you have the expenses to move all the oil. One thing about the oil in the Bakken is that it is a superb quality (~40 API I believe but have heard higher in areas as people speculate if there are two major pools or one) which sells for slightly better than the price you see in the news and doesn't produce water. Most of this oil also goes to Minneapolis or Salt Lake and the Billings refineries get Canadian oil I think.

I'm not trying to defend Big Oil, just sharing some info. Williston gas is $3.19 for 87 octane, it really sucks knowing that all the oil in Eastern Montana/Western ND is leaving the area and we are paying big at the pump. It's kind of 6 of one, half dozen of the other for me. High oil means job security and my stock will go up (kicking a$$ over the last few years - I like to think that is because I was hired and not the price of oil) and big utility and gas bills out of my pocket at home.

[SonomaCat]

The one piece of the discussion that I am not following is that people are suggesting that the price that big oil charges should track with their costs. I would assume that their costs have nothing to do with what they charge (similar to how farmers sell their wheat for as much as the market will bear, regardless of their cost per bushel produced).

It would make sense to me, in a perfect free market, that all oil sellers would actually charge the same amount as that would be the theoretical fair market value as defined by the market.

I realize that this isn't a perfect market due to the limited number of players, but I think it still begs the question of whether the costs incurred by the oil companies should have any impact on the price they charge, or whether they should instead be dictated by what the market will bear, like any other commodity?

I wish I would have bought some oil stocks about a year ago. I agree with EG -- I bet they are having record quarters from this week alone.

[DCC2MSU]

We can buy stock in 6 month plans: They take money out of each check and at the end of the 6 months you get the stock at which ever price is lower between the first day and last day of the 6 mo period. Then they take another 15% off that price. I'm not sure if this is common, but I think some oil companies also have it. How much money are the employees making there?!?!?! I've heard bonuses are going to be huge for operators this year. I have one friend whose bonus will be a minimum of 25% of his annual salary - and he is making pretty damn good money. That isn't even at a 'Major'. That is a midsized firm, nationally speaking. This past purchase date (July 1) I got my stock for around $34 I think, today it is over $60. I work with a lot of people making a killing on it.

[SonomaCat]

We can buy stock in 6 month plans: They take money out of each check and at the end of the 6 months you get the stock at which ever price is lower between the first day and last day of the 6 mo period. Then they take another 15% off that price. I'm not sure if this is common, but I think some oil companies also have it. How much money are the employees making there?!?!?! I've heard bonuses are going to be huge for operators this year. I have one friend whose bonus will be a minimum of 25% of his annual salary - and he is making pretty damn good money. That isn't even at a 'Major'. That is a midsized firm, nationally speaking. This past purchase date (July 1) I got my stock for around $34 I think, today it is over $60. I work with a lot of people making a killing on it.

Those kinds of ESPP (employee stock purchase plan) are really common in tech companies. The 15% discount is the max allowed by tax law to still qualify as a form of incentive stock option (just means that you aren't taxed until you sell the stock as opposed to when you are sold the stock at a discount).

Back in the golden days of the boom, people were getting rich on those plans around here. It's a lot more rare these days, but they're still kickarse benefits to have.

On a sad note, kiss them goodbye -- the new accounting rules under FAS 123R that will be implemented next year will kill them as the new rules will require that companies book (huge) fictional expenses for any kind of stock compensation. No company will want to mess up their income statements with a bunch of additional non-cash expenses, so it is assumed that ESPP's will essentially die out completely. I could go on a ten page rant on that subject, so I will stop there.

[grizbeer]

It is my understanding that the biggest influence on the price in recent history has been the increased consumption by India and China, and more importantly the potential future increase by those countries. I also question the $5/bbl drilling costs referred to earlier. Where does that number come from? I'm just interested. I disagree that expenditures for exploration have stayed about the same. The increase in fuel alone increases the cost to drill. I work for a service company and any added costs to us get passed onto the operator (Exxon, Conoco, and such). There was also a shortage of steel as China bought a lot of it recently. This led to a big price jump in casing for the wells. A typical well in the big play in Eastern Montana (Bakken Dolomite) is anywhere from $2.5 - $3 million to get it online. That is before you are able to sell any oil. Once they start producing you will lose roughly 12 - 16% (depends when you leased) revenue off the top to lease owner royalties. Then you have the expenses to move all the oil. One thing about the oil in the Bakken is that it is a superb quality (~40 API I believe but have heard higher in areas as people speculate if there are two major pools or one) which sells for slightly better than the price you see in the news and doesn't produce water. Most of this oil also goes to Minneapolis or Salt Lake and the Billings refineries get Canadian oil I think.

I'm not trying to defend Big Oil, just sharing some info. Williston gas is $3.19 for 87 octane, it really sucks knowing that all the oil in Eastern Montana/Western ND is leaving the area and we are paying big at the pump. It's kind of 6 of one, half dozen of the other for me. High oil means job security and my stock will go up (kicking a$$ over the last few years - I like to think that is because I was hired and not the price of oil) and big utility and gas bills out of my pocket at home.

I want to make it clear that I am not attacking big oil, at least for the increase in crude oil prices. The price is being set in the commodities market. I do think Big Oil has conveniently manipulated the processing market to make sure that (prior to the hurricane) enough refineries went down at the same time to create a minor crisis (this is similar to what happened in California in 2000 to create a crisis).

Yes China and India are increasing their demand, but crude prices have more than doubled over the last 18 months. Since 2003 Crude oil demand has increased from 79.9 million bls day to 84.38 mbd, and by 2006 is expected to increase to an average of 86 mbd. Crude Supply has increased from 79.65 to 84.12 mbd, and is expected to increase to 86mbd by 2006, so we have the same relative supply/demand as we had in 2003 - production has increased to meet the demand. China has increased from 5.55 to 6.83, so yes they have increased, but their demand has only increased ww demand by a little over 2%. By 2006 China's demand is expected to increase to 7.5 mbd. I really wouldn't expect an extra 1mbd to increase short term oil prices to double.

http://www.eia.doe.gov/emeu/internation ... ntlBalance

BAC is right that costs really don't come into affect with oil prices, unless the price drops below the pumping costs. Exploration and drilling costs are sunk, so as long as the price you get for the oil is higher than the cost to pump you wouldn't stop pumping just because you are not recovering the sunk costs on a per bl basis. The price does affect whether or not you do more exploration and drilling, though.

I really don't know the true cost of pumping oil, and I'm sure it varies by location. Wikipedia says this:

It is often claimed that OPEC sets the oil price and the true cost of a barrel of oil is around $2, which is equivalent to the cost of extraction of a barrel in the Middle East. These estimates of costs ignore the cost of finding and developing oil reserves. Furthermore the important cost as far as price is concerned, is not the price of the cheapest barrel but the cost of producing the marginal barrel. By limiting production OPEC has caused more expensive areas of production such as the North Sea to be developed before the Middle East has been exhausted. OPEC's power is also often overstated. Investing in spare capacity is expensive and the low oil price environment in the late 90s led to cutbacks in investment. This has meant during the oil price rally seen between 2003-2005, OPEC's spare capacity has not been sufficient to stabilize prices.

http://en.wikipedia.org/wiki/Crude_oil

If you ask me as an accountant what the "True" cost of pumping oil is I'll tell you ... what do you want it to be? In other words, it can be manipulated to include or exclude anything.

[DCC2MSU]

Thanks, I was just wondering where the info was coming from. That kind of stuff is interesting to me. I have a pretty good idea what costs are for local operators, but realize the companies drilling in this part of the country are very small on the world scope. The biggest would be Kerr-McGee and Amerada Hess and they aren't in the same league as Shell, BP, Texaco.... Thanks again.

[SonomaCat]

This is almost the self-satirical evening news "Man/woman standing at a gas station gassing up their Escalade or Suburban while angrily opining on the evils of high gas prices":

http://greatfallstribune.com/apps/pbcs. ... 20313/1002

[Bleedinbluengold]

What's really funny about that, BAC, and it goes to what El G was saying: Suppose the guy who filled up 3 tanks at 15 gallons per tank. That's 45 gallons. Say he paid $3/gal. He would have paid $135. If he would have paid $2.50/gal an hour earlier, he would have paid $112.50.

oooooo, he saved $23.50 today. In a week, he'll have to fill up again. I'd rather have $23.50 in my pocket for sure, but I spend about $2,000 a year in fuel. $23.50 doesn't even count as a cost savings. Now, if you could find $0.50/gal cheaper gas every week, that's another matter.

[SonomaCat]

Yeah, I was thinking about what EG had told us as I was reading that guy's comments about the timing of the gas price increases.

I don't like gas prices any more than the next guy, but I have learned that griping about the price at the pump to (or about) the guy who owns the pump isn't the place to do it.

[SonomaCat]

This article does a pretty good job of explaining some of the mechanics of the oil and gasoline markets, and appears to be pretty balanced:

http://sfgate.com/cgi-bin/article.cgi?f ... EGTV01.DTL

I actually thought that CA was getting off pretty light on these gas increases. We're usually about $0.50 higher than most of the rest of the country, but in the wake of this latest surge, it seems like our prices are now just about the same as everybody else.

[SonomaCat]

More gas price info:

http://www.slate.com/id/2125099/nav/tap2/

If I keep reading these kinds of articles, I might one day fully understand the whole nebulous oil and gas market.