A Primer on Oil Prices

"The tripling of oil prices since the summer of 2003 has unleashed forces that within the next two or three years will bring oil prices tumbling back down to below $50 a barrel." So said John Cassidy, writing about "The Coming Oil Crash" in the January issue of Conde Nast Portfolio. Yes, the price of oil will come down, though no one knows exactly when. It has topped $100 a barrel and there are indications it could go higher.

There are vast forces at work regarding the price per barrel of oil and one of them is the speculation that has driven up the cost despite the fact that there are ample supplies. The problem is not lack of oil, but whether it can be shipped to a waiting world. The potential for conflicts in the Middle East and elsewhere worries the marketplace.

Sebastian Abbot, an Associated Press reporter, points out that, "Hedge funds and other financial institutions have been buying and selling oil contracts in an attempt to generate profits." Such trading has little to do with actual supply and demand and more to do with the kind of gambling that led to the sub-prime mortgage meltdown. And what goes up will go down. The cost of a barrel of oil is also tied to the value of the U.S. dollar.

It is likely, too, that the lack of production capacity in the world oil market plays its role in the profits being made these days, primarily by national, as opposed to publicly owned oil companies. Rarely noted are the huge risks and huge investments taken by publicly owned oil companies. This is in marked contrast to the national oil companies representing some 70% of the world's known oil reserves that, with the exception of the Saudis and other Gulf states, are almost universally failing to make adequate investments in exploration or the upgrade of their facilities.

Cassidy points out that, "In the past four years, Exxon Mobil, the world's largest oil company, has invested more than $60 billion in exploration and development. Between now and 2010, the company plans to begin pumping oil or gas from no fewer than 20 new projects."

Are you prepared for a shock? ExxonMobil owns only 1.08 percent of the world's oil reserves. When you add the five largest private global oil companies together, they represent only 4 percent of the world's oil reserves.

As Richard W. Rahn, a senior fellow of the Discovery Institute, pointed out in a November 2007 article published in The Washington Times, "The high price of oil is a direct consequence of artificial supply constraints imposed by the Organization of Petroleum Exporting Countries and other countries."

OPEC is composed primarily of Arab and African oil producing nations, along with Venezuela. Together, they control about 77 percent of the world's known liquid crude oil reserves. Like Russia and Mexico, this state owned oil is widely seen as poorly managed. "By contrast," notes Rahn, "the U.S. only has about 2 percent of the world's oil reserves, but produces more than 8 percent of global production, largely because they are privately owned and managed."

Despite current high prices at the gas pump, Congress refuses to permit exploration and extraction of potential and known oil and natural gas reserves from 85 percent of the nation's continental shelf off either the East or West coasts. As this is written, China is exploring for oil offshore of Cuba, barely 90 miles from Florida.

Congress has consistently refused to allow exploration and extraction of the vast oil reserves located amidst the 1.5 million acres of the Alaskan National Wildlife Reserve. Less than 2,000 acres would be affected. The Department of Interior estimates that 3.5 billion barrels exist. I have read estimates of as high as 16 billion barrels. For all the political bombast of being "energy independent" our own government stands in the way of accessing our own oil and natural gas.

Another factor plays a role in the price of oil. It is our capacity to refine it for gasoline and other products. Not one single new oil refinery has been built in the U.S. for nearly 30 years. The reason is that environment organizations that have advocated a vast matrix of environmental laws passed since 1970 have made it too costly to build one. These are billion dollar investments and no oil company is going to spend that kind of money in the face of hysterical objections by the Greens and impossible obstacles from federal and state government agencies.

A recent explosion at a Texas refinery will only serve to drive up the cost of gasoline and other oil products. Troubles in Nigeria contribute to the recent up tick on oil prices. The slowdown of oil production in Iraq following the invasion is yet another factor.

Wonder why gasoline costs more? In order to fulfill various air pollution reduction plans, gasoline and diesel must be refined into some 17 different formulations. With three grades of gasoline, that means that refiners must produce some 45 separate blends. That's expensive and the cost is, of course, passed along to consumers. Since demand outstrips production capacity, weekly gasoline imports more than doubled between 1992 and 2004.

The hard math of a growing U.S. population, plus the fact that petroleum accounts for about 40 percent of U.S. energy supply, two thirds of which must be imported, means that Americans are caught in a government designed energy vice. American transportation runs on oil. It accounts for about 28 percent of U.S. energy use.

As America's infrastructure of roads and bridges ages, a two-year study by the National Surface Transportation Policy and Revenue Study Commission recently urged Congress to raise the tax on gasoline by as much as 40 cents per gallon.

At the same time, the latest energy bill has increased Corporate Average Fuel Economy (CAFE) standards to require vehicles to get 35 miles per gallon by the year 2020. Analysts project an increase in the cost of buying a new car between $900 and $10,000 depending on which expert is consulted. The only way to achieve this is to drastically reduce the weight of a car, thus increasing the potential for a lethal accident and more dead Americans on the highway.

The U.S. energy policy, as it presently stands, is designed to drive up the cost of oil and its derivatives for every American because it will not permit exploration and extraction, and it will not encourage or permit new refineries to be built. The mandate for ethanol use also increases costs. In addition, it is likely to increase gasoline taxes at some point.

Does this make any sense to you? In November we are about to elect a new President and many members of Congress. Each one of them must be asked what they intend to do about this mess. If they start bad mouthing "Big Oil" or "Big Coal", vote for someone else.