The Price of Oil

As oil prices start to hit new nominal price records, I thought I would do a quick run through on what I think is driving the price of oil and refined petroleum products:

1. Demand is growing faster than supply, this is the key piece of the story, the fact that under most possible scenarios will continue.

"The answer is that, in the short term at least, the cartel seems to have lost control over the market. With the exception of Saudi Arabia, its producers are pumping as much as they can—and Saudi excess capacity is in heavy crude that is harder to refine into the cleaner fuels demanded by rich countries. OPEC made a great show of raising its members’ combined quotas to 28m barrels per day (bpd) in June. But thanks to rampant cheating, they were already pumping at least that much, and possibly as much as 30m bpd, making OPEC’s promises little more than a carefully staged bit of public relations." -The Economist

2. Refineries are already running at capacity, no new refineries have been built in the US since 1973. Refineries in the US are getting older, and requiring more maintenance every day.

"Refining capacity is tight, with refineries running at 95.8% of capacity as of the end of last month. Any sizable outage almost immediately pushes up prices of refined petroleum products such as gasoline and diesel fuel, both at the refinery front gate and on commodity trading floors. Those higher prices, in turn, give refiners even more incentive to process more oil. So refiners bid up the price of light, sweet crude, the easiest grade of oil to refine and the main type for which refiners have excess capacity these days." -WSJ

3. Tight Pipeline capacity. Once products are refined they must be transported, there seems to be anecdotal evidence emerging that pipeline capacity in parts of the nation are tight, good news if you own a pipeline, bad news if you have to pay for whatever comes out of that pipeline.

""It's really starting to surface as an issue," said James Holland, vice president of logistics at Kinder Morgan Energy Partners LP, a Houston-based pipeline operator.

What started as routine supply tightness in these markets quickly snowballed following disruptive events that included a hurricane, a canceled fuel shipment and the airlines' own efforts to prevent shortages, the officials said.

Glenn Hipp, director of fuel purchasing and inventory management at Dallas-based Southwest Airlines, said late July and early August were "unprecedented for Southwest for the number of cities where we've had to manage supply problems."" -WSJ

4. We can't quickly solve any of these three. Take a minute and seriously think about it, could you cut your oil usage by 20% this week? next month? in 2006? Will the Chinese? I drive a lot for work and school, I could quit my job, I could quit my MBA program or sell my house, but if I don't do one of those, I can barley budge the amount of gas I use, and I suspect that is true for most Americans.

How long do you think it takes to build a new refinery, a new pipeline, a new deep water rig? I don't know exactly, but you measure that time in years, not months.

Timothy Burger
timothyb(at)timothyburger.com