The Unrefined Truth about Expensive Oil
By Repair Man Jack Posted in Economy — Comments (10) / Email this page » / Leave a comment »
Before Giving Leonardo Maugeri a read, I never would have believed that anyone would praise the existence of high oil prices. While I’d rather not pay over $30 to gas up a sub-compact, the author makes an interesting point. The US, and the rest of the world are not overpaying for oil based on crude reserves. We pay for our lack of refining capacity.
Maugeri points out that we are nowhere close to tapping out our current supply.
An additional 2 trillion barrels of "recoverable" reserves are not classified as proven but will probably meet that standard in a few years as technological improvements, increased knowledge of the subsoil, and the economic incentive created by higher oil prices (or lower extraction costs) come into play. Consider, for example, that only 35 percent of the oil contained in known oil fields worldwide can be recovered today with existing technologies and based on current economic fundamentals (up from 22 percent in 1980). - Foreign Affairs (March 2006)
Maugeri states a naively optimistic belief that refinery capacity will expand as a result of higher crude oil prices. In an economically rational world, he would be right. People expedite what they want done, and therefore, oil companies should feel encouraged to underwrite more refineries. However, they most definitely have not.
The US has not built any new refineries after 1979. Government environmental policy has had the unintended consequence of taxing companies into not bringing more capacity online due to regulatory compliance costs. Ben Lieberman of the Heritage Institute describes these regulatory barriers to entry.
Since the Clean Air Act’s massive 1990 rewrite, the refining sector has had to spend a much as $4 billion each year on regulatory compliance at existing refineries.[2] These investments, which by now total nearly $50 billion, maintain existing capacity but do nothing to increase it. This regulatory burden has siphoned away substantial resources that could have otherwise gone into expansion. When expansions do occur, the regulations make them much more expensive. In addition to costs, the many procedural requirements—and in some cases litigation—can delay new capacity by months or even years. - Heritage Foundation 25 July 2006
Refining has thus become highly unprofitable. Major oil companies make a lot more money finding and drilling crude than they do producing usable products from their resources extracted. Forbes Magazine reveals the extent to which the profits from acquiring and selling raw materials differ from the profits made on the finished products.
Between 1999 and 2003, the major integrated oil companies earned roughly 20% on average capital employed in the upstream, but refining and marketing companies earned less than 10%. Therefore, it is hardly surprising that investment in refining has been lacking. - Forbes magazine, 30 May, 2005
Thus, the US has overregulated the refining of oil to the part where domestic corporations won’t willing volunteer to do more than the minimum amount of work required to provide a market for their wares. This, combined with a strongly inelastic demand for gasoline amongst American drivers, means that gasoline can get very, very expensive before refineries become a profitable enough alternative to new exploration to attract major investment.
So it isn’t necessarily OPEC that has our backs up against the wall on gasoline prices. The Federal Reserve could strengthen the dollar. The US government should review its regulations that make refinery construction a last resort for industrial investments in oil production. Finally, we could drill our own reserves, assuming we have the industrial base to refine them upon extraction.
but the environmental groups. They have long recognized that plants having "excess capacity" encourage growth in times when prices support ramping capacity up. Thus, a group that is against population growth in any area will strive to limit basic needs. Water supplies and reservoirs, refining, dumping sites, buildable space, high rise construction, and electric generation capacity. All these have significant barriers to entry and the environmental movement is proud of this status quo.
Add the crack spreads to the price of crude, and you get the price of the refined products.
Very, very rough #'s- when crude was about 50 (i.e. early 2005), the crack spreads were around $10.
As crude approaches $100, the cracks are pushing $20. The cracks have risen in response to a robust economy, the limitations on refining described above, and the post-Katrina effect (when it became clear that the geographical concentration of refining capacity was an underappreciated risk).
In effect, a double whammy.
Re: The Federal Reserve could strengthen the dollar.
Not clear how the Fed could do this with implosion of mortgage markets on its plate.
To over-do a metaphor, ie about plates, there is no such thing as a free lunch. Anything the Fed does to tighten, which strengthens the dollar, will damage housing and total demand. Just as we are sliding into recession.
However, this is only a small part of your argument, the points of which are very well taken.
about the cost of building a refinery versus the amount of money a refinery can make in a year. I'm no businessman, economist, oil guy, or whatehaveyou, but it seems that building in a refinery would be a poor investment (with or without government regulations). Anytime someone builds a major factory, it takes X years to recoup the cost. If one believes that the product which one will produce in one's factory will only be in high demand for X minus 1 years, one doesn't build said factory.
In other words, everyone is looking for a way to move away from oil. Why would an investor shovel a lot of money up front to build a refinery if refined oil may be on its way out as a primary fuel source? If hydrogen cars hit the road in ten years and are popular in twenty, the refinery guy would eat quite a loss (assuming that refineries take 20 years to recoup their initial investment--an assumption that I don't know is correct).
I have no doubt that government activity may serve to discourage building refineries, but there are always ways around government regulations (even if it means building your refinery outside the U.S.). It may be that people are merely acting in their best interests by investing in other ventures.
Why would you foot the bill to build a refinery, when the gov't is subsidizing your competition and requiring by law that your potential customers patronize them? e.g. ethanol
I meant what I said and I said what I meant. An elephant's faithful 100 percent.
If H-Cars do as well as you forecast, the refinery would then have to export. That may require the acquisition of a new shipping fleet. Refineries are not ooking profitable in the long term.
Which brings us to the problem of what happens for the next 15 or so years, while we await the slow process of taking the engineering breakthroughs and turning them into safe and replicable product designs.
“The path of the righteous man is beset on all sides by the inequities of the selfish and the tyranny of evil men."
series on an experiment that Amoco Corp and the Department of Energy conducted on Amoco's Yorktown refinery in Virginia. The DOE agreed on a temporary suspension of compliance with the myriad environmental and safety rules and regs Congress had mandated for refining crude at the facility.
I wish I had NEXUS-LEXUS to find the articles, but the WSJ would have received a Pulitzer for outstanding reporting, except that the conclusions that Amoco & the DOE came to after numerous audits, control & monitoring safeguards, etc., was that Amoco could refine crude into finished product more safely and cleanly at about FORTY PERCENT of what the product following Congressional guidelines costed out at.
The Clean Air Act came about because of the huge spreads that refined product was gaining during the eighties. Amoco had gotten out of all its refineries overseas by the early eighties as the [relatively declining] oil prices were rendering them unprofitable.
The WSJ did point out that many of the mandated "catchment basins," "safety redundancies," et al. contained in Congressional legislation did benefit companies in certain key Congressional districts whose representatives had a hand in drafting and negotiating the final legislation.
But I do believe that a "zero-growth" Luddite mindset on the part of Democrat policymakers has consciously veered away from allowing abundant and cheap fossil fuels that would engineer economic growth. KC's points above cannot be stressed enough and one does not need a conspiratorial mindset to realize that artificial limits to growth are being systematically applied to our economy across the board largely without political accountability.
We seem to be getting one of these "don't worry about oil" blogs every day.
In the Foreign Affairs article Maugeri states, "Proven" reserves alone, more than 1.1 trillion barrels, could fuel the world economy for 38 years even at current rates of consumption."
38 years! How is that good news? OK, he goes on to say there is more oil that might be recovered with new more expensive techniques. You can do things like pump steam into the ground to flush out more oil, etc. This attitude doesn't address the long-term problem of what America will do for energy in the future, and it doesn't address the short term problem of dependence on certain hostile oil-producing nations.
I'd feel a lot more optimistic if we were building another 100 nuclear power plants, and not just trying to convince ourselves that petroleum will last forever.
lots of petrol solutions can be made to extract refinable products. Even oil shale and coal can be made into petroleum products at these prices. Thats why the price of oil on the national market will not stay where it is. The oil rich producers know that they have to engineer a price drop before other methods of oil production (or even large scale nuclear power generation -- which I believe we should be developing) are off the drawing boards and into production. The entrepreneur has to get the financing to start these operations, (or get a government grant) then comply with the regulations, fight off the NIMB folks, and finally get a plant operational only to find the Saudis or OPEC dropping the price to the level that will drive them out of business.
The supply of oil is not forever, but there is enough oil for the scenario I just painted to play itself out several times before it will ever be effacatious to use these deep oil reserves. In the mean time, we have to pay or drill our own oil and build alternatives that are real alternatives, like nuclear electricity and electric rail transit. I don't like being jerked around by the oil producing states, but we are dependent and they do hold a lot of easy to get supply.
In this climate one cannot blame the refinery guys from making as much as they can, can one?
Government environmental policy has had the unintended consequence of taxing companies into not bringing more capacity online due to regulatory compliance costs
Unintended ? I think not.
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"Those who expect to reap the blessings of freedom must, like men, undergo the fatigue of supporting it."
-Thomas Paine: The American Crisis, No. 4, 1777