Archive for April, 2011

$5.00 Gasoline?

I originally started this blog item in January of this year [2011], but put it on the shelf because even I wasn’t all that interested in it.  Given the fullness of time and a few Middle Eastern political revolutions and the subject is back.  [Addendum: 2 1/2 years later, there’s more, so additional material has been added at the end of the blog item, and a few minor tweaks have been done in the original text. RO’C]

Well, with the New Year we get the dire threat of $5.00 gasoline and the media are gearing up for yet another crisis.  It all started when a former president of Shell Oil, John Hofmeister, “predicted gasoline prices will spike as the global demand for oil increases“.  Everybody run for the hills!

The Federal administration promptly trotted out one of their lower level flacks, telling everyone with a camera for national media that no, this isn’t going to happen anytime soon.  Remain Calm!  Included was the kicker, “Golly, that would mean that petroleum would be selling for $180.00 a barrel.”  As of last Friday, Brent (North Sea petroleum) closed at just over $121.00 per barrel, having spiked as high as $126.00 earlier in the week.  Those who regularly read these pages know that I’m not much of a fan of the current administration; no sense saying why, you can make up your own mind.  In any case, either the administration’s attitude reflects a certain naiveté toward market realities or it is their belief that they can tell one more carefully shaded lie and everybody will believe it.  And, say what you will, regardless of their public statements, higher gasoline prices work to the advantage of their causes of high speed trains, windmills and electric cars.  With higher gas prices, these very expensive toys suddenly become more reasonable in price.  Like I said, you can make up your own mind.

Regardless, for something as important as petroleum is toward daily American life, most people really have very little understanding about this commodity.  Truth be told, all they really care is about the price at the pump, and I suppose that is as it should be.  Granted, times have changed, and the gas stations no longer give out jelly glasses with fill-ups nor S&H Green Stamps.  Going back a few decades, Shell Oil used to give away steak knives with a fill-up; given today’s “sensibilities”, that’s certainly not going to happen again.  Regardless, here are a few things to consider:

Unit of Measure

  • In the North American market, petroleum is sold by the barrel.  The standard sized barrel is 42 gallons, smaller than the 55-gallon barrel that comes to mind.  Refined products are often sold in 55’s, but not crude petroleum.  Also, the “barrel” is mostly a unit of measure since petroleum is typically transported in tankers with large holds or via pipelines.

Petroleum Quality

As it comes out of the ground, petroleum can widely vary in quality; even within an individual petroleum field, the output can vary.  The term used to describe a particular petroleum starts with the source location of that oil.  This is usually followed by a term which describes the quality of that petroleum (such as light, sweet, heavy or sour).  A few domestic examples:

  • West Texas IntermediateThe term “price of oil”, as used in the US media, generally means the cost per barrel (42 US gallons) of West Texas Intermediate Crude, to be delivered to Cushing, Oklahoma during the upcoming month. West Texas Intermediate is currently the benchmark standard for crude oil pricing in the United States.  Why?  Because it’s always been that way.  On the other hand, for a variety of reasons, this may no longer be realistic.  More about that later.
  • West Texas Sour –  Another Texas petroleum, but with more stuff in the raw product that has to be processed.  Usually, it is less expensive than Intermediate because it requires more refining.
  • Louisiana Sweet – Typically, this petroleum sells for more than the Texas petroleum.
  • Alaska North Slope – Just what it says, via the Aleyska Pipeline.

These are just a few of America’s various petroleums, the point being that when it comes out of the ground, oil has varying qualities, which results in modestly varying prices.  There are quite a number of other petroleums, such as Nebraska Intermediate, Eastern Kansas, Kansas Common, Oklahoma Sweet, Oklahoma Sour and California’s Midway-Sunset.  Each of these, and others, are different enough to have their own name, but are not as important as West Texas Intermediate.  While you can look up the daily price of Intermediate in the Wall Street Journal, others are not as heavily traded and are more likely reported in local newspapers, right next to the corn futures and pork bellies.  And, the imported stuff has names like Venezuelan Heavy, Arab Light Sweet and Bonny Light.  And Libyan Light Sweet.

Interestingly, although the popular perception is that imported oil comes from the Middle East, our largest petroleum imports come from Canada and Mexico.  Saudi Arabia is third in import volume, followed by a host of other countries from all over the world.  Current projections indicate that: “At the current rate of unchecked import growth, Americans will be 70% to 75% reliant on foreign oil by the middle of the next decade. In short, the U.S. is now more dependent on oil, and less secure in its supply, than at any time in the 145-year history of oil consumption.”  [Forbes.com]. Of course, more than a little of this projection is based upon the absence of expanded domestic petroleum development in the United States.

Oil Well Operation

  • Petroleum’s Geological Structure – In the old days, many of the rough & tumble petroleum landmen knew where the oil was because they understood geology.  This was long before the use of scientific methodology.  The landman would sniff at the oil in front of their colleagues and then point to where the petroleum was.  This was, of course, just for show because underneath it all, they really understood the geology of petroleum.  Not that this method was infallible,  because sometimes there were structures underground that were not visible to the eye.  One West Texas landman bought drilling rights across the road from the Yates Field, simply based on the very strong production of that area (“if there’s oil on one side of the road, there should be oil on the other side of the road“).  His wells discovered no oil; in the intervening years, geological research discovered that the geological structure of the Yates Field followed the path of the road.  The road itself was built upon a naturally occurring path that animals had followed for centuries.  There was oil on the west side of the road, and no oil on the east side.  So, the landman’s payments for drilling rights were gone without any return on investment.
  • Once in production, oil wells can’t be turned off – Another oddity of petroleum wells is that once they are in operation, they cannot be turned off for long periods of time.  The petroleum is not sitting underground in a large cavern, it is located in sandstone, filling in the gaps between the stone’s porous structure.  Even when petroleum was selling for $13.00 per barrel in the 1990’s, the wells were still running.  For if they were turned off, when the time came to turn them back on, there might not be any oil there at all.  After the initial well is drilled, it is the pumpjack that creates a flow of petroleum within the geological structure of the well.  If that flow is allowed to stop for long periods of time, other wells may begin to draw the oil toward them, or gravity allows the oil to fall further into the earth.  Once again, you lose your investment.
  • Well Names – Like mines, most oil wells have names to help identify them.  Many of these are named after the property owners, such as “A. B. Smith” or “Douglas #2”.  Sometimes wives or girlfriends get involved, such as “Karen No. 1”.  My personal favorite is a well in Noble County, Oklahoma; “Mighty Mouser #1”.  Makes you wonder, was it the family cat?

The Products

  • Once the petroleum is removed from the ground, it is usually transported by pipeline to a refinery.  At the refinery, the crude oil is broken down by chemical processes.  The resulting products include gasoline, aviation fuels, diesel fuel, lubricating oil, home heating oil, feed stocks for making plastics, paraffin wax, and a host of other useful products.  It should be noted that the refining process has become considerably more efficient over the years.  In the old days, a lot of the waste products were flared off, burned.  Now, uses for many of these waste products have been developed.  Just look around you at how many plastics we use in everyday life.  What was once burned, dumped into our atmosphere, is now used to make durable, reliable items that make our lives better.
  • A typical refinery is designed to handle a specific variety of crude oil.  Oil from Venezuela is refined at a specific plant because it is heavy oil with a high sulfur content.  Most other refineries are similar in that their feed stocks come from a specific source.  So, once a reliable source of petroleum has been developed, there are a lot of related investments that have to be made before the first gallon of gasoline is pumped.

As an aside, one of the processes used to produce gasoline and other refined products is catalytic cracking, commonly called “Cat Cracking” in the refining industry.  Another term is “Crack Spread”, which is not as interesting as it sounds unless you’re in the petroleum business.  It refers to: “Crack spread is a term used in the oil industry and futures trading for the differential between the price of crude oil and petroleum products extracted from it.”  That said, I fondly remember a headline from the Wall Street Journal: “Increased margins cause refiners to get cracking”.

Peak Oil

A lot of people love to speculate about peak oil.   People such as politicians who believe in solar energy, writers of apocalyptic novels  and those that feel that we should all be sitting under the banyan tree, discussing Greek philosophers.  Simply put, “Peak oil is the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline“.  Certainly, part of this statement is already true, that our petroleum reserves are limited and the day will come when the petroleum will be gone.  Going back to the Yates Field again, it was said in the 1950’s that the Yates Field was “on its last 20%”.  In the 1960’s, it was said that the Yates Field was “on its last 20%”.  And so on through subsequent decades.  In a way, this is exactly true, since the 20% is relative to earlier production.  It also does not mention the improvement of technology, that the operator of the Yates Field is now able to recover far more petroleum, far more efficiently than before.  Yes, the day of peak oil will come, but we will only know it upon reflection.  Anyone who says that we have already reached peak oil production may, or may not be right.  We’ll only know at some point in the future.

When that day of declining petroleum production becomes evident, we still have a host of other sources that can efficiently produce gasoline.  Of course, “efficiently” depends upon the pricing of petroleum.  Consider the Fischer-Tropsch process, which produces a petroleum substitute from coal, natural gas or biomass.  When petroleum is selling for $75.00 a barrel, the Fischer-Tropsch process is not economically feasible.  But if petroleum becomes $300.00 per barrel, then the economic realities kick in.  So, too, a lot of the pie-in-the-sky dreams of the politicians become feasible when petroleum is scarce, when peak oil has been reached.  Until we realize that the day of peak oil has finally happened, these things remain pipe dreams.  For additional information about peak oil, please see here.

Something must be done!

Given those gloomy figures and realities, it seems inevitable that the United States is simply going to burn up and die because of its so-called fuel addiction.  In fact, the entire world is “addicted” to petroleum, because it gives the best bang for the buck.  And you can be sure that whenever there’s crisis and the price of gasoline starts to climb, the opportunists come out of the woodwork with their quick & easy solution to the problem.

  • The Strategic Petroleum Reserve – It is inevitable that some of the addicts will demand that we open up the American Strategic Petroleum Reserve to help lower gasoline prices.  Of course, these are many of the same people that say we must spend more money to save money.  Access to the SPR is after certain conditions have been met, “primarily to counter a severe supply interruption”.  Of course, your emergency is different than mine, but whenever gasoline prices start rising due to supply problems, there are sure to be cries to open the reserves to get those prices down.  Of course, these calls are also a reflection of a mentality that has America in trouble in general, short term thinking without regard to the long term consequences.  By taking oil out of the reserves today, it makes you wonder if there will be oil there next year, when things might get really dicey.  Keep in mind that if we were to continue our current rate of consumption, that the Reserve would only last about 42 days (Reserve size – 727 million barrels divided by 17 million barrels per day consumption). [Actually, a clarification is necessary.  The United States in 2008 used 19.8 million gallons of fuel each day.  This fuel was refined from crude oil, but there is not a one-to-one relationship since there are other products that come out of the refining process.  The 17 million bbl per day number comes from the DoE website, but I neglected to note the year of that consumption rate.  RO’C]
  • Windfall Profits Tax – To quote: “According to the Congressional Research Service, the Act’s title was a misnomer. “Despite its name, the crude oil windfall profit tax… was not a tax on profits. It was an excise tax… imposed on the difference between the market price of oil, which was technically referred to as the removal price, and a statutory 1979 base price that was adjusted quarterly for inflation and state severance taxes.”  In other words, a committee determined what the price of oil should be and taxed the difference.  And while it may have made some people feel good about sticking it to the rich oil companies, it was discovered that this tax cost more to administer than it produced in revenue.  Not to mention that it killed new domestic drilling because whatever profits might have been made were eaten up by the tax.  Passed in the waning years of the Carter administration, the Windfall Profits Tax quietly went away in 1988.  And not a minute too soon.
  • Department of Energy – Another great idea from the Carter administration, the DoE was formed in 1977 to make America energy independent.  Over thirty years later, we’re more dependent than we were before.  Now, in addition to dealing with gasoline supply issues, the DoE also manages our nuclear fuel and weapon supplies.  We have good reason to save the nuclear weapons for special occasions, but we have little excuse to limit the use of nuclear fuel, even with the current problems in Japan.  Something will have to be used to generate the electricity for all those electric cars the politicians dream of.
  • Nationalization – Of course, with rising gasoline prices, any number of politicians and other fuzzy thinkers come up with the great idea of nationalizing the petroleum companies.  They need to think twice and throttle back the overheated rhetoric.  If they really got their wish, there would be unforeseen consequences.  As I opined earlier: 
    Mary Anastasia O’Grady observed in the June 16th number of the Wall Street Journal: “I have another theory. And mine fits the pattern of resource development – or lack thereof – all over the Western Hemisphere. It comes down to this: Where government has the property right, restrictions on development tend to be low. But when the private sector is the owner, environmental concerns blossom.” 
  • In other words, once the government has a financial role in the production of petroleum and the distribution of its products, then the environmental lobby may no longer enjoy the cachet that it did when the energy companies were independent. I can see it now. The government takes over the oil business and discovers the marketplace realities. Out front of the Capitol, the environmental lobby becomes flattened fauna on Pennsylvania Avenue, Schlumberger trucks are parked all over the White House lawn and the Energy Services Group is well on its way to redeeming the tattered reputation of Halliburton. So, given the laws of unintended consequence, the Democrats should be careful for what they wish for.

  • Speculators! – Speaking of overheated rhetoric, the current President has formed yet another task force.  This one addresses the growing problem of oil price speculators, who are not to be confused with gold price speculators.  Of course, a lot of the president’s actions are simply saying the right words to his political base in an effort to make them feel better about market realities.  In the end, the speculators are simply the messengers for the actual market.  They wouldn’t be getting the high priced contracts unless they felt that that is the way that the market is going.  Of course, like the housing market, the oil market is probably overheated.  And like the housing market, a large governmental presence is likely to be fraught with unintended consequences.  Of course, there is one other issue.  By the current administration’s words, these speculators are making a financial killing, so this would put them into the higher tax brackets.  At the same time, it is the taxpayers in those higher brackets that are supposed to be helping us cut the national deficit by “paying their fair share”.  Personally, it sounds like we should leave the speculators alone so that we can tax them on their profits.

The Marketplace

  • West Texas Intermediate – When the media speaks about the price of a barrel of oil, this usually refers to WTI, but an odd problem has cropped up.  Petroleum from Texas, Oklahoma and other states is sent by pipelines to Cushing, Oklahoma.  Oil production from other places, such as Canadian oil sands also goes to Cushing.  Because of fuel storage infrastructure problems (not enough storage tanks) at Cushing, petroleum production is being curtailed, and the pricing of WTI, the world’s standard for petroleum, is artificially low.  This is because the petroleum stored at Cushing has fewer pipeline connections to the refineries.  While Brent might be selling for $120.00 per barrel, WTI is currently selling for much less, around $108.00.  Or, as an oil patch expert put it, Cushing, Oklahoma is the Roach Motel for petroleum; oil checks in but doesn’t check out.  While you might think that this sort of thing doesn’t apply to you, remember that inflation indexes use WTI as a gauge of oil pricing to adjust all “cost of living” rates.  If the price of WTI is lower than what is actually being paid for all petroleum (and thus not necessarily related to gasoline prices), then the oil costs in daily life are being underestimated, too.

[Actually, there was an interesting explanation as to why petroleum was backing up at Cushing.  It turns out that one of those major pipelines that connected the Gulf Coast with Cushing was flowing in the wrong direction.  The “Seaway” pipeline was owned by ConocoPhillips, and they had no interest in reversing the flow to alleviate the backup which was occurring at Cushing.  Why?  Because the backup at Cushing was resulting in lower prices paid for each barrel of West Texas petroleum, which increased ConocoPhillip’s margins, “the crack spread”.  By November, 2011, ConocoPhillips sold its interest in the pipeline to pay off other debts.  The new owner announced that they were changing the flow direction of the pipeline, which will alleviate the backup at Cushing.  This process will take months to achieve, since pipelines are like refineries in their design.  It is worth remembering that all of this occurred without the assistance of politicians.  A free market speaks. RO’C, 2/2012]


The United States of America is a great country, A nation filled with vast resources and long distances. A land of great minds and new ideas.  America is the place of opportunity.    There was a time when we had a well developed railroad passenger system and electric streetcars that served most cities, but they are largely gone.  It would be nice if we had high speed trains that took us where we want to go, but that’s not realistic in many parts of the country.  For the short term, it remains the automobile’s world.

  • The automobile as transport  system – The automobile is blamed for a multitude of sins.  Here in Atlanta, traffic routinely backs up in several different places every weekday.  And, this in a city with an operating heavy rail transit system.  The popular notion is that people should take public transit; well, other people should take public transit.  In all the uproar, the benefits of the automobile are quickly forgotten.  Say what you will, the automobile is the height of transportation convenience.  You go when you want to go, where you want to go, in the style in which you choose to go.  For a country as large as the United States, only the automobile offers appropriate transportation for the long distances involved, especially in the West.
  • The automobile as state of mind – The other part of the automobile equation is rarely discussed.  The ability to just jump in the car and go produces a state of mind.  Some “progressives” are as uncomfortable with this notion as they are with under-regulated financial markets.  But there is an unnoted plus side.  This freedom of movement also has beneficial side effects, for it produces a unfettered state of mind.  Part of the American genius is development of new ideas, and freedom of movement also translates into freedom of thought.  This, of course, cannot be allowed to happen.  Where would it end?
  • Inflation – One other aspect of the current rise in gasoline prices is undiscussed.  In part, the increase in gasoline prices is the result of the decrease in value of the U. S. dollar.  That is, we’re paying more because it takes more of our dollars to buy a commodity.  Because the dollar is not as strong as it once was.  At least a portion of the cause of high gas prices is related to the fact that our money is being deliberately inflated.

A lot of academics and some politicians are obsessed with the prospect that America should become more like Europe.  I even wrote about it a couple years ago.  But the European mindset is also steered by its geography.  Driving from Paris, France to Rome, Italy takes about 13 hours, 35 minutes (the express train takes 14 hours 30 minutes).  Driving from Paris, California to Rome, New York takes 41 hours (a train leaving on Monday evening from Los Angeles gets to New York City on Thursday evening.  You’ll have to find a bus to Rome).

In short, America is a bigger place, but it’s more than that.  We think freely because we are able to move freely at will.  Developing ideas is ingrained in our nation because the freedom which the automobile offers means that we often think without limits.   The real fact is that American ingenuity conquers a lot of things.  We are, or were, a nation of problem solvers, a nation of inventors who find answers to daily problems.  For every pet rock, there also is the transistor.  We are a nation of great wealth, even now.

And, when the politicians strive to make us more like Europe by allowing gasoline prices to rise by restricting domestic energy production to meet political goals, it is sentencing American Ingenuity to a slow and unfortunate death.  It is important to remember that all of the uproar about expensive petroleum will quietly go away once the reliability of supplies returns and the price rises to its natural and appropriate level.  A level determined by the market, not by committee.  If the current administration ever allows it.

And, you should read the Kimberly Strassel interview with Chevron’s President, John Watson.


Of course, things come along that change the equation.  In this case, it would be hydraulic fracturing, “fracking”.  This process, which dates back to 1947, has changed the oil & gas business.  So much so that our friends the Saudi Arabians are now concerned about our ability to become energy independent.  I can’t say that I’m sorry about that prospect.

Nor is fracking just for oil wells.  Consider this satellite view of northern New Mexico and southern Colorado:


All those squiggly lines are gravel roads, and at the end of each squiggly line is a round dot.  Each dot is a gas well created by fracking.  There are literally hundreds of them all over the area, and what’s behind them is an interesting tale.

This area, west of Trinidad, Colorado and west of Raton, New Mexico, was earlier the site of hundreds of mines that worked the Raton Basin, a formation laden with coal.  The southern end of the basin was “steam coal” while the northern end of the basin was “metallurgical coal”.  Originally, back in the 1800’s, the steam coal was mined to fuel the steam locomotives of the Santa Fe, Southern Pacific and Colorado & Southern railroads or transported out to fuel boilers around the region.  The metallurgical coal was “coked“, with the resulting fuel being transported to steel mills at Pueblo, Colorado.  One major downside to the coal mining in the Raton Basin is that the mines were “gassy”.  Which means that there were numerous mine explosions that resulted in the deaths of hundreds of miners.

I’ll let Wikipedia do the talking:

During development of the Morley mine in the early part of the 20th century, two gas relief wells were drilled into the coal, as a safety measure to drain off gas ahead of mining.[8]

The first wells seeking to produce coalbed methane were drilled in the Raton Basin in 1982.[9] Thousands of wells have successfully extracted coalbed methane from the Vermejo Formation and Raton Formation coals. The productive coalbed methane area now covers the central part of the basin, and straddles the ColoradoNew Mexico state line. The two major producing companies are Pioneer Natural Resources (on the Colorado side) and El Paso Corporation (on the New Mexico side).

In 2007, the coalbed methane field of the Raton Basin produced 124 billion cubic feet of gas, making it the 17th largest source of natural gas in the United States.[10]

In other words, fracking has taken the mining process, which is dangerous to human life, and made it safer.  The coal is still down there, producing salable methane, which burns more cleanly than coal.

And, it’s not just new gas wells, but also improved fuel efficiency that is helping, too.  It is against the law for us to export crude petroleum, but it is not against the law to export refined petroleum products.  To, wit:  US becoming ‘refiner to the world’ as diesel demand grows.

No wonder the Saudis are concerned.


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