Help Me Understand The Price Of Oil

[Ratsima]

I'm sure I have a horribly naive view of how the oil industry works. Here it is:

A big oil company (like Shell) pumps oil out of the ground in a place like Saudi Arabia. Shell pays royalties on this oil. Shell then ships the crude oil to a refinery that they own on a ship that they own and they produce fuel and other petroleum products. Then Shell ships the final products to retail outlets that they own via trucks, ships and pipelines that they own. They sell those products to consumers.

So, where do the futures markets and speculators come in?

[tartempion]

Hmm, Google "oil glut" that might help

[robeetle]

Research "peak oil" http://www.lifeaftertheoilcrash.net/ and know that here in the USA , people feel the need to drive around in S.U.V's and Hummers. heres another link that explains more http://www.theoildrum.com/node/3726

Also, countries with booming economies such as China and Japan are really starting to catch up with my whobegone country in consuption.

In America, jobs are dropping at a record rate, unemployment is huge, prices for everything are at unprecedented levels, and there is no end in sight.

These <deleted> beaurocrats have sat on their hands for over 30 years doing NOTHING for alternative fuel sources.

With 75% of the world being water and land such a high premium because people refuse to tie their Johnsons in a knot, why dont they set up floating solar panels, it makes total sense and there are no more dinosaurs to make any new oil as far as I can see.

Edited June 17, 2008 by robeetle

[Ratsima]

Maybe my question wasn't clear. Both the oil companies and the oil producing nations have blamed speculators for the high price of oil. One analyst on CNN the other day said that the actual cost of producing a barrel of crude was around $50. He also blamed speculators, as opposed to supply and demand, for the high price.

My question is this: when it appears that oil companies control the process from drilling right through to retail sales, how can speculators drive the price up?

I understand that there has been a huge increase in demand, but everything I read indicates that demand alone does not account for the high price of crude. Nothing I've read explains how speculators can manage to push up the price when they don't seem to be a major part of the supply chain.

[robeetle]

Maybe my question wasn't clear. Both the oil companies and the oil producing nations have blamed speculators for the high price of oil. One analyst on CNN the other day said that the actual cost of producing a barrel of crude was around $50. He also blamed speculators, as opposed to supply and demand, for the high price.

My question is this: when it appears that oil companies control the process from drilling right through to retail sales, how can speculators drive the price up?

I understand that there has been a huge increase in demand, but everything I read indicates that demand alone does not account for the high price of crude. Nothing I've read explains how speculators can manage to push up the price when they don't seem to be a major part of the supply chain.

What the heck is a "speculator"......The links I provided tell you all you need to know. There are no more big oil fields. consumption IS the major contributor to higher prices. And since we are running out, what do you expect?

OK ...Im a speculator, I paid 25 cents a gallon as a senior in high school, now I pay $5.00 for the same product, I speculate an economic downturn of EPIC proportions. I also Speculate that since Oil is a privately owned business that GREED is a Speculator. How in the world is Oil allowed to be privately owned when the entire world bases their energy from it?

Edited June 17, 2008 by robeetle

[Ratsima]

The links that you gave me blame the high price of oil exclusively on supply and demand. Neither link even contains the word "speculator". I'm trying to understand why some oil analysts, the major oil companies and the oil producing nations all blame the high price on speculators, completely contrary to the arguments contained in the references you so kindly provided.

If, based on supply and demand, the price of crude should be about $60 a barrel, where does the other $60 or $70 come from?

If speculation in the oil futures market has nothing to do with the high prices, then why do so many people make the counter assertion that it does?

[dotcom]

Rat. One small point you are missing.

Once oil goes into a tanker it doesn't have any nationality.

Shell can & does produce oil in various countries around the world. Ditto Exxon Chevron BP et al.

However they still have to purchase oil for their refining operations. On the open market.

If you have ever watched the movie "Trading Places" you have seen how the futures pits work.

As mortgage lenders around the world have discovered "gearing" can be a good thing or a bad thing.

The reason speculators are trading oil futures is because of the incredible leverage they can get.

They can trade oil futures with as little as 5% cash money. This is known as "margin".

One way to get these pricks out of the market would be to make them take delivery of their oil.

Sadly the ICE is a non transparent market & Americans can trade on it without the regulations they would face at the CBOE.

[dotcom]

Thanks to the efforts of chairman Greenspan we live in the age of one bubble to the next.

Internet stocks

House prices

Sub prime mortgages

Oil is the latest but not the last bubble.

Greed & Fear. Runs the markets.

The authorities globally are in a race to see who can print the most paper money. Making all of it worthless. All fiat currencies end the same.

10,000 dong for a cup of coffee. 10,000 lira for a glass of water. 10,000,000 reichmarks for a loaf of bread. It's happened before.

[Ratsima]

Thank-you DotCom. In other words, although Shell pumps oil out of the ground, refines it and sells it on the retail market, they end up selling most or all of the crude they pump on the open market and buy most or all of the crude they refine on the open market? And this nifty arrangement allows speculators to drive up the price to twice of what it would be based on supply and demand alone?

What a wonderful system....

[PhilHarries]

Despite working in the oil & gas business I don't fully understand all the financial wheelings and dealings but this is how I understand it.

The price per barrel you see quoted is usually for a future delivery date of say September 2008, i.e. the oil is often still in the ground.

The speculators look at the spot price being commanded today and then assess current and cyclical trends (e.g. the northern hemisphere countries burn more oil products in winter than summer).

Then they look at the world political situation and likely future developements.

Then they do a whole lot more analyses and try and predict the price that a barrel will command at that future date and bid for/buy so many hundred thousand barrels at a price that will enable them to make a profit.

If the price on delivery of the oil is below their prediction they break even or make a loss. If it rises above their prediction they make their profit ++

So why is the price rising and not falling? Well it is like a packed auction house full of bidders who all want the product for their energy hungry clients and there is only so much product to be had. This constriction in supply is where OPEC comes in, if they ran at maximum production there'd be plenty of oil in the market and the price would come down thus they lose revenue. If they squeeze too hard the price goes through the roof and, eventually, people cut back consumption or countries start developing otherwise uneconomic areas and they lose sales.

btw do not think that a company like Shell is one concern. Shell, and all the others, is split into divisions. Exploration & production, refining and marketting (more actually but we'll stick to basics). Each is a separate concern with their own set of bean counters (accountants) charged with making maximum profit. So just because Shell E&P own the lease to the oilfield does not mean it sells the oil at a discount to Shell refining and similarly on to Shell marketting. Shell E&P sells the oil on the open world market to whoever pays the rate and Shell refining buys the oil on the same market paying the rate. Marketting buy the finished product from a similar kind of open market via trading deals with other refiners, do not think that every gallon of gasoline you buy at a Shell filling station comes from a Shell refinery nor originated from a Shell oilfield.

The only fly in the ointment, for the big boys, is the independants which is why some chains of filling stations can undercut the price (but not by much - they want a profit too).

Well that's my take on it, if I'm wrong I'll gladly accept the corrections as I don't pretent to fully understand it myself.

[Ratsima]

I just saw the Iraqi Oil Minister on CNN. He claimed that increasing production will not lower prices as there is already an oversupply of crude on the market, some of which is going in to national reserves. He also claimed that the high prices are the result of speculation in the futures market; speculation which he said is hurting both consumers and producers.

[robeetle]

The links that you gave me blame the high price of oil exclusively on supply and demand. Neither link even contains the word "speculator". I'm trying to understand why some oil analysts, the major oil companies and the oil producing nations all blame the high price on speculators, completely contrary to the arguments contained in the references you so kindly provided.

If, based on supply and demand, the price of crude should be about $60 a barrel, where does the other $60 or $70 come from?

If speculation in the oil futures market has nothing to do with the high prices, then why do so many people make the counter assertion that it does?

as I said before, what is a "speculator"...it does not matter dude. We are at the mercy of these privately owned companies, and that is a better question that what is a speculator.

WHY isn't oil a world commodity since the entire world NEEDS it with the way our fore-fathers set up the current energy systems.

[PeaceBlondie]

Ratsima, I cannot see if anybody has answered your opening post yet, although I suspect Phil Harries came close. I think jbowman said on another thread recently that there are three markets for crude oil. Maybe they are physical contracts where you know thousands of barrels will be delivered to your dock; the spot market; and the futures market. Futures have the most speculation. Commodity futures of many essential grains, metals and oils are being speculated tremendously now.

But I do not know. My one-week course in oil and gas taxation did not cover this.

[Ratsima]

It was dotcom who provided the missing link for me. I thought oil companies had possession of the crude they extract from pump to refinery to market. I didn't realize that they both sell and buy crude on the open market. This explains how speculators are able to drive the price up beyond what one would expect based solely on supply and demand. They fact that they can buy on a small margin and do not take possession of the commodity enables them to leverage big profits.

I understand your frustration, robeetle. I know we're being ripped-off. I just wanted a better understanding of just how it happens....

[robeetle]

It was dotcom who provided the missing link for me. I thought oil companies had possession of the crude they extract from pump to refinery to market. I didn't realize that they both sell and buy crude on the open market. This explains how speculators are able to drive the price up beyond what one would expect based solely on supply and demand. They fact that they can buy on a small margin and do not take possession of the commodity enables them to leverage big profits.

I understand your frustration, robeetle. I know we're being ripped-off. I just wanted a better understanding of just how it happens....

Its cool bro..here in the states, there are other mitigating factors involved..One is that all the "mom and pop" refineries were bought up on the west coast by Exxon, Texaco and several others, and rather than refurbish them and make them bigger/viable refineries, they CLOSED them...

This means a longer route from crude to gasoline and other petroleum products. Usually the west coast has benefitted from those smaller refineries and it was competion, Now, the big companies know they can just gouge away at our paychecks.

[waveydavey]

I'm sure I have a horribly naive view of how the oil industry works. Here it is:

A big oil company (like Shell) pumps oil out of the ground in a place like Saudi Arabia. Shell pays royalties on this oil. Shell then ships the crude oil to a refinery that they own on a ship that they own and they produce fuel and other petroleum products. Then Shell ships the final products to retail outlets that they own via trucks, ships and pipelines that they own. They sell those products to consumers.

So, where do the futures markets and speculators come in?

There was an article in the Economist recently arguing that speculation hasn't really affected the price

www.economist.com/finance/displaystory.cfm?story_id=11453090

[thaihome]

Here is a good explanation of the spot market for crude.

Note that Shell does not own the oil from Saudi Arabia. That is owned by ARAMCO, controlled by the Saudi Royal Family. ARAMCO has increased production three times this year without any impact to crude prices. They are trying very hard to make the point it is not a supply problem.

TH

[Pakboong]

The question in the OP is a valid one. I only know that gas at the pump in Venezuela today is 12 cents a gallon. I also know that in 2003 there was a total of $16 billion in oil futures. Today there is $260 billion in oil futures. The increase seems to be large investors such as pension funds.

[robeetle]

The question in the OP is a valid one. I only know that gas at the pump in Venezuela today is 12 cents a gallon. I also know that in 2003 there was a total of $16 billion in oil futures. Today there is $260 billion in oil futures. The increase seems to be large investors such as pension funds.

12 cents a gallon?...Im driving down there just to fill up.

[BEENTHEREDONETHAT]

Despite working in the oil & gas business I don't fully understand all the financial wheelings and dealings but this is how I understand it.

The price per barrel you see quoted is usually for a future delivery date of say September 2008, i.e. the oil is often still in the ground.

The speculators look at the spot price being commanded today and then assess current and cyclical trends (e.g. the northern hemisphere countries burn more oil products in winter than summer).

Then they look at the world political situation and likely future developements.

Then they do a whole lot more analyses and try and predict the price that a barrel will command at that future date and bid for/buy so many hundred thousand barrels at a price that will enable them to make a profit.

If the price on delivery of the oil is below their prediction they break even or make a loss. If it rises above their prediction they make their profit ++

So why is the price rising and not falling? Well it is like a packed auction house full of bidders who all want the product for their energy hungry clients and there is only so much product to be had. This constriction in supply is where OPEC comes in, if they ran at maximum production there'd be plenty of oil in the market and the price would come down thus they lose revenue. If they squeeze too hard the price goes through the roof and, eventually, people cut back consumption or countries start developing otherwise uneconomic areas and they lose sales.

btw do not think that a company like Shell is one concern. Shell, and all the others, is split into divisions. Exploration & production, refining and marketting (more actually but we'll stick to basics). Each is a separate concern with their own set of bean counters (accountants) charged with making maximum profit. So just because Shell E&P own the lease to the oilfield does not mean it sells the oil at a discount to Shell refining and similarly on to Shell marketting. Shell E&P sells the oil on the open world market to whoever pays the rate and Shell refining buys the oil on the same market paying the rate. Marketting buy the finished product from a similar kind of open market via trading deals with other refiners, do not think that every gallon of gasoline you buy at a Shell filling station comes from a Shell refinery nor originated from a Shell oilfield.

The only fly in the ointment, for the big boys, is the independants which is why some chains of filling stations can undercut the price (but not by much - they want a profit too).

Well that's my take on it, if I'm wrong I'll gladly accept the corrections as I don't pretent to fully understand it myself.

Excellent post Phil.

[johna]

ARAMCO used to be known as the Arab American Oil Company until Saudi Arabia expropriated the US share in 1980.

OPEC headed by Saudi Arabia because its the largest supplier sets quotas for all its members and enforces these quotas by increasing or decreasing its own output to control the market.

OPEC knows that by keeping supply limited price will remain high. Even Venezuela stays on board.

The independent oil companies, (IOC) Exxon/Mobil, Shell, BP, Conoco and Chevron have in places like Alaska, Nigeria, Kazakhstan, Uzbekistan etc, their own supplies from which they could if they wanted to see a fall in their profits increase supply and, that's a no brainer.

There is more proven oil reserves in the world today than at any time in history.

In 1956 M. K. Hubert (Shell) said the world oil reserve stood at 1250 billion barrels and that this would be used up by the year 2006.

In 2005 the known oil reserves stood at 1189 trillion barrels (not counting shale oil in Iraq or Canada which could double this figure) and, I think Brazil just recently announced a big find, there is no shortage of oil in the ground but, no one in the oil industry wants to bring this oil to market.

Profits for the big five IOC for 2002 $34 billion for 2005 $113 billion.

OPEC and the IOC do not want to bring more oil to market, most oil companies have reduced their budget for oil exploration.

Source "Armed Madhouse" by Greg Palast.

[Ratsima]

Good stuff, everyone. Thanks to all.

[ashacat]

There is more proven oil reserves in the world today than at any time in history.

There is also far more demand for oil now than at any time in history.

[Old Man River]

There is more proven oil reserves in the world today than at any time in history.

There is also far more demand for oil now than at any time in history.

Supporting that comment is this article:

http://www.atimes.com/atimes/Japan/JF12Dh01.html

[Smithson]

There is more proven oil reserves in the world today than at any time in history.

There is also far more demand for oil now than at any time in history.

Where are the reserves and what type of oil is it? It is unlikely that the cost of drilling most of the oil would be as little as $50. Refining will also be expensive because it's not all 'light sweet crude'.

To say producing oil only cost $50 is deceptive. If I was to go searching for gold and find a huge nugget how much would you say it cost to 'produce' that nugget?

[rethaired]

Great topic!

I am convinced that a lot of the crisis has to do with speculation because no matter how you look at things, it is not possible to make sense of the 20-fold price on commodities. Has the Chinese and Indian economy risen 20 times over the last 5 years. Are yoou kidding me? It is impossible!

Here are some of my source!

This one talks about supply being higher than demand.

Excerpt:

Tell me, how is it free when speculators rule the roost? It’s one thing when they do what they do with pieces of paper called stocks, but it’s another when they do it with a vital commodity like oil. We saw the devastation their behavior wrought in the 1990s, and we’re witnessing it again right now.

Moreover, it would be one thing if they were right and buying oil for all the right reasons. But they’re not.

Recently we saw crude oil supplies rise to a six-year high. Gasoline stockpiles were at a three-year high. Distillates have come back from a steep deficit to inventory levels that are now above where they were last year. Natural gas inventories reside well above their five-year average.

Yet prices go up and up and up.

Still not satisfied?

Okay, OPEC is producing at levels not seen since the early 1970s — and that doesn’t even include Iraq, which is struggling to achieve pre-Gulf War production levels, but will soon be there. Furthermore, global production still outpaces consumption, even accounting for China’s unsustainable economic growth rates.

In short, there is nothing in that equation that says oil should cost what it costs today. Nothing! With one exception — speculation.

The New York Mercantile Exchange is the preeminent energy futures market in the world. It has become the price-setting mechanism for oil. Even OPEC refers to NYMEX when it sets its price targets. Right now it costs exactly $3,375 for anyone to control 1000 barrels of crude oil valued at roughly $67,000. Three grand to control nearly seventy!

The NYMEX sets that margin requirement, or “good faith” deposit, based on a number of factors like volatility and price. Yet despite the fact that crude and gasoline prices have doubled in the past year the exchange has only raised the margin requirement once, and by a token amount. I might add. The reason I remember it so well is because I think I had something to do with it.

-------------------------------------------------------------------

And this one about food speculation (one of the commodities that includes oil), which is essentially the same idea. This refers essentially to the pre-Enron and post-Enron situation.

And finally, something that the congress is trying to do about it.

Edited June 18, 2008 by rethaired

[bonobo]

Despite working in the oil & gas business I don't fully understand all the financial wheelings and dealings but this is how I understand it.

The price per barrel you see quoted is usually for a future delivery date of say September 2008, i.e. the oil is often still in the ground.

The speculators look at the spot price being commanded today and then assess current and cyclical trends (e.g. the northern hemisphere countries burn more oil products in winter than summer).

Then they look at the world political situation and likely future developements.

Then they do a whole lot more analyses and try and predict the price that a barrel will command at that future date and bid for/buy so many hundred thousand barrels at a price that will enable them to make a profit.

If the price on delivery of the oil is below their prediction they break even or make a loss. If it rises above their prediction they make their profit ++

So why is the price rising and not falling? Well it is like a packed auction house full of bidders who all want the product for their energy hungry clients and there is only so much product to be had. This constriction in supply is where OPEC comes in, if they ran at maximum production there'd be plenty of oil in the market and the price would come down thus they lose revenue. If they squeeze too hard the price goes through the roof and, eventually, people cut back consumption or countries start developing otherwise uneconomic areas and they lose sales.

btw do not think that a company like Shell is one concern. Shell, and all the others, is split into divisions. Exploration & production, refining and marketting (more actually but we'll stick to basics). Each is a separate concern with their own set of bean counters (accountants) charged with making maximum profit. So just because Shell E&P own the lease to the oilfield does not mean it sells the oil at a discount to Shell refining and similarly on to Shell marketting. Shell E&P sells the oil on the open world market to whoever pays the rate and Shell refining buys the oil on the same market paying the rate. Marketting buy the finished product from a similar kind of open market via trading deals with other refiners, do not think that every gallon of gasoline you buy at a Shell filling station comes from a Shell refinery nor originated from a Shell oilfield.

The only fly in the ointment, for the big boys, is the independants which is why some chains of filling stations can undercut the price (but not by much - they want a profit too).

Well that's my take on it, if I'm wrong I'll gladly accept the corrections as I don't pretent to fully understand it myself.

Actually, that is pretty accurate.

What the Saudis and others are complaining is that the speculators are using emotions (fear, greed, whatever) to drive up the price than simple economics.

With demand going up in China and India, even with lessening demand in the EU and now the US, and with the new oil fields nowhere near production, the price should be going up. And with the weaker dollar, the price should be going up as well as oil is quoted in dollars. However, there is no economic reason for oil to be as high as it is, and those complaining about the speculators do have some basis for that.

The huge $11 jump in oil last week was instigated by a less-than-1% fall in the value of the dollar. In pure economic terms, a 1 % change in currenty values cannot result in an 8% jump in oil prices. But it did, and that was speculators over-reacting.

This all becomes a case of a self-fulfilling prophecy. Speculators think the price is going to go up, so they buy, and that buying drives the price higher, proving to them that they were right and causing them to buy more, driving the price up more, and so on and so on.

[bonobo]

There is a significant degree of truth to what he says. But it is not 100% true.

Yes, there is enough oil out of the ground to meet current demands. But with demand growing (particularly in China and India), demand will outstrip supply given current production rates.

Also, much of the oil being pumped today cost much more than oil being pumped before. The "easy" oil has been pumped already. THe huge find in Brazil, for example, is in quite deep water. And the vast amount of Candian oil being shipped to the US has to be extracted from oil sands. (THe US is sitting on huge reserves of oil in their shale deposits, but that will cost even more to extract).

Speculators are driving up the price, but high costs of extraction, a weaker dollar, and simple supply and demand economics also have theri input.

[johna]

Driving the surge in gas prices?

The Bush McCain surge in Irag

By Greg Palast for TomPaine.com/OurFuture.org

New York May 22, 2008

I can’t make this up:

In a hotel room in Brussels, the chief executives of the world’s top oil companies unrolled a huge map of the Middle East, drew a fat, red line around Iraq and signed their names to it.

The map, the red line, the secret signatures. It explains this war. It explains this week’s rocketing of the price of oil to $134 a barrel.

It happened on July 31, 1928, but the bill came due now.

Its worth visiting Greg Palast's blog for the rest of this story, OPEC will never allow Iraq to pump oil beyond the OPEC imposed quota.

Edit =grammer

Edited June 18, 2008 by johna

[LinkPopularity]

I hate all this complaining about oil prices ... this problem will solve itself ! in fact, that's what's actually happening right now ... the free market works ! too much consumption -> prices go up ... can't be any easier

about those speculators, shell doesn't own all of it, they also have all kind of contracts, they're not the only players, they sell to each other, tank station are most of the time franchises etc., they drill in different countries -> different rules etc etc etc