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The Cause of High Oil Prices

Date: 15 October, 2005

By: Chief

Imageo begin to understand the cause of the current stratospheric price of a barrel of oil, and subsequently a gallon of gasoline, we must all understand what oil currently is. Oil is:

Given those (above) pre-conditions the question now becomes what oil isn't. Oil is not:

To be sure, if oil is a monopoly resource and if oil is absolutely essential for survival, then obviously oil and its refined products cannot be taken for granted and most assuredly cannot be treated as a commodity. There is an absolute and irreconcilable dichotomy between the 'is' list and the 'is not' list.

Therefore we as citizens and our elected representatives within the several states and Congress must change our beliefs and thought processes as they pertain to oil. As such, we must turn our attention to the free marketplace.

Free market

The free market is the only way to fly. However, while the theory behind the free marketplace is and remains pure the reality is, unfortunately, that there are flaws in the market. Regarding oil and its refined products the biggest flaw is one of competition. There is none. Period.

If we accept oil and its refined products are particularly unique natural resources which are essential for survival at the present time and into the foreseeable future there cannot be competition. When was the last time you saw a TV commercial or heard a radio spot to buy gasoline or diesel from 'X' company? I have not seen nor heard a commercial in around 30 years, perhaps more.

If oil and its refined products were actual commodities versus particularly unique natural resources which are essential for survival, I submit that there would be:

Now if I am incorrect in my assumption that oil and its refined products are indeed (a) particularly unique natural resources which are (b) absolutely essential for survival and that oil and its refined products are mere commodities then the free marketplace forces of supply and demand should have already, actually sometime ago, come into play and brought the prices, both per barrel of crude oil and per gallon of gasoline or diesel, down substantially.

Hence, if the demand for a given product increases then industry historically expands its supply of said product in order to meet the increased demand. The results are:

Market manipulation

All one need do is consider the popularity (until this year) of the SUV. High demand equated to an increased supply. Supply and demand worked, just as it is supposed to.

But in the case of oil and its refined products the exact opposite is true. The world population has increased thus increasing the demand for oil and its refined products. Yet the supply for refined products, gasoline, diesel and the like, has decreased.

Supply has not kept up with demand. Furthermore, it appears that oil refiners intend to keep it that way. In other words, even though demand has increased and continues to increase refiners do not plan to increase the supply of refined oil products.

The reason for this practice is simple enough. Oil and its refined products are not commodities. Without doubt oil and its refined products are particularly unique natural resources that are absolutely essential for survival.

Indeed, Mr. Bob Slaughter, President of the National Petrochemical & Refiners Association (NPRA), in his opening remarks before the Senate Energy Committee on 06 September, 2005, said:

"Domestic refining capacity is a scarce asset. There are currently 148 U.S. refineries owned by 55 companies in 33 states, with total crude oil processing capacity at roughly 17 million barrels per day. In 1981, there were 325 refineries in the U.S. with a capacity of 18.6 million barrels per day. Thus, while U.S. demand for gasoline has increased over 20% in the last twenty years, U.S. refining capacity has decreased by 10%. No new refinery has been built in the United States since 1976, and it will be difficult to change this situation. This is due to economic, public policy and political considerations, including siting costs, environmental requirements, a history of low refining industry profitability and, significantly, 'not in my backyard' (NIMBY) public attitudes."

Mr. Slaughter thus admitted, in a public forum and for the record, that the refining industry has known for sometime, as in with actual knowledge, that:

Mr. Slaughter also stated:

"In the ten-year period 1993-2002, average return on investment in the refining industry was only about 5.5%. This is less than half of the S&P industrials average return of 12.7% for the same period. Refining industry profits as a percentage of operating capital are not excessive. In dollars, they seem large due to the massive scale needed to compete in a large, capital-intensive industry. For example, a new medium scale refinery (100,000 to 200,000 b/d) would cost $2 to $3 billion."

In short, a 5.5 percent return on investment is not good enough for refiners. They, the refining industry, want more. They are making a profit — but not a big enough profit to suit themselves. Additionally, as there have been, by Mr. Slaughters own admission, no new refineries built in the United States since 1976 it therefore cannot be truthfully said that refiners have such huge operating costs as alluded to by Mr. Slaughter.

Further Mr. Slaughter states, in a percentage fashion versus actual numbers, return on investment. Considering, according to Mr. Slaughter, that a medium sized refinery could cost upwards of 3 billion dollars and the return on investment is but a mere 5.5 percent. That is:

The only thing Mr. Slaughter did not state in his remarks was whether the 5.5 percent return on investment is annual or over the life of the refinery. Either way no reasonable person could say a refinery is a money losing business.

It is important to include one additional quote of Mr. Slaughter's opening remarks before the Senate Energy Committee:

"The natural disaster resulting from Hurricane Katrina required an understandable shift in emphasis to the human needs damages resulting from that storm and only then to supply impacts. But it is important to remember that the effect of Hurricane Katrina is an overlay on a pre-existing condition. That was and is a situation characterized by high crude prices, strong demand for gasoline, diesel and other petroleum products, and a challenged energy infrastructure, especially in refining."

Everything Mr. Slaughter stated in the above quote is absolutely true. And, with the sole exception of Hurricane Katrina, every part of that quote has been willfully brought about by the oil industry.

Greed and control equal power and wealth

To be sure, had the oil industry adhered to the principals of the free marketplace, the supply and demand practice, the effects of Hurricane Katrina would have at worst been negligible and at best not have even been noticed.

Instead the entire oil industry no later than 1973 recognized, courtesy of the infamous OPEC oil blockade, that oil and its refined products are particularly unique natural resources that are absolutely essential for individual, state and national survival. The industry further recognized the irrefutable monopoly nature of the resource.

He who controls the valve of oil and its refined products — controls the industrialized world. It is as simple as that.

This is not to say that the oil land (royalty payment) owner, the oil transportation industry (tanker ship and Floating Production Storage and Offloading (FSO/FPSO) owners), the fuel wholesale and retail market owners, the futures market, the spot market, and, believe it or not, the credit card companies are at all lily pure. Indeed each and everyone of them within the oil industry food chain are guilty of violating the free marketplace principal of supply and demand. They have all engaged in the practice of price fixing and/or price gouging. Why? Simply because oil and its refined products are absolutely essential for individual, state and national survival.

It is also known as 'because they can' and the oil industry knows that all too well.

Mr. Bill Shipley provided testimony to the Senate Energy Committee on behalf of the National Association of Convenience Stores (NACS) and the Society of Independent Gasoline Marketers of America (SIGMA). Mr. Shipley is also Chairman and Chief Executive Officer of Shipley Stores, LLC, which is headquartered in York, Pennsylvania.

In his opening statement Mr. Shipley provided a chart of the approximate gross revenues that several different parties in the petroleum exploration, refining, and distribution system realize from each barrel of crude oil.

I have reproduced the text here but please attend to the fact that the average inflation rate has been a mere 2 percent - 2.5 percent per year:

According to Mr. Shipley at the retail side of the house the price per barrel has basically remained unchanged over the past two years. However, the price at the gas pump reflects an entirely different story.

Just prior to Hurricane Katrina flattening the eastern Gulf Coast the price of oil per barrel spiked at approximately 70.00 dollars. The price we citizens paid for fuel by the gallon (86 octane) in the area where I live hit $3.15.

Yet according to University of Wisconsin-Madison economist Professor Don Nichols, for the price of gasoline to legitimately rise to 3.00 dollars per gallon, the price of oil per barrel would need to be approximately 95.00 dollars.

Additionally, off shore oil platforms, dependent upon their distance from territorial waters (12 miles or more) do not pay oil owner royalty payments if the platforms are in international waters.

Price fixing

Hence, I believe it to be a safe assumption when I say that there has been price fixing and price gouging across the board by all aspects of the industry and at the state level, national level and yes, the international level also. Once again it is a situation of 'because they can'.

Why? Because oil and its refined products are particularly unique natural resources which are essential for survival. Period.

The oil which we import from various countries arrives into the U.S. by tankers. There are various classes of tankers ranging from lighters (small to very small tankers normally under 100,000 dead weight tons (DWT)) to Very Large Crude Carriers (VLCC) and the even larger Ultra Large Crude Carriers (ULCC). To give you an example of the enormous size of ULCC class ships, the Exxon Valdez which spilled 257,000 barrels (11 million gallons or 125 Olympic sized swimming pools) of oil is only a VLCC class tanker and what she spilled only amounted to approximately 20 percent of her total capacity. ULCC class tankers have a total capacity of over 500,000 dead weight tons.

What appears to be happening within the oil shipping industry is that quite a few VLCC and ULCC class ships are being taken out of service long before it would be necessary (based upon safe operation) and are either sold for scrap or converted into FSO's.

The FSO's sit at an anchorage in foreign ports or foreign offshore anchorages loaded with oil. Said oil is either off loaded to shuttle tankers (lighters) for delivery or, at some future date, sold and off loaded to transportation tankers when the cargo owner negotiates a price per barrel that is acceptable to the owner. This is accomplished through either the spot market or the futures market or both. And, as one can tell, it is an extremely lucrative method to manipulate an already unstable market. One that is also easily accomplished.

In short, if an owner wants a higher price, notify the futures and spot market. Traders go into a tizzy looking for quick, short term and high gains. It is one of the oldest and most commonly used 'tricks in the book'.

This is not in any way a new concept. It has been done before by the sugar industry back in the late 1960's and early 1970's to produce a certain result — drastically higher prices by producing a shortage when, factually speaking, there was no shortage.

At the present time the number of VLCC and ULCC class tankers are starting to dwindle when more are actually needed to be in service. While not provable, the case seems to be, once again, profit margin. It is not that tanker operations are not producing a profit, it is that tankers are not producing enough of a profit for the ship owner.

The credit card companies are making a killing from the retail purchases that consumers make on a daily basis for essential fuel. Compared to the oil industry, the credit card industry has an almost negligible overhead. But their price per barrel over the course of two years (2003 - 2005) increased by an astounding 200 percent. And for what? Allowing consumers to 'buy now, pay later'. More truthfully, it is also because they can. And they know it.

The retailers in the area where I live do not compete. Certainly not in a true free marketplace sense. As of 24 September, 2005, there was exactly a .02 cent variance in price between gas stations and convenience stores which also sold gasoline. That cannot be classified as competition by any reasonable person.

In July of 2004 the price per gallon of 86 octane gasoline in my area was $1.67. As of the 24th of September, 2005, the price per gallon of 86 octane gasoline in my area was $2.79. That is an increase of 65 percent in only 14 months. At the same time inflation has been about 2 - 2.5 percent.

Why? I shall say it again, because they can. And they know it.

Commerce is fueled by diesel

The worst of the current situation is the cost of diesel fuel. Historically, diesel has been priced well below the cost of the lowest octane rated gasoline. This is because diesel does not require the same amount of refining that gasoline does. Furthermore diesel can be refined from lower grades of crude oil and, if my understanding is correct, diesel can be refined from synthetic crude as well.

So why is diesel so expensive? It is because:

What has never happened before is that Friday (23 September, 2005) the New York Mercantile Exchange announced a special trading day for Sunday, the 25th of September, 2005. The purpose was for trading oil and gas futures. We, as citizens and consumers, should be outraged on the one hand for the exchange having a special trading day and, on the other lucky that prices on oil and gas futures dropped on the special trading day.

We can ill afford luck.

The various environmental groups are also just as guilty as the oil industry pertaining to the exorbitantly high prices for fuel. They have used their political clout to get laws enacted, both at the state and federal levels, which make obtaining the necessary permits by the oil industry either extraordinarily difficult or virtually impossible.

In addition, various environmental groups have filed numerous lawsuits to prevent approved production, refining and distribution facilities from being built.

Lastly, due to environmental group political pressure and law, there are now somewhere in the neighborhood of 47 different types or blends of fuel which must be produced in order to comply with federal and state law and/or regulation.

This 'special interest group' appeasement has got to be stamped out. Only our elected representatives at the state and federal level can do this. And it must be accomplished in no uncertain terms.

What can be done

I fully believe that I have shown oil and its refined products are indeed particularly unique natural resources which are essential for survival. I further believe that I have shown that the oil industry and related industries have willfully created the current high price situation in which we citizens and consumers find ourselves.

The high ticket question therefore becomes what can we as citizens and our elected representatives do about this intolerable situation?

Citizens cannot do much but we can:

I do not agree with, in anyway, price controls or the infamous windfall profit tax. That said, what can state legislators do?

In New Mexico our legislature can:

At the federal level, the actions are just about the same as the state level with only two exceptions.

The future

Those above listed items are strictly near term. Mid term is to get additional production, refining and distribution capacity built in our country. Away from weather volatile areas. Not overseas. Shale oil is a prime example. Indeed, Shell Oil Company has just created and tested a successful method of extracting oil (about one-third natural gas, two-thirds light crude) from shale for approximately 30 dollars per barrel.

Quoting the Rocky Mountain News (03 September, 2005):

"Upwards of a million barrels an acre, a billion barrels a square mile. And the oil shale formation in the Green River Basin, most of which is in Colorado, covers more than a thousand square miles - the largest fossil fuel deposits in the world."

This new production method needs to be brought online soonest, to say the least. If fully developed and if estimates are correct the Green River Basin would fully extract us from any dependency on imported oil and refined fuels. This should be pursued vigorously.

Long term solutions appear to be hydrogen and, quite possibly, anti-matter. There is ongoing development of both at various universities throughout the world. Indeed the U.S. Air Force has contracted with CERN (Switzerland) for additional anti-matter research.

Both long term solutions are decades away from being viable energy solutions.

Between now and then we must keep the oil industries feet to the fire at all times, keep special interest groups away from the legislative table and never forget that oil and its refined products are particularly unique natural resources which are essential for survival of our citizens, our state and our country.

In closing, no citizen, no state and no country should be held for ransom — at the gas pump.

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