February 27, 2006
RISK NEVER TAKES A HOLIDAY IN THE WORLD OF OIL
There are several catalysts driving oil prices higher over time. Some are economic, some are geological, and some are none of the above. In the latter category, Nigeria and Saudi Arabia figure prominently in the news of late as poster children for disturbing examples of what awaits the bigger oilfields that occur all too infrequently on the planet for satisfying the increasingly ravenous consuming crowd.
Politics reborn as war on low and stable energy prices is leverage in the global economy for those who, rightly or wrongly, think they have no other means of expression and influence. For consumers, it's a new tax on an old concept: the cost of doing business.
That cost is vulnerable to upside spikes in the short run, and a slow but steady rise in the long run. For the former, Friday's attempted but ultimately foiled attack on the Abqaiq oil facility in the Saudi Kingdom was one more wake-up call about the nature of the energy business in the modern era. The site chosen for the attack was hardly a surprise. Abqaiq processes about two-thirds of the 9.5 million barrels a day of Saudi production, home of the world's largest single source for crude exports.
Reportedly, the attack on Saudi production was hatched by Al Qaeda. It's a stark reminder that terrorism in all its virulent forms continually strives to drive up the price of oil. Destruction as a means of political statement is alive and well in the 21st century. For clarity on that point, the organization issued a statement to focus the public's expectations. In the case of Friday's assault, the failure to damage the Saudi facility is only a temporary delay rather than a permanent setback, based on the promise of more Al Qaeda attacks on oil processing complexes.
But even in failure there is success when it comes to affecting the price of the world's most valuable commodity. A barrel of crude closed at a bit more than $58 last Thursday in New York; 24 hours later, after news of the Saudi attack had made the rounds in headlines, oil was changing hands at more than $62 a barrel. The mere attempt at attack is almost as damaging as completing the act when it comes to oil prices.
Some of the recent price spike can be attributed to events in Nigeria, where the Movement for the Emancipation of the Niger Delta has launched its own brand of attack on the business of oil production and exporting. That too is a problem for the United States, for which Nigerian exports are the fifth highest.
Politically, the Nigerian assault on the oil business is distinct from Al Qaeda's, although there's a common thread of trying to take back the resource for "the people," or at least making it tougher for Western consumers to buy the oil.
In the long run, neither group will succeed in turning off the oil spigot, but they will succeed in adding a risk premium to the price of crude in the long run. The size of the risk premium is debatable, although it's a safe bet that it will fluctuate over time and remain considerable.
Risk analysis has long been central to projecting the price of oil, and the art can only become more valuable for analyzing crude. We can start by going country by country for listing the size and scope of the potential hazards that loom over oil. For December 2005, the Energy Information Administration lists the top-10 countries of origin for U.S. imports of crude run as follows, in descending order:
Canada (1.899 million barrels per day)
Mexico (1.707 million barrels per day)
Saudi Arabia (1.438 million barrels per day)
Venezuela (1.183 million barrels per day)
Nigeria (1.174 million barrels per day)
Angola (0.425 million barrels per day)
Iraq (0.390 million barrels per day)
Ecuador (0.340 million barrels per day)
Kuwait (0.268 million barrels per day)
Algeria (0.212 million barrels per day).
Canada is the long source of good news, being the single-largest foreign provider of oil to America that's at once stable and allied with the U.S. Alas, it's downhill from there. As anyone with a passing knowledge of foreign affairs understands, this top-10 list is exposed to a broad array of risks that are as entrenched and unmovable as any on the planet.
Historically, the United States has sought to manage and limit those risks by the standard approach: diversification. By developing a large and diverse portfolio of exporting sources, America has kept risk under control. But time is running out for expecting the strategy to deliver the miracle cure it's dispensed in the past.
Two stubborn trends are conspiring to render the diversification a bit less effective with each passing year. One is driven by geology. As the opportunity for finding large, new oil fields fades in politically stable nations, power and influence in pricing crude slowly but inexorably shifts to those country's with the lion's share of known supply--country's that are forever on the precipice of a revolt of one kind or another. Who are these nations? The key ones can be found in the top-ten list above. Collectively, the top-ten list presents a rainbow of ebbing and flowing dangers that threaten that most precious but too often disregarded American resource: cheap energy.
Posted by jp at February 27, 2006 8:41 AM
Yes, indeed, there's much debate about whether the retail gasoline market is fixed, free, or something in between. The topic is further complicated by those who think the government should substantially increase gasoline taxes so as to create incentives to develop alternative fuels and encourage greater use of mass transit and more fuel efficient cars. But this much at least seems clear: the oil market was never truly a free market, i.e., one set solely by the forces of supply and demand. The histories of Standard Oil in its pre-breakup years, the Texas Railroad Commission, and now Opec speak loud on clear on how long manipulation of one sort or another has been going on in the energy market.
Posted by: James Picerno at March 1, 2006 8:50 AM
I concede your broader vision of oil market forces. My focus is on how the retail market is manipulated daily based upon Futures prices of oil. In this instance the retail price demanded at the pump is driven by a greedy few. There is no opportunity for individual buyers to negotiate the price they pay. Federal and Local governments have no incentive to exert change on the practice as they too benefit from the tax revenue derived from the escalated price. To bring this down to a lower level, Long Distance drivers are faced with a daily search for the best possible fuel price. The situation is critical for many drivers who must wait for credit approval before they can begin fueling for the next leg of their respective journey. No credit, no fuel, no drive. The US retail price for gasoil (Diesel) is higher than for gasoline. This too is an area where individual buyers are unable to negotiate a better pump price. You refer to terrorism as one factor driving energy prices. Western countries up till now have enjoyed a relatively secure retail market distribution system. Drivers are presented daily with news of attacks on oil facilities. I wonder how long it will be before some hot heads decide to help themselves to tanker loads of fuel and sell it to other desperate drivers? It would be very simple to do, large fuel stops are supplied by a continuous stream of mobile fuel tankers. There maybe drivers who wouldn’t blink twice at the chance for a (relatively) cheap load of fuel. I note that a gasoline theft scam was uncovered in Toronto in the past few days. No indication if it is wide spread but just the news of the scheme is sufficient to give others the idea.
Posted by: Beethovin at February 28, 2006 9:50 PM
You cover a lot of ground here, and make a lot of charges. And, yes, you're right. The oil market is bigger, much bigger, than oil futures. But suggesting that the futures market is irrelevant when it comes to pricing oil goes too far, in my humble opinion. Yes, it's true that Saudi Aramco can make whatever deals it wants with buyers and it any price deemed appropriate. But rest assured, the Saudis monitor the oil futures markets, in New York and elsewhere, and they don't consider it irrelevant. The reason? Oil futures have influence. We can debate how much, but the influence is there. Misplaced influence, perhaps, but influence nonetheless.
That said, the private market for oil is huge, much larger than what's represented in the futures market. But oil futures are the only real-time, continuous pricing mechanism we have. And something is better than nothing. Indeed, as any student of the oil industry knows, in the dark ages of the first oil crisis (1973-74), there were no futures markets in oil to speak of. For a long list of reasons I won't go into here, that absence worked to everyone's disadvantage.
Continuous pricing is a good thing, flawed though it may be. Rest assured, ChevronTexaco can buy at lower prices than the near-term contract. But ignoring the near-term contract is a bit like ignoring the gun pointed at your heart simply because it doesn't have the firepower of a tank.
Posted by: James Picerno at February 27, 2006 6:00 PM
It frustrating to follow daily reports in the Media about the price of crude oil on world stock markets. The prices quoted are commodities market prices and have no real connection with the price of crude oil paid by refiners anywhere in the world. Indeed the crude oil prices the Media so glibly quote are for contracts for future delivery of a commodity ‘crude oil’. Virtually every such contract expires before the contract due date. No oil company manager would ever pay such prices for crude oil, not ever! There may be occasions when a refiner faces a crude oil delivery shortfall and is forced to purchase (a limited amount of) crude oil on the Spot Oil Market where asking prices for crude can approximate the daily commodities prices but even then, it is doubtful if any main stream refiner would ever agree to such exorbitant price demands. No one in the industry is interested in correcting this woefully inaccurate reporting. Governments who enjoy great tax windfalls from the exorbitant end prices have no interest in telling their tax payers the truth about energy prices. Investor groups equally are not interested in pointing out the great returns from petroleum investments are partly made from the misconception the sky is falling and we will all freeze in the dark next week or is it next month or maybe next year for sure!
I wonder if my fellow numbnuts will ever wake up to this greatest of all price scams?
Posted by: bEETHOVIN at February 27, 2006 5:15 PM