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3 Crude: Barrels of fun to crack you
up By Julian Delasantellis
In 1949, the movie It Happens Every
Spring chronicled the professional baseball
exploits of a bookish US Midwestern science
professor, played by Ray Milland, who discovers a
chemical coating for baseballs that will make them
impossible to hit. However, if somebody was making
a movie called It Happens Every Spring in
2007, the subject would not be baseball, but the
now annual spring reaming that oil consumers are
once again undergoing at the hands of the world's
oil interests.
Since the seizure of 15
British sailors in the Shatt-al-Arab
waterway by Iranian
revolutionary guards on March 23, the price of a
barrel of crude oil on the New York Mercantile
Exchange (NYMEX) has risen over US$5 a barrel, to
just under $67. The American media delight in
conflating these separate incidences into one
causation; besides the nightly parade of
red-in-tooth-and-claw neo-conservatives diverting
attention from their disastrous misadventure in
Iraq by baying for Iranian blood on US cable TV, a
Google search with "Iran", "seizure" and "crude
oil" as parameters is now returning over 150,000
articles.
For the world's oil interests,
this is delightful. Just like the guy doing card
tricks at the traveling carnival, your vision gets
distracted by kinetic irrelevancies he does with
one hand while the real action goes on unnoticed
right under your nose with his other. Nations
fight and young soldiers die over access to crude
oil, but, for something universally esteemed as
the most valuable commodity in the world, a barrel
of crude oil, 42 US gallons or 159 liters, is
surprisingly useless. You can't put it in your gas
tank, and it won't heat your home. Crude oil must
be processed, or refined, to make it into usable
products such as gasoline, jet fuel, heating oil
or diesel. The world's popular media focus far too
much attention on where oil is produced, like the
area around where the British marines were seized,
and far too little on where it is refined, where
the real action is.
Before the mid-1970s,
the oil business was a lot easier to comprehend
than it is now. Seven major transnational oil
companies (The Seven Sisters was the name
of a 1975 book by Anthony Sampson detailing their
activities), all but two of them American,
vertically dominated the entire process of oil
production, transport, refining and retailing; a
gallon of petrol could very well start as Texaco's
property as it emerged from the ground as crude
oil in Saudi Arabia, and it would remain Texaco's
property until you paid someone to pump it into
your car's fuel tank, after which he would then
wash your windows and check your oil.
Around the time the Arab members of the
Organization of Petroleum Exporting Countries
(OPEC) initiated the oil boycott of America in the
wake of the 1973 Yom Kippur war, the nations of
OPEC began to realize just how lucrative the
process of pumping oil out of the ground could be.
Gradually, most of the oil production facilities
within the national borders of the OPEC nations
were nationalized away from the Seven Sisters.
Aramco, the collaborative joint enterprise (or,
depending on your perspective, the monopoly) of US
oil companies operating in Saudi Arabia, became
fully owned by the Saudi government in 1980.
The oil companies may have lost the
production facilities, but their worldwide
networks of refinery facilities, what the oil
business calls its downstream operations, remained
intact, and, as the oil companies soon learned, in
this they would be able to earn a lot more money
with a lot less public scrutiny.
Over at
NYMEX, besides trading in futures in crude oil,
they also trade futures in the major derived
products made and marketed from crude oil,
gasoline and home heating oil. Besides the
stereotypical loudmouthed and clothed peripatetic
Brooklyn guy with two years' college working as a
floor trader, the energy futures markets exist to
serve the wide variety of producers and consumers
in the world's oil markets.
Thus, any
small retailer of home heating oil can buy
futures, legal contracts that guarantee future
delivery of the product at a set price, in
sufficient quantities to meet his winter supply
needs long before it gets cold; by locking in
prices he can guarantee supplies even if prices
then rise or supplies get disrupted. An owner of a
small chain of gas stations can lock in supplies
and price of product long before the summer
driving season. Most importantly, through
commodity brokers, the world's large producers and
refiners can, and do, sell product into the
market, and, in the case of the large oil
companies' refinery operations, can buy crude
product to be refined and then sold through their
refineries.
The important point
illustrated by NYMEX's futures structure is that,
unlike the days of the vertically integrated Seven
Sisters, the process by which petroleum moves from
producer to consumer now contains at least two
transactions. There is one transaction which
consists of the producer selling to the refiner,
another in which the refiner sells to the
retailer.
By their very nature, there is a
symbiotic relationship between the prices of crude
oil and the prices of the products made from it.
Crude oil is the raw material of product
production, so, if the price of the raw material
rises, refiners, to defend their operating profit
margins, will seek higher prices for the products
as well. Likewise, if the price of the products
rise, it will put upward pressure on crude, since,
with the products now commanding a higher market
price, there will be an extra incentive, creating
more demand, to buy more crude, refine it into
product, and sell it back into the market.
However, crude prices and the prices of
its products do not move in absolute lockstep. A
5% rise in crude over some period of time may
produce a 3%, a 4% or a 6%, 7% or 8% rise in the
products. If the products' prices are moving
higher at a greater percentage rate than the
crude, it means that it is becoming comparatively
more profitable to be a refiner than a producer of
oil, since what you are receiving as a price for
your finished product, the petroleum finished
products, is rising faster than what you are
paying for the raw material you need to make that
product, crude oil.
A complex mathematical
formula called the "crack spread" ("crack" being
the industry jargon verb defining the process in
which crude oil is refined into products)
illustrates this ever-dynamic price relationship
between crude and its products. As it rises,
crude's products are becoming comparatively dearer
than crude itself. No matter what the media are
reporting about
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