Why oil chiefs are feelin'
groovy By Julian Delasantellis
In 1980, Paul Simon sang of a "One Trick
Pony", an animal that "does one trick only - it's
the principal source of his revenue". These days,
the world's major oil companies are a lot like
this animal. They do one thing - engineering price
rises by restricting gasoline supply through
manipulation of oil-refinery output - really,
really well and, much like the pony, they make
lots and lots of revenue from this activity.
products going on at that
time was not, as the popular media were then
proclaiming, the result of tensions over the 15
British sailors then being held by Iran; it was
more the result of the lack of any spare capacity
worldwide to refine oil, a condition that, at the
very least, the oil companies found serendipitous.
Now that the sailors are home, safe and sound in
the warm, loving bosoms of their literary agents,
you might have expected oil and gasoline prices,
if only just for show, to give back some of their
March gains.
Not on your life, as all US
drivers know. Like vampires, they now fear each
new rising of the sun, for it is then they will
learn just how much retail gasoline prices have
risen overnight. According to the US Department of
Energy's Energy Information Administration (EIA),
average US retail gasoline prices have risen every
week since early February. The national retail
average of US$2.876 for a gallon of regular
gasoline (75.98 cents per liter), as of the April
16 report, is the highest price since the
historical twin peaks of just under $3.10 early
last summer and just after Hurricanes Katrina and
Rita in the early autumn 2005. The national
average masks wide regional disparities; lower in
the Midwest, but on the west coast, the average is
already at $3.195 (84.4 cents a liter).
But like those of a bad magician at a
child's birthday party, the oil companies' tricks
are showing. Government-released oil-industry
data, along with the oil futures markets, are
showing the world just exactly how this trick
works - lucky for them the world, as usual, is
looking elsewhere.
When the US media
report on what's happening in the oil markets,
what they are really reporting on is a commodity
called West Texas Intermediate. WTI is what is
called a commodity benchmark - it's the basis for
the crude-oil futures contracts traded at the New
York Mercantile Exchange (NYMEX).
When a
trader commits to buy, say, 10,000 oil futures
contracts, and does not then sell or roll over the
contracts prior to one of their monthly
expirations, the trader has no intention of having
420,000 gallon pitchers filled with oil delivered
to the trading floor in Lower Manhattan. Instead,
written into the specifications of the futures
contract is a proviso that the seller of the oil
must deliver the commodity to the nexus of
oil-pipeline connections at Cushing, Oklahoma -
from there, the owner of the crude oil can make
arrangements for the product to be delivered to
and refined at one of the many nearby Gulf of
Mexico Coast and Midwest refineries. Europe has
its own oil benchmark, Brent Crude, originating
out of the oil-drilling platforms in the North
Sea, and traded at London's International
Petroleum Exchange.
WTI can be refined
into a less polluting, "cleaner" fuel than Brent,
so it normally trades at a premium of about $1
above what Brent is trading at. However, this
year, the reverse is happening, and is happening
rather dramatically. On April 10, the premium for
Brent over WTI widened to a historical high of
more than $6 a barrel.
What's happening
here, in the fall-off in demand for WTI and the
accompanying surge in Brent, is that the oil
companies are becoming so brazen in their attempts
to manipulate the markets for petroleum products
that it's becoming very, very obvious.
As
I noted in my April 4 article, crude oil, by
itself, has very little utility. It must be
processed, refined, into its usable component
products of gasoline, diesel fuel, home heating
oil, and jet fuel. The reason WTI is losing
relative value to Brent is that it's becoming
harder and harder to do that at the traditional
networks of refiners that service Cushing. The oil
companies have recently shut down so much US
refining capacity that there is no place for the
crude oil at Cushing to go, no refinery with spare
capacity to process it. The massive network of
underground oil-storage tanks at Cushing is full,
and oil being stored in tanks makes money for no
one except the owner of the storage facilities. If
you can't refine WTI, there's no reason to buy
WTI.
In my April 4 article I demonstrated
how oil companies were not building the new
refining capacity necessary to meet surging world
oil demand; figures from the EIA indicate that
they're not even adequately using the US refinery
production capability that they already have.
US oil refineries operated at less than
87% of capacity for the first three months of
2007. With the exception of 2006, when production
was inhibited by the continuing effects of
Hurricanes Katrina and Rita, and the recession
year of 2002, that's the lowest average
capacity-utilization rate for the first three
months of the year since 1992. (Oil companies
defend their low early-in-the-year
refinery-utilization rates by claiming that they
use these months for repairs, for maintenance, and
to shift their production mix from winter
home-heating-oil blend to summer gasoline blend;
be that as it may, it did not prevent US
refineries from operating at more than 93%
capacity during the first three months of 1998,
92% in 1999, and 91% in 2005.) The refinery
capacity-utilization rate reported on February 16
of this year, 85.2%, was one of the lowest weekly
rates not affected by Katrina and Rita since the
early 1990s.
You could see the workings of
the oil companies' trick as it developed. In early
January, refinery capacity utilization stood at a
healthy 91.5%, and the gasoline crack spread, the
crude-oil-to-gasoline price ratio (the crack
spread is explored in depth in my April 4 article)
that defines the profit to be made from refining
crude oil into gasoline, stood at a fairly low
$7.154. NYMEX gasoline futures were then trading
for less than $1.45 a gallon, the lowest prices
for more than a year. It was then, with US
gasoline demand still very strong, that the
reduction in refinery capacity utilization began;
all of a sudden the financial press was full of
stories related to various and sundry "accidents"
and "repairs" that were causing US refineries to
shut down and/or limit production.
By late
March, as the Iran/UK crisis began, and as
crude-oil supplies at Cushing began to build,
NYMEX gasoline futures had risen to $1.95, and the
crack spread was near $19, meaning that oil
companies were making just under two and
two-thirds times the profit on every gallon of
gasoline sold that they had in early January. On
April 13, gasoline futures topped out at more than
$2.20, up more than 75 cents since January. On
that day, the crack spread stood at just under
$28, meaning that the business of refining oil
into gasoline was now four times as profitable as
it was just three months previously.
Therefore, is it any surprise that the oil
companies have now decided that all those needed
"repairs" and "maintenance" can be put off for a
while? The most recent report released by the EIA
shows that oil refinery capacity utilization now
stands at 90.4%, up 5 percentage points from two
months previously.
Now that it's so much
more profitable to sell the stuff, they might as
well make some of the stuff.
With
refineries producing this now much more valuable
commodity flat-out, it's possible that the worst
of the motorists' short-term pain has already been
afflicted, but in the longer term, there is no
cause for sanguinity. The first of the three big
US summer driving holidays, Memorial Day,
Independence Day and Labor Day, is still weeks
away (May 28); many analysts see a real
possibility of mid-to-late-summer US gasoline
prices averaging in the mid-$3 range nationally,
and closer to $4 a gallon ($1.05 a liter) on the
west coast. Until the root cause of these price
spikes, the oligarchic nature of the oil
distribution and refinery system allowing oil
companies to engineer and sustain supply
restrictions virtually at will, is addressed,
you'll always be reading about something,
somewhere, be it Iran, Nigeria, Canada, or
Cushing, Oklahoma, that is causing gasoline prices
to skyrocket.
Imagine what it must be like
to be some young eager-beaver oil-refinery manager
seeking to rush his facility back into service
before corporate headquarters thinks the time is
right. This is the response he might get from the
head office, sung to the tune of Paul Simon's and
Art Garfunkel's 1966 hit "The 59th Street Bridge
Song" (more commonly known as "Feelin' Groovy":
Slow down, you move too fast You've
got to make this shortage last Hear the
consumers' whines and moans The oil business -
it's just so groovy!
Julian
Delasantellis is a management consultant,
private investor and educator in international
business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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