This is the second
article in a special series on oil and the Persian
Gulf. Part 1:Riddle
of the sands
Contrary to popular
belief, all crude oils are not the same. They
don't even look the same or have the same color or
smell. While there are well over 100 types of
crude, depending on where they are found (similar
to the wine regions of France!), two important
characteristics are used for their classification
- specific gravity (that is the density, referred
to as light, medium or heavy) and sulfur content
(referred to as sweet or sour).
"Heavy"
crudes are those that have an API (American
Petroleum Institute) specific gravity of less than
20 (the lower the specific gravity the higher the
density of the crude), while "light" crudes are
generally those with an API in the range of 32-42;
crudes in
the middle range of 20-32
generally classified as medium crudes.
The
characteristic of crudes matter for a number of
reasons: i. The heavier the oil, the harder it
is to pump the oil through pipelines and the more
expensive it is to refine into the higher priced
fuel products-jet fuel and gasoline; ii. Sweet
crudes are less expensive to refine; and iii.
Most refineries are built and configured to refine
a particular type of crude and produce a given mix
of products (refineries can be built to handle a
range of crudes and produce a wider range of
products, but such refining flexibility increases
design and construction cost).
It is
precisely because all crudes and refineries are
not the same that a shortfall in Libyan crude
exports (which is both light and sweet) as we
experienced during the Libyan crisis could not
immediately be filled by Saudi exports of a heavy
sour crude. It also takes time to reconfigure
refineries, shift crude exports and trade products
where they are in demand.
Also and
crucially, the extraction of crudes that are
similar to Libyan crude may not be increased
quickly because of limitations on installed
capacity. Oil fields have a capacity, and while
output may be increased somewhat and temporarily
beyond capacity, extraction beyond a certain rate
can damage the field and significantly reduce the
amount of oil that can be ultimately recovered by
conventional means.
To increase installed
capacity for crude production in a region takes
time, requiring exploration, reservoir and field
development, production installation and
transportation to markets. Depending on the
location, this could even take up to nearly 10
years.
For the reasons above, a major oil
field disruption (through fire, war, and so forth)
can have a significant adverse impact on oil
prices, especially if excess global installed
capacity is low and there is no excess capacity in
the type of crude that was disrupted.
The
most frequently cited crude benchmarks and prices
are: Brent (North Sea), West Texas Intermediate
(WTI), Arabian light, and the OPEC (Organization
of the Petroleum Exporting Countries) basket. [1]
Another factor (besides crude quality)
that affects the price of crudes is the location
of the oil - that is, how difficult it is to
transport it and how close it is to the market.
From the crude producers' side, the
production (or lifting) cost may be the most
important factor about any crude oil, and this
varies dramatically across the world depending on
the size of the reservoir, the condition of the
reservoir, the depth of the oil from the surface
and the nature of the general surroundings.
While precise figures are trade secrets,
an overall picture is possible with rough figures
we have compiled for marginal cost of a barrel
(the cost of producing an additional barrel) and
the average cost (including all costs such as
development and capital costs divided by the
number of barrels produced) over the years:
Persian Gulf on shore - marginal cost US$1-$3;
average cost $5-$10;
North America - average cost $15-$40;
Arctic fields - average cost $35-$100;
Deep off-shore - average cost $30-$70.
Modern technology has increased the
availability of crude oil through enhanced oil
recovery methods from existing reservoirs and from
non-conventional sources (oil shale and tar
sands), with the average cost of enhanced recovery
oil coming in at $30-$70, and for non-conventional
sources $35-$120.
The advantage of Persian
Gulf oil is clear - it is the cheapest oil to
produce and get to market. This affords Middle
East oil exporters an unbelievable operating
margin (or rent) when oil is selling for about
$100 per barrel.
In terms of location,
besides having the cheapest production cost, the
Persian Gulf has crude in abundance, with about
55% of global reserves of conventional crude oils.
This will likely increase to about 65% as
exploration activity in Iraq picks up, economic
sanctions on Iran are lifted and reserves outside
the Persian Gulf are depleted more quickly. The
estimated reserves of recoverable oil from
non-conventional sources are roughly on a par with
conventional crude reserves.
While the
Persian Gulf is the center of conventional crude
oil reserves, North America (the United States and
Canada) are at the center of crude that may be
recovered from shale and tar sands, with North
America having about 50% of the global reserves
from these sources.
The role of technology
in all of this must be appreciated. The reserve
figures are rough estimates with the level of
technology that we have today. Advances in
technology involved in exploration, drilling
(offshore platforms and horizontal drilling),
enhanced recovery and extraction from
non-conventional sources add to reserves and
increase the lifespan of oil-based hydrocarbon
fuels. Technology, in turn, is in large part
driven by oil prices. As oil prices rise, it is
more profitable to develop new technologies and to
produce from oil fields that were previously
unprofitable.
While oil continues to be
the world's most important traded fuel, natural
gas has become increasingly significant over the
past 30 or so years. There are two major sources
of conventional natural gas - associated or wet
gas (gas that comes out of the ground along with
oil) and unassociated or dry gas (fields that
produce only gas and little or no liquid
hydrocarbons) - and a number of sources of
un-conventional gas, principally shale gas and to
a much lesser degree methane from coal beds.
The importance of natural gas has
increased because it is a cleaner fuel than oil
(and of course much cleaner than coal where it can
be used to produce electricity) and it has in
recent years become much more tradable using ships
and pipelines.
The Persian Gulf's share of
global conventional gas reserves, at about 40%, is
well below its share of oil reserves, but it is
still the largest region for gas region, with
giant reserves in Iran (16%) and Qatar (14%) and
with the reserves of these two countries and the
Russian Federation amounting to about 55% of
global conventional reserves.
While shale
gas was produced over 100 years ago, its potential
importance has dramatically increased over the
past 10 or so years because of technological
advances and discoveries all around the world,
especially in the US, Europe and in China (where
it is close to the major end user). Some experts
speculate that shale gas may eventually change the
global energy outlook, especially if the adverse
environmental impact of its production can be
minimized. A number of experts argue, however,
that hydraulic fracturing (or fracking) and the
drilling that goes along with it pose grave
environmental dangers.
Historically,
natural gas and crude oil prices have had a
reasonably close association, but the association
has been broken in recent years, in part because
of the availability of shale gas.
The oil
and gas consumption picture is more clear-cut than
the reserve-production picture. Gross domestic
product (GDP) of countries and oil and gas
consumption go hand-in-hand. Some countries rely
more heavily on coal, but given environmental
concerns, oil and gas are increasingly correlated
to economic output, not withstanding that some
countries use energy more efficiently in producing
$1 of GDP.
The three biggest consumers of
global oil output are the US (21%), the European
Union (16%) and China (11%) and the US, Europe,
Japan and China are the biggest oil importers.
Among exporters, the two leaders are the Middle
East (36%) and the former Soviet Union (16%).
The US (22%) and European Union (16%) also
lead the way in consumption of natural gas,
followed by the Russian Federation (13%). For
trade in natural gas, the US is in rough balance,
Europe is the big importer and Russia and Qatar
are the major exporters.
NEXT:
The driver of oil prices.
Note 1. The 12
members of the Organization of the Petroleum
Exporting Countries are: Algeria, Anglola,
Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria,
Qatar, Saudi Arabia, United Arab Emirates,
Venezuela.
Hossein Askari is
Professor of Business and International Affairs at
the George Washington University.
Head
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