Oil Prices

How Oil Prices are Established

Did you realize that at our current consumption of crude oil and at our current status of known reserves, we have approximately 40 years of reserves remaining? This is a startling fact when we take into account all the products that are produced from refined crude oil or from its by-products. Many people are aware of the price increases they feel at the gas pump, but has anyone ever considered the cost or investment put forth in finding new reserves? Under the right conditions, oil would sometimes seep up to the surface, but in our times, the search for new reserves is more costly and dangerous.

When considering how the price of crude oil and its by-products are determined, one must first look at the quantities available and the amount required by its users. Crude oil by itself is not a valuable product. The products that are refined from crude oil are where the value lies. Crude oil is refined down into such products as gasoline, diesel fuel, jet fuel, propane and various flammable gasses, perfumes and insecticides. Some refined products from crude oil are also used as feed stocks in the production of other products like animal feed, plastics and other household items. With the expanding economies of various countries like China and Russia (Brown and Virmani 2007), the demand for these products has risen dramatically over the past four to five years. Many nations classified as third world countries are also increasing their need. Unfortunately for society, crude oil is a non-renewable resource, and we depend on finding new reserves to keep up with the consumption. According to the Energy Information Association’s (EIA) report on world crude oil reserves, (EIA 2007) there are approximately 1.3 trillion barrels of known reserves. Divided by the latest amount of global usage of 83.6 million barrels per day, we have approximately 43 years of supply remaining.

Through various news sources, there has been reported an increase in weather occurrences that cause temporary shortages in crude oil production. The largest of these occurrences has been from hurricanes. When a hurricane is reported and the path is determined to cross through offshore oil platforms, all production must be stopped and crews evacuated for their safety. Only once danger has passed, will production resume. This sometimes can be just a few days or longer, depending on if any damage has occurred. In 2005, the Gulf of Mexico experienced two hurricanes that devastated offshore and onshore oil production facilities. Offshore oil platforms were broken from their moorings and driven to shore, and onshore refineries suffered tremendous damage from flooding and high winds. Another weather occurrence that can have a dramatic influence on pricing is the onset of winter. Rather than winter weather causing supply shortages, the demand increases from consumers requiring fuels for heating. However, weather is not the only factor that influences pricing. With most of the known reserves currently producing and slowly depleting, the search for newer sources takes the producers into areas originally thought too harsh or uneconomic to tap.

When the oil and gas industry was in its infancy, crude oil could be found in pools on the ground surface. This was caused by cracks in the geological formation. As crude oil is naturally under pressure and in many cases over 120 degrees Fahrenheit, the oil could and would find its way up to the surface. Ranchers settling in central Texas around the middle 1800’s came across these pools or “seeps” as they are known in the industry. Some of the last remaining seeps are located in the Arctic National Wildlife Refuge located in north eastern Alaska. However, as these easy crude oil resources were used up, companies specializing in oil exploration had to find new resources elsewhere. Newer sources of crude oil have been discovered in some areas thought unreachable, but with newer technologies, these originally unreachable sources can now be produced. With the introduction of deeper drilling ocean vessels, oil companies are now drilling in depths exceeding 10,000 feet of water. These new drill ships are pushing the envelope to what was once though unreachable, but not at a cost. The costs to build these newer technology ships will be passed on to the oil producer and ultimately, to the consumer. To help eliminate some of these offshore production costs, oil companies are building ships that can store large amounts of oil (Business Week Magazine 2006). These ships known as “Floating, Production, Storage and Offloading” or FPSO vessels act as a central loading and offloading point for much cheaper oil tankers. The oil companies do not need to invest in pipelines and gathering facilities to gather and transport oil. Another type of technology the oil companies are using to reduce infrastructure costs is the use of directional drilling. In earlier days, oil wells were drilled straight down into the ground. To extract oil

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