The Oil Drum: Australia/New Zealand

A few days ago, I wrote a post titled Why Are Oil (and Gasoline) Prices So Low? Since then, OPEC has voted to cut oil production 1.5 million barrels a day. In spite of this, the price of oil is about 5% lower. The purpose of this post is to add an update, with a little more of the story about why the price of oil is dropping more than some of us would expect.

One of the issues I mentioned in that story was

4. Rising value of the dollar

I noted in that post that the price of oil seems to drop as the price of the dollar rises against currencies such as the Euro. As I delve into the question more, I am starting to learn more about why the value of the dollar has recently been rising. It seems that the rising value of the dollar is tied to a combination of things--one is the flight to the US dollar for safety, another is the unwind of the carry trade, and a third is margin calls on hedge funds and other borrowers. The rising level of the dollar because of these issues seems to be a major contributor to the recent decline in oil prices.

We all know that oil prices are lower than they were in the recent past because supply is greater than demand. In fact, OPEC oil ministers are meeting this week to try to fix supply, so it will be more in line with demand.

All of this seems a little strange, though. We are going into the winter months, when demand for oil normally rises because many people around the world heat their homes with oil. We are using somewhat less gasoline in the United States, but apart from the hurricane disruptions, not very much less than earlier this year. While we are going into a recession, it doesn't seem to have hit with full force yet. What other factors may be involved in the current lower prices? In this post, I will discuss factors besides those we usually think of as supply and demand that may be involved.

Figure 1. EIA Chart of WTI oil spot prices - One measure of oil price

With the dramatic increase in oil prices over the last decade, and even more dramatic dive since July, the perception for urgency regarding long term energy change is on a roller coaster ride of its own. As former Sec. of Energy James Schlesinger sums up "Americans have only two modes when it comes to energy - complacency and panic". Unfortunately, as financial deleveraging grabs center stage, we have shifted to full complacency mode, while simultaneously our long term energy situation is deteriorating rapidly. Changing our energy mix and more importantly, how we use it, has been relegated to the sidestage, as concerns about credit, jobs, and 401ks override. After all, crude oil is under $70 per barrel, and gasoline is cheap and plentiful. What's there to worry?

Below is an energy report from the General Accounting Office presented to Congress in 1979, (hat tip energymaven), followed by my own conclusion. After reading the GAO report (pdf warning), it becomes clear, almost painfully so, that we have missed a generation of opportunity.

I am writing this article from Atlanta, one of the places hardest hit by gasoline shortages. A person can drive for miles without finding an open gas station.

One of the major reasons for gas shortages is that fact that inventories were not very high going into the hurricanes. Then when not one, but two, hurricanes hit, inventories dropped to the level where there wasn't enough to go around. (In fact, the shortages started even before the second hurricane hit.) How could this happen? Isn't there anyone who cares about gasoline inventories?

Figure 1. US Gasoline Inventories, Based on US Energy Information Administration Data

Every year in late summer, you will start hearing references in the media about the conversion to winter gasoline, such as the following (originally in the Bradenton Herald, but the link is long dead):

Motorists can thank a mild hurricane season in the Atlantic for the lower gas prices, according to the American Automobile Association.

Other factors include the end of the summer driving season and a cheaper winter fuel mix.

Gas stations sell a special, more expensive fuel blend during the summer to cut down on smog during hot months. Stations nationwide will start selling a less-expensive winter fuel blend Friday, which could lead to even lower prices, analysts said.

So what does this mean, and why does it make winter gasoline less expensive?

NB: This is a reposting of an article written by Robert two years ago on how winter gasoline differs from summer gasoline, and why this tends to make winter gasoline less expensive than summer gasoline. We also now have a lot of reports of gasoline outages due to short supply following Hurricanes Gustav and Ike. Feel free to discuss those in this thread or scroll down to the refinery/pipeline/gas shortages thread.

Shortly after Hurricane Ike hit, I wrote an article called Implications of a Ten-Day Refinery Outage. It is a few days later, and we know a little more. The purpose of this article is to give an update on the situation.

Based on what I am seeing now, we are likely to see significant gasoline outages in the next few weeks. These may not be as long-lasting as those with Katrina, but they may temporarily be more severe, at least in some parts of the country. Diesel may or may not be a problem. We are an exporter of diesel, so can theoretically reduce exports if need be. Also distillate (used for diesel) supplies are currently at a more adequate level than are gasoline supplies. Jet fuel stocks seem to be at a relatively adequate level, so shortages may not be a problem.

Figure 1. EIA Weekly Gasoline Stocks (includes blending stocks)

As one can see from Figure 1, EIA weekly gasoline stocks are diving, on a path to 180 million barrels of gasoline or less, in the next week. Weekly gasoline supplies when Katrina hit in 2005 declined, but not nearly to the extent we are seeing today.

Where is our gasoline and diesel supply headed? Even before Ike hit, quite a few areas of the US were starting to see gasoline shortages. The impact of Ike can only make shortages worse. Most likely, it will take refineries at least a week or two to get production back to normal levels after a storm of this type, considering the impacts of electrical outages and flooding. In this article, I will examine some of the issues that seem to be involved. Based on my analysis, fuel supply shortages are likely to last well into October, and are likely to get considerably worse before they get better.

Insight 1. Even before Hurricane Ike hit, inventories were very low.

FIgure 1. EIA Graph of Gasoline Inventories

According to EIA data, gasoline inventories the week that Hurricane Gustav hit were the lowest that they had been since 2000, amounting to 187.9 million barrels, or about 21 days supply. Quite a bit of this inventory is needed just to keep the pipelines filled. EIA does not publish information as to how far inventories need to drop before we start seeing outages, but it is clear that we have now reached the point where shortages are developing.

In the last year, the price of gasoline has risen by 38%. The prices of other fuels have risen much more--diesel has risen by 64% and jet fuel has risen by 91%, and the price of West Texas Intermediate (WTI) crude oil has risen by 100%. Why aren't gasoline prices rising more than they are? Some will recognize this as the "crack spread" issue.

I see several possible explanations, including a long term shift in prices valuing diesel (or "distillate") more highly than gasoline; political pressure to keep gasoline prices low; and integrated oil companies not really needing a high gasoline pricing margin to keep overall profits at an acceptable level. I do not see ethanol as playing a significant role at this time. Regardless of the explanation, refineries and gasoline stations that are not part of oil conglomerates may find this a difficult storm to weather.

Figure 1 shows that the differential between the retail price of gasoline and the per-gallon cost of crude oil has recently dropped dramatically, leaving a much smaller margin to cover expenses and profit. It is this shift that I am discussing in this article.

Figure 1. Average gasoline price minus WTI crude price; average diesel price minus WTI crude price; and average jet fuel price minus WTI crude price. (Averages are for full years, except 2008 which is for 6 months; crude prices have been converted to a per gallon basis.)

Make sure to check out our Grangemouth/Forties poll--use this thread as the comment thread for it.

Latest:
• Grangemouth oil refinery is shutdown.
• The Forties Pipeline is shutdown
• Over 60 North Sea oil and gas fields are shutdown.
• About 700,000 bpd oil production lost costing £40 million / day @ $110 per barrel
• About 70 million cubic meters natural gas production lost per day costing £42 million / day @ 60 p / therm
• BP, Shell, Exxon-Mobil, BG Group, Conoco-Philips, Chevron-Texaco, Total, Marathon, Tallisman, Nexen, Venture, Dana and many more companies affected
• Global energy prices rise
• Rural Scottish economy hit hardest by fuel shortages
• Risk level is raised throughout the system
• Worker's grievance is unresolved
• Population calm, politicians panic, fuel rationing looms?

[update 5 by Euan, 23 April]

Latest from the BBC (Wednesday evening)

BBC Scotland understands operators Ineos and the Unite union have failed to agree a halt to an impending strike by workers at the Grangemouth plant.

It therefore looks like Ineos will have to proceed with closing the plant which they say will take 4 weeks to restart. We'll be back with a fresh thread in a couple of hours.

[update 4 by Euan, 23 April]

Latest from the BBC (Wednesday pm) with a fine video:

As the hours tick by the likelihood of widespread disruption looks increasingly likely