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by John Brian Shannon | May 8, 2016
For decades, easy access to crude oil powered the global economy and this is especially true in developed nations where the huge investment pool allowed governments and industry to capitalize on cheap energy costs. Cheap and easily available crude oil was a very necessary building block for the Western economies.
But the world is changing and although we aren’t yet at the end of the ‘Age of Oil’ we’re starting to see that day from afar.
We’ve come from $2 per barrel of crude oil (less than the cost of production at the time) to $125 per barrel and every price in between. On the supply side, we’ve seen the world’s largest oil consumer (the U.S.) increase domestic production from 10% of its demand to meet almost 100% of its demand — an unprecedented change in the global oil industry.
Due to that farsighted U.S. policy, the world became mired in its own crude oil glut and correspondingly, crude oil prices fell in recent months, only now rebounding after visiting the $26 per barrel netherworld. As of this writing, crude oil is hovering around the mid-$40 range and looks set to end 2016 in the low $50’s assuming the geopolitical paradigm remains stable.
How to Change the Oil Industry into a ‘Win-Win’ Proposition
Like many industries, the oil industry has evolved over decades of time and from humble beginnings. Had it been planned the oil industry wouldn’t have its present structure and there wouldn’t have been a need for a ‘crude oil price’ — as refining crude oil into finished products would’ve been the norm.
Evolution of the World’s Largest Oil Producer
For decades the Saudis pumped and sold oil to the Allied Powers for less than the cost of production as their contribution to the massive Western effort against Nazi Germany and later against the West’s Cold War competitor, the Soviet bloc nations.
Until the Arab Oil Embargo in 1974, the only money the Saudis made from oil was where they competed against every other oil speculator in the commodity market. They certainly didn’t make anything on the extraction of the black stuff.
The Speculators in a Supply/Demand World
From the time each supertanker left port in Saudi Arabia until the moment they tied up at an oil refinery in the United States, speculators made huge sums or lost huge sums of money playing the crude oil supply/demand equation as each supertanker made its way from a Saudi port to an American port.
After some initial horrendous errors, the Saudis learned how to play the markets as well as New York’s best oil speculators, and in that way many individual investors and Saudi Aramco (the largest oil company in the world by a significant margin) saw some amount of wealth created from their resource.
Prior to the Arab Oil Embargo the Saudis didn’t make anything on the extraction side, but made it on the margins (speculating) by making educated guesses about the daily oil supply/demand equation of the United States. That’s no way to run a railway!
The Rise of OPEC
By 1974 the Saudis and the other OPEC nations had had enough and via the Arab Oil Embargo were able to get a reasonable price for their crude oil and not be forced to rely on notoriously unreliable oil price speculation to finance 80% of their economy.
Since 1974, the Saudis (along with every other oil producer, including the United States) have been making money on (1) the extraction side, and (2) on speculation, and (3) on the refining side of the oil business.
Too many middlemen! You can plainly see that where there are three steps with each having its own profit, there should’ve only been one.
Had the oil business been planned-out from the beginning, we would’ve seen Vertical Integration — where one oil company owns its own oilfields and extracts its own oil, refines their own oil into useful products, and only then offers those value-added fuel products as commodities in the world marketplace.
What we have now is a paradigm where gross total demand sets the wellhead price on crude oil (which has a profit attached to it) and the speculating of oil-in-transit (which is where big profit gets attached) and then more profit is attached by an oil refinery — which are usually owned by a third party. No wonder they call it black gold!
In a suddenly very competitive oil world, how to cut ‘fat’ and add profit?
By creating vertically integrated oil companies where only one company extracts the crude oil, transports it to a refinery, refines it into useful products, and then sells those products as commodities, we cut out the middlemen while raising profits for oil companies and lowering costs for consumers. Perhaps by a significant margin.
How to ‘Win-Win’ in the 21st-century oil industry: Don’t ever sell crude oil!
Sell finished petroleum products exclusively
Saudi Aramco is transferring to a Vertically Integrated business model — buying-out it’s partner Royal Dutch Shell in a multi-billion dollar deal at it’s massive Port Arthur, Texas oil refinery (the largest in the U.S.) which can process 600,000 barrels per day.
Saudi Arabia is already the largest single oil producer in the world (presently pumping just under 11 million bpd, but with the ability to pump 12.5 million bpd) and have been in the crude oil business longer than any other country, and own more supertankers than any other organization, business, or country, and are now purchasing oil refineries to complete the vertical integration of their business model.
This will allow the Saudis to lower their concern about wellhead price, and the speculation factor, and concentrate on supporting their best player — which is the refining stage. That is where the entire oil industry is going, some faster than others.
By concentrating on end products, Aramco and others will create new thrust towards the Vertically Integrated business model where resource extraction and transport are geared towards supporting their star player, their own oil refineries — wherever they may be located in the world. Profit at each step of the way will no longer be necessary nor desirable, cutting costs throughout their supply chain and adding profit to their value chain.
In a perfect world the Vertically Integrated business model will sweep past the existing ‘multiple middleman’ business model over the next decade and leave it in the dustbin of history.
- Saudis to take control of largest U.S. refinery (CNN Money)
- Saudi Refining, Inc. and Shell sign letter of intent to separate Motiva assets (Motiva Enterprises press release)
Average annual OPEC crude oil price from 1960 to 2016 (in U.S. dollars per barrel)
How to make lower oil prices work for the environment | 01/12/14
by John Brian Shannon
As oil prices continue their dramatic slide, the U.S. and Europe could use a bit of progressive energy policy to put some political pressure on North Korea, Iran and Russia, while adding some momentum to the adoption of renewable energy.
All that the U.S., Canada and Europe needs to do to punish North Korea, Iran and Russia over recent political disagreements would be to ratify a unified carbon tax of (for example) $20.00 per tonne of CO2 emitted — which rate is about half of the externality cost of CO2 emissions.
A carbon tax would cost the worst polluters like coal (heavily) medium polluters like oil (somewhat) and natural gas the lowest fossil polluter (much less)
Especially over the long term this kind of taxation would depress oil demand and make other energy somewhat more attractive by comparison, thereby lowering coal and oil production and profits for Iran and Russia.
I’m certainly not proposing a level of subsidies equal to that enjoyed by the fossil fuel industry which will top $600 billion dollars globally for 2014
I’m merely proposing that the (tiny, $20/tonne) carbon tax revenue be used to fund renewable energy projects where they make economic sense, for (reactive) carbon damage mitigation and proactive energy efficiency programs.
In the grand scheme of things, the additional cost of approximately $1.00 per barrel to the price of oil via a ($20 per tonne of CO2) carbon tax is inconsequential when the per barrel price has fallen by $40.00 per barrel in the past 12 months.
The cost of a $20 per tonne of CO2 carbon tax at the gas pump?
The price of fuel at the pumps would increase by approximately $.03 per US gallon. The accumulated carbon tax revenue stream could be used to fund ongoing zero-carbon energy solutions and energy efficiency programs.
By slightly increasing the cost of fossil fuels via carbon taxation as the per barrel cost of oil continues to fall, natural gas with it’s lower carbon footprint would surge, renewable energy adoption would increase, and the West would show real progress and concomitantly lead the world towards a cleaner environment.
By initiating a small $20.00/tonne carbon tax we would reap the following benefits:
- Lower oil revenues for Iran and Russia/increased energy costs for North Korea.
- Relative to oil and coal, an increased demand for (the infinitely cleaner) natural gas.
- Gives both non-polluting renewable energy and energy efficiency a mild subsidy boost.
- Cleaner air and year-on-year lowered health care costs.
- Lowered acid rain damage to concrete infrastructure — ‘concrete spalling’ and a lower level of agricultural crops damage.
- Preserve rising domestic electric vehicle and hybrid/electric vehicle sales and the related jobs.
- Adds plenty of energy jobs to the economy via ongoing year-on-year (carbon tax funded) renewable energy manufacturing and installations.
And I get that Russia and Iran would eventually ramp-up their natural gas production to counter the lower oil price. But it would be very inconvenient for their economy over the next 24 months.
We all breathe the same air, and reducing our high-carbon-fuel use benefits us all (natural gas, instead of oil — renewables, instead of coal) no matter where it is being burned on the planet.
When we use energy policy as a judicious diplomatic lever, that too, can be a benefit.
- The Geopolitical Impact of Cheap Oil (Project Syndicate)