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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)
by John Brian Shannon | April 9, 2016
The Energy East pipeline only makes sense if global oil prices rise past $80 per barrel and there’s no guarantee we’ll see anything like that before 2020.
Meanwhile, Iran is set to add 3.5 million barrels per day by 2020 to the global oil markets which will easily meet (practically) flat demand, keeping oil prices below $80/bbl.
Not only that, Iranian crude oil is either #2 (sweet) or #3 (sweet) while Alberta’s oil ranges from #4 (sour) to off-the-scale sour. Alberta’s crude is so sour that it must be blended with #3 (sweet) or better before refineries will accept it.
Why would any refinery want to buy Canadian sour crude when they can buy Saudi #3 (sweet) or Iran #3 (sweet) for the same, or lower price? Alberta’s crude sits at an average of #4.75 (sour) with two other negatives attached — much higher extraction costs (the average Alberta extraction cost is $56.20 per barrel) along with higher refining costs.
What would capture the interest of voters, would be the Alberta government guaranteeing the financing of oil refineries located within and sized to accommodate the needs of each Canadian province.
Each province could have it’s own refining capacity sufficient to meet 100% of annual provincial demand — plus 30% (for export) to bordering U.S. states.
Existing rail links can already get the crude oil to existing refineries and to the future refineries proposed in this blog post. For those worried about oil spills when shipping by rail, they are usually limited to a few rail tanker cars and are microscopic when compared to pipeline spills.
Instead of being ‘hewers of wood and drawers of water’ how about some value-added contributions to our economy by building our Canadian refining capacity, and doing some much needed value-adding to our petroleum exports?
It’s the next logical step for the Alberta government.
Bonus Graphic courtesy of MACLEAN’S