Posted by: Rob | June 9, 2008

The High Price of Fuel – or Why We are Getting Screwed

Before I begin this little diatribe, let me just say that I don’t subscribe to the ideas and philosophy behind urban and community design in North America today. It seems that much of the way land is/was zoned following World War II is/was intended to ensure that citizens had to resort to automobile use to do pretty much anything they had to do. From getting to school, to sports activities, to your job, to the grocery store; it all requires a car. Residents are congregated in creepy little “sub-divisions” that can be, at times, akin to rat mazes where you can’t even find your way out without a map. I really can’t believe this is the best that our “brain trusts” could come up with.

So, unless you’ve been living in a cave recently, you’ve no doubt noticed that pump prices for gasoline and diesel are hitting new peaks, almost daily. Well, you say, it’s probably because of the shortage of crude oil against surging demand and the bidding up of the price of crude isn’t it? Not really.

How can you say that? How would you know? I don’t, necessarily. But here is what I suspect. Firstly, I’m not going to go into any discussion of crude oil pricing. That mess is far too convoluted and complicated to address in a short blog.

To understand motor fuel pricing, one must first know a few basics. It’s commonly thought that pump prices go up when crude prices go up (and then there is the attendant bitching when crude prices go down, but pump prices don’t). That’s not quite correct. True, crude oil is the primary (essentially sole) input to the refining process that results in gasoline and diesel. And its cost is a part of the overall cost to manufacture gas and diesel. However, not all refiners have to buy crude oil. What’s that, you say? You heard correctly. Not all refiners have to buy crude oil.

Ever wonder about the reported record profits reported by big oil companies recently? How can that be, you ask? Are they having to deal with the high cost of crude and pass it along? Not all of them. Why? Because of something called backward integration. What does that mean? Backward integration means that the fuels marketer is also the refiner and is also the owner of crude oil producing properties, gathering systems and pipelines.

Oil companies can flat out own the mineral rights as well as the surface rights in the U.S. In Canada, the government (i.e. the “crown”) owns all* of the mineral rights and sells leases to the oil companies who then have the right to exploit the oil and/or natural gas subsurface to the leases. Under the Canadian system, the leaseholder pays a portion of the resource revenue to the government holding jurisdiction in the form of royalties. So why is backward integration important? Well, because once the initial costs for exploration, development, drilling and installation of infrastructure have been recovered, there remains very little cost associated with continuing to exploit the crude oil. I haven’t heard up to date figures, but I would expect that many oil wells are being exploited for as little as $5 to $10 a barrel.

If they can get the crude so cheap, then why does big oil gouge us at the pump?!? Because they can. Niceties like “globalization” and the “commodities market” have broken down the barriers and provide the justification for the illusion that this what is being paid for crude oil. The rationale is that some refiner/marketers have to buy crude on the open market in order to run their business. And so, the companies that don’t have to buy crude or don’t have to buy all of their crude use this “market” price to value crude oil internally. In this way, the “playing field” is then “level” at the retail end of the oil business. So, to summarize, big oil exploits its own crude, perhaps for as little as $5 to $10 per barrel and then “resells” to its downstream refining and marketing division for a huge gain. And voilà: record profits. As long as you are importing foreign crude, this will continue.

Pump prices. As I stated above, while crude oil is an input (both physically and financially) to the refining process, there is no correlation between crude oil price and pump price. I repeat: there is no correlation between crude oil price and pump price. Pump price is a reflection of what the market will bear. Yes, what the market will bear.

Well, you say, then why are pump prices relatively uniform across either the U.S. or Canada? Regional variations are due to the nature of distribution and the distance from refineries. But the main “rack” price (or wholesale price) is set – at least in North America – in the U.S. commodity market.

So you have rack or wholesale price and the marketer has to add onto the rack price all the little bits to cover the cost of transporting the fuel to the filling station and the cost to run the filling station. Oh yeah, and something for profit for the shareholders. (I have deliberately left off municipal, state, provincial and federal taxes here.)

That profit bit. That’s where the whole “market will bear” thing comes in. Profit is king, baby, and that pump price will keep pushing upward until…well, until people quit buying the stuff. So, as long as the buyers and users of motor fuel keep ponying up at the pump, they will continue to “fuel” (ha ha, pun intended) the profits of big oil.

Granted, this is a pretty simplistic explanation and there are many more complexities** in the industry that all wind up as a piece of that pump price. But I will throw in one more tidbit about gasoline and diesel. As crude oil is refined, the different “fractions” that come off a barrel of crude go into essentially one of two pools: the gasoline pool and the diesel fuel pool.***

In North America, the size of these “pools” varies based on time of year. Why? Because in cold climates, winter time diesel fuel has to be “lighter” otherwise it turns into jelly. This means that during winter, more of each barrel of crude goes into the gasoline pool. Refiners have the added bonus of being able to add n-butane to gasoline in the winter as well (otherwise, in cold climates, the fuel would not vaporize and your engine might not start – especially true of carburetted engines. Oh yeah, ever notice that your fuel mileage sucks in the winter? It’s the n-butane…).

With more of the crude barrel going into gasoline, then less is going into the diesel pool. Normally, with a larger gasoline pool and a smaller diesel fuel pool, gas prices should tend downward while diesel prices should tend upward.

The reverse is true for the summer. The gasoline pool shrinks and the diesel pool gets bigger. Plus, more people do the majority of their driving in the summer time. The result? Gasoline prices go up and – normally – diesel prices would come down.****

So, you ask, what are we to do? Well, the oft promoted idea for a rally to stop buying fuel from one specific retailer until their inventory forces a price reduction will never work. The integration of the industry makes it almost immaterial what company one buys fuel from. Remember folks, we’re talking commodities here.

The only way to effect any change on the current situation is to reduce your use of the stuff. And not for awhile. Permanently. If you live in an urban environment, park your car or truck and ride the mass transit. If you’re aching for athletic exercise, get yourself a good bicycle. Or walk. Or use a longboard. Use anything but fossil fuels. And it won’t help if just a few people do this. Almost everyone has to participate.

Wouldn’t it be a wake up call for these monolithic corporations if ordinary people starting acting in concert in a manner that made a significant, noticeable and lasting impact on their business model? Stop being a sheep and acting like the corporations want you to act. Take a stand. It’s up to every one of you.

* One exception to this is the Canadian Pacific Railroad (CPR). The Canadian federal government made large land grants to the CPR as incentive to build a trans-continental railroad in the late 1800’s across miles of nothing to connect British Columbia to the rest of confederated Canada. These land grants included both surface and sub-surface (i.e. mineral) rights. CPR subsequently spun off an oil and gas company called Pan-Canadian Petroleum. Pan-Canadian could pretty much make money in any market since they did not have to buy leases or pay royalties when exploiting reserves of crude oil and natural gas. Pan-Canadian Petroleum would eventually wind up as part of EnCana Corporation.

** Complexities would be things like emission reductions the refiners have to do as regulated by government (this involves adding process equipment to the plant), reformulation of gasolines, sulfur reductions in both gasoline and diesel fuels. There are many more, but this probably already sounds like greek to the uninitiated.

*** There are other “pools” as well into which things like jet fuel, kerosine and home heating oil go, plus the bottom of the barrel which winds up in “bunker” fuels, but in this discussion I’ll simplify to gasoline and road diesel.

**** I realize that this is not currently the case in the U.S. Diesel prices are higher than gasoline prices and have remained so. This fact is evidence that our motor fuel situation is…troubling.

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Responses

  1. […] is responsible for the high cost of fuel anyway? Big Oil? Governments? Gas Guzzling […]

  2. Seriously. We do need to stop it once and for all. But you know how hard it would be to quit oil. Look at oilheat users, they live in areas where nothing else is available. They could probably use this B5 oil I learned about while working for NORA. It blends oil with biodiesel, therefore producing NO greenhouse gases, reducing emissions, and it helps conserve 400 MILLION gallons of oil. Conservation is key. Check out this site: http://oilheatamerica.com/index.mv?screen=bioheat

  3. I posted a theory (probably not news to you) on the Charles County Cafe (http://www.charlescountycafe.com/?p=3931) that if OPEC gets greedy they are going to shoot themselves in the foot because America will get fed up and actually get off our sedentary asses and do something about our energy dependence problems. It may not be OPEC necessarily but the oil industry in general that pushes the envelope a bit too far.

  4. I’m already leaving the car at home and catching the train to work. though train prices are ridiculously high in sydney 😦

  5. @ Betty: Welcome to the Tome! I checked out your link. I think bio-fuels from waste is fine (like waste cooking oils), but I have trouble with actively growing a crop just for fuel. I haven’t crunched the numbers, but engineering intuition tells me the return is not worth the input.

    @ Richard: Welcome to the Tome! I visited your link: interesting discussion. Much of it is a little beyond my ken. I do thank you for the link back, though. At one time I worked in oil refining (chemical engineer) and that forms the basis of my post. I get so sick of the erroneous information propagated by the mainstream media (disinformation, I suppose) that leads people to believe the wrong thing about crude and motor fuel and all the rest. People probably have the grounds to bitch, but they are bitching about the wrong things. Besides, if they really felt strongly about the issue, they would DO something. Until the collective actually does get off their asses and DO something, it’s all going to continue to be just talk.

    @nursemyra: Actually using the mass transit is a big step forward (one I haven’t done myself because I’ve chosen to live in the country and it just doesn’t exist). Does the high cost of the train still represent a better economic choice than driving your own car? If not, then some adjustment needs to be made – write your government rep.


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