Energy: Why we’re all on crack
prices are moving upwards again. As with many other stories, it
is improbable that the MSM will report on this in any satisfactory
way. Their energy reporting is largely confined to sound bites:
oil company profits, people complaining about how expensive it
is to fill up their SUV, dire scaremongering that we are running
out of fossil fuels and, lately, global warming proselytizing.
And don’t forget to catch Al Gore at the Oscars!
time for some Citizen Journalism. First things first, let’s
observe historical trends in energy. Energy prices are set by
MARKETS, which are composed of fallible, impressionable and emotional
human beings. So in the short term, markets can be distorted by
human traits such as the proverbial greed and fear factors. But
humans are also intelligent and analytic. Over the longer term,
this will push the markets back to rationality and a more accurate
reflection of the balance between supply and demand.
The MSM does
not care about supply and demand, preferring conspiracy theories
and portrayals of dark forces (preferably Republican) victimizing
the average citizen. Fortunately, it only concentrates on a few
industries. If it covered more territory, we would have a hard
time tracking all the nefarious plots. There would be the Christmas
Card Conspiracy, whereby boxes of cards selling for $10 on Dec
1 are dumped on the market at $2 by Jan 1. There would be the
Corn Conspiracy, where price gouging forces the price from 8 ears
for $1.50 in July to one ear for $2 in February. My favorite would
be the SuperBowl Coke Conspiracy, where those large thirstbuster
bottles get marked up 30% in the days leading up to the great
Now most people
would view such conspiracies as ridiculous. Common sense tells
us that prices respond to demand, and demand is both cyclical
and seasonal. During upticks in cyclical demand, prices rise.
During downticks, they fall. Seasonal factors affect prices in
is like any other commodity. Wall Streeters make fortunes in constructing
black boxes to analyze its price movements. Occasionally they
even make money for their clients! But we don’t need those
boxes to understand the basics. Simple charts will do. Chart 1
shows crude prices for the 2000-2006 period. The price is rising
during the waning months of the 1990’s boom, then drops
sharply during the post dot-com bust and recession. Prices rise
again as recovery commences, further strengthened by the speculative
runup to the Iraq war. After a brief post-war decline, a sustained
price increase occurs during the strong economic recovery of 2004-2006.
But this should not be a surprise. America’s consumers were
using more energy than ever for their increasingly large cars,
homes and the PC-Entertainment Complex: that new array of computers,
big screen TV’s, DVD players and other gadgets that have
become so prominent a feature in daily life. Industrial demand
by America and the rest of the West rose as well.. The booming
economies of Asia, especially India and China, were entering a
period of unprecedented growth in both their industrial and consumer
sectors. You would think that the MSM might connect the dots linking
the outsourcing phenomenon, the Asian surge and oil prices, but
you would be disappointed. It is apparently a mystery to them,
but there is no mystery.
The same applies
to the even more dramatic price increases of gasoline and heating
oil. The markets have established structures to price those products
in response to supply and demand. The key statistic here is the
crack spread: the price difference between these products and
the crude oil from which they are refined. This spread reflects
the extra cost of refining, the overhead of storage and distribution,
general demand and the supply of the refinery capacity available
to produce the product. The crack spread sits on top of the crude
price. When you add the two together, one gets close to actual
There is a
great deal of seasonality in demand for refined products. As illustrated
in Chart 2, gasoline tends to spike in advance of the peak summer
driving season. Heating oil tends to peak in anticipation of the
winter weather cycle. Jet fuel follows the fortunes of the airline
industry, which was depressed during the first three years covered
by the chart and recovering during the last three. Speculative
activity can intensify the effect of these objective demand patterns.
Just ask any futures trader who has to worry about how weather
projections affect his heating oil position.
The last three
years of the chart are characterized by increasing volatility
with crack prices trending upward. This simply reflects the demand
and supply patterns in the market. Just as demand for crude has
pushed price levels of the base commodity upwards, demand for
the refined products has a similar effect on their prices. Oil
producers (think OPEC) and the integrated oil companies benefit
from the first; integrated oil companies and other refiners benefit
from the second.
are especially important for crack spreads, because refinery capacity
is basically a constant. If demand for oil rises, producers have
the option of producing more crude. But if demand for refined
products rises, there is no virtually no option to build more
refineries: environmentalists and neighborhood opposition make
the permit process very difficult. Prices move upward rapidly
at the slightest suggestion of shortages.
provide the final piece to the puzzle. Refinery capacity is concentrated
in coastal areas of the US, most of which are vulnerable to hurricanes.
The Florida hurricane epidemic in 2004 was the precursor to the
“perfect storms” of 2005, when Hurricanes Katrina
and Rita knocked out refineries and related infrastructure, including
port facilities. Increasing demand and falling supply produced
record prices for the refined products. The sudden and dramatic
impact on jet fuel prices was the last straw that pushed a number
of major airlines into bankruptcy.
The rise in
energy prices is very explainable - increased worldwide demand
for crude, rising demand for refined products and limited capacity
to make those refined products. Speculative activity can enhance
the price pressures, but supply and demand is the driving force.
The price tag for energy is painful, but that’s what happens
when we live on crack.
is a staff writer
Petroleumworld does not necessarily share these views.
note: This commentary was originally published by
11, 2007. Petroleumworld reprint this article in the interest
of our readers.
Fair use Notice:This site contains copyrighted material the use
of which has not always been specifically authorized by the copyright
owner. We are making such material available in our efforts to
advance understanding of issues of environmental and humanitarian
significance. We believe this constitutes a 'fair use' of any
such copyrighted material as provided for in section 107 of the
US Copyright Law. In accordance with Title 17 U.S.C. Section 107.
For more information go to: http://www.law.cornell.edu/uscode/17/107.shtml.
works published by Petroleumworld are in accordance with Title
17 U.S.C. Section 107, this material is distributed without profit
to those who have expressed a prior interest in receiving the
included information for research and educational purposes. Petroleumworld
has no affiliation whatsoever with the originator of this article
nor is Petroleumworld endorsed or sponsored by the originator.
Petroleumworld encourages persons to reproduce, reprint, or broadcast
Petroleumworld articles provided that any such reproduction identify
the original source, http://www.petroleumworld.com or else and
it is done within the fair use as provided for in section 107
of the US Copyright Law. If you wish to use copyrighted material
from this site for purposes of your own that go beyond 'fair use',
you must obtain permission from the copyright owner.
web links to http://www.petroleumworld.com are appreciated.
All rights reserved.
this story to a friend
feedback is important to us!
We invite all our readers to share with us
their views and comments about this article.
question or suggestions, please write to:
Viewed with IE 5.01+
Windows NT 4.0, '95, '98 and ME +/ 800x600 pixels