Why is it so expensive to fill up your car?

Here in Australia, one of the growing social and economic problems is the increase in petrol (gasoline) prices. A number of politicians and organisations are vowing to investigate what they see as "price gouging" and collusion between oil companies.

This appears to be all the more important when you compare bowser prices to the current price of oil - which according to the real time Nymex indicator, is just under US$64 per barrel as I write this. The price of the petrol/gasoline you buy to fill up your car normally follows the price of crude oil. This time, however, it is different. The price of oil has dropped from its Katrina high of $70 to what it is now, but the price of petrol continues to rise.

The problem is not confined to Australia, as anyone who peruses international news sites will discover. Petrol prices all over the world have risen, seemingly breaking its causal link to the price of crude oil. This is not about price gouging or collusion, it is something else entirely.

There are three major reasons why petrol prices have risen, and will continue to rise.

Hurricane Katrina
The first is that the damage wrought by Hurricane Katrina on oil production in the Gulf of Mexico is still being repaired. This is a short-term problem that will balance out within the next month or so. Crude oil is both produced and refined along the Gulf coast, and the Hurricane has damaged oil rigs, pipelines, storage sites and refineries. We need to remember that crude oil needs to be refined into petrol before it is shipped to your local Petrol Station/Gas Station. We also need to remember that oil which has been refined into petrol can then be re-shipped to other countries.

According to the Wikipedia article on the economic effects of Hurricane Katrina, 10% of America's petrol is produced from crude oil extracted from the gulf, while 50% of America's petrol is processed from refineries located in that same area. Moreover, many of the oil tankers that ship oil to the US deliver their product to various oil terminals located there.

With many Gulf refineries knocked out, there is a shortage of petrol/gasoline. Whenever the supply of a product fails to meet demand, its price rises to reflect that shortage. Since America can import petrol refined from overseas, this shortage is now being felt the world over. The problem at the moment is not a lack of oil, but a lack of petrol/gasoline caused by the damage to the oil infrastructure in the Gulf of Mexico from Hurricane Katrina.

Light Sweet Crude
Not all oil is the same. Oil differs from reservoir to reservoir and from country to country. The most desireable oil is called "Light Sweet Crude". "Light" means that the oil has a low viscosity (thickness) and so is easier to transport and recover. "Sweet" means that the oil has low levels of impurities like hydrogen sulfide and carbon dioxide.

Light Sweet Crude is thus the ideal oil because it is easier to refine and turn into various petroleum products. Chances are that the petrol/gasoline you pump into your car has been refined from light sweet crude.

The August 2005 Monthly Oil Market report from OPEC, however, had bad news regarding the availability of light sweet crude. While total oil production had increased over the past twelve months, the production of light sweet crude has actually declined. This means that the oil that has been shipped to various refineries has been of a lower quality.

When oil refineries are presented with lower quality oil, they are either unable to process it, or take a longer time to do so. Either way, the time that it takes to turn lower quality oil into petrol/gasoline for your car has begun to increase. This means that the supply of petrol/gasoline will decrease over the medium term.

One way for this to change is for an increased amount of light, sweet crude to be produced overall. But this is unlikely to occur. Oil reservoirs do not contain an homogenous type of oil - in many cases the reservoir produces light, sweet crude initially, but as time goes by and the reservoir begins to drain, heavier and more impure oil is extracted. Another solution would be to build more refineries - but no additional refineries have been built in the US for many years. Besides, they take time to build.

The bulk of the world's oil fields - especially those located in the Middle East - contain oil that is increasingly impure. Unless an exceptionally large new reservoir is discovered, the days of light, sweet crude are over.

Peak Oil
Oil prices have risen dramatically over the past two years. The Wikipedia article about the subject shows that oil prices have risen from US$25 per barrel in September 2003 to nearly US$71 in late August 2005.

As a result of this massive price increase, an influential theory has again been touted as a reason for this - it is the theory known as Peak Oil.

Basically the theory is that geological research has proven that oil extraction follows a "bell curve". This means that when an oil reservoir is tapped and the oil extracted, the speed of extraction increases accordingly. However, after a while, the rate of extraction reaches a peak, and then declines.

In terms of historical proof, many Peak Oil advocates (or "Peakniks" as they are known) point to the example of the US oil industry. According to ASPO (Association for the Study of Peak Oil and Gas), America's production of crude oil peaked in 1971 with around 10 million barrels per day. The CIA world factbook shows that in 2004, America produced 7.8 million barrels per day - a substantial decrease in production since 1971. Why such a decrease in production? It is because the American oil fields have passed the peak of the bell curve - they are producing less because the oil is harder and harder to extract. If oil could be extracted as simply as turning on a tap, why isn't America simply extracting their oil faster?

In terms of economics, the problem of peak oil is simple. It's not that oil has run out - it's just that oil can't be extracted fast enough to meet demand. When supply cannot match demand, the price rises. The "knock-on" effect should be world recession.

Many economists are unable to cope with the theory of peak oil. They cannot understand that oil producers cannot simply "produce more oil" on demand. The economists that have understood and accept the theory are predicting dire consequences for the world economy.

The only way for the effects of peak oil to be negated is for a large and plentiful oil supply to be discovered. This is very unlikely. Unconventional oil sources, such as oil shale or tar sands, are now likely to be taken seriously - the amount of oil that can be recovered from these sources in North and South America combined are more than double the conventional oil reserves that exist in the Middle East. The problem is that the infrastucture to produce such oil is expensive and time consuming to build, and will take at least a decade before production levels can make any major impact on world oil supplies.

As a "peaknik" myself, I was initially sceptical of the theory of Peak Oil. But after doing the research I was convinced. Please look into it for yourself - examine the logic, examine the science and you too will be convinced.

From the Osostrian School Department

© 2005 Neil McKenzie Cameron, http://one-salient-oversight.blogspot.com/




This work is licensed under a Creative Commons Attribution 2.5 License.