The Crude Game


The greatest game in town today is the Crude Oil Game.  If you want excitement, look at what is happening with the price.

The world runs on oil.  If environmentalists tell you otherwise they are misinformed or delusional.  The price of oil determines the price of gas.  It also determines the price at which bio-ethanol becomes a viable fuel source.  So when the price of oil rises to a certain break-even point it affects the prices of bio-ethanol inputs, like Wheat, Soy and Maize.

Energy, Food and Water are the three most important components of human life.  In the modern world you need energy to produce food and water.  Oil to drive pumps to move and purify water, to irrigate crops.  Oil to power tractors and combine harvesters and spray systems.  Oil to power sewage treatment plants to prevent us all dying from cholera.  Food and Water depend heavily on Oil.

Yes, eventually we will be able to replace crude oil with sustainable energy sources, but only when those sustainable energy sources are cheaper than oil.

At present in Saudi Arabia it just takes someone to open a few taps, and the oil flows out of the ground, cheap and fast.  And that is what the Saudis are doing today.  But why?

The Saudis were instrumental in setting up OPEC in the 1960’s to wrest control of oil pricing away from the “Seven Sisters” oil conglomerates.  In the 1970’s OPEC flexed its muscles, cutting flow and strangling the west.  In response the price of oil skyrocketed.  Since then the price of oil has been artificially managed from Saudi Arabia through OPEC.

Not all OPEC members can simply open the taps.  Some nations need a higher oil price to make their marginal fields profitable.  They also need high oil export prices to balance their domestic budgets.  But over the years these higher oil prices have opened up the doors for non OPEC players.

There are now oil companies that specialize in re-opening wells that were considered to have run dry.  In fact the issue was that the flow rates were too marginal to turn a profit at low prices.  With high prices, and improved efficiency through better recovery technology, these wells are now profitable.

Oil reservoirs in more difficult to reach locations become more interesting to the market as the price rises.  We see more development of off-shore drilling, shale oil and tar sands.  There are vast reservoirs of oil in shale and tar sands, especially in North America and Canada.  In recent years production from these sources has increased dramatically.

Heavy oils have a different dynamic to light and sweet oils.  Texas and Saudi type light and sweet crude is low density and low sulphur.  It is under good pressure and has high flow rates.  You drill it, you cap it and you make money.  It is hard to find, but is literally a goldmine when you do find it.

Heavy shale oils have a dynamic more like coal mining.  Easy enough to find the stuff.  The difficulty is in turning a profit from production.  You need massive volumes and fantastic production efficiency to generate profit.

The USA has become Oil self-sufficient in recent years, by ramping up heavy oil production.  Now the Saudis have had enough.  They want to close down these “alternative” sources, and regain price control from the Americans.  So they have opened their taps and allowed a glut of oil.  Prices have fallen.

And now we are seeing a classic Texas Hold’em poker game.  On one side the Saudis.  They have a great hand and they can outplay the table.  They want to shake out the table and get rid of some of the producers.  Beside the Saudis are their erstwhile friends in OPEC, the marginal producers.  They are sweating, their cards are not so good.  Across the table are the heavy oil producers, like Continental, Husky, PetroCan.  If they can hold out just a little longer than the OPEC marginal producers they can keep their production facilities going.

Meanwhile, the lower oil prices are having positive benefits for energy hungry companies.  Airlines are having a field day.  Transport company profits are up.  Energy intensive industries are making supernormal profits on concrete, glass, aluminium, steel etc.  Anything that needs lots of heat, such as milk drying plants.

Sadly the consumers will see little of the benefit of the lower oil prices.  Businesses cannot plan long term production prices on the basis of what might be a short term oil price war.  Until we see stability don’t expect to see a large fall in the price of your heating oil and if you think electricity prices will fall, dream on.