OIL 101: A primer on rising gas prices

Published: Friday, February 25, 2011 at 9:00 a.m.
Last Modified: Friday, February 25, 2011 at 8:10 a.m.

Oil briefly topped $100 on Wednesday, a reflection of the turmoil in the North African oil producing nation of Libya, where some of the country's 1.6 million barrels per day of output has been cut back and may soon be turned off completely.

Prices ended the day at $98.10 in trading on the New York Mercantile Exchange, up $2.68. With unrest growing in other oil-rich nations, many analysts are predicting a significant and sustained price spike in the coming weeks.

It was the first time U.S. crude breached the $100 mark since Oct. 2, 2008, so we turned to some industry experts to help explain some of the basics of why prices overseas and in the U.S. are going up.

Q: If Libyan oil goes mainly to Europe why are U.S. oil prices rising?

A: The U.S. is dependent on oil imports from overseas, including the Middle East and North Africa. If Libyan oil production is shut off, then European customers normally supplied by that source will seek crude elsewhere, putting them in competition with the U.S. buyers, said Jeff Dietert, co-head of research for Houston-based Simmons & Co.

The price of oil is always set by the “marginal barrel,” the last barrel necessary to meet demand, said Craig Pirrong, a commodities professor at the University of Houston. Because the U.S. is a net importer of oil, the marginal U.S. barrel is an imported barrel that could as easily go to a European or Asian buyer if the price differences justify it.

“So as far as oil is concerned, no continent is an island,” Pirrong said.

Q: The benchmark U.S. oil price refers to crude at the Cushing, Okla., storage and pipeline hub, and that hub is practically swimming in oil. So why is that price going up?

A: Prices at Cushing have been lagging behind overseas prices by record amounts, said Dietert. Because U.S. Gulf Coast refiners who rely on oil from overseas are seeing their costs go up, they are looking to get oil from the U.S. Midwest, namely Cushing.

There aren't many ways for oil to get from Cushing to the Gulf Coast - most pipelines flow the other way - so Gulf Coast customers are using rail cars and barges to get Cushing crude, even with the added transportation costs. That increased demand is helping to drive up Cushing prices.

Q: U.S. gasoline demand is low and we have plenty of oil and gasoline in storage, so why are our prices going up?

A: The price of oil is the single largest component of gasoline prices, about 70 percent, so where oil goes, so does gasoline. But consumers are justified in a little pique about how quickly gasoline prices have reacted to the oil prices, said Amy Myers Jaffe, a fellow at Rice University's Baker Institute. One rule of thumb says it usually takes a few weeks for an oil price increase to work its way through the refining system to the gas pump, Jaffe says

“But maybe they're a little fast on the trigger on the way up and a little slow on the trigger on the way down,” Jaffe said.

Q: Why didn't we see prices spike like this during the 2010 Gulf of Mexico oil spill and drilling moratorium?

A: The spill and resulting slowdown in Gulf production affected production of oil that wouldn't have been on the market for many, many months, so it did not affect short-term prices.

Q: We've seen regular oil supply disruptions in the past in Nigeria, a major U.S. supplier, with relatively small price jumps. Why is this so different?

A: “I think traders are looking at this possibility of dominoes,” said San Diego State University finance professor and economist Dan Seiver. “Just as it started with Tunisia, a small country that nobody ever thought about, and all of the sudden it spread to Egypt . . . and even Libya. Nobody's really sure how far this will go.”

Q: Is this all caused by speculators looking to drive prices higher and rake in big profits?

A: While there are many companies buying and selling oil futures, most of the players today are there trying to manage the risks their businesses face due to changing oil prices - including airlines trying to hedge jet fuel costs.

Leo Drollas, an analyst with the Centre for Global Energy Studies, said in a presentation Wednesday that it appears fewer pure speculators - traders buying and selling oil futures just for the profit on those transactions - are in oil markets today than in 2008.

“In 2007 and 2008 you had so many financial institutions betting on oil, touting it as a safe investment to their clients,” Jaffe said. “Today there's not as much of that money in the oil market, so it makes it harder to create a bigger bubble.”

Q: Are we heading for a repeat of 2008 record oil prices of $150 or more?

A: It depends on whom you ask.

Global demand for oil is stronger now than it was going into 2008 since the global economy is on the mend, putting greater upward pressure on prices, says Dietert.

And the current crisis is more like the massive supply disruptions of the 1970s, including the 1979 Iranian revolution, so it could have a more profound and lasting impact.

But analysts with Societe Generale note that there's more spare production capacity today than there was in 2008. Members of the Organization of the Petroleum Exporting Countries have about 5 million barrels per day of excess production capacity now, versus less than 2 million in 2008. Crude oil supplies in the U.S., Europe and Japan are also higher now than they were in 2008 and there's more spare refinery capacity.

Jaffe notes the Saudis are much more inclined to bring that extra production online today than they were in 2008.

Tom Kloza, an analyst with the Oil Price Information Service, says he's sticking to his $3.50 to $3.75 per gallon U.S. gasoline prediction. A gallon of regular averaged $3.19 nationwide on Wednesday, and $3.02 in Houston. $3 in San Antonio.

“My gut tells me the world can deal with loss of lots of Libyan oil,” he said. “But the real worry is Saudi Arabia. If we wake up and see violence there, I redact all previous predictions.”

Brett Clanton contributed to this report.

tom.fowler(at)chron.com XXX - End of Story3D>


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