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Tuesday, June 24, 2008

Big Bad Oil

Much has been said about Big Oil recently, and much of it has been quite unflattering to the industry as a whole. Screams for lower prices on oil have been constant from everyone, and the politicians have put the companies in their crosshairs. This is all extremely unfortunate. While higher gas prices have been painful for everyone (I personally found it necessary to change jobs and purchase a different car over the higher price of gasoline), the situation should be viewed as an entire issue, not as an individual issue that leads to a desire to restart the Salem witch trials.

Cost of oil

One of the components to the overall cost of gasoline is the direct cost of the barrel of crude oil. Viewing the chart below (and concentrating mainly on the red line, we’ll get to the blue line shortly), you can see what has been obviously apparent to everyone over the past few years: gasoline has skyrocketed; up 100% in the last year, which is why this is the first point. Changes in supply and demand shifts the price of oil. When OPEC increases the supply (and the world’s demand stays constant), the cost of the oil decreases. When the world demands more oil (and OPEC’s supply remains constant) the cost of oil will increase. When both the supply and the demand changes, the price will shift depending on which one changes the most (a slight increase in supply and strong increase in demand will shift the cost up, while a strong increase in supply and slight increase in demand will shift the cost down). For illustrated versions of some of these events, look at the series of charts labeled “Supply and Demand” below. At this point, I need to point out that “Big Oil” isn’t a part of this conversation; most of this is controlled by the OPEC nations. Also note that we’ve just discussed at least a $60 change in cost per barrel.

Change in Currency

Another issue that has had an adverse affect on the price of oil is the change in the value of the dollar. While there certainly are positives to a falling dollar (locally manufactured products and services become inexpensive compared to internationally manufactured products, US Service and Manufacturing becomes less expensive in foreign nations, raw materials such as US Steel becomes less expensive and increases our exports), there are also disadvantages (foreign products become more expensive, travel to foreign countries becomes more expensive, inflation). With the value of the dollar falling, it drives the price of oil up more. You may not realize it in our day-to-day lives (unless you happen to sell BMWs or other foreign vehicles or be in the market to purchase such items – yes, even your Toyotas), but foreign products are getting more expensive due to the decreasing dollar. Looking at the chart above (where the blue currency comparison line follows an eerily similar increase to the red oil costs line) you can see how a single Euro has gotten more expensive in the past year (albeit not at the 100% rate of oil, but this is just another part of the story).

Who Profits

Much has been said about Big Oil and their rising profits from the increased price of oil. While this is true, there have been several parties missing from this argument. I will not disagree, Big Oil obviously has profited from the increase, but my point is this is not the whole story.

To get a better view of the oil profits, we need to start where the oil comes from. Oil Sheiks (specifically the OPEC nations) have experienced a great inflow of cash because of the shift in prices. Follow the numbers, and try not to skip ahead. The OPEC Nations in 2007 produced an average of 30,743,000 barrels of oil a day. Now, last year the prices of oil were lower than they are this year. However, since I intend to use this year’s oil numbers, I’m going to factor in a decrease of oil production (which would shift the supply/demand curve, but this is illustrative – oil production has also gone up this year with additional promises to raise production, if necessary, being given). Assuming a 10% decrease in production (which would be devastating to the world’s economy) we will start with 27,669,000 barrels a day. Multiply that by 366 (leap year) and then by $120/barrel (you’re getting a deal), and that comes to 1.215 trillion dollars being sent to the OPEC nations this year. Makes the 389.30 billion in revenue (and 71.879 million in profit) seem a little smaller, doesn’t it?

Aside from Big Oil and the Oil Sheiks, let’s not forget about YOU! If you invest in Mutual Funds, Index Funds, and stocks, you probably profited from the increase in oil prices as well! Top Mutual Fund holders include the Vanguard 500 Index Fund, the Fidelity Contrafund, Income Fund of America, Washington Mutual Investors Fund, and many others! These funds are owned and operated by people investing for you, your 401(k)/403(b) (check out what you’re invested in!), and your pension funds as well! It doesn’t take the sting away, but don’t forget that you’re helping your retirement fund every time you fill up! (Yes, I’d trade the retirement increase for lower gas prices too, but that's not the point.)

Who It Hurts

I think this one is obvious, but I would be remiss not to discuss those who really struggle with the higher prices. While those who make the most in the country are truly not as concerned with the high prices of gas, those who make the least are severely affected by it. Al Gore* uses an astronomical amount of energy – it was reported that in 2007 he consumed between 12 and 20 times the amount of energy that an average house uses. At the same time, some seniors are forced to choose between heating and eating**. There are also many stories about people working for days to pay for gas in their cars, and other stories discussing the number of days the new Economic Stimulus Checks will pay for.

Besides the actual cost of gasoline, the other side of the story is the availability of hybrid vehicles (and other Flex Fuel vehicles) that would help dampen the affects of the higher cost of gasoline. Not only do many states offer rebates, but the IRS has an offer out as well. However, I view the “fairness” of this policy as questionable. How many people out there, working and living on a household income of $48,201 (with which they’re supporting their family of 3.14 people), would be able to afford a brand new vehicle with a sticker price of $21,500 (Starting price for the very efficient and very small Toyota Prius) plus the corresponding licensing and insurance. It seems to me that these benefits don’t naturally lend themselves to those hit hardest by the higher gas prices.

What Can You Do?

The good news is that there are several things that each of us can do. First, you could always buy a new hydrogen car. While these cars are nice, with the limited supply of hydrogen stations, you’ll have to be very certain of locations to stop before making any road trips in the car. (It should also be noted that these vehicles use hydrogen that is produced through a process that consumes fossil fuels, so our dependence on foreign oil does not dramatically change by shifting demand to these vehicles.) The high price of the car will also be an issue for many Americans. Another option would be for you to pay for hybrid vehicles, but this is a short-term answer to the long-term question, as these vehicles still consume large quantities of gasoline with varying success.

There are also options available that are more financial in nature. By lowering taxes, the Federal and State governments would lower the price of gas. However, the gas taxes pay for a lot of the infrastructure in the United States; highway, interstate, and local road repairs are funded by these taxes. There would also be the unintended side affect that the lower gas prices would push back the desire of Americans to become more self-dependant concerning oil, as well as slowing the desire to increase and discover alternative fuel sources. Neither option is necessarily a good one.

Besides the tax option, there are other financial options available. One option would be to buy gasoline futures which would allow you to set your price over longer periods of time and avoid the day to day fluctuations that can be frustrating (you would need to consider what you would do with a barrel of gasoline though, as placing it in your garage might not be the best idea). Continuing this line of thought, you could also purchase shares of an oil company’s stock. This would allow you to offset your increase in fuel spending with an increase in your investment portfolio (no, they would probably not offset each other, but you might not feel as bad hearing about the “windfall profits” of the oil companies).

*Because of his position on global warming and subsequent availability of personal information, not because of his political stance, Al Gore is used in this example. Yes…yes…yes…huge house, used for business, pleasure, and I don’t care. You’re missing the point. This article has strived to stay completely neutral on the global warming stance. If you read something in this section that offended you, reread it. There is nothing that could or should be viewed as politically leaning. If you’re still offended…go away.

**I tried to find an article without a comment concerning “The Bush Administration giving millions to XYZ for heating costs”. I didn’t try very hard because I again wasn’t concerned about a political lean. I’m not saying “Bush Rules and Gore Sucks”. I’m just using two examples. If you want to do the research and provide other examples (that are not political), email me.


Blogger Knight9man said...

You can't just have a normal blog huh?? Oh ross....

June 25, 2008 at 3:28 PM  
Blogger Ross S said...

I was tired of hearing people complain about oil prices in an uneducated manner, and I needed to insert my two cents. Don't worry, I'm going to tone it back on future posts and leave the dissertations at home...

June 26, 2008 at 11:51 AM  
Blogger Mike said...

I'm surprised that you left out that as much as 60% of today's current price may be pure speculation. Between the speculators and inflation the true cost of a barrel of crude may be nearer to $80. For shame Ross...

July 7, 2008 at 3:28 AM  

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