LL: Gasoline prices are soaring and now the Administration is thinking of opening the strategic reserves. There is only so much oil in those reserves.
If this was done, how long could the United States do this? How much would it reduce the price?
KB: The 727 million barrels of oil in the U.S. Strategic Petroleum Reserve (SPR) can’t be sold onto the open market all at once.
Infrastructure bottlenecks limit throughput to between four and five million barrels per day, and throughput will decline near the end of a sustained draw. In other words, the SPR can displace about 50% of U.S. oil imports for about six months.
LL: The oil is extremely limited; it’s only a temporary measure. Will Americans be happy for even only a slight reprieve?
KB: The problem is: it isn’t clear that selling SPR oil would lower gasoline prices very much right now.
If U.S. refiners were running out of oil, then tapping strategic reserves could lower the sale prices for crude oil and gasoline. But U.S. refiners aren’t short of oil at all—they have plenty of it.
Most U.S. refineries are high “complexity” facilities, which means they can use many different kinds of oil, including low quality oils that sell at a discount to West Texas Intermediate and Brent (the high quality benchmarks). Why would a refiner buy high-quality oil from the U.S. government to make gasoline and diesel when it could buy a lower-quality oil on the open market for $15-25 per barrel less?
Because the U.S. economy isn’t running at full capacity, our refiners haven’t been making as much excess diesel fuel, jet fuel and heating oil for export as we were in 2008. If we had been, our surplus could have taken some of the price pressure off of Europe and Asia and delayed or lessened the run-up in Brent crude since the Egyptian Revolution.
LL: This Middle East turmoil is shining a bight light on just how vulnerable the United States is when it comes to "energy security".
KB: I would say the problem is really that the global oil system is very interconnected and very tightly-strung. Because U.S. refiners are privately-held entities that pay market prices for a global commodity (oil), weak links anywhere in the system can raise the price at home. Shoring up weak links means building out refinery infrastructure and commencing new production – projects with two-to-five-year horizons.
Refineries in Asia and Europe are less complex, which means they have fewer options. When Libya went offline, those refiners (and some non-commercial traders) were competing for the high quality oil, and that drove up Brent prices. As oil shipments to the U.S. have diverted to Asia and Europe, that has contributed to the rise in the WTI benchmark, too.
LL: The oil industry is trying to get back to work by instilling confidence in its systems. You had ExxonMobil , ConocoPhillips , Chevron and Shell joining forces to design a state of the art Marine Well Containment System that would control a spill like the Deepwater Horizon disaster. Will this help remove some of the taint on the industry?
KB: When it comes to managing public perceptions, it isn’t easy to be an oil company, and high prices will probably make it harder still. The same high prices that create dire challenges for cash-starved end-users are likely to generate staggering profits for upstream producers.
This divergence could lead elected officials here and overseas to pass policies motivated by populist outrage, including royalty hikes, production taxes and “regulatory surcharges” that undermine the long-term stability that encourages oil companies to invest in the upstream and downstream to offset shortages in the future.
BOEMRE appears uneasy with green-lighting the industry-led safety effort … and this isn’t surprising; no regulator wants to be responsible for any future accident in the wake of the Deepwater Horizon spill. Nor is there any obvious political reward for President Obama rushing back to the offshore unless supply to the U.S. is physically disrupted.
Safety isn’t the only sticking point, however. We have suggested that getting back to deepwater drilling may also require the White House to get enough money to move ahead (very cautiously) with the regulator out there today at the same time that the Interior Department builds the regulator the Obama Administration wants to have in place for tomorrow.
Whether the industry or Republican appropriators come up with this money remains to be seen, but until the White House can fund its own safety program, BOEMRE may continue to be uncomfortable with relying on private-led efforts.
LL: Many say the energy infrastructure in the United States is also in dire need of repair. How would you grade it?
KB: The simplest test—does energy show up?—means that, on a pass-fail basis, U.S. energy infrastructure passes. It’s easy to forget that this isn’t the case everywhere in the world. It’s also easy to overlook the substantial improvements in air and water quality that have generally accompanied our abundant and (relatively) low-cost energy resources. That doesn’t mean every component of our energy infrastructure deserves a passing grade, however.
The long useful life of U.S. energy infrastructure means that age alone isn’t necessarily grounds for failure; timely upgrades can keep old facilities young. On the other hand, the vastness of our infrastructure imposes significant monitoring costs.
The combination of maintenance cap-ex and diagnostic outlays can soak up money that private companies might otherwise have allocated to innovation. In many cases, we spend more and more each year just to keep performance where it has been for decades.
Aging pipeline infrastructure is not ideal. Neither is a lossy electrical grid. Neither are low-efficiency power plants and refineries. Most of the nation’s aging assets have two things in common: they’re paid for (which means any new investment will bring higher fixed cost amortization) and they have received environmental permits (a time-consuming and sometimes insurmountable hurdle).
But how many voters would seriously be willing to pay more to fund innovation and elective, non-maintenance cap-ex? Our market democracy makes energy policy idealism difficult, if not impossible.
LL: How high do you see oil going?
KB: On a year-average basis, we could still end up back at our projection of $87/bbl WTI for 2011, but we’re more likely to get there through economic collapse than we are from peace breaking out all over.
It’s impossible to know whether Algeria—another exporter of high-quality crude—might be at risk of Libya-style disruptions.
It is somewhat easier to imagine the “knock-on” risk that could come from opportunistic threats issued by Iranian President Mahmoud Ahmadinejad or Venezuelan President Hugo Chavez.
It is very easy to look at the grim condition of OECD end-users and conclude that the collapse will come sooner this time around.
At our $87/bbl WTI projection, the world’s oil acquisition costs would rise to 4.3 percent of projected global GDP this year. From a historical perspective, this is about 30 basis points into the danger zone and about 1.7 percent from a serious problem.
We project that U.S. end-users will be spending 10.4 percent of disposable income this year on gasoline, home heating and electricity—and that’s a national average that conceals significant pockets of weakness.
Yes, the U.S. still matters when it comes to oil price formation, at least for a few more years. There’s still somewhere between 500,000 and 1 MM bbl/d of demand contraction available here at home if prices stay this high.
Asian decoupling doesn’t mean China won’t be affected, either. China is still an import-dependent, oil-consuming industrial nation…and so are most of China’s export partners.
LL: Do you think oil will ever go back to 75 a barrel?
KB: Almost certainly. Over the long term, oil tends to trade at about three times finding and development costs, although there are significant deviations caused by short-run factor cost inflation. By that crude proxy, $60-90/bbl would be a reasonable range. The problem, of course, is that prices provoke policy responses and innovation spending that may lag price peaks by years. Likewise, there is a latency in behavioral shifts: efficiency gains require money, so a structural downward shift in demand generally requires a recovery after the spike.
LL: Where so you see gasoline prices going?
KB: Depending on the resilience of the U.S. driver, a $4 handle is feasible for the short-term. I would be surprised to see the year average significantly higher than $3.50 to $3.65 per gallon.
LL: What are you hearing from clients? What advice are you giving them?
KB: Clients have been asking most about (a) further unrest in the Middle East and North Africa; (b) President Obama tapping the SPR; and (c) whether EPA and Interior Department strictures governing fossil energy can survive these high prices. There have been surprisingly few inbound inquiries surrounding alternative fuels or vehicles technologies, including ethanol and natural gas vehicles. Our responses haven’t changed much from what we last published:
- The world is well supplied, but ongoing risk of fast-moving political changes that could disrupt that supply clearly has driven a spot market premium, to say nothing of the obvious futures market premium, and uncertainty and information costs are a part of both premiums. How can one expect to get solid supply data from wartime Libya when many producer nations are opaque in peacetime?
- Tapping the SPR may have more political validity than economic justification and, for that reason, we can’t rule it out. It appears unlikely to change prices very much, though.
- The Obama Administration is fighting criticism from industry and environmentalists alike, but there are few reasons why either group is likely to win big concessions.
Genuinely expediting deepwater drilling has little political value. President Obama is unlikely to win Texas, Louisiana, Mississippi or Alabama in 2012, but he cannot afford to give Florida voters a reason to stay home or vote against him by looking loose on drilling. At the same time, the White House can’t look unresponsive with prices as high as they are.
Similarly, the White House has little to gain by alienating Steel Belt voters whose economies depend on coal-fired power, but little to lose by alienating environmentalists—Democratic Party greens aren’t likely to vote Republican for environmental reasons. By the same token, the Administration still has to honor court-defined deadlines to propose new environmental rules, if only because a citizen’s lawsuit against EPA would give Republicans ammunition to attack President Obama’s energy policies as weak on the economy and the environment.
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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."