Wednesday, July 27, 2005

All about the oil

I would like to pre-empt the nonsense we had inflicted upon us last year about £1 per litre petrol (and that was when crude oil prices were way under $50 a barrel). That led to an unholy alliance of anti-capitalists, do-gooders and panicky petrolheads, in a bid to boycott BP and Esso - the bits in bold below are lifted from one such email (and slightly updated for this year).

So let me take a moment to point out to you why this is a completely stupid and worthless idea, canard by canard...

1. “We are going to hit close to £1 a litre by the end of summer”

This is not a foregone conclusion. The Saudis will use their “swing capacity” (unused space in their refineries) to bring extra oil onto the market and force prices to at least level off. On a smaller and more local scale, UK refineries switch production during the summer months to less heavy heating fuel and more road fuel. Most rises tend to be due to a government increase in duty. This would not be until Gordon Brown’s autumn budget, and there is already a considerable lobby, not least from the oil majors, to make an emergency cut in this levy.

Also Hurricane Dennis was less disruptive of supplies, Iraqi fuel is beginning to trickle through to the market, the Nigerian unrest has settled down, Chinese demand has cooled, so any rise in barrel costs is more likely to be due to speculation than shortage.


2. "The oil companies and the OPEC nations have conditioned us to think that the cost of a litre is CHEAP at 70p-80p"

This is patently untrue. Have a look at price per barrel trends in dollar terms and real terms (ie against inflation) and you'll find that OPEC, who have the only real "swing capacity" in the world, mostly in Saudi Arabia, use this extra to regulate the price of crude to a reasonable rate. They're just as unhappy when prices are this high; OPEC policy is a price range of $30-$40 a barrel.

The price of both crude oil and what you pay at pump go up in general because of three things, which are standard trend-setters in anything on an open market with fluctuating value:

a. We in the developed world use proportionally less than we have before - simple economics mean the producers need to charge a bit more to balance their books – for example, modern jets use 40% of the fuel used by equivalent planes in the 1960s

b. There's a finite supply that has probably peaked (lefty Greens take note that this still means another 50 years of commercial exploitation of oil, and 100 years of natural gas), so it becomes more expensive to explore and extract

c. Speculation, growth and inflation have impacts on all prices of any commodity from a Mars bar to a glass of water


3. “The only way we are going to see the price of petrol come down is if we hit someone in the pocket by not purchasing their petrol”

BP’s response to this has appeared in several media outlets – they’re not budgeting for any big dip in their profits due to a boycott, besides which it would have to be a virtual 100% stoppage to make a dent in their recent string of record profits in the billions bracket. And they made all of that on a strategy based around a $20 per barrel strike price. 1% of BP’s resources are involved in the retail side, out of which some stores make twice as much on the shop as on the fuel.

Not only that, but government regulations prohibit the oil companies from cross-subsidising their petrol stations with their very lucrative upstream and refining operations (that's where the billions in profit actually comes from). Supermarkets are allowed to though, so their operational overheads are absorbed into the adjacent store, thus giving them a larger operating margin which they can pass on to the consumer. Of course, this attracts you into the store, and they hit you in the pocket then. Boycott Tesco, anyone?!


4. “The two biggest oil companies (which now are one), ESSO and BP”

First I heard of a rather important merger. Any insider tips? I think our misguided chappy may be confusing with the merger of Exxon and Mobil to form Esso’s parent company, and British Petroleum’s mergers with Amoco, ARCO, Castrol and Veba among others to form the new-look BP.


5. “If they are not selling any petrol, they will be inclined to reduce their prices. If they reduce their prices, the other companies will have to follow suit”

Sorry, that’s not how it works. From your 85p-87p per litre being charged at most BP Connect stations (if it doesn’t say Connect, it’s a franchise, and you’ll be boycotting some poor little fellow’s livelihood, not a multinational oil company), the first 65p-68p or so goes on government duties and taxes. About 15p-18p will go on the basic cost of running the petrol station and the cost of the fuel. The oil company might take between 1p and 6p in “profit”, which it may have to reinvest in capital expenditure to find you the thirsty consumer, more oil. Not only that but oil companies have different overheads, supply and trading structures etc, and may choose to take a higher point in the market. That’s why there’s never really a petrol price war.


6. “Buy your petrol at Shell, Tesco, Sainsbury's, Morrison's, Jet etc”

How smart! Give them a captive market so they can raise their prices too! OK, some education on exploration and production here. The best ways of avoiding high petrol prices are as follows:

a. lower the excessive duty on petrol – the aviation industry thrives even post-Iraq, 9/11, bankruptcies and big air crashes because there’s a worldwide moratorium on VAT for jet fuel. In this country it’s so high Eddie Stobart’s taken all his girly-named lorries to Belgium. In France, for every 2 Euro raised in income tax, 1 Euro is raised on fuel tax

b. help the non-OPEC countries and the 8 oil majors who can really afford it to explore more and build more refining capacity and strategic reserves to avoid price hikes. The big 8 by the way in roughly size order: Exxon Mobil, BP, Shell, Chevron Texaco, TotalFinaElf, Conoco Phillips (you know them as Jet), Agip, Repsol YPF. But wait - that would mean drilling in Alaska etc. Huh. Environmentalism and economics aren't great bedfellows.

c. note how Tesco’s, Sainsbury’s and Morrison’s don’t feature in the list. They may be great at exploration and production of cheap white bread, value bourbon biscuits and milk that costs less than water, but the last time I looked, they weren't heading to the North Sea to hunt for oil they could put in a blue and white stripy box for you. Oh, and whichever moron wrote the original knows so little about the industry that he didn't know Jet was a retail brand of one of the nasty majors. See also myriad articles on Shell’s inability to correctly account for what it has in reserve. Also beware the supermarket fuels! They tend to be of a lower grade and can be bad for your car if used exclusively over a long period. This is how they get the fuel cheaper. It’s the equivalent of factory seconds.


7. Some simple truths…

a. you’re relying on a pyramid scheme to spread the word here. Ask an economist why these don’t work. Ask Albania, a country which went spectacularly bust because the state actually backed one. My guess is that you could cause the spread of a nice virus or maybe just overload a couple of servers

b. you’ve picked on two random oil companies, one of which is American, and has therefore little sway over the British government – as discussed, they’re the people who can actually make a decent price cut across the board – and the other of which has long held a strategy of pricing towards the top end of the market. If you really wanted to make a difference, you should boycott all of them, or perhaps go after Q8, Aramco etc – OPEC-based companies

c. even if you were successful and suddenly the majors either dropped their prices or lost loads of customers, the most likely effect would be a sharp drop in their share prices, which would cause lots of uncertainty and probably, um, trigger higher oil prices


At this point a disclaimer for legal purposes: the views represented above are not the official views of BP, certainly not those of Exxon Mobil, and should not be considered as a basis of recommendation for any kind of investment or trading activity. Nothing contained herein is commercially sensitive or confidential – all could be obtained with some thorough research of the industry.

Please feel free to pass on the link to this page to anyone who you feel needs re-educating.

http://www.freedmanslife.com/2005/07/all-about-oil.html

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