Economic Prosperity and Fossil Fuels, Part 3; Complain about price of gas while paying $5.00 for a coffee or $2.00 for a bottle of water

Facts versus Myths about the US Energy Industry

By —— Bio and Archives--July 16, 2009

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As we discussed in parts 1 and 2 of this series, the global demand for energy, and the fossil fuels that are the source of that energy, is increasing while at the same time, the supplies to meet that demand are declining. We examined how the gap between supply and demand is at risk of becoming too large and making a current economic crisis far worse. Finally we examined a number of ways that the government can help avoid this crisis.

Yet many individuals, fueled by misinformation from the media, are hesitant to do anything that might be seen as helping the big greedy oil companies. In discussions with people around the world, it is obvious that the vast majority have little to no understanding of the energy business.

This final essay is intended to help you have a better understanding of where oil and gas comes from, how it is found and produced, and what oil companies are actually like. With this information, you will be better able to determine what energy future you want your legislators to vote for.

The nature of oil and gas exploration

Many people envision oil and gas being found in underground caverns, rivers, or pools, needing simply for a well to be put into it like a straw into a drink to suck the oil out.

For the straw analogy to work, envision a glass of crushed ice filled with your favorite beverage. Before inserting your straw, plug the bottom and poke a number of holes in the side of the straw.

You will find it difficult to drink, as the crushed ice, like geologic reservoirs, holds much of the drink in the porous spaces between the ice particles. The more you pack the ice in the glass, the less of your drink you’ll get. As you can see, developing an oil or gas deposit is more complicated than simply poking a well into it; so too is finding that oil or gas deposit to begin with.

The first step in exploring for oil and gas is to acquire seismic data over the area of interest. Seismic, like a giant sonogram, gives us an image of the subsurface. It takes upwards of a year to permit and shoot and process a new seismic survey. The cost of the seismic is several million dollars.

Once the survey has been acquired, geoscientists will interpret the seismic, along with information from previously drilled oil and gas wells to develop a picture of the subsurface and delineate areas that are likely to contain oil or gas. It is somewhat like putting together a complicated jig-saw puzzle without the cover, and can take several months to several years, depending on how complex the subsurface is.

Once a company makes the decision to drill the prospect they acquire access to the mineral rights and prepare to drill. For most prospects, the target will be 1 to 4 miles deep. Depending on the depth and the environment, the well will cost between 1 and 50 million dollars.  This first well has a 70% chance of being a failure, a dry hole.

In the event that the well is a success, more than likely one or more additional wells will need to be drilled to appraise the size and producibility of the discovery. Each of these wells will cost between 1 and 50 million dollars.

Should the company decide that the discovery is commercial, they will sanction its development and drill the appropriate number of development wells and install the necessary facilities and pipelines needed to produce the deposit and transport it to the refinery. The cost of the development can range from several million to close to 1 billion dollars.

The rate of production will be controlled by a number of factors including the nature of the field, the capacity of the pipelines to accommodate the new production, the capacity of the refineries to handle the production, and State and Federal regulations.

With the present day technology, all aspects of exploration and development can be accomplished with virtually no environmental impact.

The nature of oil and gas companies

Most people seem to have a misunderstanding as to the nature of the oil and gas industry, their impression being formed only by the large multi-national integrated oil companies who make “billions of dollars of profit”.  In actuality, the industry consists of thousands of companies ranging from one-person independents to the large multi-national integrated oil companies.

Another long standing misunderstanding is that the 5 super-large companies work together to control the price of oil. If that were true, then the companies would not have allowed the low prices of 1996 to 2000, nor would they allow the current unstable oil prices. Oil and natural gas are commodities, and like orange juice and gold they are traded on the commodities market. It is that market that sets the wellhead price.

Finally, regarding those billion dollar profits; yes some oil companies do make “billions of dollars of profit”, but they do so only after investing “billions of dollars”. The true measure of a company’s profitability is their return on investment. In the oil industry, that has ranged from 0 to 25%, a range typical of mutual funds.

The cost of a gallon of gas

It is always amazing to see people complain about the price of a gallon of gas while paying $5.00 for a cup of coffee or $2.00 for a small bottle of water.

When you pump $30 into your tank, that money gets distributed among several entities. The media can sometimes lead you to believe that the price of gas is based solely on the price of crude oil, but there are actually many factors that determine what you pay at the pump. No matter how expensive gas becomes, all of these entities have to get their share of the cost. According to the U.S. Department of Energy, here’s an approximation of where each dollar you spend on gas goes:

Taxes:       11 cents
Distribution and Marketing:   6 cents
Refining:       10 cents
Crude oil:           73 cents

As you can see, the cost of crude oil is the single largest factor. As we discussed in parts 1 and 2 of this series, the cost of crude oil is a function of the supply of oil relative to the demand. Globally, demand is increasing whereas the supply is decreasing.

Any policies or laws enacted by your legislatures that affect the supply, or the demand, will impact the cost you pay at the pump. Laws currently being considered such as the Waxman-Markey Bill will almost certainly result in potentially significant cost increases.

What we need is a comprehensive energy policy to help ensure that we have a reliable source of low-cost energy. That policy needs to embrace the energy industry, not punish it. Without it, we will face a serious economic crisis. Just how serious will be discussed in the conclusion of this series.


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