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With the WTI-Brent spread at 8-month wides, RINs having collapsed, and US investors buoyed by gas prices at the pump near recent lows, the surge in crude oil prices today – by their most since October 2nd – may take some of the ‘tax-cut’ punch from the party (remember gas prices are still 11.4% above recent seasonal norms). The 2% jump in WTI (and 1.85% rise in Brent over the last 2 days) may have only pushed it back to one-week highs but breaks a trend of lower prices that many have hoped would persist. Desk chatter is that much of this move is a re-up of middle-east premia as Iran’s nuclear negotiator says no deal today.
Bear in mind that despite the euphoria over lower gas prices, they are still 11.4% above seasonal norms of the last 5 years…
While the White House spied on Frau Merkel and Obamacare developed into a slow-moving train wreck, while Syria was saved from all-out war by the Russian bell and the Republicrats fought bitterly about the debt ceiling… something monumental happened that went unnoticed by most of the globe.
The US quietly surpassed Saudi Arabia as the biggest oil producer in the world.
You read that correctly: “The jump in output from shale plays has led to the second biggest oil boom in history,” stated Reuters on October 15. “U.S. output, which includes natural gas liquids and biofuels, has swelled 3.2 million barrels per day (bpd) since 2009, the fastest expansion in production over a four-year period since a surge in Saudi Arabia’s output from 1970-1974.”
After the initial moment of awe, pragmatic readers will surely wonder: Then why isn’t gasoline dirt-cheap in the US?
There’s indeed a good explanation why most Americans don’t drive up to the gas pump whistling a happy tune (and it has nothing to do with evil speculators). Let’s start with the demand side of this equation.
Crude oil consists of very long chains of carbon atoms. The refineries take the crude and essentially “crack” those long chains of carbon atoms into shorter chains of carbon atoms to make various petroleum products. Some of the products that are made from petroleum may surprise you.
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Use Compounds Made from Crude Oil
The United States has the largest refining capacity in the world and is still by far the largest consumer of oil in the world (though China is beginning to catch up), and its refineries require 15 million barrels of oil a day. That means even though, due to the shale revolution, domestic production has dramatically increased to about 8 million barrels, the US still has to import between 7 and 8 million barrels of expensive foreign oil a day.
Let’s take a look at who the US buys the imported oil from. (Now that I finally figured out my way around the new Windows 8—which, by the way, really sucks—I can even add some color to my tables.)
Millions of barrels
exported to US per day
Canada is blue because it is not only friendly with the US, but also has the ability to increase oil production. The other countries are red because they either have decreasing oil production, or the country is not on good terms with the US government, or the production may be at risk for various reasons. The “red countries” all sell oil to the US at higher prices than does Canada.
As I said, the US imports about 7 million barrels of oil a day, and our top 5 exporters make up between 5.6 and 6.8 million barrels while the rest is split among other countries.
This means that even though the US has significantly increased its oil production in the past five years, a good chunk of oil has to be imported at much higher prices. And higher crude oil prices for refineries means higher prices at the gas pump.
But that’s not the only issue: The “new oil” produced from the shale oil fields in the Bakken and Eagle Ford formations isn’t cheap. Both the Bakken and Eagle Ford have been hugely successful, and an average well in either region can produce over 400 barrels of oil per day.
That may sound like a lot, but drilling thousands of meters into the ground (both vertically and horizontally), then casing and fracking the well, costs millions of dollars. And the trouble doesn’t end once the well has been drilled: oil and gas production can drop as much as 50% in the first year.
Think of it as running on a treadmill—but the incline gets steeper and steeper the longer you run. That’s the current reality of America’s oil production.
Now, these areas also have to deal with declining legacy oil production (“legacy” meaning older oil wells that produced before fracking became popular) due to depletion rates. Freeze-offs, and even hurricane season can affect the legacy oil wells’ production decline.
As the old wells begin to deplete, they need to be replaced by unconventional wells with horizontal drilling and hydraulic fracturing. Even though these new wells provide an initial burst of production, they decline very quickly. That means you need to drill even more wells just to keep up—and the vicious cycle continues.
The costs, as you can imagine, are forbiddingly high. Even in known oil-rich regions like the Bakken and Eagle Ford, the all-in cost of extracting a barrel of oil from the ground can cost as much as US$75 per barrel (for comparison, Saudi Arabia can produce oil for as low as US$1 per barrel). To put it in simple terms: cheap oil in North America is a thing of the past.
So, the US produces expensive oil and relies on imports of even more expensive oil. And since the refiners need to make money as well, this means higher prices at the pumps. Who loses? The US consumer, of course.
What would help lower gas prices? Building more pipelines to deliver cheaper Canadian oil to refineries in the US and decreasing the refineries’ dependence on expensive foreign oil. Until these new and much safer pipelines are built, rail has to pick up the slack. Almost 400,000 railcars full of oil are expected to be shipped in 2013, compared with just 9,500 railcars in 2008, a whopping 41-fold increase.
But rail is not the answer. In fact, transporting oil by rail is much more dangerous than transporting it by pipeline. Just last week, we wrote about two recent accidents, one of which claimed 47 lives.
Federal and state taxes at every step of the gasoline-making progress make the pain at the pump even worse. The US government already takes more than 60% of the divisible income from every barrel of oil produced… and another 50 cents per gallon at the pump.
Then there’s the matter of Obama’s supposed “Green Revolution” and how America would be saved through the use of alternative energies. Obama wrote massive checks to different renewable energy firms that went belly-up, the most famous of them all being solar panel manufacturer Solyndra, whose bankruptcy cost American taxpayers more than $500 million. Obama is also a heavy supporter of ethanol (his home state of Illinois, after all, is the third-largest ethanol-producing state) and has increased the targets for the use of ethanol in transportation.
Someone has to pay for all of these subsidies, so why not get the dirty, evil oil companies to pay for them? Keep in mind, though, that the oil companies have enough lobbyists and lawyers to keep the government at bay—so the higher prices will be passed on to the consumers.
To sum up why the price of gasoline is so high even though the US is producing so much more oil than before:
- The high cost of American oil production
- Even higher costs due to imported (non-Canadian) oil
- Obama not allowing cheaper Canadian oil to flow to the refineries via pipelines such as the Keystone XL
- The taxes on crude are used to fund Obama’s green dream—his green-energy “legacy”—and his love for ethanol and the taxes at the pump will not decrease
So what does this mean for you, the consumer?
You have two options: You can gripe about high gas prices… or you can choose to profit from the situation, no matter how dire. If you’re the former type, so long, and I hope you enjoyed my missive today. If you’re the latter, let’s talk money.
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- Oil falls below $98 on plentiful supply (kansascity.com)
- Retail gasoline prices across Texas down 2 cents (wfaa.com)
- Gasoline could fall to $3 a gallon as crude prices continue to drop (jsonline.com)