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1
World Petroleum MarketsWhat the Past Tells Us About the Future
April 11, 2008Capitol Hill
Washington, DC
Lucian PugliaresiLarry Kumins
Energy Policy Research Foundation, Inc.Washington, DCwww.eprinc.org
2
IntroductionEnergy Policy Research Foundation Inc.
(EPRINC), formerly the Petroleum Industry ResearchFoundation Inc. (PIRINC)Founded in NY in 1944 Moved to Washington from NYC in Feb
2007 EPRINC brings policy analysis and
industry economics to bear on currentenergy issues
Note: All data in this presentation are from EIA unless otherwise noted. Summaryconclusions, comments, etc, are the sole responsibility of EPRINC.
3
TOPICS FOR TODAY
EPRINC’s Perspective on Structure and Pricing in the Upstream CrudeMarket (some history is useful)
Why Are Crude Prices So High Today?
What Does History and the Structure of the Crude Oil Market Tell UsAbout Policy Choices (and what is the problem we are trying tofix?)
Assessments of Trends in US and World Petroleum Product Markets
4
1973-74 Arab Oil Embargo
NOT AN EMBARGO, but instead a
•Structural Shift in Ownership and Control of the Resources of theMiddle East
•Fundamental Change in Expectations on Production from Middle EastProducers
As an Embargo it was a failure, market was integrated (lesson not yetlearned by Chavez)
5
1979 Price 1979 Price ““ShockShock””
OIL MARKET WAS NOT FRAGILE, but instead there was a shift in:OIL MARKET WAS NOT FRAGILE, but instead there was a shift in:
••expectations regarding regional risk; i.e. more riskyexpectations regarding regional risk; i.e. more risky
••Prospects for future output from Iran and Iraq were reducedProspects for future output from Iran and Iraq were reducedsubstantially, i.e., access to those reserves would now besubstantially, i.e., access to those reserves would now bedelayeddelayed
6
1986 Price Collapse Saudi Arabia abandons role as swing producer at low levels
of net demand for SA crude
Shift in expectations on Saudi decision making within OPECand as regulator of world oil market
Sustained reduction in oil use as a percentage of GNP inmajor Western countries
7
1998 Price Collapse: Six Central Issues1998 Price Collapse: Six Central Issues
Asian economic crisis bringsAsian economic crisis brings a collapse in net a collapse in netdemanddemand
•• OPEC misreads the oil market OPEC misreads the oil market•• Warm 1997-98 summers in N. America, Europe, Asia Warm 1997-98 summers in N. America, Europe, Asia•• Increase in Russian oil exports as Ruble collapses Increase in Russian oil exports as Ruble collapses•• Chinese authorities decrease imports in Q4 of 1998 Chinese authorities decrease imports in Q4 of 1998••UN authorizes increase in Iraqi exportation in 1998UN authorizes increase in Iraqi exportation in 1998•• Asian economic crisis brings Asian economic crisis brings a collapse in net a collapse in netdemanddemand
8
A Series of Unfortunate Events Leading to New Expectations
4.25.8
1.9 1.3 0.95 1.3 1.970
72
74
76
78
80
82
84
86
88
90
2001 2002 2003 2004 2005 2006 2007e
Glo
ba
l P
ro
du
cti
on
, m
illi
on
b
/d
0
10
20
30
40
50
60
70
80
90
100
$/b
bl
World Oil Production (EIA) Expected Production (EIA 2001 Predictions) OPEC Excess Capacity (EIA) Crude Oil Price
Iraq invasion: outlookpositive for new oilfield rehabilitation
Positive Expectations Expectations Shift Negative Expectations
Yukos -- Kremlintaking control of
Russian oildevelopmentOil
development inIraq delayed
Russia takes overSakhalin II, Chavez
Nationalizes Projects
Nigeriarebelshurt
output
Continuing civilstrife in Sudan,
Nigeria
OPEC Excess Capacityremains limited
Congress continues banon ANWR and offshore
development
Outlook positive forexpanded output from
Nigeria, Mexico, Venez.,Russia, North Slope
9
The Peak Oil Problem:New Supplies Will Be More Expensive, but We Are
Not Running Out of Oil
10
San Joaquin ValleyTesting Hubbard-Method Predictions for Reserves and Production
(Billions of Barrels)
597(actual)18944-112Year 2000productionprojected in:(mmb/d)
16.1-16.211.9-12.18.0-9.5Cumulativeproduction as of
76%69%49%PercentAttributable to1915
16.111.87.7CumulativeDiscoveries
1964 1982 2000
Source: EPRINC, October 2006. Does the Hubbard Method Provide a Reliable Means for PredictingFuture Oil Production, Richard Nehring, October 2006,
11
Permian BasinTesting Hubbard-Method Predictions for Reserves and Production
(Billions of Barrels)
910(actual)326-479162-479Year 2000productionprojected in:(mmb/d)
35.8-37.528.5-30.519-27.5Cumulativeproduction as of
84%86%85%PercentAttributable to1950
35.227.917.6CumulativeDiscoveries
1964 1982 2000
Source: EPRINC, October 2006. Does the Hubbard Method Provide a Reliable Means for PredictingFuture Oil Production, Richard Nehring, October 2006,
12
What Does the Permian and San Joaquin Tell UsAbout the Hubbard Predictions
Knowledge and technology grow overtime
Big payoff to long term access to bothexisting and new oil provinces
More importantly Hubbard Method doesnot reveal………… The Backstop Price Total Recovery
13
WHAT DOES THIS ANALYSIS TELL US ABOUT THE ENERGY SECURITYPROBLEM?
Current Market Price Probably Tied to a “Perfect Storm” ofUnfortunate Events – More Than Declining Reserves (Peak Oil)
Longer Term Energy Security Problem Remains “A Concentration ofLow Cost Reserves Among Relatively Few Players.”
This Concentration of Low Cost Reserves Poses Risks to the US(wealth transfers, price spikes)
Focus on Import Dependence Not Likely to Fundamentally AddressEnergy Security Problem and Can Be Costly. Policy Focus Shouldbe On Reducing Vulnerability.
What Would be the Elements of an Effective Strategy Given ThisAnalysis?
14
The Refining Sector
Imbalances andUncertaintiesCapitol Hill Briefing
April 11, 2008
15
Declining Dollar Value Relative toForeign Currency Basket
Declining Dollar Relative Value to Foreign Currency Basket
60
70
80
90
100
110
120
Jan-
00
Apr-0
0
Jul-0
0
Oct-0
0
Jan-
01
Apr-0
1
Jul-0
1
Oct-0
1
Jan-
02
Apr-0
2
Jul-0
2
Oct-0
2
Jan-
03
Apr-0
3
Jul-0
3
Oct-0
3
Jan-
04
Apr-0
4
Jul-0
4
Oct-0
4
Jan-
05
Apr-0
5
Jul-0
5
Oct-0
5
Jan-
06
Apr-0
6
Jul-0
6
Oct-0
6
Jan-
07
Apr-0
7
Jul-0
7
Oct-0
7
Jan-
08
Apr-0
8
Relative Value
Dollar peaked in Feb 2002. Currently, down 37% from Feb
2002 high.
16
Nominal and Dollar- Adjusted CrudePrices
Nominal and Dollar-Adjusted Crude* Price Contrasted
0
10
20
30
40
50
60
70
80
90
100
Janu
ary-00
July-
00
Janu
ary-01
July-
01
Janu
ary-02
July-
02
Janu
ary-03
July-
03
Janu
ary-04
July-
04
Janu
ary-05
July-
05
Janu
ary-06
July-
06
Janu
ary-07
July-
07
Janu
ary-08
($/b
bl) Nominal Crude Price
Currency Adjusted Crude Price
*Note: Actual Refiner Acquisition Cost
17
Whatʼs a Refinery?
Alkylation
CatalyticReforming
Isomerization
Coking
Fluid CatalyticCracking
Hydrocracking
Lubricants
Deasphalting
Hydrotreating
VacuumDistillation
AtmosphericDistillation
gas oils
residue
distillates
naphthas
gasesFuel GasPropane
GasolineBlendstocks
Jet Fuel
Diesel Fuels andHeating Oils
Gasoline andDistillate
Blendstocks
Lubricating Oils
Coke
Asphalt
18
Modular Investment in RefineryUpgrades
Need to:Make high specification productsMake cleaner gasolineMake gasoline for ethanol blendingMake ultra-low sulfur diesel (ULSD)Make across-the-board sulfur reductionAdjust to declining crude qualityReduce refinery site emissions
19
U.S. Oil Refineries History:1970 - Present
US Oil Refineries - History 1970 - Present
10000
11000
12000
13000
14000
15000
16000
17000
18000
19000
20000
1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
(00
0 b
/d)
100
125
150
175
200
225
250
275
300
325
350
# u
nit
s
Operable Capacity
Operable Refineries
* Many sub-economic, little ref ineries could not make
unleaded gasoline.
* Small unit issues: population shif t and US crude supply
runs out
20
U.S. Oil Refineries History:1970 - Present
1970s: The Small Refiner Bias in the 1973 price control programencouraged the building of excess small refineries.
1979: Price controls end. 1980-1990: Rationalization of refining.
Closure of small, uneconomic units - adversely impacted bypopulation and crude supply shifts.
Capacity at existing, better-located facilities expanded. Remaining refinery campuses become bigger, more efficient.
Mid-1990s: Capacity grows; demand grows faster. 2000s: More investment needed to expand existing refineries.
Regulatory issues Capital requirements and investment decisions
What happened to “Refining’s Golden Age?”
21
World Petroleum Consumption andRefining Capacity: 1980 - 2007
World Petroleum Consumption and Refining Capacity 1980 - 2007
50000
55000
60000
65000
70000
75000
80000
85000
90000
95000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
(mil b
/d)
World Total Capacity
World Total Consumption
* Global excess
capacity until
early 1990s -
investment
climate?
* 2003: Demand
catches up with
capacity - China?
* 2007: Demand
exceeds
capacity?
22
U.S. Gasoline and Diesel Pump Prices2005 - 2008
Gasoline and Diesel Pump Prices 2005 - 2008
150
200
250
300
350
400
450
Janu
ary-
05
Mar
ch-0
5
May
-05
July-0
5
Sep
tem
ber-05
Nov
embe
r-05
Janu
ary-
06
Mar
ch-0
6
May
-06
July-0
6
Sep
tem
ber-06
Nov
embe
r-06
Janu
ary-
07
Mar
ch-0
7
May
-07
July-0
7
Sep
tem
ber-07
Nov
embe
r-07
Janu
ary-
08
Mar
ch-0
8
(cen
ts/g
al)
U.S. All Retail Gasoline
U.S. No 2 Diesel Retail
2005: Oldrelationship:Gaso pricesabove diesel.
2006:Relationshipchanges.
2007/8:Dramaticchange.
23
Global Distillate ConsumptionGrowth: 2003 - 2006
Distillate Consumption Growth 2003-2006
334
619744
2489
0
500
1000
1500
2000
2500
3000
USA Europe China World
Thou
sand
bd
24
U.S. Refined Product Consumptionand Refining Capacity: 1973 - 2007
US Refined Product Consumption and Refining Capacity 1973 - 2007
10,000
12,000
14,000
16,000
18,000
20,000
22,000
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
(millio
ns b
/d)
Refining Capacity
Refining Consumption
25
U.S. Gasoline and Diesel Pump Prices2005 - 2008
Gasoline and Diesel Pump Prices 2005 - 2008
150
200
250
300
350
400
450
Janu
ary-
05
Mar
ch-0
5
May
-05
July-0
5
Sep
tem
ber-05
Nov
embe
r-05
Janu
ary-
06
Mar
ch-0
6
May
-06
July-0
6
Sep
tem
ber-06
Nov
embe
r-06
Janu
ary-
07
Mar
ch-0
7
May
-07
July-0
7
Sep
tem
ber-07
Nov
embe
r-07
Janu
ary-
08
Mar
ch-0
8
(cen
ts/g
al)
U.S. All Retail Gasoline
U.S. No 2 Diesel Retail
2005: Oldrelationship:Gaso pricesabove diesel.
2006:Relationshipchanges.
2007/8:Dramaticchange.
26
U.S. Wholesale Gasoline Price andCrude Cost: 2006 - 2008
Wholesale Gasoline Price and Crude Cost
100
125
150
175
200
225
250
275
300
Mar
-06
Apr-0
6
May
-06
Jun-
06
Jul-0
6
Aug-0
6
Sep-0
6
Oct
-06
Nov-0
6
Dec-0
6
Jan-
07
Feb-0
7
Mar
-07
Apr-0
7
May
-07
Jun-
07
Jul-0
7
Aug-0
7
Sep-0
7
Oct
-07
Nov-0
7
Dec-0
7
Jan-
08
Feb-0
8
Mar
-08
(cen
ts/g
al)
Crude Cost
Wholesale Gasoline Price
Note recentrefiner margincompression
27
Gasoline and Distillate Prices:NYH vs. Rotterdam
2006 - 2008Gasoline and Distillate: NYH vs. Rotterdam
100
120
140
160
180
200
220
240
260
280
300
320
Jan-
06
Feb-
06
Mar
-06
Apr-0
6
May
-06
Jun-
06
Jul-0
6
Aug-0
6
Sep-0
6
Oct
-06
Nov
-06
Dec
-06
Jan-
07
Feb-
07
Mar
-07
Apr-0
7
May
-07
Jun-
07
Jul-0
7
Aug-0
7
Sep-0
7
Oct
-07
Nov
-07
Dec
-07
Jan-
08
Feb-
08
Mar
-08
cen
ts/g
allo
n
NYH RBOB
Rotterdam Gasoil
Rotterdam Gaso
•2006/7:Gaso &distillatepricestrack. NYHgaso hassummerspike.
•2007/8:Worlddistillatepricesexceedgasoline.
28
U.S. Wholesale Distillate Price andCrude Cost: 2005 - 2008
2005 - 2008 Wholesale Distillate Price and Crude Cost
100
125
150
175
200
225
250
275
300
325
Janu
ary-05
Mar
ch-0
5
May
-05
July-0
5
Septembe
r-05
Nov
embe
r-05
Janu
ary-06
Mar
ch-0
6
May
-06
July-0
6
Septembe
r-06
Nov
embe
r-06
Janu
ary-07
Mar
ch-0
7
May
-07
July-0
7
Septembe
r-07
Nov
embe
r-07
Janu
ary-08
Mar
ch-0
8
(cen
ts/g
al)
Crude Cost
Wholesale Distillate Price
29
Gasoline Imports as Percentage ofConsumption: 2005 - 2008
Imports Share of U.S. Gasoline Supply: 2005 - 2008
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
Janu
ary-05
Mar
ch-0
5
May
-05
July-
05
Septe
mbe
r-05
Nov
embe
r-05
Janu
ary-06
Mar
ch-0
6
May
-06
July-
06
Septe
mbe
r-06
Nov
embe
r-06
Janu
ary-07
Mar
ch-0
7
May
-07
July-
07
Septe
mbe
r-07
Nov
embe
r-07
Janu
ary-08
Mar
ch-0
8
%
Imports as % of Consumption
Noterecentdeclinein gasoimports
30
Imports Share of U.S. DistillateSupply: 2005 - 2008
0
2
4
6
8
10
12
14
16
18
Janu
ary-05
Mar
ch-0
5
May
-05
July-05
Sep
tembe
r-05
Nov
embe
r-05
Janu
ary-06
Mar
ch-0
6
May
-06
July-06
Sep
tembe
r-06
Nov
embe
r-06
Janu
ary-07
Mar
ch-0
7
May
-07
July-07
Sep
tembe
r-07
Nov
embe
r-07
Janu
ary-08
Mar
ch-0
8
%
Distillate Imports as % of Consumption
Note steady distillate import decline
31
US Ethanol Consumption:2000 - Present
US Ethanol Consumption 2000 - Present
0
50
100
150
200
250
300
350
400
450
Janu
ary-
00
July-
00
Janu
ary-
01
July-
01
Janu
ary-
02
July-
02
Janu
ary-
03
July-
03
Janu
ary-
04
July-
04
Janu
ary-
05
July-
05
Janu
ary-
06
July-
06
Janu
ary-
07
July-
07
Janu
ary-
08
(00
0 b
/d)
US Ethanol Consumption
32
US Ethanol Consumption:2000 - Present Quick ramp-up made it look easy—but really was displacement of
MTBE Ethanol does not displace much foreign oil. 6 bil gallons per year of
ethanol saves approx 100 million bbls of oil. Corn prices have risen from $1.60 to $6.00. How much attributable to
ethanol driven demand? $1.00? $2.00? At $1.00/bu, oil saved cost $130/bbl; at $2.00/bu, the figure is $230 per
bbl. Current Ethanol Economics Looks Dicey—With high corn prices, low
fuel ethanol prices, existing plants earn losses. Existing plants have 7 bil gal capacity; mandate calls for 2 bil more Plants under construction and planned may not be completed/brought
on line If corn prices remain stable at current levels, ethanol prices must rise
by at least $0.50 per gallon in order for ethanol to be sufficientlyprofitable to attract investment.
More capacity needed to meet 9 bil gal mandate for 2008
33
CBOT Ethanol Futures versus CBOTCorn Futures
34
Ethanol Production Cost ($/Gal)
Sources: Simmons & Company International; EPRINC Calculations
-0.050.36Remaining To Cover FixedCosts/Profit
2.552.14Subtotal
-0.41-1.03Co-product credit
2.142.31Corn ($6/bu)
0.520.56Miscellaneous Inputs
0.300.30Natural Gas
Dry MillWet MillCost
Ethanol Production Cost ($/gal.)
35
U.S. Retail Prices: Gasoline vs. Diesel2006 - 2008
Retail Prices: Gasoline vs. Diesel Jan 2006 - April 2008
150
200
250
300
350
400
450
Jan-
06
Feb-0
6
Mar
-06
Apr-0
6
May
-06
Jun-
06
Jul-0
6
Aug-0
6
Sep-0
6
Oct
-06
Nov-0
6
Dec-0
6
Jan-
07
Feb-0
7
Mar
-07
Apr-0
7
May
-07
Jun-
07
Jul-0
7
Aug-0
7
Sep-0
7
Oct
-07
Nov-0
7
Dec-0
7
Jan-
08
Feb-0
8
Mar
-08
Apr-0
8
(cen
ts/g
al)
US Regular - All
US Diesel - All
US Ultra Low Sulfur
US Low Sulfur
36
Global Oil Consumption –All Products and Middle Distillates
Global Oil Consumption - All Products and Middle Distillates
20000
30000
40000
50000
60000
70000
80000
90000
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
00
0 (
b/d
)
Total World
Middle Distillates
37
U.S. Distillate Imports by SulfurContent: 2005 - 2008
US Distillate Imports by Sulfur Content: 2005 - 2008
0
50
100
150
200
250
300
350
400
Jan-
05
Mar-
05
May-
05
Jul-
05
Sep-
05
Nov-
05
Jan-
06
Mar-
06
May-
06
Jul-
06
Sep-
06
Nov-
06
Jan-
07
Mar-
07
May-
07
Jul-
07
Sep-
07
Nov-
07
Jan-
08
Mar-
08
(000 b
/d)
0 -15 ppm
15 - 500 ppm
500 - 2000 ppm
> 2000 ppm
38
U.S. Distillate Consumption andImports: 2005 - 2008
US Distillate Consumption and Imports 2005 - 2008
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
Janu
ary-05
March
-05
May
-05
July-05
Sep
tembe
r-05
Nov
embe
r-05
Janu
ary-06
March
-06
May
-06
July-06
Sep
tembe
r-06
Nov
embe
r-06
Janu
ary-07
March
-07
May
-07
July-07
Sep
tembe
r-07
Nov
embe
r-07
Janu
ary-08
(000 b
/d)
US Distillate Consumption
US Distillate Imports
39
U.S. Gasoline Consumption andImports: 2005 - 2008
U.S. Gasoline Consumption and Imports: 2005 - 2008
0
2000
4000
6000
8000
10000
12000
January
-05
Marc
h-0
5
May-
05
July
-05
Septe
mber-
05
Nove
mber-
05
January
-06
Marc
h-0
6
May-
06
July
-06
Septe
mber-
06
Nove
mber-
06
January
-07
Marc
h-0
7
May-
07
July
-07
Septe
mber-
07
Nove
mber-
07
January
-08
Marc
h-0
8
(000 b
/d)
U.S. Gasoline Imports
U.S. Gasoline Consumption
40
Capitol Hill BriefingApril 11, 2008
THE END