I wonder how many people understand how oil markets work. If more people did, I wonder if there would be so much talk about ensuring energy self-sufficiency through drilling for more domestic oil and gas. I expect some smart reader to set me straight on this puzzling issue. But until that happens, here’s how I see it.
I believe it’s just about impossible to tell where the gas in your car originated because the oil from which it was made was traded on a worldwide market. The way I understand it, oil is not necessarily refined and sold where it comes out of the ground, so the gas you buy in your hometown may have started out in a well in Venezuela or oil sands in Canada, or who knows where else?
That means the United States would have to change the way its oil is marketed to ensure that all of it goes to consumers back home. Right now, American-produced oil may end up in gas tanks in China or India by the time the trading process is completed. Again, I could be wrong, and I hope that if I am someone will enlighten me, but if I’m right, how will increasing domestic oil production create energy self-sufficiency?
In case you’re interested, here’s some information I picked up on the Internet about the way oil is marketed. It may be a little outdated, but I still think it helps to make my point.
Just 10 companies control 68 percent of the world’s proven oil reserves. Nine of the ten biggest oil reserve holders are state-owned National Oil Companies.
Oil and Gas Journal, 2006
Since 1960 the world oil market has been significantly influenced by the Organization of Petroleum Exporting Countries (OPEC). There are 11 members of OPEC, most of them in the Middle East and Africa. OPEC countries control close to 70 percent of the world’s proven oil reserves and in 2005 accounted for about 41 percent of the world’s supply of oil.
Canada holds the second largest oil reserves in the world, with over 178 billion barrels of oil. Over the next decade, Canada’s importance as a leading oil producer is expected to increase, as oil sands production is projected to triple. Other key non-OPEC producers include: Russia, the United States, Mexico, China and Norway.
Oil and Gas Journal, 2006
Oil refineries convert crude oil into products such as gasoline, diesel, jet fuel and home heating oil. The main consumers of oil are the United States, Europe and Japan, which together consume about half of the world’s annual oil output. However, consumption in emerging markets, such as China and India, is expanding rapidly. The transportation sector accounts for about two-thirds of the oil used in the world and for about half of the oil consumed in the United States.
Oil is traded around the world, just like coffee and soybeans, and attracts investors from various countries who see an opportunity to make money by speculating on its price. These traders are not generally involved in the actual production or use of oil – they buy and sell paper contracts, not actual oil – but can often have a significant influence on market prices.
The price of oil has traditionally been determined by the relationship of supply to demand. When there is more supply than consumers want, they can shop around for the best price. If demand is higher than the available supply, consumers compete with each other, bidding for the supplies they need and driving prices up.
However, it is not only the current supply-demand balance that determines market prices. Buyers and sellers also factor in what they expect will happen to prices in the future. If buyers think that supply might be lower in a few weeks or months and the price could go up, they will stockpile oil now and might even be willing to pay a premium today to protect against a higher price in the future. Similarly, if buyers think that the supply of oil will increase in the future or that the price will decline, they will delay their purchases or demand a discount.
The price of oil is set in the global marketplace. Oil is traded all over the world and moves from one market to another by ship, pipeline or barge. Therefore, it is the global supply-demand balance that determines the price of crude oil anywhere in the world. This explains why crude oil prices are similar all around the world. Prices vary only to reflect the cost of transporting crude oil to a given market and the quality differences between the various types of oil. The global nature of the market also explains why events anywhere in the world affect oil prices everywhere.
O.K. now, we have some idea of the global nature of the oil market. So, tell me, how can any one country ensure energy self-sufficiency by producing more oil?