How is Fuel Priced?

Most of the mails you receive as forwards that offer you mind boggling information are half cooked or plain darn stupid. Take this one for instance which tries to tell you that you pay an exorbitant price for your fuel:

One liter = 0.26417 gallons
A standard barrel of oil = 42 gallons
Barrel oil = 42/0.26417 = 158.988 liters

One Barrel Oil Cost now $ 54.27 @ INR 51.175 = Rs. 2777.27 for 158.988 liters

So the real purchase price of oil Per Litter is = 2777.27 / 158.988 = Rs 17.47

(Currency and Crude Price Source: Oanda.com and NYMEX; as on 6th April, 2009)

So whats the problem with this seemingly simple logic??

The problem is that out of a blue barrel of crude oil, not the entire 42 liters give you the fuel that you use for your car. The break up is as shown in this image:

So only 19% of a blue barrel gives you gasoline i.e roughly 8 liters. Apart from this, Crude Oil just consists of 64% of the final cost that you pay for the fuel. By the time crude oil is converted into usable gasoline, it goes through refining, marketing and distribution and has taxes levied on it. As such the breakup of the cost becomes as follows:


So the simple and harmless looking Rs 17.47 liter has a marketing, sales and distribution component to it, plus the taxes. Apart from this refining is an expensive affair and the margins are usually low as not many refineries have a very large scale. The infrastructure for such a setup and the labor cost is high. If you keep all this in mind, you would understand why most non oil producing nations have to heavily subsidize fuel prices. If they did not, then you would be paying between 20%-30% more for your fuel.

I hope this helped in making you understand how your fuel is priced.

Crude Stocks at Highest Level Since July 2008

US crude inventories escalated by 7.2 million bbl and stood at 346.1 million bbl in the week ended January 30th. The slip in crude contracts was initially thought to be because of the build up in inventories but some analysts are of the opinion that it was because of the fall in the Dow Jones Industrial Index and not the inventory build up. The push in inventories marked the sixth consecutive increase pushing crude stocks to the highest level since July 2007. Gasoline inventories increased by 300,000 bbl to 220.2 million bbl in the same period, while distillate fuel inventories fell 1.4 million bbl to 142.6 million bbl (OGJ Online, Feb. 4, 2009)

OPEC is planning a further 500,000 b/d cut if oil prices don't stabilize around $50/bbl soon.

The Price of Speculation

I have always believed that speculation is the reason the concept of modern markets is in existence. Speculation is a zero sum game. Someone pays the price for it and someone else pockets the profit. Crude is a classic example of how speculation can drive a commodity to more than 4.5 times its utility value. The following graph shows the Price of Speculation for Crude from May 2008 to November 2008. 

In august this year, the Price of Speculation for Crude was 3 times the utility price of Crude as on 8th December, 2008 ($ 39.74) and with time, this has come down to as low as $10.10, i.e. 1/3rd of the utility price.

In fact the Average Price of Speculation for Crude has been $60.92 for the period which means that we have been paying twice as much for Crude, just based on speculation. Interesting.....