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.

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.....

Oil & Gas: Strategic Business Risk 2008 by Ernst & Young

A report by Ernst & Young on Strategic Business Risk for Oil & Gas in 2008 listed the top 10 risks for the oil & gas industry:
1. Human capital deficit
2. Worsening fiscal terms
3. Cost controls
4. Competition for reserves from National Oil Companies (NOCs)
5. Political constraints on access to reserves
6. Uncertain energy policy
7. Demand shocks
8. Climate concerns
9. Supply shocks
10. Energy conservation

The report categorizes these threats as macro threats, sector threats and operational threats.
The high points of the report have an underlined message in the form of a trade off between continuous supply and climate & environmental change considerations, BRIC energy consumption vs Organization for Economic co-operation and Development (OECD) countries, trade off between upstream investment and alternative energy sources and others climatic concerns(Kyoto Protocol, WWF Report, Atmospheric carbon levels, Ozone depletion)
The report is an interesting read...

Oil Drilling Falls from 23 Year High in US

Drilling activity in the oil industry is measured by the number of rigs. These rigs are further sub divided into Land Rigs, Inland Rigs and Offshore Rigs. US drilling activity today dropped from a 23 year high with 18 rigs down and 2013 still working as per a report by OGJ.

The major contribution to this decline was due to a fall in land rigs which were down by 19 rigs at 1919 rigs functional. Inland waters saw a decline by 1 rig and offshore rigs declined by 2 to stand at 72 for US waters overall.

Worst hit in terms of drilling capacity for rigs is natural gas. The rigs for natural gas dropped by 20 and stood at 15686 rigs or the week. The decrease in active rigs would account to a fall in upstream production, particularly from the Texas area. This might temporarily push up oil prices.