The IEA in its ‘World Energy Outlook 2008’ articulates that it costs between US$6 and US$28 to produce a barrel (bbl) of crude oil (in 2008 dollars) in the Middle East and North Africa. The range of production cost for other conventional fields is between US$6 and US39 per bbl. However, the production costs of deep/ultra-deep-water oilfields varies between US$32 and US$65 per bbl. Reuters conducted an investigation and came out with the followings production cost figures, which are not too different from IEA’s estimates:
Source: FACTBOX-Oil production cost estimates by country, 28 July 2009, Reuters
If the production costs, say for some OPEC countries, vary between US$4 and US$15, why do we pay close to or more than US$100? The answer is explained in the graph below: it is to pay for the economies of these countries. The red-shaded region at the bottom is the ‘breakeven cost’ for producers (as estimated by the French oil company Total). That is, the red shading reflects how much it costs to lift barrels of crude oil out of the ground. Yellow ‘budget break-even’ line is the price at which the major crude oil producers have to sell their oil in order to fund their national pending.
We have to keep in mind that all of the countries on the list – from Qatar to Venezuela – rely on oil sales for the vast majority of their national income. Forty per cent of global oil production comes from places where the national governments cannot afford oil prices to go much lower than they currently are. Specifically, Libya, Saudi Arabia, Algeria, Iraq, Angola, Nigeria, Ecuador, Iran, Russia and Venezuela all require oil prices of at least US$80–US$100 (or more) just to have sufficient income to run their national budgets. Without a strong oil price, these countries will have bread lines and riots.
West Texas Intermediate at $97 a barrel and Brent at $107 a barrel1 ‘is the threshold of pain for the world’s largest oil-producing nations’. ‘Oil prices are now well above the $50–$80 per barrel cost of production from most of the world’s newest oilfields, a level believed to be a natural floor for oil prices’.
Does it mean that ‘poor’ OPEC countries are the only ones who need 6- or 10-times their production costs to survive? No, perhaps not. Big multinational oil companies are in the same boat. In a recent US Senate hearing on tax subsidies to oil industries, CEOs of BP, Shell, Chevron, ConcoPhillips and ExxonMobil disclosed that the average cost of producing a barrel of oil in the US was US$11 while the market price of WTI was at that time US$72; that is, ‘6.5 times the cost of getting oil out of the ground’ (Forbes 14/5/2011). It has all to do with free market economy and supply/demand!!
In the same Senate hearing, according to the CEO of ExxonMobil, in an ideal world driven only by supply and demand, the oil price should have been in the US$60–$70 a barrel range in 2011 instead of hovering around US$100. He blamed it on the future contracts and speculators; that is, market speculation was adding between US$30 and US$40 to a barrel of crude oil!
OPEC also blamed high oil prices primarily on market speculators.
Speculators and crude oil price
In February 2012, Forbes reported that as of 23 February 2012 ‘managed money held the position in NYMEX crude oil contracts equivalent to 233.9 million barrels of oil – equivalent to one year’s supply from Iran to western European nations like France, Belgium, Greece, Italy and Spain‘. It then refers of a Goldman Sachs estimate: ‘each million barrels of speculation in the oil futures market adds about 10 cents to the barrel of oil i.e. the speculative premium in oil prices due to speculation is as much as US $23.39 a barrel in the price of NYMEX crude oil’.
Later, on 7 March, 2012 Bloomberg Businessweek reported that money managers held a record-long exposure to oil through 638,774 futures contracts equating to 638.8 million barrels of oil, which was about 290 days’ worth of Iranian oil export. It also reported that is not the first time speculators have flocked to oil futures and pushed the price up. However, ‘the scale of what’s happening now dwarfs previous run-ups’. In July 2007, a year before the price of oil peaked at US$144/bbl, money managers held a net long position of 160,000 WTI future contracts on the NYMEX. In March 2012, that number was 272,000.
It is reported by HowStuffWorks.com: ‘Before most people were even aware there was an economic crisis, investment managers abandoned failing mortgage backed securities and looked for other lucrative investments. What they settled on was oil futures, thereby taking the market to strange new places on the fringe of legality’.
A report by the US Congressional Research Service on ‘Rising Gasoline Prices 2012’ comments: ‘pure financial speculators, who never deal in physical oil, but earn large profits if they can correctly forecast price trend’. ‘Speculator, unlike hedgers, never intend to deliver or receive anything. They make their money by correctly guessing the direction the price will go’. ‘The big oil traders (speculators) need the price to move. It does not really matter whether it rises or falls. In a rising market, the speculator ‘goes long’ which effectively means that they own crude oil now and hope it goes up in price. Then they sell to take their profit. In a falling market, the speculator takes a “short position” which is like selling crude oil now at a particular price for supply at some future date in the hope that at the supply date the price will have dropped’. If actual demand goes down and actual supply increases the speculators starts ‘going short’. ‘Of course big speculators can impact the market themselves by taking huge futures “short” contracts through NYMEX and creating a “synthetic” drop in demand’. George Soros, hedge fund operator, who took a massive short position at US$137/bbl in crude oil in 2008 when the peak was US$145/bbl and profited when the prices subsequently fell.
According to Professor Michael Greenberger (of the University of Maryland and former Director of US Commodity Futures Trading Commission), ‘a rule of thumb is that an optimal commodity market needs 70% natural hedgers and 30% speculators. However, today, there are more than twice as many financial speculators in oil markets as there are hedgers and consequently the spot price of oil has become “unmoored” from actual supply and demand fundamentals’.22 & ‘The market is decoupling from fundamentals’, says Carsten Fritsch, an analyst at German’s Commerzbank in Frankfurt.
For example, in the four months between 6 October 2011 and 1 March 2012, oil prices increased from US$100/bbl to US$126/bbl in spite of an abundant supply and weak global demand; such a sharp increase in price (26%) has been attributed to speculators. According to these reports, speculators have priced-in war with Iran. However, there are some dissenting voices in this regard; that is, commentators and scholars disagreeing with such direct linkage between speculation and rapid price increase.
Forbes’ report on 27 February on US$23.39/bbl addition to the crude oil price also estimated that it would translate into a premium for unleaded petrol (gasoline) at the pump of US$0.56/gallon or 14.79 US cents per litre!
US Congress passed a new legislation (the Dod-Frank Wall Street Reform and Consumer Protection Act of 2010) that would affect the trading of energy derivatives (futures, options and swaps). It included measures that aim to increase market transparency, expand federal anti-manipulation authority and establish position limits according to the Congressional Research Service’s report on ‘Rising Gasoline Prices 2012’.
In case of OPEC countries dependence on oil revenue will remain in place for the foreseeable future. Powerful multinational oil companies will remain powerful as ever. Speculators with deep pocket are here to stay. Often governments in both developed and developing countries are powerless against such dominant market forces, therefore, it seems consumers have to “Wait for Godot” to deliver cheaper petrol prices. Is it called a daydream?
Rabiul H. Zaki is a BUET and AIT graduate currently working in Australia.