Economics of oil production and market dynamics

Economics of Oil

Today 90% of the world's energy needs come from oil and this is due to the fact that this is the energy source powering most vehicles and it is also the origin of most industrial chemicals. This has become a very important commodity. Getting oil was the reason for many battles including World War II and the Gulf War. The distribution of oil in the world is skewed with 80% of the resources being in the Middle East and USA having less than 3%. The cost of the oil is not in pumping it out of the ground as it is around one dollar per barrel, but most of the costs come from refining and distribution as also the profits and taxes that come in between the producer and the user. The price of crude in the end of 2004 was near $50 a barrel.

There is a lot of variation in the price of oil and that is due to crisis or recession in major countries, and even the suppliers in OPEC decides on what price they should charge for oil. During 2004 the declared price for oil by OPEC was between $22 and $28. A low was reached in January 1999, when there was increased oil production from Iraq and a financial crisis in Asia. The prices increased then through 2000 and then fell again in 2001. Currently the price is hovering between $50 and $57 a barrel and the prices keep fluctuating everyday. (Petroleum) Thus it is clear that there is no pattern in the increase of oil prices and it is being controlled more by speculators than other sources. One has to understand how the control of prices has shifted to the speculators from the governments who think that oil is an important item for their national economies.

Technically the name for oil is petroleum and the word is a combination of two Latin words - Petra meaning rock and oleum meaning oil. This is crude oil and appears from the surface of the earth as a thick liquid dark brown or greenish in color. This can catch fire when it comes out of the earth's crust. This is a mixture of many different hydrocarbons and the appearance changes from place to place, as also the composition and purity. Most scientist feel that crude oil has been prepared within the earth like coal and natural gas and this is due to the compression and heating of vegetation formed on the earth many centuries ago. This vegetation may have come from the spoilt remaining of either sea animals or surface plants. These items had got mixed with mud and were buried in a natural process. Once under ground there was a lot of pressure and heat on the mixture and this turned first into a waxy material called kerogen and then into liquids and gases through a process called Catagenesis. These liquids and gases then moved among the layers of rock till they reached a level of porous rock and formed reservoirs, which are now called oil fields. The original liquids or gases are today taken out by drilling and pumping. Once the liquids come to the surface, they are then separated into different components through a process known as distillation and the products that are formed are called kerosene, benzene, gasoline, paraffin wax, asphalt, etc. The process of extraction is to drill a well underground. In the past, there were some well fields in USA which existed and which sent up the oil to the top and no wells were required, but these have long ago stopped supplying oil. (Petroleum)

It is not essential that only one well goes into a reservoir, but more are dug so that the site can yield economic quantities of oil. Some times the wells are used to force water, steam or mixtures of different gases into the reservoir so that the required pressure exist with that the oil reaches the surface. This pressure is required to make an oil field economically viable. In most wells, different gaseous fuels or natural gas are also present and they also provide the required pressure to the well for the oil to come out. The presence of many different materials within the field requires the field to have many different valves on the yield pipes so that they can be connected to a network of pipes for storage and sending for processing. As more and more oil is taken out, the pressure of the well will drop and there will be a stage when the pressure in the well will not be enough to force the oil out, and then there will be dependence on pumps to take the rest of the oil out of the well. All this began when Edwin Drake found oil in 1859 in Pennsylvania. The growth of the industry was slow in that century, but the demand rose rapidly in the 20th century. The first fields were quickly finished and there were many fields found later in Texas, Oklahoma and California. Even other countries found oil in their colonies in those days and they developed them at a high level. (Petroleum)

Even today, many countries depend on other countries for expanding their oil production and this has a lot of political implications. Repsol YPF is a giant Spanish oil and gas company which has hired a Norwegian drilling company to hunt for oil in Cuban sea off the northwestern coast. The cost is $200,000 a day. The new effort is a joint effort with the government oil company of Cuba called Cubapetrolo. The American oil companies are watching this with a lot of interest as if oil is found; it will help Cuba a lot. At present most of the oil for Cuba comes from Venezuela, and does not often have the hard currency for paying for it. It will also change the situation of production of oil in the Gulf of Mexico where the oil is now being produced only by USA and Mexico. Cuba suffers a great deal from this as USA prohibits any commerce with Cuba and that affects the relationship between the two countries. Previously Cuba got most of its oil from Soviet Union and that arrangement ended with the Soviet Union. This caused a lot of oil shortages in Cuba and the government started permitting foreign companies to look for oil in the country from the middle of 1990s. The country has had some success in using new technology to get more oil from its small oil fields in the north of the country - 75,000 barrels a day from 10,000 barrels a day. A new discovery of oil would change the economy of the country and give it a source of hard currency, which is now obtained only from tourism. Even the previous claims against the country could probably be settled more easily. (Spanish Seek Oil off Cuba, as Americans Watch Silently) This makes it clear that oil is a product which was being used against Cuba by U.S..

Countries like China, Korea and Japan, none of whom had been very renowned for the production of petroleum have started taking great interest recently in the finding of petroleum within their own country. A few months ago, the trade minister of Japan, Shoichi Nakagawa took a flight in a coast guard plane belonging to Japan. This was to conduct a survey over the bright yellow gas production platform that is being constructed by China in waters which are a mile west of sea claimed by Japan. He then met a Chinese negotiator and dropped two straws in a glass of orange juice and said that China was now starting to "suck out Japan's resources with a straw." According to Japan the two deposits that are being developed by China have their gas even under waters that extend into Japan. This is happening because of the rapidly increasing oil prices. Japan is the second largest user of oil after United States and their demand is also increasing. (Drawing the Line on Energy)

There is a similar fight that is now taking place between Japan and South Korea regarding a disputed island group. This is seen in an announcement by the Korea Corporation in the middle of March that it was now trying to invest $225 million to develop gas hydrate deposits worth $150 billion. This quantity of gas will meet the needs of South Korea for 30 years. This is not unique as Even Japanese companies are busy in Sakhalin, which is a Russian island and was half owned by Japan up to the end of World War II. The investment is worth $1 billion a year. According to Japanese news agencies, the oil companies and trading houses of Japan are about to invest $20 billion for the production of oil and gas. This is double the level of what was being invested in the previous three years. All the activity has started as from 1960 both China and Japan believes that the waters lying between China and Okinawa Island have large quantities of oil and gas. (Drawing the Line on Energy) the newly emerging economies are also trying to find more and more oil for their economies to advance rapidly.

There is a lot of difference among the countries in terms of the amount they produce and in terms of the quantities they export. In terms of production the order is Saudi Arabia, United States, Russia, Iran, Mexico, China, Norway, Canada, United Arab Emirates, Venezuela, United Kingdom, Kuwait and Nigeria. In terms of exports, the order is Saudi Arabia, Russia, Norway, Iran, United Arab Emirates, Venezuela, Kuwait, Nigeria, Mexico, Algeria and Libya. It is clear that USA does not export as it consumes all the quantities that it produces. The need is for USA is to ensure that it gets all the oil it needs and that was probably the reason to attack Iraq. One of the persons contributing to that view was the Vice President Richard Cheney. In August 2002, he had declared that "armed with an arsenal of these weapons of terror, and seated atop 10 per cent of the world's oil reserves, Saddam Hussein could then be expected to seek domination of the entire Middle East, take control of a great portion of the world's energy supplies, directly threaten America's friends through the region and subject the United States or any other nation to nuclear blackmail." (America's disastrous energy plan)

Of course U.S. oil production is long past its prime, having occurred in 1970s and today the country imports about 11 million barrels a day. This is expected to increase by 2025 to around 20 barrels a day. The rest of the world also requires more oil as China is becoming a major importer of oil. There are lots of areas where oil is being found, but it is expected that two thirds of the world's oil will come from the Middle East and the Caspian Sea area even in 2025. This has led U.S. To try and secure its supplies from the Middle East through military methods. This has a large cost, and there are no advantages in getting petroleum at that price. The cost in terms of policing Middle East is around $70 billion and that is about $10 per barrel. The other cost is in terms of the unpopularity it has created starting with the stationing of troops in Saudi Arabia. That has helped the start of al Qaeda. That is also probably the main reason why U.S. does not want the policing in Iraq to be done by United Nations and wants to do it itself. The net result is that every time USA plays up to any regime in that area, the regime becomes unpopular. (America's disastrous energy plan) Thus planning for oil is an area where U.S. has not had great success.