Friday, December 09, 2005


This morning it was interesting to read that Kuwait is selling a boat load of BP shares right after reading that BP is producing steam at one of the last refineries shut down by Katrina. Oil supplies are looking better and better and yet "cold weather is pushing up the price".

Folks, cold weather should not be big news on December 9th. A little bit of cold weather is no big deal when crude supplies and distillate supplies are well ahead of last years numbers. The US just went back over 5 million barrels per day of production for the first time since Katrina hit. Refining utilization is now at 90% and was only at 94% last year at this time. The BP plant restart will drop the shut-in production down to 300,000 barrels per day, putting utilization back at last years level.

My figures come from industry analyst, James Williams of WTRG Econometrics. Williams has a public web site and subscription service. I have found his information to be highly reliable and I recommend his service.

The one area where I slightly disagree with him is in regard to the reasons for the current high prices. I tend to agree a little bit more with the Saudi's in this regard. The Saudi's contend and Williams agrees that they have excess capacity but the problem is that the excess is heavy or sour crude. The Saudi's believe that the new refineries being built will help solve the pricing problem as they will be able to refine these heavy supplies.

Williams offers valuable insight. He shows that the spread in the price of light versus heavy is up to $6 per barrel. This spread was about 75 cents in 2002. In percentage terms the spread has widened from 3% to 15%. My conclusion is that the completion of heavy crude refineries will reduce the price of oil. The availability of this heavy crude is just as good for the oil market as the discovery of 2 or 3 million barrels per day of new supply.

It is true that this is only a marginal improvement for the long haul. New discoveries will still be needed. The willingness to refine these heavier supplies will also serve to encourage gas to liquid and coal to liquid projects. The total cost including the refining cost for the heavy crude is closer to the total cost of converting other supplies.

Williams and I agree that we need more supplies and more refineries. I am not convinced we need many more refineries in the US. Growth in usage in the US has not been very strong for many years; about 1.2%. Conservation efforts, mandated by price, could slow the growth of consumption to nearly zero.

Developing nations need refineries. Many are on the drawing boards. Developing nations have been hit hard by the increase in price. Indonesia has cut back consumption by a significant percentage. Others, including China, are at or near zero growth for the year.

Cold weather is ahead but then it will go away. Cold weather is a very short-term and expected event. When crude traded for $12 in 1999, there was little drilling activity and little incentive to conserve. The intermediate term clearing price has been reached. Three years ago, drilling activity started picking up. Now there is a frenzy to find oil. Consumer’s attitudes have changed. Consumption growth has slowed. The current price is near the intermediate term peak. Three years from now, the price of crude will be at $40 or below! That's my story and I'm sticking to it.