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Thesis & Antithesis

A critical perspective on energy, international politics & current affairs

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Location: Washington, D.C.

greekdefaultwatch@gmail.com Natural gas consultant by day, blogger on the Greek economy by night. Trained as an economist and political scientist. I believe in common sense and in data, and my aim is to offer insight written in language that is clear and convincing.

25 August 2006

Difficult bargains

On Tuesday, Alaska Governor Frank Murkowski suffered a humiliating electoral defeat, coming third in the Republican primary and securing only 19% of the vote. The reasons for his defeat vary—the Wall Street Journal believes “incumbent arrogance” is the problem—but negotiations for the building of a gas pipeline from Alaska through Canada and into the United States has to rank high among his constituency’s grievances.

The idea of a natural gas pipeline linking Alaska to the Lower 48 has been floating for years, and Gov. Murkowski has been an ardent supporter. As governor, he negotiated with the oil companies involved—ExxonMobil, BP, and ConocoPhillips—about the terms under which the pipeline would be built. At issue was the tax rate that would apply to earnings from the oil companies’ operations in Alaska as well as tax breaks on investment that were meant to make the capital expenditures for the pipeline more attractive.

After the governor came to an agreement with the oil companies, however, the Alaskan legislature voted into law a bill that varied from the governor’s initial agreement. The version that became law last week imposed a higher tax rate on net revenues, and also increased that rate as oil prices went higher. Needless to say that the oil companies and the governor were not pleased, and it remains to be seen how this different law will affect the building of the pipeline.

What this story underlines, more broadly, is the difficulty of striking a bargain between state and company when it comes to oil and gas. Venezuela and Bolivia, for example, are accused daily of bullying oil companies and of being inhospitable to foreign investment. It is easy to assume that such issues are the purview of “dysfunctional” polities in the developed world. But Gov. Murkowski’s failure in the Republican primary ought to remind us that finding a proper way to split revenues between the people and the oil companies is always an arduous task.

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09 August 2006

Oil companies in the wilderness

A New York Times editorial on the lessons of Prudhoe Bay writes that, “the BP fiasco also reminds us why we should not put the fate of America’s wilderness in the hands of the oil companies.” It is interesting, then, to read that the fiasco has prompted a different reaction on who live in the “wilderness.” Alaska governor Frank Murkowski called on lawmakers to support his proposal for the construction of a gas pipeline that will bring gas from Alaska to the Lower-48 through Canada as a way of diversifying the Alaskan economy.

True, a gas pipeline poses less of an environmental threat than an oil pipeline, and true too that there is still political infighting before the proposal gets approved by Alaskan legislators. But it is interesting to see how different the lessons are on those who live in the “wilderness” and earn their living (plus a check from oil royalties) through the oil business.

References:
“Lessons from Prudhoe Bay,” New York Times, 9 Aug 06 (link)

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08 August 2006

A conspiracy in Prudhoe Bay?

Greg Palast never ceases to amaze me; this is his take on BP shutting production at Prudhoe Bay: “Why shut the pipe now? The timing of a sudden inspection and fix of a decade-long problem has a suspicious smell. A precipitous shutdown in mid-summer, in the middle of Middle East war(s), is guaranteed to raise prices and reap monster profits for BP. The price of crude jumped $2.22 a barrel on the shutdown news to over $76. How lucky for BP which sells four million barrels of oil a day.” (link)

Begin with the main error: BP does not sell 4 million barrels a day; it sells 4 million barrels of oil equivalent. Oil production, according to the company’s annual report, was closer to 2.5 mbd in 2005 with the rest being natural gas. (It is actually amusing to see him get this wrong given that he writes, in his bio, that he is “an energy economist.”)

Do the (big picture) math: 2.5 mbd x $2.2 rise in prices comes to $5.5 million a day. What about the loss? From the 400 kbd shut-in, BP is entitled to about a quarter (even less—92,000—by some estimates). So the loss is 92 kbd x $76 is about $7 million a day (even if you discount the oil price, given that Alaskan oil is heavy, the difference is still large). The monetary loss is larger than the gain (puting aside all other issues to reputation, etc.). This is hardly “monster profits.”

If you want to make more accusations, Mr. Palast, at least begin with getting your facts straight.

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07 August 2006

Are refiners to blame?

That domestic refining shares the blame for high gasoline prices has been a political accusation for a while now; in April 2006, for example, Senator Charles Schumer (D-NY) accused refiners of keeping plants off-line as they switched to summer fuel blends to keep prices high. Now the attack has come alive again, prompted by a report by Jeff Donn of the Associated Press (link), which claims that gas prices are high because of market power in the refining sector.

The arguments made in the report merit close attention, even though, after close examination, they lose much of their potency. But before turning to the report, here is a graph to get the argument going: it plots the price of gasoline based on where the money goes—crude oil, refineries, distribution & marketing and taxes. Two trends are clear: first is that an ever smaller percentage goes to taxes (since most taxes are unit taxes that do not increase with prices) and second, that more and more money goes to crude oil. Refining and marketing, on the contrary, have retained an almost constant share (a volatile one too) of the final price of gasoline.

What does this say about the AP report? Mr. Donn writes that, “Crude oil [accounts] for just under half the price of gasoline.” Although he writes this to explain the industry position that high crude oil prices lead to high gasoline prices, implicit is the idea that this is not too much (I am reading between the lines here). After all, Mr. Donn writes that, “A big chunk of gas prices -- almost a fifth -- pays refiners who make gasoline from oil,” suggesting that he thinks these numbers important.

The first issue is that how much of the overall gasoline price goes to crude oil is irrelevant; what is important is how much of the change in gas prices can be attributed to changes in the price of crude (in econometrics lingo, how much of the variance in one variable can be explained by variance in other). In a study I did for gasoline prices and crude oil between January 2000 and January 2006, that number was 0.91, meaning that 91% of the change in gasoline prices can be explained by changes in crude oil prices (time series models usually yield very high results anyway, though I did use a control trend variable).

The other interesting number is that the coefficient is 0.80 implying that a 1% change in crude oil prices leads to a 0.8% in gas prices (I used logs; also, I did not test, as the AP did, whether whether prices rise and fall by the same proportions, although I will get to that). These numbers may seem high, but they are consistent both with a look at a graph plotting the two variables (the two really high gas values were September and October 2005 following Hurricanes Katrina and Rita), as well as with other studies (look at the Cato study in the references).

The AP report then goes on to look at refining margins: the difference between input costs (crude oil) and output prices (gasoline and distillate). Below is a graph with that spread, with data taken from the BP Statistical Review of World Energy 2006; one thing to note is that margins have gone up for all three major refining centers, not just the United States (the spike in the US in 2005 is, again, due to Katrina and Rita). If market power alone explained refining margins, there should be a dissimilar pattern in margins (unless we assume that those two centers also have concentrated market power); we would also expect a more consistent upward trend in prices since industry consolidation (in refining) has dated to the early 1980s (after the repeal of the Emergency Petroleum Allocation Act in 1981).

But are there other reasons to expect margins to increase? The AP reports writes, “In a competitive market, when raw material gets more expensive, margins typically shrink, economists say.” This is not necessarily true when demand for the final good is inelastic (as gasoline is). What is more, refineries are capital-intensive industries that exhibit considerable returns to scale. No refinery has been built in the United States since 1976, but overall capacity has increased all the same from 15.2 mbd in 1975 to 17.3 mbd. This has been achieved through capacity expansions at existing refineries and through efficiency gains (for example, by adding catalytic hydrocracking processes that increase the amount of gasoline or diesel that can be extracted from a barrel of oil).

A second reason is that oil coming into the United States is heavier and sourer. The average API gravity of crude oil inputs into US refineries has decreased from 32.64 API in Jan. 1985 to 30.25 in Aug. 2005, and the sulfur content has increased from 0.88 in Jan. 1985 to 1.40 in Aug. 2005. In simple terms, this means that refining is harder because refineries need to make premium content from lower quality inputs. As refining gets harder, it is reasonable to see higher margins, particularly for refiners that can process lower quality crudes. Also, in tight markets, the premium between high and low quality oil increases further given that refiners bid up the price of higher quality crudes much faster than low quality crudes.

Two more points to make: the first is that refining is a separate business, related but not identical to oil. Oil prices reflect the scarcity of oil, and similarly, gasoline prices reflect the scarcity of refining capacity. In 1983, utilization rates were 72% in the United States; in 2004 they were 90.3% in 2005. The scarcer a service becomes, the more valuable it is; no collusion is necessary.

The second is that quality differentials are having a major impact because they limit intra-US trade (the so-called “boutique fuels”). At some point there were 17 different gasoline standards nationwide, although this is set to decrease due to the Energy Policy Act of 2005. But different standards mean that having a surplus in one state and a shortage in another will not necessarily lead to trade. Add to that Congress’ effort to phase out MTBE and replace it with ethanol rather quickly, and this too has created constrains in the refinery market.

What about the idea that prices change asymmetrically: “The Associated Press analysis looked at weekly federal pricing data since September 1999. It found that a gallon of retail gas rose an average of 6 cents for a 10-cent rise in oil, but dropped only 4 cents for a 10-cent decline in oil -- suggesting that gas temporarily resisted downward shifts more strongly than oil.” This is important, but the report offers various reasons that are very persuasive (price stickiness or retailers trying to maximize profits), even though they are dismissed by the author. (Another issue is to examine whether this discrepancy disappears when we use lagged variables—essentially a lower crude oil prices will have an effect after some time given that a refinery still purchased past oil at a higher price and is more inclined to charge more for it.)

In the end, market concentration is surely a concern, although this trend has more to do with the regulatory problems (and adverse economics) involved in building refineries than in any specific design for collusion. It is frustrating to think that an American living in Wyoming will pay more to drive to work because China is buying more oil, or because Kuwait has struggled for ten years to pass a law that will boost foreign investment in its oil sector, or because nearly all of the oil revenues in Mexico go to the government leaving little for re-investment. But it is no less true.

*

Despite my overall criticism, I am glad that the AP did this study. This has been a popular issue for quite some time and the evidence to examine it has been absent from public debate. It is depressing to hear so many politicians discuss this topic without spending some time to study it methodically; it is even more depressing to think that when I did my own study (for a class), all it really took me was some knowledge of statistics and five-six hours on a Thursday afternoon.

References:
Unless otherwise indicated, data comes from the Energy Information Administration; Nick Snow, “Schumer seeks probe of refining capacity utilization,” Oil & Gas Journal Online, 19 April 06;
Peter Van Doren and Jerry Taylor, “Economic Amnesia: The Case against Oil Price Controls and Windfall Profit Taxes,” Cato Institute Policy Analysis (12 Jan 06); Franz B. Ehrhardt, “Refining and price,” Oxford Energy Forum, August 2005; Bob Williams, “Refiners’ future survival hinges on adapting to changing feedstocks, product specs,” Oil & Gas Journal, 11 Aug 2003; “Margins soar,” Petroleum Economist, September 2004; “Attention to refining,” Oil & Gas Journal, 26 Sept, 2005; “Big profits, big decisions,” Petroleum Economist, September 2005; David Nakamura, “Refining industry to sustain strong margins through 2004,” Oil & Gas Journal, 15 Mar, 2004; “Devising a winning strategy,” Petroleum Economist, September 2005

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The virtues of populism

Last Thursday, union workers picketed facilities belonging to the Colombian state oil company, Ecopetrol. Their grievance was a government plan to sell off 20% of the company (not to privatize it fully, repeats the government) in order to raise capital and allow it to explore further in the country. The workers doubt the government’s sincerity and see the in plan the seeds of privatization. So they protested.

So often when I read of Hugo Chavez’s latest shenanigans, I get sad to think how bad populism can be for a country. But now I read this news from Colombia (news that has replicas around the world) and I am reminded of just how hard it is to take on the street. No wonder Chavez (and Morales, and others) just decide to ride the wave of populism rather than try to counter it.

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When the good oil company gets hit

There is irony in the news that BP has stopped operations from Prudhoe Bay due to corrosion in the pipeline system that comes from the field: in an industry with few friends, BP has been an exception, led by the statesman-like CEO Lord John Browne and having a commitment to alternative energy that has earned it many friends in and out of the oil business.

It is ironic, then, to see a company that has developed such a positive image be hit by a wave of misfortune: first came a fire in a Texas refinery in March 2005 that killed 15 and injured 170; then were oil spills in Alaska that culminated in the current shutdown; and in June, regulators charged BP with trying to manipulate the propane market in the United States.

All this comes amidst an internal fight in the company which brought Lord Browne to butt heads with company chairman Sir Peter Sutherland about whether Browne would be forced to retire when he turned 60. A compromise followed by which Browne would step down in the end of the calendar year that he turned 60 (2008), about 10 months after his birthday.

Investigations that will follow may weigh more heavily on BP’s responsibility for the oil spill and the accusation on market manipulation. (BP accepted responsibly for the fire at the refinery.) This will show whether BP has had more than just misfortune.

Even more ironic, however, is that ExxonMobil—a company which a far greater reputation for efficiency in the industry (which includes environmental protection at operations)—is still bedeviled by outsiders, at a time when the same people (I include myself here) hail a company such as BP for its corporate responsibility. I guess there are worse things that being ruthlessly efficient.

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05 August 2006

Rebelling from afar

From the Wall Street Journal on Fidel Castro: “Of course it may be no coincidence that most of the admiration all these years has been from afar. The idea of "Fidel" allows his leftish admirers from the comforts of free, mostly capitalist societies to imagine that someone out there is struggling to build a better, more egalitarian way of life -- without any of them having to live amid the daily Cuban reality of grinding poverty and political intimidation.”

This reminds me: one of teachers on the Middle East always likes to point out how the radicals on the Palestinian issue were (and are) so often those far removed from the West Bank and Gaza. It is much easier, it seems, to be adamant and uncompromising from Baghdad or Cairo … just as it easier to earn revolutionary praise from those who are unaffected by your cruelty.

References:
“Romancing Fidel,” Wall Street Journal, 5 Aug 06

04 August 2006

Oil costs what we pay for it

(This is a post I made to an online discussion poll conducted by the Financial Times (link). The question was: Can the world live with oil at $80 per barrel?)

It is almost pointless to ask “Can the world live with oil at $80 per barrel?” For the past few years, the world has lived with very high oil prices and has actually fared quite well, at least at the macro-level. True, economic growth may be starting to slow in some places, but this is often attributable to factors unrelated to oil. Today’s oil crisis is hardly a replica of the 1970s when economists had to coin a new term—stagflation—to describe the peculiarity of the predicament that had befallen upon us.

The reason that the world has coped with high prices is that the price hike is demand driven. Just like any other product, the price of oil is driven both by fundamentals (what it costs to produce it and how scarce it is) and by the market’s willingness to pay for it. Usually prices settle in between these extremes, even in a market where politics tamper with prices all the time. This means that prices are at $75/bbl because firms and individuals think that buying oil at that price is better than not buying oil at all. Ultimately all prices reflect their marginal product and so oil prices will keep rising until the cost of a barrel exceeds its utility for firms and individuals.

The risk that we face today is twofold: first, fuel inflexibility may be forcing buyers to pay for oil a higher price than they can afford. But, thankfully, this is only a short-run issue, and given the economy’s resilience in dealing with higher prices, a longer-term adjustment may not be too painful. The second risk is an asymmetrical ability to pay for oil: given that oil prices are set at the margin, a problem exists if the marginal buyer can set prices that are too high for other consumers. Many fear that China is playing that role today given its ability to grow despite higher oil prices. But this risk, however, is less acute when an overall slowdown in demand will help bring prices down.

In other words, it’s not whether the world can live with an $80 barrel oil; rather, the price of oil will mostly reflect what the world can live with.

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01 August 2006

The other Hugo

There is no end to the trouble that Hugo Chavez seems to be causing around the world. His most recent extravaganza was a world tour that included buying arms from Russia, a few handshakes with Mahmoud Ahmadinejad of Iran, and a feeble attempt to shore up revolutionary credentials by visiting an erstwhile American enemy, Vietnam.

But whatever the bombastic rhetoric, there is a pragmatic side to Hugo Chavez, as is evident by two pieces of news from Caracas. The first is that Venezuela and Colombia have begun constructing a gas pipeline that will link Colombia to the remote Venezuelan region of Zulia (link); for seven years, Colombia will export gas to Venezuela, which will return the favor once it develops its own gas fields. The second is that Venezuela has almost reached an agreement with Trinidad and Tobago to develop jointly cross-border fields that hold approximately 10 tcf in gas reserves. Technical details are the only remaining issues to be worked out by the countries.

Not meaning to overstate the significance of the news, but remember that both Colombia and Trinidad & Tobago are American allies, and that Venezuelan relations with Colombia have been inimical for years. That there is a pragmatic side to Chavez may not mean much, but at least in a world that lives with constant insecurity, to see a country such as Venezuela deepen energy ties with neighbors that hardly share Chavez’ enthusiasm for Bolivar is heartening.

References:
Curtis Williams, “Venezuela, Trinidad to jointly develop fields,” Oil & Gas Journal Online, 25 Jul 06

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