June 02, 2008

Oil, Gas and Rising Prices

A couple months ago, I mentioned my new job as a tax accountant within an industry (as opposed to an accounting firm).  Today, I'm going to talk about that industry a bit.

I work in the Oil and Gas industry, aka the Petroleum industry.

For those of you who didn't already know that, I'll give you a minute to let it sink in since it seems so at odds with the environmental lifestyle I try to live....

I truly enjoy my job, and I'm proud of the company I work for.  I won't name them, but I will tell you it isn't one of the big American companies.  My company drills for oil and gas here in New Zealand, mostly off-shore.  And not only do they hold very strict safety standards for all employees on- and off-shore, but they meet with local Maori iwis and NZ DOC before beginning any project.  

I would say more about my company, but I'm not sure how much I can say without violating confidentiality, and it's not really the point of my post today.  The point is the industry, and explaining a bit how it all comes down to that price per barrel and huge profits you hear about on the news.   Part of this post was inspired by an excellent course I attended for my job, "An Introduction to Petroleum Exploration", as well as a blog post from my friend Arthur.  

1) Oil fields are owned by governments.  The companies who drill oil fields can only do so with permission from the governments who "own" the fields.  Each country handles the situation differently - some demand a large stakehold (i.e. 80% or more) in the business, but most have their own geologists determine where oil and gas fields may be located, then open the land for bids.  Many bids do not involve upfront payments, but some do.  

Typically, a company is bidding for the right to explore the land and is promising to drill a set number of wells in a certain amount of time.  If the winning company does not honor that promise, the permit area can be taken away from them.   A typical exploration 'work program' (exploration and drilling three wells) over 5 years can cost approximately $40 million.  That's all before finding oil or gas, if any is ever found.  Nine out of 10 wells are 'dry'.

If oil and gas are found, the government will charge either a 'windfall tax' (typical in South America) or royalties based on the volume or dollar amount sold.  Additionally, the profits of selling the oil and gas are taxed via income taxes.

2) Oil and gas are not free-flowing.  I have never been a science person, so this was all news to me!  I've always been under the impression that oil was just under the ground somewhere, sitting around like a big oily lake.  Nope!

Oil is the leftover bits of animals that lived a long long time ago, crushed into a liquid.  That liquid is trapped in porous rocks millions of years old.  Just how many millions of years ago depends on the continent.  In New Zealand, oil and gas is found in rocks of the Mesozoic (specifically Triassic) age, while in the Middle East, oil/gas is found in older rocks.

Since the oil is not free-flowing, it must literally be sucked out of the rocks.  Typically, drilling down that far into the earth creates enough pressure to draw the oil and gas out to the well and up to the surface.

3) Oil naturally leaks to the earth's surface.  Oil floats on water.  And while oil is trapped in rocks, water is too (from ancient lakes and rivers).  As the oil finds water, it floats to the top, going from rock to rock until breaking out onto land, or into oceans.  Scientists in the US estimate that 700,000 barrels of oil per year naturally leak into the Gulf of Mexico!

'Back in the day' oil leaked to the surface quite regularly - esp in Texas.  It is not always an indicator that an oil field is directly below the leak, but back then, there was a fair chance.  The world is running out of such easily found oil, and Oil companies are having to explore more and more remote regions, increasing the cost of exploration and drilling.  

4) Exploration is primarily guesswork.  As oil can and does naturally leak towards the surface, there are no sure places to find oil, even when looking in the correct 'age' of rocks.  Many events happen over time to affect rock layers, and only porous (sedimentary) rocks will contain oil or gas.  Since geologists cannot slice open the earth to see what's going on down there, seismic reflection  studies must be done.  Even the results of these studies can be misleading, however.  In the end, a well must be drilled to be certain. 
(Image courtesy of Geosphere, Inc.)

5) Not all oils are created equal.  This is where I tell you about the barrel price.   Oil is either 'sweet' or 'sour'; it is classified by the amount of sulfur within the oil.  A sweet crude takes much less refining than a sour crude.  Typically, sweet crude is used for petrol (automobile gasoline), while the sour crudes are used for petrochemicals.   As you can imagine, sweet crude is much more valuable than sour crude.

The ever-increasing price you see on the news is based on a West Texas Intermediate (WTI) sweet crude. It is not an average price; it is the price of a barrel of that particular oil in Texas.  Sweet crude from New Zealand commands a higher price per barrel, while sour crude from the Middle East is priced below the WTI.  

This explains why you'll hear of countries exporting as well as importing oil.  A particular country may produce and export sour crude, but still need to import sweet crude.  

6) Many everyday items are made using petroleum.  I'm sure this isn't news.  However, this fact often gets lost in the hubbub of rising gasoline prices.  Some of the products include:

Aspirin (the coating on tablets)
Ballpoint pens
Disposable diapers
Golf balls
Lipstick, mascara, nail polish
Soft contact lenses
Toilet seats
Water pipes

7) Before oil there was whale blubber.  The industrial revolution was fueled by oil.  Back then, whale blubber was the primary source - it was melted down from slaughtered whales and made into candles and lubricants for machinery.  

To summarize -

It is easy to blame the big bad oil companies for drilling into our precious earth to retrieve oil and sell it at what we believe are exorbitant prices.  And many people will get upset and picket particular gasoline companies (which has no effect - read this article to see why) or suggest that world governments should do something to make sure oil isn't so expensive that we can't continue to live our modern lives.

As evidenced above, world governments profit from oil and gas drilling and sales. In fact, some world governments own percentages of oil companies.  However, since the governments 'own' the land, they also control where companies can drill, and regulate the safety of on- and off-shore operations.

Surely, then, the oil companies are slowing production or hiding oil...?  Yeah, don't think so.  The world is running out of oil, and it is not something that can be created.  It is even possible we have reached 'peak oil'.  As oil companies search for oil in more remote places, the cost of exploration increases, as does the environmental impact.  Exploration is very expensive as it is, and most (if not all) oil and gas companies generate huge losses for several years before finding oil.  

A common model for an oil and gas company is to have huge expenses up front, followed by (hopefully) large profits with low expenses as the discovered oil fields produce oil to sell.  And as oil is a very sought after commodity, when the price of a barrel of oil rises, oil companies make profits.  They need to, in order to continue exploring for more oil as demand increases daily from industrialised nations.  Even so, the profits you hear about on the news aren't necessarily the whole picture; accounting profits and tax profits are calculated differently, and often accounting profits are shown pre-tax and certain other expenses.

Then the Middle East must be to blame...?  As mentioned above, most of the oil from the Middle East is sour crude; it is primarily used for petrochemicals.  In fact, the US gets most of its sweet crude from Canada and South America.  Any oil from the Middle East must go through extensive refining to be used for gasoline.  And if the refineries are overwhelmed, the supply will be slowed.  

The relationship between the price of a barrel of oil, to the price at the gas pump to an oil company's profits is not a simple one. There are many complicated factors involved, including oil companies selling oil to each other and the refining process.

The only sure action to bring down the price of oil is to lower consumption of gasoline and petrochemicals.  If governments interrupt the free-market and lower the price of oil artificially with taxes, individuals and industrialized nations as a whole will continue to consume oil at the current pace (if not faster).  There would be no incentive to do otherwise.  Products other than gasoline are also increasing in price because many of them are made with petroleum, or moved from place to place via vehicles that run on gasoline.

If oil disappeared tomorrow, how sustainable would your life be? How many plastic items do you rely on each day? Personally, I rely on heaps.  The soup I eat most days for lunch comes in a plastic container, and I reheat it in a reusable plastic cup.  I wear lotion and makeup every day, and shower with shampoo, conditioner and soap that are all contained in plastic bottles.  I drink water from a reusable plastic bottle all day.  I walk to work most days, but sometimes I take a bus that is fueled by gasoline.  I ride in the elevator most days 10 floors up to my office - an elevator that has working parts and needs lubrication to keep going.  

And I work for an Oil and Gas company.  A company that will disappear with no oil or gas to drill and sell.  

Alternative energy sources are definitely a viable option.  But will we ever find enough sources to satisfy the increasing demand?  


Arthur (AmeriNZ) said...

This was certainly among the most generally informative blog posts I've ever read. In fact, you explained more about petroleum, and more simply, than any news media article I've seen. Thanks!

The biggest problem with this whole issue is that, as you say, it's not simple. In fact, it's so complex, with layer upon layer of complexity, that ordinary people feel as if there's little they can do. But there are things we can do, and we each need to find those things.

After reading this, I think that maybe we bloggers should start focusing more on solutions and less on what got us to this point (which becomes like arguing how many angels can dance on the head of pin). I'll do my part!

Karen said...

Amazing post! I'm definitely passing it along. :-)

Marrisa said...

Wow you are kicking out some good posts lately! This is a cracker - so well written and I learned heaps from this in a very simple way so thanks (god knows how long it took you to do!!).

I would like to say we wouldn't be affected by any changes but who knows? I for one though think there should be more focus from the government by getting people to realise all this - maybe then more people would pull together. Yeah, maybe not too.

Anyway, good post sweetie!! Off to read the one with the duck photo on it!! xx