{"id":609,"date":"2013-03-09T20:39:54","date_gmt":"2013-03-10T03:39:54","guid":{"rendered":"https:\/\/allenergyconsulting.com\/blog\/?p=609"},"modified":"2014-02-04T16:26:20","modified_gmt":"2014-02-04T22:26:20","slug":"refining-in-the-21st-century-part-1","status":"publish","type":"post","link":"https:\/\/allenergyconsulting.com\/blog\/2013\/03\/09\/refining-in-the-21st-century-part-1\/","title":{"rendered":"Refining in the 21st Century Part 1"},"content":{"rendered":"

\u201cLife can only be understood backwards; but it must be lived forwards.\u201d – S\u00f8ren Kierkegaard<\/p>\n

This is my thoughts on refining and where it is likely to go from here.\u00a0\u00a0 Why would\/should you care to listen to me?\u00a0\u00a0 I had the fortune to work at the beginning of my career at Purvin & Gertz Inc.\u00a0\u00a0 I had a great boss, Ken Miller, who unselfishly gave me his 30 years of experience in rather a short time period.\u00a0\u00a0 My 15 minutes of fame was used up early in my career.\u00a0\u00a0 I had the call of my lifetime when the oil markets collapsed in 1998.<\/p>\n

Months ahead I was at my desk managing the firms World Supply\/Demand balances.\u00a0 With my boss gone, a reporter, Beth Belton, from the USA Today called.\u00a0\u00a0 I discussed my concerns at that time and was quoted that \u201cIt was very possible there will be a price collapse to $10\/bbl.\u201d\u00a0\u00a0 As the cards turned out the market collapsed and in fact hit $8\/bbl.\u00a0\u00a0 At that level you might as well burn oil rather than refine it.\u00a0 This is important to understand if you want to understand refining.\u00a0\u00a0 The value of petroleum products becomes very dependent on the price of the feedstock.\u00a0\u00a0 If the feedstock becomes too low the products can only be valued so much.\u00a0\u00a0 As the feedstock price rise, so will the ability of the product price rise.\u00a0\u00a0 Many forecasters still fail to account for this simple concept.\u00a0\u00a0 I still see many forecasts try to revert to old absolute value refining margins in face of this current $100\/bbl environment.\u00a0\u00a0\u00a0 This is no longer your grandfathers’ market.\u00a0\u00a0 We have moved into a new world in understanding the dynamics of petroleum market.<\/p>\n

Part 1. How we got here<\/p>\n

I plan not to cover the history of oil as presented so well in The Prize by Daniel Yergin, but to unearth the recent shift in oil price.<\/p>\n

The sudden rise in crude oil prices in 2005 has been poorly explained in my estimates – see below.\u00a0 The crude oil markets are no different than any other commodity or goods other than its vast uses and requirements in modern day living.\u00a0\u00a0 The rule of economics of supply\/demand and price interaction applies.\u00a0 If we don\u2019t understand the past we will likely not understand the future.\u00a0\u00a0 There were two major forces to produce our current price regime.\u00a0\u00a0 The most talked about is the enormous demand of the developing countries.\u00a0\u00a0 However people stop there and make the assumption that the growth in those regions should explains the paradigm shift we see in prices.\u00a0 They don\u2019t take the time to explain how exactly the growth in those areas could cause such a high price response.<\/p>\n

\"\"<\/a><\/p>\n

If we pause and take a look back at the spike in 1979, we see the market acted rationally.\u00a0 There was a supply shocked placed onto the market amounting around 4.5 million b\/d.\u00a0 Annual prices moved up almost 3X in four years resulting in the first annual drop in world oil demand for three consecutive years (3% annum drop per year from 1979-1982).\u00a0 The market, then, entered into its new $20\/bbl paradigm.\u00a0\u00a0 The market had a few spikes with the Gulf War and other Middle East related issues, but overall the market was range bound.\u00a0 The growth from the 1980 to 1990 was around 0.7% per year.\u00a0 From 1990 to 2001 we saw demand rise by 2% per year \u2013 yet the price rise was relatively stable.\u00a0 Table below presents the change in demand in key areas.<\/p>\n

\"\"<\/a><\/span><\/span><\/p>\n

 <\/p>\n

Combined this with the price chart you get a fascinating picture.\u00a0\u00a0 Within 4 years from 2001 to 2005, prices had more than doubled and by 2007\u00a0prices\u00a0had moved up\u00a0larger than the spike from 1977 to 1980.\u00a0\u00a0 If you recall the previous rise resulted in 3 years of decline in demand, in this case nothing of the sort happened.\u00a0\u00a0 World oil demand continued to grow.\u00a0\u00a0 The reason for this is obvious if you examined the regions of strong growth.\u00a0\u00a0 China, India, and the Middle East represent over 80% of the demand increase from 2001 to 2011.\u00a0\u00a0 Each of these areas heavily subsidized the price of petroleum products for their citizens.\u00a0\u00a0 To remove any regional issues you can look at Mexico in the Other OECD category.\u00a0 Mexico continued their demand growth in face of significantly higher prices while both US and Canadian growth declined.\u00a0\u00a0 Mexico was able to do this because of the subsidies supplied by the Mexican government to its citizen.<\/p>\n

The cure for high prices is high prices, but when the majority of the growth of oil demand does not see high prices; this causes an exponential price response.\u00a0\u00a0 The demand response was shifted to the baseload demand in other regions.\u00a0 This is how the demand growth of the other regions impacted our price so significantly.\u00a0\u00a0 It really is a trade issue.\u00a0\u00a0 However for some reason this has escaped most of the pundits and the government officials.\u00a0\u00a0 For the regions which exports oil, this was their bonanza.\u00a0\u00a0 They got the rest of the world in essence to pay for their internal subsidies.\u00a0\u00a0 Countries like China and India, they made a bet that the cost of the subsidy represented enough value for maintaining growth and civil obedience.<\/p>\n

The \u201cfree\u201d market countries basically got taken for a ride.\u00a0\u00a0 One could say those who are subsidizing pay for it, but the question is who is getting paid and who really pays.\u00a0\u00a0 I believe without this discussion and issue being brought to the forefront, many pundits misforecasted \u00a0their outlook. \u00a0\u00a0People expected an economic response to pull price back down, but it never came.\u00a0\u00a0 By itself one would think prices this extreme \u00a0(nearly 4X that of the previous price level) should start modifying behavior and planning.\u00a0\u00a0 However, demand and subsidies by itself cannot rationalize the extreme\u00a0new price regime.\u00a0 It is the second reason that people fail to even consider to be a part of this historic price rise \u2013 Monetary Policy.<\/p>\n

\"\"<\/a><\/p>\n

The chart above clearly shows the rise in US money supply began a new path in 1998 and accelerated in 2001.\u00a0 This was all done under the Greenspan’s thinking that we could avoid a recession through monetary policy, known as the Greenspan Put.\u00a0\u00a0 It started in late 1998 while Greenspan initiated his first experiment by lowering rates to help recapitalize Long-Term Capital Management L.P. (LTCM).\u00a0 Many have deemed this a success in the early 2000\u2019s and for that Greenspan, Robert Rubin and Larry Summers graced the cover of Time magazine.<\/p>\n

However no good deed goes unpunished.\u00a0 As I have noted several times on my blog, spending what you don\u2019t have, always will feel good in the moment.\u00a0\u00a0 If you can spend without a credit limit you would probably be happy for the next 30 days before the bill comes.\u00a0\u00a0 In the case of government spending, they never were forced to pay the bill \u2013 yet.\u00a0\u00a0 The US is riding a credit card bill that has a perpetual moving due date with low interest.\u00a0\u00a0 When you increase debt you are in essence borrowing from the future growth.\u00a0 In fact when you think about it, monetary policy is subsidization but in a more obfuscated form.\u00a0 Society does not really see the true cost until much later.\u00a0 Is there any difference to that and ignoring climate change? (for a future discussion).<\/p>\n

The new trajectory in essence has further discounted the value of the currency as compared to the expected value.\u00a0 At some level the market begins to realize this issue as excess money cause asset values to rise, such as commodities.\u00a0\u00a0 As a consequence many have suggested to blame traders for the run up in prices, partially true but more symptomatic\u00a0as excess money\u00a0usually tries\u00a0to find a home.\u00a0 I ran multiple regressions from demand to population but no variable by itself produces a better correlation than money supply to the price of oil.\u00a0\u00a0 If we take the former trajectory of money supply and compare it where we are now, the monetary impact would be 40%.\u00a0\u00a0 This would in effect suggest without monetary impact the price of oil would be more in the range of $60\/bbl vs. $100\/bbl.\u00a0\u00a0 This price still represents a strong price rise of over 2X from 2001 prices. \u00a0\u00a0Remember the 1979 issue saw a price rise of 2.6, but in seven years the new price regime settled at 2X.\u00a0 The combination of demand growth with subsidies for the growing regions along with monetary policy has given us our current landscape and\u00a0both of these factors\u00a0allows us to\u00a0understand our current situation with our past.<\/p>\n

Part 1 will be continued as we talk about the refining side of the picture and then move on to Part 2 where\u00a0I plan to cover where we are going.\u00a0\u00a0\u00a0 I look forward to your comments and feedback.\u00a0\u00a0 Please do consider All Energy Consulting for your energy consulting needs.\u00a0\u00a0 I offer a unique blend of Oil, Gas, Coal, Power, and Renewable Experience.\u00a0 I have been blessed to have a very dynamic career, allowing me to continually grow which is perfectly situated to help your company not to be static in this ever changing world.\u00a0 I can offer my own forecast, or better yet, help you develop one, including many scenarios.<\/p>\n

Your Energy Consultant,<\/p>\n

David K. Bellman<\/a><\/p>\n

614-356-0484<\/p>\n

“How you gather, manage, and use information will determine whether you win or lose.”\u00a0 Bill Gates<\/p>\n","protected":false},"excerpt":{"rendered":"

\u201cLife can only be understood backwards; but it must be lived forwards.\u201d – S\u00f8ren Kierkegaard This is my thoughts on refining and where it is likely to go from here.\u00a0\u00a0 Why would\/should you care to listen to me?\u00a0\u00a0 I had the fortune to work at the beginning of my career at Purvin & Gertz Inc.\u00a0\u00a0 […]<\/p>\n","protected":false},"author":1,"featured_media":35,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1,26],"tags":[40,197,49,66],"class_list":["post-609","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-market-insights","category-oil-petroleum-products","tag-demand","tag-monetary-policy","tag-oil","tag-subsidies"],"_links":{"self":[{"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/posts\/609","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/comments?post=609"}],"version-history":[{"count":23,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/posts\/609\/revisions"}],"predecessor-version":[{"id":615,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/posts\/609\/revisions\/615"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/media\/35"}],"wp:attachment":[{"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/media?parent=609"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/categories?post=609"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/allenergyconsulting.com\/blog\/wp-json\/wp\/v2\/tags?post=609"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}