We like to watch the O'Reilly Factor on FOX.  It's enjoyable entertainment.   The other night he expounded on the price of gasoline. He wants to boycott Exxon Mobil because he believes the company is charging too much for its gasoline.  And besides, the company makes too much money.

Nonsense.   

Bill.  You have spun into orbit.  Boycotting Exxon Mobil may make you feel good, but it will not bring down the price of gasoline. You have obviously failed to do your homework on the subject of world oil production and consumption, oil resource depletion, or how these factors impact the price of gasoline.

A Few Facts

According to the United States Department of Energy (DOE), fossil fuels – coal, oil and natural gas -- currently provide more than 85% of all the energy consumed in the United States, nearly two-thirds of our electricity, and virtually all of our transportation fuels.  Moreover, despite the development of alternative energy solutions, America's reliance on fossil fuels is actually projected to increase.

Gasoline, one of the main products refined from crude oil, accounts for just about 17 percent of the energy consumed in the United States. Most of the gasoline we use is pumped through a network of pipelines from a refinery to a local distributor, who then sends it by truck to one of our nation's 168,987 gasoline stations.

The following chart shows that the average retail price for a gallon of regular gasoline in the United States increased by 19 percent in the four year period from 2000 to 2004. If, as expected, the average price reaches an annual average of $2.86 for all of 2006, it will have increased by another 55 percent in two years. The chart shows refining, distribution and marketing, taxes, and crude oil costs as a percentage of the price you pay at the pump. In 2004, 15 percent of the price you paid ($1.56 per gallon) went to refine the gasoline you use. Another 14 percent went to cover the cost of moving that gallon of gasoline to the pump. Federal and State taxes added 27 percent to the price of regular gasoline. Less than half of the money you spent (44 percent) actually went to the owners and producers of crude oil.

A Profile of the Price You Pay for Regular Gasoline

* Estimated.   Source Data: EIA/DOE. Percentages are based on national average costs. Because of variations in local tax codes and distribution costs, these percentages will vary by region.

But all of these percentages change as the price of crude oil increases. The higher the cost of crude oil, the greater impact it will have on the price of gasoline. If the estimated national average price per gallon of regular gasoline reaches $2.86 in 2006, it will do so because the price temporarily exceeds $3.60 before the end of September. In California, environmental regulations could briefly drive the  price of regular gasoline to more than $4.00 per gallon.

Historically, the price of gasoline has been quite volatile. That will not change. Even if we do nothing, economic and cultural forces beyond our control will continue to drives prices up and down. It would not surprise me if the average national price for a gallon of regular gasoline temporarily dropped below $2.50 per gallon. But don't be deceived by a short-term price decline. A price above $4.00 per gallon of regular gasoline is equally possible.

Supply Vs. Demand

We can mitigate the upward trend in gasoline prices, and - of course - the coincident increase in the price we pay for diesel, heating oil, and propane fuels.  All of these fuels are made from oil.  All we have to do is either increase the supply of oil, or decrease the demand for products we make from oil.

Increasing the supply of oil would certainly ease the upward pressure on gasoline prices. We can drill for oil off our coasts, there is more oil to be had in Alaska and the Arctic, and new discoveries promise additional oil in Africa and South America.

Unfortunately, there are two problems with the supply side:

1. Even assuming we know where the oil is located, it takes 5 to 7 years from the date you say "Go" to bring a new field on-line.  Existing and planned drilling programs will not provide us with enough additional oil to bring down the price of gasoline in 2006.

2. Projected increases in the supply of conventional oil from all known drilling programs, less the rate of depletion at existing oil fields, will not exceed the projected long term growth in world-wide demand. Although in a "Best Case" scenario, production may occasionally exceed consumption over the next few years, oil shortages are inevitable. It's not a case of "if". It's only a question of "when".  And that simple fact, Dear Bill, will raise hell with the price of gasoline.

Why?  Because oil is a finite resource and we humans are running out of easily accessible (low cost) conventional oil.  That's what "Oil Depletion" is all about.  And it is very clear to me that oil depletion has already begun to impact the price and availability of oil.

But there is some good news.  If there is a sufficient decrease in demand, production will exceed consumption, and the price of oil will come down.  The nations that own the world's oil reserves have a tendency to over-produce in order to protect the stream of revenue they receive from the sale of oil.  Competition for the available market will thus force the price down.  If the price of oil declines, the price of gasoline will decline.  

So we do have a demand side solution to the high price of gasoline.   Use less. 

Here are two specific ways to use less gasoline.

1. Decrease personal consumption.

If we make fewer and shorter trips in our cars and trucks, we consume less gasoline. Everyone can participate. Our children can walk to soccer practice.  We can car pool, ride a bicycle, use public transportation, and telecommute to work. There's an almost endless list of ways to curtail our driving. We can also junk our gasoline powered water craft, lawn mowers, airplanes, quads, dirt bikes, tools, and equipment. And finally, when we do purchase a gasoline powered vehicle or product, we can chose one with a smaller motor.

Projection. Highly likely.  Consumers, already feeling wallet pain at the pump, will make minor adjustments to their life-style. The average  price per gallon will come down.  But not by much.  Deep price cuts would require a substantial change in consumer lifestyle.

2. Have a recession.

Nothing reduces the price of oil like a really bad world-wide recession. Oil demand growth is moderated by declining employment and business activity. The longer and deeper the recession, the longer the price of gasoline will be (comparatively) inexpensive. Oil prices declined by 47 percent in 1986, bringing the price of gasoline down by $ .27.

Projection. Highly probable. Look for a recession to put downward pressure on the price of gasoline.

A Few Challenges

Lord Browne, the man who runs BP, has said that the price of oil may decline to the $40 range in the intermediate term, and perhaps lower in the longer term. There are, however, a few "challenges" to be resolved before we can expect to see consistently lower gasoline prices. These caveats all put upward pressure on the price of oil – and gasoline.

1. International contracts are worthless.

Let's say you run a really big oil company. You have negotiated a good faith contract with a foreign nation to explore, produce, refine and transport oil from that country to world markets.  Your company's total investment has been several billion (that's billion – with a "$ b") dollars. Your efforts have provided the technical expertise, capital, and labor for a successful venture. Then an elected dictator assumes control of the host country government. He soon insists that a national oil company, which his political cronies manage, take a 51 percent controlling interest in your venture, raises the tax rate on the oil you produce from 34 percent to 50 percent, and hikes the royalties you must pay from 16.7 to 33 percent.

Would you think you were double-crossed?

But that is exactly what Hugo Chavez has done in Venezuela, the world's fourth largest oil exporter and a primary supplier to the United States.  Hugo has raised the price of gasoline.

Projection.  World oil depletion has changed the rules of international trade. Producer nations believe they have the right to tear up existing oil (and natural gas) production contracts whenever they please.

2. Futures trading distorts the intrinsic value of oil.

Futures traders set the world price of oil and gasoline.  In the Futures Market, buyers trade to lock in the price they will have to pay for oil (or unleaded gasoline) at some future point in time. Sellers trade to lock in the price they will get for the oil (or unleaded gasoline) they plan to sell at some point of time in the future. Speculators buy and sell futures contracts based on their optimism (greed) that prices will go up, or on their pessimism (fear) that prices are going to fall. Competition for available supplies forces prices up. If the traders perceive a surplus is possible, prices decline. Price changes can be very volatile.

Want to blame someone for high oil prices? Censure Wall Street firms such as Goldman Sachs and Morgan Stanley, or hedge funds that invest in speculative investments for the wealthy. Oil futures trading activity at the New York Mercantile Exchange, London's ICE Futures Exchange, the Tokyo Commodity Exchange, and the Atlanta Intercontinental Exchange soared in 2005. NyMex, the largest oil trading exchange, handled over 60 million oil contract sales and 13 million gasoline contract sales in 2005. Think billions of barrels of oil and multiple billions of gallons of gasoline. All priced by contracts for the delivery of oil or gasoline at some point in the future. If you are paying $3.00 for a gallon of regular gasoline, there are those who believe that maybe $ .30 to $.45 of that price is based on speculative trading in the Futures market.

Projection: Although most of the oil we humans consume is not traded through a futures exchange, these institutions will continue to set the price for open market purchases, and hence the "peg" against which the price of other oil deals are established.

3. International market agreements would stabilize supply.

If they can be enforced.  Here is the theory.  Consumer nations need to work together with supplier nations on a consumption plan that fairly allocates the world's remaining oil reserves.

Projection: Will never happen.  An allocation plan would require a level of international sophistication and cooperation that simply does not exist.  Consumer nations have neither the will nor the leadership necessary to build a constructive coalition. Most producer nations are driven by unconstrained greed, uncompromising ideology, and a passion for political power. The trend is clear. A dwindling supply of "open market" oil ensures higher prices at the gas pump.

4. We need to stop price gouging.

As your comments demonstrate, American media is dominated by people who just don't get it.  Exxon Mobil is not the world's largest oil company. In fact, independent oil companies – upon whom most English speaking and European nations depend for oil – are relatively small potatoes. Back in 1963, "Big Oil" – defined as the independent oil companies - had a large influence on the price of oil. But their influence has been declining.  OPEC cartel decisions, producer nation policy, futures trading, government regulation, and distributor competition for available gasoline supplies all play a key role in determining what you pay at the pump.  Although many politicians still believe it's 1963, the price of oil, and hence the price of gasoline, is largely outside the control of "Big Oil".

Bill.  If you really want to stop price gouging.  Go after national oil companies like Saudi Aramco, the world's largest oil company.  Saudi Aramco, largely owned by the Saudi Royal family and a few close friends, is an integrated global petroleum enterprise. Saudi Aramco produces and exports more crude oil than any other company. Recent production has averaged some 8 million barrels per day. That is more than twice the output of the next highest national oil company and nearly three times greater than Exxon Mobil. If all of the oil produced by Saudi Aramco were convertible to gasoline, (it is not) it would have produced enough oil in 2005 to make (roughly) 50 billion gallons of gasoline.  Saudi income soared by 49 per cent to $153 billion in 2005 and is projected to swell further to $162 billion in 2006.

Can you guess how much of this income is pure profit?  The U. S. EIA's estimate of 2005 OPEC revenue is $473 billion. Was the gross profit more than $345 billion? Was that 10 times more profit than Exxon Mobil made?  If so, then just who is really doing the price gouging?

Projection.  The United States is unlikely to pursue a case for price gouging against any national oil company.  Potential price reduction: None.  

5. Our politicians need to get real.

China is driving up the price of oil. The price is going up because the world's Democracies refuse to deal with reality. Here we are, competing with China for what's left of the world's remaining cheap oil with Alice-in-Wonderland energy policies.  We worry obsessively about being politically correct, whine about abusive human rights behavior, demand economic reform, and push foreign governments to espouse our political objectives.

China has no such restrictions. The Chinese just want to make deals. With whoever is in charge. They will trade for cash, military weapons, diplomatic favors, and whatever else it takes to lock down the world's remaining oil reserves. They bid up the price of oil using the cash they make from selling manufactured goods to the West.   

If the future availability of a commodity is influenced by depletion and shortages, the only way for a buyer to avoid price volatility and ensure commodity availability is to negotiate long term supply contracts.  If the world's democracies want to nail down better oil prices, they have compete for oil on a national basis, deal with repressive regimes, use weapon sales, bribery and intimidation as bargaining tools, ignore producer nation human rights abuses, and form coalitions with other consumer nations to stabilize the oil market.

Yes, I know.   It's nasty stuff.  Unpleasant.  Repugnant.  But if the world's democracies want to exercise some measure of control over the price they pay for oil, they have to deal with reality.  Life.

The real deal.   Bad as it is.  

Projection.  Unlikely.  China, Russia and Iran are in a three way chess game to control most of the world's remaining cheap oil. The Washington establishment will continue to pretend it's 1963.

Consequently, America will fail to take the steps necessary to shore up it oil resource base until the only recourse is military action. American consumers will see higher prices at the gas pump.

6. America must stay in Iraq.

There are those who believe going into Iraq was dumb. Senseless killing continues. The war effort has been appallingly mismanaged.  Efforts to create an Iraqi democracy have failed.  Backed by the United States, the Kurds are in a four way struggle with Syria, Iran, and Turkey for control of the Kurdish ethnic areas of Iraq, Syria, Turkey, and Iran. At stake: the oil fields near Kirkuk.  Shia factions and criminal gangs are in a three way conflict over who will control Southern Iraq. At stake: the oil fields near Basra.  Saudi Arabia and other predominately Sunni nations are backing Al-Qaeda and the Iraqi Sunni population in Central Iraq.  At stake: the Sunni's want to control all of Iraq with an iron fist theocracy.

But wait.  Iraq does have the world's third largest reserves of cheap oil.  If America leaves, Iraq will be taken over by people who have no love for the United States, Canada, Australia or Western Europe. There will be a very bloody civil war. If that conflict can be resolved (not a sure thing), then whatever oil production Iraq can muster will go to nations favored by the winners.

Everyone else will have to compete for what's left over. The price of oil will be astronomical.

Yes.  This is all very ugly.  But, Europeans can not afford to be blasé about Iraq's oil. Like the Americans, they do not have enough oil to sustain their economies. What we need, is an unprecedented level of diplomatic cooperation among all consuming nations.

Projection.  Not good. Bringing peace to the Middle East would require a massive, creative, intelligent, and politically neutral cooperative effort among the world's democracies. But we currently do not have the will, vision, or leadership it would take to reach this goal.

More conflict is inevitable.

7. Consuming nations must control the outcome in Iran.

Iranian President Mahmoud Ahmadinejad is an ambitious man. He wants to lead the Islamists to greater political power. Worldwide. Ahmadinejad knows the more oil and natural gas he controls, the greater the leverage he will have over his chosen enemies. He looks west. Neighboring Iraq has plenty of oil. If he controls Iraq, then Iran would have the first or second largest reserves of low cost conventional oil and natural gas in the world.  Copious wealth beacons.  Money to achieve his ambitions.

So.  Does he covet the oil fields of Shia dominated Southern Iraq?  Can he maneuver his way into the Kurdish oil fields of Northern Iraq?  Does he have the military resources?  Do you think he will try?

And then there is Iran's Supreme Leader Ayatollah Ali Khamenei - the man who holds the real political power in Iran.  He has made it very clear.  Iran will use its military power to disrupt oil shipments from the Gulf region if the United States makes a "wrong move".  Note: - he did not say "Iran".  He said "Gulf".   Iran has drawn up plans to sabotage oil shipments from the entire Gulf region. That's where the world gets 27 percent of its crude oil. 

Does anybody think there is a problem?

Projection. Political instability always reduces oil exploration and production. In the Middle East, the trend is toward increased cultural instability.  The inevitable result is more conflict.  If Iran's disruption is successful, the world will be plunged into a depression.

8. America will wrestle with nationalization.

Back in 1963, Western oil companies ("Big Oil") had virtually unrestricted access to more than 80 percent of the world's known oil reserves. They could make exploration and production deals almost anywhere they wanted on this planet.  No more.  Big Oil now has relatively open access to less than 20 percent of the world's remaining reserves. A combination of national self interest, political conflict, and environmental restrictions have sharply decreased upstream opportunities.

But these are the very same companies that supply much of the oil consumed by the world's democracies. If these nations want to assure themselves of a reliable and stable flow of oil, they will have to establish a constructive partnership with the oil industry that puts national interests before intramural politics. Liberals have an easy solution. Nationalize the capitalistic oil companies. Replace the top two or three tiers of management with political appointees. Operate "Big Oil" as a national trust.

Projection:  Maybe.  I'll make a prediction.  The Washington Establishment will eventually propose to nationalize America's oil industry.  The legislation will be launched in an environment of extreme economic stress, debated with bitter acrimony, and accompanied by savage political infighting.  Many of the proposed rules, regulations, and directives will not make any sense.

9. Reduce taxes and fees.

Exxon Mobil made a lot of money in 2005. Income from continuing operations was $36.1 billion. But that's not the whole story. Exxon Mobil paid almost three times that amount, $95.6 billion, in direct taxes, royalties, fees and duties. That's 45% more than this company paid in 2000. Trust me. You paid for these government imposed taxes, royalties and fees at the gas pump. Exxon Mobil simply passed them on to your wallet. And Exxon Mobil is not alone. High taxes, duties, fees and royalties are a key expense for any company in the oil industry. In addition, consumers also pay Federal, State and (usually) Local taxes in the United States on every gallon of gasoline they buy.

So. Do your own homework. How much are all these levies costing us per gallon of gasoline? And just who is really making the big money from the sale of oil?

Projection. There will not be any substantial reduction in government mandated costs – foreign or domestic.  Washington politicians have no way to fund the lost tax revenue. Producer nation politicians clearly intend to milk consumer nations for as much $$ as they can. The long term trend for oil royalties, duties, taxes, and fees is up.   Not down.  

10. Don't Boycott Exxon Mobil

You assume that by boycotting Exxon Mobil, the company will be forced to reduce the price of gasoline.  In a way, you are right.  Exxon Mobil could reduce the price of the gasoline it sells though the company's branded gas stations.  If Exxon Mobil's upstream operations reduced the price of the oil they sell to the company's downstream operations, and the refinery shaved its profits, Exxon Mobil could reduce the price of gasoline it sells to you.

But they won't.  There are two key problems with this idea.

First. Let's deal with reality. Oil is a BIG business. Even with 2005 revenues of $370.68 billion, Exxon Mobil is too small to set the price of gasoline in the United States – or anywhere else.  Boycotting Exxon Mobil's gasoline sales would work if there were a surplus of conventional light, sweet, crude oil, and excess gasoline refining capacity.  But that's not the case.  Oil supplies are tight and world refining capacity is stretched. In the event of a boycott, the company would simply sell its product to other distributors. You would buy Exxon Mobil gasoline at some other station's pump.

Second. Gasoline sales account for a fraction of Exxon Mobil's profits. Read the company's 10K filing with the Securities and Exchange Commission (SEC), and compare Exxon Mobil's total gasoline sales with world gasoline sales. Then calculate how much of this company's profits come from the sale of gasoline. (Hint: In addition to gasoline, Exxon Mobil's profits include sales of natural gas, crude oil, naphtha, aviation fuel, heating oil, diesel fuel, chemicals, and other petroleum products).

The bottom line. The market for oil and oil products is so large that boycotting Exxon Mobil, as big as it is, would not make any difference to world gasoline consumption, or the price of gasoline.

11. Face up to the reality of oil depletion.

The economic and cultural challenges of oil depletion are not going to begin sometime in the future. They have already begun. Go back through the challenges discussed in this article. If oil were plentiful, most of them would be trivialized. The challenges of Iraq and Iran, the use of oil and natural gas as a political weapon, the rising price of gasoline, the disregard for oil exploration and production contracts, the competition for oil resources, and the distrust of "Big Oil" are all symptoms of a depleting resource. We need to face the issue of depletion head-on.

Bill. You and your friends at Fox can do your viewers and listeners a great service by providing them with the truth about oil and natural gas depletion. Somehow we must encourage Congress to replace the current Energy Bill with one that will actually help America. (For more about energy legislation, see my article "  The Energy Policy Act of 2005, Legislative Achievement or Management Fiasco?).

Prudent energy resource management must include conservation, ecologically responsible energy production and consumption, and the development of alternative energy resources. Oil and natural gas depletion will inevitably force extensive cultural change. Of particular interest is the development of a constructive response within our state, municipal and county infrastructure, the implementation of a pragmatic federal agenda, and the formation of productive partnerships between private and public organizations.  Since no nation will be able to resolve its energy challenges without due consideration for the energy needs of other nations, we must encourage international cooperation in the development, production and consumption of our planet's energy resources.

Conclusion.

OK.  By now your feeling a mixture of incredulity and anger.  You don't like the challenges that lie ahead.  This oil thing is nasty stuff.  It sneers at your beliefs.  Ignores your needs.  Every possible option comes with its own economic, cultural and/or ecological baggage.

But that is precisely the point.   There are NO painless ways to reduce the price of gasoline.

Bill.  This is serious stuff.  You have the opportunity to provide a great service to your viewers and listeners. Oil exploration, production, transportation, refining, and distribution is a complex subject. The economic and cultural impact of oil depletion is a real problem – today.  You can see it in the rising price of gasoline.  This is no time for pop-culture journalism.  Please. Undertake the responsibility to clearly understand the issues.  Make an effort to explain them in a clear and concise manner to your audience.  America needs a credible "No Spin" approach to the cultural and economic realities of oil depletion.

Is that too much to ask?

"Oil, Jihad and Destiny"	"Detensive Nation"