Wells of Fortune

The Story of Oil

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“We live in biological time, and we have beginnings, middles, and ends.”
― The Arabian Nights: Tales from a Thousand and One Nights

To appreciate any story, one should always look to the past, see how the past connects to the present to understand how the future could unfold. That has been my endeavor with every story. This story is no different.

Setting A Context

In 1974, Anthony Sampson wrote a seminal book called ‘The Seven Sisters: The Great Oil Companies & The World They Shaped’. In my opinion, the book romanticized Oil and I also think it did rightly so. I would recommend this book to anyone interested in learning about “Red Line Agreements”, “Phantom Freight” etc. More so because this book is a historical perspective of the saga of Oil and the fortunes that the likes of John D. Rockefeller- (the richest person in American history)-made.

Besides being a subject close to my heart, the other reason I feel it is important to learn about oil today is because of three developments that could redefine the future of fossil fuels and really the world beginning with the OPEC (Organization of Petroleum Exporting Countries):

a. We are at an inflection point as far as oil is concerned. The trajectory has already changed. Some opinions about the oil market heading downwards. How soon? That’s anybody’s guess

b. The advancement of autonomous and electric cars with Tesla Motors, Lucid Automobiles and China’s CJH Automotives in the race to bring electric vehicles into the mainstream. The debate has moved beyond viability towards growth and eventual domination. That tells you something about the future of oil. China could very well lead the manufacture of electric vehicles. A recent report titled “World Energy Investment”by the International Energy Agency (iea.org) reported that investments in the electric sector edged past the investment in fossil fuels for the first time in 2016.

C. The biggest IPO the world has seen in recent times i.e. that of Saudi Aramco. For starters, the size of the IPO is estimated to be between $400 Bn to $2 Trillion. On the optimistic side, the size of the IPO is larger than the top 3 US companies by market capitalization (Apple: $730Bn, Google, or should I say Alphabet: $581Bn and Microsoft: $497Bn). On the lower side, the IPO is still comparable to the 4th largest US company by market capitalization i.e. Berkshire Hathaway (market cap: $432Bn) — (market cap data by CNBC)

This IPO could signal an acknowledgement of the inflection point I mentioned in bullet a above.

How the Story Begins

The history of petroleum also known as ‘Gas’ in America really begins with Colonel Edwin Drake drilling an oil well in Titusville, Pennsylvania in 1859. Edwin and his backers were looking for a source of kerosene to be used as lightning fuel. Oil began to suffer from weak demand when Edison invented the light bulb in 1882.

Incidentally, the History of Fracking (hydraulic fracturing) can be traced back to 1862. It was during the battle of Fredericksburg VA., where civil war veteran Col. Edward A.L. Roberts saw what could be accomplished when firing explosive artillery into a narrow canal that obstructed the battlefield. This was described as superincumbent fluid tamping. (Businessinsider).

In 1865, Col. Edward Roberts received a patent for an ‘exploding torpedo’.

To understand fracking better, here’s an illustration of the process:

Ecotricity

The invention of the automobile (Internal Combustion Engine) was the first chapter in the commercialization of oil and really, the dependence of the world on Middle Eastern oil. At the beginning of the 20th century, there were 8,000 registered vehicles and by 1920, there were 23 million cars.

After World War 1, oil began to be recognized as a strategic mineral for which supplies had to be ensured. Germany’s U-boat attacks cut off supply of oil for British use.

The 1940’s — 1980’s saw the rise of the seven sisters of oil, namely:

  1. Anglo-Iranian Oil Company (now BP)
  2. Gulf Oil (later part of Chevron)
  3. Royal Dutch Shell
  4. Standard Oil Company of California (SoCal, now Chevron)
  5. Standard Oil Company of New Jersey (Esso, later Exxon)
  6. Standard Oil Company of New York (Socony, later Mobil, now part of ExxonMobil)
  7. Texaco (later merged into Chevron)

These companies also contributed to an oil glut in the 1980’s. The oil glut of the 80’s resulted in the abandonment of many initiatives to find alternatives to oil.

President Gerald Ford, in a bid to reduce the dependence on the middle east for oil (which kept getting disrupted when Egypt and Syria attacked Israel and when Iraq invaded Kuwait) created a ten year plan called “Project Independence” to create 200 coal powered and 150 nuclear powered plants.

Fracking, which started getting commercialized in the 1960’s really took off because of high oil prices which encouraged drilling. Massive fracking began with Pan American Petroleum in Stephens County, Oklahoma, USA in 1968.

Oil production stagnated in 2004 while demand continued to increase. The result was a global oil price spike. Also, the Deepwater Horizon demonstrated that most of the underwater oil is deep and in locations difficult to reach.

As of 2013, massive hydraulic fracturing is being applied on a commercial scale to shales in the United States, Canada, and China. Several additional countries are planning to use hydraulic fracturing.(source: wikipedia)

The following countries have the most oil reserves:

The Value Chain

To obtain an overview of the gas supply chain, look at the infographic below:

blog.williams.com

The Present

I will let the chart above do most of the explaining. But, any supply disruptions i.e. wars, pipeline bursts, curtailment of supply to stabilize prices by the OPEC tend to spike oil prices because of heavy demand that outstrip supply and recessions and economic crisis understandably dampen the demand. The highest oil price recorded in the recent past was July 2008 when the WTI was over $145 and Brent crude was $145–$146 per barrel. 1 barrel is equal to 42 gallons. At today’s price of roughly $46 a barrel, it comes down to $1.09 per gallon. But, by the time it reaches the local gas station, it can add a dollar more and be $2.09 per gallon. A wide variety of factors including import duty, zip code level competitive economics affect the difference between the price per barrel on an exchange and the one you pay as a consumer. The price on the exchange itself is affected by a range of factors including currency exchange rates and interest rates. This interplay goes beyond classic demand and supply factors.

As mentioned earlier, what enabled the boom in fracking is high oil prices. The capital investment needed to support extraction wouldn’t be commercially viable without higher oil prices.

If the marginal cost of producing a barrel of shale oil falls above the marginal revenue by selling it, the shale producers would have to pump more to make up for the revenue. In turn, the OPEC could hold prices high and lose a little market share or reduce prices and keep market share stable. Of course, the relationship is much more complex with other players such as Russia in the mix. This is how the picture looks at present.

Oil Consumption is poised to match the supply in Q4' 2017 as per Oil and Gas

How Oil Could Unravel

Siemens.com

While Saudi Arabia tries to reduce it’s dependence on Black Gold, and the electric car manufacturers ramp up their capacity (Tesla setting up its Gigawatt factories), the world is waiting with bated breath for a possible decline in the consumption of fossil fuels. However, more important is the upgradation of infrastructure i.e. old, rusting pipelines that could burst and lead to a catastrophe. Consider this excerpt from David Yager (oilprice. com):

Enbridge Line 5 crosses from Wisconsin to Michigan under the Mackinac Straits between Lake Michigan and Lake Huron, a distance of about 4.5 miles. Built in 1953 to the most demanding standards of the day, the Enbridge website says Line 5 transports about 540,000 b/d of Canadian light and synthetic crude and natural gas liquids to markets in Michigan and beyond. What has emerged is concern among campaigning Michigan politicians about the potential for a major spill into the Great Lakes, an event being politically branded as inevitable

One possibility, although it seems unlikely is that the oil industry could be a sunset industry as early as 2030. However, some say later. Take the case of International Energy Administration:

“The IEA predicts that renewable energies will account for almost one fifth of global energy consumption by 2040. In 2012, that figure was only about 13 percent. The share of wind and photovoltaics in the global energy mix is expected to quadruple. The highest global growth rates are for wind power (34%), hydropower (30%) and solar energy (18%). In the European Union, for example, wind power is expected to rise to about 20 percent of total power generation by 2040" (source: Siemens.com)

Also, consider this recent article by the Wall Street Journal which analyzes how electric vehicles would find it hard to compete in the absence of government subsidies and tax credits.

But, electric autonomous vehicles, tax credits, climate change,falling demand are all contributing to the acceleration of oil’s decline.

Ironically, Thomas Edison had pulled the plug on oil to create light by inventing the light bulb and Nikola Tesla could be synonymous with a new movement to do just that.

What will save oil this time around? I have provided some factors that could help you understand the future of oil.

Having said that, I still feel the future is much more volatile than linear thinking would have us believe but that’s why it is interesting. As Malcolm X said:

The future belongs to those who prepare for it today.

After a possible spike in prices, the good news for consumers could be low oil prices not without extracting a toll from the overall economy. The other side of the equation is a very difficult and heart wrenching story.

So, is anybody heading to the Tesla Motors or the Lucid motors website to learn more about electric cars today?

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Additional References:

International Energy Agency

OPEC

Energy.Gov

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