What is the real price of a barrel of oil?

What is the real price of a barrel of oil?

By

Bello Salihu, PhD

J. Paul Getty made a name, not mention lots of money, for himself as the founder of the Getty Oil company. In 1966, the Guinness Book of World Records named him the world’s richest private citizen. During that era he was a poster boy for a lot of folks involved in free enterprise but especially those involved in the oil and gas business. He was to our industry in the 50’s and 60’s what Bill Gates, Larry Ellison and the late Steve Jobs are to today’s IT entrepreneurs and enthusiasts.

It was quintessential Getty to pay Ibn Saud, the founding king of Saudi Arabia and the father of the current monarch, King Abdullah, nine and a half million dollars plus a promise of 1 million dollars a year for a 60-year concession on a barren tract of land near Saudi Arabia’s border with Kuwait.  This was in 1949 when such an amount was more whispered than spoken of. And for the next four years he invested further multiples of that sum searching for oil in what everyone in the oil game then told him was a waste of time. In 1953 his gamble paid off with a massive find that would produce 16 million barrels of oil a year  - every year - thereby catapulting him to be amongst the very rich. A few years after that he was named by Fortune Magazine as the richest living American.

But I introduce today’s discourse with this larger than life personality more for his epigrammatic wit and less for his fabulous wealth or business acumen. Two of his many famous sayings sit succinctly and comfortably with the two global and linked viewpoints on the issue of the actual value of a barrel oil.

So let us start with his answer to the question I paraphrased and used above as the title of this article; when asked what he thinks should be the price of a barrel of oil, he was reported to have answered simply, “However much you are ready to pay for it”.  With such a deft and intelligent response, Getty switched the question from that of price to that of value. Which we all know are not always one and the same thing.

As I write this the current price of a barrel of oil hovers just over $110 dollars for the Brent blend light crude. Other crude benchmarks vary in price but I will take the Brent blend as my reference benchmark not only because it is used to price over two-thirds of the worlds traded crude oils, but, most importantly, because it is the benchmark for the Atlantic Basin crude oils, under which Nigerian production falls.

The same barrel was sold for slightly less than $25 dollars a quarter of century ago. It experienced a spike in 1990 when Saddam adventurously annexed Kuwait and a dip -  averaging just above $12 - in the 1997 as a consequence to the Asian financial crises. But for the twenty years between 1987 and 2007 its average peak was about $40.

The nearly $100 dollars above that average peak price that is being paid today for each barrel has been attributed to many factors - principal of which is the dreaded peak oil scenario - which paints a gloomy picture for the future easy availability of oil if the current production rate at which global reserves are being produced and depleted is maintained. Another major factor is the rise in demand from emerging economies - especially India and China. Countries with both massively expanding manufacturing bases and billion-man populations.

From all pointers, oil price will continue to soar for sometime - the peak oil prediction is taking root everyday as nations, basins and fields continue to conform to the predictions made by the proponent of the peak oil theory over half a century ago. And at the rate at which China and India are going, the two countries will continue to move massive swathe of their population into the middle class bracket where, with more disposable income, the new ‘global citizens’ will be expecting and demanding an energy-hungry way of life equal to that which obtains for the citizens of developed, first world economies. The aforesaid factors add more fuel, if you will forgive the pun, to the massive price speculation that has forever been intrinsically linked to the energy industry.

But even after considering all of the aforesaid factors one still has to concede that there are a few commodities in the world that can manifest such a rise in value in a span of 60 months - without a global war and/or a major natural catastrophe or some form of disruption at their production source.

To try to put such a rise into perspective we have to remember that oil and gas drive the global economy because of two simple reasons - the first is that hydrocarbons are unsurpassed as a cheap form of energy and industrial feedstock and the second is that almost anything we can touch or feel is either made from hydrocarbons or has hydrocarbons involved in its production. As an example, 90% of all transportation globally is powered by hydrocarbons, 95% of all goods in a typical supermarket have hydrocarbons as their base raw material or a major processing input and most importantly, 99% of global food production and processing involves hydrocarbon products either as fertilizer, other agrochemicals or fuel. So it is not far-fetched to see that, yes, as long as current global demand holds - and all trends show that it will - then the price of a barrel of oil will continue to rise.

When refined, out of the 42 gallons that make up that barrel of oil that was sold for just over $110 dollars refiners can obtain up to 20 gallons of gasoline, up to ten gallons of diesel fuel and another ten gallons of jet fuel/kerosene depending on refining yield. All the three fractions mentioned above average about $3 a gallon in today’s international commodities market. So in a simple ‘back-of-the-envelop’ calculation it can be seen that with its first three major derivable fractions our barrel has already paid back its cost. 

But these three major fractions are just the beginning of a long list of  value that will be extracted from that barrel. Heavy fuel oil for industries, propane gas, asphalt for road building, petrochemical feedstocks for plastics, resins, medicines and fertilizers and many other derivatives will be extracted from that barrel. And these are just the tangibles. The intangibles include employment and a raised standard of life in the country where the barrel is refined. 

For some of the developing nations of the world, and especially those in Africa, for  centuries our fore bearers were selling agro-based primary commodities to the developed world, which were processed and returned to them as value-added goods for much higher amounts than they sold the raw materials for. These primary commodities were sold cheaply when viewed in contrast to the value of the finished product derived from them.  Not to mention the jobs they generate - which feeds an upward spiral of literacy, social stability and development in their citizenry - in the receiving countries. 

In many cases the under-developed and developing world is still doing that. Most of the chocolate-loving world have cocoa producing countries of West Africa to thank for even if the actual cocoa farmers in Nigeria, Ghana, Cote D’Ivoire see only a trickle of the actual value of their produce get paid to them. The same goes for countless other commodities both agricultural and mineral that today’s world cannot do without.

Unfortunately, same goes for hydrocarbon resources - which almost the entire oil producing nations of Africa sell to the outside world without adding any value to. But what makes hydrocarbon resources a different issue all together is three fold; firstly, unlike farm produce, they are a non-renewable and wasting resources in which case every barrel produced and sold or used up is gone for good. Secondly, hydrocarbon resources are so intricately intertwined with political, social and economic stability of the present world that, for now, no people or nation can do without them. The huge price movements that we see in the market for crude oil only goes to show that we are still far from a point of value of saturation that the world can see a barrel of oil as being too expensive to buy. 

At a given peak price point the world can find a bar of chocolate too expensive to buy - which will see the crashing in the price of cocoa in the international commodities market or the manufacturers finding an alternative raw material as substitute to cocoa in satisfying the craving of their sweet-toothed customers. But, for the foreseeable future, that scenario cannot be seen to happen to a barrel of oil.

Third and most importantly, the availability of directly useable form of oil and gas, especially in the form of energy-producing fuels, in any country dictate how far and how fast that country develops industrially - because these fuels constitute an energy source that is so dense that, at its current price, it is essentially free energy. Apart from nuclear fission there exists no richer source of energy in the world than fossil fuels.

To drive this point home, all one has to look at is the roll call of the top oil producing  and exporting nations on one hand and that of top consuming nations on the other.

Russia, Brazil, Mexico and Saudi Arabia are the only countries that feature in all the three lists of fifteen top oil producers, exporter and consumers. About the only surprise there to the uninitiated is Saudi Arabia. Russia and Brazil are part of the BRIC countries that include China and India - countries with emerging industrialised economies that are enjoying unprecedented economic growth - a growth that is occasioned and powered by massive energy consumption. Mexico on the other hand is in the backyard of the world’s richest and biggest consumer nation, the United States of America for whom most of their industrial output is targeted - so their high energy consumption can also be explained.

Some of the countries in the top list of producers such as United States, China and Canada do not feature as exporters because they consume what they produce internally and, in the case of United States and China, even have to depend on imports to satisfy their thirst.

However, countries such as Iran, United Arab Emirates, Venezuela, Nigeria, Iraq and Angola all feature in the list amongst the top fifteen major producers and exporters of oil and gas.  But none of them feature amongst the top fifteen consumers of energy. They all depend on oil and gas as the mainstay of their economies - but not oil and gas as an energy source to power their industries, generate employment and raise the standard of life of their people - but oil and gas to be exported in crude form to generate easy revenue that, more often than not, is whittled away through fanciful projects or corruptly diverted.

If Nigeria can process and consume half of what it currently exports in the form of raw crude oil, there will be no clearer indication to the rest of the world that the country is using its strength as an energy producer to empower its massive population to be industrially productive. That in turn means that the country is turning its strength in numbers from being a liability to being an asset.

China understands this all too well. That is why the chinese are all over the world cutting deals and exploring for hydrocarbons wherever they can. The chinese may have laid the first ever recorded oil pipeline using bamboo sticks thousands of years ago, but they have now come to the scary realisation that they have arrived a tad too late for the massive oil and gas rush of the past century where European and American companies and countries have carved for themselves massive slices of the global hydrocarbon reserves.

The current estimate is that by the middle of this decade China will overtake the United States of America as the number one oil consumer in the world. With such a rising demand China must find its own source of energy to remain competitive. About the only thing that can hamstring China’s current double digit growth is an inability to access cheap energy. The only scenario in recent history comparable to that is General Rommel  of Germany losing the battle fields of North Africa in the Second World War because his troops were immobilised by lack of fuel!

Each barrel of oil sold in its crude form with no value added by the producing nation - even at prices multiple of what currently obtains - is more a loss to the selling nation than a gain. It is an unequal barter in which the buyer gives the oil producing nation a token amount of cash in return for a commodity that provides for the buying country abundant and cheap energy to power their industries, raise their people’s standard of living, provide jobs and fuel their relentless development. The end products so produced by the industries in the buyer’s country, in more ways than one, find their way back to the oil exporting country as valued added goods paid for with the same petro-cash earlier earned selling crude oil. 

The so-called developed nations of today became developed at the expense of nations that sell to them cheap energy.

In the peculiar case of Nigeria it is additionally disturbing that a great chunk of the revenue gained in selling that barrel is again “dashed” back to the buyer in return for petroleum products bought at a premium that are used not to power industries or drive tractors in our farmlands, but to fuel cars and electricity generating sets.

This brings us to the second wise quip from Getty. He was reputed to have rephrased a famous biblical injunction by stating that “The meek shall inherit the earth, but not its mineral resources”. Or in other words, it is not enough that your country sits on top of massive mineral resources - it amounts to nought if you are too timid, docile and tame to take advantage of such a gift to better the life of your people. The not-so-meek will take that mineral resource from you and show you how better to use it while you watch mouth agape.

At prices even higher that what it is currently sold for, there will always be someone ready to take that barrel from you - not because their dollars are not valuable to them but because what they are buying from you is far more valuable to their country’s economic and social stability than the paltry sum they are giving you in exchange for it. 

This was published earlier in my column 

'Oil and Gas Weekly' in Government, a publication of
Leadership Newspapers , Abuja, Nigeria.