Let’s get this straight: At the moment, the U.S. has plenty of oil.
Let’s get another thing straight: The price of oil is likely to keep rising because of market psychology and buyer panic about Mideast turmoil. And there’s nothing you can do about it.
To understand why, start with the fact that the price of a barrel of oil or a gallon of gasoline has little or no connection to the cost of producing it.
As of last week, there was some 346 million barrels of oil in American storage, according to the Department of Energy, comfortably above the five-year average range for this time of year. Reserves represent about a 25 day supply for the U.S., a comfortable cushion by historical standards. But, that has done little to keep prices from surging. On Monday, amid news that Libya’s civil war posed a new threat to that country’s oil exports, the benchmark price of U.S. crude hit $107, the highest level in over a year and a jump of nearly 30 percent in less than a month.Story: Rising gas prices could hamper spring, summer travel plans
Gasoline prices have also surged in the past month, even though roughly 234 million barrels of it were sloshing through the system as of last week, well above five-year averages. The average price of a gallon of regular gasoline hit $3.51 last week, up 13 percent in a month.
The loss of Libya’s oil output — even all of it — would remove a relatively small percentage of total global supplies. In any case, Saudi Arabia is believed to have enough spare capacity to cover any shortfall.
But that’s where the oil market’s nightmare scenarios begin. With virtually no other spare capacity, the global oil market is running on fumes. And no computer model can predict whether — or how far — the turmoil will spread in the richest oil production region in the world
“A little over two weeks ago, we were trading below $85 a barrel,” said Addison Armstrong, research director at Tradition Energy. “This price move that we've seen over the past 14, 16 days is all related to what amount to concerns over what could happen."Story: Price of oil retreats as OPEC mulls raising output
So why are prices skyrocketing?
For starters, there’s a huge range of cost from one oil producer to the next. Saudi Arabia can pull a barrel of oil out of the ground for just a few dollars; that same barrel extracted from tar sands in Alberta, Canada could cost $60.
Further, not all crude is created equal. Oil comes in a wide range of blends with properties that can have a big impact on price. Gasoline is cheaper to produce from “light” oil, which flows better, so refiners have to pay more for it. The same is true for “sweet” oil, which comes out of the ground with lower sulfur content; the “sweeter” the oil, the more gasoline refiners have to pay for it. (Not all refiners can handle heavier, sour grades of oil.)
Though oil prices are widely reported based on the costliest “light, sweet” blends, oil sells for a wide range of prices.
On top of these variations, oil and gasoline prices depend heavily on just how much the last buyer is willing to pay. It’s pretty much like the last-minute airline ticket buyer who is willing to pay a big premium to sit next to a passenger who paid substantially less for the same flight.
As oil prices have become more volatile in the past decade, more buyers have tried to lock in the cheap seats to guard against future spikes in those last-minute fares. Ironically, that increased demand for “paper oil” — from airlines to Wall Street hedge funds — has had the perverse effect of adding to the upward pressure on prices.
“The size of the oil industry — in terms of demand — has increased by 15 percent in the last eight years, while the size of the oil market as a financial instrument has increase by 600 to 700 percent,” said Tom Kloza, publisher of Oil Price Information Service. “The number of companies that trade oil in the paper market has increased many times from what it was 10 years ago.”
The latest price surge comes as paper oil buyers, fearful of even higher prices, have swarmed the market. Kloza says the price squeeze has been made worse by a dearth of oil companies willing to offer up contracts to sell at current prices.
“What happens if the price goes to $150?” he said. “With those paper losses, I’m going to the board room and get beaten up because I sold at $100.”
And it's hard to see how tapping into the U.S. Strategic Petroleum Reserves will help. Investors know the U.S. government is sitting on 727 million barrels — about a 38-day supply. And it still doesn't make them feel any more in contol of the Mideast's future.
Dealing with volatility
As painful as the latest price spike may feel to consumers, gasoline prices — adjusted for inflation — are lower than they were in 1980. Consumers, businesses and the economy at large feel little or no impact from gradual price increases. It's the sharp sudden spikes that set drivers howling in protest.
So why can't someone figure out how to get rid of those spikes? It's not for lack of trying.
For decades, the job of maintaining stable oil prices fell to the Texas Railroad Commission, which stepped in after a 1930s oil boom sent prices plunging.
Since the 1973 Arab oil embargo, the U.S. government has gone to extraordinary lengths to try to maintain stable oil prices and adequate supplies. Hundreds of billions of dollars have been spent to station troops through the oil-rich Middle East; billions more have been spent in tax breaks and direct subsidies to promote domestic oil exploration, boost dwindling supplies and reduce reliance on imports.
A 2009 report by the Environmental Law Institute found that from 2002 through 2008, some $72 billion in tax breaks and subsidies was spent to support development and production of fossil fuels. The recent turmoil in the Arab world has demonstrated that investment has done little to dampen the volatility of prices at the gas pump.
But as oil prices have surged, those subsidies have been harder to maintain. From China to Iran, gasoline subsidies have been rolled back recently, often sparking protests from cash-strapped consumers.
Other developed countries have taken a different approach, adding a heavy tax on gasoline to try to reduce consumption. For consumers, it’s a costly solution — one that holds little political viability in the U.S. But it can provide European consumers and business with an important safety valve that helps dampen the painful impact of quick price surges, according to Jaydee Hanson policy director the International Center for Technology Assessment.
“Japan and Europe have much higher taxes on fuel,” he said. “But they’ve been able — when the spike come up — to reduce temporarily the taxes to keep the prices more or less steady.”
Though many Americans chafe at the suggestion, the most effective solution may be to simply use less gasoline. That process is already underway. Though gasoline demand continues to follow a seasonal pattern — rising in summer, falling in winter — consumption peaked the week of July 6, 2007 and has been trending lower since then. That trend will likely continue over the longer-term if the price of gasoline continues a gradual move higher.
Industry watchers like Kloza say that’s the most likely scenario. But with the recent volatility in the Arab world upending everyone’s forecasts, they can’t rule out painful price spikes along the way.
“At a meeting today, I asked if our programmers wanted to make sure that we have the ability to show gasoline prices that were above $9.999 a gallon,” he said. “I don’t think it’s likely. But its certainly in the realm of possibility in this decade — or dare I say this month or this year.”
© 2013 msnbc.com Reprints