Why Does Gasoline Cost So Much, Daddy?

Basics of the Petroleum Industry VI: The Economics of Big Oil (and Your Local Gas Station)

For most of us, our chief exposure to the economics of the oil industry comes in the form of two-foot-high letters displayed somewhere along the streets we travel to work or play. Though we may not know the current price of a barrel of crude oil¹ - may not even know how big a barrel of oil is² - we are usually aware of the price of gasoline in our neighborhood. What most of us don't know, as a rule, is why gasoline costs what it does. The answer is simple on the surface, and devilishly complex below that simple answer.

One simple fact is that oil companies, no matter how large or small, do not set the price of their product. Crude oil and refined products are commodities, like corn and pork bellies; and the price of commodities are by commodity traders who broker deals between sellers and buyers. Traders perform a balancing act between the least a seller will accept for the product and the most a buyer will pay for it. According to the law of supply and demand, buyers will pay more for a commodity when supply decreases. That's why whenever there is a restriction in the supply of oil production within or imports to the USA, the price rises. Even more, whenever there is fear of a reduced supply - due to weather, natural disaster, or political instability - the price also rises. In fall of 2008, the price of oil fell dramatically because of the belief that that economic upheaval would reduce demand for petroleum in large markets like Southeast Asia. The same supply and demand cycle affects beef and milk (mad cow disease, anyone?) and corn and soy beans: like farmers who are paid less for crops after a good growing season, oil companies get less for their product when the supply exceeds the demand.

Remember, too, that the cost of the raw materials (crude oil) is only about 65% of the price of your gasoline: there are also the costs of transporting the crude oil to a refinery, refining it, and transporting the refined product to your local station; not to mention the cost of the additives, most of which are also petroleum products. Besides the cost of producing, transporting, and refining the gasoline you bought on the way to work today, the station that sold you that gasoline also has to pay for the property and building (a small station can easily cost more than a million dollars to build and equip), employees, and the rights to sell that particular brand - very few stations that sell Exxon gasoline, for instance, are owned by the company. Most are owned by local business-men and -women. Oh, and one more cost: taxes. On top of a federal tax of 18.4 cents per gallon, every state (and some large cities) also charges "road-use" taxes. Depending on where you live, taxes range from a total of 26.4 cents/gallon (Alaska) to 65.8 cents/gallon in California (see a list of US state tax burdens here). Internationally, except for a few petroleum-exporting countries such that subsidize the price of gasoline (e.g., Venezuela and Saudi Arabia), taxes can be even higher; though the proceeds are frequently used to pay for public transportation.

Remember the twenty gallons of gasoline that cost you fifty bucks this morning? The station probably made less than a dollar of net profit - that's why they want you to come inside and buy snacks in their convenience store. Back in the mid-nineties, when oil was at nine dollars per barrel, the company I worked for made most of its profit off "The four Cs"- cigarettes, coke, chicken, and condoms - in their chain of convenience stores, and actually lost money selling gasoline. If you really want to make a gas station owner happy, come inside and pay $1.59 for a bottle of water after you're done pumping - you may double his profit on your visit.

What should you take away from this? First, oil companies don't set the price of their product -- they're at the mercy of the law of supply and demand. Sure, when prices are set high they can rack up substantial profits, but when prices fall, they'll take it in the shorts. Second, the guy in the local gas station doesn't arbitrarily jack up the price to try to fleece you: the station owner has plenty of costs to cover, not just the price of the raw material - and it's fairly likely that the station isn't making a great deal of money off the sale of gasoline in the first place.

This is number six in a series of minilectures on the oil industry:

1) Where Does Oil Come From?
2) Where Do Oil Companies Find Oil?
3) How Do Oil Companies Find Oil?
4) The Economics of Petroleum Exploration and Production
5) Refining 
6) The Economics of Big Oil <== You are here.  The next installments is:
7) The Future of Oil


¹ If you're curious, it's displayed to the right of this blog entry (assuming the gadget is working today)
² A barrel is 42 US gallons, a smidgen less than 159 liters, or just under 35 imperial gallons. It's a unit of measurement, however, not a physical container: petroleum and petroleum products aren't poured into 42-gallon drums and shipped; it's pumped into large tank trucks, rail cars, and tanker ships; or they're pumped in a continuous stream through a pipeline.

copyright © 2009-2016 scmrak

Statistics Never Lie - but Liars Use Statistics

If you’ve visited your local Valero gas station lately, you might have noticed a little political theater right there at the pumps. Not content with spending their money on K Street lobbyists in hopes of influencing the government in their favor, the Texas-based oil and gas company has instituted a “grass-roots” campaign in hopes of quashing climate legislation. Like most, although not all, other fossil-fuel companies, Valero’s management (led by CEO William R. Klesse) is staunchly – almost virulently – opposed to climate legislation. This may in part reflect the extreme rightward political leanings of former Oklahoma congressman Don Nickles, a board member, but is a position that is in no way unusual at the top of the industry. Rank-and-file employees, especially scientists (of which there are few on boards of directors) are less hard-line, by the way.

All that means, however, that Valero has begun displaying posters at company stations (many former Diamond Shamrock sites) flatly stating that the Waxman-Markey climate legislation passed by the House of Representatives this past summer is, in the words of Klesse, “a hidden tax.” Klesse further claims that “more than a million high-paying jobs will disappear from our already weakened economy, with no measurable improvement in global climate change.” Perhaps Klesse is concerned that one of them will be his, for which he was compensated to the tune of $10.5 million in 2008 (per Forbes). Valero’s poster, attributed to an organization called Voices for Energy (apparently another name for “Valero”) repeats Klesse’s statements, and states flatly that the Waxman-Markey bill will raise the price of a gallon of gasoline by seventy-seven cents - or more!!! democracydata.com, the domain hosting Voices for Energy, is a Virginia-based political consulting organization that terms itself specialists “in database management and zip to district matching supporting virtually any sort of grassroots lobbying activity.” Grassroots my ass: it’s just astroturf.

So anyway, let’s get to the claim of “77 cents per gallon.”

The impression left by the wild-eyed Uncle Sam is that, if Waxman-Markey passes, your gasoline will cost at least 77 cents more per gallon the next day. However, the 77-cent estimate comes from a compilation of studies performed by the American Petroleum Institute (API), an industry trade association and advocacy group, and represents their estimate of the increase ten years out in 2019 (ignoring inflation, if any). API didn’t crunch the numbers themselves, however; they used numbers from a study published by EIA, the Energy Information Administration (the statistical agency of the U. S. Department of Energy, nominally independent). To sum up that study: EIA estimates that if energy markets were to continue unchanged, the average price of a gallon of gasoline in 2019 would be $3.62/gallon. With Waxman-Markey in place (unchanged from its current form), EIA estimates a best-case scenario of $3.74/gallon and a worst-case scenario of $4.29/gallon – the 65-cent difference is due at least in part to variable estimates of the effectiveness of carbon offsets in reducing costs. The API’s, and Valero’s, 77-cent “estimate” is that worst-case scenario, in which no refiner or producer reduces costs by a single penny – perhaps out of distaste for the practice of using carbon offsets…

The EIA figures are used by the Congressional Budget Office (CBO, the non-partisan agency that provides economic data to the legislature), which has estimated that the use of all available carbon offsets would cut the cost of the cap-and-trade legislation by 70%, or about 54 cents of that worst-case scenario. CBO, by the way, calls the API figures “extreme” and protests that the use of the EIA’s 77-cent figure misrepresents the non-partisan group’s calculations.

Undeterred by the protests of non-partisan statistical organizations, however, the API not only continues to quote that 77-cent figure, but has also allied itself with that paragon of non-partisanship, the Heritage Foundation, to figure out on a state-by-state basis how much the cap-and-trade will “cost” people.


Both EIA and CBO have stated that the effects of using carbon offsets, details of which are still vague, on the ultimate costs can't be reliably calculated - which is part of the reason for the sixty-five cent spread in their estimates. For the API to use only the estimate that best supports their cause is, however, to be expected. It's akin to a Celtics fan shouting that The Sporting News says his team will will 80 games this year when the article says "between 60 and 80." And, of course, the Nets fans will sneer that the News said the Celtics would only win 60...

As always, the best policy is to take the Heritage Foundation’s numbers, add them to Ralph Nader’s, and divide by two… To recap: statistics never lie, but liars use statistics - only they don't use all of them. The API is cherry-picking...

Oil Industry Basics: Refineries and Refining

Basics of the Petroleum Industry V: A Simple Look at Refineries and Refining Costs...

If you’ve been following along, you’ve learned some basics about where oil comes from, how large accumulations of oil form, and how oil companies find those accumulations. Last time out, we looked at the economic realities of the oil business; how companies need to factor in not only the costs of finding new oil (finding costs), but also of getting it out of the ground (producing costs), and getting it to market (transportation costs). That’s only part one of the process, though, because there is almost no use for oil in its raw state. Crude oil, oil that’s just as it comes out of the ground, is highly variable in both chemistry and composition; but almost every use for petroleum products requires that the product fall within a narrow range of compositions. You think “Oil is just oil”? Well, no: oil is composed of lots of things, which is one reason why it’s proven so versatile over the last century or so.

Crude oil is made up mostly of two elements: hydrogen and carbon, which is why we call oil a hydrocarbon. Those two elements can combine in a great many different physical arrangements, and each of those arrangements forms a different kind of hydrocarbon molecule. You may be familiar with some of these molecules already; molecules with names like methane, propane, butane, and octane. Hydrocarbons have unusual physical properties that allow complex molecules to join with other complex molecules to form  even more complex hydrocarbons. There are hundreds of different molecules in nature, and even more among the vast number of man-made molecules that we lump together under the term "plastics." Crude oil also contains other elements in different amounts; among them oxygen, nitrogen, sulphur, and trace amounts of many metals.

Produced crudes are composed of many slightly different hydrocarbons, mixed together in different proportions. How much of which hydrocarbons are present in a given crude oil is a result of many variables. Among them are things like the original source material that was “cooked” into crude oil, the length of time the oil spent in the cooking pot, how high the temperature was, and the chemistry of the water with which the crude oil was mixed in its reservoir. If the field from which the crude comes is fairly shallow, bacteria can also have consumed some of the lighter hydrocarbon molecules over the millennia, leaving behind oil made heavier by the process of biodegredation.

Hydrocarbons are usually separated into light and heavy classes. The higher the ratio of hydrogen atoms to carbon atoms gets in a given molecule, the lighter the hydrocarbon. Methane (a gas), is the simplest and lightest hydrocarbon: it has four hydrogen atoms and one carbon atom. Heavy hydrocarbons are those with a low ratio of hydrogen to carbon atoms. Heavy hydrocarbons include the asphaltenes, which have only about 1.2 hydrogen atoms for every carbon atom. Crude oils are also classified as light or heavy, depending in part on which hydrocarbon molecules are most common. When we hear reports about the price per barrel of oil, the price quoted is usually for the best-quality oils: so-called light, sweet crude. Light hydrocarbon molecules tend to produce more energy than heavy hydrocarbons when they’re burned, and since the majority of crude oil is turned into jet fuel, gasoline, diesel, and heating oil; light crude tends to be in high demand. “Sweet,” by the way, means that the crude contains less than 0.5% sulfur – sour oil, which has more sulfur (usually in the form of hydrogen sulfide) needs more processing steps to make fuel.

The process of turning crude oil into the many different petroleum products used in our society is called refining. Refineries are industrial sites where many different processes are used to separate out individual hydrocarbons or groups of hydrocarbons. The world’s largest refinery, Paranaguá, is operated by the Venezuelan national oil company Petreleos de Venezuala, S. A. (Pedevesa). Actually a complex of three refineries, Paraguaná can process almost a million (940 thousand) barrels of crude per day (a barrel is 42 US gallons, about 1.6 cubic meters). The largest refinery in the USA is ExxonMobil’s complex in Baytown, Texas, which has a maximum capacity of 570 thousand barrels/day. Refineries usually cover large land areas, often several square miles. Most refineries are in or near areas where oil is produced, although many near the Gulf Coast of the United States process crude oil shipped in tankers from overseas. Refinery complexes are notable for their enormous, tangled masses of pipes of many sizes that come together to create towers and other strange arrays; for having few buildings for their large footprint; and for often having an open flame, or “flare,” atop one or several towers. In addition to separating out the various hydrocarbons, refineries also remove other impurities from the oil.

Many processes are used to separate the different hydrocarbon molecules from each other. An atmospheric distillation unit simply allows molecules of gas (methane, for instance) to bubble out of the oil; the gaseous portions are siphoned off at this point. Some of the gas may be flared (burned), but this product is commonly piped elsewhere in the refinery complex to be used as fuel for later steps. The liquid portion continues into giant furnaces, where batches of crude are heated. Different liquid hydrocarbons boil at different temperatures, which allows them to be separated from one another by fractional distillation: the boiling crude feeds into tall distillation columns, and light hydrocarbons like butane and propane reach the very top of the column and leave by piping there. The hydrocarbons in gasoline leave the tower lower down; followed by kerosene (principal component of aviation fuel), diesel, and heating oil. The processing is much more complex than this, of course, and even the simplest refining will involve multiple stages of fractional distillation.

Leftover heavy hydrocarbons are also processed further. The lightest remaining fraction can be turned into lubricating oil, such as that in your car’s crankcase, but most of the remaining portion of the crude oil consists of heavy molecules – those with small amounts of hydrogen, which burn poorly and aren’t suitable for fuel. Some of what remains is only suitable for making asphalt and paraffin, but a modern refinery is like a meat-packing plant that “uses everything but the squeal.” Better living through chemistry means that refineries employ several different techniques to “crack” a single heavy hydrocarbon molecule into two or more lighter molecules. These processes require more time and more energy than the first, simple distillation process, and most also require the use of catalysts – substances that speed up chemical reactions. The cracking process can turn heavy hydrocarbons into gasoline or kerosene, even propane. For those crude oils that don’t have large amounts of the lighter hydrocarbons, hydrocracking and catalytic cracking are important in producing the light fractions that can be used to make fuels. Cracking heavy hydrocarbons to make gasoline requires more time and energy than distillation, and also requires the introduction of catalysts. All three factors add to the expense of refining heavy crudes, which explains why light crude has a higher price on the commodities market.

In addition to passing through multiple separation processes and perhaps cracking as well, every drop of crude that enters a refinery also passes through several steps intended to remove metallic and non-metallic impurities. These may be as simple as salt, which comes from water mixed in with the produced oil. Sulfur is a common contaminant, one that must be removed for clean-burning fuels – US refineries generate tens of thousands of tons of sulfur every day. Metal impurities such as nickel, iron, and copper are also removed, though in much smaller quantities than sulfur.

In what seems like a violation of the law of conservation of mass, a forty-two-gallon barrel of oil usually yields fuels, lubricants, and other hydrocarbons that add up to a little less than forty-three gallons of product. The “excess” is a result of the cracking process, which transforms dense molecules into light, less dense hydrocarbons. Even though refineries seem to put out more than they take in, in truth efining crude oil into gasoline is an expensive process, in part because of the large capital investment needed to build a refinery. Energy costs are also substantial, though at least a portion of the energy is generated through combustion of “waste” gases at most sites. Additives such as catalysts are also part of the costs, as is labor and maintenance of tens of thousands of pipes, vessels, towers, and other containers that must be carefully monitored. All told, crude oil’s visit to a refinery adds anywhere from twenty to thirty cents to the price of a gallon of gasoline in the US, according to the United States Energy Information Agency.

This is number five of a series of minilectures on the oil industry:

1) Where Does Oil Come From?
2) Where Do Oil Companies Find Oil?
3) How Do Oil Companies Find Oil?
4) The Economics of Petroleum Exploration and Production
5) Refining  <== You are here.  Future installments include:
6) The Economics of Big Oil
7) The Future of Oil

Calculating Gas Mileage in Miles per Gallon (MPG)

Are you convinced that the EPA window sticker lied to you about your car's estimated mileage? Well, they might be wrong (it wouldn't be the first time); then again, you may not be calculating yours correctly. Don't panic: it's totally easy to do! All you'll need are a pencil and paper, or a calculator if you've forgotten how to do long division by hand.

Step 1: Fill your gas tank. Let the pump run until it shuts off by itself. Don't top off the tank, this adds to air pollution and wastes a little gas.

Step 2: If you have a trip odometer, zero it before you leave the pump. If you don't have one, record the odometer reading - I often write the number on the receipt.

Step 3: Drive until you need to refuel.

Step 4: Fill the tank again; remember to not overfill. Record the number of gallons from the pump readout; the number usually appears on the receipt as well (example: 12.45 gallons). This is the NUMBER OF GALLONS CONSUMED

Step 5: If you have a trip odometer, record the miles driven since the last fillup (writing it on the receipt works fine). If you don't have a trip odometer, record the odometer reading just as in step 2, and subtract the mileage at your last fillup from this new number (example: 109234 - 108891 = 343). This is the NUMBER OF MILES DRIVEN.

Step 6: To calculate gas mileage, the formula (eeek!!!) is

NUMBER OF MILES DRIVEN

----------------------------------------------

NUMBER OF GALLONS CONSUMED

You can do this with a calculator, by long division on paper, or in your head...

In our example, the gas mileage is

343 / 12.45  =  27.55 MPG

And that's all there is to it!

The Economics of The Oil Industry

Basics of the Petroleum Industry IV: It costs a lot to produce oil

OK, so far, we’ve talked about how oil forms, how it accumulates in fields, and how scientists look for new oil fields. Everything we’ve looked at so far has been about science or technology, and how the nerdy guys and gals who work for oil companies use their high-tech toys to help find new fields. At one time, oil companies were the world’s leading users of technology; and they’re still close to the top. We’re talking about more than numbers of computers and amounts of memory and data storage; we’re also talking about software. One high-end software program widely used by large oil companies has a list price of a quarter of a million dollars – for every one-seat license – and the big multinationals have paid for hundreds of licenses and training so their staff can run these highly complex programs. And computers, software, and training are just a tiny part of the cost of finding new oil…

This time, let’s take a look at the economics of the petroleum industry. That gallon of gasoline you burned on your way to work this morning has had a long journey. Let’s ignore for now the minor miracle that had to happen for oil to accumulate in the first place and concentrate on what it costs along the way to get that stuff out of the ground and into your gas tank.

Step 1: Finding the oil

The business calls this “finding costs,” the expense of searching for oil fields. It might seem simpler to just take a drill and go out and stick a new hole in the ground every couple of miles, but the cost of doing that would be astronomical – not to mention that you might miss the good stuff (and you’d never be certain that you hadn’t stopped drilling a foot or two too soon). So companies work hard to reduce risk so they only have to drill one – or maybe two or three – exploration wells to find out if a prospective site has oil or not. To do this, highly-trained geoscientists make educated guesses about the area using data from nearby wells; and they also use seismic surveys. Now we’re talking about money: a seismic survey of an area will cost hundreds of thousands to several million dollars depending on the size of the survey and the difficulty of getting the data. Those billions of digital records must be processed and reprocessed with highly technical software, and then they’re loaded into high-end computers running expensive software. All that to just look for a prospective location…

We’ll skip the details and cut to the chase: an oil company has determined that there is a sufficient probability of a sufficient amount of oil that they’re willing to take the risk and drill. Before they can do that, however, they have to get permission to drill in the form of a lease. Companies pay for the right to lease land, either from individuals or governments, and also promise to pay part of the profits from any oil that’s produced from that property. Those payments are called royalties, and range from 10% of the sale price of oil up to more than half the proceeds in some foreign countries. The company must also pay to prepare the site if it’s on land, and usually pay for a permit to drill. The up-front investment to drill a well – including salaries for the exploration department – can be, shall we say, “substantial.” Exploration budgets for large companies are typically on the order of hundreds of millions to billions of dollars. Companies spend millions of dollars just picking a place to drill – and then the real money comes into play. Drilling a shallow well on land, perhaps 2500 feet deep, costs on the order of $75-100,000. Offshore exploration costs are far higher, and increase rapidly as the well gets deeper. A recent discovery in 4000 feet of water in the Gulf of Mexico is estimated to have cost a quarter of a billion dollars to drill!

Obviously, if oil sells for $50 per barrel and it costs $55 per barrel just to find it, the company is not going to make any money – that’s one reason why company projections of changing oil prices have to be taken into account just like company guesses at the size of the oilfield.

Step 2: Producing the oil

Let’s say you drilled yourself a gusher. Whoopee! But except for what returned to the surface from that one well, everything else is still deep underground. The physics of fluids like oil and water just don’t allow you to pump all the oil out of one hole, so you need to drill more wells to produce what’s down there. If you’re on land, you could just drive the drill rig to another spot and poke another hole, but if you’re in water, you will have to build an offshore platform and drill several wells to out at an angle. Each of those wells also costs a bundle, and the offshore platform could easily cost hundreds of millions of dollars. That’s all before you pump a single drop of oil into a tanker. If you’re on land, you still need to move the oil from all the individual wells (sometimes hundreds or even thousands of them) to central collection points so that the oil can be piped or trucked to market. There is a lot of money tied up in all the infrastructure, maintaining it, and the personnel needed to keep it operating. That’s a big part of “producing” or “lifting costs.”

But wait, there’s more: there’s also water produced along with the oil, more and more of it as the field ages. The water has to be separated from the oil and disposed of – usually by pumping it back into the reservoir, since it can’t just be poured out on the ground or dumped in a river because it’s salty. More expense…

Remember that we learned some time ago that oil doesn’t collect in underground streams and lakes, but is stored in the tiny pore spaces between grains of rock? That has an important side effect: most of the oil would rather stay clinging to its grains of sand than flow to a well. Companies use all sort of tricks to break that hold: pumping in lots of water, pumping in natural gas, even pumping in carbon dioxide in an effort to”re-energize” the oil and get it moving. Guess what: more expense! and there’s one truth that every oil company scientist and engineer knows: you can never get all the oil out of a field – you’re lucky when you can get half of it.

Step 3: Moving the oil to market

Though it’s not as expensive as finding or producing the oil, getting it to market also has its associated costs. You can’t drive a couple of tank trucks up to a field that produced hundreds of thousands of barrels of oil per day; that would eat up all your profits. So when a company finds a new field, transportation costs are another factor. Building a pipeline big enough to transport that volume of product costs hundreds of thousands of dollars for every mile of pipe. If you can’t get the oil to a refinery or a terminal to sell it, then producing it does you no good!

The bottom line:

Every drop of oil that a company like Shell or Conoco-Phillips sells has all of those costs, and more, associated with it. Just finding oil can cost a bundle, and that’s only the beginning: getting it out of the ground costs even more, and a company is still not done paying to produce oil until it finally reaches a buyer. It is possible – in fact happens frequently – to strike oil but determine that there isn’t enough in the reservoir or it’s not of good enough quality to pay for pumping it out of the ground. When this happens, the find is called “uneconomic.” Obviously, if prices increase faster than producing costs and transportation costs, a find can become economic sometime later.

A company will not drill a well unless they believe that there is enough oil at the site to pay back every one of the costs and have some left over for profit – without profit, they can’t drill the next well. This explains the so-called “obscene profits” that oil companies rake in when the price of oil hits $140 per barrel. Their experts forecast that they would make a reasonable profit at a price of $50 or $70 per barrel, and when the market started paying more, the extra dollars become pure profit. This is no different from a farmer who plants soybeans expecting to make $7 per bushel; except that if he gets $10 instead, no one talks about his “obscene profits.” Oil companies and farmers have the same downside as every commodity producer, because they don’t control the prices – their buyers do. So if our hypothetical farmer got paid $6 per bushel instead of the $7 he was expecting, he has a bad year, and the same with oil companies: if they’ve forecast $50 oil and the price drops to $35 (as it did in December, 2008) then they’re losing money.

So there you have it. That gallon of gasoline you bought today did not simply run out of the ground into a handy gas pump, it’s had a arduous journey from the reservoir to the pump – a journey that had costs at every step along the way.

This is the fourth of a series of minilectures on the petroleum industry from the ground up

1) Where Does Oil Come From?
2) Where Do Oil Companies Find Oil?
3) How Do Oil Companies Find Oil?
4) The Economics of Petroleum Exploration and Production <== You are here.  Future installments include:
5) Refining
6) The Economics of Big Oil
7) The Future of Oil

How Do Oil Companies Find Oil? Basic Petroleum Geology, Part III

The Hunt for Hydrocarbons

Last time, we learned that four things are necessary to create and capture oil. Those four are, an organic carbon-rich source that gets “cooked” deep underground; a reservoir rock layer with bazillions of tiny empty spaces to hold liquid petroleum and water; a shape to the underground rocks that will trap the fluids in a confined space; and non-reservoir (impermeable) rocks to seal the hydrocarbons inside the trap. Now that we know which puzzle pieces have to join to create an oil field, to find oil we have to look for places where all four pieces are present.

Scientists who work for oil companies will tell you, “There is no direct hydrocarbon indicator.” That’s a fancy way of saying that there is nothing we can see or measure that lets us just point to a spot and say, “Drill here!” and know that we’ll strike oil. Instead, we have to study blurry images of the rocks deep beneath the surface and use training and experience to interpret them. That’s how we hunt for places where source, reservoir, trap, and seal all come together in the right relationships.

The first people to use oil found puddles where it had leaked out on the ground’s surface, like at La Brea Tar Pits in California, USA. Oil found at the surface, however, is usually gummy and thick because it’s been exposed to air and water; so early use was often as salves and medicines (not a good idea, really, since petroleum is an organic poison). Not only that, but the amount available in these leaks, or "seeps," is small. Early entrepreneurs dug wells by hand near seeps looking for larger deposits and, when they were successful, also noticed that the oil was higher quality – it was lighter and thinner, and could be burned in a lamp, for instance. The first successful drilled oil well in North America, the Drake #1 in Pennsylvania, was located near a surface seep. The presence of a seep is the closest thing there is to a direct hydrocarbon indicator, but we still have to figure out which direction to go if we want to find the good stuff!

As we entered the age of oil, demand grew faster than wells drilled or dug near a few surface seeps could supply it. Short supply means higher prices, and this bigger payback for the work ushered in an era of surface mapping to hunt for oil. By studying the shapes and order of rocks exposed at the surface, early oil-company geologists (scientists who study the earth) could identify possible traps in the crumpled layers around basin edges. Drilling holes in geological structures – bent or broken sedimentary rocks - caused a boom in oil exploration in the early twentieth century. This method also introduced the oil-seekers to risk: even though a trap is visible, that doesn’t mean that the other three pieces of the puzzle are present. If there’s no reservoir rock, there can be no oil accumulation. If there’s no source, there is nothing to put in a reservoir. And if there is no seal, anything that does enter a trap simply leaks out. Early “wildcatters,” as oil-drillers were called, either learned how to identify which structures had the best chance of all four components being present, or they went broke drilling “dry holes.”

Where there’s money to be made, technology soon comes along to make it easier (or not as hard) to earn it. This has happened in the “oil patch” many times. The first big leap in exploration came soon after World War I began, when French scientists developed a way to record the order and thickness of rock layers encountered in a well, and well logging was born. Well log measurements were soon invented that helped scientists figure out which deeply buried rocks are sources, reservoirs, or seals. Almost a century later, well logs are still used to help geologists understand the rocks in the subsurface, though the sorts of information collected today are much more complex than the first logs.

Just before World War II, there was second forward leap in exploration. Research scientists devised a way to bounce sound waves off underground layers, and record the waves that return to the surface. By carefully measuring the time it takes for that sound to return, scientists can create a sort of “sound image” similar to the layering of the rocks underground. This method, called seismic exploration, created a new field for scientists who called themselves geophysicists. The new tool came along just in time: geologists doing surface mapping had found most of the fields visible on the ground. With seismic tools, the two groups of scientists – geologists and geophysicists – could work as a team to identify traps that aren’t visible from the surface.

Today, geologists and geophysicists work together exploring for oil fields using powerful computers and special software. Exploration geologists and geophysicists are like detectives: they spend their days following subtle clues, putting together complex puzzles for which there are never enough pieces – and when they’re done, the ultimate test of their puzzle-solving skill is an exploration well. As a famous geologist said more than fifty years ago, “All the easy oil has been found.” These days, the hunt for oil involves months and years of painstaking work by highly-trained professionals using state-of-the-art technology. Even with all that power brought to bear on the problem, only about one of every eight exploration wells drilled finds enough oil to pay the cost of the well.

And here you thought all they had to do was stick a pipe in the ground…


This is the third of a series of minilectures on the petroleum industry from the ground up

1) Where Does Oil Come From?
2) Where Do Oil Companies Find Oil?
3) How Do Oil Companies Find Oil? <== You are here.  Future installments include:
4) The Economics of Petroleum Exploration and Production
5) Refining
6) The Economics of Big Oil
7) The Future of Oil

Where Do Oil Companies Find Oil? Basic Petroleum Geology, Part II

The Essentials for an Oil Field: Source, Reservoir, Trap, and Seal

Last time, we learned how oil (petroleum) forms: it’s a slow process by which an oil source – a rock full of ancient plant and animal life - transforms deep underground, over hundreds of thousands or millions of years. The long time this takes explains why, on a human scale anyway, oil is a non-renewable resource. Geologists call this “cooking,” and even call the deeply-buried area a “kitchen” or a cooking pot. To extend that metaphor, after we cook dinner, it has to be brought to the dining table so we can eat. In the world of oil and gas, our dining table is what is called a reservoir.

Remember that one of the four things needed to turn organic matter into oil is pressure? Well, you can imagine that with thousands of feet of rock on top of it, our source layer has been subjected to a lot of pressure. At about the same temperature, pressure, and time that our oil finishes cooking; water trapped in the buried layers starts moving, pushing the newly-generated oil ahead of it. That happens because oil and water don’t mix, just like an oil and vinegar salad dressing never quite mixes. The water and oil move from the source bed into adjacent rock layers with tiny cracks, or tiny spaces between the grains. From there, all that oil and water has one purpose: to move to the surface, a movement called migration (did you know that petroleum migrates, just like birds and butterflies?). This step, like the cooking process, is very long and slow.

At this point, we need to talk about rocks for a minute. Oil-bearing rocks are almost always the kind of rocks called sedimentary, which form huge layers like some Texas-sized wedding cake. To our moving oil and water, each layer is one of two kinds of rock: it’s a reservoir or a seal. The difference is that a seal is impermeable to fluids like oil and water, meaning that it won’t allow them to move through it, forming a barrier. A reservoir is permeable, however, and fluids can move through it, either when migrating out of the kitchen or someday moving into a well. Our big slug of oil and water starts out in the deep parts of sedimentary basins, which are shaped much like what they’re called: gigantic shallow bowls. All those layers of rock are slightly tilted, following the curve of that bowl’s sides from rim to bottom. This allows our oil and water to keep moving toward the surface even when it can’t go straight up. Sometimes it makes it all the way to sunlight, forming an oil seep like the world-famous La Brea Tar Pits near Los Angeles in the USA.

Most of the time, however, our mix of oil and water runs into some sort of physical barrier. That barrier brings the migration to a stop. The permeable rock through which the oil and water have been migrating might run into a geological wall, in the form of a fault such as the San Andreas Fault (also near Los Angeles). This is quite literally a dead end, and those fluids get trapped because they can’t reverse course and go back downhill. The rock layer through which our fluids are migrating might end for other geological reasons, one of which is that the conditions for the layer’s creation or deposition did not exist everywhere. Again, the moving fluids become trapped because they can’t go backwards. A common occurrence is that all those sedimentary layers become crumpled or folded near the edges of our basin, forming sort of a three-dimensional roller coaster shape. The fluids migrate uphill into high spots, but then they can’t move down. All of these situations are common forms of traps – the third component needed for an oil field. If you think about it, though, the oil could just move sideways or across whatever is in the way – that is, it could move, unless there are layers of impermeable rocks or seals, surrounding it.

So to recap, to make petroleum you need a source of organic carbon that can be cooked in a huge geological pressure cooker. Once our dry bits of organic carbon are transformed by heat, pressure, and time into liquid petroleum; it (along with a lot of water) starts searching for a route to the surface. This is migration, when fluids move out of the source layer and into a layer that lets natural uphill movement happen. This rock layer, which is permeable to oil and water, is reservoir rock. If that reservoir rock ends or gets bent back downhill at some point, then the moving fluids are caught in a trap. They can only stay trapped, though, if there are non-reservoir rocks surrounding the trap that prevent them from moving straight up or going out the sides of the trap. These are the seals. Those are the four essential parts of an oil deposit: reservoir, source, trap and seal.

One more point to consider: sometimes people think of oilfields as underground lakes and rivers, but this is not the case. Oil is found in reservoir rocks, not in puddles and pools. A reservoir rock looks just as solid as any other rock, but under a microscope you’d see that it’s really made of tiny grains, and between those grains are even tinier empty spaces. You can make a model of a reservoir rock by dumping a handful of marbles into a water glass – there are lots of odd-shaped spaces left over because the marbles are spheres and don’t fit together like puzzle pieces. If you pour water into that marble-filled glass it can fill those void spaces, which geologists call pores. In good reservoirs, pores occupy 25% or more of the rock’s total volume; all filled with oil and water. That might not seem like much when you hold a single rock in your hand, but an oil field is a lot bigger than your hand. A good-sized oil field is miles across and the reservoir layers can be hundreds of feet thick. If you don’t think that’s a lot, let’s do the math: 25% of the volume of a cylinder one mile in diameter and 100 feet thick is still almost 180 million cubic feet! So zillions of spaces so tiny you can’t see them still add up to a whole lot of volume – and that’s where oil fields come from.

Now that we know how an oil reservoir is found, next time we’ll look at how oil companies find reservoirs.


This is the second of a series of minilectures on the petroleum industry from the ground up

1) Where does Oil Come From?
2) Where do Oil Companies Find Oil?  <== You are here. Future installments include:
3) How do Oil Companies Find Oil?
4) The Economics of Petroleum Exploration and Production
5) Refining
6) The Economics of Big Oil
7) The Future of Oil

Will BP's Tiber Discovery End Oil Imports? Nope.

It’s all over the papers this morning: BP (formerly BP-Amoco, formerly British Petroleum) has officially announced what’s been a poorly-kept secret in the halls of Houston for weeks; a potential three-billion-barrel oil field in the waters of the Gulf of Mexico, 250 miles southeast of the Bayou City. The conservative pundits on AM Radio and FOX will be howling with glee this afternoon; and I can already hear Sarah Palin sitting on that porch with a view of Russia chortling, “I told you to let ‘em ‘Drill, baby, drill!’” A couple more of these, and America won’t have to kowtow to them Ay-rabs or that commie Chavez any more! Energy Independence is upon us!

But before you trade in that Escape hybrid on a new Unimog, maybe you’d better take a deep breath and consider some facts.

Fact 1: BP’s discovery, called Tiber, was drilled in the area known as Keathley Canyon, in some 4132 feet of water. The well penetrated another 35,055 feet of rock to reach its target (Lower Tertiary rocks, if you care). That means the discovery well has a total depth of 39,187 feet – deeper than any current oil production in the world. For reference, the 35,055 feet of rock between the sea bottom and the reservoir is a mile more than the total height of Mt. Everest.

Fact 2: This is the sixth discovery in this “trend” since 2000, including Shell’s Perdido discovery (in 10,000 feet of water) and Chevron’s Jack discovery in 2006. So far, there’s been no production. None, whatsoever – Shell predicts that Perdido development will begin in 2010.

Fact 3: Oil doesn’t just pour into tankers after it’s discovered like cows coming back to the barn at night. It will take billions of dollars of equipment and human talent to produce oil from a discovery this deep. In the case of Tiber, current technology very likely is insufficient to produce hydrocarbons from this depth; necessitating millions of dollars in research to develop this technology. Unless BP and its partners believe they can expect to turn a profit on oil produced from this field and others in the trend, the oil will stay in the ground. Most industry experts predict that the technology for production under these conditions will not be in place for a decade. The industry is well-funded and some of the brightest minds around are at work on solving the logistical problems involved in production at this depth – but until oil prices reach a level where the sale price exceeds the cost to produce a barrel of oil, it’s staying right where it is. Speaking of money, the “street” estimate of the cost to drill Tiber is over $250 million. And here you wondered where those "obscene" profits Big Oil made last year were going...

Fact 4: Energy independence it’s not. The USA imports between ten and eleven million barrels of crude oil every day. At 3 billion barrels and an estimated thirty-year lifespan, Tiber would produce an average of less than 300,000 barrels per day (although that would be front-loaded to an extent). Or, looking at it another way, US total consumption of crude oil averages between 19-20 million barrels/day. At that rate, three billion barrels is slightly less than a six-month supply.

Go forth and listen to your pundits, left or right – and remember that all of them are leaving out facts that don’t support their arguments.

Where Does Oil Come From? Basic Petroleum Geology, Part I

It's tough to wrap your head around the oil industry without a basic understanding of just what oil (petroleum) is and how it gets to consumers. When we see headlines like "ExxonMobil and Shell Post Record Quarterly Profits" on the same day we've paid almost $5.00 per gallon to fill our tanks, anger and disgust are natural reactions - as is suspicion that the companies making all that money are ripping us off; big time. The huge profits oil companies, large and small, make when oil prices rise into the stratosphere don't however, come (as some might believe) from manipulating prices at the pump. Those profits are, instead, the result of a series of happy accidents and calculated risks, just as are the profits from opening a body shop or buying a fast-food restaurant. The big difference between the oil companies and Wendy’s or Joe's Collision Service is that almost everyone knows where beef patties come from and how fenders get dented. Many people, on the other hand, haven't given much thought to how gasoline gets to the pump or even where it comes from in the first place. You want to know a little more? Let's begin at the beginning...
   
If you ask a third-grader, “Where does oil come from?” he'll probably say, "From dinosaurs!" Ask him again when he's a college senior, and he'll probably give the same answer. He's wrong: though they're among the biggest animals ever to walk the Earth, dinosaurs are way, way, way down the list of sources of oil. The biggest sources are at the other end of the size scale: microscopic plants and animals like algae; most of which were plankton floating in oceans and large lakes. When uncounted billions of those animals and plants died, their bodies settled to the bottom along with fine sediment, and the whole shebang ended up buried. That's a key to turning that dead organic matter into petroleum: burial. One of the reasons why dead dinosaurs - most land animals for that matter - didn't get turned into oil is that they were exposed to the air and oxidized, just like a hunk of iron left sitting behind the garage rusts away to nothing with enough time.

Now we have an underwater layer of sediment chock full of dead stuff - organic matter or complex carbohydrates (compounds of carbon, hydrogen, and oxygen). What's it gonna take to make petroleum out of that stuff? It takes four things:

First, it takes a high enough concentration of that organic matter: a "rich" layer can contain fifteen, twenty, or even fifty per cent organic carbon. As a general rule, concentrations of less than four to five per cent organic carbon are too lean to produce much oil. Just like it is with parents, richer is better.

Second, it takes pressure.

Third is heat: things don't even start until the temperature is somewhere between 120° and 190°F.

Fourth is time: lots of time.

The amounts of pressure, heat, and time necessary to "cook" organic carbon into the oil we humans crave are a complex system. Lower temperatures for long periods can generate as successfully as higher temperatures for shorter periods. Two of the three variables, though, require that the carbon-bearing layer be buried; and the deeper the better; though not too deep - if things get too hot, the oil "overcooks." Complicating matters is that different kinds of organic carbon generate different hydrocarbons at different pressure-temperature levels. An entire branch of geology (organic geochemistry) is devoted to the study of this process, which scientists call "thermal maturation."

This is the first step in the lifecycle of oil; creation of a petroleum source and its conversion from tiny bits of dry organic matter into the liquid we know as crude oil. Remember, there are four things, all of which must be present in the right amounts to generate oil: organic matter, heat, pressure, and time. And when we say time, we don't mean on the order of days, weeks, months, or even years. We're talking tens or hundreds of thousands of years; even millions of years. That last explains why fossil fuels such as petroleum are called "non-renewable" resources: the rate of replacement is so slow that, for all practical purposes, no new petroleum is being created.


Where Does Oil Come From? is the first in a series of posts on oil and the oil industry.

Stay tuned. Future installments will cover:

Where do Oil Companies Find Oil?
How do Oil Companies Find Oil?
The Economics of Petroleum Exploration and Production
Refining: It's not all Gasoline
The Economics of Big Oil
The Future of Oil