Can you pass this test?

J. Michael Sharman
Published: July 14, 2008

Good morning, class, and welcome to Oil and Gas Economics 101. Please pay attention because you are going to need this information when we have our multiple-choice final exam on Election Day, Nov. 4.

On July 7, the average price for a gallon of gasoline in the United States was $4.11. Back in 2003, the average price hovered around $1.50 per gallon. 

On July 14, 2008, the price of a barrel of crude oil was $145. The average per barrel price in 2003 was $27.69.

So, from 2003 to the summer of 2008, the price of a gallon of gasoline increased 274%, but the price of a barrel of oil increased 523%. If gasoline had increased at the same rate as crude oil, the price of gasoline would today be $7.84 per gallon.

Thus, the price of a barrel of oil bears no logical economic relationship to the price of a gallon of gasoline.

Therefore, a good question for us to ask would be: How much have the costs of producing a barrel of oil increased?

The “Total Production Costs” for producing a barrel of oil are the sum of: “finding costs,” “lift costs” and taxes. “Finding costs” are the total costs for finding, exploring and developing an oilfield. The “Lift Costs” are the oilfield’s operating costs to lift the oil out of the ground. 

The Department of Energy’s most recent figures show that the average global total production cost for a barrel of crude in 2003 was $17.45 and in 2006 it had increased 39.2% to $24.29 per barrel.

Assume the cost of production increased from 2006 to now by the same amount as our Consumer Price Index, which would be 15%. If so, the total production cost is now around $27.93.

Therefore, the $17.45 cost of producing a $27.69 barrel of oil was 63% of its sale price in 2003; in 2006 the $24.29 cost of producing a $58.30 barrel of oil decreased to 41% of its sale price; and by July 2008, the $27.93 cost of producing a $145 barrel of oil had further decreased to 19.2% of its sale price.

So, we see that the cost of production has become inversely proportionate to the cost of sale. In other words, the cost of producing oil has absolutely nothing whatsoever to do with the increasing price of oil.

But to be fair, we must ask: Has the supply of the raw materials of production, the known and proven oil reserves, shrunk so much that the scarcity of future resources might be a likely cause for the price increase?

Worldwide, in 1973, there were just over 600 billion barrels of petroleum reserves known to exist, and today, there are 1,317 billion barrels of proven reserves. The Middle East holds 65% of those proven reserves. 

Here in the United States, in 1944, we had 20,064 million barrels of known reserves and because our exploration and development has kept pace with our consumption the U.S. still has 20,972 million barrels of known reserves.

Since we see that proven global reserves have doubled in the past 35 years and our proven U.S. reserves have remained unchanged for the past 64 years, we have learned that the availability of the proven oil reserves has no connection whatsoever with the increasing price of oil.

For the multiple choice final exam coming up on Election Day, here is the key to selecting the correct answer:

If a candidate for any office suggests that the reason for our high cost at the pump is because it costs too much to produce the fuel or because we are running out of fuel, you know that candidate is either ignorant or deceitful. That candidate would, therefore, be the wrong answer.

Good luck, class, and make sure to get a good sleep the night before the exam.

J. Michael Sharman is an independent columnist who practices law in Culpeper. His column appears Tuesday in the Star-Exponent.