The surge in oil price and is there any easing in sight?

Surge in Oil prices

Oil sits at the start of inflation as the energy resources go into every part of the market. Fuel costs cascades down into the energy, utilities, supply chain and then into products & services.  For businesses that can pass additional costs to customers, they will pass the costs increase to the customers.  

Let us look at oil for a start and how this commodity can create an inflationary impact whenever the crude oil price surges:

Oil price increase > fuel price increase > utilities cost increase > supply chain costs increase > goods and services price increase.  (This leads to inflation as costs go up.) 

We need to understand that the challenge in the USA is not really due to the oil supplies but rather the bottleneck in the refinery capacity.

US petroleum consumption will reach 20.51 million bpd (barrels per day) in 2022

US refinery capacity is short by 1 million barrels per day as per EIA chart above

To meet the shortfall in refinery capacity, can we not just build new refineries?  This is an easy answer but requires time, work and resources.

Costs and time to build new oil refineries

Oil refining is a capital-intensive business. Planning, designing, permitting and building a new medium-sized refinery is a 5-7 year process with costs ranging from $7-10 billion, not including land acquisition. This gives a capacity of 250k to 500K.  

There is a need to design pipeline (and relocate affected real estate like homes, offices, factories or community spaces), source materials, environmental responsibility, and get supply chain partners and support.  This will be a long process.  Thus, it is structural challenge and has no quick fix in sight.  When winter approaches, it worsens due to the heavier energy demand for heating. 

Russian oil to China and India

As per the Nikkei news above, China and India have been buying up "sanctioned" Russian oil cheaply.  

As per the chart dated 21 June 2022 above, Russian Rubles have hit a 5 year high recently even though "sanctions" have been applied since March 2022.  

Oil Outlook

Surrounded by a persistent COVID, climate challenges of drought, fires and hurricanes will affect agriculture as a food crisis develops. No one can replace Russia's output for grains and 40% for fertilizer (at least in the short to mid-term). This could lead to a bigger food crisis that is unfolding as United Nations reported 276 million facing food insecurities.  It is not an achievement if Singapore needs to buy eggs from Poland.  In fact, it just shows how severe the situation has become.

Refinery capacity is unlikely to increase in the short term as it will take years and sizeable investment to build new ones.  Thus, we should expect shortfall in the short and mid-term.  This implies that there is more room for the upside in oil prices.  At the same time, Berkshire has been increasing their states in oil companies of Chevron and Occidental.  This is not a good sign as they usually buy and hold for long, expecting the business to do even better in the future.  

Refinery process and proOiltankingm oiltanking)

Through the refinery process, crude oil is transformed into different products like LPG, petrol, diesel, lubricants, bitumen and plastics.

Why plastics could be staying for the near future?

Global plastics production and consumption, 1910-2018

From the chart above, the global plastics production and consumption reached 438 million metric tons in 2017.  From the chart above, it seems that consumption of plastics should continue to grow despite greener options becoming available.  

More than 50% of plastics ever produced have been made since 2000 (source: Plastic Atlas 2019)

From the graph above, we are expecting plastics production to reach 600 million tonnes per year by 2025.

Apart from the pollution issue, we need to find greener, sustainable alternatives to plastic.  With the expected increase in consumption and also the bottleneck of the refinery capacity, we can expect the oil prices to remain heightened.  The end of the Ukraine war may bring some relief to the market.  However, Russia may not need to sell oil back to the US-led West (Europe) anymore.  Thus, it is also possible that the oil crunch remains.

Hurricane Ida (2021) knocked out refineries for weeks

Let us also look out for weather extremities as these could affect refinery productions too.  In 2021, Louisiana oil refineries shut by Hurricane Ida took weeks to restart, costing operators tens of millions of dollars in lost revenues as they waited for water and electrical power to be restored.  With winter's surge in demand for power (due to heating), a tough winter can await the US.

Let us monitor the situation closely.  Unfortunately, crude oil may remain a big part of our lives unless we find greener and sustainable alternatives in the near future.  Let us spend within our means and invest what we can afford to lose.  Let us research before we invest in great companies at good discounts.