The Oil Drum

54 comments on Open thread

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step back on September 24, 2005 - 11:16am

Chris, I'm no expert on this, but I recall someone explaining the refinery capacity thing using an oil tanker hypothetical.

Say you are a Sheik and you've just filled a tanker with crude but have not yet committed that tanker into sailing to the East or sailing to the West. You're waiting for the markets to tell you which is the best direction (maximum profits) to aim your tanker as you start collecting bids from potential buyers.

All of a sudden you hear that Allah has smitten the infidels in the West with a devastating storm (--praised be his name). Their refinery capacity is down. They will not be able to buy your tanker full of oil because they have no immediate use for the oil. So you turn your tanker East.

It will take a few weeks or months for your tanker to show up in port. Futures traders in the West see this tanker turning happening not only for your tanker, but a lot of others. They realize there will be no oil heading West for a while. The refinery shortage has led to an oil flow curtailment in that direction.

OK that was a crude (and rude) attempt at an explanation. Does it help?

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ChrisPhoenix on September 24, 2005 - 2:48pm

So it sounds like you're saying it's just an overcorrection. Refinery capacity falls, so a herd of oil shipments goes elsewhere, so then there'll be less oil than needed, so the price rises...

But that still doesn't make sense to me. I'm assuming they don't direct multiple tankers, covering long time periods, simultaneously. Each tanker is an individual decision based on profit, which can be contracted in advance. And I'm assuming that one tanker more or less will not affect oil price significantly.

So, the oil price starts to inch upward because of the expected shortfall... and the next tanker gets directed to the storm-damaged area. End of problem... right?

Chris

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step back on September 24, 2005 - 3:18pm

Well, no.
If YOU ARE THE SHEIK, you do not want crude to start accumulating at a refinery that cannot absorb the oil flow because that will cause local crude prices to collapse, and it will be lost opportunity elsewhere. Remember, YOU as the sheik want high prices combined with high volumes. Your proft is basically the sum of (Price at refinery #1) times (Quantity absorbed at Refinery #1) + P2*Q2 + P3*Q3 +... You use a computer to plan out which routes your oil volumes should move along to maximize this sum in each projected time period. So if Q1 (Quantity absorbable at location #1) is trending down, you divert your quatity flow to another location where the quantity can be absorbed at a relatively better price. You do not want elastic prices to develop at any location, you want to operate at the threshold of elasticity. That is why you are a member of OPEC. The markets do not control you, you control the markets. You can do this because your customers are addicted to the product. They must have it, more and more, no matter what the costs.