September 25, 2012

The Geography Of Gas (Part 1)

Why does a gallon of gas cost what it does? Geography plays a role. Not only does it matter which countries have the natural resources to produce oil but who is using it, the world economy, natural disasters, political crisis and other factors. And, in one way or another, they are all related to geography.

Let’s focus first on supply and demand, the simplest factors to understand when it comes to the price of gas. Grade school economics teaches us that when supply is limited, the price goes up; when there is a surplus, the supply goes down. With crude oil, the equation isn’t quite so straight forward because the quality varies.

In a general sense, however, there is plenty of oil. Dr. Maizar Rahman of OPEC stated in a 2004 economic forum in Vienna that accounting for the world’s proven reserves of around 1,100 billion barrels, at the time, there is enough oil to meet demand for the next several decades. And, that’s just the reserves. He told the forum, “Over and above the world’s proven crude oil reserves, there is still plenty of oil that has yet to be discovered, in regions whose geological structures suggest a high probability of commercially viable reserves.”

Demand shouldn’t be an issue any time soon, but the quality of what’s available could affect prices. Oil does not come out of the ground in the same form—it is graded by its viscosity (light to heavy) and by the amount of impurities it contains (sweet to sour). The price for oil that is usually quoted is for light/sweet crude, which is easier to process than its thicker, heavier counterpart. The more impurities, the more processing, the higher the price.

Until recently, light/sweet crude has been widely available, but it is becoming harder to obtain while heavy/sour is fairly easy to obtain. Because heavy/sour requires a higher capital investment, though, it does cost more. So, even though supply remains steady for the foreseeable future, price may increase because of the quality of that supply.

Demand will also force prices up. Both China and India have expanding middle classes with the cash to purchase cars. China plans to build 42,000 miles of new highways by 2020 to accommodate all the new car sales (the United States has about 86,000 miles of interstate highway total); India will add another 12,000 miles by 2022. That’s a lot of gas. Higher demand, higher prices.

But it’s not just the average driver that figures into the equation of demand—growing economies need fossil fuels. According to the United States Department of Energy, China is the world’s largest energy consumer. Its economy has grown at an average rate of about 10 percent per year over the last 10 years. Again, higher demand, higher prices.

To complicate matters, oil doesn’t subscribe to the typical supply and demand model where a company produces a product that it sells to consumers. Many countries count oil among their natural resources, including the United States, but just because oil is drilled here doesn’t mean it stays here. Often, it is shipped overseas where it can fetch higher prices.

So, while we have a supply, to an extent, we rely on other countries to meet our demand. (In addition to selling oil overseas, we are also prohibited from using many of our known oil reserves, and we haven’t built a significant oil refinery in the United States since 1976.)

Where we get our oil from and who we sell our oil to—along with the quality of the current supply and the increasing demand of emerging middle classes and growing economies—all affect the price of gas. Tomorrow, I’ll explore some of the other factors that contribute to the price of gas and how geography plays a role.

Image Credit: Photos.com

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