I'm always trying to come up with an explanation of why oil prices are going so high. It finally dawned on me today that one of the not well advertised factors was decreasing supplies of light sweet crude. It was brought on by a comment to one of my previous posts, I don't know which one or by who, but thanks to whoever it was. It turns out several other articles have been written on the subject, but this is my version.
While we may have fairly large oil reserves remaining, the peak production of "conventional oil", the nomenclature that is used by many to describe the inexpensive light sweet oil that has made up our oil supplies until recently, has passed. While conventional oil still makes up the majority of oil that is processed, the quantity of it is now decreasing and must be made up for by other supplies as well as the amount needed to supply the 1.5% increase in demand that has historically taken place (higher prices eliminated the increase during March and may continue to do so until, if ever, the prices go down). This shortfall is being made up by inexpensive heavy sour oil. Heavy oil is oil that has a higher viscosity (thicker, more gooey) oil than conventional oil. Sour oil is oil that contains more sulfur than conventional oil. Both of these properties make the oil more difficult to process.
This oil cannot be processed by refineries designed to process conventional oil and very expensive (read billions of dollars) "upgrades" have to be made to refineries to enable them to process heavy sour crude. Fortunately, in the US about 75% of refineries can handle heavy sour crude, and this may, in part, be responsible for their high profits. OPEC estimates that 45% of the worlds refineries can handle heavy sour crude and estimates that only 30% of remaining reserves are are conventional oil (I am a little wary of this number as the percentage could easily be reduced by counting the tremendous unproven reserves of heavy oil in Venezuela and Canada). On top of this, environmental regulations have become increasing stringent on the quantity of sulfur that is allowed in diesel and gasoline requiring even more modifications to the refineries.
Thus while the total supply of oil that we have is not decreasing, a premium price is now commanded for conventional oil. Conventional oil now receives a price premium of $10-$16 over heavy sour oil. We also still have a shortage of refinery capacity due to the damage done to refineries due to Katrina and a longer than usual shutdown of refineries for repairs and upgrading to allow more refineries to be able to process heavy sour oil. This can be seen in recent figures that show increasing inventories of crude, accompanied by a higher than usual drawdown of gasoline inventories.
I found a longer and more elegant explanation in the Econbrowser, an excellent blog that you might add to your regular reading if you haven't discovered it. The Forbes article focuses on the refinery side of the problem. The Alexanders article provided information on the how many refineries could process heavy sour oil.
One additional comment is relevant to this subject. The refineries that can already process heavy sour crude are enjoying higher than usual profits as indicated in the Washington Times article.
Sweet and sour crude, Econbrowser, August 21, 2005
Sour crude oil sweetens profits for refineries, Washington Times, March 13, 2006
US refiners get rid of sour oil, Alexanders Gas and Oil Connections, November 17, 2004 (from Kansas City Star)
Refining Problems Swell Oil Prices, Forbes.com, June 30, 2005
Topic Report: Impact of Refinery Capacity on Crude Oil Prices - Part 2, Apache Corporation, March 14, 2005