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Crude oil outlook for 2011

The last week of 2010 has come and gone; for some it couldn't come soon enough, and for others it has shown up way too soon. As the new calendar year starts we want to expand on the column last week that covered natural gas and its anticipated price movement in the future. This week we want to discuss crude oil and what 2011 may have in store for crude oil consumers. And in one way shape or form, we all utilize crude oil.

Before we start into the discussion about oil it might be helpful for some quick facts (data supplied by U.S. Energy Information Administration):

--One barrel of crude oil contains 42 U.S. gallons.

--A 42-gallon barrel of crude oil provides slightly more than 44 gallons of petroleum products. (Processing of crude allows for its expansion much like popping popcorn.)

--One barrel of crude oil yields 10.04 gallons of diesel and 19.36 gallons of gasoline.

--71 percent of the average retail cost of one gallon of November Regular Gasoline was determined by the cost of crude oil.

--65 percent of the average cost retail cost of one gallon of November On-Highway Use Diesel was determined by the cost of crude oil.

--The U.S. consumed 18.8 million barrels of oil per day in 2009 while only producing 5.4 million barrels per day domestically.

In keeping some consistency with our outlook on natural gas, we are going to look at supply and demand and how the battle between them may shake out in 2011. Due to the many issues regarding the supply and demand of crude oil, we are going to break our crude oil outlook into two articles.

Much like domestic natural gas reserves in 2009, domestic crude oil reserves increased. Dec. 31, 2008, reserves were 20.6 billion barrels versus 22.3 billion barrels at the end of 2009. Total new discoveries totaled 1.5 billion barrels while net revisions added 2.1 billion barrels. Production of domestic reserves totaled 1.9 billion barrels adding a net increase to reserves of 1.8 billion barrels. Please keep in mind, the numbers reference above are for domestic United States proven reserves. Worldwide proven reserves vary widely and can be unreliable and subject to varying analysis. Although the total assumed reserves of crude oil remains at acceptable levels with anticipated draw downs going forward, the true "supply" side of the price of crude oil is more related to the ability to produce, refine and transport it.

Two prime example of production constraints are as follows: First, much of the world's proven reserves are with countries that for the most part do not have stable governments, are state owned, or the oil reserves may be taken by the state at any point in time. It is estimated that up to 65 percent of the world's oil reserves are currently under state ownership. Most companies refuse to invest money into production infrastructure for fear their efforts will become state owned without reimbursement. Venezuela has a bad habit of doing this to privately owned corporations. This justified concern limits production of easily accessible oil fields and in essence "chokes" down supply. Any disruption in the political landscape can cause production stoppages and cripple world crude oil supply.

The second constraint is the ability to refine oil. The refining of crude oil for the most part is not something anyone wants in their area. We all desire the effects of the operation but don't want to deal with the operation. The United States has not added any significant oil refining facilities since 1976 due in large part to environmental issues. Aging refineries are being taken off line never to return to production while others run at a low efficiency ratio. Some refer to this as the capacity squeeze. We have the oil, but we cannot refine it quickly enough when demand spikes. Add in certain regulations on what types of gasoline must be produced during certain times of the year only adds to more down time of refineries which leads to supply constraints.

Yet another item that can compound the problem for the United States is that most refining facilities are located near the fields in which the oil is harvested. This is a huge benefit to those who live in the Midwest region but a severe drawback for those who live on the East Coast. A quick glance at a map showing the location of refining facilities reveals most refining capacity is located between Louisiana and Corpus Christi, Texas. The east coast relies heavily on imported oil and gasoline to meet its demands. Any small disruption in transportation of crude oil products, like in the country of France earlier this year, will cause prices to increase dramatically while the rest of the U.S. prices more closely follow the price of crude oil.

As regulatory and environmental items continue to be brought to the energy conversation it appears that producing, refining and the transportation of crude oil and its refined products are driving the price higher. Next week we will look at demand and how it might compound the supply side items we discussed this week.

Editor's note: Agvisors provides commentary about agricultural markets, including grain, dairy, livestock, equities, financials, and energy, highlighted by a live weekly webinar discussing conditions and responding to questions. For more information, visit http://agvisors.com.

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