The Intellectual Cowboy

In a previous article written on April 30, it was noted in The UAE and OPEC that the United Arab Emirates (UAE) announced its intention to leave OPEC, largely driven by a desire to increase oil production beyond existing quota limits. The UAE possesses one of the largest oil fields in the world by proved reserves—the Upper Zakum offshore oil field. Increasing crude production would, in theory, allow the country to generate greater revenue, an obviously desirable outcome.

However, while some Middle Eastern countries are relatively well known to Western audiences, there is a good chance that the UAE itself is less well known. This article provides some background on the country, its political structure, and its economy – specifically its oil production.

What Is an Emirate?

The name of the country is the United Arab Emirates. This begs the first question: what is an emirate? An emirate is a political territory ruled by an emir. “Emir” is a historical Arabic title for a ruler or leader.

In general, emirs:

• Are hereditary rulers
• Hold very significant political authority within their territories (quasi-absolute in some cases)

An emirate can be thought of as analogous to a monarchy in many ways. For example, while Saudi Arabia is a kingdom ruled by a king, and the UAE consists of emirates ruled by emirs, both systems have very powerful, hereditary rulers.

The term “sheikh” is also commonly used to refer to very wealthy leaders in the Gulf region. A sheikh is very similar to an emir.

The Emirates of the UAE

The United Arab Emirates was formed in 1971, as the British withdrew from their former imperial holdings in the Gulf region.

Seven emirates on the eastern side of the Arabian Peninsula joined together to form a federation:

1. Abu Dhabi
2. Dubai
3. Fujairah
4. Sharjah
5. Ajman
6. Umm Al Quwain
7. Ras Al Khaimah

Some of these emirates are more widely known internationally:

• Abu Dhabi – the capital and largest emirate, as well as the center of political power
• Dubai – a major global city and site of the Burj Khalifa – the tallest building in the world
• Fujairah – strategically located on the Gulf of Oman, outside the Strait of Hormuz, and a very important petroleum terminal for both crude and refined product exports

The rulers (emirs) of these seven emirates form the Federal Supreme Council (FSC), the highest governing body in the UAE. The FSC selects the president from among the rulers. In practice, the ruler of Abu Dhabi has consistently been chosen as president.

The current president is Mohammed bin Zayed (often referred to as MBZ). He is distinct from Mohammed bin Salman (MBS), the Crown Prince of nearby Saudi Arabia.

The Economy of the UAE

As far as Middle Eastern economies go, the UAE has an extremely diversified economy. Well less than half of its GDP is derived from the oil and gas industry. This is a statistic that would greatly surprise the casual American. The country possesses very strong financial and tourism sectors. An additional portion of that non-oil-and-gas GDP is generated by its airline industry and the now famous Emirates first class long haul flight experience.

The UAE Oil Industry

Despite this diversification, the oil industry remains enormously important to the UAE and its global role.

In 2025, the UAE produced roughly 4 million barrels of oil per day and has the capacity to substantially increase production further. A significant portion of this output is exported, making oil a key source of national revenue as well as regional and international influence.

As today’s events showed, this characteristic makes the country a prime target for Iranian attacks during the present war.

In Short

The United Arab Emirates is a federation of seven emirates located on the eastern Arabian Peninsula. Each emirate is ruled by a hereditary leader, and together these rulers form a federal governing structure that selects the country’s president.

Abu Dhabi, the largest emirate, serves as the capital and political center. Dubai is a very internationally recognized emirate, known for its business district, tourism, and the Burj Khalifa. Fujairah is the site of a major oil terminal and is especially important today due to its location outside the Strait of Hormuz.

While the UAE has successfully diversified its economy beyond oil, petroleum remains a critical component of its wealth and driver of its national policy.

Crude oil is the most important and widely used commodity in the world. Today, the “black gold” is entirely synonymous the term Energy – the source of all action – economic and otherwise. The substance came into widespread use in the late 19^th century and continues to be the fundamental driver of the world’s economy here in the 21^st. This article aims to provide a basic understanding of crude oil – what it is, where it is from, and what it is made into. This issue will then provide the foundation for a future examination of the economic side of the industry – especially relevant in light of the recent trade disruptions from the Russian – Ukraine War.

What is Crude Oil

Crude oil, also known as petroleum, is composed of various hydrocarbon molecules of different molecular sizes and properties. Contained in one barrel of crude oil is everything from butane for tiki torches to bitumen for asphalt. The ratios of the different molecules depend on the specific geographic location of the oil well and ultimately on the underlying envronment of the rock formation in which the oil developed millions of years ago.

In the crude oil samples below, one can visually see the differences between different types of crude. On the left are heavy, sour (high H₂S) oils. The two lighter samples to the right are lighter and sweeter (low H₂S) oils. There are many different types, or grades, of crude oil but all are categorized by whether they are heavy or light and whether they are “sweet” or “sour”. As an example, the U.S. oil benchmark used for the futures tading market – West Texas Intermediate (WTI) – is defined as light, “sweet” crude. West Texas is known for this type of oil.

Historical Uses – “Burning the Midnight Oil”

Today, oil is best known for its widespread use as a transportation fuel of some sort. However, this was not always the case. Oil “springs” leaking oil and gas out of the ground have been known of for thousands of years dating back to Biblical times (Yergin, 23). From its original discovery and continuing up to the 1900’s, oil had many but limited uses – some examples of which are illumination, tar, and medicine (if one loosely defines the term). However, the scale of applications was nowhere close to what petroleum and its byproducts are used for today.

In the United States in the 1859, the non-sunlight sources of illumination were candles, town gas from coal, and kerosene – the best option. The kerosene market was to undergo a massive disruption in that same year.

Kerosene is a petroleum product, but in the mid-1800’s its primary source was not crude oil from the ground but rather whale oil from the blubber of sperm whales. However, the reliance on whaling for kerosene had some issues. The inevitable hunting failures, limited supply of whales, and the nature of the on-ship blubber boiling process resulted in a very expensive final product. A gallon of kerosene back in the mid 1800’s cost $2.50/gallon or $85.46/gallon in today’s money (Yergin, 22). As a result, only the rich had access to kerosene, the peasanty had to make do with their candles.

This was soon to change.

In 1859, oil was struck in the United States in Titusville, Pennsylvania. The petroleum industry subsequently exploded resulting in vast economies of scale for all facets of the business – drilling, transportation, refining, and marketing (sale to customers). The price of kerosene plummeted as a result and became a commodity good accessible to all. The immense wealth of John Rockefeller and the success of Standard Oil (now Chevron, ExxonMobil, Marathon, and others) demonstrate the value of kerosene at the time.

The booming kerosene market for illumination was not to last, however.

The Midnight Oil Burns Out

Thomas Edison would invent the lightbulb in 1882 and electric illumination would increasingly replace the burning of kerosene. While this transition was not instant (many parts of the country did not have electricity until well into the 20^th century) it was steady (Yergin, p. 79). However, at the same time, a new market for oil was to present itself – transportation fuels.

The automobile came into widespread use in the U.S. and in Europe in the early 1900’s providing a market for two other refined products of crude oil – gasoline and diesel. Additionally, it was around this time and that the world’s major navies – the U.S., England, and Germany began to transition their navel armaments off of coal and on to petroleum for power (fuel oil aka “bunker fuel”). These principle uses for crude oil remain to this day, and while many more uses for petroleum have been found, transportation fuels remain one of the largest and important markets.

Where Oil Comes From

With the cursory summary above, one has a concept of when oil became important and perhaps its most important use – transportation. However, one may begin to ask a more fundamental question – where does crude oil come from exactly and how does it end up as gasoline in my Ford F150? This will be explained below, while hopefully avoiding the overly cumbersome technical details despite how intellectually stimulating they may be.

While this is a slight digression, there is, however, one geological technicality that must be understood – how oil resides underground.

Oil – and natural gas for that matter – reside within the pores of the rock itself.

A common misconception is that there is some large pool underground that contains millions of barrels of oil – like a underground big lake. According to this errant way of thinking, the given oil exploration company – Chevron for example – drills thousands of feet through the ground into the pool like placing a straw in a milkshake. But in fact, oil does not reside in such large underground “pools”, rather it sits within the pores rock itself in large pockets of interconnected deposits – like water in a soaked sponge.

Why the emphasis on this hair-splitting detail? The reason is that by understanding that oil (and gas) resides in the actual rock, one will better understand how oil is drilled for in U.S. and how it differs from the parts of the world like the Middle East. The “Shale Revolution”, “Shale plays”, “tight oil plays”, and fraccing, do not make much sense without understanding 1. where the oil is – actually in the rock and 2. how shale rock is different from “traditional” rock that it requires fraccing to extract the oil in an economic fashion.

Shale Oil vs. Conventional Oil

Explaining the difference between Shale (Unconventional) and Traditional (Conventional) wells and production methods requires its own literary dispatch, but it ultimately boils down to the type of rock in which the oil resides. Of specific importance is the prospective rock formation’s porosity and permeability.

Stated simply, traditional oil resides in fairly porous and permeable rock and therefore, the oil flows “easily out” of the formation and into the well when the rock formation is drilled into. Shale oil, on the other hand, resides in much less porous and much less permeable rock and requires hydraulic fracturing in order to flow oil from formation to well in suitable amounts to actually make money on the investment.

In a traditional oil well (Saudi Arabia still mainly has these), a vertical well is drilled into the oil deposit, the casing is perforated, and oil begins to flow plentifully (assuming one employs good geologists and they picked the right place to drill). If one was to attempt this process in a shale rock formation, barely any oil would flow despite drilling the well in the “correct” place. The oil is there, but the rock is not permeable enough to allow it to flow from the formation over to vertical (or horizontal) well. Fraccing fixes this flow issue by artificially increasing rock permeability by pumping water (and sand and chemicals) into the well at high pressure to fracture the rock and “free” the oil.

Most new wells in the United States require this fraccing method – hence the widespread news coverage of the technique. Among other things, oil from shale is more expensive because of the additional work required to produce the well. Because of this, the U.S. oil industry tends to have a higher breakeven price than that of other countries who do not relying on fraccing as much for oil and gas extraction.

Understanding the very basic differences between conventional and unconventional wells will prove very useful in understanding future topics such as oil price, breakeven prices, oil and gas capital investment and the like. For now, the focus will shift to the next step after the drilling phase – the refining process and the creation of substances that can actually be used for things.

From Wellhead to Fuel Tank

Regardless well type – shale or conventional – all crude oil ends up at a refinery. In the U.S., producing wells are located everywhere from Alaska to Pennsylvania to California to Texas to Louisiana and many other places both onshore and off. After the oil is extracted, it flows to a refinery which also plentifully dot all parts of this country.

At first glance, a refinery appears to be an enormously complex operation. And while many subsequent glances may not reduce the complexity, the basic operation of a refinery is simple – 1. take in crude 2. heat it to separate the different components, and 3. process and sell those components separately.

The process works as follows:

• Crude oil comes in (from somewhere in the U.S. or via import)
• The oil is heated to progressively higher temperatures
• The different hydrocarbons that make up the crude oil, boil off at different temperatures
• The separated byproducts are then utilized separately – some are reprocessed within the refinery itself; others are sold directly to market like gasoline and butane.

It is also worth noting from that table above that kerosene has returned to relevance after no longer being ultilzed as an illuminant. With the advent of jet engines, kerosene’s primary use is in jet fuel – which just so happens to be one of the highest margin businesses in the petroleum industry.

In Short and In the Future

Oil – whether crude from the ground, whales, or from any other source – is not at all new to humanity. But it has grown to take on enormous economic importance as it has been put to increasingly more uses – transportation and power generation being the most significant, not to mention plastics and other petrochemical substances. It is also a truly global commodity due to the global span oil deposits can be found as well as its world wide usage. As such, understanding the economic and financial side of the industry is not only exceedingly interesting, but required study for understanding global affairs.

This will be examined in the next issue.

References

Yergin, Daniel; The Prize: The Epic Quest for Oil, Money, & Power; Amazon Link

Leffler, William; Petroleum Refining In Nontechnical Language; Amazon Link

Understanding Traditional Diesel vs. its Renewable Alternatives

Alternatives to traditional diesel are beginning to garner serious investment. Outside of farmers, refiners, and scientists, many are unfamiliar with Renewable Diesel and Biodiesel. In fact, many probably don’t even understand the difference between gasoline and diesel much less the different diesel flavors. Why should you? Only Europeans drive diesel cars. In America only large trucks and heavy equipment run on diesel.

However, among those that do understand the difference, the most important are large oil and gas companies. Two of the industry heavyweights – Marathon Petroleum and Chevron – have recently signed massive deals to expand into the Renewable Diesel space.

Obviously, the current domestic political climate, the global push to reduce emissions, and the recent conflagration between Russia and the Ukraine are some of the drivers for these decisions. But fundamentally, the question is the following: What is being made “renewable” and how does “renewable” compare to traditional diesel? Additionally, what is the significance of “biodiesel” and how does it differ from “renewable” diesel?

Diesel Production Overview

Conventional, fossil-fuel diesel is produced as follows:

• Drill – for crude oil
• Refine – run that crude oil through a distillation tower (heat the crude so that the different components separate at their different boiling points– gasoline, naphtha, diesel, etc)
• Market – sell the refined products separately – the two most familiar of which are gasoline and diesel.

Renewable and biodiesel differ from Traditional Diesel (TD) in both feedstock source and process method. The table below lists the respective feed stocks for differnent diesel types.

While traditional diesel is refined from crude oil, renewable diesel is refined from crop oils. Both are refined, the difference is in the feedstock. Despite the difference in feedstocks, the refining processes for traditional and renewable diesel are extremely similar. One important technical detail of the refining process is that both fuels are hydrotreated during the refining process and produce a hydrocarbon.

It is because of these refining similarities that Marathon is able to refit its existing refinery in Los Angeles, California with “relative” ease and switch from producing TD to RD.

Biodiesel does not share that same refining and as a result is a completely different beast. It is similar to renewable diesel in its feedstock – both utilize crop oils, but it has a completely different production process (refined is not the correct term to use). To make Biodiesel, the feedstocks undergo a process of transesterification.

In addition to easily winning word of the day, the process reacts the oils and waste fats with methanol in the presence of hydroxide catalysts. Transesterification is more a chemical reaction to create something new that did not previously exist, than it is refining an imperfect input into a final product. The bottom line is that biodiesel is made in a completely different process from that of regular diesel and renewable diesel. Renewable diesel can make use of expensive, existing refinery infrastructure, BD cannot.

In summary, TD and RD are refined in a similar way, but differ in feedstock. Renewable and biodiesel have similar feedstocks but differ in production processes. Both renewable and biodiesel have chemical differences from traditional diesel. And lastly, traditional diesel is the cheapest to make of the 3 – by far. So why bother with the alternatives?

The Rationale behind Alternative Diesels

Traditional diesel, and all fossil fuels, have two prominent negative characteristics. First, they are non-renewable: oil and gas formation takes millions of years. Second, they are non-environmentally friendly: their production and burning emits, among other pollutants, copious amounts of CO₂.

Biodiesel attempts to be a better option on both fronts. On the renewable front, biodiesel attempts to solve the issue by utilizing organic waste and crops which can be renewably farmed as feedstock. Environmentally, the production process is presumed* to have less carbon intensive production processes – farming and ultization of waste. It also burns slightly cleaner than traditional diesel emitting less CO₂ at the tailpipe.

Renewable diesel, as the name implies, attempts to solve the renewable problem by using crop oils exclusively as feedstock. On the environmental front, it, like biodiesel, is also presumably* produced in a less carbon intensive manner and also emits less CO₂ at the tailpipe when burned as fuel.

The catch is in cost and power content. In addition to being much more expensive, both alternative diesels are less energy dense than traditional diesel – somewhere in the range of 4-8%. Biodiesel has an additional problem of being inconsistent in cold weather – a chemistry byproduct of transesterification. Because of this, renewable diesel is the hotter market of the two and the one which the major energy companies like Marathon and Chevron are pursuing.

Policy Incentives – U.S. Government and the State of California

While not economic in most of the country, one place where selling renewable diesel does make sense is in the State of California.

Two specific policies make RD cost effective:

1. The Renewable Fuel Standard – passed by Congress at part of the Energy Policy Act of 2005 (contains the Biodiesel Tax Credit).
2. California Low Carbon Fuel Standard (LCFS) – took effect in 2011 (contains low carbon fuel credits).

The Renewable Fuel Standard (RFS) contains a Biodiesel Tax Credit – which also applies to “renewable” diesel – for $1.00/gallon. This is the same standard that deals with Small Refinery Exemptions (SRE’s) which have been in the news recently.

California’s LCFS adds on an additional $0.83-$0.86/gallon. With the application of some 4^th grade algebra, the total tax credit for renewable diesel in California is calculated to be $1.86/gallon. One can begin to see the business opportunity alternative diesels and why some are pursuing them.

Raining On the Parade

While the prevailing thought is that both diesels – Renewable and Bio – are less carbon emitting and scarce by being renewable, there is some evidence to the contrary. While claiming to release less CO₂, when the entire process is considered, that may not be the case. Both diesels have reduced CO₂ emissions at the tailpipe, but the additional forest destruction, farming, and transportation emissions that result may not have a net carbon reduction. Various studies argue both sides.

Additionally, depending upon one’s definition of “renewable”, crops and the farmland itself have limits. Soybeans and corn are major global food sources in addition to being potential feedstocks for transportation fuels. The farmland itself must be farmed such a way to as to preserve its nutrients.

Regardless of future feasibility, Renewable Diesel has a market and policy to back it. Oil majors, agricultural conglomerates, and even major airlines (seeking Sustainable Aviation Fuel) are moving in that direction.