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Breaking down the cost of home heating oil

28th August 2014 All News and Offers

Barton Petroleum truck delivering home heating oilWe sometimes get asked what makes up the price of our home heating oil quotes and why it is more expensive one day than another.

The price of heating oil is directly related to the price of crude oil and that is why the prices for home heating oil can fluctuate daily.  When demand is high, prices are high; as demand falls so too does the price of heating oil and that is why it is always prudent to plan ahead and buy at a time when the weather is warmer and less people are reliant on heating.  We receive our fuel prices from our supplier 48 hours before it is delivered to us, so we know 48 hours in advance whether prices are going up or down.  You will always be charged the price on the day you placed the order.

When heating oil prices spike it is natural for people to think they are getting a bum deal, but heating oil suppliers, like petrol retailers, make a small margin, typically a few pence. The majority of the price is made up from government taxation and the cost from the oil companies who supply our kerosene.

The price of a barrel of oil on the open market is well documented, but how this figure is broken down into its component parts is much harder to determine.

Cynics would say this is because vested interests within the oil industry don’t want us to know. But delving just a little into the actual cost of producing oil, rather than its price, suggests this view may be a little simplistic.
One of the main reasons for the lack of transparency is simply that there is no standard barrel of oil – the cost of producing one varies massively depending on which of the many thousand oil rigs around the world it comes from.

For example, a bog standard barrel of oil from Saudi Arabia costs about $2-$3 to extract from the ground, whereas a barrel taken from tar sands in Alberta can cost more than $60.

But this in no way represents the cost to oil companies of producing the black stuff.

First they have to find it, which actually accounts for remarkably little of their overall expenditure on production, despite the fact they are having to look further and wider, given dwindling supplies from traditional sources.
For example, setting up a deep water exploration well can cost between $100m and $200m, and only has a one in four chance of success on average, according to Robert Plummer, senior analyst at global energy research group Wood Mackenzie.

Maintaining oil rigs is an expensive business

Then they have to lease the land on which they want to drill, obtain the rights to do so, appraise the reserves they are tapping into, lease the rig and put in place the pipelines and shipping contracts needed to transport the oil for refining.

And this is a lengthy process – typically about seven years from discovery to production.
Roughly, this accounts for about 20% of the cost of a barrel of oil, but it’s getting ever more expensive as oil runs out and companies are forced to drill deeper in more remote places.

Then of course they have to operate the rigs, which involves maintaining the heavy equipment needed to pump the oil, monitoring and managing reserves, redrilling blocked wells and paying for supplies for crews, who need to be compensated handsomely for the risky work they undertake. This accounts for about 10% of the cost of oil.

This gets us roughly to what a barrel of oil costs to get out of the ground. These figures are based on a proxy cost of oil, which actually includes a not-insignificant weighting for gas. Also bear in mind that these percentages are based on figures for 2011, and they do vary from year to year (see chart below).

Taxing profits

But this is not the cost of oil, for there are two major components missing – tax and the profit the oil companies themselves make. These will account for almost two-thirds of the overall cost of oil in 2011, according to Wood Mackenzie’s figures, although it’s clear who the biggest recipients are. You guessed it: governments.

Tax on oil is a complicated business – some is charged as a percentage of revenue, while export duties can be onerous – but a good chunk of government revenue comes from taxing the profits of oil companies.

Marginal tax rates on profits in the UK are 62%, more than 80% in Norway and about 90% in some countries. And when profits rise, taxes rise, not just because they are based on a percentage of profits, but also because governments can raise the actual rate of tax itself.

However, even with such high rates of tax, this year oil companies are looking at margins of about 25% of the total cost of oil, which is pretty spectacular by most industries’ standards, although this figure does not include financing costs. UK gas and electricity companies, for example, work to margins of about 9%, according to the regulator Ofgem.

But again, these margins vary widely from year to year. For example, in 2009, margins were about 8%, while in 1998, oil companies made no profit at all.

Finally, then, we have a rough idea of the how the cost of oil breaks down. To get the latest heating oil prices please use our quote form. Remember that we can provide plans to help spread out the cost of your order, so please talk to a representative at your local depot for more information.