October 20, 2008 | posted by Michael Baxter in Oil | comments (0) |

The prices of oil, wheat and rice are collapsing. At last, the good news we have been waiting for is here.

In fact, it was predicted here some months ago, and a long time before it was fashionable to do so, that these prices would fall.

This is the stuff the economic cycle is made of.

And so worried is OPEC, that it is panicking.

Talk is that it may cut production by 1.5 million barrels a day. Not all oil exporters like that idea – with price down, they want to get sales up in order to try and maintain revenue.

Oil is one of those curiosities. In the short term, the forces of demand and supply work in reverse. It does not seem to matter how expensive it is, demand for oil always seem to rise and supply can never keep pace. Then when it goes into reverse, supply never falls as fast as you would expect.

That is why in the last cycle, oil finally fell to just $10 a barrel, leading Gordon Brown to claim he could end fuel poverty. The collapse of oil back then also triggered off the Russian crisis of 1998.

Well, it would be a brave forecaster indeed to predict oil falling that low again, and this writer is certainly not that brave. But it seems clear oil is on its way down, so too is food, and that will help boost their affordability.

In the longer-term, demand in the oil and food business works just like it is supposed to.

We are seeing the delayed effect of oil reaching levels that were just unaffordable.

As oil falls in price, in time exploration will be cut back, supply will fall and price will rise again.

If you really want to end boom and bust, then the answer is to spend money now on developing alternatives to oil. If Alistair Darling is to really adopt the ideas of Keynes, and spend, spend, spend, then if this money was spent on renewable energy, we would all be a lot better off in the long-term as a result.

OPEC will not stop the tide of crashing oil prices. But, in the longer-term, a Keynesian recession-busting spending spree could enable us all to benefit from the wind, solar power and, of course, the tide.

September 30, 2008 | posted by Michael Baxter in Oil | comments (0) |

Oil fell $10 yesterday,  gold soared.  Volatilility was of course the order of the day.  It was not a day of rational decision making.  Yet the changes in oil and gold are perhaps,  highly significant.

It wasn’t the first time oil collapsed recently.  It fell from $107 yesterday to $96 this morning.  But it experienced a similar sized fall in the middle of this month.  In fact, September has seen oil fall from $111 to $93 dollars in the first two weeks,  then climb back up to $108 last week,  and now fall back again.

The truth though,  is that the initial recovery in oil seen mid month was irrational and wholly without foundation.

The Paulson plan was never going to stop recession.  Without doubt,  the Paulson plan would have represented the most drastic example of US government interventions since the Great Depression,  but such action could only be justified if the alterative was economic catastrophe.  If there really was,  or indeed is, a genuine prospect of such catastrophe,  then the price of oil is way,  way too high.

If the panic we are witnessing on the markets,  is in anyway appropriate,  then oil should have collapsed by now.

But to believe that the Paulsom plan could somehow turn catastrophe into boom is naive in extreme.  Yet,  only the prospects of an economic boom could possibly justify the current price of oil.

The likelihood,  however,  is that even with a Paulson plan,  or maybe with something else that is better,  the US will still hit recession.  The global economy will limp forward for a few years.  And in that environment,  demand for oil will fall significantly,  which is why oil is still way too high.

The fact that black gold surged last week,  once again approaching $110 just goes to show how irrational the markets have become.

September 16, 2008 | posted by Michael Baxter in Oil | comments (0) |

Yesterday saw one of the most significant developments of the year. It provides the single biggest ray of hope we have seen since the credit crunch first erupted onto the world stage, and it barely got a mention.

As Rolf Harris, might have said, “Do you know what it is yet?”

Here is a clue – its fall yesterday was far more dramatic then any fall seen on a stock market. Its rise earlier in the year hit households harder and in a far more damaging way than the fall in house prices.

Here is another clue – the cycle related to this product tends to coincide with the economic cycle. When it is expensive, economic recession often follows; when it is cheap, boom often follows.

Surely you have got it by now. Just in case not, here is another clue; it’s black and oozy.

It’s called oil and it fell by $10 a barrel yesterday – or at least by $10 between midnight on Sunday and midnight yesterday when we took our regular reading. That, by the way, is a fall of 10 per cent. Ten per cent, in just one day.

Why did it fall so fast – the reason is easy to see.

The collapse of Lehman Brothers, the purchase of Merrill Lynch and the troubles with AIG convinced markets the global economy was in trouble.

Speculators, who for so long pushed up the price of oil, pushed it down.

In all the hullabaloo of recent months, two laws have been forgotten. Rule 1: In the long-term, price is determined by demand and supply. Rule 2: Demand falls with price. (Or as an economist would say, the demand curve slopes downwards from left to right.)

In the short-term, demand, for oil and, as it also appears, for houses, is quite inelastic – meaning that demand is not affected by price. But in the long-term this is not the case.

As price goes up, demand stays put, the economy suffers. Then demand falls, and price begins to fall too. The economy recovers.

Some said that the bail out of Fannie Mae and Freddie Mac marked the turning point of the credit crunch. Events of the last few days have surely shown how wrong this view was.

Some said the failure of Lehman Brothers heralded the turning point. Yesterday’s fall in shares surely shows how wrong that piece of analysis was.

But yesterday’s fall in oil is a different matter altogether – and provides the single biggest reason to expect recovery.

September 15, 2008 | posted by Michael Baxter in Oil | comments (0) |

Airlines fold. Something big came to an end in China. Two events, two ends of the earth. Put them together – and you sow the seeds of recovery.

“I remember the time,” said the old man, “when you could fly from London to a European capital and still get change from a fiver.” Do you remember that time? It came to an end last week.

Three years ago, the boss of EasyJet warned of an impending bloodbath in the airline industry – he was not wrong , it is just that his timing was out a bit.

The airline industry is a sector is characterised by low barriers to entry. For that reason it goes through periodic clean outs. Airlines calculate that if they reduce fares by, say, 10 per cent, demand will rise and they will sell more tickets. So seductive is the business model, that new airlines are formed to exploit this opportunity. The snag is when all the airlines are at it, the calculations go out of the window.

The inevitable consequence of the savaging of the airline industry will be higher fares. Combine these higher fares with the lower pound, and the cost of travelling abroad will just be too high for many Brits.

This will have several implications. For one thing, we will holiday more in Britain. Presumably that will be good news for the British seaside resorts, and particularly good news for the piers that haven’t burnt down. And if the next summer is anything like this last one, it will be a good time for sales of umbrellas too. No doubt the song Brits will sing most of all will be “Singin’ in the rain”.

More seriously, however, airline collapse will be another major factor affecting the price of oil. This is one of the reasons why it was argued in the article above (Once in a hundred years event happens again – that’s the second time this week) that oil could fall dramatically over the next couple of years.

But while more forces were developing in Europe that will have a downward effect on the price of oil, something else happened in China of almost greater significance.

As you probably know, the Chinese government subsidises oil. This in turn has distorted Chinese demand. Well, of late it had been reducing those subsidies. Now, the less heavily priced oil in China and the falling price of oil on the open markets have met.

At current prices, China no longer subsidises oil, at least that’s what Capital Economics says.

Capital Economics says: “With Chinese CPI inflation back at 5 per cent, the stage is set not just for China’s fuel price caps to be adjusted, but for them to be lifted altogether. In the short term, pump prices and demand would be little changed. But in the long term, such a shift would make Chinese demand more responsive to international oil prices, helping to dampen any further run-ups in the cost of crude.”

September 1, 2008 | posted by Michael Baxter in Oil | comments (0) |

When it comes to oil policy, sometimes it seems as if we have got a tiger by its tail. We are just hanging on for dear life, we dare not let go unless the beast turns on us. Yet, if we were to throw sufficient resources into finding alternatives, it is quite possible we could put an end to our reliance on oil once and for all – and lock the tiger that is oil up in a cage.

Forgive the rather contrived intro above, but that analogy was made because, recently, Russian Prime Minister, Vladimir Putin, quite literally took on a tiger. The muscular hero of Russia was visiting a Siberian Tiger reserve in Siberia, when one striped beast escaped and charged one of the camera crew. And before you could say Vladimir Vladimirovich Putin, Russia’s man of steel fired a tranquilizer gun, sedating the beast, apparently saving the entire Russian TV crew.

What would Western leaders do with a photo opportunity like that? And that in a way is the point about Vlad. The Russians love the former KGB man, and they love it when he tests his mettle against the West.

If international conflict was settled the old fashioned way by single combat between the word’s leaders, Vlad would surely win, although the President of the South Pacific Island of Nauru might give him a hard battle, for he was a former Commonwealth Games weightlifting champion.

But these days, fights are determined by money – and the dollar is still the tough guy.

But Russia has seen its strength return. And fresh from wrestling with tigers, Putin dropped a hint. Still in Siberia, he was looking into the pipeline under construction for linking Russian gas to China. The Russian state-owned news agency RIA said the country’s PM signed a government order “on speeding the building of phases of the Eastern Siberia – Pacific Ocean (pipeline) and not allowing delays.”

Putin did jot need to say anything official – actions like that speak volumes, and the press is full of talk about how Putin will use his country’s status as the world’s second largest exporter of oil as a retaliatory weapon should the West try and impose trade sections against Russia.

Yet, while Putin struts his stuff, Russia’s energy minister tried to soothe us all with kind words.

“We are doing everything we can so Druzhba can keep working stably and supply European consumers with enough oil,” he said. He added: “We have worked for many years to gain not just the image, but the status of a reliable energy supplier to Europe and we would never let it suffer, even in this political situation.”

Last week, Russian President Dmitry Medvedev syndicated an article to Western newspapers justifying Russia’s actions in Georgia.

So in a way, we are getting good cop–bad cop. Putin is all muscle and strong words, the country’s president and energy minister all sympathetic.

And yet, here is the odd thing. The world’s second largest oil exporter has gone all grumpy. On top of that the US faces a grumpy old gal, in the form of Gustav (is Gustav a boy or a girl’s name, I thought all hurricanes were given girl’s names – ed?). Remember the impact Katrina had on the US – the price of oil went shooting up. Yet, still oil stays below $120 a barrel, well below the highs set earlier this year when it closed in on $150.

The recent strength of the dollar helps. But maybe the real reason is that the demand for oil is falling so fast, thanks to that thing called a credit crunch, that oil just has to fall, even when Vlad is busy roaring like a tiger, and Gustav is wailing like a… well, like a wind.

August 11, 2008 | posted by Michael Baxter in Oil | comments (0) |

Here is a strange thing. You may recall from a few weeks ago, predictions from the National Housing Federation that house prices will rise by 25 per cent over the next five years. Well now, the oil industry has seen its equivalent of this prediction.

According to Professor Paul Stevens, former Professor of Petroleum Policy at the CEPMLP Dundee University, the price of oil could hit $200 within the next five to ten years.

Now, the professor is Senior Research Fellow for Energy at Chatham House, the home of the Royal Institute of International Affairs, and in this capacity has penned a report “The Coming Oil Supply Crunch.”

“Investment in new supplies has been and will be inadequate,” says the report. “This is partly due to incentives for international oil companies to return dividends to shareholders rather than reinvest them. It is also a result of a resurgence in ‘resource nationalism’ and some governments starving their national oil companies of investment funds.”

The report adds: “The rise in price itself has continued partly because OECD governments are reluctant to intervene in energy markets. The market alone cannot necessarily provide sufficient incentives for conservation, fuel-switching or bringing more energy on-stream, so this laissez-faire attitude has failed to either constrain demand or increase supply. But, given the coming price spike, governments may well be forced to change tack.”

Professor Paul Stevens, the report’s author, explains the dynamics of current high prices in comparison with past oil shocks. The report argues that not enough money and expertise were invested in the 1990s to maintain excess capacity to produce crude oil if consumption continued along present trends. History shows us that whenever such excess capacity is run down, the oil price rises sharply.

And the conclusion: “The world will experience a serious oil supply crunch within five to ten years.” And the headline: “a resulting oil price spike that could exceed $200 a barrel.”

But there is a caveat to this report, and the caveat is the key. This spike in oil will be avoided if “there is a collapse in oil demand.”

But surely, this potential collapse in demand is what it’s all about.

Professor Stevens boasts an impressive CV – his academic credentials mean his views must be taken seriously. But can the global economy afford oil at $200? For that matter, can it afford oil at $116, the price at the time of writing?

We suspect not. If oil stays at this level, or even rises over the next few years on a course that seems set for $200, the global economy will hit recession long before the $200 price is reached. Demand will collapse, because the world can not afford oil at current prices – certainly not at even higher prices.

Then again, the professor does have a point about this lack of investment.

According to James Martin, in his book The Meaning of the 21st Century, “The world’s reserves of oil, not counting the undiscovered ones, have a value of about 60 trillion USA dollars… coal reserves have a similarly-high value. If humanity set out to save energy, and move to non-carbon forms of energy… much of this vast amount of energy would be abandoned. Both oil-rich countries and petroleum companies want to hang on to their potential wealth.”

And this is the real dilemma. It rather seems oil producers like oil at present prices – it’s a foolish hope, because the ultimate consequence of any deliberate policy to maintain oil at current highs, will be global recession and a crash in the price of oil.

The are two sides to the price of oil equation – demand and supply. If prices stay above $100, demand will fall. It will, however, take supply longer to adjust. But, in a way, for the longer-term it may be a good thing if oil stays up in price. The longer oil is priced at over $100, the greater will be the appeal of alternative and renewable sources of energy.

The only reason why alterative sources of energy have not taken hold up to now has been lack of investment. Reports suggest solar or wind power are too expensive, but investment will lead to technological innovation and costs will then fall dramatically. This lack of investment is a scandal. And the longer oil stays up in price, the more likely it is this scandal will finally be righted. The oil industry, and oil exporting nations, could be shooting themselves in their collective feet.