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.

August 5, 2008 | posted by Michael Baxter in Oil | comments (0) |

And the price of oil falls again. So too does corn. Platinum is down, gold too. Is the commodity boom over?

At the time of writing, oil is just 24 cents over the magical $120 a barrel price. That’s the cheapest it has been since early May. Platinum is now at a six-month low, corn a three-month low. Why?

Well, actually, there isn’t just one reason.

The reasons for the fall in the price of oil are easy to understand and have been rehearsed here many times. Americans are driving less, and looking for more-fuel-efficient cars. We have seen evidence of this manifest itself in the crashing share prices in the big US car makers, and in the booming performance seen at Honda.

According to Merrill Lynch economist David Rosenberg, Americans are now driving 4 per cent less. He says, in inflation adjusted terms, energy use has dropped 2 per cent, “an extremely rare” occurrence says Rosenberg.

There is now growing evidence from China that exports are feeling the pinch. It is becoming harder for them to export, partly because their main customer, the US, has less money, and partly because the high price of oil is making it more expensive to transport goods long distances.

That oil will fall in price has long been inevitable. But is the fall we are seeing now the one we have predicted? It might be.

Recently, Jon Hunt, the former head of estate agent Foxtons told the Evening Standard the time to buy is “when there’s blood on the street.” He was talking about the property market, but the same principle applies to oil. Bubbles only seem to burst when just about everyone is talking about how this time it is different, and this bubble will just carry on. Recoveries only seem to occur when just about everyone has given up.

There has been a lot of talk of late about peak oil, about how oil will never be cheap again, about how it will go on rising in price – but surely not enough talk. Maybe markets adjust more quickly these days. But it still seems unlikely this is the big crash in oil prices that we predicted some time ago. It may be, but we suspect the oil price crash is still a way off yet. Then again, it is one thing saying a market will return sooner or later, but getting the timing exactly right is nigh on impossible.

As for the fall in the price of corn – it seems there is an even less powerful reason for this fall. Crop cycles are slow cycles. We don’t just cut back on eating overnight. The crops we start growing at the bottom of our garden don’t give us food straight away.

It will surely be a while yet before the effects of more-expensive food are dealt with through rising supply and falling demand in the form of more-careful cooking practice. That said, if programmes on Radio 4 are any guide, the UK has now gone local food mad, and farmers markets are the answer to our ills.

By the way, a lot of this talk about farmers markets and buying local could backfire. Many of the arguments put forward for local food are promoted by well-meaning people who believe in concepts like equality. Actually, truly unencumbered trade could well be the answer to solving poverty in the world. The ultimate solution to the food crisis lies in more trade, not less.

If the UK starts focusing its resources on agriculture – maybe even encourages tariffs to deter competition from overseas, the result could be far bigger problems in the future.

As for gold, it is odd but despite all the talk about inflation making a comeback, gold has stayed stubbornly below $1,000 an ounce. It was more expensive in the spring.

Maybe that is because the speculators know inflation is not the real problem at all. As has been argued here many times, in the medium-term – deflation remains a bigger danger.

July 24, 2008 | posted by Michael Baxter in Oil | comments (0) |

Bubble watching is a difficult game. The Crash of 1929 was preceded by a number of phases of panic sell offs, followed by recoveries. Even the run up to the dotcom bust saw a number of sharp sell offs, followed by even sharper recoveries. But the continuous fall in the price of oil is just beginning to smell like something more promising than that.

It fell another 3 1/2 dollars a barrel yesterday. It is now $21 down from the all-time high reached in early June, or, to put it another way, it has fallen 14 per cent.

And, right on cue, yesterday also saw the first report from a respected analyst predicting sharp falls in the price of the black stuff for some time.

Ed Morse, chief economist at Lehman Brothers reckons oil is nearing a tipping point and will fall to $90 within a year.

Meanwhile, others are calling the end of speculation. Speculators, of course, have been at the receiving end of US politicians’ wrath in recent weeks, but this morning, the Telegraph reported Rob Laughlin, senior energy broker for MF Global as saying “We’ve seen the exiting of some of the speculative fund money re-entering equity markets.”

When oil does finally begin its descent into the sub $100 region, there will of course be two sides to the story. There will be the story of falling demand, and there has been plenty of evidence of that in recent weeks, and there will be the story of rising supply.

And this morning the pink ‘n’ revealed the other side of the coin. It reported on the latest findings of US scientists who reckon they have managed to show the Arctic could hold as much as $90bn worth of undiscovered oil and natural gas, equivalent to the known reserves of Russia.

It went on to talk about the race to exploit the Arctic, with the US, Russia, Canada, Denmark and Norway all hoping to get their share of the pie.

This could of course lead to all kinds of tensions – especially, one assumes, between the US and Russia. It is strange because, right now, the Arctic doesn’t really belong to anyone. If one was to be truly objective about this, then really there is no reason why it shouldn’t stay that way. Instead, the Arctic should perhaps be seen as the world’s resource. It does, after all, serve the world pretty well via its storage of water in the polar ice caps. It won’t happen, of course. But it is fun to dream, even if its just for a few seconds.

As regular readers will know, for some time now this column has been arguing that oil is too expensive, and will fall back to $70 within a couple of years. But the speed with which the current falls are occurring is surprising.

They say bubbles burst when just about everyone is talking about jumping on the bandwagon. And that has simply not happened. Mind you, the economic news has been pretty diabolical of late, so maybe we don’t need to look far for evidence that the price of oil is really hurting, and therefore inevitably leading to cutbacks. The speed with which the economic downturn is occurring has caught everyone by surprise; maybe oil can slide in price just as fast.

July 23, 2008 | posted by Michael Baxter in Oil | comments (1) |

Oil fell yet again yesterday, down to $127.75 on the New York Mercantile Exchange at the time of writing. It is now $17 lower than the price it reached on the 7th July. It seems unlikely oil has ever fallen so rapidly over such a short time frame.

The key question though is, are we seeing the bursting of the oil bubble or are we merely seeing normal market volatility? Consider this: oil may have fallen by $17, but in percentage terms it is down just by 12 per cent.

Evidence to support the argument that the price of oil has crashed comes in the shape of auto sales. According to yesterday’s Telegraph, European auto sales fell 7.9 per cent in the year to June, while US sales fell to their lowest level in 15 years. Chrysler saw year on year sales drop 36 per cent and, for the first time since England got knocked out of the World Cup by the Hand of God – Maradona, GM are not paying a dividend.

But, perhaps even more tellingly, in China, despite a 3 per cent fall in average car prices, the stock of unsold cars rose by 50 per cent on this time last year. It appears, even Chinese consumers, despite heavy gas subsidies, are feeling the oil pinch.

But, on the other hand, yesterday, billionaire oil investor T. Boone Pickens told the US Senate Homeland Security and Governmental Affairs Committee: “oil will hit $300 a barrel in 10 years,” unless the US reduced its dependence on overseas oil.

The falling pound and dollar are not helping, either. Every time the US and UK currencies fall relative to a basket of currencies, oil tends to rise in dollar terms and we feel the pain on both sides of the pond.

It has been argued here that oil at $130 is too expensive, far too expensive. Not only will oil at this price hurt the world’s great importers, that’s economies such as the US and UK, which in turn will impact on global trade, it will also hit the cost of trade. Goods that are sold overseas have to be transported.

These days trade is a complex web. Some countries make components, others assemble, the consumer products we enjoy in the West, imported from China, were not just made in China. A number of factories in different locations will have contributed. As oil moves up in price the cost of this practice will be hit hard.

Up to now there has been no sign of a major slowdown in world trade. In fact, recently the IMF upped its projections for economic growth for most major economies.

In the early 1970s, and then again 1980s, the world economy was brought to its knees before oil started to fall. The economic cycle surely hinges on boom and bust type patterns. Prices don’t tend downwards unless things are really dire. It took a combination of overpriced properties and a shortage of credit to bring the property market to its knees. House prices were overpriced for years, too.

This time around, oil is actually less important than before. In the West, oil makes up a lower percentage of our spending. Yet, while things are tough they are not desperate.

And that brings us to the big surprise in the current falls in the price of oil. Maybe it has come too soon.

If oil has peaked already, and we are seeing the correction, then this has been one of the shortest lived bubbles on record.

July 18, 2008 | posted by Michael Baxter in Oil | comments (0) |

The key to how the economic crisis of 2008 will end surely rests with the price of oil falling, and maybe depends on the speed at which asset prices adjust. In the early 1990s the housing market collapse was painfully slow.  Agony was poured on more agony for years. It is possible that, this time around, the falls will occur much quicker; this will be a good thing. As it were, getting the bad news over with as quickly as possible.

As for oil, we have been predicting sharp falls in the black stuff for some time. $130 a barrel or more is just too expensive. People can’t afford it at that price. It is surely inconceivable oil can stay at that level for a sustained period, which is why we have predicted oil falling back to $70 before the end of 2010.

But, the last few days have already seen startling falls in the price of oil, down from $145 to $130 in three days. Is this the fall we predicted?

If so, then all of a sudden it looks like the IMF’s optimism yesterday, see story above, may be underdone.

It is just that we doubt this is so. The fall we are seeing now is too soon. It will take time before the high price of oil takes its true toll, before we all start driving around in Kas and electric cars, and SUVs start bringing back memories of the Dodo. It will take even longer before we see any meaningful availability of energy generated from renewable sources.

In a way, we hope the oil slide seen over the last few days is just temporary. If this is the start of something bigger, the real structural changes that are required in the longer term will not have been given time.

Of course, actually, the scenario described above is the precise opposite of what OPEC wants. If OPEC has any sense at all it will ramp up oil supply as fast as it can. The Saudis already appear to be doing this. We are not so sure, though, that this move would be in western interests, or indeed the interests of the developing world, in the longer-term. And we say this purely on an economic basis, without even considering climate change.

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

From peak to trough oil fell by over $10 a barrel yesterday, and this morning when we took our daily reading stood at $138, that’s 6.8 dollar a barrel lower than the same time yesterday. (Prices from the New York Mercantile Exchange)

Admittedly, in early June oil was cheaper than this. For that matter, until five weeks ago the current price would have been an all-time record. Even so, these days we need to make the most of falls like this, and ask, is this the first stage in the fall in the price of oil to more sustainable levels?

The reasons given for yesterday’s price falls were manyfold. OPEC helped. Yesterday it said that thanks to the declining economic outlook, demand for oil in 2009 would be less than it originally estimated. But then again, it wasn’t much of a downgrade. It had previously expected global demand to rise by 1.28 per cent next year, now it thinks it will rise merely by 1.2 per cent. So, whoopee to that.

Ben Bernanke helped too. He helped by telling bad news. He said high energy prices are acting as a drag on the US economy, and limiting US households’ purchasing power. To which analysts looked up in surprise and “oh, hadn’t thought of that.”

George Dubya helped too. He wants to lift the ban on drilling for oil in coastal waters, although his decision has to be ratified by Congress. The ban that had been in place since 1990 when a certain George Bush senior was President.

The ban was implemented after the Exxon Valdez spillage disaster (was that really 18 years ago – ed), although has never applied to coastal waters in the Gulf of Mexico.

But then again, what difference will that make? It will take years before oil will actually flow, and in the US many were quite dismissive of the move. “If offshore drilling would provide short-term relief at the pump, or a long-term strategy for energy independence, it would be worthy of our consideration,” said a spokesmen for Barack Obama. “But most experts, even within the Bush administration, concede it would do neither.”

In fairness to George Dubya, who remember comes from Texas, the state of Dallas and JR Ewing, he was well aware of the time lag between lifting the offshore drilling ban and oil availability, but argued it would help lower the price of oil anyway, because when markets price oil they take into account future supply. Remember, the futures markets are supposed to discount future flow, which is why talk that we may or may not be approaching peak oil in a few years’ time is relevant to the price now.

There are, however, certain other factors that will have a much more significant impact on the price of oil over the next few years.

Firstly, there’s the slowing US and European economies. Surely, by reducing its estimate of how demand for oil will grow next year by such a small amount, OPEC has grossly underestimated the effect that oil at $130 plus is having on western economies.

At its current price, the price of oil is hurting, really hurting. It is inconceivable that western demand for oil will not fall dramatically over the next few years as a result.

But there are two other key factors too. One in favour of oil falling, one against.

The high price of oil will also hit international trade. China imports goods, does a bit to the goods it has imported, and then exports them. It is like that these days. The flow of trade is a hugely complex web, and the cost of transport is the key. If you like, transport is a little like trade’s bandwidth.

The cost of trade is in part determined by the price of oil, and in part due to other factors, such as containerization in which one global standard was defined for the size of all crates used for transporting goods. But as oil surges in price, this bandwidth will clog up. International trade will be hit. Global economic growth will slow, and demand for oil will fall.

But the other factor, that could work in the opposite direction, is the vulnerability of the dollar and sterling to further falls.

Both countries now have wafer-thin foreign reserves. As Ambrose Evans-Pritchard argued in the Telegraph this morning, if foreigners lose patience with the constant flow of profit warnings and losses coming out of western banks they may stop lending us money altogether. This could lead to big falls in our currencies. In the long term this may be no bad thing. In fact, it could be a very good thing, since it will help correct the global imbalances and enable the US and UK to expand through trade, rather than borrowing. But in the short term it will hit the economies hard, very hard.

If the dollar and pound fall much further, regardless of how much less oil we demand, the price of oil valued in dollars and sterling will continue to rise.

July 14, 2008 | posted by Michael Baxter in Oil | comments (1) |

Have you ever watched that Channel 4 TV programme Deal or No Deal? If you have, you may have realized that the probability that individual contestants will win the maximum £250,000 is different from the probability that the banker will give away £250,000.

The reason is this. Individual contestants play the game once. There are 22 boxes; one contains £250,000. There is a one-in-22 chance of them winning the big prize.

The banker, by contrast, knows that if he plays this game every day, and each contestant goes all the way to the end, he will give away an amount of money equal to the total sums of money available, divided by the amount of boxes – this is in fact £25,712.16 per contestant.

But for the contestant, playing the game just once, the odds are different. In fact, the contestant would expect to take away between £750 and £1,000, because there are exactly the same number of boxes containing money above these amounts as there are below.

The point of this anecdote is this: we are not good with probability. It is not something we intuitively understand

Take as another example, peak oil.

There are 1.2 trillion barrels of proven oil reserves in the world. That is enough at current consumption to last 40 years. But, according to Richard Pike, president of the Royal Society of Chemistry, this is a very misleading figure, and this is why.

Each oil company estimates proven oil reserves for each oil field. The reserve is defined as proven if the company has a 90 per cent confidence in its estimate for that field’s capacity.

So, the various authorities, such as IEA, which work out global oil reserves, take all these proven estimates for each field and add them together.

So that means there’s 1.2 trillion barrels of proven oil reserves. How confident can we be of this? Ninety per cent, right? Wrong. In fact the laws of maths would suggest that total reserves are likely to be much much higher than that. And the probability that is so, is much greater than 90 per cent too.

Why is that so? Well, actually, when you think about it, it is obvious. If you have a ten sided dice with numbers one to ten, you know there is a 90 per cent chance you won’t get, say, the number ten. But if you throw that dice ten times, the chances of getting ten tens is in fact 0.1 to the power of ten. An incredibly small number.

It is the same with proven oil fields. The chances that each and every oil field in the world does in fact only have this proven level of oil is tiny.

“Part of the oil industry is perfectly familiar with the way oil reserves are underestimated, but the decision makers in both the companies and the countries are not exposed to the reasons why proven oil reserves are bigger than they are said to be,” said Dr Pike.

But there is more reason to doubt all the predictions of gloom on the supply of oil. Oil flow is more a matter of infrastructure, such as refinery capacity, for example, than how much oil there is. Dr Pike says, “No matter how much oil you have in the ground, if you don’t have facilities, the limits to your production at any one time are constrained.” He said it is “like having an enormous tank with one tap.”

Dr Pike says oil flow may well peak soon, because we don’t have the facilities. Even so, he says, oil will be available for many years.

“The bad news,” says Dr Pike, “is that by underestimating proven oil reserves we have been lulled into a false sense of security in terms of environmental issues, because it suggests we will have to find alternatives to fossil fuels in a few decades…We should not be surprised if oil dominates well into the twenty-second century. It highlights a major error in energy and environmental planning – we are dramatically underestimating the challenge facing us.”