17 October 2007

Talk of $100 oil -- again?

Column - The Organization of Petroleum Exporting Countries says the recent meteoric rise in oil prices has everything to do with market speculation while those supposedly doing the speculating are firm in their belief that the rise in prices is supported by supply-and-demand fundamentals. Either way, oil closed at US$87.61 per barrel Tuesday after going as high as $88.20; that is up more than 10% in the last week. Tuesday's close brought it closer to the inflation-adjusted record high of $90.46 reached in 1980. Many people have been calling for $100 a barrel for the better part of the last 12 months -- it could very well be that this milestone will be reached in the coming weeks, well before the end of the year.

But does $100 a barrel oil make sense? One way to look at it is by looking at the current state of affairs from the perspective of an oil producer. Between oil prices being high and the US dollar low, oil producers want to sell as much as they have into current market conditions in order to get the highest price and maintain purchasing power parity. This situation causes the inventory numbers to fall, because no one wants to hold the oil if they have the opportunity to unload at a higher price. It's a bit of a self-fulfilling prophecy. Is the situation sustainable? That depends on whether one buys into whether the sabre-rattling going on between Turkey and Iraq -- more specifically, Kurdistan -- materializes into something bigger and knocks out supply. The way the market has been behaving these last few days suggests it is anticipating a worst-case scenario. But the reality is there isn't much production from that part of the world and its impact on the oil price wouldn't be significant if something were to occur. Looked at another way, what this illustrates is the lack of spare capacity in oil producing nations. Making things more complicated is the fact that the non-OPEC suppliers are not delivering on their forecasted production increases. That's another reason why oil prices are so skittish. Then of course there is demand, which is pushing prices upwards as consumption in both China and India continue to rage. Most analysts expect prices will soften below the $80 mark, which is believed to be a more sustainable price range given current fundamentals. Still, it's unlikely the kind of price spike that has been seen in the oil markets of late won't be the last for 2007; there's no getting away from the basic facts that consumption is rising and supply is not and this isn't about to change any time soon.

Oil at $100? Don't bet against it.
(Calgary Herald 071017)

Okay, so who's telling the truth? Is the high price due to market jitters or is there truly a supply/demand squeeze that is creating a natural price increase? And if the latter, what would one expect for the winter season when fuel demands go up further?

Are events unfolding in such a way as to support the near-peak or the far-peak forecasts? If we define oil narrowly, then Deffeyes's forecast for a peak in 2005 may already be confirmed. According to the Energy Information Administration (EIA), a division of the US Department of Energy, the monthly average for daily world production rates for crude oil achieved 74.2 Mb/d in May 2005; that figure has not been equaled since. The last month for which totals have been published is April 2007, which saw average daily production of about 73.4 Mb/d.

This by itself is an extraordinarily suggestive piece of information: the past two years have seen sustained high prices for oil, a situation that should provide a powerful incentive to increase production wherever possible. However, evidence presented below suggests that, on the whole, ramping up production may not be possible.

If oil is defined more loosely, the situation is similar, though the decline is less severe. Production rates for "all liquids" (a category that includes natural gas liquids and condensates, synthetic oil from tar sands, refinery gains, and biofuels) have been more or less static during the same period: according to the EIA, the twelve-month monthly average for daily production of "all liquids" reached a peak in
February 2006 at 84.578 Mb/d; for April 2007, the equivalent figure was 84.474 Mb/d, indicating essentially flat production rates for the past 14 months.

Production problems or actual production declines are being reported in all of the nations that produce 3 Mb/d or more (production figures are the averages for 2006):

1. Russia (9,247,000 b/d): forecast for future production is worsening; exports are declining
2. Saudi Arabia (9,152,000 b/d): production has been declining for over a year; the reasons for this are disputed
3. United States (5,136,000 b/d): production is in long-term decline
4. Iran (4,028,000 b/d): production is currently declining, apparently as a result of lack of investment in production infrastructure
5. China (3,686,000 b/d): production in the nation's largest oilfield (Daqing) is declining
6. Mexico (3,256,000 b/d): production in the nation's largest oilfield (Cantarell) is declining at a double-digit annual percentage rate
7. North Sea (Great Britain, Norway, and Denmark, collectively producing 4,343,000 b/d): production is declining rapidly; Britain is or will soon be a net oil importer.

Meanwhile, the most obvious confirmation of problems with the global oil supply is the fact that prices have soared from $12 a barrel in 1998 to over $80 today.

Can that be attributed to speculation spooks alone?



Anonymous said...

A lot of the market turmoil right now is related to the mortgage issues in the US, which has led to the Fed reducing interest rates which has led the US dollar going into the toilet.
Oil is priced in US$’s so US$87/barrel is not really a meteoric rise if you take into account dollar depreciation.

Regardless, the price is high and supply concerns and not unfounded – though most likely blown out of proportion given that there are just too many people who benefit when the price is high.

The really insanity is what is going to happen to the oil market over the next couple of years. Is the US$ going to remain the world standard? Right now the US essentially gets their oil for free so changing the standard is going to have a massive effect on the US coffers.

RD said...

Very true. The dollar depreciation has a lot to do with it. There are as many theories about how the price of oil will go post peak (generally there's agreement that there will be lots of spikes and troughs as the price becomes a lot more sensitive to global issues since the Saudi Arabian 'cushion' is now gone) as there are theorists.

As well, with the rise of China and India, the US is not going to be looked at as the no. 1 consumer society for much longer, and when that playing card is gone, I don't think the U.S. is going to fare so well either. Why ship the goods to a nation that has a devalued currency and bankrupt populace, when you can sell the same goods to people in your own country?

Strange times immediately ahead....