Oil Prices
Two years ago –as oil prices began to rise– two friends of mine in the industry said to look for a dramatic climb in prices but “over the long term” (a decade? fifteen years?) look for oil to settle in a zone of $40 to $55 a barrel. When oil reached $70 a barrel I thought about that “zone.” Demand generated by India’s and China’s growing economies contributed to the rise in prices. War in the Middle East and insanity from Iran add a “security preimum” (or risk premium) to the price.
Oil, however, is a commodity (I repeat, a commodity, not a conspiracy). Higher prices encourage conservation and exploration– reducing demand, increasing supply.
A couple of emailers tell me to look at $55 a barrel as the market price later this fall. Right now oil is at $63 a barrel. $55 is a real possibility, but rattle a few uranium centrifuges in Iran (or stage another military exercise in the Strait of Hormuz) and the price will rise again. (Ask yourself– Would the Iranians rattle the market, say, the last week of October? An October Oil Surprise the week before America’s 2006 election?)
The Reuters report (linked above) says that “OPEC expects demand for its oil to be 800,000 barrels per day less next year [2007] than this [2006].” OPEC anticipates a larger “supply cushion” (and hence, during that time period, a trend toward more stable prices).
Powerline linked to this article in The Seattle Times.
The lede:
The recent sharp drop in the global price of crude oil could mark the start of a massive sell-off that returns gasoline prices to lows not seen since the late 1990s — perhaps as low as $1.15 a gallon.
“All the hurricane flags are flying” in oil markets, said Philip Verleger, a noted energy consultant who was a lone voice several years ago in warning that oil prices would soar. Now, he says, they appear to be poised for a dramatic plunge.
Crude-oil prices have fallen about $14, or roughly 17 percent, from their July 14 peak of $78.40. After falling seven straight days, they rose slightly Wednesday in trading on the New York Mercantile Exchange, to $63.97, partly in reaction to a government report showing fuel inventories a bit lower than expected. But the overall price drop is expected to continue, and prices could fall much more in the weeks and months ahead.
Here’s why:
For most of the past two years, oil prices have risen because the world’s oil producers have struggled to keep pace with growing demand, particularly from China and India. Spare oil-production capacity grew so tight that market players feared that any disruption to oil production could create shortages.
StrategyPage has done a particularly good job of following events in Nigeria (follow this link to the StrategyPage Nigeria index, but this particularly post provides useful background–see the June 10, 2006 post). The article doesn’t mention Venezuela’s Hurricane Hugo Chavez and his anti-American petro-populism, but Chavez delights in rhetorically shaking the oil markets.
China’s Sinopec group –with India’s Oil and Natural Gas Corp as a partner– intends to buy a large stake in Iran’s Yadavaran field (this report says 51%). Is this an Iranian payoff to buy a Chinese veto of UN econonic sanctions against Iran? The answer– a qualified “yes.” China has been negotiating with Iran for several years, so it’s not a sudden “tit for tat.”
UPDATE: $55 a barrel still encourages exploration (particularly in politically stable areas).
I seem to recall that Royal Dutch Shell came up with a process of developing oil shale (of which we have a ton in Colorado, Utah, and Wyoming) that was viable at $30 a barrel. That “zone” is anywhere from 33-83% higher than the viability level. And we’re not even touching some of the other finds (like that 3-15 billion barrel find in the Gulf of Mexico) in our domestic reserves.
Comment by Harold C. Hutchison — 9/15/2006 @ 7:01 am
If oil reserves are a function of price, a higher price implies larger reserves. Oil shale in Colorado, tar sands in Canada, deep ocean recovey in the gulf of Mexico can/may all become profitable reserves.
Comment by Scott Leaver — 9/15/2006 @ 7:26 am
There is still a lot of fear priced into oil. Even if risks don’t disappear, investors can come to understand and tolerate them. I think investors are coming to understand that the consequences to Iran itself of an oil shutoff - voluntary or imposed - are even more sever than the impact on purchasers. Iran imports most of its gasoline and subsidies the price. Even with oil revenues, that is probably unsustainable in the long run. Without oil revenue, big and immediate problems for the Iranian economy and regime. It benefits the regime to threaten a shutoff, but not to impose one. Sooner or later investors will catch on.
Comment by Mark Laskow — 9/15/2006 @ 7:52 am
Prepare for the Plunge?… AUSTIN BAY expects oil prices to keep dropping…….
Trackback by The Indepundit — 9/15/2006 @ 8:00 am
What did China provide as payment for the stake in Yadavaran? C-802s? FC-1 fighters? Missile boats?
Comment by Harold C. Hutchison — 9/15/2006 @ 8:06 am
Per Scott’s comment, oil reserves are indeed a function of price - but that is today’s price and today’s cost. What we saw in the 1970’s was that higher energy prices due to shortages drove inflation so that development and production costs for future production went higher too. A way to estimate viability of future enerrgy supplies is to do an Energy Return on Energy Invested (EROEI) analysis. An energy ressource is only really useful if it is enegetically “profitable.” The Ghawar oil field in Saudi Arabia has probably the best EROEI of any source available to mankind, maybe 100:1 at its peak. Looking at oil shale, the EROEI is only marginal although some technology development better it is forseeable. The big debate now is over ethanol. Even at its best, ethanol is on the ragged edge. Of course, an EROEI analysis has its problems, largely bounding and energy input/output quality, so it remains a bit loosey-goosey. Predictions of substantially lower prices in a free market can be based on three main drivers: 1) lower global demand, 2) higher production 3) lower risk. I have a hard time seeing any of these happen barring a global recession.
Comment by Whitehall — 9/15/2006 @ 8:07 am
VP of Shell gave a public talk recently where he stated that Shell’s internal research projects are based on an assumed long-term price (inflation adjusted) of about $40 a barrel. Make of that statement what you will. ED NOTE: I think that’s an honest statement. Did he mean inflation-adjusted for, say, 2004? That’s when my oil business friends gave me their “spread” prediction of $40-$55.
Comment by ghost — 9/15/2006 @ 8:24 am
Gas prices to plunge:… the analyst who some time ago was the lone voice warning that oil prices would surge, Philip Verleger, now predicts a significant decline: “I, of course, blame George Bush. Like the booming economy, it’s all part of the evil Rethuglican……
Trackback by Pajamas Media — 9/15/2006 @ 8:46 am
[…] Austin Bay wonders whether there will be an October suprise with oil prices just before election day. […]
Pingback by One Hand Clapping » Blog Archive » Oil prices and October surprise — 9/15/2006 @ 8:48 am
The recent sharp drop in the global price of crude oil could mark the start of a massive sell-off that returns gasoline prices to lows not seen since the late 1990s — perhaps as low as $1.15 a gallon. If this happens after the Democrats win control of Congress in 2006, the lame stream media will give them the credit.
Comment by Anonymous Coward — 9/15/2006 @ 8:52 am
$55/bbl oil also supports conversion of oil sands and shale, of which the Southwestern US and Alberta, Canada has enough to supply North American needs for several centuries. IMO, put a mandatory minimum price per bbl of oil in order to give breathing room to the entrepreneurs who are developing those alternate sources, with any proceeds going to pay down the debt or support lower income taxes.
Comment by otis wildflower — 9/15/2006 @ 9:28 am
The $40-55/barrel limit probably comes from the price at which synfuels (for example, Fischer-Tropsch liquids from coal) are economical. At today’s oil price, the internal rate of return of a Wyoming mine-mouth FT plant would approach 100%/year. Competitive markets abhor huge profit margins, so clearly prices have to come down at some point.
Comment by Paul Dietz — 9/15/2006 @ 9:48 am
BMW offers its first dual fuel car, a 7-series which runs on gasoline or hydrogen. Audi is listed as preparging to follow suit. Look to this announcement as the begining of the end.
Comment by Citizen Deux — 9/15/2006 @ 10:13 am
I came across this site, http://www.oiltechinc.com, which is currently certifying their clean, no-cake, oil shale technology. I also like butanol (http://www.butanol.com/) over ethanol because the state won’t be looking over your shoulder at being a moonshiner.
Comment by Ian Random — 9/15/2006 @ 5:57 pm
Auatin 1)testing your comment tool 2)I made a prediction on Aug 7 (looneydunes.blogspot.com) 3)posted a “challange” on longbets about hydrocarbons as fuel http://www.longbets.org/bet/257 4)”Any time that OPEC got a little too overzealous in pushing up oil prices back in the 1970’s, the legendary Saudi oil minister Sheik Ahmed Zaki Yamani was fond of telling his colleagues: Remember, the Stone Age didn’t end because we ran out of stones. What he meant was that the Stone Age ended because people invented alternative tools. The oil age is also not going to end because we run out of oil. It will end because the price of oil goes so high that people invent alternatives. Mr. Yamani was warning his colleagues not to get too greedy and stimulate those alternatives.” 5) for those touting H2 - it’s a transport medium, not a fuel More later if you want to “chat” : jthoagland@voyager.net
Comment by JTHoagland — 9/15/2006 @ 8:57 pm
The $40-55/barrel limit probably comes from the price at which synfuels (for example, Fischer-Tropsch liquids from coal) are economical. Exactly. Oil prices cannot survive at a sustained price above that level, because coal and water are too abundant. It can do it for short (well less than a decade) periods, because FT is so capital-intensive, and becomes a huge loss if oil drops to $35 a barrel. If oil ever stays at over $70 a barrel for, oh, five years, you’ll see lots of FT plants start springing up in the US and PRC — and a subsequent drop in oil prices to match FT hydrocarbons. By the way, this is why I’d almost like to see the PRC rattled over the Straits of Malacca. If they built a lot of FT plants for strategic oil supply purposes, it would (just because they’d be kept in operation to partly offset the costs of construction) displace some ME oil consumption, reducing prices for everyone else.
Comment by Warmongering Lunatic — 9/16/2006 @ 12:56 am
We will never run out of oil — but we long ago ran out of $0.05 and even $0.25/gal gas (though I remember the latter and “gas wars” with triple green stamps). Bush was possibly a bit silly in not using the Strategic Petroleum Reserve to also manage supply — the US gov’t could be selling oil out from the SPR when prices are “high”, and buying whenever prices are “low”. In fact, they almost could do at profit, but they should certainly be doing some of. There hasn’t yet been a peak price of 30% higher than the prior year’s average where the price hasn’t then come back down, some. Or a lot. Anybody who is serious about getting alternative fuels sooner should want to impose an increasing gas tax to partially offset the decrease, so as to keep prices higher and encouraging a little conservation. Of course, voters strongly want conservation — meaning OTHER people change their behavior (not them!).
Comment by Tom Grey - Liberty Dad — 9/16/2006 @ 3:22 am
It is possible for an “October surprise” by Iran, but would that be worth the risk? 1) If China & India are basically taking over one of Iran’s assumedly best oil fields, why would Iran risk doing anything negative? Wouldn’t it cause them pain first 2) I heard that stocks or oil companies held back their risk premiums after the real “war” in Iraq (Mar - May 2003) because they wanted to see if things would stablize. If that is true, wouldn’t such companies see this and hold up risk premiums 3-4 weeks over a tiff in Iran? 3) Nine times out of ten, W. et al know this risk (I hope) so they would most likely sit on their hands until after the election, in hopes of keeping Republican hedgemony(Although I believe once the Dems were in power, such grand ideas about impeaching W would dissapear as they had to face the reality of war and defense) 4) if oil prices are significantly low, such “October surprise” the could be absorbed by the American public, as they had to deal with extremely high fuel costs after Katrina
Comment by Rachel — 9/17/2006 @ 7:30 am
A Question: Has the US Government completed its replenishment of the Strategic Reserve? This factor has many implications: A full reserve can be used to stabilize prices. A full reserve is one preparation for war in the Middle East. A full reserve means that the US Government is not competing in the market. Economic factors: What is India’s current economic status? What is China’s current economic status? What is the economic matrix of a barrel of oil costing $70 and a gallon of gasoline costing $2.50 (refined cost estimate). We know a barrel (55 gallons) cannot all be refined to gasoline so I am guessing the math sucks for Iran. They sell 55 gallons of oil at $70, Exxon or Shell or TotalFinaElf refines the oil to gasoline and other fuels, and sells it back to Iran at let’s say $2/gal. That is, export at $70, repurchase at $110. Very unsustainable. And, very difficult to remedy without internal refining capability. Political factors: Is Iran being slowly subsumed by another great power – thus following a pattern of weak ME pashas becoming clients of major powers? Is this a bad thing? Can we deal with China on a civilized basis, Iran? In my very humble and unlearned opinion I would greatly prefer Libiesque ‘Frank Diplomatic Discussions’ with China to similar talks with Iran. And, one market factor: How many times can Mahmoud Ahmadinejad cry wolf before the markets ‘discount’ him? This may not be the smart thing to do, but it is the natural thing to do. Very coy regarding the August 22 thang – but also dumb long term. When he is discounted he will cease to affect the market price.
Comment by Boghie — 9/17/2006 @ 9:22 am
gas prices will crash and stay in chash mood 4 at least 5 to 6 years.What doesany one eles thinks about this? Is it good or bad thing?
Comment by ronnie — 9/24/2006 @ 5:13 am
So now the price of oil has hit $85/barrel - I think it’s time for the shieks and US oil companies to curb their greediness - it hasn’t been a supply and demand commodity for the last five years - the oil price is linked to greed. When the US oil companies are making billions of pure profit each quarter, and the arab countries are making ski resorts in the desert, you wonder how they can sleep at night - when the US oil companies say that the rise in prices is partially due to refining capacity in one breath and the next breath they say they won’t build any more refineries because it will drive the prices down, something is wrong with our society. It’s time for some government control - the government doesn’t hesitate to control milk prices and agricultural prices, why won’t they control oil prices - you can say what you want about high prices leading to alternative energy sources, but those alternative energy resources will be priced at the same level as oil - let’s stick with a commodity that has reserves that will last for the next two centries at a price that doesn’t hurt the average person…
Comment by roburk — 10/15/2007 @ 11:47 am
Bush was over there again this week making sure they don’t pump any more oil so he and his crew can retire from the whithouse as billionairs. There is no shortage of oil. This was all set up by the bush people and the stock traders.You will never see gas prices below $4.50 after this year. We have been screwed !
Comment by J. Mitchell — 5/17/2008 @ 9:52 am