June 03, 2004

The Oil Market

The London Economist's take on the oil market:

Economist.com | OPEC’s meeting in Beirut: ...the 11 oil producers of OPEC agreed to raise their production quota of 23.5m barrels per day (bpd) by 2m bpd next month; they may increase it by a further 500,000 bpd in August. The oil markets had been told to expect such a deal, and many traders and consumers had let themselves hope for even more, such as the wholesale suspension of all production caps. The benchmark price for crude oil began the day a whisker under $40 per barrel. It remained thereabouts after the deal was announced. Indeed, raising the quotas by 2m bpd may not boost the flow of oil at all. OPEC members are already producing about 2.3m bpd more than their quotas allow. The Beirut deal simply gives sight to the blind eye OPEC had turned to this cheating.

What has constrained this cheating thus far is not the artificial limits on production imposed by the cartel, but the physical constraints imposed by the oil world’s overstretched wells, pipes and refineries. The industry is trying to feed the fastest world economic growth for 20 years (according to Morgan Stanley) with the thinnest margin of spare capacity for 30 years. The problem is not a lack of reserves per se. Thanks to seismic probes and satellite imaging, new pockets of oil are being found all the time. But no one is investing in the means to exploit them. Low prices deterred investors in the 1990s, and the risk of invasions, insurgencies and other instabilities in the Middle East has put them off since.

When outdated supply meets unprecedented demand, prices inevitably rise.... The official price range it is supposed to target—of $22-28 per barrel—now looks like a quaint anachronism, and its production caps no longer have much bite.... OPEC has never been a conspiracy of equals. But the dominant position of its leading producer, Saudi Arabia, is now more apparent than ever. It is the only country that has enough spare capacity to make a big difference to the price. Hence it was a string of recent, unilateral commitments by the Saudis—to pump over 9m bpd this month and tap more wells in the months ahead—that brought oil prices down last week. Likewise, it was the murderous terrorist attack on the Saudi oil city of Khobar on Saturday that pushed them back up again...

Posted by DeLong at June 3, 2004 09:33 AM | TrackBack | | Other weblogs commenting on this post
Comments

All this talk of supply and demand seems to oddly and assiduously avoid the real issue; i.e. near term risk. The breadth and depth of the unknowns. The market's estimate we will see significant disruptions. I can't believe that anybody thinks that those risks are not now substantially higher than they were some year ago. I can't believe that we seem to focus on the supply and demand when all the nearterm risk is in the distribution system.

Posted by: Ben Hyde on June 3, 2004 10:43 AM

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All of this talk of high oil prices is grossly exaggerated by the fact that it is denominated in US dollars. Oil prices are not strictly inverse to the slippage of the Bush-administered greenback, but the effect is strong: the dollar and the euro traded about even when Bush was inaugurated, and it costs US$1.30 to buy a euro today.

Put the other way around, America's forty dollar barrel of oil is Europe's thirty dollar barrel in pre-Bush terms, not far off the $28 that Americans would like to think of as normal.

Posted by: David Lloyd-Jones on June 3, 2004 11:15 AM

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Exactly. With everything at near capacity, a relatively minor disruption, for example another Venezuelan strike of less than a week's duration, will send prices sky-rocketing.

I am surprised that no one is looking to the 2+ year drop in the Dollar ($0.94:Euro to $1.22:Euro) as a factor.

Oil producing nations are being paid in devalued currency, and even the most basic economic theory implies price increases.

Posted by: Matthew Saroff on June 3, 2004 11:16 AM

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Not too bad except for this lie "The problem is not a lack of reserves per se. Thanks to seismic probes and satellite imaging, new pockets of oil are being found all the time. But no one is investing in the means to exploit them".

The real story is that thanks to seismic probes and satellite imaging we KNOW that there aren't anymore large fields in the entire world. The oil that is being found are relatively small pockets that won't come close to replacing what is being depleted daily.

Because of the lead time required to bring a large field on line, it doesn't take any real effort to see what is coming down the pike. There are a few that will be online in 2005, a bit more in 2006 and nothing at all for 2007. The center for oil depletion analysis predicts that 2008 will see the peak in production. It won't be more than 3 years plus or minus that date. 2003 was the first year that absolutely NO major oil fields were discovered.

Posted by: SW on June 3, 2004 11:17 AM

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The Economist's track record on oil prices has not been somthing to be prouud of.

Posted by: spencer on June 3, 2004 11:18 AM

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SW- Do you have links for new oil? Thanks

Posted by: bakho on June 3, 2004 12:13 PM

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> [...] The problem is not a lack of reserves per se. Thanks to seismic probes and satellite imaging, new pockets of oil are being found all the time. But no one is investing in the means to exploit them. Low prices deterred investors in the 1990s, and the risk of invasions, insurgencies and other instabilities in the Middle East has put them off since. [...]

In other words, the prices are *still* too low to keep investors from being deterred from putting their money into the extraction of these "new pockets of oil" that people keep finding all the time. Why would that be Mr. Wizard? Could it be that the cost of extraction in these new reserves is a lot higher than the cost of pulling it up out of the ground in West Texas was forty years ago?

Posted by: s9 on June 3, 2004 12:21 PM

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bakho, there is a reprint here...

http://www.commondreams.org/news2004/0128-11.htm

Posted by: SW on June 3, 2004 01:24 PM

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Hubbert's Peak, Hubbert's Peak, Hubbert's Peak,...

Posted by: BayMike on June 3, 2004 01:27 PM

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Time to find a new energy source hydrogen is decades away what about biotech fuels tweek the genes on soybeans presto new fuel source feed them to a diesel electric poof renewable fuels energy independance if it was only this easy but I do see alot of biotech guys on kos and atrios complaining about losing their jobs.... time to connect the dots

Posted by: chuck on June 3, 2004 01:27 PM

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hydrogen is not an energy source

Posted by: SW on June 3, 2004 01:44 PM

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I read a research report by a BearStearns oil industry analyst back in 1999 about oil prices. The report speculated that the saudis were pushing the price of oil down to historic lows to discurage new infrastructure development. In addition, they were also going to attempt to increase the volatility of oil prices for the same reason.

Seems very prescient today. I would not be surprised to see oil reach $50 a barrel, and then plunge to $20 for a year or two over the next 5 years. Talk about discouraging new production capacity! Forced to lose $8/barrel for 2 years...
Who can risk it?

Posted by: mickslam on June 3, 2004 03:12 PM

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There will never be $20 barrel oil again. I'd bet against $30. $40 is closer to the new floor.

Posted by: SW on June 3, 2004 03:50 PM

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Though all such guesses are tricky (I feel better that they aren't my guesses), published estimates of the geopolitical risk premium in the crude oil market have recently run in the $6-$10/bbl range. That would put the average Nymex crude price over the past month, ex-geopolitical risk premium, at between $30.50 and $34.50 per bbl. Each of us can make our own assessment of the odds that the risk premium will shrink soon. Interesting that Matthew S points to Venezuela just as that country seems on its way to a referendum on whether Chavez gets to remain (legitimately) in power. Uh oh.

By the way, in euro-demonimated terms, crude oil is up about 40% over the past 6 months. IEA estimates that a rise in crude prices from $25 to $35 (something like a 10 euro rise is essentially what happened if to euro-denominated oil prices) will pare 0.5% from Eurozone growth in each of the first two years of a sustained rise. UEA puts the impact on the US at -0.3% GDP growth each year. The slide in the dollar against the euro in that period means the dollar cost of crude has risen about 25%-30% more. As a simple matter of math (rather than economics), that would still mean a lesser impact on the US economy than on the Eurozone. Easier US monetary policy might also mean that more of the oil price shock would translate into inflation in the US, less into slower growth.

Posted by: kharris on June 3, 2004 05:13 PM

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It is interesting. Many of us have been looking for a cross-over in the demand/supply figures sometime around the end of this decade when we reach the peak in production of all liquids. However, I think that what most of us didn't anticipate is the exploding demand from China and the relative price insensitivity in the US. It seems to me that this introduces the real possibility that demand will outstrip supply before the peak in production is reached.

Posted by: SW on June 3, 2004 05:38 PM

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We are facing a real oil problem, but it is easy to exaggerate its seriousness. As my professor taught me some 60 years ago: "ore" is a mineral that is worth mining under the presently prevailing price and cost circumstances. The Nazi Luftwaffe flew on fuel produced from liquified coal. The technology is known, the world reserves of coal are tremendous. Deep oil and gas may not be profitable at current prices and costs, but gigantic reserves are awaiting more favourable economic incentives. Of course the transition period could be rather unpleasant, but the Club of Rome type doomsayers are vastly exaggerating the crisis. And all this holds true even under the present knowlege of science and technology. If the petroleum consuming countries would have spent over the last 30 years a fraction of their military expenditures on an Energy Manhattan Project, today we could tell the oil producers what to do with their oil, and the whole Middle Eastern problem would not exist. Mind you, the price of oil would be $20 per barrel and some shortsighted Conservatives would maintain that the research expenditures were a waste of money. But the low price of oil would be the consequence of the Manhattan Project and the expenditures would have been the insurance premium for not being exposed to the blackmail of the oil producers.

Posted by: Thomas T. Schweitzer on June 3, 2004 06:50 PM

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There was absolutely nothing wrong with the Club of Rome conclusions except the exact date. And come on. We're talking about geology here. Getting anywhere within a century would be good work. The attitude seems to be that they cried wolf and now aren't to be believed. This is patently bullshit. These ARE finite resources. Petroleum is not an element. It is an complicated mix of large molecules that took millions of years to create and about 100 to burn. Even the coal reserves have been vastly over-estimated if we begin to use coal as a transportation fuel, and the ecological consequence of doing so will be horrific. No this is patent misapplication of a pseudo-science (economics) to a physical problem.

Posted by: SW on June 3, 2004 07:33 PM

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fusion, anyone?

http://www.iter.org/

Posted by: non economist on June 3, 2004 10:10 PM

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"fusion, anyone?"

I checked out that site last week when I read about it in the news. Usually when a technology makes a steady progression like fusion has been doing (finally they plan to get energy out of it) the best projection for the future is to assume the pace will continue. So decades from now energy might be the least of our problems.

But that doesn't mean it won't get uncomfortable between now and then. I agree with the previous comment by Thomas Schweitzer that we ought to spend what it takes to eliminate the dependence and not worry about a few bucks. Even if it costs 1-2% of GDP it is better than being at the mercy of unstable countries that don't appreciate the Western world.

One laughable statistic that keeps getting tossed around lately is how the ratio of oil to GDP has been shrinking since the last crisis and this makes us less vulnerable. This is ridiculous of course because oil still functions as an economic bottleneck due to the role it plays in transportation (fortunately we hardly use it at all for electricity now). This ratio does suggest that it would not be painful over the long term to switch to a more expensive solution, but in the short term when we reduce this ratio we increase our sensitivity to it. So the more efficient the world becomes at using oil the higher the price spikes when there is a shortage. It's much more important to develop at least a partial substitute to break the bottleneck.

Posted by: snsterling on June 3, 2004 11:29 PM

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Anybody thinking about secondary impacts of higher oil prices. For example, the main reason that productivity was low from 1975 to 1995 was that a lot of investment was aimed at improving energy efficiency rather than labor efficiencey.
Would another round of higher oil prices have a similiar impact?

Posted by: spencer on June 4, 2004 05:01 AM

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Can you fill that claim out a little spencer --"... the main reason that productivity was low from 1975 to 1995 was that a lot of investment was aimed at improving energy efficiency rather than labor efficiencey."
Seems counter-intuitive that productivity overall would drop as a result of obtaining better energy efficiency.

Posted by: calmo on June 4, 2004 08:52 AM

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snsterling: "I checked out that site last week when I read about it in the news. Usually when a technology makes a steady progression like fusion has been doing (finally they plan to get energy out of it) the best projection for the future is to assume the pace will continue."

Not to be too pessimistic here, but the scientists working on fusion (or at least working on fusion funding) have been saying that commercial fusion power was 20 years away for the last 30 years. On that basis, one might argue that the progress that has been made is an understanding that the problem is much more difficult than initially or subsequently imagined by those most experienced with it. Further, the cost of the experiments (hence the eventual cost of the power plants?) seems to be increasing rapidly.

I keep a mental list of neat-o technology that I expect to see in my lifetime. A few years ago I discarded hot fusion power plants from that list. Part of that decision, of course, is that there's a lot less of my lifetime left, but that wouldn't matter so much except that they don't seem to be getting any closer (in time) to a profitable commercial plant.

Posted by: Michael Cain on June 4, 2004 10:37 AM

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The problem is not that we are running out of oil. In fact, the amount of oil pumped from the ground on a daily basis in 2004 is more than at anytime in the history of oil. The real problem is that we are also consuming more oil than ever before, and while the capacity to pump more oil has grown, the ability to refine it into gasoline in the U.S. has remained basically constatnt for 25 years. This is due to the not-in-my-backyard mentality of the general population and the ability for fringe enviornmental groups to prevent new refineries. In addition, another posted made reference to the fact that they would be willing to sacrafice 1-2% of the U.S. annual GDP to reduce our dependence on Mid-East oil. There is a way to reduce our dependence today without sacraficing GDP, it is called the Alaskan Wildlife Refuge. I really don't understand how the same people who want to stop importing oil from Saudi Arabia also won't to prevent new drilling here at home. The result of this position is more dependence on foreign producers and more work for our soldiers.

Posted by: Andy on June 4, 2004 11:14 AM

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Andy,

I do support the drilling there. But at best it only amounts to about 1/2 a year of supply given current world usage. It can also be described as about 2 years of American demand, but I would think it is global demand that matters. The numbers I used come from here, someone please correct me if I'm off on this:

http://www.anwr.org/backgrnd/potent.html

So it would only be a small part of a long run energy security policy. If we use it to temporarily lower oil prices and end up stimulating more demand in third world countries as well as our own country I don't see how it helps energy security at all.

Posted by: snsterling on June 4, 2004 12:04 PM

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@snsterlig: On the ANWR potential, predicted oil reserves there amount to a drop in the bucket, so says CalTech professor David Goodstein. http://mobjectivist.blogspot.com/2004/05/ripple-in-energy-pond.html

At the lower end estimate of 590 million barrels (found at the web site you quote), this amounts to like 30 days worth of US oil consumption. And you know why I use the lower end? Because these oily oilers usually LIE about estimates.

Check my blog below, I tend only to write only about energy issues.

(BTW, I just posted pretty much this same comment to the outsidethebeltway.com blog, and it was removed after only a few minutes. Is there an agenda there?)


Posted by: Webster Hubble Telescope on June 5, 2004 02:03 PM

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Regarding fusion I am only skeptical because of the people involved.

I once had a run-in with Prof. Martin Fleischmann (one-half of the infamous Cold Fusion duo). I was giving an invited presentation at a summer conference retreat. As I got into the Q&A session, Fleischmann openly commented in the stupidest way possible. Even though most of the experiments and data I described in my presentation used present-day technology (circa 1987) he had the nerve to pronounce that most everything I reported on happened to be old news by the late 1920's. As I recall, this hit me hard until I found out more about his work at that time; even though he had expertise in electrochemistry, he wasn't well funded and had an out-of-date lab (according to other people at the conference I hazily recall).

Only a year or two later (circa 1989) did the loudmouth open his yap too wide and suffer ridicule on what some consider the Scientific Fiasco of the Century. Suffice to say, cold fusion will not meet any energy needs in our immediate future.


The other side of the coin is if you dare speak the truth as fusion pioneer Robert L. Hirsch of RAND did on potential for new energy mechanisms. More here:
http://mobjectivist.blogspot.com/2004/05/toe-company-line.html

Posted by: Webster Hubble Telescope on June 5, 2004 02:35 PM

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Dont think of ANWR as a national park.

Think of it as part of the US Strategic Oil Reserve.

The 'normal' US Strategic Oil Resreve has about 700 million barrels in it.

ANWR has somewhere around 600-4 000 million barrels in it (probably. We think. It hasnt been drilled, and Mother Nature has her habit of biting geologists in the ass).

As long as it is undrilled but very prospective greenfields country, the US has a credible threat to cover a couple of years of US demand internally.

I'm just guessing here (although I'm sure engineering studies exist), but ANWR could probably be brought on line in 3-5 years as a crash project. I'm sure that Halliburton, Schlumberger, the DOE etc have done studies.

If oil prices stay at US$20-US$30 a barrel, then you want to leave ANWR right where it is, and buy cheap oil off the Saudis.

If, on the other hand, oil prices go to Euro 40 and stay there, then the US may want to bring ANWR into play.

Until then, leave it in the ground where it can't go anywhere.

Oh, and Webster, oil geologists dont lie about reserves numbers, as the drill bit eventually tells the truth ... it's just they are perennial optimists, as a pessimistic oil geologist will never want to drill anywhere, and thus leaves the business.

Posted by: Ian Whitchurch on June 5, 2004 04:17 PM

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Dont think of ANWR as a national park.

Think of it as part of the US Strategic Oil Reserve.

The 'normal' US Strategic Oil Resreve has about 700 million barrels in it.

ANWR has somewhere around 600-4 000 million barrels in it (probably. We think. It hasnt been drilled, and Mother Nature has her habit of biting geologists in the ass).

As long as it is undrilled but very prospective greenfields country, the US has a credible threat to cover a couple of years of US demand internally.

I'm just guessing here (although I'm sure engineering studies exist), but ANWR could probably be brought on line in 3-5 years as a crash project. I'm sure that Halliburton, Schlumberger, the DOE etc have done studies.

If oil prices stay at US$20-US$30 a barrel, then you want to leave ANWR right where it is, and buy cheap oil off the Saudis.

If, on the other hand, oil prices go to Euro 40 and stay there, then the US may want to bring ANWR into play.

Until then, leave it in the ground where it can't go anywhere.

Oh, and Webster, oil geologists dont lie about reserves numbers, as the drill bit eventually tells the truth ... it's just they are perennial optimists, as a pessimistic oil geologist will never want to drill anywhere, and thus leaves the business.

Posted by: Ian Whitchurch on June 5, 2004 04:17 PM

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I.W.
You think ANWR is 3-5 years?

Can't you do simple math? 600 million / 20 million/day = 30 days.

Geez.

Posted by: Webster Hubble Telescope on June 10, 2004 10:26 PM

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