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High Demand Or Rather An Oil Bubble?

A tip from our reader Don has led us to an article in the London Times. In it, economics columnist Anatole Kaletsky argues that the astronomical oil price is not caused by economic fundamentals like supply and demand,

but rather the product of a typical financial boom-bust cycle, which could be deflated - especially with some help from sensible political action - as quickly as it built up. [...]
In the late stages of financial bubbles, it is quite normal for prices to become completely detached from economic fundamentals. House prices in Florida and Spain kept rising even after property developers built far more homes than they could possibly sell. The same thing happened in credit markets: mortgage securities kept rising even while banks created “special purpose vehicles” to acquire vast “inventories” of bonds for which there were no genuine buyers - and dozens of similar examples can be cited from the bubbles in internet stocks and Japan. Similarly, the International Gold Council reported this week that gold demand for commercial uses and investment fell 17 per cent in January, just as the gold price surged through $1,000 for the first time.
Now consider the situation today in oil markets: the Gulf, according to Mr Rothman, is crammed with supertankers chartered by oil-producing governments to hold the inventories of oil they are pumping but cannot sell. That physical oil is in excess supply at today's prices does not mean that producers are somehow cheating by storing their oil in tankers or keeping it in the ground. All it suggests is that there are few buyers for physical oil cargoes at today's prices, but there are plenty of buyers for pieces of paper linked to the price of oil next month and next year. This situation is exactly analogous to the bubble in credit markets a year ago, where nobody wanted to buy sub-prime mortgage bonds, but there was plenty of demand for “financial derivatives” that allowed investors to bet on the future value of these bonds.

The article quotes a book by George Soros which is available on Amazon.de or Amazon.com.

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Don S on :

It's interesting. seems as if there was a 100,000 BBL per day discrepancy between demand and supply even last year - before oil prices jumped over the moon this spring. With far higher prices I suspect demand is tanking even more than it was last year, and supply may well be rising if anything. So the daily surplus may be more, much more. Moreover with the new price level having been set at this astronomical level I expect two longer-term effects to occur in company behavior. In the short term we'll see major efforts to save on oil use at all costs by both consumers and businesses. Big SUV's will be considered white elephants even more than before among consumser and sales will tank even more while people buy gas-efficient small cars (as occured in the late 70's). Businesses are already making long-term investments in projects to save fuel and will redouble those projects. When they plug a price of $131 into their models ALL KINDS of investments suddenly make sense, and even a sudden drop in prices won't derail many projects because businesses don't want their survival threatened by off the wall oil prices. I'm talking about airlines and other transport businesses here, and other high users. These kind of behavior changes have lasting effects over many years and will serve to shrink the growth in demand both now and in a lasting way. Or rather that was our experiences after the oil shocks of the 70's and almost certainly will be the modern reaction. The oil producers are riding high today, but a major oil depression may occur - again. Rememebr $10 a barrel oil? Well I doubt we'll see THAT again - but $20 may not be impossible a decade or more down the road.

Don S on :

Looking farther ahead this is going to bail out Iran and Venezuela in the short term. It's keeps their drunken luau going for another year or three. But...... what comes after? A bigger hangover, I think. In Iran's case a huge hellacious havering hangover. They may have their atomic bomb by then, but the Iranian economy will have a migraine to end all migranes. A migrane such as France suffered on the eve of the Revolution, or Iran did during the late 70's and which blew the Shah out of power? Possibly.... Hugo Chavez will go rather more easily when the time comes but the US won't have to lift a finger except perhaps to grease the schute perhaps.

Pamela on :

Um, I think he's missing something. I've had to watch this market as energy prices are such a significant input cost in agriculture production. There is indeed some 'speculation' going on, but the futures markets are named appropriately. They bet forward. As it happens, production is dropping. Russia has already announced a decline. Saudi Arabia has done something I find striking. It's gone back in to its 2nd largest field to see if it can get any production out of it. The problem is that the geology is treacherous - if they mishandle the extraction, they will ruin the field. That is quite a risk to take if you're not looking at future shortages. Mexico is declining, same with North Sea, etc. I know the EIA (Dept Energy) is planning to look at supply issues, as is a private Paris-based group - a first for both apparently, as they've only looked at demand previously. Both studies will have to be 'guesstimates' as some countries, e.g., Saudi Arabia, consider oil reserve numbers as state secrets.

Don S on :

Possibly. Possibly not. There have been oil panics periodically since the 1930's at least. This may be the final diop - or it may not. Prices are up %1000 since the late 90's - does that lead you to think there may be a slight bubble effect?

Pamela on :

"does that lead you to think there may be a slight bubble effect?" I think there is a bit, but not as much as I see in ag commodities. Here's the article on the Khurais oil field in Saudi Arabia. http://www.energyinvestmentstrategies.com/2008/04/22/new-saudi-capacity-the-worlds-most-difficult-plumbing-problem/ Note that they have to build 120 miles of pipe to get the filtered sea water to the oil fields to be used to pump out the oil. (And given this is Saudi Arabia, every mile is going to be guarded - a huge cost). Have you watched the rise in steel prices and their projections? So, I would add that in addition to projected declines in production (due to depleted fields or aging infrastructure), the projected COSTS of getting that oil are also increasing.

Don S on :

Steel up? That shouldn't surprise anyone. Particularly 'commodity steel'. Since that business moved out of the developed world, labor is no longer the proportion of costs which it used to be. No, I'm certain that raw materials are. Ore - perhaps. And energy, no perhaps about it! If oil prices go up and stay up for a long period, other sources of energy can become economic, because it's cheap oil which have been preventing their development. Rememebr oil shale? People have been very excited about it periodically. I think I read somewhere that oil at $40 bbl would make oil shale economic, but that's old data, so probably the figure is higher. The problem for shale developers was always that OPEC could always open the spigots and bankrupt them, so nobody got seriously interested in developing the technology. I'm not sure what the figure would be today - it would certainly vary with the richness of the shale, the quality of the oil extracted, how much the energy costs to do it, and cost of pollution abatement. Anyway there are lots of things which could become economic with high sustained oil prices. Including conservation of course. And if the major producers are losing production they no longer will hold the power to stop them with low pricing.

Pamela on :

Went back thru my bookmarks to give you an example of what I've been tracking: From May 22 Wall Street Journal "that the Paris-based IEA will slash its forecasts of global oil supplies, after years of rosy predictions that oil output would rise in lockstep with developed countries’ appetites. The IEA’s latest project? A close look at 400 of the world’s biggest oil fields to figure out how much oil is really left, and how much production is declining. Nobuo Tanaka, head of the IEA, said Thursday the plan is to provide a “more realistic supply potential” estimate of what’s really out there. That marks a fundamental shift for the IEA, founded in the wake of the 1973 oil embargo and subsequent supply shocks. Ever since, the IEA spilled a lot more ink studying oil demand in rich countries than oil output in the developing world. Two developments appear to underly the shift: Rich country demand no longer calls the tune, given China’s implacable thirst for petroleum, and global oil reserves no longer seem a bottomless well. IEA chief economist Fatih Birol told the WSJ that oil production at big fields will continue to decline at an accelerating rate, leaving the world with a big shortfall of crude even as demand growth marches on." http://blogs.wsj.com/environmentalcapital/2008/05/22/peak-oil-in-paris-international-energy-agency-now-skittish-too/?mod=WSJBlog ------------------------------------------ And this from a year ago "60 percent of oil and gas execs believe trend of declining reserves is irreversible In the KPMG survey, which polled 553 financial executives from oil and gas companies in April 2007, twenty-five percent of the respondents said that at least 75 percent of government funding into energy should be directed at the renewable sources sector and a further 44 percent said that at least 50 percent of funding should be allocated in the same way. These feelings stem from the overwhelming majority, or 82 percent, citing declining oil reserves as a concern. http://www.energybulletin.net/30106.html

Pamela on :

Here's more from this week's Financial Times "Running on Empty?" He found that the world depends on just a few giant, old, declining oilfields and that almost nothing to match them has been discovered since the 1970s. One in every five barrels of oil consumed each day is pumped from a field that is more than 40 years old. Not a single field discovered in the past 30 years has ever been able to produce more than 1m b/d and the number and size of fields discovered since then have been shrinking dramatically. Output declines as an oilfield ages - sometimes dramatically. One example is Mexico's Cantarell field. Discovered by a fisherman in 1976, Cantarell at its peak produced more than 2m b/d. Today, the field pumps half that volume and is in relentless decline, losing 24 per cent of its production each year. The same trend - though at a slower pace - is plaguing most fields around the world, possibly including the four biggest: Ghawar, Cantarell, Kuwait's Burgan and China's Daqing. This means running to stand still: each year as much as two-thirds of new oil supply capacity goes towards covering for the slowdown at ageing fields. http://www.ft.com/cms/s/0/aba39212-2607-11dd-b510-000077b07658.html --------------------- Oil futures near $140 on shortage fears "Even some industry executives have warned that geopolitical supply constraints will mean oil production will not be able to match demand as early as 2012 to 2015. Those are the years that saw the greatest jump in oil prices yesterday and have rallied since the start of the year." http://www.ft.com/cms/s/0/deb38774-26d0-11dd-9c95-000077b07658.html

Elisabetta on :

http://www.thelocal.de/12083/20080525/. Spiegel or NZZ don't have anything on this, but I think Mr. Gehrcke gots some splaing to do.

Pamela on :

It is Tuesday May 27. From today's Financial Times, Russia's government took its first steps yesterday towards $4bn of tax cuts to boost investment in the oil industry, amid warnings the country's output could fall for the first time in 10 years. [I tried to cut/paste the link but it came in as garbage. So go to www.ft.com and search for the headline 'Putin quickens tax cuts to revive oil flow']

Joe Noory on :

Wow! Supply responds to demand! How novel! One feature that has barely drawn a mention is the factor by which subsidized oil consumed in producing states matters because it has a larger impact on the price driven up by either demand or speculation the higher the price goes. Moreover, the consumption pattern doesn't change for these folks, making others' use of less oil lengthen the time it takes for the effect of demand destruction to have an effect on price. Point 2: if you know that oil is subsidized in China, Iran, and until recently in Indonesia, and you could move a business such as a shipping operation there, then you are indulging further an artifical intervention on the market. It causes a run by proxy.

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