What’s the Right Price for Oil? 21 comments
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By Byron King
02/11/09 Pittsburgh, PA Last year — 2008 — started out so well for the world’s energy industry. The price of oil was in the $90s and low $100s per barrel, not exorbitant. That is, the price of oil was high enough that people were beginning to change their usage habits, but the price wasn’t bad enough to break the banks (so to speak). The worldwide pace of well drilling was strong, but not unsustainable with the existing fleets of onshore and offshore rigs. Meanwhile, across the world, the oil patches were booming.
What a difference a year makes. By about March last year, the price of oil began to spike upward. Eventually, in July 2008, it reached $147 per barrel. And then the price broke. Oil prices slid down into the $100s by Labor Day. Between late September and late December, prices dropped as low as $33 per barrel. Now in January 2009, oil is hovering around the low $40s per barrel, $100 less than back in July, only six months ago.
We had a wild ride in 2008. And I believe 2009 will give us some new shocks. First, we are seeing significant companies in the domestic gas drilling business, like Chesapeake Energy (CHK), scaling back their drilling programs. And we’re seeing eye-popping fourth-quarter losses from key industry players like Conoco-Phillips (COP) (lost $31.2 billion in the last quarter) and Shell (RDS.A) (lost $2.8 billion in the last quarter). We will see more reports like that, of operating losses, diminishing reserves, reduced earnings, write-downs and even some shotgun weddings (if not bankruptcies). Remember how Congress spent much of last year licking its collective chops over how it was going to tax those horrible so-called “windfall profits” of the oil firms? Well, not anymore, eh?
Also, watch how fast the drilling and oil service industry decelerates. Oil companies that lose money also scale back their capital expenditures. Conoco-Phillips and Occidental (OXY) are cutting back. We’re seeing layoffs in key parts of the oil service sector. Companies like Schlumberger (SLB), Halliburton (HAL) and Baker Hughes (BHI) have announced personnel cutbacks just in the past week. And Rowan (RDC), a large offshore driller, is canceling new rigs. Across the oil patch, the hiring boom of the past couple of years has halted, while the average age of the current work force just gets older by the day.
With less drilling going on, we will soon start to see tighter output for both oil and natural gas. In Russia, oil output decreased by a seemingly small — but telling — 1% toward the end of 2008. You can expect a larger drop from Russia for 2009. Mexican oil output dropped by about 10% in 2008, and is on track to drop even more in 2009. According to figures recently published by the International Energy Agency, about 58% of world oil output comes from just 800 oil fields. And most of those oil fields are in the “mature” category. They were discovered in the 1950s-70s and are past their respective output peaks. So the macro view is grim, out beyond two years or so.
Markets work, right? Yes, basically. That’s the idea, anyhow. Unless, of course, they don’t work very well. And if something doesn’t work very well, does it still work? A stopped clock tells the correct time twice a day, right? But what if the clock just stops and starts whenever it gets banged around? To use another cliche, is that any way to run a railroad?
Let’s try to figure this out. What’s the difference between oil at $100 in January 2008, $147 that July, $100 in September and $33 in December? Has global demand been changing all that much? (Hint: Worldwide demand was not rising all that much in the first half of 2008. And demand is down over the past six months, but not by large factors.) Is the current oil price — in mid-January 2009 — in the low-$40s per barrel the “right” price? Can we believe the market?
One key thing that has changed in recent months is the oil market’s perception of the future. The marketplace is predicting lower oil usage as the world recession unfolds. So oil prices tend to fall with the release of bad economic news. But that perception is just plain myopic. Look at both the amount and the composition of the oil for sale. We’re seeing falling oil prices in the face of flat (at best) world output. And total world oil output includes increasing volumes of natural gas liquids (NGLs) and tar sands from Canada.
Let me translate that for you. NGLs are evidence that the oil industry is blowing down the world’s gas caps. And tar sand “oil” is the capital-intensive stuff with low energy return on investment. Tar sands use a lot of water and energy and come out at great capital cost and environmental cost to the North American landscape.
Ask yourself a couple more questions. In the near term, will worldwide economic contraction lower the use of oil? Yes, probably. And in the medium-to-long term, will depletion lower the worldwide output of oil? Yes, as well.
For now, lower oil demand is trumping stagnant supply. Oil prices are down. Near-term issues are beating out the medium-and-long term issues. But the longer oil prices stay low, the more damage will be inflicted on the world oil and drilling industry. More rigs will not be built. More wells will not be drilled. More prospects and fields will not be developed. More personnel will not enter into an aging industry work force. More of the current infrastructure and human capital will just run down.
In short, we are setting ourselves up for a period of severe volatility in oil prices. When demand starts to recover, supply falls below some not-yet-defined volume or perceptions change about the future of oil availability… prices will take off.
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This article has 21 comments:
This depression could last for years.. we are in
uncharted territory, at least for this generation.
I would like to offer a different perspective from the title of your article, if I may.
Instead of debating, or even defending the "right" price for oil, isn't it time that we, American, wake up to cease our addiction to cheap oil?
If indeed we had learned our lessons from the early '70s Arab oil embargo crisis, and started to build energy efficient cars like the Japanese did, we would have been in much better shape today. We spent about something like a little less than $1T each year importing oil. Imagine if we had succeeded in conservation, and invested in converting to renewable energy, the money saved would have gone a long way in paying down our national debt, and in cleaning up the environment.
The truth is we don't want to, unless we are forced to, on top of other political and economic reasons that the readers only know too well, and which I do not want to elucidate here, after listening to the Bankers on Capital Hill this morning.
In my view it has to do with our culture too. i could recall in the roaring '60s gas was so cheap selling for 33 cents a gallon. The Japanese being a island country with almost no oil reserve and production at the time, everyone knew from childhood the high cost of gasoline and the need to conserve. As a result they have been way ahead in building more energy efficient cars.
I read today an article that says the Dept. of Energy (DOE) has stopped filling the Strategic Oil Reserve as of June 08. He finds it baffling that the historic relationship of WTIC trading higher than Brent Crude has reversed. The explaination of this is market intervention by DOE. You can find the article here...news.goldseek.com/Gold...
he only started to deliver to junk emails his once in a lifetime opportunity newsletters about investing in some Oil/Gas Smallcaps when Oil started to bruumbblee.
He lost on this newsletters, before sending 100,000 newsletters Daily Reckonong guys buy some penny stocks with websites (no assets of course) promising trillions of barrels in the ground, greedy investors jump on it and get crashed.
This time he was crashed himself.
It is a necessity and there is nothing on the horizon to replace it.
Ethanol, for example is a government subsidized joke that raises food prices.
The price of oil rising is just a matter of time, the question is not Will the price rise, it is when will the price rise?
Investors have been burnt by the stock market crash and very few will get back in anytime soon. The same thing is happening to the drillers and exploration. These companies will not invest money in new rigs therefore when oil does comeback it will be years before the exploration part catches up. So once oil goes higher, it will stay there for years.
On Feb 12 12:50 AM Teutonic Knight wrote:
> To the Daily Reckoning,
>
> I would like to offer a different perspective from the title of your
> article, if I may.
>
> Instead of debating, or even defending the "right" price for oil,
> isn't it time that we, American, wake up to cease our addiction to
> cheap oil?
>
> If indeed we had learned our lessons from the early '70s Arab oil
> embargo crisis, and started to build energy efficient cars like the
> Japanese did, we would have been in much better shape today. We spent
> about something like a little less than $1T each year importing oil.
> Imagine if we had succeeded in conservation, and invested in converting
> to renewable energy, the money saved would have gone a long way in
> paying down our national debt, and in cleaning up the environment.
>
>
> The truth is we don't want to, unless we are forced to, on top of
> other political and economic reasons that the readers only know too
> well, and which I do not want to elucidate here, after listening
> to the Bankers on Capital Hill this morning.
>
> In my view it has to do with our culture too. i could recall in the
> roaring '60s gas was so cheap selling for 33 cents a gallon. The
> Japanese being a island country with almost no oil reserve and production
> at the time, everyone knew from childhood the high cost of gasoline
> and the need to conserve. As a result they have been way ahead in
> building more energy efficient cars.
>
2. Price of b. oil in '98-2000 from as low as $12 to 20s range. - yes in the teens, after APAC & Russian financial crisis in '98-99
3. Supply/demand relationship of oil has not change that much (98-2008)- spike in price all due to speculation.
4. High mileage diesel engines - made by Ford, GM & local european ( 35-50+mpg) in Europe - reason we do not use them in the US is our reg. ( our air is different, our global warming, diff. world, etc) - see also higher price of diesel in US vs. lower than gas in Eu.
- conclusion we need to Drill, Drill, throw some $ as alternatives, Drill, more nuclear plants, use European auto diesels engines in US - probability of above happening - with current "smart" bunch in US gov. 15%. Again more price volatility in the near future - b. as low as teens, but no $100 in 2009. Would be nice to control or reg. speculation - I do not think is dooable, this is to global to control.
1) Many key oil E&P projects have been shelved due to low oil prices and the scarcity of investment capital.
2) Demand has dropped enough to tumble prices and discourage any serious alternative energy projects.
3) The current low oil prices have fooled most people into thinking that $147 oil was a one time aberration and most have gone back to their wasteful ways.
In the near future (circa 2015) after the economy has recovered and oil demand returns to its pre-July 2008 trajectory, $147 oil will seem like a bargain.
6.4% (assuming additional investment of almost $1 trillion annually over the normal maintenance)
or 9.1% with little or no extra investment
assume decline of 5% annually = 3.5 mbpd annually
Question; can the planet cough up 3.5 million new barrels each and every year or to put it another way
we need another Saudi Arabia EVERY 2 YEARS
I stand corrected on my estimates. My numbers are a few months old and from a different source which makes your numbers even more troubling. I like this quote from Niels Bohr (Noble Prize Physicist) "Predictiion is very difficult - especially if it is about the future". Major oil companies have merged because they can't find enough oil themselves. Why? It costs less to buy reserves than to go looking for it. With todays low oil costs we may see more mergers and less drilling. More layoffs, fewer university graduates, fewer employees and fewer new development. Oil, we all know, is a non-renewable resource and we may well be near an economic "tipping point" where companies will just stop looking for domestic oil. There will still be "mom and pop" operators but no more "Big" domestic oil companies. Regardless of the percent decline or supply. The end result will be the same. So how much do you want to pay for it? I write this blog on my Dell which is made with oil. My ceramic coffee cup was made with energy derived from oil. The coffee came in a plastic bag made from oil. The coffee itself was transported to my home on ships, trucks and a car that runs on oil (and electric..a hybrid). Energy drives civilization. Are you ready for a future civilization without oil?
On Feb 11 05:57 PM ricardomarcos wrote:
> what isn't factored in here is that even those prices last year weren't
> fuelled 100% by demand. There was a big inflow of cash from into
> the commodities markets as the financial sector, flush with cash
> from pyramiding off of mortgages with derivatives, sought to stash
> their money in "sure" commodities futures. All those investors, like
> all others, snowballed to create the astronomical prices of last
> year. So we did have a bubble. Now of course we're running low on
> oil. Of course demand will decline however long this depression plays
> out. And of course the interplay of going green and the normal growth
> in demand for oil will make things interesting. But really, my guess
> is, just with last year's figures, oil should've been at 70-80, without
> the speculators. That, after all is the likely price when substitution
> with other energy products kicks in.