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The subprime crisis might have been what precipitated the credit crunch, but it was arguably the high oil prices that first pushed the world towards recession by catalyzing the US slowdown at the end of 2007.
Whereas historical oil price shocks were primarily caused by physical disruptions of supply, the price run-up of 2007-08 was caused by strong demand confronting stagnating world production.
According to a paper by James Hamilton of UC San Diego, although the causes were different, the consequences for the economy appear to have been very similar to those observed in earlier episodes, with significant effects on overall consumption spending and purchases of domestic automobiles in particular.
In the absence of those declines, it is unlikely that we would have characterized the period extending from Q4 of 2007 to Q3 of 2008 as one of economic recession for the U.S. The experience of 2007-08 should thus be added to the list of recessions to which oil prices appear to have made a material contribution.
Of course the hand that takes can also give. The fall in oil prices have now helped the world economy to stabilize. In comparison to the stimulus provided by oil, government handouts are peanuts. Last year the world was consuming 88 million barrels per day at an average cost of $100 per barrel, at an annual cost of $3.2 trillion.
If this year's average cost of crude oil around $50 per barrel holds up, the annualized savings will be about $1.6 trillion. The International Monetary Fund estimates that the fiscal stimulus to be provided by the G20 countries for this year and next will amount to $1.2 trillion at best, excluding bank bail-outs.
According to a just released report by the International Energy Agency (IEA), global investment in oil and gas projects is expected to slump 21% this year from a year ago, falling for the first time in a decade.
More than 50 major oil and natural-gas projects around the world have been canceled or delayed by at least 18 months since October, the IEA, the energy advisor to 28 major energy consuming countries, said in the report. According to the IEA, $170 billion worth of projects, involving around 2 million barrels a day of oil production and 1 billion cubic feet a day of gas output have been canceled.
In addition, 35 projects, involving 4.2 million barrels a day of oil capacity and 2.3 billion cubic feet of gas capacity, have been delayed by at least 18 months
With oil demand expected to rebound next year, following two consecutive years' decline, failure for oil production to keep up with a rising demand could drive up oil prices and put a nascent global economic recovery on screeching halt.
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economy catches wind, higher energy prices will kick in. So true economic recovery won't occur until 2012?
35 projects have been delayed because prices are not high enough to justify the investment. So, that would imply that $50 oil isn't sufficient to justify projects to add new production. This implies that the incremental replacement costs for production are north of $50. This means that prices will have to seek some level above $50 in order for supply to balance with demand, since current supply is declining.
Those who talk about oil being at $35 for any significant length of time (more than 3-6 months) are delusional.
It's also not clear to me that the oil price run-up in 2008 was related to supply / demand issues (the quote from the article: "...the price run-up of 2007-08 was caused by strong demand confronting stagnating world production"): in fact, if anything, the collapse in price suggested the opposite (which is that it was largely driven by financial investment in the commodity and the price collapsed when other factors drove the financial players out of the market in August/ September/ October last year). Demand in the US (the bellweather for the oil market) started to drop in late 2007 - as Americans increasingly parked their cars.
As for the cancellation / delay of oil projects, Mmmark's comment above (that $50 oil isn't sufficient to justify investment in replacement supplies, also needs careful consideration. First, most the projects were delayed or "cancelled" when prices hit the $35 mark, and seemed poised potentially to drop lower. Expanding your investment in an environment where oil prices are dropping is tough to justify to shareholders. Second, the credit markets were frozen. The small to medium players had no access to capital (indeed, entirely worthwhile projects collapsed because alternative funding could not be found - for example, Oilexco's North Sea project). Investment was impossible (and continues to be difficult). The larger players also saw their cost of capital rise, and saw no rush to develop or aggressively pursue their projects.
Things appear to be loosening a bit now, as credit markets become more accessible and oil prices stabilize - Imperial Oil just announced that it is proceeding with its major oil sands development in Alberta (the Kearl project - projected to produce about 100,000 bbls/day). Ironically, it was the downturn in the investment environment that helped push the decision - the overheated Alberta labour market has essentially collapsed, and Imperial Oil has managed to reduce its overall costs on the project by at least C$1 billion. I expect other projects will similarly be brought back online over the next few months.
Oil is cheap. The dollar is just junk. Remember eight years ago when you could go to a restaurant and buy dinner for five bucks? Now it's ten. Cable is more, phone is more, gas is more, clothes are more, and the dollar is going down the tubes.
That so called $60 oil is closer to $30 oil.
If the price of oil continues to rise the way it has the past couple months, you will NOT see much - if any - of a rise in consumption even if the economy gains steam. Nobody's going to buy any more oil than they absolutely need if it's $80/barrel. Plus the high price will encourage additional production. Combine those two and it will inevitably lead to (another) crash.
Beware of investors killing their own market.
On May 27 11:29 AM Mmarrkk wrote:
> All of this magnifies a big issue going forward:
>
> 35 projects have been delayed because prices are not high enough
> to justify the investment. So, that would imply that $50 oil isn't
> sufficient to justify projects to add new production. This implies
> that the incremental replacement costs for production are north of
> $50. This means that prices will have to seek some level above $50
> in order for supply to balance with demand, since current supply
> is declining.
>
> Those who talk about oil being at $35 for any significant length
> of time (more than 3-6 months) are delusional.
The reason that we aren't seeing a lot of exploration activity is that demand is still down because of the economy, and the oil rights owners know once it heats and OEC gets maxed out again they will get a better price.
Now that the price of oil is going back up, guess what? Delayed projects are being put back on the front-burner:
www.bloomberg.com/apps...
^
"Imperial Oil Ltd., Canada’s biggest oil company, will proceed with an C$8 billion ($7.1 billion) project to extract tar-like bitumen from sands in Northeastern Alberta . . . Imperial, which is controlled by Irving, Texas-based Exxon Mobil Corp., put Kearl on hold last year after oil prices tumbled."
If the price of oil continues at this rate, you will see more of these.
Even the Saudis pumped out 300K additional barrels/day in March. Gee, I wonder why:
www.energy-business-re...
Oil prices rise because "spot" is allowed to price it all the way to the pump. P/S has nothing to do with it, as clearly evidenced by the oligopoly's income statements, and off balance sheet in Iraq and Afghanistan. (BTW, shorting the airlines wasn't the only crime on 9/10/2001. Just ask ICE.) So, if you think refineries are processing spot crude, I've got a mothballed tanker I'll lease to you for your delivered.
a speculative premium has existed in oil for many years. this premium was once solely attributable to the threat of mideast supply disruption due to war and/or embargo by unfriendly producing countries. but the character of the speculative element now includes the threat of a permanently unstable financial system in the west, accompanied by political instability that threatens to unleash economic horrors in years to come....whether runaway inflation, currency instability or even government default on its obligations. the great irony is that this threat of political, financial and economic instability in the western world will only be exacerbated by an oil price that is unjustified based on fundamentals alone. it is a vicious circle from which there appears to be no escape.
we have met the enemy and he is us.
On May 27 03:17 PM dw57 wrote:
> not sure why the author thinks there was strong demand last year.
> when the amount of gas being used has been collapsing since 2007,
> and the number of miles driven has also been collapsing. and the
> amount of oil being stored has been sky rocketing. all of the price
> for about 2 years has been driven by one thing speculators. and most
> of them were trying to make up for losses in other investments
They are an estimated 10 million Americans out of a job today, Americans are driving less then they have since the 1950's.
Fluctuations and hyperactive are words being used for manipulation and control in the oil industry. Plenty of crude today, around a 19 year high, and yet the price of gas is on the rise.
We can all thank Phil Graham for that.
So how about something original lets regulate the futures energy commodities market? Or better yet, free us from the use of oil altogether? The oil industry as a whole made around $476 Billion in net profit over the last 6 years, the pulse of the worlds economy is under the thumb of 13 OPEC nations and 5 major oil companies. Is this the legacy we want to leave our children and grand children?