The Great Oil Deception 22 comments
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What matters is growth from the emerging markets, not the United States or other mature markets.
Oil Bulls love to trot out China, and to a lesser extent, India, when discussing the unbelievable growth from emerging markets. I heard a money manager call such growth "massive." Well let's see just how massive this growth is. In 2006, China consumed 7.2 million barrels a day, and in 2007 it consumed 7.58 million barrels a day. This is "astounding" growth of 380 thousand barrels a day. In 2008, the barrel per day growth is estimated to be 420 thousand barrels. While the growth rate is fairly impressive on a percent basis, the absolute increase is hardly more than a rounding error in an 87 million barrel a day market.
Now let's look at the "mature" markets that don't matter. Demand from the 30 countries countries belonging to the Organization for Economic Cooperation and Development [OECD], was 48.96 million barrels per day in 2007. This demand has been flat for several years and is roughly the same as it was in 2003. This demand will begin to fall, as it has done in the past when oil prices reach very high levels. We have already seen evidence of this in reports on miles driven on U.S. highways which fell 4.3% in March 2008.
Let's look at what that impact will be:
OECD Demand declines one percent - 490,000 barrel per day decline.
OECD Demand declines two percent - 880,000 barrel per day decline.
As you can see, a one percent decline in demand from "mature" economies would wipe out all of China's absolute growth last year. A two percent decline would be equal to twice China's barrel per day growth. So emerging markets don't really matter except in the context of the entire market. Are the OECD demand declines I listed above realistic? Yes, demand has fallen in previous years when prices were high.
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"We are reducing our US demand outlook to incorporate a 3% y/y decline in 2Q’08, 3Q’08 and 4Q’08, which results in an annual decline of 3.3%. This would represent the steepest decline in US demand since the 1980-1982 period following the price spikes in the late 1970s and the associated economic downturn in the early 1980s. Assuming a 0.5% decline in the other OECD regions (consistent with 1Q’08 performance), we estimate overall OECD demand will be down 1.7% y/y in 2008 (-0.8mb/d). "
Now, when you address supply, please make sure you factor in the cost to find and develop and bring to market the "new" incremental barrels. As you will see, a lot of the oil we have left to find/develop is in high cost areas. Super deepwater, Chukchi sea, canadian oil sands, US oil shale, etc. These will cost close to $100/bbl to develop. So while I see prices moderating, there is a floor to that effect as anything too low will not allow these new barrels to come to market, allowing supply to be outstripped once again by demand. And the whole cycle kicks back into gear!
www.td.com/economics/s...
Area/2007 Demand/2008 Demand
Former Soviet Union 4.28 4.41
Other Asia 8.78 8.83
Other Non-OECD 15.01 15.62
1) If you are going to do the analysis, you should include ALL increases versus ALL decreases in demand, and come up with a final number. You have not done so in this article, but I am sensing that your conclusion would be that taking all into account, you believe world oil consumption in 2008 will be even with 2007.
2) If that is so, the IEA and others disagree with you--projecting around an 800K bpd increase in consumption.
3) I have no idea if this will be correct--it depends on the economies of various countries, degree of fuel conservation in the OECD countries, and what percent of the subsidies will be removed in subsidized countries.
4) Let us assume, however, that you are correct, and that demand and supply remain essentially in balance in 2008 as they essentially were in 2007. Here is the key problem with your analysis:
Economic theory tells us that if supply and demand are balanced, the price can be anything. There is no way to predict price simply on the knowledge of balanced supply/demand. It could be $50 or $150.
Then your question will be--if supply/demand was balanced last year, and price was $80, and supply/demand is balanced this year, why should price be almost double?
Good question, IF THIS WAS A FREE MARKET.
IT IS NOT.
I would be willing to bet ANYONE that OPEC will never let oil go below $100 ever again (that is what is oil is worth in inflation-adjusted dollars compared to oil peak in early 1980's). Although many people are doubting whether OPEC can INCREASE oil production, nobody can doubt that OPEC (especially Saudi Arabaia) can DECREASE oil production without any meaningful negative consequence.
So even though oil supply and demand may be balanced, oil traders may believe that if demand falls, so will supply, to keep the price at a level that OPEC likes.
Did OPEC protest $100 oil? $110? $120? Only in the $130's did OPEC do anything to suggest the price of oil had gotten too high, but we're still not clear what OPEC's new "price setpoint" is.
This is almost precisely what I predicted would happen in an article I wrote on SA in Feb of this year as oil was crossing $100.
Finally, when supply and demand are in balance, that is not a hunky-dory situation for a commodity that the whole world runs on. Why?
Because potential sudden DECREASES in production can be readily anticipated, whereas sudden rises have a zero percent chance of occurring--eg, what's the likelihood that we wake up tomorrow and learn that world oil production INCREASED by 2 mbd?
Zero.
What's the chance that we wake up and learn that Israel attacked Iran and Iranian productiion of 4 mbd has been taken off the market? Certainly greater than zero.
What's the chance that other significant disruptions occur? Substantial.
Thus, upside bias far exceeds downside bias, because OPEC will put a floor on the price, whereas nobody can put a reasonable ceiling on the price.
That is why I believe oil will never go to double-digits again, and why oil at $120-130 is realistic for the rest of this year with outside moves of maybe $100-110 on the downside and who knows what on the upside if a major disruption occurs.
Jack
Let's be realistic. You used to hear about OPEC members "cheating." Kuwait can't send police to Venezuela to make Venezuela export less oil. Venezuela can't send anyone to Saudi to audit their production either. But now, you don't hear about "cheating," and they hardly even bother to set quotas. Why not? Because they are all producing to capacity, with the possible exception of Saudi Arabia.
There is no collusion. They just don't have any more oil to put out. And don't take my word for it. Just google "Samotlor," "Ekofisk," "Cantarell," "Romashkino" etc for proof- all former giants of the oil producing world that are now rapidly entering the world of reference books.
We'll need more oil to get lower prices, and we're not drilling for it. Does that our correctly summarize our current situation?
"I am sensing that your conclusion would be that taking all into account, you believe world oil consumption in 2008 will be even with 2007."
I actually think that demand will fall in 2008 vs. 2007 not stay even.
"I would be willing to bet ANYONE that OPEC will never let oil go below $100 ever again."
OPEC has been very disciplined in recent years but the historical track record is not so good.
"nobody can doubt that OPEC (especially Saudi Arabaia) can DECREASE oil production without any meaningful negative consequence.'
If OPEC cuts production significantly then that would increase the level of spare capacity. Then we would be in a normal market with excess capacity and normal inventories.
"What's the chance that we wake up and learn that Israel attacked Iran and Iranian productiion of 4 mbd has been taken off the market? Certainly greater than zero."
Iran produced 3.9 million BPD in 2007 - but only exported 2.2 million BPD. Israel won't attack the oil infrastructure of Iran. I would worry more about Iran attacking its Arab neighbors who are allies if the U.S in retaliation.
"We'll need more oil to get lower prices, and we're not drilling for it."
that is not the only way to get lower prices, as a fall in demand may have the same impact.
You missed my point, which is that (1) OPEC is disciplined enough now to CUT production, and (2) that puts a floor on the price of oil. That is my opinion as an oil speculator, and I suspect other oil speculators join me in that opinion. If I can speculate on a commodity for which I believe a price floor exists, but upside is not likely to be similarly limited, I consider that to be an excellent risk-reward trade (and actually, given these facts, one might argue it's not all that "speculative.").
To Mr. Fox:
OPEC's lack of discipline in the old days is just that--the OLD days. OPEC finally discovered in the past 12 months that (1) they can sell the same amount of oil at $130 that they were selling 18 months ago at $60, (2) that their resource is dwindling faster than they previously realized, and (3) that there are very few (if any, as long as they don't overdo the price point beyond $120-130) negative consequences to this approach.
Now this statement by you, Mr. Fox, completely baffles me:
"If OPEC cuts production significantly then that would increase the level of spare capacity. Then we would be in a normal market with excess capacity and normal inventories."
Huh? If Saudi Arabia decreases production from, say, 10 mbd to 8 million, sure, they now have 2 mbd of production capacity sitting idle, which some paper-pusher can then list as "spare capacity" on some useless report. But who cares? If Saudia Arabia won't PRODUCE those 2 mbd because they want to maintain, say, $120 oil prices, the fact that it is "spare capacity" in somebody's report is irrelevant.
Finally, I said this,
"What's the chance that we wake up and learn that Israel attacked Iran and Iranian productiion of 4 mbd has been taken off the market? Certainly greater than zero."
TO WHICH YOU RESPONDED:
Iran produced 3.9 million BPD in 2007 - but only exported 2.2 million BPD. Israel won't attack the oil infrastructure of Iran. I would worry more about Iran attacking its Arab neighbors who are allies if the U.S in retaliation.
Sure, Iran only exported part of its oil, but even 2.2 mbd taken off the market will push oil by $20/barrell, if not more. My point wasn't quantitative--my point is, disruptions of 1-2 mbd are much more likely than sudden over-supply of 1-2 mbd.
Finally, as an Israeli-born American, I probably agree that Israel will not attack Iran's oil facilities--although I am not quite as sure about that as you are (for example, . But again, my hypothesis is not based on an Israeli attack against the Iranian oil facilities.
Again, my point is that conflict in the Middle East, whatever its nature, is (1) likely, and (2) more likely to raise oil prices than lower them. I might add that a likely Iranian response to an Israeli attack is to SHUT DOWN its exports unilaterally, pushing the price of oil by $20-30/barrell--for which Israel will get the blame all around the world.
In summary, I believe OPEC will UNDER-produce oil sufficiently (and let me add that non-OPEC oil producers such as Russia might even help) to maintain its price at a level of at least $110-120, whereas forces which tend to push oil up are not as controllable.
Jack
Thanks for the article and for bothering to reply to so many readers.
I'm not sure you've convinced me to exit my energy positions. But, you've expressed something I've been thinking about for a little while and given me reason to think of it again/more.
Everyone and his grandmother has written about the fundamentals driving oil prices the past few years. It's nice to read a contrarian piece once in a while.
That useless entry in a report entitled "spare capacity" is one of the justifications for high oil prices used by analysts and traders. If oil fell and OPEC cut supply to balance the market, we would no longer have that excuse. You are a self admitted oil speculator, but there are other types of investors in oil, and they may react to this change and other fundamental changes.
You said - "My point wasn't quantitative--my point is, disruptions of 1-2 mbd are much more likely than sudden over-supply of 1-2 mbd."
This maybe true, but you have to admit that demand contractions are more likely than increases in the high price environment we are in.
Last, the Iran situation. We have spent the last few years building the SPR which will cover any loss of Iranian crude in the short term, so I believe that any jump in the price of oil after an attack on Iran will reverse. And if it doesn't it will make the point of this article more likely to occur - that high prices will kill demand in the OECD and overwhelm any growth from the emerging economies.
"When you google sub salt discoveries and Brazil's new discovery, did you also read that these discoveries will cost about 10 times more per barrel than Saudi oil to produce?'
The Saudis have some of the cheapest production costs on earth. this proves nothing. Second, these costs are cyclical as you can read in Part II of the great oil deception:
seekingalpha.com/artic...