As Global Demand Rises, Oil Production Remains Flat

Economics clearly supports the notion that in a functioning market economy, increases in revenue are likely to lead to investment in the industry, expansion of supply, and ultimately moderating prices for consumers in the longer term. If this self-correcting process is not working, as seems to be the case with oil lately, then - this could be a rather strong indication, that factors other than profit and investment incentives are at work. This unavoidably, as we have experienced with crude, will result in additional long term increases in price and profit for the industry.

The international conference of oil producers, which was held in Jeddah , Saudi Arabia on June 23, kept as its focal point not only the unprecedented hike in oil prices, but also the role of speculators in shooting up prices in world markets. Now, and quite honestly here - this game of “let’s blame the speculators” has gotta stop. Speculators are not the driving force behind rising demand for oil in the emerging economies and they are certainly not the reason the current Saudi production of 970K barrels a day is not at an all-time high. Oil producers are the ones that ultimately determine the long-term price trend, not speculators.

Frankly, not only is the speculator-argument unrealistic and without base, but it’s outright laughable.

Even U.S. energy secretary Bodman last week said “There is no evidence that we can find that speculators are driving futures prices” for oil. I agree with the energy secretary’s assessment. All we have to do is look at commodities such as iron ore or coal, which are not traded on the futures exchange and are not influenced by speculation. Both of these commodities have risen at a higher rate than oil since the end of fiscal ‘02. And it’s not just oil, prices are up across the board and that’s a fact.

Another interesting aspect is OPEC’s constant claim that there is significant speculative premium in oil prices. Well, let’s take a look at some data. - Our imports from Mexico, and Venezuela are running more than 30% below year-over-year basis. Libya keeps threatening to cut back on their production. Nigerian exports are way off due to political instability. Saudi exports are running below fiscal ‘05 levels, (true - the Saudis pledged to add 200K barrels a day to the market, but let’s face it - that’s just a drop in the bucket in the context of global consumption), and Russian production is starting to fall.

Furthermore, the U.S. Congress has convened at least 40 hearings on the issue of skyrocketing energy prices in the first half of fiscal ‘08. At least 160 witnesses have been sworn-in and questioned and yet nothing has been done, in terms of effectively addressing energy issues let alone finding solutions. In fact, many of the experts called to testify were rather misinformed about how the markets realistically function.

Meanwhile, more than 73 million new cars hit the road last year.

It is a persisting and irrefutable fact - world demand continues to rise while the production has remained flat since fiscal ‘05. Output at several major oil exporters is in decline and no big fields are slated to come on steam anytime soon. Let’s face it. This is not about speculation, it’s just good old supply versus demand. Whether we like it or not, price will function to equalize the quantity demanded by consumers.

Interestingly, after OPEC President Chakib Khelil predicted on June 28, that the price of oil will climb to $170 p/b before the end of the year, several analysts came out saying that they expected the ‘oil bubble’ to burst soon. In fact, they called for a 25%-30% drop in oil prices over the next six months.

While this would certainly help return oil prices to more practical levels, a 25%-30% drop in oil prices is only a correction. A 30% correction in a commodity or even a blue chip stock is not uncommon. That’s why we don’t understand the ‘bubble’ analogy used by different analysts, including an article published by Barron’s recently where oil was analyzed in bubble terms.

The essence of a bubble is that it involves a sharp rise in the value of an asset that inevitably destroys the reason behind the rise. Tech was a classic example. That’s not the case however, with oil. We don’t have a scenario in which newly issued shares are diluting earnings and funding capital investment that could lead to vast overcapacity and ultimately earnings collapse. Many energy stocks are cheap by any measure, whether relative or absolute.

Comments

[echang]

typo-- saudi arabia produces 9.7 mbd, or will if the 200k increase goes into effect this year.

i have yet to read anything or see anything about the increase or decrease in chinese/or indian gas consumption (i hope to have a better idea by the end of the summer), but i do believe the high crude prices have finally begun to destroy demand in the United States. Perhaps its the economic problems but people are beginning to cringe at the mention of high gas prices. I think four a gallon is the tipping point for the American consumer, especially if 9/10 of them think we are in a recession. Gas consumption dropped 1.8% last month, and I heard it fell 3% this month (have not come across this figure in writing). Chinese, Indian and other growing economies may very well offset declining gas consumption here. But there is the chance that their roaring economies slow down. Perhaps its the Chinese economy that crashes after the Olympics and not the stock market; crash might be too strong of a word.

[Dan Walker]

Curious how everyone with any media access, shilling for any speculator(s), has stepped up the parade of 'facts' about how the run up in oil is not because of speculation. The reason these 'facts' can be tossed about is the way it occurred. ETFs can invest in oil and many do via, ironically, 'derivative contracts' with securities firms. Pension funds have jumped on this band wagon to the tune of Billions of dollars. The problem is they 'buy and hold'. This is supposedly a sound financial tactic for stocks, real estate, etc. In the commodities market, this is called HOARDING. The reason the flim-flam artists can disguise this is that these 'customers' don't take delivery because there is no place to store the oil. The securities firms issuing the derivatives just roll the contracts into the next month (320 million barrels in June).

The next problem is you have Goldman and Morgan (the two who still appear solvent due to their long oil profits) buying oil both to facilitate the trading market and for their own account. They are allowed to ignore the normal position limits because of the 'Enron Loophole' which, when it was 'closed' excluded crude oil.

The solution is fairly straightforward. Pension funds and primary dealers are both regulated as well. Forbid pension funds from buying oil ANYWHERE. While you are at it, throw in insurance companies as well (just in case). If they are genuinely looking for protection against inflation, gold will substitute nicely and no one needs it to get to work. Re-establish the position limits which were eliminated with the Enron loophole. The CFTC now has the emergency powers to do that TOMORROW. If we want to address the problem quickly, release the strategic petroleum reserve at about 40 millions barrels a month, physical delivery on NYMEX. As already mentioned, the storage facilities are full (a dead giveaway of a phony shortage and rampant speculation). Since the storage facilities are full, when tanker trucks start backing up on Broad Street in front of Goldman HQ, the NYPD will take care of oil prices by hauling all the traders off to jail for blocking traffic . (Again, I am being facetious, but not by much). If all the President's buddies weren't in the oil business, he could have the Fed short oil futures before this happened and pay down the national debt significantly by the time oil hit $30. THAT would bring the dollar roaring back and in large part solve the crisis which is about to unfold (but that is for another rant).

[mangolfer]

When the Saudi's, Oil companies and even a speculator say it, I believe it. It's all speculation. I agree with Dan Walker, make them take delivery. Senate testamony from a speculator says it's speculators. Go to and read for yourselves:

hsgac.senate.gov/publi...

[lakeside]

Every time Congress gets involved, it's another debacle (think ethanol; think no drilling for 30 years -- Congress can override President's action; think no nuclear for 30 years. And increased regulation of investing: the investors ("speculators&quo... whoever they are) will move to London and Dubai. If you want to see your portfolio take a huge fall -- greater than what it already has -- make your manager sell all oil-related holdings per Congressional mandate. If you think the free-fall in your portfolio has been bad so far, wait until your fund has to sell its oil-related holdings. Oh, did I already say that?

[Eric Fox]

"Meanwhile, more than 73 million new cars hit the road last year."

The relevant stat is not how many new cars hit the road, but how many net cars hit the road - how many were junked last year."

The second stat you should be looking at is what is the average MPG of those 73 million new cars -compared to previous years and where will that average MPG be going the next few years.

[Eric Fox]

"Economics clearly supports the notion that in a functioning market economy, increases in revenue are likely to lead to investment in the industry, expansion of supply, and ultimately moderating prices for consumers in the longer term. If this self-correcting process is not working, as seems to be the case with oil lately..."

You are correct, this is the way it has worked since the dawn of recorded history. It is not working now because investors are bidding the price up above its true worth - A growing speculative bubble.

[Eric Fox]

"Speculators are not the driving force behind rising demand for oil in the emerging economies..."

No one said that speculators are behind demand for oil, they are behind the demand for financial products linked to oil. Speculators don't take delivery of the physical product as you know.

[john s. gordon]

dan w. - right on.
> jack

[Eric Fox]

"U.S. energy secretary Bodman last week said “There is no evidence that we can find that speculators are driving futures prices” for oil."

He is right, there is no evidence, but of course that doesn't mean it is not happening. There was no evidence that financial players were manipulating Erie Canal bonds in the 1840's, or railroad bonds in the 1880's, or any number of other manipulated markets that are too numerous for me to mention. After the fact, it all became clear.

[Eric Fox]

"(true - the Saudis pledged to add 200K barrels a day to the market, but let’s face it - that’s just a drop in the bucket in the context of global consumption)"

The Saudis pledged to add 500k BD, which by the way, would cover all of China's growth estimate from 2007 to 2008.

[john s. gordon]

eric f. - daniel drew is alive & well in the commodity pits.
? jack

[Commodity bubble proponent]

Hey genius...your article is statistically inaccurate:

www.eia.doe.gov/emeu/s...

Figure 3a: International Supply and Consumption.

Bodman needs to go read the statistcal informtion produced by his own agency.

Supply is up about 2% year over year from last year. So before you go publishing your bs about how oil production is flat and no new supplies are coming,go get educated smart guy.

[iThinkBig]

Dan Walker - You hit the nail on the head. But don't expect the CFTC to get off there ass before elections. The Senior Directors are in on this game. Why doesn't Congress add one to two lines of verbage to close the Enron Loophole now? I could go on an on at how simple this is to fix, but it is arrogance, privalege and selfishness that must go. And for it to go, pain must be administered to those in charge. That hasn't occured yet but it will and the nation will self-correct (here's to hoping we don't become the Nazis' part 2 in the process).