Offshore Drilling Isn't the Answer - Supply and Demand Is

In my last post I made clear that due to increased demand and a lack of excess capacity, I expect oil prices (and commodity prices in general) to stay high. That being said, I think there’s a strong chance that we could see a pullback in the short term. Such an easing will not come from political rhetoric. Instead, prices will ameliorate when the symbiotic relationship between supply and demand turns favorable. Such a trend is beginning to take place.

Politicians are touting numerous so-called “solutions” to help ease the pain. Mr. McCain, for example, wishes to suspend the tax on petrol and open up the artice wildlife refuge for drilling. These ideas may seem appealing, at least on an artificial level, but after delving into these “solutions” it’s clear that, if implemented, there will be little to no positive short-run effect on energy prices. The development of deep-sea drilling rigs, after all, takes nearly 10 years before oil can be extracted. And placating the burden of high petrol via a tax reduction is counter-productive -- a lower price will just lead to increased consumption. These are not “solutions;” the free-market mechanism of demand destruction is.

$138 oil and $4.00 petrol is clearly starting to temper demand, just as economics textbooks say it should. On a side note, it’s interesting to point out that $4.00 per gallon is relatively inexpensive in the world economy. Nonetheless, Liz Ann Sonders, Chief Investment Strategist at Charles Schwab & Co, highlights that the world expenditure on oil (as a percentage of GDP) is at an all-time high (see chart). Small wonder that last month’s decline in miles driven is the largest on record.

click to enlarge

Fortunately, demand is now falling in developed economies and slowing in emerging-markets. China’s growth, for example, is slowing considerably, acting as a headwind, thereby helping reduce demand.

Another favorable trend is the relinquishment of gas subsidies. Although gas is heavily subsidized in many countries, we’re starting to see reductions in some countries and eliminations in others. To date, Indonesia, Taiwan, Malaysia, Sri Lanka, and Bangladesh have either raised prices or pledged they will. And in a surprise announcement last week, China said that it would raise fuel prices by as much as 18%. This is comforting news, as China has long been reluctant to surrender fuel subsidies.

Even speculators are now betting on a fall in gasoline prices (see chart).

If this reduction in demand continues (and is supported by a stronger dollar), a 20 point move to the downside over the next six months is quite possible. Time will tell. As always, I put my money where my mouth is -- I'm short at $138.

Disclosure: Short USO

Comments

[nakedjaybird:]

Alternatives may be our Nation's BEST DEFENSE!!

2008 Jul 17 05:04 PM

[nakedjaybird:]

Right, Felix - I'm going to go mow the lawn while it's green and growing.

2008 Jul 17 05:05 PM

[FDA:]

Go do that, its better than delaying the unevitable.

2008 Jul 17 05:21 PM

[mouth:]

We need to do something now. All of our money is leaving us for imported oil. According to Global Insight, sovereign-wealth funds like Mumtalakat, the Abu Dhabi Investment Authority and the Qatar Investment Authority hold assets worth $3.5 trillion and will overtake the U.S. economy in size by 2015. Bahrain's fund is smaller, but it is also much younger than neighbor ADIA, which is estimated to hold assets worth about $900 billion and has been around since 1976 Time is running out.

2008 Jul 17 06:07 PM

[Jason Rines...:]

I can't figure out who is more naive or outright stupid, the author Dave or nakedJayBird.

2008 Jul 17 07:29 PM

[nakedjaybird:]

Ithinkbig - we'll get our answers in the future to the quandry you have and also those questions the rest of us have. U cn cont on it.

2008 Jul 17 10:00 PM

[Macro Monitor:]

First of all, thank you all for your comments -- I enjoyed reading them. Since it would be difficult to reply to each of your individual responses, I’ll attempt to conjure a “one fits all” response.

It seems that most criticism comes from my comment that, ‘opening up the artic wildlife refuge will do little to ameliorate prices.’ My reasoning stems from the fact that there are already 68 million acres currently leased offshore that contain an estimated ~70% of our oil reserves. I am not opposed to deep sea drilling in the least; in fact, the future anticipation of increased oil production can influence prices today. So, from a short-run perspective, the answer is not to open the Artic Wildlife Refuge, but to engage in contracts in the 68 million acres already leased.

From initial conception through project completion, offshore drilling rigs take years before becoming operational. An offshore jackup rig, for example, will take approximately 3-4 years before becoming operational. Construct a semi-rig, and you’re in the ball-park of 5 years. But these numbers only include construction times -- there are many other necessary steps (feasibility studies, environmental regulations, etc) that add significant time to these estimates. More information can be found here: www.eia.doe.gov/oiaf/a.... How will this help reduce demand or increase supply in the short run?

In the end, oil prices will ease when demand subsides. Eventually, as ‘Mathman Prophecy’ posted, people will spur demand destruction. This is best accompanied by maximized oil production, and significant investment in alternative energies. The profit motive will accomplish this.


PS – I strongly disagree that speculation plays a key role in the price of oil. I commented on this here: davews.blogspot.com/20....

PPS – Correction (per Investor612): President Bush, not McCain wants to open the ANWR to drilling.

2008 Jul 18 11:24 AM

[Old Wizard:]

The timelines you site,Dave are not what most oildrillers, not oil companies, believe. While there are these number of acres under lease, Places off-shore where large oil deposits have already been verified should be tapped first. Locations off Florida which hitherto have been off-limits, and where China is going to drill, are a case in point. As far as restriction and environmental concerns, it is interesting that we say we shoulld put alternative energy supply on a crash program, ignoring what has happened when large windmill farms have been proposed or even built only to encounter all kinds of obstacles in installing power lines for delivery to the end user. The obstacles often are generated by the same people who maintain that fossil fuels are creating global warming and ruining the environment. Look at the Cape Wind project for a text book example. Further, the texas decision to make a big commitment to wind is a good instruction mechanism. The cost of putting the power lines up was equal to or greater than the cost of the windmill farm. Massive Solar energy farms have not even started to deal with the means of getting the energy to the end user. I am a believer in getting off the foreign energy dependence situation as soon as possible for the good of all the people and think the either/or approach stands in the way of what is best for the USA.

2008 Jul 18 01:01 PM

[Confident28:]

Off-Shore, ANWAR - who cares, they're not cures their diversions from the real problem. The US consumes 20-22 million barrels a day. We currently pump about 1.2 million barrels a day from off-shore oil and 1.4 Million from Alaska. If we even doubled that production without increasing demand you're talking 10% increase?! $.40 at the pump. Not even. The US is in terminal decline so any increase is at best going to keep US production flat. If we're luck we'll still be at $4. a gallon in 10 years. So go ahead and spend billions drilling in ANWAR and off-shore. We'll just be having this same conversation in 10 years (or sooner would be my guess) and have wasted resources chasing a declining commodity.

2008 Jul 18 02:12 PM

[nakedjaybird:]

Theoldwizard- here's some wind for you:

www.pse.com/SiteCollec...

2008 Jul 18 07:35 PM

[nakedjaybird:]

And here's additional wind to existing facilities: successful.

Siemens To Power Washington State with 130 Wind Turbines Apr 1, 2008 ... Siemens To Power Washington State with 130 Wind Turbines. ... wind farm and 58 for the Windy Flats wind farm near Goldendale, Washington. ...

azom.com/News.asp?News... - 40k - Cached - Similar pages

2008 Jul 18 07:44 PM

[nakedjaybird:]

Obviously, what sickens me is that too few folks address the fact that of all the consumed crude we both import AND produce which is then burned in TRANSPORTATION (85% of the ~20+ mbbl/day or the ~40 Quads/yr), only 7 Quads is actually converted to useful energy, while 80% of the energy is wasted in exhaust stacks, cooling water, tail pipes, etc.

Whereas, if crude-based TRANSPORTAION were electrifed, requiring even fewer than those 7 Quads of useful enengy for the same work, and those < 7 Quads were supplied from "forever available on the surface" solar, wind, tidal, etc., at current conversion efficiencies which are pure gain, we would need only to add to the 12 Quads of electricity we already generate, transmit and distribute from source to end user.

We know how to electrify and find wind, sand and water to do solar, wind and tidal, etc.

We should strive much more to put solar and wind into place than to ever explore and drill or mine coal, oil, or gas, etc.; it would be simpler and easier, including the electrification of TRANSPORTATION, starting with the diesel-electric rails, and the others to be built, etc.......

2008 Jul 18 08:44 PM

[Old Wizard:]

Cofident28, Even if your conclusion is correct, which is doubtful, I think that 10 years might be enough to bring substantial alternate energy into practical operation. Just taking your numbers and tranlating 2.5 million barrels of oil /day at $130/barrel to balance of trade reduction we get over 115billion/yr. If we multiply by 10 years, the number exceeds 1.1 trillion. Now let's address your numbers. The estimates for off-shore oil near california,alone is 3 billion barrels. At a rate of usage from mid-east and Venezuela @ 5 millions barrels/day, we could go almost two years without importing any oil from those places. What would that do to the price of oil? It would certainly be a boon to the balance of payments. I believe that your numbers are way too low,since you have not taken into account the oil shale deposits that could provide up to 60 tears worth of oil at 5.5 million barrels/day. Iwouldn't choose Anwar as even close to my first source of more domestic oil. Far less investment would be needed at the sites above. I'd like to understand what the total investment against a realistic timeline it would take to replace the energy of half ot barrels of oil we use today. If we look at Obama's plan, he wants to devote 30billion a year for ten years without stipulating what will be the reduction in our need for imported oil. Further, as I've said before, we need not have an either or solution but one which as quickly as possible fixes our gigantic negative cash flow problem and supplants fossil fuel. Oil from known sources is the best near term solution.while the alternatives are being introduced because no short term alternate can make the required impact needed to address the urgency of our economic and strategic problems.

2008 Jul 18 09:07 PM

[Macro Monitor:]

The Old Wizard - Shale is one of the most expensive means of obtaining oil. You're looking at well above $60 per barrel, just for extraction. Huge investment isn't going to happen because companies are too conservative (rightfully so) about the future price of oil. That's the brute reality of the geology and the economics.

2008 Jul 18 11:19 PM

[nakedjaybird:]

I hear you old wizard - yes, let's contine producing from what we already have in place and import all we can, while drill no new and we like crazy reduce the crude consumption via every possible method with as much emphasis as possible. Every reduction in consumption can come off our own production first (like it has for 30 years) if we want to keep our resources in the ground for the future for many reasons, and then apply our reductions in crude to imports (unless gasoline goes to $10/gas and the balance of trade becomes an even higher priority, which some say it is at $5, but I won't believe it until we start reducing crude consumtption seriously).

We must address our consumption with more than mileage targets, clean air reasons, etc, and Al Gore tribe global warming noise. Deliberate conversion from crude to many free "somethings else" in parallel, like a house afire. Again, we are a very resourceful people under wise leadership.

Hey, according to this mornings paper even Al Gore agrees with 1/2 of my argument (no hydrocarbons for POWER GENERATION; now if we can convince folks of no hydrocarbons for TRANSPORTATION). So, now we're getting somewhere; well the Democrats are. Goodness! If the drill, drill, drill Republicans are not careful this election will go to the Dems. And they (the Republicans deserve it -and I am one; well, have been one!).

2008 Jul 19 12:47 PM

[Old Wizard:]

I can't say which party will have the political will to solve our energy problem, because a real solution will be in conflict with at least one pressure group or minority constituency. Importing other people's oil and leaving ours in the ground , while we develop alternatives over ten years has the very negative effect of increasing our negative trade balance and imperiling the sovereignty of our country. That's why we must have a comprehesive plan with a heightened sense of urgency that involves more domestic oil, focused alternative energy plans where special interest obstacles are removed and conservation. Wind is probably the most viable near alternative, massive solar farms are much behind and regulatory and safety issues hamper new nuclear to come on line in less than 7years. Wind is interesting because many viable projects have been stymied for 5 years for reasons like hampering the view, restricting leisure boating, power line rt. away, local opposition, etc. For all who are interested I refer them to the Cape Wind project history at Cape Cod and the windmill farm in central New York. Last I looked the electric power generation plant on Cape Cod is oil-fired and uses 1m barrels of oil/yr. The cape wind proposed windmill farm would supply 80% of the Cape's electric power needs and has been opposed by powerful Democrats and environmental groups. The proponents have already spent over 50m in environmental studies, plans and legal fees dealing for the most part with opposing forces who have spent over 30m over the last 5years. The vast majority of the citizens are for the pproject. Oh by the way, even if it would cost 60/barrel to get oil from the shale deposits it would 1] put a ceiling on high oil prices would go,2] we would not have to import that much more oil and thereby reduce our balance of payments and 3] signal to the oil exporters that when push comes to shove that we intend to stop selling the assets of this country to a cartel who can control the price of oil while they buy us.Meanwhile we as an electorate must realize the economic threat to our way of life and stop allowing minority pressure groups and special interests to impose sub-optimum solutions. Obama may be the next president, but if we don't force a well thought-out comprehensive plan on the table before any candidate gets our vote, we deserve the result. When we went to the moon we set up Nasa to focus on that goal and spent more than even Obama has promised in today's dollars,where Gov. made initial investments in technology that industry would or could not fund on a cost-risk reward calculation. The products developed in that process were commercialized by private industry after much of the R&D was finished. To get the comprehensive solution something similar must be done. Wind generated energy is not yet competitive unless the generators are paid at retail, not wholesale prices. This might be ok for the consumer, if the distribution means exist or he gets it at no additional cost. If not, someone will have to pay the freight.

2008 Jul 19 03:31 PM

[nakedjaybird:]

We have all been paying the freight for import, import, import and will also pay for drill, drill, drill, regardless; it just got a little more expensive recently. So we might as well pay for solar and wind now for a little while and then no more, which is not true for drill, drill, drill or import, import, import.

Where were they and/or what happened to all the objectors to oil rigs during the last 100 years (while farmers throughout the Nation huggged and blessed their windmills)?

2008 Jul 19 07:54 PM

[Old Wizard:]

Probably true that the consumer wii pay in the end, no matter what. It has been the American way. My point is I want to keep my country American. Further the great productivity our farmers have managed to achieve came with fossil fueled tractors, sowers and reapers and the electrification of the country using mostly coal. China and India are just in the beginning of the same cycle. Why aren't they going directly to alternate energy generation if it requires the same time and investment?
Nakedjaybird since you don't quantify anything,equating the alternatives as to time to achieve a given amount of energy or the relative costs, is simply an assertion of the either /or persuasion and not the comprehensive plan that solves our most pressing economic problem.

2008 Jul 19 09:09 PM

[nakedjaybird:]

China and India have been hoodwinked to a degree. Any energy used for the past 60 years was patterned after many foreigners producing whatever in their country (chinese hydro) or their neighbors (the US has been consulting in India, etc., long before the 60's in chemicals, etc., plus many were educated and trained in the US, learning our ways). China recently announced they are not going to build 30 planned coal fired plants; they have made a commitment to solar, ...

Solar, wind, tidal have not been the first choice; China and many developoing countries has learned what pollution does and that there are now alternatives. They will switch just as Europe, Brazil, Switzerland, Germany, Spain, Holland when "foothold" power defeated - just as what the US is fighting right now in big oil, coal, etc. Alternatives have a difficult row to hoe. Just as defeating unions required elimination of mfg, outsourcing, etc. The energy transition will be slow but sure here and worldwide. Guess we just get to watch, should we live that long.

Do you think hydro would have ever made it in the US if it was strickly based on private business push and cost/benefit analysis?

2008 Jul 20 02:42 PM

[Old Wizard:]

I can't process so much conflicting info. First we say the price of oil and coal is rising so quickly because of large increases in demand from developing countries headed by China and India, then China is planning to drill for oil off the coast of Cuba, 50 mi off our Florida coast then we say that China is quickly going to wind and solar.Citing Holland as an example of wind power is a little disengenious. They are one of the original users, long before oil was the prime driver. By the way they have long ago switched to the large turbine blade windmills, something that Cape cod hasn't been able to do, primarily because of politics and environmentalist special interest opposition

2008 Jul 22 05:24 PM