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Countdown to 100$ oil (3) - industry is beginning to suffer

by Jerome a Paris
Mon Jun 27th, 2005 at 05:32:50 AM EST

with oil prices now hovering above 60$, some industrial sectors are beginning to squirm seriously:

Energy prices appear to have reached a tipping point for many industrial users, as inflation outstrips companies' capacity to absorb higher costs by increasing the prices they charge consumers.

More below the fold. (See also Rimjob's earlier diary - Oil Prices Break $60 Mark In Morning Trading )

Previous "countdown" posts:

Countdown to 100$ oil (2) - the views of the elites on peak oil

Countdown to 100$ oil (1)

Financial Times

FedEx, for example, the US <u>delivery group</u> that has been a leading beneficiary of booming global trade, broke its winning streak by warning that this quarter's earnings would be hit by jet fuel costs despite an automatic surcharge for customers.

And the <u>metals industry</u>, which had been enjoying its best growth for years, is now squeezed between the high cost of energy-related inputs such as electricity and coal and slowing demand from leading customers.

Corus, the Anglo-Dutch steel producer, last week warned it may have to shut its aluminium plant in Voerde, Germany, because of high electricity costs. Alcoa, the world's largest aluminum maker, warned of 6,500 jobs cuts and plant closures in Germany and the US because of a drop in its prices and higher energy costs.

Energy prices have hit German business on two fronts by weighing on the already feeble domestic demand while eating away at companies' margins, especially in the large industrial sector.

The affected sectors are not very surprising: transport and metal bashers are big energy users. But as they are vital sectors for the rest of the economy, it is unlikely that the pain will not be passed on pretty quickly to others.

Very heavy energy users like aluminium producers (which actually use electricity rather than oil) can decide to arbitrage their production: when they have access to cheaper energy under long term contracts, they can decide to stop producing aluminium because they make more money re-selling that energy on the open market instead of using it. This reduces demand and acts as a brale on energy price rises - or it triggers price rises on the aluminium market... Using electricity, they also often have the possibility to arbitrage between different fuels: fuel oil if they use it, natural gas, coal, or via the wholesale electricity market.

But the transportation sector has no alternative to oil. Despite the ferocious competition in that sector, the regularly increasing price of its most fundamental input can only lead to increased prices for transport, which translates into inflation for consumers and into increased costs for all industries that move things around, which is pretty much everybody.

As the stories above note, the stock market is beginning to notice:

Growing fears that high energy prices will eat into corporate earnings as companies prepare to report second-quarter results, have left global equities struggling in recent days.

US crude for August delivery surged to a new record of $60.50 a barrel, triggering losses in markets across Asian countries, most of which rely heavily on oil imports. Exporters and energy-intensive companies such as airlines were among the hardest hit.

(...)

"The surge in oil prices is different to last year's," said Leo Doyle, strategist at Dresdner Kleinwort Wasserstein. "It is now expected to last. Eventually the effect on growth will unwind but we now estimate that the 0.6 per cent drag on eurozone GDP growth this year will not improve much for 2006."

Asian currencies also weakened on higher dollar demand for oil imports. Japanese yen, Korean won and Taiwanese dollar all fell against the US dollar.

(...)

Energy prices have hit German business on two fronts by weighing on the already feeble domestic demand while eating away at companies' margins, especially in the large industrial sector.

Increasing oil prices are temporarily creating additional demand for dollars, thus strenghtening the currency in the short term, but as they are likely to make the US trade deficit increase even more (10$ more on the barrel for a full year increase the deficit by close to 45 billion dollars; at current prices, the annual oil import bill is about 250 billion dollars), this is unlikely to last.

The oil price increase is creating several dangers for the US economy:

by biting into corporate profits, it kills the only metric that has made the US economy look good in recent years, and increases the chances of a stock market decline;
by increasing the costs for consumers, it bites into demand for other goods, thus threatening economic growth altogether, debt bubble or no debt bubble;
they also threaten to re-ignite inflation, thus making interest rate increases (whether by the Fed for short term rates or by the markets for long temr rates) more likely, and threatening the whole debt-supported US economy;
by sending record amounts of dollars to oil producers, it increases the volume of dollar reserves that are held by countries that have an interest in maintaining the value of the dollar (the Asian consumer goods exporters). Oil producers don't care about the dollar as much, as their exports are not dependent on any exchange rate, and their spending is mostly done in euros. Russia or Iran have little incentive to hold on to their dollars...

Oh well, still 40$ to go...

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Countdown to 100$ oil (3) - industry is beginning to suffer | 17 comments (17 topical, 0 editorial, 0 hidden)

Re: Countdown to 100$ oil (3) (4.00 / 6)

test

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Jun 27th, 2005 at 08:28:32 AM EST

Yes, the comments are working but (none / 0)

I noticed that not many people have been on the internet for the past couple of days.

I usually get tons of email everyday and I have only rec'd about 6 in the last two days. Strange. Perhaps its the hot weather.

by Hausfrau on Mon Jun 27th, 2005 at 08:42:03 AM EST
[ Parent ]

Re: What's going on here? (none / 0)

Iraq: The carve-up begins

As the costs of the Iraq occupation spiral, British and American oil companies meet in secret next week to carve up the country's oil reserves for themselves. Tom Burgis reports
In the driving seat: with so much clear profit at stake, the question of who owns Iraq's biggest natural resource is hotly contended / GettyThe Iraq war has so far cost America and Britain £105billion. But the financial clawback is gathering pace as British and American oil giants work out how to get their hands on the estimated £3trillion worth of oil.
Executives from BP, Shell, Exxon Mobil and Halliburton, Dick Cheney's old firm, are expected to congregate at the Paddington Hilton for a two-day chinwag with top-level officials from Iraq's oil ministry. The gathering, sponsored by the British Government, is being described as the "premier event" for those with designs on Iraqi oil, and will go ahead despite opposition from Iraqi oil workers, who fear their livelihoods are being flogged to foreigners. The Met will be on hand to secure the venue ahead of the conference.
"This is a networking opportunity for UK businesses involved in Iraqi oil," explained Dr Hussain Rabia, managing director of the consultancy Entrac Petroleum Ltd. "We have the moral support of the UK government. They're bringing the guys over from Iraq, offering them visas. We expect all the big oil companies to be there," he said.

by Fran (fran at eurotrib dot com) on Mon Jun 27th, 2005 at 10:03:36 PM EST
[ Parent ]

Re: What's going on here? (none / 0)

It's just a conference. Of course the oil companies keep an eye on what's happening on Iraq, and conferences like this are the easiest and cheapest way to do it and meet whatever officials are in charge.

That does not mean that there will be a "carve out".
There will be NO investments in Iraq as long as the Americans are there, becasue there will be no security to invest, it's as simple as that.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Jun 28th, 2005 at 01:36:39 AM EST
[ Parent ]

Please explain - (none / 0)

Why is the price of oil growing so rapidly and why do you think it will reach $100 per barrel?

I am not familiar with the oil industry. I know I should be.

Is the price high right now because of the instablility in the middle east OR is it that many wells are going dry?

On personal note, my brother lives in the states and runs a truck brokerage firm. The high price in gasoline has had a terrible impact on his business. The trucking companies have to raise their prices because of the high gas prices and my brother has to lower his profit margin so that customers will continue to use his company to ship products. I am sure that his customers have to raise their prices in order to pay for the higher transportation costs. And it goes on and on and on.

You are exactly spot on how the transportation industry has no other alternatives.

by Hausfrau on Mon Jun 27th, 2005 at 08:40:15 AM EST

Germany in the forefront of the problem... (4.00 / 2)

I waffle about the aluminum industry. Obviously aluminum is important, but it's also used in many inappropriate places, such as window frames. It should be saved for the places where it's most appropriate, like car bodies.

So on one hand the increasing price of energy will move the use of products and materials in the "right" direction, but on the other hand there will be considerable dislocation across the economy.

The Economist article about the energy situation in Germany is interesting. (Requires registration.)
http://www.economist.com/business/displayStory.cfm?story_id=4113477

Basically, the regulatory environment in Germany makes power both expensive and difficult to source from other countries. Nuclear power is not currently an option, and despite massive wind power generation it's not nearly enough to support heavy industry.

Really it's just another example of how the world does not have a sensible energy plan in place.

by asdf on Mon Jun 27th, 2005 at 09:05:46 AM EST

Re: Germany in the forefront of the problem... (none / 1)

Here is part of the article:

The problem, all agree, is rocketing energy prices, more marked in Germany than in the rest of Europe and beyond. Higher oil prices have been abetted by under-capacity, tough green laws on renewable energy, the phase-out of nuclear power and a transmission grid unable to cope with the biggest collection of wind farms in the world. All this is combined with imperfect price competition: the market is dominated by four major producers, two of which also control a large part of the grid. Setting up a European Energy Exchange (EEX) in Leipzig was a nice idea, but producers have an information advantage and liquidity is scarce.

And your right about the windpower.

That leaves Germany facing a long-term capacity shortage that will not be solved by renewable energy. Dena, a government-sponsored energy think-tank, calculates that wind-power will replace only 6%of Germany's conventional energy needs. Meanwhile, power companies such as Vattenfall Europe are working on developing cleaner thermal plants.

by Hausfrau on Mon Jun 27th, 2005 at 09:33:21 AM EST
[ Parent ]

Re: Germany in the forefront of the problem... (none / 0)

I am far more optimistic than you on this one. While the current level of renewable energy generation is still modest it is rapidly increasing in use (annual growth rates are like 30% in EU as whole while power generation needs increase 1.6-1.9% a year).

Renewables are now respectable power source and their use is steadily coming more and more common. Give it a decade or two and then we'll see entirely different picture from now (making the EU's energy outlooks look outmoded).

by Nikita on Mon Jun 27th, 2005 at 10:14:33 PM EST
[ Parent ]

Looking at Malaysian Palm Oil Today (none / 1)

First, it is traded at Bursa Malaysia, and daily prices are on their website listed in the form of Excel spreadsheets. Crude palm oil (FCPO) for July delivery closed at 1441 Malaysian ringgit per tonne. Converting ringgits to dollars and tonnes to barrels leaves us with a price of about $51.71 per barrel.

Last time I did the math, it was $47 per barrel when crude petroleum was around $52 per barrel.

Ethanol for July delivery is $1.41 per gallon on the CBX right now, being around $1.34 at one point last week.

Biofuels are somewhat following the price of crude, though it seems palm oil is a bit out of the loop as far as immediate price rises and falls.

According to this interview with Dato' Lee Oi Hian, Chairman of the Malaysian Palm Oil Promotion Council, Malaysia expects to produce (an equivalent of) 104 million barrels of palm oil this year. The world consumes 82+ million barrels of petroleum oil per DAY. Malaysia is the world's largest producer of palm oil.

by capslock on Mon Jun 27th, 2005 at 10:12:43 AM EST

Re: Looking at Malaysian Palm Oil Today (none / 0)

Is palm oil used as a fuel? I have only seen it as an ingredient in processed foods.

by corncam on Mon Jun 27th, 2005 at 11:34:23 AM EST
[ Parent ]

Re: Looking at Malaysian Palm Oil Today (none / 0)

Any vegetable oil or animal fat can be used to make biodiesel.

by capslock on Mon Jun 27th, 2005 at 12:20:50 PM EST
[ Parent ]

Re: Looking at Malaysian Palm Oil Today (none / 0)

Someone I know has tampered? with his car and uses know used cooking oil (mostly for frying), which he collects from restaurants. Seems a good idea to me, though I have no idea if this could be used in a larger scale.

by Fran (fran at eurotrib dot com) on Mon Jun 27th, 2005 at 12:31:03 PM EST
[ Parent ]

Re: Looking at Malaysian Palm Oil Today (none / 0)

theoretically yes.

Our energy coop's renewables study included an oil palm plantation to supply our diesel engines. Came out pretty expensive though.

by HiD on Mon Jun 27th, 2005 at 01:34:11 PM EST
[ Parent ]

CERA Report (none / 0)

In the last Countdown diary, Jerome mentioned that Cambridge Energy Research Assoc. (CERA) had released a report showing that a glut of oil would arrive between 2006 and 2010. We tried to figure out how they got their numbers, but we couldn't really get very far since their summary didn't have many details.

However, Robert Esser and Peter Jackson, the authors of the study, gave an interview to the Oil and Gas Journal with more details about their report. As we expected, some of their assumptions are very optimistic; for example, they are predicting increases of 1 million barrels per day in both Iraq and Iran, in addition to big increases in Nigeria and Saudi Arabia. For the non-OPEC producers:

The non-OPEC areas with the best prospects for increased production, said CERA, are the Caspian region, up 2.5 million b/d; Russia, slowing to 1.15 million b/d of growth through 2010 from 1.97 million b/d in 2002-05; Brazil, 1.16 million b/d; Angola, 1.35 million b/d; and Canada, 1.32 million b/d. Production declines are expected in Norway, down 330,000 b/d; the UK, 360,000 b/d; Mexico, 200,000 b/d; and the US, 470,000 b/d. CERA expects production in the Far East to be "relatively flat to increasing a little bit."

Meanwhile, the article reports that energy industry insiders seem to be of two minds about future oil prices.

... at a June North American energy and power conference in Boston sponsored by RBC Capital Markets, ... two thirds of the energy executives and institutional investors surveyed said they expect oil prices to fall back to $35/bbl in 5 years, while the rest said it could hit $100/bbl in the same timeframe.

There was also some discussion of how they think that improved technology will allow producers to increase their reserves, but I didn't find it very convincing.

by corncam on Mon Jun 27th, 2005 at 11:55:20 AM EST

Re: CERA Report (none / 0)

Thanks for that info.

What do they mean about Russia?? That it will grow by 2mb/d in 2005, and then by 1 mb/d per year until 2010?? That would mean a production level of 16 mb/d in 2010. Or that it will grow by 1 mb/d by 2010, having grown by 2 mb/d in the past 3 years (I thought it was slightly more than that)? In that case, that's just 1 mb/d more to 10 mb/d.

I also don't see an additional 2.5 mb/d from the Caspian. ACG will add 800,000 b/d in the best case, Karachaganak 200,000, Tengiz say 400,000, and Kashagan - well they'll be lucky if they have 400,000 b/d by then. The rest is too small to make up the rest.

And a decline of 500,000 b/d for the US. How realistic is that?

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Jun 27th, 2005 at 12:28:31 PM EST
[ Parent ]

China is building a strategic oil reserve (none / 0)

This article on Yahoo News reports that China is building a strategic crude oil reserve. Over the next five years its capacity is expected to rise to 101 million barrels. Just filling that up will consume 100,000 barrels per day (that's equal to the production from a mid-sized oil field) every day for nearly three years.

by corncam on Mon Jun 27th, 2005 at 12:01:16 PM EST

Re: China is building a strategic oil reserve (none / 0)

This is as good a place as any to put this quote:

Energy insecurity may spark last scramble for oil

Is China's bid for an American oil mini-major just a reasonable business deal or a serious outbreak of energy insecurity in the country set to become the world's largest economy? In other words, has the final scramble for oil actually started?

(...)

One thing is certain: the bid highlights the common desire of the US and China to achieve energy security. As present and future superpowers, they are reluctant to accept import dependence for so vital a commodity as oil.

In fact, Beijing is also trying to cut oil use, and has dispatched its oil companies far afield to find and produce new oil. But China's thirst for oil - helping drive the crude price over $60 a barrel - is such that it is now also trying to buy reserves on the stock market, as so many western majors have done in recent years. India shows signs of following the same energy security strategy. Both the new Asian giants stand in contrast to Japan.

(...)

n theory, it ought to be irrelevant which or how many sources of oil a country has, because all such sources effectively feed one big pool, the world market, from which everyone buys. In practice, and certainly in war, things are different. Big powers, such as Britain and the US in the last century, felt they needed their own oil to fuel their navies; the UK government once owned BP for this purpose and the US still has its Naval Petroleum Reserve in Alaska. Nowadays the connection is often reversed. The US feels it needs its navy to protect oil supplies and routes.

(...)

In general, owning foreign oil reserves does not increase energy security. Were CNOOC to win Unocal, it could not insist on shipping Unocal's US oil off to China; US law would prevent this. But there are two other possible ways of enhancing energy security. One is through long-term supply contracts, which existed in the energy-anxious 1970s and before the development of the oil futures markets. Opec producers now prefer to play the spot market for the highest price. But it is possible to imagine oil importers of the weight of China and India striking deals where smaller oil consumers could not. The second option is to build up an oil stockpile. China is doing this and India is talking about it.

(...)

In the end, the best energy security money can buy is: money. Oil will go to the highest bidder. When Ali Naimi, oil minister of Saudi Arabia, which holds the world's largest reserves, last year predicted that his country would be the one to produce the last barrel of oil on earth, he did not forecast the nationality of the buyer. But, on present trends, it could be Chinese.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Jun 27th, 2005 at 12:33:04 PM EST
[ Parent ]

Countdown to 100$ oil (3) - industry is beginning to suffer | 17 comments (17 topical, 0 editorial, 0 hidden)

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