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Countdown to $100 oil (27) - 'Mission Accomplished' - High oil prices are here to stay

by Jerome a Paris Sat Jul 8th, 2006 at 04:00:33 PM EST

Oil hit $75 per barrel again this week, setting once again new highs.

While not very spectacular - after all, we hit $70 almost a year ago, and $75 a few months back already, recent price increases are part of a pretty consistent upwards trend worth putting in context again.

Before I take off to my much needed holidays, let me chart once more why many anlysts don't see oil prices go down in the foreseeable future - and why I personally believe they'll go up significantly.

And of course, go read ManfromMiddletown's diary on the same topic, with an excellent summary of how the Mexican election might have a major impact on oil prices: Jerome may get his $100 barrel... from Mexico


I like this graph because it shows something simple:

Oil prices have basically increased in a straight line from $25/barrel to $75/barrel since Bush's 'Mission Accomplished' stunt. Until then, you could argue that they had remained in their general flat trend, with a dip after the 98 Asian crisis, and upwards bumps during the dotcom boom or the run up to the Iraqi War. In May 2003, at 25$/barrel, oil prices were not news (other than, possibly, to underline the "accomplished" thingy). Since then, they have gone up relentlessly.

One reason, shown in the graph on the left above (from last year, but the correlation still holds up pretty well today) is the increase in Chinese demand - as well as that, slightly more unexpected, from oil producing countries themselves (the countries with the biggest increases in oil demand in the past 5 years are China, the USA, Saudi Arabia and Iran);

The other, as suggested by the date flagged before, is the geopolitical uncertainty created by the occupation of Iraq (and the accompanying loss of production) and the rumblings of war surrounding Iran. That uncertainy has brought in a lot of speculation, which simply reflects the fact that we do not know what may or will happen in a number of countries, and that any production disruption, whether wilful or accidental, will have an immediate upwards impact on prices in a context of generally tight supplies.

But that context must be remembered. Speculators cannot make money in a predictable and stable market where there is excess supply. As the chief economist of Morgan Stanley Japan, Robert Feldman, wrote a few days ago in the Financial Times (behind sub wall):


An optimistic view of oil falling to $40-$50 a barrel requires six "quick" things to happen: a quick discovery of new oil, quick time to market, quick development of alternative energy sources, quick progress in conservation, a quick solution to the Iran problem and quick reduction in energy demand elasticity around the world. Greater predictability of prices is likely only if there is progress on each of these issues, which is unlikely to occur rapidly.

Beyond the point that $50 oil is now seen as "optimistic", the notable fact is that getting prices down requires several things to happen, only a few of which are likely to happen.

Let's take them in order:

  • discovery of oil. We've been using more oil than we've found in every single one of the past 20 years. Most regions with oil potential have been pretty thoroughly explored, and the discovery of big fields appears increasingly unlikely. There's some hope in ultra-deep offshore, and possibly in the pole regions, but that's speculative - and will come at a price, both economic and environmental. In addition (see table below), a lot of the official reserves from the largest oil producers are of extremely dubious value, not having changed by a single barrel in the past 20 years, despite significanty volumes (for instance, Saudi Arabia has produced something like 30 billion barrels in the past 15 years). Chalk this one a dubious "maybe";

  • time to market. With new discoveries coming from increasingly tough places, and governments grabbing a larger slice of the pie and making things difficult for oil companies, a number of projects are struggling. In recent news, Shell announced a 50% cost increase for its big oil sands project in Canada, a harbinger of things to come in that sector, often touted as the hope of the West for new oil (go read this excellent series at the Oil Drum on oil sands for more technical details). Shell also doubled its cost estimates for its big Sakhalin project and, lest it be said this is just Shell fucking up, these graphs show that this is really an across the board phenomenon, triggered by increasing raw material costs, unexpected difficulties due to the tough environment, and shortages of various supplies like rigs or experienced engineers.

    Both the average cost of production, and the marginal cost (i.e. the cost of the most expensive barrel required to fulfill all demand) have increased brutally in recent years.

    The result is that markets, who until recently always expected oil prices to come back down to $20 or so, no longer believe that prices will ever come down:

  • development of alternative energy sources. This one is actually happening, with wind and solar taking off (wind power has represented more than half of the power production capacities built in recent years in Europe, for instance). But, despite massive interest from the financial world, many people in the industry are not really taking the sector seriously, still seeing it as something marginal and unlikely to ever be noticeable nor competitive.

  • progress in conservation. this is a harder call, as the increase in oil prices seems to have had little impact yet on oil demand growth. Some countries like France and Germany have seen decreasing demand for gas, coming both from improving fuel efficiency (thanks to an ongoing switch to ultra-efficient diesel engines for passenger cars) and from less kilometers being driven, but the same trend is not yet noticeable in the US and is counterbalanced by massive increases in the emerging world.

  • the Iran problem. Well, all that can be said is that war has not happened yet. That risk premium is likely to remain until Bush is stripped of his powers.

  • energy demand elasticity. Actually, demand elasticity needs to go up, not down, i.e. demand needs to react more to price increases than it has so far.

Altogether, we are in a situation where oil demand, driven simultaneously by emerging markets, the USA and oil-rich countries, is going up relentlessly, and is now pretty much equal to available supply, which is itself struggling to increase (see below, form the Oil Drum's plateau series)) as reserves become harder to find, more difficult to exploit for political reasons, and more expensive to produce.

So yes, I'm still bullish on oil prices. The fundamentals say that oil prices will remain high, and the risk of an international crisis threatens to send the prices to much higher levels at any time and thus justify a permanent, but extremely volatile, "speculative premium" in addition to the "normal" high price.

::

Earlier "Countdown Diaries" (links to both ET and DK when the versions are different enough):
Countdown to $100 oil (26) - Time to bet again (eurotrib)
Countdown to $100 oil (26) - Time to bet again (dKos)
Countdown to $100 oil (25) - Iran vows that oil prices will not go down
Countdown to $100 oil (24) - What markets are telling us about future energy prices
Countdown to $100 oil (23) - Running out of natural gas in North America
Countdown to 100$ oil (22) - gas shortages in the UK - 240$/boe
Countdown to 100$ oil (21bis) - long term vs short term worries (dKos)
Countdown to 100$ oil (21) - 8-page extravaganza in the Independent: 'we're doomed'
Countdown to 100$ oil (20) - Meteor Blades is Da Man in 2005
Countdown to 100$ oil (19) - Your bets for 2006 (Eurotrib)
Countdown to 100$ oil (19) - Your bets for 2006 (DailyKos)
Countdown to 100$ oil (18) - OPEC happy with oil above 50$
Countdown to 100$ oil (17) - Does it matter politically? A naked appeal for your support
Countdown to 100$ oil (16) - We'll know on Monday
Countdown to 100$ oil (15) - the impact on your electricity bill
Countdown to 100$ oil (14) - Greenspan acknoweldges peak oil
Countdown to 100$ oil (13) - Katrina strikes / refinery crisis
Countdown to 100$ oil (12) - Al-Qaeda, oil and Asian financial centers
Countdown to 100$ oil (11) - it's Greenspan's fault!
Countdown to 100$ oil (10) - Simmons says 300$ soon - and more
Countdown to 100$ oil (9) - I am taking bets (eurotrib)
Countdown to 100$ oil (9) - I am taking bets (dKos)
Countdown to 100$ oil (8) - just raw data
Countdown to 100$ oil (7) - a smart solution: the bike
Countdown to 100$ oil (6) - and the loser is ... Africa
Countdown to 100$ oil (5) - OPEC inexorably raises floor price
Countdown to 100$ oil (4) - WSJ wingnuts vs China
Countdown to 100$ oil (3) - industry is beginning to suffer
Countdown to 100$ oil (2) - the views of the elites on peak oil
Countdown to 100$ oil (1) (eurotrib)
Countdown to 100$ oil (1) (dKos)

Display:
...the most succinct energy diary yet.

It is getting to the point as a narrative which will be much easier to communicate to a comatose audience.

The thing which is still missing is the reason why Joe Schmoe should reduce his demand, in the context of a global situation of increasing demand.

The narrative should say something along the lines of "But Joe, you're already wasting so fucking much, couldn't you be a bit more careful?"
I don't know what the soundbite should be, but if we can get it, it could change the world.

You can't be me, I'm taken

by Sven Triloqvist on Sat Jul 8th, 2006 at 05:31:40 PM EST
A large percentage of people don't do the right thing without pressure-- peer pressure, govt pressure or price pressure.

I'm sure you saw this study.

http://www.sciencedaily.com/releases/2006/06/060628091247.htm

European tax policy on trans. fuels made sense, but the US voter just doesn't have the maturity to sacrifice now for the future.  Hence enormous deficits and off to the mall.  Friend was whining last night because gas was so high.  He's getting 12 MPG in a V-8 pickup truck that never hauls anything or goes off road road.  Why I asked.  "It's comfortable".....good solid Republican voter.

by HiD on Sat Jul 8th, 2006 at 08:23:03 PM EST
[ Parent ]
I am Joe Schmoe, and even I can see it...  The question is how?  I saw electric underfloor heating for the first time yesterday.  A thin sheet of plastic, temperature control for each room, to cover the flat (60 or so square metres) was £14,000 (including VAT--govt. tax), or, say, 21,000 euros.  There are other costs, but I thought, "Okay, if I had the money, I would invest in a company that produced underfloor electric central heating because...electricity can be produced by windfarms.

The narrative for Joe will simply be: "This costs X, it is better than Y, will give you Z benefits and, really, Y is a load of pants, right?"

The car, for example, is a smoggy, polluting menace that serves a specific purpose: get person A to point B, where point B is not close to mass transit.  Great!  So why do Europeans and why does anyone else drive when that rule doesn't apply?

(My vision at this point is of a thousand swearing teenage boys on hybrid scooters...my ears will curse me, but my lungs will thank me.)

Don't fight forces, use them R. Buckminster Fuller.

by rg (leopold dot lepster at google mail dot com) on Sat Jul 8th, 2006 at 08:59:25 PM EST
[ Parent ]
(cough)

Dividing by TEN, those numbers should be:

£1,400

and

2000 (ish) euros

to lay underfloor heating in a medium-size flat.  You wouldn't get radiators plus associated plumbing for less.

Don't fight forces, use them R. Buckminster Fuller.

by rg (leopold dot lepster at google mail dot com) on Sat Jul 8th, 2006 at 09:41:35 PM EST
[ Parent ]
"Okay, if I had the money, I would invest in a company that produced underfloor electric central heating because...electricity can be produced by windfarms.

And if you had the money, I would strongly recommend against it. Heating by electricity is very wasteful compared to using the electricity to drive a heatpump. For reasons of thermodynamics you get 3 times the heating if you use it to drive a heatpump (like a refrigerator but reversed). Electrical heating was installed in many swedish homes during the hey-day of the nuclear program and is today being replaced by heatpumps or a line to a central heating plant.

A vote for PES is a vote for EPP! A vote for EPP is a vote for PES! Support the coalition, vote EPP-PES in 2009!

by A swedish kind of death on Sat Jul 8th, 2006 at 10:08:23 PM EST
[ Parent ]
I will go and look up "heat pump", thanks for that.

Don't fight forces, use them R. Buckminster Fuller.
by rg (leopold dot lepster at google mail dot com) on Sun Jul 9th, 2006 at 05:35:29 AM EST
[ Parent ]
Given the prices you quote, I thought you were already talking heat pump electric... For plain electric, it's a rip-off. For heat pump, it's the price of the hardware (you'll pay just as much to have the collectors buried under your lawn ... No lawn ? you're, er... probably fucked, sorry, deprived of the most efficient heating system, like most urban dwellers)

Pierre
by Pierre on Mon Jul 10th, 2006 at 06:39:35 AM EST
[ Parent ]
It's all flats where I live, mate.

I looked up "heat pump" on wikipedia, and found this:


Note that when there is a wide temperature differential, i.e. when heating a house on a very cold winter day, it takes more work to move heat indoors, and it is possible that a heat pump's COP would be below 1 in such a case. In other words, when it's extremely cold outside, it's better to just make new heat indoors using a conventional heater, than to try to take it from outdoors using an air-sourced heat pump.

My ignorance on such topics is, well, now stated, but living where it can get cold for more than a couple of months every year, and where we heat a flat with radiators, which have their water heated by gas, which has gone up in price by 25% in a year, I like the concept of underfloor electric heating.

A search on google for "electric underfloor heating" brought up a load of businesses (so my non-investment investment has already been made by others.)  I clicked on a link, found a Q & A, and read this, relating to bathroom underfloor heating:


Question

Isn't it expensive to run ?

Answers

The devimat® tile warming system only uses as much electricity as a standard light bulb per m². The on-off cycling effect of the floor temperature-sensing thermostat can reduce this by as much as 50%.

It seems a huge market (and as gas prices rise, an ever-cheaper heating resource) for people who live in flats, though maybe not an idea for people who live in detached properties.

I don't see the "rip off" aspect.

Don't fight forces, use them R. Buckminster Fuller.

by rg (leopold dot lepster at google mail dot com) on Mon Jul 10th, 2006 at 07:55:36 AM EST
[ Parent ]
(Note I over-stated the prices by a factor of TEN (ouch!)in the orginal post, due to, er, human error on my part.  The correct figures (I added them in an addendum post) are:

Electric underfloor heating mat = approx. £1,400, or approx 2000 euros.

(I quickly check the zeros...yes, they are correct.)

The flat (not mine, one I saw) is between, say 60 - 90 square metres (lots of rooms in funny places, and I'm no good at guessing room sizes), and had no heating system installed (apart from two hundred year old fire places.)

Don't fight forces, use them R. Buckminster Fuller.

by rg (leopold dot lepster at google mail dot com) on Mon Jul 10th, 2006 at 07:59:56 AM EST
[ Parent ]
Actually, you have the problem of COP<1 only with the "cheap" (that is 5000 €) heat pumps fitted on the balcony, and which try to exchange heat with the atmosphere like an air conditionner. They practically stop working at 0°C because of frost on the exchangers.
"Real" heat pumps take the heat from 1.5 m underground, where it's 10°C almost all year long, with burried pipes (that's where you need a lawn and big work $$$). You may need additional fuel heating a few days/weeks per winter if you are in a really cold area where the ground freezes in the winter (like: there is 20" of snow on you lawn for 2 months every winter...)
There is still a variant to fix this problem: the heat well heat pump, with a few 50-100m wells which get the heat from the waterbed, which never freezes in any  place that actually has grid power (Siberia is a special case...). And you actually need less lawn area to conceal those wells, but they're even more expensive to drill (expect 20-30k€ for a mid sized house - you may have a tax rebate on this in some countries).

Pierre
by Pierre on Mon Jul 10th, 2006 at 11:53:24 AM EST
[ Parent ]
That sounds awfully expensive for just the well...

I have just contracted a company for drilling a 650 feet deep well for a 9kW heat pump. The drilling cost is about €5500 or $7200. The heat pump costs about €7500 ($9600). Add installation and the total is about €15000. I already have radiant floor heating and radiators since I've been burning oil until now.

They don't usually drill multiple wells here unless you need more than ~700 feet depth which means 11kW pump and up.

Year average COP should be about 3.5, time to earn back is about 10 years with todays oil price, much less if it hits $100 :)

by jkirkebo (jkk@scm.no) on Mon Jul 10th, 2006 at 06:34:01 PM EST
[ Parent ]
I was thinking of the price for the complete setup (couple of 50-m wells, heat pump, low temperature radiators, possibly solar-hybrid with hot water). Well-collector heat pumps have much higher COPs these days: Viessmann claims up to 6-7 (but that brand is really pricey).

Pierre
by Pierre on Tue Jul 11th, 2006 at 03:27:57 AM EST
[ Parent ]
Peak COP and year average COP is quite different. You'll never get the higher COP when producing hot tap water in the summer. Also a some brands don't include the power consumed by the circulation pumps when calculating COP :(

I've never heard someone reporting a year average COP of more than 4. Still, when already at 3.5 or so, higher COPs mater less and less. The difference in savings from 2 to 3 is huge, from 4 to 5 is miniscule in comparisation.

by jkirkebo (jkk@scm.no) on Tue Jul 11th, 2006 at 04:05:49 AM EST
[ Parent ]
It's true COP doesn't matter on the power savings side, but it helps in that you can heat a bigger space with a pump of a given size (you save upfront cash on the collector, you save room in you basement, you need less of complementary heating, things like that... and also, I like the best technology, better have it in heat pumps than in sport cars !)

Pierre
by Pierre on Tue Jul 11th, 2006 at 04:21:24 AM EST
[ Parent ]
BTW, why do two 50m wells ? A single 100m is far cheaper and just as efficient. Only when one requires more well depth than the max collector length (usually 400m/1312 feet) can support it makes sense IMHO.
by jkirkebo (jkk@scm.no) on Tue Jul 11th, 2006 at 04:09:01 AM EST
[ Parent ]
Viessmann has a system of variable flow rate pumps, so they save on the flow pumps by switching off a well if it's not needed. And you have less load loss with shorter parallel fluid circuits than with a single long one. For horizontal collectors, they also have between 1-8 separate circuits, depending on the heat pump size, for the same reason.

Pierre
by Pierre on Tue Jul 11th, 2006 at 04:17:06 AM EST
[ Parent ]
How much alternate fuel would need to be produced in order to remove the current competition for the "last barrel"?

Commodity markets are easily spooked as each sector thinks their demand is inelastic and drives up the price in a panic situation.

For example, there was going to be a electric power generation crisis in the US starting about 20 years ago, but the ease and speed of bringing natural gas-fired power stations online changed the dynamics.

So, if, for example, ethanol production increased to 10% of gasoline demand would this change the market dynamics, just like the loss of 10% of refining capacity caused by the hurricanes did last year.

There are already dozens of ethanol plants being planned and built in the US.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Sat Jul 8th, 2006 at 07:21:42 PM EST
Interesting question.

Right now the market is very nervous about supply security.  Clearly there is no front end shortage which is easily proven by looking at the shape of the curve.
Aug futures closed at $74 while Jan 2007 are $77.  In a tight market the premium is at the front.

The crude price is being held up in fear that one wrong move in the AG or a Nigerian revolt or Venz political problem or Mexican political problem and we will have a real shortage.  I don't see the price retracing too far until we see crude backing up such that production is trimmed back somewhere other than in Saudi.  I believe it would take a demand drop of 5-10% worldwide to seriously crimp Saudi production enough that they use the price weapon to enforce shared sacrifice on the other OPECers.

Gasoline prices are a little different.  Right now the gas crack is wide -- approaching $20/bbl compared to $6 this time of year in the 90's.  That premium would evaporate with as little as 1-2 MMBD of alternatives hitting the market (about 10%-20% of US mogas demand).   At that level you'd be backing out almost all our imports of gasoline and blending components.  Those export refiners would sell down the US market to their marginal cost of production.  

About 1 MMBD of MTBE has been backed out of the mogas pool in the last couple of years.  That's part of the supply problem.

Most of the ethanol plants are pretty small.  That industry talks in terms of 50 million gallons/year plant size.  Or 1.2 MM bbls/year which is just 3300 bbls/day.  Small potatos in the US gasoline mkt.

by HiD on Sat Jul 8th, 2006 at 08:49:28 PM EST
[ Parent ]
In the past 6 years (since 2000), suppliers have had all the incentives to produce more, and are finding it surprisingly difficult to do so.

Apart from BP, whose production increase is linked to its purchase of half of TNK in Russia, all the majors are seeing their production stagnate or decline.

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

by Jerome a Paris (etg@eurotrib.com) on Sun Jul 9th, 2006 at 05:18:45 AM EST
[ Parent ]
This presupposes that the oil companies want to increase their production.

Their profits are rising nicely at current levels. Why incur the added expenses of exploration and increased capacity. I know we don't think much of their abilities to plan for the future (BP aside), but why expand now when one can harbor one's resources and reap the benefit of higher prices in the future.

If oil goes to $100 then the companies show a 25% increase in value with no effort on their part. This is a better return than pumping oil currently yields.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Sun Jul 9th, 2006 at 09:24:27 AM EST
[ Parent ]
Interesting to see the table of changing OPEC reserves over time, and the dramatic increases totalling around 300 billion barrels during the late 1980s.

Presumably much of this increase was a game aimed at maintaining production quotas within OPEC?

Is there a legitimate explanation for these seemingly competitive increases - or do these barrels not exist?

by Nick Oz on Sun Jul 9th, 2006 at 03:15:22 AM EST
They were indeed increased unilaterally to boost quotas. It is hard to know if there is a serious underlying reason for the increases and, in any case, the reserves have never been adjusted for actual production, which strongly suggests that the numbers have little relation to reality.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Sun Jul 9th, 2006 at 05:14:50 AM EST
[ Parent ]
Jerome, we have a contest here, and I'm wondering where we all stand on the bottle of wine.  I think we all cleverly posted our bets on the year high, and the year end price,,,,,and I'm in jeopardy on the high,,,,I think another few bucks will sink me.  How about an update on all the prognastications----just thinking of the Mexican vote, and not wanting ET to appear on the front pages in terms of recounts, voter fraud, etc, etc.
by wchurchill on Sun Jul 9th, 2006 at 03:37:39 AM EST
Re: Countdown to 100$ oil (19) - Your bets for 200 (none / 0)
2006 WAGs (wild ass guesses)  All front month WTI on the day.

1)  Highest touch on WTI at any point intra day
$ 77.75.  Iraq civil war stops exports and sets oil world on edge.

   2.  Year end $55.00

   3.  Year High  $14.5, year end  $9.00.  

Both Henry Hub in normal units.  Nat gas will slump in 2006 as drilling will go wild, Hedges for petchem and fertilizer guys will be gone so production will slump and therefore demand for nat gas drop.  Ditto electricity generation.  nat gas turbines aren't economic at these prices so demand will wane.

4)  $100 WTI won't occur until 2009.  
by HiD on Tue Dec 27th, 2005 at 09:53:41 PM HST

I'm liking the nat gas call -- I'd have never bet we'd be under $6/MMBTU but we are.   Given the US consumer's refusal to stop buying, I'm looking to be in real trouble on the crude bets.  My high is already pierced once and we haven't even had a real hurricane yet or Iraq coming unglued.

by HiD on Sun Jul 9th, 2006 at 07:16:44 AM EST
[ Parent ]
I'll have to look mine up.  I think my oil SWAG's (mine are scientific wild ass guesses) are remarkable close to yours, so we're both suffering there,,,but I don't recall making guesses on natural gas.
by wchurchill on Sun Jul 9th, 2006 at 02:26:50 PM EST
[ Parent ]
Re: Countdown to 100$ oil (19) (none / 0)
1.Highest: $80 due to some unrest in Middle East, but also just normal variation around the mean.
2.Year-end: $58.
3.Natgas highest: $16/mbtu. Year-end: $12/mbtu.  No real event on the highest, just variation around the mean.  
4. $100 per barrel will not be reached in 2006.  Cause is if the year high is $80, I don't think we can mathmatically reach $100 <snark>
Does Louis XIII qualify as the reward?
Thanks for reminding me where this could be found.  That Louis XIII is likely not coming my way.
by wchurchill on Sun Jul 9th, 2006 at 02:31:37 PM EST
[ Parent ]


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