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)