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Countdown to 100$ oil (14) - Greenspan acknoweldges peak oil

by Jerome a Paris Fri Oct 21st, 2005 at 10:34:05 AM EST

Back from front page ~ whataboutbob

Greenspan had a big speech on oil (via the Energy Bulletin) two days ago.

Journalists focused mostly on his upbeat pronouncement that higher oil prices would have a real, but limited, impact on growth.

I would like to focus on some ignored parts of his speech which deserve a new countdown diary, despite the lack of headline-generating spot oil prices.

The key paragraph of his speech is the following:

In early August, prices for delivery in 2011 of light sweet crude breached $60 per barrel, in line with recent increases in spot prices. This surge arguably reflects the growing presumption that increases in crude oil capacity outside OPEC will no longer be adequate to serve rising world demand going forward, especially from emerging Asia.

To parse the Greenspeak, that means that non-OPEC oil supply increases will be unsufficient in view of demand growth. It's not exactly peak oil for all oil production; it's not even peak oil for non-OPEC producers (as he talks about inadequate "increases"); but it is still an important acknowledgement: supply from the non-OPEC world cannot keep up with demand. Call it the weak version of peak oil, maybe, but it's there.

The other interesting point to note is that Greenspan flags a very important price indicator, which is usually ignored by the press.

As the numbers provided on this page make clear, markets are expecting prices to remain in the 60$/bl range for the next 5-6 years. This is VERY different to what you had in the past when, irrespective of what the short term price (driven by events and volatile) was, the long term prices would gently come back to what was then the long term expectation for oil prices, around 18-20$/bl. No longer. The market does not believe that we will "go back to normal" any time soon ("normal" being what happened since the mid-80s, which is the experience span of most traders at best).

The fact that Greenspan flags this price means that he understands pretty well what's going on, it's simply, as usually, well dissimulated in obtuse language behind a few easier to digest soundbites for the general public.

Let's see what else is hidden in his speech:

How did we arrive at a state in which the balance of world energy supply and demand could be so fragile that weather, not to mention individual acts of sabotage or local insurrection, could have a significant impact on economic growth?

This seems like a banal acknowledgement of recent news. It is really more than that. He is stating that there is no supply cushion and that small events have direct macro-economic consequences. This is a big deal.

Although the production quotas of OPEC have been a significant factor in price determination for a third of a century, the story since 1973 has been as much about the power of markets as it has been about power over markets. The incentives to alter oil consumption provided by market prices eventually resolved even the most seemingly insurmountable difficulties posed by inadequate supply outside the OPEC cartel.

Here, he renews his faith in the markets to solve the problem. I note the adjective "seemingly unsurmountable" to describe the situation in the 70s and, implcitly, today. It took a pretty big economic crisis for the "markets" to solve what was an artificially created supply crisis. Today, the crisis is not artificial (no supply surplus avialable anywhere), so any "pure" market solution (i.e. price driven and not regulation-driven) will likely be more painful than in the 70s. Of course, we'll find substitutes to 600$/bl oil. But can we find substitutes to 30$/bl oil or even to 60$/bl oil without economic pain? That question is not answered.

the opportunities for profitable exploration and development in the industrial economies are dwindling, and the international oil companies are currently largely prohibited, restricted, or face considerable political risk in investing in OPEC and other developing countries. In such a highly profitable market environment for oil producers, one would have expected a far greater surge of oil investments.

Again, Greenspan is acknowledging what many of us doomers and gloomers have been saying: "the opportunities are dwindling". Reserves are running out is, again, what it means. BigOil is running out of places where to invest. Their record profits are the swan song of a dying industry.

because of the geographic concentration of proved reserves, much of the investment in crude oil productive capacity required to meet demand, without prices rising unduly, will need to be undertaken by national oil companies in OPEC and other developing economies. Although investment is rising, the significant proportion of oil revenues invested in financial assets suggests that many governments perceive that the benefits of investing in additional capacity to meet rising world oil demand are limited. Moreover, much oil revenue has been diverted to meet the perceived high-priority needs of rapidly growing populations. Unless those policies, political institutions, and attitudes change, it is difficult to envision adequate reinvestment into the oil facilities of these economies.

So, no investment from the OPEc countries either... They don't see any benefit to do so? Why would that be? I suppose he suggests that they think that oil prices will go down as demand is cut by greater efficiency and that surplus capacity would be unneeded, but he also leaves the door open to simpler explanations, notably that they don't need to produce more oil to get more income as prices are inexorably rising.

But the point is - Greenspan is saying that oil production will not increase because nobody is investing in the sector near enough to what would be needed, oil majors because they cannot, and oil countries because they won't (they "have other priorities", maybe...)

We can expect similar increases in oil efficiency in the rapidly growing economies of East Asia as they respond to the same set of market incentives. But at present, China consumes roughly twice as much oil per dollar of GDP as the United States, and if, as projected, its share of world GDP continues to increase, the average improvements in world oil-intensity will be less pronounced than the improvements in individual countries, viewed separately, would suggest.

After repeating many times that energy efficiency will allow us to live with these dwindling supplies, Greenspan drops his last bombshell, in the above paragraph: the simple fact that China, an inefficient energy user, is growing a lot faster than the West, means that the average energy-efficiency of the world economy is going to decline, even if all countries improve their individual efficiency

This is a fundamental insight. Basically, it says that China's demand for energy is growing. Even if it grows slower than its economy (thanks to efficiency), that demand is growing, and, as China becomes a bigger chunk of the world economy, the absolute size of that increase is world-significant. Even if we all make efforts, the simple fact that China is on a high growth trajectory means that oil demand will keep on growing, thus putting unbearable pressure on the market.

In fact, the only way to balance the markets, as suggested by Greenspan, would be a collapse of Chinese growth, an event which would likely have massive repercussions within China and outside of China.

So yes, get ready for 100$/bl oil and more. Even Greenspan implicitly ackowledges it.

Earlier "Countdown Diaries":
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
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)

there is no calendar: list of projects coming on stream for the next three years. We know that there is no big project for 2009 but what about the years before?

I want a list Jerome.. je je jeje I am joking.

By the way, I think 80$ will be the wake-up call not 100$. The first measures to curb demand strongly will be taken then so I think we will not touch 100$ until 2010. But, I would be more assured if I would know how many oil is coming on line!!

Non-OPEC countries are rather well audited.  Greenspan is basically accepting the fact that the Northern Sea was the big elephant in the room. They peaked two years ago so now we can only expect slight increases or a long-plateau in NON-OPEC countries.

Just the time to save the easy-20% oil by getting rid of SUVs , oil for primary energy and car in the cities.

Brilliant diary as always.

A pleasure.

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Wed Oct 19th, 2005 at 09:56:39 AM EST
by Jerome a Paris (etg@eurotrib.com) on Wed Oct 19th, 2005 at 03:40:37 PM EST
[ Parent ]
Great assessment, Jerome. Man, you really have to work to make sense of what this guy is really saying...

"Once in awhile we get shown the light, in the strangest of places, if we look at it right" - Hunter/Garcia
by whataboutbob on Wed Oct 19th, 2005 at 09:58:05 AM EST
I have a couple of comments about Greenspan's speech.  

In spite of $60 futures prices, the US stockmarket is pricing oil stocks as if crude will stabilize at about $40/barrel.  Either the futures traders, or stock traders will be proven right, and my money is with the commodity guys.

As for lack of investment by OPEC countries, I think there are two reasons.  First, they simply plan to let supply stagnate, and cash in on increasing demand.  But there is a more fundamental problem - all the countries of the Persian Gulf have young, rapidly growing populations that depend on the state for everything.  The governments of those countries will need their profits just to meet those demands, and avoid revolution.  What's more, some OPEC countries are heavily in debt to the west; for example, Saudi Arabia has an external debt greater than its GDP.

by corncam on Wed Oct 19th, 2005 at 11:10:48 AM EST
Futures: are they payment today for promise of delivery in five years, or are they promise of payment for delivery in five years?

If the former, I would think the "real price in 2005 dollars" is higher than listed (adjusted for lost interest), while if the latter the "real price in 2005 dollars" is lower than listed (adjusted for inflation).

by jobh (jbh@lupus.ig3.net) on Thu Oct 20th, 2005 at 05:33:45 AM EST
closer to the second.

Futures exchanges require full settlement once the contracts expire and the counterparties are matched.  BUT in the meantime, you have to have margin in place to secure your positions.  

For example, if you put a trade on in WTI for 1 lot at $60 (so $60,000 worth of oil as 1 lot = 1000 bbls), you have to pony up around $5000 IIRC whether you are the buyer or the seller.  This amount varies depending on your credit rating, history, overall net position etc.

If the trade moves against you, you have to put up more and more such that you have enough cash on deposit with the exchange that they can cover your loss if/when you liquidate.  IE if you sold at $60 and the market moves to $63, the exchange wants to have $3000+ in hand.  The + being enough to cover a days estimated move while they are shaking you down for more cash.

The same thing happens in OTC markets.  The credit guys spend a lot of effort tracking who owes who how much. You should see the scramble to net out positions when an Enron or Refco goes belly up. People put up margin or letters of credit or otherwise your positions get forced to close and the losses booked.  A BP or Exxon will usually have open credit with everyone as they are solid to perform.  Harken Energy under GW -- Full L/C per terms of counterparty drawn on a AAA bank!  A good credit manager is worth his/her weight in platinum.  Nothing worse than having a great trade with a counterparty that can't/won't perform.  Lawsuits take forever and usually recover jack.

this may not be 100% correct.  While I traded these things for years, I always worked for companies with stellar credit and we had lots of nice accounting types that handled the details.

But the rest of your argument is correct.  Trades settle in then current dollars.  However, the headline futures quote is usually for the prompt contract which only has 0-30 days left to run.  Not much interest rate effect over such a short period.  Interest rates are very much a part of a trader's analysis of his/her forward book.  Especially if there is a lot of derivative risk esp. options.

by HiD on Thu Oct 20th, 2005 at 05:59:12 AM EST
[ Parent ]
Thank you for the explanation. Is it then (approximately) correct to say that the 2011 price, $53.50, predicted by the futures market price corresponds to about $46 in today's money?

(assuming 2.5% inflation: 53.50/1.0256)

by jobh (jbh@lupus.ig3.net) on Thu Oct 20th, 2005 at 11:07:34 AM EST
[ Parent ]
If I am not mistaken you have to correct not by inflation but by the risk-free interest rate you can get on your money, but it really depends what question you are trying to answer.

The question I am answering is, how much money do you need to have today to have $60 in 6 years' time? You need much less than $46, because you can get at least 4.85% if you buy US treasury bonds. That is 33% over 6 years. So if you buy $40.27 in 6-year bonds today you'll have $53.50 in 6 years' time.

Now, you are right that, adjusted for inflation, that is $46 today. So, investing $40 today you can make the equivalent of $46 of today's money in 6 years.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Thu Oct 20th, 2005 at 11:21:39 AM EST
[ Parent ]
but it really depends what question you are trying to answer

Indeed. The question I was trying to answer was: What is the real price, in 2005 dollars, predicted by the futures market? And the answer to that question must be to adjust for inflation but not for interest.

The result then is that the market really expects oil to drop (gradually) 25% in six years, not the 10% that the raw numbers imply.

by jobh (jbh@lupus.ig3.net) on Fri Oct 21st, 2005 at 05:19:46 AM EST
[ Parent ]
But the point is, to you the future oil price looks like $46 because you expect your income to increase at about the average inflation rate. To the traders it looks like $40 because that's all the money they have to have today to pay for the oil in 6 years.

It looks paradoxical to me and I don't quite know how to resolve it. Both numbers are right for what they calculate, but notice that someone said upthread that the stock market is pricing oil stocks as if the long-term price of oil were $40. Maybe there's something there.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Oct 21st, 2005 at 06:05:25 AM EST
[ Parent ]

here is a very interesting interview with Henry Groppe about oil prices, Saudi Arabia etc:


by Greco on Thu Oct 20th, 2005 at 09:40:58 AM EST

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