I’m just a wee observer of skeptical temperament. A move of this magnitude based on one analyst’s reading seems a bit disproportionate. Even Abby Joseph Cohen and Mary Meeker didn’t have this sort of sway in their heyday. However, contracts that far out are thinly traded, so it doesn’t take much of a change in demand to skew the price.
Similarly, I must note in all these discussions, no one talks much (at all?) about Iraq. Now I admit that Iraq will not solve a long term “we’re running out of oil” problem. But depending on which source you consult, Iraq has the second or third biggest oil reserves in the world. In fact, Iraq recently claimed improved surveying makes it number one:
The Iraqi Deputy Prime Minister told The Times that new exploration showed that his country has the world’s largest proven oil reserves, with as much as 350 billion barrels. The figure is triple the country’s present proven reserves and exceeds that of Saudi Arabia’s estimated 264 billion barrels of oil. Barham Salih said that the new estimate had been based on recent geological surveys and seismic data compiled by “reputable, international oil companies . . . This is a serious figure from credible sources.”
This bit of news sounds awfully convenient. However, as of 2002, Iraq had substantial unexplored regions, and given the instability of the country, there hasn’t been much exploration since then. Only 2000 wells had been drilled, versus one million in Texas alone. Nevertheless, I’ll believe the factoid about Iraq’s newly-discovered reserves when I hear it confirmed by third parties.
Is it too embarrassing for oil analysts to discuss how the deteriorating security situation has reduced output? (Although now note the Iraq Oil MInistry is targeting daily output of 3 milllion barrels by year end, up from 1.9 million in March. Note the pre-war peak production was 3.5 million b/d).
Again, inclusion of Iraq may not make much difference. But when analysts are considering the impact of production in Brazil, the use of very heavy (read nasty) crude from Venezuela and Iran, and even upon occasion Canada’s tar sands, the absence of Iraq from mention seems a considerable, peculiar omission.
From Bloomberg:
Oil prices are heading to almost $140 a barrel in the next eight years, futures contracts on the New York Mercantile Exchange show.
Oil for delivery in December 2016 surged $17.08, or 14 percent, in the three trading days since Goldman Sachs Group Inc., the world’s biggest securities firm by market value, forecast oil would average $141 a barrel in the second half of 2008 and $148 a barrel next year because of supply constraints.
The gain, more than triple the rise in oil for delivery this summer, “fits in” with the Goldman forecast which “talked recently about long-dated crude in particular,” said Tim Evans, an energy analyst for Citi Futures Perspective in New York.
Oil giants such as Exxon Mobil Corp., Royal Dutch Shell Plc, BP Plc, Chevron Corp., Total SA and ConocoPhillips will spend a record $98.7 billion this year on exploration and production, more than quadruple the amount eight years ago. The supplies they tap from non-OPEC countries will only meet about 20 percent of world demand growth over the next four years…
“The move was a big jump in one day for markets that far forward, which also makes it seem as if the market’s thin out in those contract months,” Evans said. Sixty-seven contracts traded, compared with more than 296,000 for the most-active July contract…..
Oil for July delivery climbed $2.26, or 1.8 percent, to $128.98 a barrel.
James Hamilton at Econbrowser has a nice post that looks at oil fundamentals. He believes that the oil run-up has a speculative component but sees underlying demand-supply trends at work too:
Although I believe this speculation has gotten ahead of fundamentals in the last few months, there is no question in my mind that market fundamentals are the main reason for the broader 5-year move up in oil prices. Here I review those fundamental factors…..
The developed economies consume a disproportionate share of the world’s energy, with North America and Europe accounting for about half of the total oil use in 2006. However, it is the newly industrialized countries and oil producers that account for the recent rapid growth in demand, with Asia and the Middle East accounting for 60% of the increase in petroleum use between 2003 and 2006. North America and Europe contributed only 1/5 of the growth.
Particularly dramatic in this growth has been China, whose petroleum consumption between 1990 and 2006 increased at a 7.2% annual compound rate. It’s always amusing to project these impressive exponential growth rates. If that rate of growth were to continue, China would be using 20 million barrels a day by 2020, about as much as the U.S. is today. By 2030, China would be up to 40 mb/d, twice the current U.S. consumption.
Are such projections plausible from the point of view of potential demand? During 2006, China used about 2 barrels of oil per person. For comparison, Mexico used 6.6– Chinese oil consumption could triple and they’d still be using less per person than Mexico is today. The U.S. used almost 25 barrels per person….. Yes, I would say that these astonishing numbers for potential future Chinese oil demand are not at all inconceivable.
Are such projections plausible from the point of view of potential supply? Not remotely….At any point in time, some of the world’s producing fields are well into decline, some are at plateau production, and others are on the way up. It is not clear what average decline rate is appropriate to apply to aggregate global production, but a plausible ballpark number might be 4%. That would mean that in the absence of new projects, global production would decline by 3.4 mb/d each year.
To summarize, I think we will see some net production gains this year, and expect this to bring some relief for oil prices. But I cannot imagine that the projected path for China above will ever become a reality. Oil prices have to rise to whatever value it takes to prevent that from happening.
Note that Hamilton has a chart that projects a demand trend line for China out to 2030. Things are going to start getting complicated in the next six to seven years as its demographic problems start to hit (the number of aged relative to productive will get out of whack). China also has roughly 800 million subsistence farmers. It does not seem obvious that the number of people from the countryside (even a shrinking number) can attain even a Mexican standard of living. Thus the growth in energy demand from China may slow not simply for price reasons but also due to the fact that there simply isn’t enough higher value added work for enough of them to increase their energy consumption at a robust rate. Note that does not mean that energy demand from China will not continue to grow, but there are reasons to think the trajectory will flatten.
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This huge run up in oil prices comes on the heels of Bush’s disatrous trip to the Mid East. The catastrophic Iraq adventure marked a sea change in power relations in the region, the full import of which is now only being realized.
There was an excellent article yesterday in Asia Times discussing the waning influence of the United States and Israel in the region. Bottom line is that we can expect absolutely no help from anyone in the region to 1) stabilize Iraq or 2) confront the growing influence of Iran or Syria. The chances for a stabilized (oil producing) Iraq grow dimmer and dimmer, while at the same time the chances for greater instability, not only in Iraq but in the entire region, grow greater and greater.
Bush’s visit to the region put on plain view for all the world to see just how much the US’s influence in the region has plummeted. This was probably lost on most Americans, who are still in total denial and blinded by their unshakable faith in American exceptionalism.
But oil is a fungible commodity that is traded in international markets, and even though the United States has its head firmly burried in the sand, the rest of the world does not.
For expatriots like myself who are not captive to the parochial viewpoint that dominates American politics, this is the second watershed event that acts like a megaphone announcing to the world the foreign relations blunders of this administration and the concommitant diminished prestige of the US. Just like he did last week, Bush returned from the 2005 Summit of the Americas held in Mar del Plata, Argentina, with his tail between his legs. Argentina’s Kirchner and Brazil’s da Silva, along with every other Latin American leader (with the exception of Colombia’s Uribe and Mexico’s Fox), essentially told him to take the neo-liberalism and trickle-down economics being peddled by the United States and to shove ’em up where the sun doesn’t shine.
Speaking for myself, I fully expect increased production from Iraq. I just don’t think it will make much of a dent in prices because of an increasing production decline rate in the rest of the world. Reserves don’t set prices–production rate is all that matters. And many of Iraq’s reservoirs have been severely damaged.
As for Hamilton, how does an academic make a statement like “Although I believe this speculation has gotten ahead of fundamentals in the last few months…” without any back-up from data whatsoever? Large speculators were net long only 70,000 contracts in last week’s report–as opposed to 115,000 contracts last August or 100,000 contracts last December. Plus, overall oil-related inventories are slightly below the average for this time of year. This week even gasoline moved below the 5-year average. It looks to me as if the current price is pretty much the “correct” price.
We were due for a small worldwide production increase in June that would have stabilized prices, but that was before the China earthquake shut down so much of their oil and natural production. And now they have all of this rebuilding to do.
Again, it doesn’t require consumption growth rates to keep oil prices increasing when you have production in decline. And remember that the oil production plateau we’ve seen since mid-2004 has only been possible with a rapidly increasing number of rigs. It’s costing more energy to get the same amount of energy, so even a plateau means decline.
Moe Gamble
I think it’s very optimistic to bet on 140 dollars in 2016. It takes time to start exploiting new oil fields, but eight years is plenty enough. By then Brazil, Africa and hopefully Iraq will be major players. And if we could just break people’s perception that spending money on efficiency is a cost, instead of the investment that it properly is, then I could see consumption going down a bit in the west. And speaking of investment, commodities are increasingly looking like speculative bubbles which bodes ill for 140 bucks a barrel.
Here’s a link to the article I cited above:
http://www.atimes.com/atimes/Middle_East/JE21Ak02.html
“The point is, the historic failure of the Iraq war is yet to be fully grasped. On a regional plane, as the Iraq war interminably rolls on, the situation is fraught with the immense consequence of the unraveling of the entire system of states that was created in the Anglo-French settlement after the fall of Ottoman Empire in 1918. The Iraq war has triggered Shi’ite empowerment and unleashed historical forces that lay chained for centuries. Its geopolitical significance is yet to sink in as winds of change sweep across the entire region.”
While you’re waiting for third party confirmation of Iraq’s reserves, you may want to ponder that there hasn’t been any such confirmation of Saudi reserves in over 40 years, and they’re very likely lying outrageously about the reserves that actually exist.
Otherwise, a very good article.
The IEA is preparing a sharp downward revision of its oil supply forecasts: http://online.wsj.com/article/SB121139527250011387.html?mod=googlenews_wsj
Brazil oil trapped by 500 degree heat, salt barrier, and pressures strong enough to crush a pick-up truck: http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=aOspOz2AMLLU
Angola, one of the great sources of new supply in recent years, has gone flat: http://africa.reuters.com/energyandoil/news/usn521A0502-1ABB-11DD-A4F6-AC6634A97898.html?rpc=401&
A lot of traders thought it optimistic to bet on $140 in 2016. They are now getting crushed.
My entire life has been about calculating odds, and I have been extremely successful at it. I would say the odds of oil being at $140 or less in 2016 are virtually zero.
Moe Gamble
The chances are virtually zero. The odds would be something like a million to 1 against.
Moe
Yves, one more thing. Just because Bloomberg tells you that the price move is based on the forecasts by Goldman and Pickens, doesn’t mean the price move is really based on the forecasts by Goldman and Pickens. For one thing, the IEA let it be known in recent days that they are revising their supply forecasts sharply downward.
But IEA forecasts have been so consistently bad that no forecast from them could do it either. The oil producers are struggling with decline rates past 8%. Discoveries peaked over 40 years ago–new discoveries can only be described as dinky in comparison. And oil company reserves have been in steady decline now since 2001.
Moe Gamble
Yves, here’s a pre-emptive strike, because I know that tomorrow you’ll to link to articles about the oil execs’ testimony today. Here’s part of the reason not to believe their statements about what the oil price should be:
“Industry executives ‘have consistently underestimated price inflation with respect to oil and the sustainabilility of higher oil prices,’ said Bill Herbert, head of research at Simmons & Co. International Ltd., a Houston investment bank specializing in the energy industry.
“History drives their bearishness.
‘A lot of the folks running these companies are burdened with the accumulated scar tissue of the last 20 years when you had difficult conditions for the industry,’ driven mainly by overcapacity and a lack of discipline on behalf of OPEC, Herbert said.”
http://www.philly.com/philly/business/20080510_Oil_executives_still_see_prices_dropping.html
Simmons has also pointed out (can’t find the link at the moment, but you will understand the logic) that oil exec compensation depends up on share price, and maintaining share price means denying production limitations. How do you justify huge executive salaries and exploration budgets when almost all of your profit is coming from pumping your heritage reserves?
Moe Gamble
Moe,
You may have some useful information to convey, but I for one find the presumption and arrogance annoying.
You say for instance that the odds of oil being below $140 in 2016 are “one in a million.” That shows ignorance of large numbers.
I would put the odds of deflation, a very serious global recession (not as bad as the Great Depression, but close), or protectionism leading to a significant fall in trade (and therefore growth) in emerging markets at at least 1 in 10,000, perhaps as high as 1 in 1000. Those scenarios would lead to a fall in advanced economy demand (which remember are the biggest users if not the biggest source of marginal demand) and at least a slackening of demand from emerging markets.
Even 1 in 10,000 is 100 times larger than 1 in a million.
As per the oil execs, I don’t see how you can assert you have better fundamental information than they do. And the quality of information IS lousy:
http://www.businessweek.com/bwdaily/dnflash/content/may2008/db20080513_734146.htm
Moreover, the inventories counted are primary inventories. Any end-user inventories are counted as demand. China is known to be stockpiling for the Olympics but no one knows how much. How many industrial users have decided to stockpile is also unknown, but I have to believe that is taking place too.
retread,
There could be non-economic disasters too, like a pandemic. Multi-drug resistant tuberculosis is a worry, for instance. Low odds yes, but greater than one in a million? I’d venture yes.
Moe,
It is NOT in Big Oil’s interest to get up before Congress and say prices “ought” to be substantially lower. That is an invitation for an excess profits tax, and a big one at that.
The AP reported a couple of months ago that the Iraqi government had $60 billion in oil revenue that it was holding from recent production. The point of the article was that the US was deficit spending on rebuilding Iraq while the Iraqi government was sitting on this pile of cash. My point here is that regardless of their true reserves, Iraq is contributing meaningfully to global oil supply right now.