A very good short piece at the Financial Times by Ed Morse, chief energy economist at Lehman. Readers may know that Lehman has been the staunch oil bear in contrast to Goldman’s uber oil bull posture.
Note that Morse’s argument is similar, although more short-term focused, to a post we discussed, “Peak Demand.”
From the Financial Times:
World oil consumption is now growing at a significantly lower pace than had been imagined a year ago. Last October, the International Energy Agency was forecasting global demand growth for 2008 of 2.1m barrels a day, with 750kb/d from the OECD and 1.33mb/d from emerging markets. In their latest monthly report, the IEA has slashed this by more than 60 per cent to 800kb/d, with OECD demand actually forecast to decline by over 600kb/d and emerging markets demand to grow by 1.4mb/d.
In our judgment, the IEA’s forecasts for emerging markets will turn out to have been far too optimistic…. two other articles of faith are being challenged. First, the consensus thinking that emerging market oil demand has decoupled from industrial countries will be severely tested over the next half year. Second, the growing consensus that lower prices and higher economic growth will result in a rebound in global demand growth is wishful thinking….
There is growing evidence that the economic malaise affecting many of the OECD economies is spreading into emerging markets…
For China….challenging times are ahead for exporters and the metal and energy-intensive producers of steel, aluminium, cement, and other primary products.
Contrary to popular myth, these energy- intensive industries rather than the transport fleet are consuming the middle distillates that drive two-thirds of China’s petroleum demand growth. And now due to higher energy costs, an appreciating yuan, weak export markets, and a protectionist backlash, exports are falling,..demand growth could drop from its three-year average of 490kb/d to 350kb/d (up 4.4 per cent) in 2009…
Efforts to de- control prices in many Asian countries, have raised end-user prices significantly, some by more than 50 per cent. The few historical lessons about the effect of price hikes of such magnitude on demand growth point to structural tipping points….
The old adage that “nothing cures high prices like high prices,” is as true today as in the 1970s….We expect prices to stabilize at $90-100 per barrel but to still stimulate structural demand adjustments – we don’t foresee world demand growth exceeding 1mb/d per year for some time.
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Interesting story and has some good points. Yet it is strange how fast forecasts can change with sentiment. Oil barrelling to $200 was almost fait accompli a few months ago. Now, $100 is in range.
Also the article only attribute Asia as the main cause of the oil price increases. There are are other factors, as I wrote about recently :
– Tensions between Iran and the U.S. and other Middle east countries don't look like abating in the longer term despite recent diplomatic efforts and a lull in tensions.
– We'll drive more, fly more and waste more. As prices fall, the alliance of environmentalists and consumers, brought together by pain at the pump, is already coming apart. When has is below $4, people will think of it as a relief and unfortunately most will go back to their old habits. Holidays that were put off in the summer due to high gas prices, will now be back on the Agenda.
– Renewable energy is still a long way from being a viable alternative to oil in terms of widespread usage. The world economy cannot and will not quickly convert from an oil-based consumer to a blend of other energy options such as natural gas, solar, wind and so on," said Neal Ryan, a manager at Ryan Oil & Gas Partners. "Until we do, I certainly expect oil prices to remain at these elevated levels over $100 a barrel and eventually challenge their all-time highs again — and then surpass them in the coming year."
– Speculation is also a big factor.
Oil is not a complicated story. The demand is increasing faster than production, which has been essentially flat for sometime now. All these informed economists can write what they want, but that simple fact will remain and drive the price up, notwithstanding these short-term fluctuations.
It would be interesting if Mr. Morse had something to say about the following situation. In the good old days of $30 oil, OPEC producers needed every dollar of revenue they could get, and would break their quota in pursuit of it. Today they are faced with more unwanted dollars than they have any useful purpose for, and a sovereign wealth surplus is at pains to protect itself from devaluation. Perhaps they might leave a few more barrels in the ground? Maybe just enough to match the modest decline in consumption?
FT: we don’t foresee world demand growth exceeding 1mb/d per year for some time.
If supply stays constant while demand grows 1%/yr then why should we not expect rising prices? Demand growth can keep decreasing but as long as supply growth is not larger, upward price pressure will persist.
Everything that I have seen living in the U.S. has shown me that cultures that have been infected with consumerism will use as much oil as they can reasonably afford, or in some cases, not reasonably afford.
This is just silly ex-post facto rationalization. Check out the trends in demand for distillates and gasoline domestically; no correlation with the violent price swings over the last 6 months. If anything, the demand destruction has lessened since that occurring during the large spike during the spring.
http://tonto.eia.doe.gov/oog/info/twip/twip_distillate.html#demand
http://tonto.eia.doe.gov/oog/info/twip/twip_gasoline.html#demand
We’re just witnessing deliberate (and well-executed) squeezes on, initially, over-leveraged shorts, and now on over-leveraged longs. It’s worked. We’ve seen big declines in open interest. My investment posture towards oil hasn’t changed in the last six months and I don’t anticipate it changing over the next six.
The fundamentals have not changed. If Russian and Mexican production don’t decline much, and Khurais comes on strong, we might see a modest increase in supply. If Ghawar waters out concurrently, we might see a modest decline in supply. Otherwise, this is just trading as usual.
Question
When the US begins to rebuild the infrastructure what will that do to energy cost?
Morse has not changed positions on this matter, so calling it “rationaliztion” is inaccurate. He has long maintained that oil should be below $90. If you had bothered clicking on the link to the earlier post, even Goldman, which has had the most aggressive near-term price forecasts, sees oil being cheaper longer term.
This section comes from The Inquisitive Mind;
Lost in the bullish talk of $200 oil was Goldman’s notes about demand destruction. The same report which predicted the super-spike also said that by 2012 the price of crude oil would fall to $75 normalized. Goldman expects the current euphoria to lead to a spike in crude oil prices, which will spur new supply development and also lead to permanent demand destruction.
We have written before that the data on demand and supply is lousy, so even comments on current conditions are more guesswork that the confident tone of news reporting might suggest. The one bit that is somewhat reliable, inventories, as we have also discussed at considerable length, is much less meaningful than the press and economists indicate, because 1. storage is so limited and problematic that production is tweaked so as not to overrun storage and 2. around the margin, inventory levels depend on the perceived profitabilty of holding inventory, which depends on the RELATIVE attractiveness for Big Oil of carrying inventories versus other uses of funds (which can include paying down debt).
Morse has not changed positions on this matter, so calling it “rationaliztion” is inaccurate.
He was mainly calling for massive increases in supply and a reduction in Chinese demand, not a pull-back in OECD demand.
http://www.businessweek.com/magazine/content/08_30/b4093000546844.htm
We’ve seen a pretty consistent decline in crude inventories since that time, and signs on Chinese demand are inconclusive. From his own editorial, the IEA just revised upwards emerging market demand. Here’s further analysis on China in particular, too.
http://tonto.eia.doe.gov/oog/info/twip/twip_crude.html#stocks
http://uk.reuters.com/article/oilRpt/idUKPEK12282120080812
He was right on the timing and price, for which I give huge, well-deserved kudos. That’s what trading’s about. The reasons he presented then weren’t quite right; the reasons presented now don’t make much sense in review of available data; and I think the reasoning is what good analysis is about.
As an aside, I think his comment on improved refining narrowing the price differential between grades in the Business Week link is probably the most important in the whole discussion from a fundamental standpoint.
data on demand and supply is lousy… inventories… is much less meaningful than the press and economists indicate, because 1. storage is so limited and problematic that production is tweaked so as not to overrun storage and 2. around the margin, inventory levels depend on the perceived profitabilty of holding inventory…
I agree that the data’s not perfect, but what else are we supposed to go by? Price signals have proven themselves to not be very clean here. In looking at stock and housing bubbles, we have a variety of good fundamental valuation metrics, like price to earnings and price to rent. We should’ve fallen back on those when market pricing and demand signals failed in the mania.
Our metrics just aren’t as good in the world of commodities. Marginal production costs don’t capture cartels, supply shortages, or demand shifts. Flatly calling the data available — that do attempt to reflect these things — lousy doesn’t really leave us much.
What would you recommend using instead? If you have some ideas, that’d be a great help.
ndk,
One method, which I’ve never formalized, sets the cost of production/supply/demand data against an objective as possible analysis of global and regional macro tendencies, e.g. rate(s) of economic profit, changes in levels of excess capacity, changes in employment and wages, in social tensions, in industry concentration, in govts’ policies, in trade flows, etc, not simply ‘as advertised’ but also beneath the surface.
Macro deterioration and recovery become evident in advance, and so do degrees of contradiction between the real economy and financially determined prices such as most commodities. In a sense, a battle of tendencies that can help one ‘see’ through, and recognize, the fog of hype, promotion and causes.
IOW, everything is relational and in motion but data sets, taken on their own, tend to freeze and hide. Slightly paraphrasing Brecht: In the contradiction(s) lies the truth.
“If anything, the demand destruction has lessened since that occurring during the large spike during the spring.”
What data are you looking at, NDK?
Distillate stocks increased for 20 weeks straight up until last weeks drawdown.
Refinery utilization rates are at 17 year lows for this time of the season.
In fact, the beginning of the rise in diesel inventories (march)matches up almost perfectly with when oil started breaking through 100 with conviction.
Not sure if you are intentionally misleading readers just to prove your point, or if you just don’t know what you’re talking about.
Distillate stocks increased for 20 weeks straight up until last weeks drawdown.
Of course they increased. They always do this time of year, as refiners transition in preparation for the winter, and we’re right in the middle of historical norms.
http://tonto.eia.doe.gov/oog/info/twip/twip_distillate.html#stocks
What part of “crude inventories” was unclear to you?
http://tonto.eia.doe.gov/oog/info/twip/twip_crude.html#stocks
Refinery utilization rates are at 17 year lows for this time of the season.
Yes, that’s true. It implies insufficient demand for finished product in the U.S., which is consistent with everything else.
In fact, the beginning of the rise in diesel inventories (march)matches up almost perfectly with when oil started breaking through 100 with conviction.
Right! It fits (a) the normal seasonal pattern perfectly; (b) the idea that the price delta was just overleveraging in both directions that is being shaken out now, given that we went straight up to 147 and straight back down from there.
“normal seasonal pattern perfectly”
At the risk of stating the obvious, wti price increases (expectations?) were far from normal, given the normal-seasonal inventory builds (supply).