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VK2AAB > FUEL 21.05.09 09:47l 106 Lines 6997 Bytes #999 (0) @ WW
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Subj: Oil Price recent history
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From: VK2AAB@VK2AAB.#SYD.NSW.AUS.OC
To : FUEL@WW
An interesting article on the effect of arriving at peak oil.
It discusses the effect of rising prices from 2004 to today.
The effect of China's demand and the recession.
Barry VK2AAB
Steven Kopits, Managing Director, Douglas-Westwood, New York, EnergyCurrent,
11 May 2009
View original article
http://www.energycurrent.com/index.php?id=2&storyid=17976
In seeking to explain the run up in oil prices from 2004 to 2008, commentators
often turn to "speculation" as the primary cause. While speculation - or at
least a kind of piling-on - may have explained the very late stages of the oil
price rally, the willingness to attribute oil prices primarily to financial
investors - as the CBS news show '60 Minutes' did a few months back - risks
drawing the wrong lesson from the period. Let's re-wind the clock and recall
the events of the time.
After many years of solid growth, oil production plateaued in October 2004.
Regardless of the price level, the oil supply simply stopped responding, and
from then on, the world had to make do with broadly flat supplies. Ordinarily,
the expansion of the world's economy would be accompanied by increased energy
consumption and an inelastic oil supply might have been expected to hinder
economic development. It didn't. In the four years to mid-2008, the world
economy expanded by 18 percent. The global economy boomed, even without new
oil.
However, this came at a price. In the absence of oil supply growth, demand
accommodation was required. This was achieved by secular prices rises
averaging 25 percent per annum from 2003 to the end of 2007. In other words,
the price of oil went up, and this constrained consumption by causing the
marginal consumer to drop out of the market. This proved a workable solution
for a time, but the global economy could not sustain 25 percent annual price
increases indefinitely, and by the second half 2007, the situation was
becoming critical. Consumption was being maintained by continuing draws on
inventories averaging 1.4 mbpd, and virtually every producer, with the
possible exception of the Saudis, was running flat out. By early 2008, even
the Saudis were throwing the kitchen sink at the market - all to no avail. On
paper, it looked like a peak oil nightmare.
Of course, consumers were responding. From 2005, the EU and Japan began to
shed consumption and, from late 2007, US consumption also began to decline as
the US consumer sought to escape high oil prices. Notwithstanding, developed
economy consumers were not abandoning the market as fast as Chinese consumers
were entering it, and prices continued to rise. In early 2008, prices took off
and some argue that speculation took over. Still, as inventories continued to
fall until May 2008 and all the oil producers were running at full output, the
case for market manipulation at that time is hard to make. Indeed, the market
was in backwardation most of this time. In backwardation, futures prices are
lower than spot prices, the equivalent of the market saying, "Well, prices are
high now, but they'll be lower later." The market - those very speculators -
believed that oil was over-priced but was continually surprised as demand kept
pushing up prices.
Prices did ultimately fall, but not because the supply situation eased, nor
because speculators fled the market, and not because inventories were
released. Prices fell because the global economy collapsed.
This period then shows us two of the possible adjustment mechanisms in the era
of peak oil: oilless growth characterized by increasing prices and continuous,
incremental adjustment; and recession accompanied by a dramatic step drop in
consumption and a collapse of oil prices. The lesson to be drawn is that
conservation can work within limits, but at some point, there is a straw that
breaks the camel's back and the whole system collapses. Ultimately, the
inability of the oil supply to keep pace with global demand proved to be a key
contributing factor to the current recession. I would note, however, that the
proximate cause of the recession is China, not peak oil. China ultimately
provided both the financial liquidity and the commodities demand which brought
down the global economy. Were China not so large and not at its current stage
of development, peak oil could pass without anyone noticing for some time. As
it was, China hit its stride just as the oil supply was stumbling. The issue
was not, therefore, peak oil in and of itself, but rather the supply/demand
imbalance caused by the inability of the global oil supply to adjust to
China's incremental demand.
As for market manipulation, it has recently been running at full tilt. You can
read about it daily in any newspaper or news website. OPEC, acting as a
cartel, has reduced production by millions of barrels a day in order to drive
prices up. Investment banks have chartered supertankers and hoarded perhaps
100 million barrels of crude to profit from current market conditions. Both of
these remove supply from the market and drive up spot prices. Indeed, were
OPEC to pump at full capacity and oil move out of those storage tankers at
reasonable speed, the oil supply could be 5 mbpd higher than its current
levels. That would depress prices by quite a bit, perhaps by half or more. So
there is plenty of market manipulation at present.
Why no outrage? Surely the economy could use the implicit stimulus now more
than ever. Why are commentators failing to take OPEC or the investment banks
to task? Is it not a question of principle? Is 'market manipulation' not a bad
thing?
Or is the real issue a matter of interests? Does really come down just to
price? So it would appear. And this, then, is the greater lesson. When oil
prices are high, even ordinarily reserved and thoughtful people will abandon
their principles and demand action, demand that someone be held accountable,
insist that someone pay. For some, it will be the bankers; for others, the oil
companies or the Saudis. Some may come to blame the Chinese, or perhaps the
Russians, Iranians or Venezuelans. But someone will have to pay and guilt may
be difficult to assign precisely. When this happens, those suffering high oil
prices may seek redress by using their national might and influence to ease
the burden or exact retribution, even in contravention of obligation, prudence
or proportionality.
So as we consider policy in the next cycle, the central issue is not whether
to curb speculation by insuring that margin requirements on commodity futures
are high enough or by hiring more regulators. The central issue is the
containment of oil prices within bands that prevent a second peak oil
recession. In doing that, we will prevent the irrational and reactionary from
dominating policy and undermining the system of global trade and international
relations upon which all our prosperity rests.
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