An Amazing Disconnect

Why Are Oil Prices Rising? The Picture Tells the Tale (Credit to Optimist)

The recent, rapid climb in oil prices has started to get everyone’s attention. In fact, when people use Google to search for information, and then link in here, I can see that information. Lately I have noticed a dramatic rise in the number of people searching for an explanation for why oil and gas prices are rising. It seems Congress is also searching for answers, as they once again hauled oil executives to Washington for a public whipping. This time, it was the Senate Judiciary Committee putting on the show:

Don’t blame us for prices

Reading through the testimony, it is amazing to me that these senators are so fundamentally ignorant of supply and demand. Some of the statements:

“You have to sense what you’re doing to us – we’re on the precipice here, about to fall into recession,” said Sen. Richard Durbin, D-Ill. “Does it trouble any one of you – the costs you’re imposing on families, on small businesses, on truckers?”

To me, that is a highly offensive question. Does he seriously think that oil company executives believe that these prices are good for the economy? I know – and I have personally heard one oil company CEO say this in a small private meeting with employees – that they want to see prices cool off.

Durbin is pointing fingers directly – “This is your fault” – and then implying malice. Durbin either believes that oil prices are going up because oil companies are making them go up, or he actually knows better and would rather throw these guys to the wolves than have a serious discussion on energy policy. I am troubled by either option.

Committee Chairman Sen. Patrick Leahy, D-Vt., likely summed up the feeling of many senators on the panel. “The people we represent are hurting, while your companies are profiting,” he said. “We need to get some balance.”

You have “just a litany of complaints that you’re all just hapless victims of a system,” Sen. Dianne Feinstein, D-Calif., told the executives. “Yet you rack up record profits … quarter after quarter after quarter.”

Not “hapless victims”, Senator Feinstein. Beneficiaries of higher oil prices, to be sure. But they are beneficiaries of a system that is the result of bidding in a global market. These executives have little power to influence that.

More comments from the L.A. Times:

“Consumers are angry, and they have every right to be,” Sen. Herb Kohl (D-Wis.) scolded the oilmen at the Senate Judiciary Committee hearing on rising oil prices. “You’re making more money than ever. It doesn’t seem fair, guys. It just doesn’t seem fair.”

But senators became incredulous when Lowe was unable to tell the committee chairman, Sen. Patrick J. Leahy (D-Vt.), how much he earned last year. “I wish I made enough money that I didn’t even have to know how much I made,” Leahy said.

Yet I bet if Leahy was asked that question under oath, he would have trouble answering it exactly. After all, most people can state their base compensation, but throw in interest payments and any other odds and ends, and you are suddenly at risk of perjury by stating the amount incorrectly. But hey, it makes for a good sound bite.

Leahy also made perhaps the most ignorant comment of the day:

“People we represent are hurting, the companies you represent are profiting,” Sen. Patrick Leahy, D-Vt., told the executives. He said there’s a “disconnect” between legitimate supply issues and the oil and gasoline prices motorists are seeing.

Why is that ignorant? Because it presumes to define how high prices should be given a supply/demand imbalance. Does he think – as I have seen some suggest – that a 10% imbalance in supply and demand should cause prices to go up by 10%? Here’s an analogy I have used before in this case. Imagine that everyone in the world requires a certain substance every day, otherwise they die. How high would prices go if there was a 10% shortage of this substance? 10%? You have to be kidding. People would be willing to pay literally anything to get the substance. In the case of such a substance, any shortfall is going to have a disproportionate impact on the price. And in the case that the substance is a diminishing resource, over time you would have the rich bidding against each other and driving the price far higher than might seem rational.

While oil is not quite in that category, it is a highly demanded commodity, and demand is pretty inelastic. Shortfalls are going to disproportionately impact price. Look at the graphic up top. Supply and demand are out of balance, and the price is rising to bring them into balance. That some of our fine senators are too ignorant to understand the implications does not bode well for the U.S. to ever have a comprehensive, consistent energy policy.

Finally, why are oil and gas prices rising? Gas prices are being driven by oil price increases (whereas last year they were driven by low inventories). Funny that the committee would focus so much on gas prices, when the refining sector has seen profits all but vanish. Presently, oil company profits are being driven by high oil prices, and most of that oil is extracted from outside the U.S.

So why are prices rising? I believe this is Peak Lite in action. For those unfamiliar, the concept of Peak Lite is that we will have shortfalls and huge price increases before oil production actually peaks. This is what we are seeing now. Even as we are setting new production records, demand has far outstripped new supply.

The concept of Peak Lite is explained here: Peak Lite Revisited.

27 thoughts on “An Amazing Disconnect”

  1. I watched none of this circus, but happened to catch one exec on the evening news defending high profits by saying “we reinvest it all”. That’s probably a flat-out lie, though I can’t say for certain because I didn’t recognize him. He may run some smaller outfit which does in fact reinvest all profits.

    The supply/demand chart is weak. Unless global stockpiles are building or draining then supply=demand, by definiton.

    From 1982-2003 the world had plenty of slack capacity. The last few years oil markets have tried to guess the equilibrium price at which supply will increase and/or demand will stop growing. $135 may or may not be the right price. It’s hard to say because OPEC, which supplies more than half the world’s oil exports, will not increase supply at any price and China, which is causing about half the world’s demand increase, has a near-infinite supply of US dollars to subsidize consumption.

  2. DDW, global stockpiles are definitely draining. I saw this in a story a few days ago.

    Also, from today’s WSJ –

    The world’s premier energy monitor is preparing a sharp downward revision of its oil-supply forecast, a shift that reflects deepening pessimism over whether oil companies can keep abreast of booming demand.

    “The oil investments required may be much, much higher than what people assume,” said Fatih Birol, the IEA’s chief economist and the leader of the study, in an interview with The Wall Street Journal. “This is a dangerous situation.”

    But the direction of the IEA’s work echoes the gathering supply-side gloom articulated by some Big Oil executives in recent months. A growing number of people in the industry are endorsing a version of the “peak-oil” theory: that oil production will plateau in coming years, as suppliers fail to replace depleted fields with enough fresh ones to boost overall output. All of that has prompted numerous upward revisions to long-term oil-price forecasts on Wall Street.

  3. Yeah, the graph is compelling. But where is the information from? There’s alot of disagreement about total supply (at least) judging from the EIA/IEA discrepancy. I would expect that the demand values would likewise be less than certain.

    The basic concept of the graph is powerful, and there are folks I would like to show it to. But it would be much more powerful if the sources were cited, and if there were error bars to indicate the spread of values from different sources.

  4. Americans should be angry — at themselves and their leadership. We have not developed domestic sources of energy, and taxed down our demand. To use football vernacular “we are wide-open” to plundering. So it is happening. Sure, the oil guys are making gobs of money. That is their job. You can be angry at wolves for hunting. OPEC and thus oil states are making out like bandits. El Presidente Bu$h jr? It’s Miller Time, every day since inauguration day El Numero Uno.
    There was interesting testimony in recent Senate hearings about huge commodity funds opening up, and becomig net buyers (long on huge amounts of commodity futures contracts). As commodity prices have risen, more money is attracted into the commodity funds, and they keep buying. A cycle.
    This is worth pondering. After all, sugar and wheat and rice markets are all going up, gold, copper….you get the picture.
    As for “booming” oil demand, British Petroleum reports that worldwide demand for oil grew 0.6 percent in 2006, down from the previous two years. 2007 will likely come in flat, and 2008 will likely witness “Peak Demand”
    In California, land of convertible SUV-Escalade with TV’s and outdoor sunning platforms, gasoline demand is down 5 percent year-over-year.
    I confess, this price has surprised me, but I still think the concept of Peak Oil is deeply flawed. I suspect this is a speculative bubble, aided by OPEC, thug states, commodity funds, hedge funds and speculators of every rank, and a few hysterical Peak Oil websites.
    I am nearly certain that 2008 will mark the year of Peak Demand (unless it was 2007). Just check out world oil demand back in 1980, after that spike.

  5. doggy said: “we reinvest it all”. That’s probably a flat-out lie,

    Most of the majors are investing MORE than their earnings, and are able to buy back stock at the same time. There is a difference between earnings and cash flow. For people who are paid salaries our after-tax income and cash flow are the same. Corporations report earnings after depreciation. Cash flow is earnings PLUS depreciation. So yes, it is possible for them to invest more than they make. They could also borrow more money or issue additional stock.

  6. “I still think the concept of Peak Oil is deeply flawed”

    Care to elaborate?

  7. DDW, global stockpiles are definitely draining.

    Stockpiles always drain in 1Q due to heating oil. IEA says OECD stocks fell 200k bpd in 1Q08, half of normal.

    One could argue based on yearend stockpiles that world oil demand exceeded supply by 200k bpd during 2007, but one could also argue that 2007 started out at the very high end of the range so some bleed down was called for. 200k bpd is a rounding error — a few tenths of a percent of total oil demand. These fluctuations happen all the time without oil prices spiking.

    Oil markets are guessing at the equilibrium price at which supplies will increase and/or demand will fall. I think this equilibrium is well below $135 because it’s simply too easy to shift to wind or other cheap energy sources. The time required for such a switch is measured in decades, though. Oil prices may go much higher in the interim.

  8. Most of the majors are investing MORE than their earnings

    Replacing depreciation and depletion is not investing. It’s maintenance. Only oil company execs trying to scam people say otherwise. No other industry talks about maintenance capex this way.

  9. The show trials continue today in the US House Judiciary committee.

    Just when you think politicians don’t get it, one comes along that shows a brilliant insight.

    Rep. Tom Feeney (R FL-24th) just said something like this:

    “We blame speculators for the high prices. Speculators are nothing more than sophisticated betters. And they are looking at this Congress and betting that they will do nothing meaningful to give access to additional supplies. So they are betting that prices will to to $150, 200 or $300 a barrel.”

    Kudos to Rep. Feeney for having a clue!

  10. Durbin, Boxer, etc. are complete ideological pols without an ounce of real world responsiblity. They put domestic energy sources off limits and severely hamper the ability to develop nuclear resources–then they blame the oil co’s!

    Oynklent Green [OTC:OYNK] has a use for corrupt politicians of that stripe. We run them through a patented thermochemical process that turns them into energy. Voila! A problem becomes part of the solution.

  11. You really have to admire Barbara Boxer. Her state, California, consumes a huge amount of oil and natural gas, yet is against offshore drilling, LNG terminals, etc, and she still has the balls to sit there with a straight face and call oil execs out.

    I shudder when I listen to these morons.

  12. Lots of you (Benny, King, al) like to talk about domestic energy supplies, and the damn dirty hippies that are keeping the oil companies from poking holes in every nook and cranny of the country looking for oil.

    But what are you really talking about? Yes, there are (potential) resources that are currently off limits. But we are currently importing more than half of our oil, and no amount of domestic development is going to change that basic picture. Do you really think it is worth destroying our national natural treasures so that we can cut our imports to merely 40% of our usage for a few years? Do you really think that is going to change the geopolitical or economic reality that we are mortgaging our future to the oil exporting countries?

    Also, it’s pretty clear that in the absence of a high price signal, consumption increases exponentially. As long as oil (or energy generally) is cheap enough to waste, we’ll find ever-more creative ways to do so. And simple math tells you that you cannot meet exponentially increasing demand with supply side solutions, except in the very short term. If you had your way (or had had it historically, long enough ago that ANWR and the California coast were presently developed and online), what would you have accomplished? You would destroy the high price signal that is the only thing that appears to be able to restrain consumption even a little bit. What good would that do? We could party hearty for a few more years, maybe stretch out the short-sighted hedonism of the ’90s for another decade or two. And for what? When it’s over, we’re back where we started, except with more carbon in the atmosphere and even less potential domestic energy security.

    Fossil fuel resources are non-renewable (doh!). That means the only way — the only way — to achieve domestic energy security is to reduce and ultimately eliminate our dependence on them. There are certainly better ways to do this than to line the pockets of the middle east with our cash, but it’s obvious that our culture and the political “leadership” that it supports lacks the foresight and will to anticipate limits and enforce them on ourselves in advance.

    So instead we will learn to conserve because economic realities force us to do so. If it doesn’t break us economically, the end result will be a positive shift in American culture and attitudes, towards accepting the reality of living on a finite planet. In the meantime, the process of weaning ourselves from fossil fuels will be a long and slow one, and we may in fact need to develop all of our remaining domestic supplies in order to carry us through that time. But to do so now, when SUVs are still status symbols and 30 MPG is considered good mileage, would be ludicrous and stupid. Developing these remaining resources just to bring down the price of gas is absolutely equivalent (and equivalently stupid) to releasing the SPR for the same purpose. Same dumb idea, different timescale.

    There may come a time when it is both rational and necessary to destroy ANWR to get the oil we need to survive. But we’re not there yet, by a long shot, as evidenced by our continued attempts to perpetuate an unsustainable way of life. In the meantime, all you arch “conservatives” (gods, what a misnomer) should thank your neighborhood dirty hippie for obstructing the wanton development of these resources, so that we have them in the future when things really start to pinch.

  13. Dea Anon:
    Probably best not to start another war on Peak Oil. Suffice to say that there are 1.2 trillion barrels of shale oil in Wyoming (Green River), and Shell says they can get it up for $30 a barrel. That is just one development.
    Most easy-to-get oil right now is being left untapped, as it resides in Thug States. It is a political problem, not a geological problem.
    Okay, but forget all that: My real beef with the doomster-sky-is-falling P.O. crowd is that they fail to recognize something even bigger and faster: Peak Demand.
    Go to the Britsih Petroleum websites and check out world oil demand back after 1979. It fell 11 percent, and did not recover for 10full years, and then only when oil was cheap again.
    Tis time ‘around, we have a magic bullet: The PHEV. GM claims their Volt will be here in less than 2 years. Maybe.
    The PHEV shifts energy demand from oil to the grid. And it easy to juice the grid — nukes, solar, wind, geothermal, even dirty coal (hopefully, burned cleanly).
    I have not even started on F-T process synfuel from coal.
    Not only that, the PHEV will make city air cleaner, and quieter.
    We have a surfeit of solutions to declining oil production (caused by political, not geological reasons).
    We just need will and leadership.

  14. It is endless disturbing to me how wrong so many people see this. This country has become so short sighted. The short term answer to huge oil company profits is to buy stock in oil companies. The short term answer to soaring crude prices is to buy crude futures. Further the idea of retroactively taxing profitable industries is fundamentally disturbing as well. Taxing them higher going forward though is a different matter which I would hearty support. Further spreading the tax burden along different levels of the oil production chain would also make sense. Levy an extraction tax, a refinery pollution tax and even a distribution tax.

    Long term higher fuel prices will drive long term consumer changes. Consumers are finally starting to buy smaller cars after a decade of SUV addiction. Consumers a doing energy audits on their homes and improve the efficiency of their energy use.

    The biggest risk here is gross over-reaction by a powerful entity, the government for example, that could disrupt the evolving dynamic. What the government can and should do is work on the OTHER side of the equation. Don’t attack gas prices, rather attack the cause, high demand. Make alternatives even more affordable: public transportation, fuel efficient vehicles, etc…

  15. sen durbin knows well what he is doing/saying! notice the state[ill] represented, a member of “BIG GRAIN/farm-agro”. keep the focus on the industry causing pain to AGRO business expenses and is not totally cooperative with “corn ethanol” sales/distribution.

    for most of the other sens, remember their smiling faces at the signing of the AG/ENERGY legislation for 2007? it was played up as great stuff for USA, conjured up by new legislative body in record time.

    typical short sighted, incomplete, off the mark, pandering material–the MARK of these same folks. voting citizens, is it not clear yet whose influence[MONEY?] is in control?

    it’s not USA’s “BIG OIL”


  16. Green – Do you really think it is worth destroying our national natural treasures so that we can cut our imports to merely 40% of our usage for a few years?

    I reject the premise that oil exploration is necessarily destructive. Have you heard of the Sabine National Wildlife Refuge? Probably not. It is a national treasure that has active oil and gas production, pipelines, gas plants and other infrastructure. SNWR took a direct hit from hurricane Rita without spills or major incidents. We can drill and explore for oil and gas in virtually any environment and remediate the site back so that you wouldn’t even know that we are there. We have the technology to do zero discharge drilling.

  17. We can drill and explore for oil and gas in virtually any environment and remediate the site back so that you wouldn’t even know that we are there.

    Knowing a bit about the “remediation” standards that are applied in the context of mining operations, I am skeptical of your claims. Planting a monoculture of fast-growing pioneer species where there used to be a mature forest is not meaningful remediation in any ecological sense. But that reality is rarely understood by resource developers or the regulators that oversee them — and why would it be? It’s not in their best interest to do so.

    But let’s say I accept your assertion at face value: oil development can be clean. But the fact remains that most oil development, in most places, is in practice dirty. It’s always cheaper and/or more (short-term) profitable to exploit a resource irresponsibly than to do so responsibly. And even with the best technology and the best intentions, mistakes happen. So to develop these areas in a responsible manner will be expensive, and there will be constant pressure to cut corners, and even with perfect, uncorrupt oversight, there will still be damage. So I’m skeptical on that basis.

    But more to the point, you haven’t addressed the larger question. We cannot drill our way out of this mess. We can, at best, judiciously develop our resources as part of a transition to a renewable energy economy. But so far I see very little evidence that that is the agenda of those who would see us open those areas to development.

  18. Transportation uses 70 percent of the world’s oil. And PHEVs are on the horizon (I mean EVs, that have on-board gasoline engines that re-charge natteries, and which get 40 miles per charge from grid).
    Yes, it will take the btter part of a decade, maybe 15 years, to re-tool world fleets.
    But if I had an oilfield I would do the gouging now. It ain’t going to last.
    The estimates of demand growth are just shortsighted.

  19. I ask my friends “At what price will gasoline be to expensive”? They all reply “It’s too expensive now”, to which I reply; obviously not because you got here in a car.

    I try to explain to them that the price of gas will go up until they reduce there consumption. most people then look at me funny and say they have to drive.

    People who can wrap there heads around the fact that they need to change the way they live will get along just fine, the rest are in for a very rough ride.

  20. Knowing a bit about the “remediation” standards that are applied in the context of mining operations, I am skeptical of your claims.

    Oil production is not mining. The surface requirements are substantially less. We can drill 20-50 wells from a single gravel drill pad reaching out miles from the site. The drilling fluids can be contained in a mobile tank. In the case of the 1002 area we construct ice roads and drill only during the winter.

    But the fact remains that most oil development, in most places, is in practice dirty. It’s always cheaper and/or more (short-term) profitable to exploit a resource irresponsibly than to do so responsibly.

    And most of the oil production is in the hands of the state oil companies. Who do you think will do it more safely and environmentally responsible? State owned companies or investor owned ones? (Before you answer, Google “Top 10 most polluted places” – hint 4 are in the former Soviet Union and 2 in China.)

    There are a number of active oil and gas wells in my neighborhood. I live in a suburban area with homes selling from $200,000 to over $1 million. We hardly knew they were drilling. So no, it doesn’t have to be dirty. I doubt we could mine in my neighborhood as cleanly.

  21. Benny “Peak Demand” Cole

    I know you didn’t want to start a peak oil war but I wanted to respond to some of your comments. The cited figures for how cheap it is i.e. 30$ a barrel for shale oil are not sufficiently updated. The true cost will be much higher as conventional oil peaks and drives prices up, causing more inflation and making it certainly higher than 30$ to get oil shale. Also, how much of that oil is going to be used for it’s own process, not to mention how much water, a lot if you have been paying attention to Colorado water right leases. At present you are subsidizing unconventional oil processes with cheap conventional oil.
    As far as “thug states,” a phrase taken right out of right wing energy play books such as McCain’s and Bush’s. What do you propose we go over and steal their oil, how dare those dirty brown skinned people try to prosper and interfere with our “God given right” to their resources?
    Yes we will hit “peak demand” eventually, but at what cost? Our economy may be destroyed and whats to say that oil prices are going to become cheap again? Oil is a resource that is required for the survival of industrial society, there is No reasonable alternative to oil as a transportation fuel right now. The idea you are going to replace millions of years of ultra dense stored solar/geothermal industry with PHEV’s or something is a bit childish.
    PHEV’s a silver bullet really, so once they produce enough phev’s for EVERY American we can all sell our cars, and go out and buy brand new shiny PHEV’s? The idea that refining capacity and speculators are the problem are ridiculous it’s supply and demand, and Robert is right, everyone needs oil for survival so a small difference in supply and demand will cause a huge difference in price.
    Also keep in mind you can build all the wind turbines, nuclear plants and solar plants all you want but we will still have to heavily update the grids infrastructure or it will be like trying to fit an elephant into a dog house.
    I agree with several of the things you said, but maybe you have over simplified the situation, but denying peak oil without throughly evaluating the supposed “solutions” is bad science.
    Would you car to elaborate why I am wrong, I don’t mean to be rude btw, just trying to make an argument.

  22. But more to the point, you haven’t addressed the larger question. We cannot drill our way out of this mess.

    Not sure which mess you mean. High prices? Opening up additional US acreage would help. In the late 1990’s OPEC had just 2 million barrels of spare capacity. That was enough to drive prices to less than $20. Estimates show the 1002 alone should produce 1 million barrels a day for 20-30 years. In the 1970s adding the UK/Norway North Sea and North Slope led to a decade or more of lower prices.

    That said, I don’t think we should go back to business as usual with 2 ton SUVs and a single passenger getting 12 MPG. I would support an oil import fee that keeps prices at $60-70 per barrel or some level that doesn’t destroy the economy but drives conservation and alternatives.

    The problem is we need a bridge to alternative energies. The “greenies” will tell you we don’t need one, just jump across the chasm to the other side. They are lying to you. The executives at the hearings are the ones telling the truth. We need conservation, alternatives, nuclear, conventional oil and gas, coal. Nobody at the hearings said we could drill our way out of the problem.

  23. Oil is a resource that is required for the survival of industrial society, there is No reasonable alternative to oil as a transportation fuel right now. The idea you are going to replace millions of years of ultra dense stored solar/geothermal industry with PHEV’s or something is a bit childish.
    I would say it is childish to suggest that we need cheap oil for oor survival, with no data to back it up.

    Evidence to the contrary: oil has just doubled (bit more I believe) over the last year, and increased by a factor of five over the last 8 years (go Dubya). Yet the world economy is just humming along for the most part. Sure, cheaper energy would be great, but not essential.

    OTOH, our wise elected officials have given us such bird-brained ideas as corn ethanol, which is quickly bringing us global food shortages. I rest my case.

  24. I wanted to say that with regards to greenengineer’s arguments about how best to utilize our remaining fossil-fuel resources –

    My approach is very conservative in general, and I find myself agreeing with what you said 100%. I couldn’t have said it better. ANWR and other such places are our strategic petroleum reserve. We should all want to hold on to them for a later time, when they will be used for purposes much more valuable than propelling more SUVs down the highway.

    Today’s typical “convervative” is most definitely still in knee-jerk anti-hippie reaction mode about our energy situation. And today’s typical liberal usually takes a “faith-based” approach, with regard to how renewable sources and EVs are going to somehow magically step in to fill the gap.

    We have some serious adjustments to make between now and our “renewable energy future”. It won’t be all bad, some will be quite good. But there is quite a bit of economic dislocation ahead, perhaps very soon.

    I’m resigned to zero political help in this regard from either party. I just hope and pray that they don’t make things much worse than they already have.

  25. I caught some of that show trial on C-span last night. Energy Secretary Sam Bodman impressed me no end, as he was trying to explain this very graph to the members of Congress. Of course, it’s much harder to do without the picture, so Mr. Bodman, next time you’re due in a hearing, let us know, we can set you up with some nice graphics. 😉

    Of course, then he had to go sing the praises of ethanol, and my opinion of him descended to a more reasonable level.

    It was a bit hair raising to listen to some of our elected officials show their ignorance. Rep. Emanuel Cleaver, II (D MO) actually seems to believe that somewhere in the bowels of Big Oil is a guy (perhaps the guy who took over RR’s job), who decides oil is going to trade for $131.05/bbl today, and whose main job is then to come up with justification for that price: “The Nationals lost again!” Hard as it is to believe, he actually used that example! And this guy has the power to influence energy policy? Chilling thought.

    To be fair, some of the Congresspeople were not that dim, like the guy from FL (see King’s comment) who pointed out that restricting supply has its consequences. Or the guy (I believe it was Rep. Jay Inslee [WA]) who pointed out that one thing that can be done immediately was for Bodman and the president to encourage Americans to conserve fuel. Good luck with that – nothing that may be interpreted as we-may-have-made-a-mistake gets out of this White House.

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