Mega-Bear versus Super-Spike

Update: Never say never. Today, the prediction I made in 2005 that WTI would never again fall below $50 has fallen. Front month WTI as of this writing has dipped to $49.75. But it will never fall below $40. 🙂

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In 2005, with oil trading in the $40’s and $50’s, Goldman Sachs raised some eyebrows when they predicted that we could soon be looking at a ‘super-spike’ and oil prices going as high as $105. As this scenario played out this year, the analyst who made that call – Arjun Murti – raised the ante and said that we could soon see oil at $200. The New York Times, in an article in which they dubbed him an ‘oracle of oil’, reported:

An Oracle of Oil Predicts $200-a-Barrel Crude

Arjun N. Murti remembers the pain of the oil shocks of the 1970s. But he is bracing for something far worse now: He foresees a “super spike” — a price surge that will soon drive crude oil to $200 a barrel.

Mr. Murti, 39, argues that the world’s seemingly unquenchable thirst for oil means prices will keep rising from here and stay above $100 into 2011. Others disagree, arguing that prices could abruptly tumble if speculators in the market rush for the exits.

There are some things to be said about predictions. If a person makes enough predictions, they are going to miss some – no matter how well they know their subject matter. On the other hand, when many people are making predictions, some will inevitably get it right for the wrong reasons.

Today I spotted a story in CNN that contrasted Mr. Murti’s prediction with that of Paul Sankey at Deutsche Bank:

Deutsche Bank ‘Mega-Bear’ Stomps Goldman’s Oil ‘Super-Spike’

I have a lot of respect for Paul Sankey. In my opinion he is very knowledgeable about the fundamentals of the oil markets. I commented on his 2007 testimony to the Senate Committee on Energy and Natural Resources on oil prices previously here. So where does Sankey think things are headed?

NEW YORK -(Dow Jones)- Oil prices could fall as low as $40 a barrel next spring as an overhang of new, efficient refineries come on line, an analyst at Deutsche Bank said Wednesday.

Calling it the “mega-bear” case for oil, analyst Paul Sankey said the combination of weak demand for gasoline and other products, coupled with the start-up of 2 million barrels a day of processing capacity at a new generation of refineries in India and China and expansion projects in the U.S. will combine to depress oil prices.

Sankey’s stance, while pessimistic, still anticipates slightly higher oil prices than the bank’s commodities analysts, who on Friday said that oil futures prices could fall further to $30 a barrel under their worst-case scenario.

While I don’t discount that Sankey could be right, I don’t think his reasoning in this case is sound. Added refining capacity does nothing to help add new crude supplies. New refinery capacity would primarily put downward pressure on gasoline and diesel prices. Of course if the added capacity is designed to primarily handle cheaper crudes that are heavier and more sour, then it would lessen demand for light, sweet crude and Sankey’s scenario could come to pass.

In some cases, those who get it right can be spectacularly wrong on their reasoning and may not really understand much about the fundamentals. I am not suggesting that Mr. Sankey or Mr. Murti fall into that category, but I have run across speculators who cited their conviction that Saudi production was on a steep decline as the reason they were betting on higher prices. For a while, it was difficult to argue with these people, as they could simply point to the oil price as vindication. In the short run, smart people can get it wrong and uninformed people can get it right. But those anomalies will tend to correct themselves in the long run.

Personally, I predicted in May of 2005 that we would never see oil prices drop below $50 again. While I have been correct for the past 3.5 years, when I checked prices last night after touching down from Europe I saw that I am coming increasingly close to being wrong on that account. Oil is now trading at $52 and change, so my prediction could be falsified any day now.

For me, the important thing is to understand why that prediction is on the verge of being falsified. Have I been one of the lucky who was right, but for the wrong reason? What I foresaw was continued tightening demand that kept upward pressure on oil prices. What actually happened played out like that at first, but then we saw a huge spike that ultimately crushed demand. I think without this summer’s huge spike that today we would be trading in the $70’s or $80’s as demand continued to creep ahead. So I think that even though my prediction may be falsified, the reasoning behind it is still sound.

In the long run, I still see the same thing. I believe we will revisit $100 oil within a couple of years (in my ‘steady growth’ model, I foresaw us first cracking $100 in 2009). While there will be great volatility as we are seeing now, I don’t believe we will return to years of oil prices at this level. I think that we are bottoming out, and 20 years from now we will see a whip-saw on the graph for 2008, but we will continue the same upward trend that has been in place since 2002.

45 thoughts on “Mega-Bear versus Super-Spike”

  1. Considering the quickly deteriorating state of the world economy and increasingly bold predictions for Great Depression 2, I would not be surprised by much lower oil prices to come. A combination of slackening demand and the gloomy economic outlook are depressing the market. Actually, when you consider what oil does for us, it’s worth more than a mere $50/bbl.

    But, I see high oil prices again in the future. Not because of a substantial rise in demand, but because there is not enough money being invested in oil infrastructure and the development of new oil fields. There are two reasons for this. One is the credit crunch, which ultimately leads back to oil. The second is that the price of oil is too low to kick enough money back to producers for new field development. In fact, if you peruse oil industry sites, you’ll find no shortage of articles pointing out that too-low crude prices are jeopardizing new field development. Therefore, a combination of production decline in existing fields and not enough new fields to replace them are going to create a serious supply crunch. Exactly when that happens of course depends on a number of variables.

  2. In pre-Revolutionary France; in Ireland in the potato famine, and in the US during the great depression, many people starved in the midst of relative plenty.

    There are signs that we – the world – has reached or will soon reach a Catch-22 situation regarding oil. If the price is too low, as now, then investment in “difficult” extraction projects ceases. If the price rises in response to increased economic activity, constraints on flow, now that we are probably on the peak plateau, quickly stifle recovery.

    The huge economic contraction taking place around the world seems likely to crimp the ability to raise flow rates in the future. After a year (or several) of going “backwards” economically, we could see recovery faltering if prices reach “only” $80 or $90 in today’s money.

    That could happen if Stoneleigh’s deep deflation scenario on Wednesday’s Automatic Earth comes about. We could go into post peak renal failure at say $90 (heck, it could be $51) while waiting for a $300 a barrel heart attack that never comes.

  3. The massive amount of credit and cash being injected into the worlds’ economies guarantee that prices in general (oil prices included) will escalate … someday. In the meantime, yes, we are going to have to sit out a deflation/depression (and hugely change our way of living) for God knows how long. There is something bigger than the oil industry. It’s called the “world”. 🙂

  4. Did I hear my name? Did somebody say “Mother Of All Gluts” (And that is gluts, not glutes).
    First I would like to comment on RR’s observation that smart people can get it wrong in the sort run. Hey, I have been wrong in the sort-run, the long-run and the medium-term term in my storied careers. And I will be wrong again.
    Back to the news: Oil at $40? That’s a wimp forecast. It is trading right now at $46 on the Brent Spot market.
    A serious question for RR: Did even one member of the ASPO or TOD predict sub-$50 oil by yearend? Does even one predict $10 oil by next year?
    What does that say about the diversity and intellectual curiousity about those two groups?
    There is a vaulable lesson for all of us in this: Always welcome dissent, always encourage people to speak their minds (excepting hate messages, perhaps), always be curious about why people believe something different from you.
    None of that exists at TOD, and possibly ASPO.
    I commend RR for tolerating all points of view on his website, and it is a richer place for it.
    Frankly, it is a wonder to me that anybody thinks oil will stay above $40 next year. A global recession and increasing output of oil and liquids surely means Mr. Glut is stepping into the batter’s box.
    But that’s why I read R-Squared: I want to know why people think it will stay above $40.

  5. Just consider the discussion in the Saudi palace: oil price dropping, what to do? Hey, what if one of our tankers got hijacked (wink, wink)? That could drive up the price of oil. And if that does not work, then ….

    Price of oil is a reflection of both supply and demand. That is true on the downside as well as the upside. There are many ways for key players to influence the supply side — OPEC cuts; buying elections in selected democracies; supporting terrorists in specific countries.

    Bottom line is that we should all be prepared for volatility & surprises in the price of oil.

  6. Drivers in my city get about half their gasoline from Canadian heavy sour that is piped directly from Alberta. I have never seen a definitive range of how much it costs to produce that oil/barrel, but I have heard 70-95$/barrel. Can anyone say if the oil sands operations are losing money or how long they can continue like this?

    Robert

  7. Kine: The price of oil is also set speculatively on the NYMEX, and given that demand is short-term inelastic, speculators can control the price for months, maybe even years.
    Oil exporters no doubt try to manipulate trading prices on the NYMEX, and finance hedge funds and others to that end. If I were an oil-exporting nation, I would also fund peak oil hysteria, through compliant websites, and “news media.”
    That latter option might explain the utter lack of intellectual diversity at some peak oil websites.

  8. Added refining capacity does nothing to help add new crude supplies. New refinery capacity would primarily put downward pressure on gasoline and diesel prices.
    It’s amazing how many analysts fail to understand this. Of course, OPEC takes full advantage, blaming a lack of US refining capacity anytime oil prices spike.

    What is so hard about understanding that refineries BUY crude and make (SELL) the fuels we all use (mainly gasoline and diesel)? More refineries mean more expensive oil (more demand for crude) – ignoring for the moment the different grades of crude.

    I suppose the people who should be out there explaining this to the public is API.

    In pre-Revolutionary France; in Ireland in the potato famine, and in the US during the great depression, many people starved in the midst of relative plenty.
    Of course, the potato famine was exacerbated by British athaurities who bought the Malthusian BS about Ireland’s population exceeding its carrying capacity. We’d be all right, unless Mr. Obama is a believer in Malthus…

  9. I wouldn’t put much stock in the predictions of these gentlemen.

    The oil market is very simple because the marginal supply is OPEC. If they can act cohesively as a cartel to cut production, they can increase the price of oil.

    When (at what price?) you can count on OPEC members adhering to quotas is a mystery itself.

    Of course, they may think it is in their best interests for oil to be very cheap for a certain period of time. Cheap oil will likely kill many plans to develop alternatives to their product as well as provide a strong disincentive for their competitors to engage in new capital projects. It will also make life easier politically for them.

    I don’t know much about the individual members of OPEC, so I will refrain from making any predictions. I will just wait for the Platts numbers to come out. I suggest that is what the rest of you do, rather than fretting about something which is impossible for you to know.

  10. I feel somewhat vindicated. All this last year I’ve said I didn’t see how fundamentals supported the high crude prices. There wasn’t $100 oil on the margin. Speculators were testing the upper end of the demand curve – and got burned.

    It turns out that speculators and excess liquidity WAS driving up the price. Now a lot of those traders are no longer creditworthy and can’t trade the volumes they were just a few months ago.

    Just as in the late 1980s and again in the late 1990s, OPEC will attempt to set quotas but member nations will cheat, attempting to raise revenues at the expense of others. This will put further downward pressure on their prices. With 3-4 million barrels of excess capacity available, prices should stay low until the worldwide slowdown is over.

  11. A serious question for RR: Did even one member of the ASPO or TOD predict sub-$50 oil by yearend? Does even one predict $10 oil by next year?

    I can say I haven’t seen anyone predicting $10 oil. At ASPO, there was one fairly optimistic presentation that supply was going to continue to grow. I missed the presentation because I was preparing for my own. But some people complained about it.

    Bob Hirsch gave a fairly optimistic presentation. He is not a doomer, but does acknowledge that we face a serious threat.

    Cheers, RR

  12. OilGuy said:

    Robert what are your feelings about incredible amount of censorship going on at TOD? I read that they deleted Datamungers account, all he ever did was challenge the ideas that were presented there. Are you planning on continuing associating yourself with such a group that only accepts one point of view?

  13. RR:
    Well, I applaud the ASPO for having at least one presentation showing a different point of view. I gather no one predicted $50 oil.
    And not one ASPO’er ot TOD’er predicting $10 oil now. Is that not a sign of group think, or a lack of diversity? A willful lack of diversity?
    After all, in the last global economic slowdown, in 1998, oil in fact hit $10 a barrel. (Actually, that slowdown was more Far East-centric than the current one. This one looks worse.)
    $10 a barrel seems plausible scenario now too–especially if we have 10 mbd of unwanted oil floating around.
    Will we see $10 oil again? I don’t know. I wonder if oil-exporting nations would first try to goose the NYMEX higher, spread some scare stories around.
    Russia is facing disaster. Mexico and Venezuela could also collapse. Iran and Iraq could see huge internal upheavals.
    May you live in interesting times.

  14. There is little doubt in my mind that this little “diversion” from normal economic times is just a breather. There are still LOTS of cars and trucks driving out there, burning lots of oil. The dropping oil prices and credit contraction (drowning expensive oil projects) are going to make cheap oil in any form near impossible medium term. Just a matter of time. The needed, overdue deflation/depression will have the stage for awhile. Then prices will escalate.

  15. It turns out that speculators and excess liquidity WAS driving up the price.
    Oh yeah? How’s that? Just because prices came screaming down does not imply that it was speculators that drove up prices.

    As an alternative view: As shown before, demand kept growing from 2005 – 2007, while supply was static. Of course, I doubt that the numbers are exact enough to say when demand might have exceeded supply, but the trend is obvious.

    It takes time for the market to respond to these things. Once the market reacted (belatedly) it overreacted. Again, to be expected in a market where there is some lag.

    Then came the financial crisis, and now we have the double whammy of recession (no longer deniable) and overshot prices.

    Keep your pants on. If these price take supply off the market (tar sands), then supply starts coming down. And you know what that means. And don’t blame the speculators when that happens.

  16. “given that demand is short-term inelastic”

    Benny, the situation is more complex than that. Some demand is inelastic (we need to eat); some demand is quantized (factory shuts down); some is partially discretionary (why refill my propane tank this week when the price is going down and I still have 30% left?).

    Politicos have also made the markets more volatile by squeezing down speculators — the guys who might buy when the price is low to sell later at higher prices.

    And supply is not fixed — any more than demand is. Unfortunately, the now-ascendant left-wingers are stuck in some '60s time warp, where evil Big Oil rules the roost. We all know better than that. The guys who rule oil supply today don't have to play by economic rules, or by any rules at all. Do the names Chavez & Putin & Ahmadingdong mean anything?

    RR's steadily rising oil price prediction is the logical "efficient market" base trend. But actual prices will increasingly be highly volatile around that trend, because the market is driven by decisions made by a few large sovereign players.

  17. Kine: Agreed.
    Still, I am beginning to wonder about Peak Oil, and rising oil prices. Imagine a world in which we utilize shale oil, or Chavez reforms and invites development of Venezuela’s trillion-barrel hoard of heavy oil in the Orinoco. Imagine palm oil plantations in which output is quadruple today’s rate. Imagine CTL. Imagine Iran and Iraq coming to their senses.
    I can sketch out a scenario in which liquid production slowly increases for centuries.
    It is not geology or science that prevents this outcome. Only man.
    We could see a peak in 2300 as easily as 2030.
    Dated Brent spot at $45 and sinking….

  18. Oilguy:
    TOD banished me twice. If you read RR’s website, you know I have a point of view, but I am always friendly and polite. I genuinely like to read what others post, and enjoy alternative points of view.
    I have deep, deep reservations about TOD, and their credibility is very suspect.

  19. BTW-For those of you who think oil will get pricey again, you might want to look at COP. BusinessWeek’s Marcial wrote a favorable piece on 11/17, and liked it at $47. It since has fallen to $41. It pays a 4.5 percent divvie now.
    Personally, I think it is too early to buy, as oil can go a lot lower. But as a long-term hold, COP is interesting. You get “paid to wait,” that is, you can collect your divvie every year. If oil goes to $100 again, you will do fine. And you can wait until that day.

  20. Looks like the new refining capacity in India could be for the heavy crude.
    http://www.zawya.com/printstory.cfm?storyid=v51n31-1TS05&l=133200080804
    " New refineries in Asia, particularly the 580,000 b/d Jamnagar II refinery in India, will account for most of the 2mn b/d increase in crude distillation during 2009, the IEA said. …The significance of the Jamnagar II refinery, operated by India’s Reliance Industries, is that it is a full-conversion, export-oriented refinery designed to process the heavy, sour crudes that are so prevalent on the market. …

    In China, the Sinopec Qingdao refinery will process 200,000 b/d of 27.5° API, 2.9% sulfur Saudi Arabian Heavy crude and 31.8° API, 2.5% sulfur Arab Medium.

    Another article says the Jamnagar II refinery opening could be delayed until April of next year. Should we even count on then?
    http://www.livemint.com/2008/11/07000617/RIL8217s-Jamnagar-refinery.html?d=1
    “Moreover, gross refining margins are so low anyway, what’s the point of adding capacity at this time?”

  21. “I can sketch out a scenario in which liquid production slowly increases for centuries.
    It is not geology or science that prevents this outcome. Only man.”

    Absolutely, Benny. We have the technology today to provide every human being with enough energy for a great standard of living indefinitely. And there is every reason to expect that future advances in technology will only increase our options.

    But instead of progress, we get the kind of anti-nuke anti-coal anti-drilling anti-industry nonsense that ends up at the dead end of subsidized windmills & ethanol.

    Eventually, the immutable laws of physics will catch up with those who put politics first. But there will be a lot of unnecessary human suffering in the meantime. The price of oil in this kind of environment is essentially unpredictable.

    If politicians were smart — today's low oil prices would be a great time for rapid international efforts to buy & store very large volumes of oil; then in the future when the world price risks getting too high, sell that stored oil to stabilize the market.

  22. In the comments of a thread, if you try to click on his name now, you get permission denied, which means they are deleted

    OK, I was hoping there was some public discussion on this. I don’t want to air dirty laundry, but I will make a couple of comments. The diversity of opinions over there is wide-ranging among the editors and contributors. People have very different ideas about how far to let people go. I try to err on the side of free speech, and I only support bannings in very extreme situations.

    There have been bannings that I strongly disagreed with, and others that I didn’t even know about until long after the fact. However, datamunger is alleged to have contacted one of the contributors’ employers to cause them some trouble at work. I do not know details on this, and I can’t attest to the level of accuracy. But my understanding is that this was a factor in the banning.

    Again, not my intention to air dirty laundry. I don’t agree with everything that goes on there, but I credit TOD for really boosting my visibility. A lot of the traffic to this blog originates there, so there has been a mutually beneficial relationship.

    That’s about all I can say on the matter, but if you do see this being publicly discussed, someone let me know.

    Thanks, RR

  23. I too was following Datamunger in that thread, and I believe I know what happened. Datamunger made a post saying basically that maybe their should be a watchdog to watch the watchdog (TOD). Nate got pissed and called Datamunger a A$$hole (which he deleted an hour or two later), something tells me this pissed off (rightfully) datamunger….

  24. Optimist – I believe in markets too. But if I attend two auctions with identical items. The first auction has 10 bidders and the second auction has 100 bidders. Knowing nothing else, which auction do you think would pay the higher prices?

    We had so called “energy experts” trading crude oil futures who know nothing about our business other than what their Black-Scholes models told them. Your supply-demand chart showed 2003 as being just in balance, but we didn’t see runaway prices then. The marginal price of production is somewhere around where we are today $40-60. (I know Benny it is maybe $10 in Saudi Arabia). Above that was pure speculation on what consumers would be willing to pay.

  25. “The marginal price of production is somewhere around where we are today $40-60. (I know Benny it is maybe $10 in Saudi Arabia).”

    With much respect, King, those figures may not be relevant.

    Efficient market economic theory suggests that the price of an item should approach its marginal cost of production. But the marginal cost of which source of production?

    For an existing big oil field with all infrastructure in existence (eg in the Middle East), the cost of production may be only a few dollars per barrel. Is that the marginal cost?

    However, replacing that production through discovering & developing a new field may be very expensive indeed — around $100/bbl. Production history shows that, for most producing countries, replacing production is not possible at any price the world has seen so far. Hence we see most countries with declining production.

    For a global commodity, the marginal price is that price which will support the last tranche of production necessary to meet demand (at that price). In the case of oil, that may be the price necessary to develop new Canadian tar sand production — which is certainly above the current $50/bbl.

    To put it more simply, if the global market for oil can over-shoot by reaching an unsustainably high price ($150/bbl), why should it not also be possible for the market to over-shoot in the other direction and reach an unsustainably low price? Expect volatility!

  26. I think we are arguing the same thing. To my knowledge there wasn’t oil sitting on the sidelines at $120 per barrel that got produced when prices hit $147. Oil sands might be the best example. There is little or no exploration risk, the biggest cost is the energy required to extract the oil sands. That depends on both the price of oil and on the price of natural gas. Since I’ve heard of rigs laying down in Alberta, I would assume that the current $50 prices don’t support further development.

    We may soon see another large marginal source of crude oil emerge with enhanced oil recovery. Estimates show that if enough CO2 were available, the US could produce an additional 2-3 million barrels of crude through EOR primarily in the Gulf states and Oklahoma. CO2 legislation will make a lot of CO2 available.

    EOR barrels will be a new source that may be marginally high cost to produce but have low political and exploration risk.

  27. King/Kine:
    The marginal costs of production tends to be low, much, much lower than the cost of development. In the Mideast, the marginal cost is usually considered to be in low single digits. Tar sands are probably at the high end, given the machinery and labor involved in just excavating the stuff.
    I never worked in an oilfield, but I am told that “shutting in” existing production almost never happens, and is very unlikely to happen when oil is still over $40 (a fat price just three years ago).
    Sheesh, $30 was the going rate until the bubble.
    How did we ever reach $10 in 1998 (adjusted for inflation, maybe $15). It happened, it is a fact. $10 a barrel is obviously possible, as it happned only 10 years ago.
    Note to RR:
    I doubt TOD is a balanced website, and never has anyone explained who funds it, or its editors. Ask yourself, who is the TOD regular contributor who predicted an oil glut, or $40 oil, or who now predicts $10 oil?
    There is not a diversity of views there— that leads to intellectual inbreeding. It leads me to suspect they have an agenda or mission. They do not seek out the author of a new book calling the PO crisis a myth and ask him to be a contributor. They are intellectual weaklings.
    They censor views other than their own, and I have been banished (my sole sin was having a different point of view).
    What would be the reason for banning Freddy Hutter, other than the fact his view of P.O. meant the peak would happen many years later? Not soon enough to juice oil prices now?
    When the TOD actively invites contributors who think PO is many years off, or can be easily handled by the price mechanism, then we will know it is a serious website.
    As is it, they publish hate-peddling against authors of books which refer to the PO crisis as a “myth.”
    I am beginning to think the PO crisis is a myth too.
    The price mechanism seems to readily dampen demand, while boosting alternative fuels and fresh production, The PHEV marks a seminal change in energy demand. It is the death ray for thug oil states.
    Rather than shortages, the next two years will bring huge gluts. Maybe I am wrong — but a website that purports to be a forum should invite such viewpoints, not ban them.
    TOD is a fraud.

  28. Efficient market economic theory suggests that the price of an item should approach its marginal cost of production. But the marginal cost of which source of production?
    Efficient markets also assume that information is freely available, something OPEC goes to great lengths to avoid.

    I’d love to see an US president take a hard line on OPEC. Not unfair (“Give us cheap oil, or else!”) just hard, something approaching the way Uncle Sam treats the De Beers Diamond Cartel.

    Would make a nice contrast with the way Dubya acts around King Abdullah (“May I hold your hand? Oh, thank you! Oh! Oh. Can I call you Abe?”)

  29. By the way, the new book is entiled, “The Myth of the Oil Crisis: Overcoming the Challenges of Depletion, Geopolitics, and Global Warming,” by Robin M. Mills.
    On TOD, posters actually put up threats against this author. Those posters were not banned. Freddy Hutter was banned. I was banned. But people putting up death threats are not banned.
    Hey, maybe Mills is wrong. But he is a credible fellow. He should be part of the discussion. He should be invited in, and treated with respect.
    That doesn’t happen at TOD. The opposite happened — posters (to be honest, not editors) actually suggested violence against the author. But those posters comments remained online, and they were not banned.
    Something smells very wrong at TOD. I get a whiff of Russia.
    Optimist: You are right, that is why I post here. I look forward to your posts, even the ones that rankle me.

  30. “Efficient markets also assume that information is freely available, something OPEC goes to great lengths to avoid.”

    Don't be naive, Optimist. OPEC does not have any market strength.

    You are right that OPEC does not promote freedom of information about production & reserves. Astonishingly, OPEC (as an organization) does not even receive actual production data from its members to compare with their allocated quotas. OPEC is simply a convenient curtain behind which Saudi Arabia can operate (with occasional help from Kuwait).

    So don't expect to see The One walk up to the Saudi King and smack him in the mouth. We still don't know where all those peculiar donations to his campaign came from. And even if O owes Saudi nothing, they are still one of the most important sources of oil & finance in the world today.

  31. A serious question for RR: Did even one member of the ASPO or TOD predict sub-$50 oil by yearend? Does even one predict $10 oil by next year?

    I did. Several times on TOD and on Global Public Media interviews. this one from Dec 07.

    What does that mean? Not much. Price is poor signal of scarcity, as should be clear by now

  32. Good call, Nate H.
    So, do we go to $10 from here?
    But if price does not reflect scarcity, or more properly, supply and demand….we are joining Alice in Wonderland.
    I agree with you in one regard: Price as set on the NYMEX can, for months and even years, reflect the mood of speculators and possibly is subject to manipulation (actually, almost certainly in this last bubble).
    But fundamentally, price reflects scarcity, or more properly supply and demand (my toenail clippings are very scarce, but not valuable).
    You lost me with your price comment, which is declarative but not explanatory.
    PS Dan Stets of Bloomberg reported Friday that there is now more long positions on the NYMEX than short. We could see some NYMEX price stability for a while. The speculators, or hedge funds with money from who knows where, may want NYMEX priices up.
    I think the fundamentals assert themselves anyway in 2009-10, and we see oil well below $20 a barrel.
    With global demand ready to fall 10 percent, but liquids production up a couple percent, there will be the Mother Of All Gluts. Imagine 9 mbd a day with no home.

  33. Here is story from Bloomberg. I wonder if the speculators can keep oi up….

    Crude Oil Traders Reposition for Price Rise, CFTC Data Shows
    By Dan Stets

    Nov. 21 (Bloomberg) — Hedge-fund managers and other large speculators reversed from a net-short position to a net-long position in New York crude-oil futures in the week ended Nov. 18, according to U.S. Commodity Futures Trading Commission data.

    Each Friday the CFTC publishes aggregate numbers for long and short positions for speculators such as hedge funds and institutional investors, as well as commercial companies that buy or sell futures to protect against price moves. Analysts and investors follow changes in speculators’ positions because such transactions can reflect an expectation of a change in prices.

  34. I’m still confused about the exact mechanisms that allow speculators to have such a massive effect on prices (assuming they actually do).

    I have read, and can believe, that actual oil producers will only sign contracts with buyers who are technically capable of receiving the oil, ie, own tank farms or the like. So it’s not clear to me how a purely financial institution can actually speculate in oil, unless they do a Morgan Stanley and buy actual ships. But I’d imagine such speculation must be small relative to the actual trade in real oil.

  35. I’m still confused about the exact mechanisms that allow speculators to have such a massive effect on prices (assuming they actually do).

    There is still huge confusion regarding this issue, and the recent selloff has exacerbated understanding of speculation. Here is what happened in a nutshell. Commodities as an asset class, ebb and flow based on a)inflationary expectations (which are in turn based on a great many factors) and b)financial asset supply/demand for ‘securitizied exposure to commodities’. In the last few years we have had huge runs in many commodities – many metals had much higher runs than even oil. Hard red wheat had went from $2 a bushel to over $25 at one point. Oils run was part of a greater commodity run, but since oil directly and indirectly has more of an impact on consumers lives, it was a lot more publicized.

    Most of the events since 1999 low were fundamentally in favor of higher oil prices. The last part of the run (say from $125 to $145) was probably influenced by some large hedge funds getting ‘blown out’ (e.g their margin clerks, over a span of 2 weeks, covered all their shorts to raise funds). The credit crisis and subsequent dollar rally and equity market selloff all snowballed together as summer went on. This caused rule changes, hikes in margin %s, reduction in leverage available to investment banks (like GS and MS who changed charter and then as the major prime brokers they in turn increased margin rates for their customers) which all has led to a global margin call on FINANCIAL ASSETS, of which oil futures is one. The pre-Jul 08 correlation of oil, dollar, equities, and other commodities is mildly positive. Since July there has been an R^2 of all these of over 80% and in many cases over 95%. Recently, this ‘leverage unwind’ has been joined by concerns over future growth, so not only have people liquidated their longs but are now going short (though as of Friday crude oil in particular is showing long interest).

    In sum, financial assets dwarf the size of commodity markets. What once would have been a normal sell-off in an overbought but fundamentally strong market (oil) got expanded into a once in a lifetime (species?) deleveraging selloff. Price in this case is irrelevant – and clearly only works on the marginal barrel (e.g. irrespective if there will be shortfalls in 2016, if there is a glut of oil in December, futures prices will go down until they meet level where sellers are no longer willing to sell. That is very close to these levels – Norway already making noise about not selling crude and keeping it in ground for later years, etc.

    Speculation played a role. Govt intervention, rule changes, and massive credit crisis trumped impact of speculation on way down times 10.

  36. Nate H-
    Still, you are ignoring fundamentals coming into play 2009-10. If demand wilts as it did 1979-1983, we see an 11 percent drop in demand. It could be worse this go ’round. Plus, we have liquid coming online (gas and biofuels).
    Also, you may be able to find the report by MacKenzie Wood somewhere still online, that counts the new refineries that are coming online that can handle sour crudes. Sellers of heavy crudes complain they have no buyers, but now they will have buyers.
    Fundamentally, we could see giant global floods of oil everywhere with no home 2009-10. Yes, so bad Norway shuts in production — that validates the point. When people shut in existing, developed production, that is a sign of a honking glut to the moon.
    Demand could be very, very slow recovering, and, if demand follows the pattern of the 1980s, it won’t recover for a full 10 years. This time, with better technologies onstream, it might be longer. Certainly, if the United States adopts higher CAFE standards, it could be well longer.
    I find your explanation of the recent $100 per barrel price dump somewhat credible — yet revealing. It suggests that in fact financial players set the price of oil for months or years at a time. You say when oil dumps it is financial players, but the skyrocketing price was mostly fundmentals. Okay. I think you have it backwards, but time will tell. Eventually, the fundamentals come into play (remembering that OPEC seeks to limit production, a fundamental).
    I predict the Mother Of All Gluts drives oil down in the $20s, maybe to $10, and soft oil markets for four-five years.
    By the way, Russia looks headed straight into the toilet.

  37. “By the way, Russia looks headed straight into the toilet.”

    It is November. Despite all the Anthropogenic Global Warming that taxpayers' money is being used to study, winter will still come. And if Russia goes into the toilet, EU will freeze in the dark. Which the EU will try very hard to avoid, of course.

    Too many major players have too much at stake for them simply to stand back & let things happen. Those political factors make it very difficult to predict what happens to the price of oil in the short term.

    For example, China has enormous financial reserves and declining export markets — what if they decide to divert a lot of resources immediately into building storage facilities and importing lots of cheap oil for future use?

    There are simply too many possible occurrences to reliably predict either glut or scarcity in the near-term.

    In the long-term, there most likely will be scarcity (high oil price) until technology gets to the point where alternatives set a cap on the price of oil. But we have not yet seen the technology or the price.

  38. I think Sankey’s comment on refining reflects the nature of the new refineries, which are set up to process heavy/sour. This DOES increase effective crude supply, because a well-publicized lack of heavy/sour capacity was keeping some of this low-grade oil off the markets.

  39. John Stinson:

    1)You selectively left off part of the title of my July 28th post. The full title was CFTC Report on High Oil Prices – “Speculation My A$$”. The post was not about my opinions but my summary of a CFTC report saying that oil speculation was not (primarily) responsible for the price rise.

    2)Not one word of that post was my own opinion, EXCEPT the conclusion:
    OK, at least based on this preliminary report, speculators are not the primary culprit behind high oil prices. Clearly SOME % of oils rise is due to speculators, in the same vein that some rise in corn, live hogs and SP500 is due to speculation – in the intermediate term fundamentals will always win. The year of production peak is largely irrelevant – what matters is cheap and abundant liquid fuels to power the economic system the world has become dependent upon – for all practical purposes we are already past this point. We are likely going to continue to witness denial of this obvious but threatening theme from the Wall Street -government-OPEC trifecta. Investment analysts will claim demand destruction, governments will blame speculators and OPEC will posit that the markets remain well supplied. There will be no end to how long these parties continue to use these arguments. Every year there will be a normal 20+% correction in oil prices and confident authority figures will say that peak oil is a myth.

    3) From a post in June regarding Soros view that oil was in a bubble, again in the conclusion,I wrote:
    One of my concerns is when the pendulum swings back the other direction, and we head towards one of those ‘higher lows’, that the urgency of both supply and demand response will be lost. Both oil prices and energy stocks will overshoot on the downside and we will lose sight of the long term situation.

    4)There is a big difference between OIL specific speculation and overall FINANCIAL speculation. My two comments you cherrypicked were relating to different phenomenon.

    5)If you read all my public writing, speeches and interviews, I have been open to new trends, but in reality have not changed my views much in the past 5 years. Peak is past. Net energy is even further past. Deflation first followed by inflation. End of economic growth etc. I’m no Nostradamus, but I’m no waffler either.

    Good luck

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