$90 Oil: How We Got Here

David Ivanovich at The Houston Chronicle always does a nice job of covering the energy markets. His latest article gives a comprehensive overview of the events of the past few years that put us on the cusp of $100 oil (I actually dreamed last night that we hit $100 this week, which means I am thinking too much about it):

Factors converged to send oil prices gushing

On the catalyst that kicked off the price rise in 2004:

WASHINGTON — China’s electricity grid was near the breaking point in the spring of 2004. Facing repeated blackouts, Chinese exporters, clustered in the southern province of Guangdong, fired up their own diesel-powered generators.

China’s petroleum demand rocketed up 15 percent that year — catching world oil markets unawares. Though oil prices had begun to rise the previous year, that surprise demand from China helped propel crude costs along a trajectory in which prices have nearly tripled in just 3½ years, oil analysts say.

On OPEC’s historical role:

In 2002, OPEC had nearly 6 million barrels a day in spare production capacity. That started melting away in 2003, hitting a low point of about 1 million barrels in 2005.

For years, OPEC oil ministers struggled to keep prices within a band of $22 to $28 a barrel for the cartel’s basket of crude grades — comparable to about $24 to $30 a barrel for West Texas Intermediate, the U.S. benchmark. The fear was that if oil stayed above $30 a barrel for any length of time, the world economy would be tipped into recession. Such concerns seem almost quaint today.

As oil prices began to climb, OPEC officials came to realize high prices would not lead to “economic Armageddon,” said David Hobbs, vice president and managing director of global research for Cambridge Energy Research Associates.

OPEC abandoned its price band.

Of course as I have argued before, if OPEC does have spare capacity, as I think they do, they are playing a dangerous game with the world economy. At some point, the “economic Armageddon” may in fact materialize.

On the role of the falling dollar and instability:

The dollar’s long descent against the euro and other world currencies also has played a key role. Worldwide, oil is priced in dollars. When a dollar buys less, oil producing countries raise prices to maintain their purchasing power. Book estimates that about $17 of the current price of oil can be attributed to the weak dollar.

Political instability has always played a role in the price of oil. Estimates of the “security premium” factored into a barrel range as high as $30 or $40, Hobbs noted. Four years of war in Iraq — where production has yet to match pre-invasion levels — and rising tensions with Iran also have taken their toll.

Last week, Harvard University professor Linda Bilmes told a House panel the Iraq war may account for $5 to $10 of the price of a barrel of crude.

On the role of speculators:

In recent weeks, for instance, traders have been spooked by Turkey’s clashes with Kurdish rebels in northern Iraq. But fighting in that region could justify a run-up of maybe $1 or $2 a barrel, not the $7 or $8 per barrel seen in response, Book said.

Some analysts attribute the difference to speculation, hedging and other financial maneuvers that skew the market. Book argues that market fundamentals can explain an oil price of perhaps $65 a barrel, with political risks pushing that up to $70 or $75 a barrel.

But with the markets carried away by what Book calls “the emotions of the mob,” many oil traders expect oil prices could zoom up to $100 a barrel in coming weeks. “What people are doing is pricing in yesterday’s expected catastrophe and adding in tomorrow’s expectation of greater catastrophe. But that’s a funny way to count,” Book said.

I have been thinking lately that there is a Catch-22 in the markets right now with respect to inventories. If refiners want to wait out the current high prices by drawing their (high) crude inventories down some, the speculators say “Inventories are crashing! Not enough supply!” Then they bid up prices. If refiners choose to pay the current market prices, then they are helping support that demand at current market prices.

And of course the ever-rosy future price projections:

Oil analysts surveyed by Bloomberg forecast oil prices will fall to an average $65 a barrel next year and below $56 a barrel by 2010. But as Edward Morse, chief energy economist for Lehman Brothers, noted, analysts have been making that prediction for several years.

I mentioned two of those analysts a couple of essays back: Fadel Gheit and Daniel Yergin. Both have been consistently wrong on the direction of oil prices, and yet they are still the two main “go to guys” when someone wants an opinion on the direction of oil prices.

13 thoughts on “$90 Oil: How We Got Here”

  1. I heard him first in an audio presentation. I got the feeling that he was both full of himself, and had a sense of humor about that.

    I hope that humor part is true, it would be the only thing making the first part tolerable.

    Ah, here it is as video.

  2. You echoed my comment a few posts ago. If I were planning crude runs I might tell my refinery to stay out of the physical market for a few months and pull down inventory. Margins at $90 crude are down to $4-5. Speculators may be misreading the tea leaves.

    OPEC may have overplayed its hand as well. Americans are changing their habits to use less oil. KingofKaty has declared 2007 his year of peak oil light. In 2008 I am replacing 2 vehicles with more efficient ones. I’ve added about $500 in insulation to the attic. Our electricty usage is already down 14% this year. Other Americans could do the same.

  3. kingofkaty: First, if your moniker is in reference to your wife, I want to ask, does she know about it? Second, I want to say you are a brave man.
    Recent four-week motor gasoline use figures out from EIA show declines year-over-year, for USA. There are a lot of kingofkaty’s out there.
    Moreover, newer cars get higher mpg’s (in general) than ones retiring. This is akin to an ocean liner changing course. It takes forever, as we have 220 million cars and trucks on the road. But once it starts turning, it stays turned. Look for annual declines in motor gasoline use for a long time, perhaps even decades, if oil prices hold up.
    I think world oil consumption will also move in minor declines per year, either this year or next.
    Expect no help from Thug States. I think KSA does not really care if the West has a recession or not.
    Remember, it was a KSA-backed group, Al Queda, that destroyed the heart-achingly beautiful, nearly pre-historic statues at Bamiyan, in Afghanistan, and then subjected half of the population (women) to near servitude. They were not alarmed in the KSA. You think they wil cry if our economy goes into the dumps?
    However, a recession at this point, in conjunction with fuel-saving technologies and alternative fuels, could finally crack oil prices.
    A fun bet is puts on the NYMEX at one and two years. Be prepared to lose it all, but hope for 10-to-1 returns.

  4. “Facing repeated blackouts, Chinese exporters, clustered in the southern province of Guangdong, fired up their own diesel-powered generators”…so are they still running on the diesels, or has normal power-plant capacity caught up by now?

  5. B. Cole – my alias is a reference to where I live, an unincorporated area where the nearest town is Katy. It is also my daughter’s name. My wife knows and just laughs.

    The automakers and the public are taking fuel economy seriously. I picked up the automotive section in the Sunday newspaper to find 3 stories on fuel economy. I think Americans are serious about this time.

  6. The King of Katy is the monarch of a suburb of Houston Tx. about 30 mi due west of downtown Houston on I-10. If he were married and his wife’s given name were Catherine, or some variation thereof, and it pleased her to be known as Katie, she would probably spell it like I just did. If you Google Katy, the first half dozen references are to the Texas town.

  7. Give Fat Man a cigar – you are correct sir! The “King” moniker is a joke. I used to call myself the “Mayor”, but there really is a mayor of what we call “old Katy”. So I promoted myself.

    I live in an unincorporated affluent community of nearly 200,000 people. There is no mayor or city council, no village council. We contract for services through a municipal utility district, we have a “volunteer” fire department with full time professional firefighters. Police services are provided by both the school district and the county. There is no zoning in Texas, so the developers use restrictive covenants to limit commercial development. We have a homeowners association and about a 200-page agreement on what is allowed in our community. We have a county commissioner, but I don’t know who it is (I can name all 9 supreme court justices, the cabinet and nearly all 50 senators, but I don’t know who my representative is!) Essentially we do without a whole layer of government – and we like it that way. So the title of King was up for grabs, so I took it. I am a benevelont unseen monarch.

    I tried to describe our government to some people in New York, they looked at me as if I was nuts.

    What is really odd is that while downtowns are dying in most towns, we have a growing little downtown area with shops, restaurants, the local library, just 1 mile from our house. My kids and I walk to get our hair cut. As services have moved closer to us, we find that we drive less. But I do have a 30 mile daily commute to work. By early next year I hope to cut that to 1 gallon of gas per day.

  8. A fun bet is puts on the NYMEX at one and two years.

    I assume you mean puts on NYMEX oil futures instead of puts on NMX common stock? If so, I think you need to go out further.

    When oil prices spiked in ’79-80 it took six years of declining global demand and rapidly rising non-OPEC production to trigger a price collapse. Non-OPEC production today is rising much more slowly (if at all), and global demand is not yet in decline.

    China and India are projected to add 150 million cars (net) in the next 15 years. Even with a massive incentive program, we cannot build and sell plug-in hybrids that fast.

    That’s not to say oil prices won’t decline. But you need sub-$50 in one year and probably sub-$40 in two years for your 10x return. Short of global recession it’s hard to see a demand reduction scenario to support such a price collapse.

  9. China and India are projected to add 150 million cars (net) in the next 15 years.

    Of course, if China and India also committed to PHEVs, demand could fall pretty fast. The Chinese e-bike market is supposed to exceed 20m this year, so they’re way ahead of us in battery-powered transport. But that part of the world is trying to build $2500 cars, not cars with $5000 batteries.

  10. Simple Robert …

    Gas $7.29 a gallon

    Hydrogen $7,29 a gal. equivalent

    The Natural Gas (oil companies) and their spin-offs make 95% of all hydrogen currently produced.

    Wonder where the big push for the hydrogen fuel cell “economy” is coming from ?

    Fuel cells are less efficient than electric motors powered by the grid and will create more greenhouse emissions than pure electric vehicles..

    The reason ? The water vapor produced by reactions in the H2/O2 PEM fuel cell produce water vapor which is by far the most significant GREENHOUSE GAS of all, more important quantatively than CO2.

    But, it’s too late now. The lithium technology is out of the bag and there are many other battery technologies and storage techniques such as the Vanadium redux fuel-cell/battery.

    Chevron bought up Ohvshinsky’s NiMh patents to stop the electric trend.

    With 100 Trillion dollars of oil (est.) still in the ground at 100 bucks a barrel……………

    Well. you’re smart …

    I leave it up to you TAMU …


  11. 1. China and India are projected to add 150 million cars (net) in the next 15 years.

    2. Of course, if China and India also committed to PHEVs, demand could fall pretty fast.

    I’m sorry, statements #1 and #2 are incompatible. No matter how fuel efficient all those cars are, adding that much transportation will increase demand for oil substantially.

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