This Week in Petroleum 10-17-07

As I watched oil hit $89 earlier today, I just shook my head and said “We have to be very close to the top.” After all, this happened in spite of bearish news that crude inventories increased this week much more than anticipated. This happened despite OPEC boosting crude production. Today, OPEC made another statement saying they won’t rule out putting even more crude on the market. But that’s not the strongest indication to me that we have entered a speculative bubble. When people who have no knowledge of the oil industry start asking me how to buy oil futures, as they have been recently, it is a strong indicator that it may be time to exit.

Will oil run up to $100 this year? I don’t think so, but I wouldn’t have bet we would be where we are now. If you had told me at the beginning of 2007 that on October 17 oil would hit $89 a barrel, I would have thought that 1). We had attacked Iran; 2). OPEC had continued to cut production; 3). A massive hurricane had taken out a lot of oil infrastructure; 4). Terrorists had disrupted a major pipeline; or 5). Global crude inventories were low and falling fast. Yet none of those things have happened.

If we aren’t near a local top, then I will be very surprised. This is not the time of year for strong demand, and as I have said repeatedly I would not be a buyer at $90. If inventories were low and falling, then I might be of a different opinion. OPEC exports in September were up 609,000 bpd over August. Currently, they are in the process of bringing another 500,000 bpd online. But, as I have alluded to several times, they were definitely playing a risky game with the economy: Keep oil prices as high as possible without triggering a recession. Well, it is possible that they waited a little too long to boost production, and now can’t bring it online fast enough to keep prices from skyrocketing (which they have essentially done) and potentially crashing the economy. I said before spring that I thought they would boost production in the summer – as long as crude inventories were falling. Some people thought they didn’t boost production because they couldn’t. I thought they were just trying to figure out how far they could go. They may have found the edge of the cliff. We will find out pretty quickly whether they leaned out a bit too far over the cliff.

So, with that intro, on to this week’s numbers, from the EIA:

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) rose by 1.8 million barrels compared to the previous week. At 321.9 million barrels, U.S. crude oil inventories are above the upper end of the average range for this time of year. Total motor gasoline inventories increased by 2.8 million barrels last week, and are just at the lower end of the average range. Finished gasoline inventories fell last week while gasoline blending components rose. Distillate fuel inventories increased by 1.0 million barrels, and are at the upper limit of the average range for this time of year.

Now, this week I am going to disagree with something Doug MacIntyre wrote. Doug occasionally stops by and says hi, so maybe he will respond. In This Week In Petroleum, Doug writes:

EIA’s current analysis suggests that supply and demand fundamentals, including readily quantifiable factors such as the level of inventories and spare upstream capacity, and less quantifiable ones such as the effect of heightened geopolitical risks on desired inventory holdings under conditions of tight spare capacity, can provide an explanation of the recent increase in oil prices.

That’s hard for me to swallow. And I know Doug doesn’t want me dragging out some of the old EIA analyses on oil prices. πŸ™‚ I have some of those at work. Just a few years ago, lots of organizations were forecasting $25 oil for many years to come, based on the supply and demand fundamentals as they saw them.

Indications are that supply is on the way up. Crude inventories are very high in the U.S., and not in terrible shape for the OECD as a whole. Fall turnarounds are under way, so crude demand will be down. The fundamentals haven’t so drastically shifted in the past couple of months to justify this sort of run-up. I could much easier explain why gasoline should be $4 based on the fundamentals. But $90 oil? Not yet.

The data I posted yesterday show that speculators are piling in. How much impact are they having on the price? Hard to say. In a very tight market, it doesn’t take too much speculation to have a disproportionate impact. How does speculation drive up the price? I have seen this question frequently asked. If you are speculating, you are an additional buyer or seller of crude. If the speculators are heavily weighted toward people wanting into the market, then demand is artificially high, so prices are bid up.

Now don’t get me wrong. I am not trying to talk down the price of oil, nor am I whistling past the graveyard. I want to see oil climb to an even higher level. That will stimulate conservation so supplies will last longer (and my kids will have some), and it will stimulate investments into alternatives. But I would prefer not to see it get way ahead of itself in a speculative bubble that could pop and cause investors to push the price down lower than it should be. I would also prefer to see the economy have time to adjust to higher prices.

I do want to see $100 oil. But not until January 2008. πŸ™‚

11 thoughts on “This Week in Petroleum 10-17-07”

  1. tRobert – you are right as usual. Looking at the current inventory levels, turnaround schedules, and the fact that OPEC is turning on the taps, even if lightly – how can we justify these prices.

    Doug may be afraid to say that the emperor has no clothes – because the emperor has really good lawyers. It looks to me as the only thing supporting this level of price is a lot of paper traders convincing each others that the fundamentals work.

    Things just aren’t that tight. One of the majors needs to just witdraw from the physical market and cruise on inventory for a few weeks. They can then replace supplies in a month or two at $50/barrel. December crack spreads are down to about $4/barrel. Someone is going to figure out that things are out of whack and begin cutting back on crude runs.

    $89 crude is total madness. I would suggest that TWIP not try to justify it, at all.

  2. I have said this before, so I hope you will pardon me if I say it again.

    The Fed gets a vote on the price of anything in dollars. All sorts of commodities are going up in dollar terms. Not just oil. If you chart the price of oil in euros, you will see that the price has behaved in line with market fundamentals (at least as I see them).

    For this reason, a lot of commentators are out there telling people to buy commodities because they are a hedge against inflation. If the Fed cuts interest rates again, oil will hit the magic hundred mark regardless of inventories. Ditto if inflation shows signs of picking up in the US.

    On the other hand, if the dollar stabilizes, you may yet win your bet.

  3. the world is in a secular bull market for commodities, and will remain so until growth slows/stalls or some other thing happens to change economic dynamics. during such markets there are alternate up and down surges[crashes followed by growth]–but always up long term.

    speculation froth is always a part of the action[frothier the faster the up/down movement]. remember in a market there are always people betting on the upside equal to downside[lest long term the market fails].

    i would never try to predict highs or lows in any market dynamic. use the change-up or down to advantage. therefore when 100$$$/bbl occurs is irrelevant to the market. to a long term investor that in some reasonable timeframe it occurs is meaningfull.

    the whole set of dynamics can be portrayed in any fiat currency so long as volume data has long term integrity.

    we’re in a 30+ year bull cycle, so have at the one/two year anomolies.

    MAYBE IT IS NEXT YEAR, NEXT MONTH, OR 2009. BUT I’LL BET ON 150$$$/BBL BY 2015. IF I’M STILL ALIVE!

    fran

  4. Robert,

    If we agreed about everything, where would the fun be in that? Actually, we do think speculators have some impact, just not the huge impact some give it. This is how we see the market right now:

    1. OECD commercial inventories were 150 million barrels above their 5-year average at the end of September 2006. By the end of September 2007, we estimate ALL of that surplus was whittled away. By the end of this year, we estimate that OECD commercial stocks will be about 20 million BELOW the 5-year average, with stocks even going lower relative to the average in the firt quarter of 2008. So inventories are falling and are getting to be “low”. By the way, most estimates of crude inventories in Asia (and to a lesser extent Europe) have them low already.

    2. While OPEC has increased their production some, planned maintenance in the UAE in November is likely to slow the increase. OPEC is still producing significantly less than they were in September 2006.

    3. We’re showing a global oil balance in the 4th quarter that has demand 1.8 million b/d higher than supply, which is an implied draw at least twice the seasonal norm. The first quarter of 2008 is showing an implied draw of 1.5 million b/d, again, much larger than normal. This would mean 6 consecutive quarterly draws! A key stat we like to look at is the year-over-year increase in non-OPEC supply vs. global demand. If the world is relying on OPEC or inventories to bridge any significant gap, that is a signal of a tight market, in our view.

    4. Fall refinery maintenance in the US should begin to tail off very soon. If crude inventories are significantly lower in Asia than in the US, as US refineries come back online, US crude inventories could get drawn down if crude oil is flowing more to the East. Whether or not US refined products get drawn down will depend on the weather and the economy, but unless the US economy tanks or New England weather feels like Florida in November and December, refined product inventories are likely to be drawn down beginning sometime over the next few weeks, even with an increase in refinery throughput.

    5. Our premise is that if the fundamentals weren’t so tight to begin with, speculators would be in some other market. They are a symptom of a tight market, not the cause.

    The point of TWIP this week was not to justify anything, but to point out that in our opinion, the market is tight. Of course, smart people like yourself and kingogkaty may disagree with our assessment. At EIA, we’re not arrogant enough to think we have all the answers, as you can point out from our previous forecasts. But we have recently been more bullish than many private analysts, which has often made us less wrong about the near-term path of oil prices than many others. Our view is that the runup in prices since 2004 is demand driven and until the price gets high enough to affect the global economy enough to limit oil demand growth to less than non-OPEC supply growth for several quarters, the market will remain tight and prices high. Is that price $89? Possibly. I’m not smart enough to know the answer to that question. All we attempt to do is to explain to everyone how we see the market, which is what TWIP tries to generally do.

  5. You know, I was being a little light and not too serious when I said “black swan” above, but I think the ideas in that book have value, and might apply to a situation like this.

    Basically Taleb, and researchers like Robert J. Shiller of Irrational Exuberance (Paperback), tell us that “post hoc” analysis may differ from what we project, and even what we feel at the time.

    People have talked generally about causes that might give us this price, and then we got the price without those causes.

    The next step is negotiate a consensus on why we got this price.

    I mean, the “cause” of this price spike may be agreed upon ultimately by the financial and oil communities, but that may be more a demonstration of social cohesion than true understanding. πŸ˜‰

    I’m not saying (and I don’t think those authors are saying) we should never try for understanding (maybe Taleb goes that far?), but certainly this argues for humility.

    We can posit our best guess at an underlying mechanism, but we should always remember that we can be completely wrong. Even the consensus can be wrong.

    (There’s no way to check it in experiment, with 1000 parallel worlds or whatever.)

  6. Robert,
    I am going to have to side with Doug MacIntyre on this one.
    If you had told me at the beginning of 2007 that on October 17 oil would hit $89 a barrel, I would have thought that 1). We had attacked Iran; 2). OPEC had continued to cut production; 3). A massive hurricane had taken out a lot of oil infrastructure; 4). Terrorists had disrupted a major pipeline; or 5). Global crude inventories were low and falling fast. Yet none of those things have happened.

    Let’s go through those five points and look at perceptions rather than historical facts:
    1) This looks increasingly likely. I actually agree with your statement that it won’t happen. But with the president making references to WWIII, the risk that it could happen is increasing.
    2) What, we are going to rely on that self-serving bunch of _____? As Doug says, relying on OPEC shows how tight things are.
    3) I’ll spot you that one. It could change within a week, but the probability is low.
    4) Again, the events on the Turkey-Iraq border is making this more likely than before.
    5) Point 1 or 4 could make this a reality.
    None of these have happened, but three of them are more likely than they were even one month ago. I would say the market is responding rationally to the odds. But what do I know?

  7. Well, it is possible that they waited a little too long to boost production, and now can’t bring it online fast enough to keep prices from skyrocketing (which they have essentially done) and potentially crashing the economy.
    As I have said before, I beg to differ. I see record oil prices as a sign of a booming world economy. Afterall that’s where the demand is coming from. Where did the low oil prices of the late nineties, early 00s come from? That’s right, the fall of the Asian Tigers. I even have the MSM supporting my sentiment: From a low of just over $50 a barrel in January, oil prices on the futures market have surged nearly 75 percent. Yet the economy remains relatively healthy, corporate profits are holding up well.

    A more likely threat to the world economy is the mess in US real estate. Again, the MSM supports my case (not that having the lazy MSM in your corner counts for anything…): “Let me be clear, despite strong economic fundamentals, the housing decline is still unfolding and I view it as the most significant current risk to our economy,” Paulson said in a speech delivered at Georgetown University’s law school. “The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth.”
    IMHO, a crash in the US housing market could hurt the global economy severely. It would also give us lower oil prices.

    Personally, I prefer high oil prices and a healthy global economy.

  8. Hey, it is a bull market in oil. No fighting it. There was a bull market on the NASDAQ, and it went to 5000 in 1999. No quite an analogy….but still. Bull markets have a psychology, and it builds momentum, and then there is an exciting top.
    My bet is that oil is cheaper in five years than now. But when the top?
    I don’t know. Maybe today, maybe in a month, maybe in two years.
    The fundamentals will reassert someday.
    We could see a long secular decline in oil prices, ala 1980 though 1998.
    Look for demand to start reversing. No more growth in fossil oil demand. Since global fossil oil demand was up only 0.7 percent last year, I do not give credence to suppositions that demand is up more than 1 percent this year.
    There is a nagging problem in that oil is controlled by Thug States. There has been a perverse result going on for the last five years. The more thuggy thug states get, the less supply of oil there is. And so prices go up.
    Venezuela precedes to wreck its oil industry, and makes more money than ever. Mexico’s elite spends oil profits on larger ranches for their narco-buddies, and Canterelli declines, but the thug elite makes more money than ever. Iran, Iraq, Libya. KSA. Russia and former SU republics.
    The moral of the story is to be despotic, vengeful, corrupt and lazy, and you will make more money than ever. That is the unfortunate reality in Thug Oil States today.
    This situation may correct someday. Mexico is thinking about Canterelli. Iran is inviting oil developers. Libya has Italians in. Kuwuit, Qater and KSA are boosting capacity.
    But one can count on thugs to stay thugs. Sheesh, look at the way people live in those countries, instead of having great schools and wonderful public hospitals they have tinpot shitheads in palaces. You have to be crazy to do business in almost any Thug State.
    That is why I say we have Thug Oil and not Peak Oil.
    But thugs have staying power. Maybe we do see $100 oil. A year ago, I thought we would see glut. But since then I have looked more closely at who owns the vast reserves. It ain’t anybody you want to do business with. That is a bad, bad sign.

  9. Hi Robert,

    Yes,more than 6 months ago, I wrote an opinion to Steve Hargreaves in response to his article on “Why oil wont’t hit $100” -here it is:

    ” Hi Steve,

    What’s all these rethinking about possible oversupply of capacity, mitigating a fall in oil prices ?
    It wasn’t too long ago, when all these same analysts, strategists, experts, et.el are predicting oil will breach $100 ?

    As I have alluded in previous commentaries, to the run up in oil prices, there never has been any real fundamental reasons of supply and demand, refining capacities – they are spins emanating from the funds to make these volatility acceptable. Now that an imminent credit crunch is unleashing the full power of its rage, pricing of, $40 is being touted or is that a new spin ? Someone is making an arbitrage here !”

    Then, I have not read of the conspiracy by the bankers – “The Money Masters” .

    The most remote rationale for prices is that of supply / demand. It has all to do with the traders making a gamble, aided and abetted by Wall Street Bankers and Funds.

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