October 25, 2007
Why is oil above $90?
The answer is pretty simple, really-- demand keeps going up but supply doesn't.
The above graph plots global production of crude petroleum. Historically, the long-run upward trend was interrupted only by recessions (bringing down demand) or temporary supply disruptions arising from geopolitical disturbances. But even in the absence of such events, world production failed to increase during 2006 and is down slightly so far in the first 7 months of 2007 compared with the first 7 months of 2006.
One can look in more detail at the contributions of individual oil-producing countries to this stagnation in global production. Within the OECD, Canada was able to increase oil production by 0.2 million barrels per day in 2006 compared with 2005, thanks to booming production from its oil sands. But this was not enough to offset declining production from the North Sea, which is in a chronic downward trend due to depletion:
Comparing the first six months of 2006 with 2007:H1 one sees a similar story. U.S. production gains this year were added to those from Canada, but both were more than offset by an acceleration of the decline in Norway and the clear depletion now setting in for Cantarell, the main Mexican field.
Within OPEC, there has been good news from Angola and Iraq, which would have been enough to compensate for the turmoil in Nigeria. But all this was swamped by the 400,000 b/d cut in Saudi production during 2006, on which we've commented at length here, noting that it coincided with a big increase in their drilling efforts and circumstantial indications that production from northern Ghawar (by far the most important historical source of Saudi production) is declining due to depletion.
The same trends continue through the first half of 2007:
If production is down overall within both the OECD and OPEC, how did we manage to keep global production from actually falling? The answer has been solid production gains from the former Soviet Union areas, whose production increased 400,000 b/d in 2006 and almost an additional 700,000 b/d in 2007:H1.
Total global production may have stagnated, but demand has not. Demand for oil from China has continued on its exponential trend, growing more than 8% in 2006. Whereas Chinese consumption accounted for 3.4% of world demand in 1990, it now represents 8.6%. And if Chinese consumption has increased with global production constant, that means oil use by all the rest of us must decrease. For example, U.S. petroleum consumption fell 200,000 b/d during 2006. And what persuaded Americans to do that? Higher oil prices.
You mean it's as simple as supply and demand? Yes, I do.
But what's going to change the situation? Unfortunately, that's a harder question.
Posted by James Hamilton at October 25, 2007 08:12 PMdigg this | reddit
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As oil prices in New York rose over $92 per barrel for the first time, I guess it’s understandable that everywhere I turned this morning there was a story on oil that caught my eye. In the first (hat tip: Memeorandum) a group of oil experts agr... [Read More]
Tracked on October 26, 2007 06:41 AM
Thank you for an excellent straight forward, simple to understand economic analysis of the current petroleum market. If you are so inclined send a copy to each member of congress; single handily, you might be able to raise the collective IQ several points.
Posted by: macquechoux at October 26, 2007 04:32 AM
Why the rigs: http://www.washingtonpost.com/wp-dyn/content/article/2007/10/25/AR2007102502840.html.
Posted by: kp at October 26, 2007 05:57 AM
one word concerning supply and demand: ENRON
Posted by: anechoic at October 26, 2007 05:59 AM
Its more than just supply and demand:
1. Falling U.S. Dollar gets some credit -- The dollar is at 15 year lows versus a basket of currencies. Blame the Federal Reserve for failing to protect the currency, and forcing capital to go where its treated better.
2. Wars in Iraq, Afghanistan
3. Infra-structure constraints: Globally, there is a tight supply of ships, refineries, pipelines, and storage facilities. This contributes to a minimum amount of reserve -- no buffer -- which means Crude Oil Futures fluctuate even more than they might otherwise
4. Saber-rattling against Iran.
There's more at the link above
Posted by: Barry Ritholtz at October 26, 2007 06:46 AM
Unfortunatly I don't think even JH can raise the IQ of Congress on this or any other issue. Collectivly they have a learning disability, you might know it as, Special Interest.
Posted by: JS at October 26, 2007 07:07 AM
Oil will stay expensive. For the next several years at least. This will change exactly at the point when we can substitute oil with something else. My best guess is solar energy. Wind power is competitive now, but only in some areas (Europe has to build new wind parks offshore). Solar power will get competitive in sunny states in perhaps 5 to 10 years. That will be the end of the oil price peak and some years later the end of the oil age. At least the end of the oil burning age ...
Posted by: egghat at October 26, 2007 08:33 AM
Well - you ain't seen nothing yet.
Just wait until Dubya starts issuing ultimatums against Iran in his 2008 State of the Union address - the ratcheting up to prepare for this started just this past week, and it will keep going up.
Oil will spike to $120/$130 a barrel in late Jan after the State of the Union, and if, as I suspect, Dubya & Cheney decide to carry through with their threats - it will double by mid-year - around $220/$250 a barrel - this is made definite if one of Iran's retaliatory options is to sink some Saudi or Qatari oil tankers, oh, and maybe lob a few missiles at Dubai and all those nice shiny new buildings - send the Gulf into a Panic!
Posted by: Julian at October 26, 2007 09:10 AM
some of the leading indicators of oil demand and price look like this:
or look at the crb for industrial raw materials.
Both of these indicators signal that the world economy is just perking along despite the slowdown in the US economy-- US real POL imports have not grown for several years so US demand is essentially irrelevant as far as world oil demand is concerned.
As long as the world economy remains strong oil prices will continue to trend higher.
Posted by: spencer at October 26, 2007 09:21 AM
There was an interesting article on TheOilDrum.com last month that pointed out something new about the oil price futures strip:
Robert Smithson notes there that for the first time in years (perhaps ever?), the oil market has moved into a position of long-term contango, with the most distant futures prices being higher than ones somewhat closer in.
This has been largely overlooked because of the much more prominent change from short-term contango (rising prices as we go out a couple years) to backwardation (falling prices). This can be interpreted different ways but one version is that the market expects a slowing economy, reduced demand and softening prices over this time frame.
But the expectation of prices actually rising in the 2010-2015 era is new. It's a modest increase right now, less than a percent, but it is still perhaps significant that for the first time the market sees things getting worse for oil as we go out into the twenty-teens. This is the first evidence I have seen that perhaps the Peak Oil message is starting to make itself felt among oil traders. It will be interesting to watch these long-term futures prices to see if we ever align with the canonical PO prediction of a straight contango relationship all the way out.
Posted by: Hal at October 26, 2007 09:37 AM
A quick check of historical prices show that until about 2002, the price was below $30. I don't think 5+ years is enough to (a) convince producers that higher prices are permanent and (b) bring more production on line or (c) increase conservation radically.
Longer-term - we will adjust.
Posted by: Rich Berger at October 26, 2007 09:38 AM
The Inevitable Peaking of World Oil Production by Robert L. Hirsch
"higher prices and improved technology are unlikely to yield dramatically higher conventional oil production"
"waiting until world oil production peaks before taking crash program action leaves the world with a significant liquid fuel deficit for more than two decades"
"failure to initiate timely mitigation with an appropriate lead-time is certain to result in very severe economic consequences"
"Over the past century, world economic development has been fundamentally shaped by the availability of abundant, low-cost oil. Previous energy transitions (wood to coal, coal to oil, etc.) were gradual and evolutionary; oil peaking will be abrupt and revolutionary."
Robert L. Hirsch has served on numerous advisory committees related to energy development and is the author of the Peak Oil Report for the United States Department of Energy. Hirsch directed the Office of Fusion Energy during the evolution of the Atomic Energy Commission, through the Energy Research and Development Administration to the present Department of Energy.
Posted by: peak oil at October 26, 2007 09:58 AM
as long as folks are making predictions -- i think american and other global credit problems will put a damper on global growth over the next few years (the economic rise of china and india will not, after all, occur in a straight line any more than the united states' rise did -- their bubbles will pop). that will, i think, mitigate real price increases in the short- to intermediate-term.
but i'm as convinced about ghawar as i am about cantarell, and i think it means the end of cheap oil. there's simply no "adjusting", short of rationing... or...
i think it's indisputable that the united states invaded iraq primarily with the intention of putting oilfield development in iraq on a modern footing. IF western iraq -- which is still largely unexplored, as i understand it -- yields huge new strikes and there's enough stability in country to actually develop them, the global production plateau might be significantly extended.
Posted by: gaius marius at October 26, 2007 10:05 AM
JDH, can you please reconcile your statement that "Total global production may have stagnated, but demand has not" with your statement on Aug 9, 2005, that "Supply equals demand today, supply will equal demand in 2025, and supply will equal demand in 2050." (This earlier statement was made in a harsh criticism of the Hirsch report on energy, which said that "World oil demand is expected to grow 50 percent by 2025." You ridiculed this statement as hopelessly ignorant of economics.)
Posted by: Avo at October 26, 2007 10:44 AM
Avo, please allow me to distinguish between an upward shift of the demand curve (people would purchase a larger quantity of oil if the price were to have remained the same) and movement along the demand curve (people cut back consumption of oil because the price goes up).
We have seen an upward shift of the global demand curve, in no small part from changes in China. Because there has been no corresponding shift of the supply curve, the price has risen so as to prevent total quantity demanded from going up. Quantity demanded is higher in China and lower in the U.S., but global quantity demanded is about where it was a year and a half ago.
That is why it is simultaneously true that "demand keeps going up" (i.e., the demand curve has shifted up), (2) supply has not increased, and (3) demand equals supply.
Demand equals supply in 2007, just as I predicted it would in 2005, and just as I predict it will in 2010 and 2015. But having demand equal supply in 2007 requires a higher price than it required in 2005. That's the point of my post.
Posted by: JDH at October 26, 2007 11:11 AM
Demand is a function of price, as is supply, and where those curves cross we find the market price and quantity. But those curves also shift over time. So when people say, "Demand will increase by X%" they mean, "at a given price".
Historically, the demand curve has been shifting to higher quantities -- more and more people willing to pay $30 for a barrel of oil. Supply has also been shifting to higher quantities as more fields were found, infrastructure was developed, secondary/tertiary recovery methods were adopted. The net result was steadily rising quantity at a more-or-less constant price. Now I think things are changing due to depletion, and the supply curve is shifting back towards lower quantities (or higher prices for the same quantities). The result will be a fundamental change in the oil market, from rising quantities and stable or cyclic prices to rising prices and stable or cyclic quantities. Higher prices will continue to bring oil to market, but it's going to take continually higher prices to do it. And Rich Berger is right that the psychology of rising prices hasn't yet caught on.
egghat is right that in the long run, the price will be capped by the price of substitutes and/or the price of conservation. That happened for power generation and most home heating in the 80's. We don't yet have good alternatives for transportation fuel, but there's a lot of room for conservation there. I'm worried about the transition however. We have a lot of sunk costs based on our current oil paradigm, and short-term price spikes could be quite severe before we invest in a new infrastructure.
Posted by: lilnev at October 26, 2007 11:14 AM
Oil prices are not in long-term contango. The prices for 2009 through 2015 contracts are all in the $78-$79 range. As always, the far-out curve is basically flat. An occasional uptick here or there is not really neaningful in markets that are so thinly traded.
Posted by: bartman at October 26, 2007 01:40 PM
Just criss-crossing my hands and sliding them, it appears that if we just see an upward shift in the demand curve with no change in the supply curve, the price will go up, yes, but the quantity supplied will also go up.
In this case, we have quantity supplied staying the same for the past couple of years while the price increases. That would suggest an upward shift in the demand curve coupled with a downward shift in the supply curve.
It is confusing that people often write, somewhat colloquially, "demand" when they mean "consumption". Likewise they write "supply" when they mean "production" (which basically equals consumption, modulo a small percentage which is stored or withdrawn from storage). I have been guilty of it myself; it is a hard habit to break.
In this case the graph relating to China is of consumption and not demand. By itself it does not prove that Chinese demand is increasing. However since we also know that oil prices have been rising over this period, then the increase in consumption must be due to increased demand, and the case is made. But we do need that extra step.
Posted by: Hal at October 26, 2007 01:42 PM
The price differential between sweet, light crude and sour crude is growing and so more sour crude is being used. I am no expert but from what I have read this has been good for US refineries because they can process sour crude more easily than other refiners. Sour crude is difficult to crack into gasoline but can be cracked into diesel. If you diesel prices decline you will see the sales of diesel automobiles increase and gasoline usage decline.
There is no real crisis. The market will take care of distributing products as long as the folks in government don't step in a screw it all up like they usually do.
Posted by: DickF at October 26, 2007 01:54 PM
I would think supply is also price sensitive. Of course, only above a certain price. Coal can be liquified, and above say 100$ it is already a good business.
Posted by: Tom at October 26, 2007 02:12 PM
Hal: "Just criss-crossing my hands and sliding them, it appears that if we just see an upward shift in the demand curve with no change in the supply curve, the price will go up, yes, but the quantity supplied will also go up."
Hal, bend the fingers of your left hand straight up....in the short run I'd suggest the supply curve is essentially vertical... it is very, very hard to scale up production quickly in the high-cost, high-expense areas that are coming on line now (the Alberta Oil Sands are a case in point: that area of Canada is so busy and strained that the existing infrastructure is ready to strangle itself)... meanwhile, the easy oil is inexorably running out.
Posted by: D Slam at October 26, 2007 05:46 PM
JDH, I'm more than happy to allow you to distinguish between an upward shift of the demand curve and movement along the demand curve. But you really ought to extend the same courtesy to others. When the Hirsch report referred to rising demand, it was pretty clearly talking about the former. Yet your response at the time (8/9/05) dripped with nasty sarcasm, and seemed to deny this possibility altogether: "I'm sure that most of my economist readers are shaking their heads in disbelief at this point ... How much oil is demanded at any given time depends, among other things, on the price. ... I suppose that if one did have the view that demand was something that just grew on its own without any regard to the price (as this study seems to me to do) ... Since Hirsch is using this notion of "world oil demand" in a way that he presumes holds meaning to any reader, but is definitely not the way mainstream economists would use the expression, I simply have to guess about what he thinks he means by the phrase ..." And on and on. And now we find out that, gee, demand curves can shift upward! From your 8/9/05 post, one would never have guessed that you (or any economist) considered this possible at all.
Posted by: Avo at October 26, 2007 06:05 PM
Avo, if you see me as nasty and sarcastic, perhaps that says more about your judgment than mine.
I discussed this precise issue at length with Bob Hirsch a year and a half ago. I assure you that his interpretation at that time was not the one you are putting in his mouth for him today, though I hope that he was closer to this understanding after our discussion than he had been before I debated these issues with him. And I assure you further that my exchange with him was unambiguously friendly and courteous. I came away admiring Hirsch a lot for the way he is able to reconcile his personal passion for these issues with an openness to try to understand the perspective of others.
But I would nevertheless suggest that his 2005 report contained some basic misunderstanding about the role of supply and demand.
Posted by: JDH at October 26, 2007 10:21 PM
JDH, I'm glad that you had a friendly and courteous discussion with Bob Hirsch, but I'm going to guess that you didn't start it off by handing him a copy of your old post (the tone of which readers can judge for themselves). Incidentally, at time you wrote that post, you were also quite insistent that the best possible predictor of future oil prices was the futures market, which was predicting (as it nearly always does) essentially flat prices going forward. Some of us claimed that rising prices were far more likely, due to obvious facts about available supply. You and other economically sophisticated commenters were quite certain that these facts had already been taken into account by the futures market. I and other peak oilers believed that it was clear that the market was not accounting for these facts (since if it was, it would predict rising prices). Score today: peak oilers 1, economic sophisticates 0.
Posted by: Avo at October 27, 2007 08:37 AM
Professor Hamilton, you definitely have to take into account that you are measuring prices with a shrinking yardstick.
It's not just WTI above 92. It's also EURUSD just below 1.44, USDCAD at 0.96, gold above 780, soybeans at historic highs and wheat just below them. And it's rampant inflation in all countries with Current-Account surpluses that keep their currencies pegged to the dollar: China, GCC, Argentina...
The point is that, unless the Fed changes course, the USD will lose value against real things, no matter what central banks of countries with Current-Account surpluses do with their exchange rates:
- if they stop intervening and let their currencies appreciate against the USD, prices will keep stable in those currencies, but will rise in USD;
- if they keep buying dollars and printing huge amounts of their currencies (as China, GCC, Argentina et al are currently doing), they will keep the exchange rates stable but will have high inflation, so prices of real things in USD will rise just the same.
Players all over the world are starting to assume that the USD will just keep losing purchasing power in real things. The US is risking a massive run away from the USD and the loss of its role as reserve currency. As Krugman said in his latest paper, the USD could have a "Wily E. Coyote moment". And as he also said, the US in 2007 isnít Argentina in 2001. Only that, contrary to what he meant, the US could be in a much direr situation now. Because even when Argentina's imports dropped from 20 billion USD in 2001 to 9 billion in 2002, she was an oil and natural gas exporter. What if oil and ng exporters now decide (realize?) that they have way more than enough USDs and USD-denominated debt in their reserves and stop selling their precious finite, absolutely-exhaustible resources to the US until they have exchanged at least half their stacks of printed paper for real things? Given that the US imports 59 % of the crude oil and petroleum products they consume, the impact on US life would be truly shocking.
This is also a natural conclusion from the Rueff's tailor metaphor, as quoted by Steil (2007)
Here's a customer (the US) to whom a number of providers sell real things (suits, shoes) in exchange for IOU's. (And by IOUs we mean US dollars themselves, not US bonds, because a fiat currency abroad is intrinsically a promise to the holder that he will be able to exchange it for goods, services or property rights from the issuing country. A bond is just a promise to get more promises.) The providers have been doing that for some time and by now have piled up a huge stack of IOUs, to the point of starting to worry whether they will ever be able to exchange the IOU's for real things from the customer. And as they see that the customer is showing no sign of lowering the amount of IOU's he issues per year (and much less stopping issuing them, and even less starting paying them out!), they can be reasonably expected to take action about the situation. What kind of action? Basically, stop selling anything to the customer until they have cashed out (exchanged for real things from the customer) at least a large part of their stacks of IOUs. Which in the real world is particularly important for the shoemaker because the product it sells (oil) comes from a finite, absolutely exhaustible endowment.
The one thing the Fed can do to stop this collision course is to send a very strong signal that they care about the USD's role as international reserve currency and about it keeping its purchasing power in internationally traded goods. That signal would be a rate HIKE of 50 bp on Oct 31. That would send this message to the world: "We acknowledge the important role the USD plays in global trade and we assure all countries that our monetary policy will be geared first and foremost to preserve the purchasing power of the USD for international transactions, so that countries can confidently hold it (or debt denominated in it) as a store of value."
Conversely, a further rate cut would reinforce the Sep. 18's message, which was: "Look, the only thing we care about when setting our monetary policy is the level of our internal economic activity. And by that we mean mainly the production of goods and services that you can't buy from us. We don't care much about our currency holding its purchasing power internally, let alone when measured in internationally traded goods. So, if you use our currency to trade between yourselves, it's your problem. And if you are so stupid as to use it (or debt denominated in it) for holding your savings, you do need professional help."
I recently published an essay on this issue at
Posted by: Beach Boy at October 27, 2007 08:56 AM
Avo, economists generally respect the opinions of the futures market over predictions in general because people in the markets are putting money behind their guesses about the future, giving them more incentive to be careful about their predictions than the typical talk-is-cheap internet blogger.
How, I wonder, do you explain the fact that the markets stand ready even today to give away enormous sums for free to Peak Oilers, if they are right? You can buy futures options that will return ten or even 100 times your investment if oil goes above $100 or $200 as many Peak Oilers believe. In fact probably quite a few Peak Oilers would see such a bet as a sure thing, yet they can get better than 50 to 1 odds in their favor from people who are basically professional gamblers. How do you explain it?
Do you believe that commodity investors are just stupid? Or perhaps they are the kind of people who are extremely careless with money, and instead of letting thousand dollar bills fall out of their pockets as they normally do, they have put up bets in the futures market without bothering to read even a few web pages on the topic of Peak Oil? Is that your explanation for why people who largely make their livelihood out of such betting are so ignorant of what you view as obvious facts about the situation they are betting on? I am genuinely curious about how you see the world.
To me, this picture is not credible. Rather, I see the situation a year or two ago as genuinely uncertain about how oil prices would change, and I would say that Peak Oilers just got lucky that their predictions were right. And I would say that today, a similar situation exists: there is no assurance about where oil prices will be a year from now, and any Peak Oiler who convinces himself that he knows for sure that oil will be $120 or whatever is being foolish and not recognizing the inherent uncertainty of the future.
(Let me also suggest that you do some research on overconfidence. People replying with intervals that they are 90% certain will contain the answer to a question are actually right less than 50% of the time.)
Posted by: Hal at October 27, 2007 05:26 PM
What about the fact that there seems to be a whole heck of a lot of demand w/o a subsequent need for delivery?
Posted by: Greg Harris at October 27, 2007 06:40 PM
Hal said: "Avo, economists generally respect the opinions of the futures market over predictions in general because people in the markets are putting money behind their guesses about the future, giving them more incentive to be careful about their predictions than the typical talk-is-cheap internet blogger."
This is a question I've raised in the past when JDH referenced futures markets for elections and futures markets for commodities: Where is the proof that they are predictive? What is their success rate?
JDH provided a reference for the accuracy of election markets--I'm not sure how accurate they were for 2006 though--but I've not seen much to tell me how well they work in the commodities realm.
Posted by: General Specific at October 28, 2007 12:54 PM
I think a part of the explanation for Oil heading towards $100 / bbl is that less than 10 years ago oil was at $10 / bbl in the mid-to late 90's. I see 2 major impacts. Some large capital projects which can take 10 years to develop from concept, negotiation with the resource owner, design, construction and startup, don't make sense in an environment where oil might be $10. And the downsizing in the industry has seriously depleted our ability to develop and execute projects...
Maybe this is peak oil, but it looks more to me like the top of a really long cycle, which sooner or later will head back down...
Posted by: dbr at October 28, 2007 03:49 PM
Hal, you have a short memory. All your questions were asked and answered back in the original comments of 7/11/05 and 7/14/05. For example, you ask if I believe that traders "have put up bets in the futures market without bothering to read even a few web pages on the topic of Peak Oil?" Yet on 7/14/05, Tim wrote about his discussion with an oil-futures trader who had, in fact, never heard of peak oil. JDH then explained that this was perfectly fine, because "there are a number of arbitrage relations that have to hold between spot prices, storage costs, futures prices, and option prices, and it's possible to make a fine living from recognizing deviations from these, even if you don't know the first thing about peak oil."
Furthermore, in the comments on 7/11/05, JDH cited data that showed that, historically, oil futures have done a poor job of predicting future spot prices. Certainly, futures prices did not predict the big spot price collapse in the eighties, or the big run-up in the aughts. Does this repeated failure signify nothing to you?
It seems pretty clear that participants in the oil futures market consist overwhelmingly of (1) those who also trade the physical product, and need to hedge prices, and (2) the arbitrageurs, trend followers, and speculators who are trying to make a buck off short term movements. Evidence for this includes the fact that trading volume drops precipitously for settlement dates past about 2 years. It seems that essentially no one is betting one way or the other on the long term trend in oi prices.
Furthermore, Jeffrey Miller cited evidence from some Harvard economists that showed that readily available information on events that were almost certain to occur in more than five years time were completely discounted by markets.
These are facts. They do not comport with your theories today, just as they did not two years ago. Yet this appears to have made no impression whatsoever on you.
You ask for my world view. I would say it is based on facts and evidence. If the available facts and evidence contradict my theories, I revise them. (For example, my view of peak oil has changed significantly in the past two years, one key reason being that the more dire near-term predicitons of peak oilers like Matt Simmons did not come to pass.)
Posted by: Avo at October 28, 2007 07:56 PM
I am no expert but from what I have read this has been good for US refineries because they can process sour crude more easily than other refiners.
The refineries that are left in the US are what is known as "super complex refineries". They have cat crackers, hydrotreaters, and the most important piece of equipment, a coker.
The coker is key. It is what turns the crap at the bottom of the barrel into stuff that can be used to blend gasoline. Without a coker, 60% of a heavy sour barrel would be asphalt.
Just about every midwest refinery is spending furiously to be able to refine the canadian tar sands. Marathon and BP are spending billions per plant.
Technically, the tar sands are known as "unconventional crude". That's the mid-term future for oil refining in the US. It is very capital intensive, and if you're interesting in global warming, it releases A LOT of CO2, much more than refining WTI, for example.
Sour crude is difficult to crack into gasoline but can be cracked into diesel.
I've never heard that before. Any chance you have a reference?
If you diesel prices decline you will see the sales of diesel automobiles increase and gasoline usage decline.
The biggest driver of diesel prices right now are the ulra-low sulfur regs. All the new hydrotreaters that have just come online have a learning curve that has not been climbed completely. The nature of the super-complex refinery is that if one of these hydrotreaters goes down, the whole refinery goes down. This is quite different from the past, where the refinery could work around any unit that was down.
This has a lot to do with all the price volatility lately. Refinery operations drive the cost of fuel more than anything else, even the cost of crude.
Posted by: Buzzcut at October 29, 2007 08:03 AM
Refineries also drive demand: crude oil is worthless unless refined.
Refinery capacity takes even longer to expand than production capacity, so regardless of where the demand curve is going supply takes a long time to respond.
And, of course, producers know this. So OPEC cuts production until global production is just AT that level of refinery capacity and no more. Any more, and the oversupply of crude would drive down crude prices, letting refiners collect the windfall rents from the bottleneck. So OPEC carefully manages supply to squeeze refiners' margins, capturing as much of the windfall as possible.
Posted by: EthanS at October 29, 2007 12:05 PM
FWIW, I've changed my view on this recently. I used to think that most of the price change occurring due to the plateauing of world oil supply had already occurred in going from $20ish to $60ish. However, conversations with a number of folks in the financial industry at the recent ASPO conference all indicated that while they personally believed in peak oil, they had to find complex euphemisms and evasions to talk about this in their institutions. They felt that articulating a view in peak oil as support for their trading positions would be professional suicide (regardless of the fact that it has in fact been very profitable the last few years).
This suggests to me that the old paradigm is still dominant in the financial markets, the new paradigm is only in the early stages of conquering the view of traders, and therefore that there are still significant profit opportunities in being long oil (though the picture is certainly complicated in the shorter term by the ongoing credit market implosion).
Posted by: Stuart Staniford at October 29, 2007 03:17 PM
Oil is above $90/barrel because the major oil producers (countries and companies) are greedy. They donít care at all about the little old lady in Wichita Falls who had to skip lunch today so that she could afford that tank of gas. Until they get some serious competition from new technologies (like electric, hydrogen, hybrid, natural gas, etc.) look for prices to continue to rise and profits to continue to soar.
Posted by: Bobbi Jo at October 29, 2007 06:59 PM
Stuart, that's interesting. Did you get any understanding of why peak-oil aware traders do not seem to be buying long-term futures in any great numbers? I've always assumed that the usual risks involved with leverage and precise market timing were too big for the potential profit (which is far less than 10,000% claimed by Hal), but it would be nice to get some field data on this.
Posted by: Avo at October 29, 2007 11:13 PM
I've always assumed that the usual risks involved with leverage and precise market timing were too big for the potential profit (which is far less than 10,000% claimed by Hal), but it would be nice to get some field data on this.
Most peak oilers seem to be buying options, not futures. (This is what Hal's 10,000% figure might refer to.) Trading options is comparatively simpler, since one could just buy some cheap out-of-the-money calls and then forget about them until the market moves in one's favor.
Posted by: anon at October 30, 2007 06:53 AM
Anon, trading volume of the relevant options is also very very small. And no option will get you a 10,000% profit on a doubling or even tripling of price.
Posted by: Avo at October 30, 2007 08:52 AM
And no option will get you a 10,000% profit on a doubling or even tripling of price.
Well, perhaps true. But peak oil theorists have been around since mid-2005 at least (see JDH's post). It could be that potential profits from peak-oil awareness have declined as egregiously mistaken expectations were corrected.
As for low trading volume, as long as speculators and arbitrageurs are willing to provide liquidity it does not have much effect on market effectiveness.
Posted by: anon at October 30, 2007 12:41 PM
Just a quick comment here on this old thread. I apologize for not remembering that I was reopening a discussion Avo and I had two years ago, and I don't want to rehash it now. I will just point out that today December 2008 $200 call options traded for 26 cents, so if oil goes up to $226 you will make your 10,000%. That is I think consistent with my claim that "You can buy futures options that will return ten or even 100 times your investment if oil goes above $100 or $200 as many Peak Oilers believe."
Posted by: Hal at November 27, 2007 10:58 AM