Oil / Gas price. Supply and demand.

[Sam]

Not wanting to hijack the other "Gas Price" thread.

So, not surprisingly, I'm scratching my head.  Nothing has really changed in the past 6 months, and suddenly pump gas price goes down by 20%!

China, India, and other developing countries continue to use more and more oil.  The US is still oil addicted.  OPEC and other oil producing countries have not increased production.

The Alaska oil pipe incident is supposed to have some minor negative effect.  The newly found oil field in the Gulf is years away from affecting today's price.

What's going on?  I don't believe politicians are manipulating (no new or modified taxes).  I don't believe the oil companies are manipulating (too much competition, too many competitors). 

I do know that summer is over, and price usually comes down a little.  But 20%

 

[d]

i suspect the run-up in price included considerable premia for both the gulf hurricane season and middle-east tensions ... both of which, at the moment anyway, seem to have been overblown. i further suspect that some of the run-up was fueled by speculation, which having been considerably diminished, has lead some to the exits.

 

[astromeria]

It's possible that the US economy has started to slow (most economists expect slower gorwth if not recession in late 2006 and in 2007), which means projected lower demand for oil next year. I read somewhere recently (the Economist?) that China has been making improvements to its transportation and power generation systems to take better advantage of locally supplied (and very dirty) coal, which means not less demand for oil, but slowing growth in demand. Plus who knows what the Bush administration might be doing...they have that history of secretive talks (deals?) with the oil bidness. They did pull some supply from the reserves (last year? earlier this year? I forget-). Maybe that's having an effect now.

Plus the usual post-Labor Day, pre-election shenanigans.

 

[d]

there has been a modest reduction in forecasted demand growth, but i doubt the release from the reserves is having any effect at this late date (and since it must be replenished, could have a minor negative impact). domestic and global inventories are good; there are no threats of supply reduction. i seriously doubt there is any domestic politics involved in this.

 

[dmpi]

What's going on?  I don't believe politicians are manipulating (no new or modified taxes).  I don't believe the oil companies are manipulating (too much competition, too many competitors). 

Isn't it strange that they announce that the Alaska pipeline is rusted out just when oil is hitting its peak price? Turns out the pipeline has been rusting for twenty years. Then as oil falls on the way down they announce giant reserves have been found (probably like two years ago) in the Gulf of Mexico. Making it fall even faster. The timing of all this is either a terrible coincidence or a conspiracy.

 

[Gone4Good]

So, not surprisingly, I'm scratching my head.  Nothing has really changed in the past 6 months, and suddenly pump gas price goes down by 20%!

Prices running up like they did was really never justified by the fundamentals in the first place. Inventories are pretty full. Impressive world-wide economic growth has driven up demand and a number of international incidences have spooked the market (Iran, Iraq, Nigeria, Castro Jr. in Venezuela). But it seems as if a lot of speculative money piled in driving prices to unreasonable levels. Now the US and China are both trying to slow their economies, with some apparent success, and the fast money is moving out of the trade. If Iran comes around and we have a reasonably mild winter, you could see the fast money piling on in the other direction driving oil much lower.

 

[Sam]

Isn't it strange that they announce that the Alaska pipeline is rusted out just when oil is hitting its peak price? Turns out the pipeline has been rusting for twenty years.  Then as oil falls on the way down they announce giant reserves have been found (probably like two years ago) in the Gulf of Mexico. Making it fall even faster.  The timing of all this is either a terrible coincidence or a conspiracy.

OK, so far so good.  Please go on.

 

[Sam]

Prices running up like they did was really never justified by the fundamentals in the first place. 

What were the fundamentals?

 

[Leonidas]

Prices running up like they did was really never justified by the fundamentals in the first place. Inventories are pretty full.

I think I posted about this somewhere else here a while ago, but the speculators have used a change in trading regs (lobbied for by Enron) to make an end run around most of the oversight mechanisms. The London exchange has a US exchange terminal that allows them to trade here electronically. It's suspected (maybe known) that US traders have been going through the London market to use that terminal to make trades on the US market. Who's trading what is a mystery with no apparent reporting or oversight. They're free to run wild and do their damndest to manipulate the market. The bizarre price levels seen, followed by this sudden drop, are signs that the govt. needs to make some changes.

 

[wabmester]

What were the fundamentals?

The question shouldn't be why did prices drop recently.   A better question is did the supply/demand picture really change so much in the last 4 years to justify a 300% change in price.

If that price rise wasn't justified by fundamental supply and demand, then who knows where the floor might be.

 

[larry]

Speculation has kept the price high and volatile. On a side note, I just talked to a buyer for a local utility who found some pretty cheap natural gas but found all of their storage capacity full (storage facilities in 4-5 states). Had to turn around and sell what he'd just bought.

 

[Ed_The_Gypsy]

...The timing of all this is either a terrible coincidence or a conspiracy.

Black helicopters, man!

Actually, having seen behind the curtain at Big Oil (and, in a related subject, the US Govt--Army, Pentagon, etc.), conspiracy stories don't ring true to me.  You have no idea how dysfunctional those two groups are.  The only conspiracy that is credible to me is how they manage to close ranks to cover their mismanagement and incompetance. 

God bless the free press.  We would be up the creek without them.

 

[Sam]

The question shouldn't be why did prices drop recently.   A better question is did the supply/demand picture really change so much in the last 4 years to justify a 300% change in price.

If that price rise wasn't justified by fundamental supply and demand, then who knows where the floor might be.

As always wab, you're full of




charts!

Supply basically remains constant, while demand has increased significantly in the past four years.  So yeah, price change is justified.  Not sure if 300% is right amount, but whenever demand exceeds or threaten to exceed supply, price tends to go wild.

 

[wabmester]

Supply basically remains constant, while demand has increased significantly in the past four years.  So yeah, price change is justified.  Not sure if 300% is right amount, but whenever demand exceeds or threaten to exceed supply, price tends to go wild.

I'm pretty sure 300% isn't the right price increase.   Supply has kept up with demand.   Demand has always been increasing.

The average annual growth rate of oil consumption from 1997-2001 was +1.5%. The average annual growth rate for the growth of oil consumption from 2002-2006 (using EIA's estimates for '05 and '06) is +2.2%.

And instead of a chart, this time I'll give you a quote from Warren Buffett:

I don't think there's a bubble in agricultural commodities like wheat, corn and soybeans. But in metals and oil there's been a terrific [price] move. It's like most trends: At the beginning, it's driven by fundamentals, then speculation takes over. As the old saying goes, what the wise man does in the beginning, fools do in the end. With any asset class that has a big move, first the fundamentals attract speculation, then the speculation becomes dominant.

 

[Sam]

Supply has kept up with demand.

I don't believe this is true.  But I have no data to back it up.


But if it were true (supply has kept up with demand), then yes, price increase in the last 4 years has been speculative at best.  But that is too hard for me to believe.  There are so many oil producing countries in the world, and they definitely are not always best friends.  Competition is always there.  There is no room for price to go up purely on speculation.  And what speculation?  I respect WBuffet a lot, but I don't undertand this one.

 

[haha]

Over the past 5 years or so excerss production capacity has pretty well been sopped up.

There is a great deal of controversy about what happens next.

It is interesting to me that forward contracts are staying pretty high.

Ha

 

[wabmester]

I don't believe this is true.  But I have no data to back it up.

Are you interested as an investor?   If so, some data would be a Good Thing, I think.

If you can show me some data that justifies the incredible 4-year run-up in the price of oil, then I'll happily show you some data that says:

1) Demand has increased, but not a lot.

2) Supply has met demand.

3) There is excess capacity, and that excess capacity is increasing.

4) Crude inventories are at a 7-year high.

5) There is a lot of speculation in oil (as if the fact that we're talking about oil isn't evidence enough )

Honestly, I have no idea how the price of oil relates to supply and demand, but the run-up seems a bit overdone, so the recent sharp drop doesn't seem too surprising in that context.   Let's revisit this again in 10 years, when Peak Oil is really here. 

BTW, has anybody heard of these guys:  Stirling Energy?

Pretty interesting stuff -- they have a Solar Stirling Engine that is twice as efficient as solar PV cells, and they're deploying a couple of solar farms in SoCal.

 

[Sam]

Are you interested as an investor?   If so, some data would be a Good Thing, I think.

No, not as an investor. Just curious.

I did read about demand exceeding supply more than one times, but did not save the info for future reference.

 

[Gone4Good]

What were the fundamentals?

Most credible estimates put the current marginal cost of production at $30-$40 per barrel. Typically commodities will trade around their marginal cost of production but can swing widely from those levels. Significant deviation from marginal cost typically happens either with excess supply or shortages. As Wab mentioned earlier, inventories are quite high so there is no shortage. Analysts have been at great pains to explain $70 oil given the huge disparity between current prices and MCP coincident with high inventory levels. Many have now become accustom to tacking on a "fear premium" built into current prices over and above MCP. Nobody can really explain why the premium exists or why it has persisted as long as it has. Everyone assumes it is due to "geopolitical" risk and also weather related risk in the Gulf of Mexico. But all that is saying is that while no shortage exists today, the market is speculating that some event will cause shortages in the future. Now if a time comes when geopolitical risks calm down and hurricane season disappoints (as it has so far this year) that speculative "fear premium" can evaporate quite rapidly. Meanwhile $70 oil is prompting a lot of investments that might not otherwise be made . . . possibly exacerbating a correction when one finally arrives.

 

[Sam]

Thanks. I need to reread it a few more times. Not sure I fully understand it.

 

[dmpi]

OK, so far so good.  Please go on.

The oil companies are net seller of oil futures. They want to sell all the future at top dollar for X year out. So during this phase they want the price of oil to go up. After they sold out all the futures (to some hedge fund) for mega bucks, they get concerned about the demand for oil. If the price is way too high, people might even find alternate sources of energy. Now they want the price to fall. So they time the release news to help their bottom line.
Here's my prediction: You will see record profits for oil companies for 3-4 more quarters. You will also see one or two giant hedge fund bite the dust because they bet wrong on oil.

 

[larry]

This environment for high oil prices is unsustainable IMO. I've been in the oil biz for 25 years and have seen some booms and busts (remember the old bumper sticker: "Please don't tell my mom that I work in the oil patch, she thinks I'm a piano player in a whore house" That reputation has changed a bit.) Hell, we could make money at $23 oil, you certainly weren't getting rich but it paid the bills.

 

[haha]

Hell, we could make money at $23 oil, you certainly weren't getting rich but it paid the bills. 

I sure don't want to disagree with someone in the ahl bidness, but when I hear something like this I wonder if it is so easy to make money at $23, why aren't more rigs running at $60-$70? Last week, during the prime season for drilling, there were 1728 rigs running in N. America, including Canada and offshore. In ‘81 and ‘82 there were weeks on end over 4400, and some over 4500.

If you can make money at $23, you ought to be able to displace Bill Gates at $65. Why the puny rig count?

Ha

 

[wabmester]

I sure don't want to disagree with someone in the ahl bidness, but when I hear something like this I wonder if it is so easy to make money at $23, why aren't more rigs running at $60-$70? Last week, during the prime season for drilling, there were 1728 rigs running in N. America, including Canada and offshore. In ‘81 and ‘82 there were weeks on end over 4400, and some over 4500.

If you can make money at $23, you ought to be able to displace Bill Gates at $65. Why the puny rig count?

Good point, but I don't think there's much debate that the US fields have peaked, is there?

So a better question is why don't the Saudis, who do have excess capacity, crank out all the oil they can at $70/bbl?   They say their buyers aren't asking for more oil:

Saudi cut shows record oil defies market logic

Now, how can prices get that high if it's not truly demand driven?

Remeber Enron?

Here's the senate subcommittee findings that Leonidas posted a while back:

The Role of Market Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat

 

[mathjak107]

Rigs are a big problem,there is a huge shortage.My buddy is ceo of dune energy.They have oil producing properties but had to wait months for rigs.They just got 1 rig finally 2 weeks ago.
  We have about 2 million barrels a day spare capacity if all is up and running world wide right now..With india and china adding millions of cars a year that will be gone in a few years.