Enjoy the cheap fuel prices while you can

[24KT]

Enjoy the cheap fuel prices while you can


With demand on the rise, existing wells drying up and a dearth of big discoveries, the oil price is only headed in one direction.

In July 2008, the oil price hit a record high of $US147 a barrel. In its journey from the lows of 1998 to the highs of last year, many reasons were put forward for its ascent. Explanations included a so-called "war premium" , "a terrorist premium", hurricanes and evil speculators - the list of things and people to blame for the rise in oil prices was long.

As the price rose, calls were made by political leaders and interest groups for oil producers to lift production and for a cut in taxes on oil and petroleum. Accusations of price gouging and profiteering by oil companies and producers soon emerged.

Under the glare of TV cameras, OPEC promised to lift oil production and bring prices down. Yet the price continued its march upward and production rose only marginally.

The key point that appears to have been missed was that in the decade from 1998, demand grew about 16 million barrels a day while supply struggled to keep pace, particularly during the later years.

Now that the oil price has collapsed from $US147 to the $US40-$US50 region and it's off the front pages, it is yesterday's story. But is it really an old story. Have we been told the true state of play?

According to most mainstream news reports and even views presented by the investment community, oil was in a bubble and the global financial crisis has plunged the world into recession, which is leading to demand destruction for oil and hence the low oil prices.

However, in all the stories and debates that have taken place during the rise in oil price and its subsequent fall, very little attention has been paid to what is actually going on with supply.

What is also not well understood is that the oil price is set in what is called the "paper" or futures market, predominately in New York. The oil price is not set in the actual "physical" market as commonly perceived.

The players in the futures market do not all accept delivery for the contracts they trade. In fact, for a vast amount of trading that occurs, it is actually not done by oil companies or producers at all, and for a large portion of the contracts outstanding no actual oil delivery occurs. In effect, the physical barrels mirror the paper barrels and not the other way around.

In recent years, new investors such as specialised investment funds, exchange traded funds and hedge funds and oil speculators who play via the futures market have emerged. None of these are going to take oil delivery at contract expiry, either.

For the most part, it is a price-taking, not price-making, market for the producer. Rarely is this reported and this leads to a misunderstanding by the public as to the exact price setting mechanism for oil and the prices they pay at the petrol pump.

While ultimately fundamentals will win out, a big disconnect can occur between what occurs in the so-called paper market and what the reality is in the physical market. Markets are not perfect by any means. The credit crisis is a case in point.

It is in knowing these facts that we can begin to understand the basis of the wild gyrations in oil price.

To be sure, the futures market does play an important role. As with broader financial markets, there has been heavy selling in the oil market as various financial players seek to raise cash and deleverage their positions. Everything gets sold in the scramble to raise cash to pay off debts and shore up their balance sheets. This scramble would not necessarily result in prices that reflect the physical market or the fundamentals.

As we look at the numbers the International Energy Agency (IEA) publishes on oil production, a disturbing picture begins to emerge: conventional world oil production peaked about mid-2005 and has been on a slow decline since. Demand is being met by non-conventional oil sources.

Non-conventional oil is derived from activities such as oil sands and bio-oils. This production brings the supply of world oil productions up to about 86 million barrels a day, sufficient to meet current demand. Conventional crude production accounts for about 75 million barrels a day. Non-conventional sources are more expensive and require oil prices to be upward of $US30-$US40 to be viable. In fact, according to the IEA, to significantly expand non-conventional oil production to meet demand growth, prices would need to be well above current levels to make any sense.

Non-conventional sources are expensive compared to cheap Middle Eastern oil. Even deep water and ultra-deep water oil are expensive compared to Middle Eastern oil and still require oil prices well above current levels to be viable.

In the conventional oil space, Saudi Arabia, for so long the world's biggest oil producer, could potentially lose its leadership in conventional oil production, with Russia almost at level pegging according to 2007-08 data. In terms of overall energy production Russia is now the world's biggest producer.

Moreover, Saudi Arabia is resorting to massive water injections into some of its major wells to maintain production. It is difficult to know what are their true reserves and production capability.

According to IEA data, it appears Saudi Arabia's production peaked in 2005; it has not been able to surpass that year's production and has produced less and less oil in subsequent years, despite the "increased production rhetoric" that it maintains.

Unbeknown to most people, oil field discoveries peaked during the 1960s and 1970s. During the 2000s, there have been relatively few new major field discoveries - about 70 so far, versus more than 1200 during the 1960s and '70s.

In the IEA World Energy Outlook, it is estimated that the oil well decline rate is running at about 6.7 per cent. It is estimated that natural decline rates (without any capital spending to maximise production) would run at 9 per cent.

There are about 70,000 oil fields in production, with about 20 super-giant fields that account for more than 25 per cent of world production. Most of these fields are at least half a century old and well past their peak production years. For example, the top three fields of recent times in terms of reserves - Ghawar (Saudi Arabia), Cantarell (Mexico) and Burgan (Kuwait) - are all in decline.

The world is excessively reliant on oil production from "old" fields and has resulted in an implied belief of "cheap" oil continuing to flow.

Oil production is expected to decline at a significant rate from here on. To meet demand this decreased production output must be replaced and in fact added to, such that demand growth can be met in years to come.

The credit crisis has seen funds dry up for oil exploration and the commissioning of new production. Numerous projects globally have been shelved or put on hold. Many non-conventional sources of oil become uneconomic at $US30-$US40 a barrel and cannot be sustained long-term if prices remain at, or drop below, these levels. The key decision variable will be sustainable long-term price not short-term price blips.

In fact, a January press release by Schlumberger, a leading oil and oil services company, stated: "At current prices most of the new categories of hydrocarbon resources are not economic to develop."

So what does all this mean? While the focus has been on the demand side, on the effects of the credit crisis and so on, the real story is what is going on the supply side and the supply destruction that is occurring. Despite all the rhetoric on oil in recent years, very little has appeared in the mainstream press to date about the seriousness of the issue. Without the ability to meaningfully increase production, the production decline rates are likely to exceed any demand destruction resulting from a global recession.

Granted, there is oil in storage and many countries have "oil reserves". However, when considering the big picture, these reserves are by and large irrelevant.

In fact, financial markets seem to have an very unhealthy obsession with oil inventory data that comes out of the US.

Truth be told, these numbers are only estimates based on surveys - there is no one who walks around with a dipstick that can provide an exact measure of oil reserves.

Either way, these inventories would constitute at best a few months' supply. Hardly something to pin one's hopes on. Relying on, say Iraq, to be the next Saudi Arabia, may be a pipe dream with only marginal impact at best, and that is if the conflict there is ever resolved.

Also, oil-refining capacity is constrained. Very little investment has occurred during to the 1980s, 1990s and in this decade on brand new oil refining capacity, though efforts have occurred in recent years to meet the increased demand for petroleum products. Yet there is still insufficient new infrastructure to cope with a significantly higher demand scenario and a lot of older infrastructure still needs to be modernised. The credit crisis is putting a lot of things on hold.

In the meantime, the world's population grows. With more than 6 billion people on the planet, the Third World moving into the Second World and the Second World striving to make it to the First World, all this adds up to ongoing demand growth. Countries like China and India will continue to grow demand despite the global slowdown.

The real question is whether supply can grow to match. The IEA anticipates by 2030 the global daily demand for crude will be more than 120 million barrels. That is about 50 per cent higher than today.

Without new investment either in oil or some alternative, it will not take long for oil prices to begin a renewed march upwards, most possibly exceeding their previous highs. Unfortunately most alternatives are quite a way from being either viable or rolled out en masse, while other alternatives such as biofuels and similar ventures use way too much energy versus what they yield. Besides, diverting food production into fuel production while there are people starving is a perverse use of technology.

The state of play in the oil industry is unsustainable and a critical situation will be reached unless concerted proactive action is taken to address the coming crisis. Unfortunately, if history is any guide, actions will only come once the crisis is upon us.

Demand for oil has consistently grown since 1890 So, unless the world population stops growing and starts to decline, the Third World stops industrialising and the world begins to de-industrialise, it is difficult to see how demand is all of a sudden going to diminish to negate production declines from existing wells.

With no quick end in sight to the credit crisis and many oil companies in "survival mode", where will the oil production increase come from? Where are the "new giant" wells to take up the slack when the "old giants" decline?

Moreover, with uncertainty and volatility in the oil price, will companies be prepared to invest large sums in developing production of new discoveries when basic price stability is lacking? Even if an oil source is found today, it still takes considerable time, sometimes years, before any meaningful output can be achieved.

With the collapse of the oil price since last July, several major oil-producing countries are also sabre rattling and threatening to cut production to force prices to what they believe is a more "economic" level. That may create an interesting scenario where a particular price is set in the paper market but one cannot get it in the physical. Some of these nations are arguing that oil should not be priced solely in US dollars but in a range of currencies. Some are trying to lock up supplies and take them off the market.

So, has the oil price bubble burst - as so loudly broadcast by various investment pundits - or are we really sitting in the calm before the storm?

What will happen once economic activity picks up? Maybe we should enjoy the relatively low oil and fuel prices while we can.

[24KT]

For those of you who are technically inclined and like to crunch numbers... it's all in the data.




The above diagram shows that the pattern of growth in oil consumption has varied greatly for different groupings of countries. Oil consumption in China and India has continued to grow, whether or not oil prices rose greatly. Oil consumption also continued to grow in the "Others" category, which includes many of the oil producing nations. Oil consumption in the Former Soviet Union also followed a pattern somewhat independent of world oil prices. It was only the OECD whose consumption changed significantly as world oil prices changed.

Based on this comparison, it seems to me that OECD consumption is far more affected by oil price changes than the consumption of other countries. Based on data shown in this post, it seems to me that OECD economies can only absorb a price increase of US$10 per barrel in a year, without experiencing slowdowns in their economies and a reduction in oil consumption. Non-OECD economies (including BRIC countries) are more resilient, and are more likely to continue to show growing consumption.

Below, I examine similarities and differences in oil consumption patterns of OECD and Non-OECD countries and offer my view as to what the future may hold.

Recessions tend to follow increases in oil prices-for example price spikes lead to recessions in 1973/1974, 1979/1980, and 1990/1991, as indicated on this graph by Jeff Rubin when he was Chief Economist at CIBC World Markets. Even if this economic downturn is somewhat different from previous ones, it seems like strong growth in oil prices in 2008 is instrumental in slowing down OECD economies. In the early 1980s, some substitution took place, mainly replacing oil consumption with nuclear and natural gas consumption. This time there is no meaningful scalable substitute for oil, putting the OECD countries in a much worse position than they were when oil prices spiked earlier.

It looks increasingly like the OECD economies are falling victim to what I have started to refer to as the “Oil Price Trap”. The oil price (at today’s US$50/Bbl) is presently too high to add valuable pulling strength to slow down the economic downturn and bring the OECD economies back into growth. At the same time, the present oil price is too low to stimulate sufficient investment in future capacity growth to bring about much needed renewed economic growth.




Figure 01 The above figure illustrates the world supplies of all liquid energy split on classes for the period January 2001 to December 2008 as reported by EIA in their International Petroleum Monthly’s (IPM) plotted against the right hand axis. NOTE: Axis not zero scaled. The diagram also shows the movement (yellow circles connected with black line) of the average monthly oil price (Europe Brent Spot FOB) plotted against the left hand axis.

The global oil supply (all liquids) has for all practical purposes been on a plateau during the last four years. It took almost a quadrupling of the price to increase total oil supply by approximately 1 Mb/d.




Figure 02 The above figure illustrates OECD countries total petroleum consumption for the period June 1987 through November 2008 as reported by EIA plotted against the left hand axis. NOTE: Axis not zero scaled. A 12 Month Moving Average (12 MMA) is added (yellow line) to smoothen seasonal swings in consumption. The diagram also shows (thick red line) the average monthly oil price (Europe Brent Spot FOB) plotted against the right hand axis.

The diagram illustrates that as oil prices moved above US$60/Bbl, it affected growth in consumption. The diagram also illustrates that as oil prices continued to rise above US$75/Bbl, consumption started to decline. This decline accelerated with growing prices and the emerging economic slow down in 2007/2008. When oil prices remained at US$30/Bbl or below, oil consumption continued to grow at a stable rate. For OECD, historical data suggests that growth in oil consumption could be maintained while oil prices increased by about US$10/Bbl per year, and the economies continued to grow.

It is also worth noting that the growth in OECD consumption ended early in 2006. This is before Nouriel Roubini stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing, and before the acronyms CDS, CDO, SIV, Alt-A etc. became mainstream. Between early 2006 and November 2008, OECD oil consumption declined by 2,5 Mb/d or approximately 5 %, and the decline continues.

The diagram also illustrates that at higher prices, oil becomes increasingly unaffordable for OECD customers. Because of this, price rationing sets in as prices breach a certain level.

Oil prices are presently around US$50/Bbl while the OECD economies are projected (on average) to contract 5 % in 2009. If economies are contracting, this suggests that these economies now have a weakened ability to support higher oil/energy prices.

Inasmuch as the OECD economies consist of several regions with differences in taxation of petroleum products, one might expect that a higher taxation level on petroleum products would introduce some moderation in the decline of petroleum consumption when crude oil prices grow.




Figure 03 The above figure illustrates OECD Europe total petroleum consumption for the period June 1987 through November 2008 as reported by EIA plotted against the left hand axis. NOTE: Axis not zero scaled. A 12 Month Moving Average (12 MMA) is added (black line) to smoothen seasonal swings in consumption. The diagram also shows the movements (thick red line) of the average monthly oil price (Europe Brent Spot FOB) plotted against the right hand axis.

The data suggests that for OECD Europe, which has higher petroleum taxes than the US, consumption grew until oil prices reached US$60/Bbl and decline in consumption set in during winter 2007 as oil prices continued even higher.


DOES THE EXCHANGE RATE BETWEEN EURO AND US Dollar MATTER?




Figure 04 The above figure illustrates the exchange rate between US Dollars and EUROs since 1999.

For the period shown, there is little indication that swings in the exchange rate have played a significant role in OECD Europe’s oil consumption. Variations in the exchange rate seem only to introduce ripples on the surface.




Figure 05 The above figure illustrates US total petroleum consumption for the period January 2000 through March 2009 as reported by EIA plotted against the left hand axis. NOTE: Axis not zero scaled. A 52 Weekly Moving Average (52 WMA) is added (red line) to smoothen seasonal swings in consumption. The diagram also shows (thick black line) the average weighted crude oil price plotted against the right hand axis.

The diagram shows a similar pattern as for all OECD and OECD Europe. US total petroleum consumption reached a high (or peaked) about the same in time as housing prices peaked as illustrated here. The continued decline in consumption after the crude oil price collapse seems to be mainly driven by growing unemployment and the recession.




Figure 06 The above figure illustrates US gasoline consumption for the period January 2000 through March 2009 as reported by EIA plotted against the left hand axis. NOTE: Axis not zero scaled. A 52 Weekly Moving Average (52 WMA) is added (dark red line) to smooth seasonal swings in consumption. The diagram also shows the movements (thick black line) of the average gasoline price plotted against the right hand axis.

The diagram illustrates that gasoline consumption reached a high in the second half of 2007. (This also happened for diesel, while kerosene reached a high earlier.) An average gasoline price of US$2,60/gallon slowed consumption, and as the price moved higher the decline in consumption accelerated. This again illustrates that there is a threshold above which gasoline becomes unaffordable for some people, and these people start to make adjustments. The diagram also illustrates that as prices retreated to around US$2,00/gallon, the decline in consumption came to a halt.




Figure 07 The above figure illustrates oil consumption for OECD (blue), China and India (yellow), Former Soviet Union (FSU) (brown) and the others (grey) for the years 1965 through 2007 plotted towards the right hand axis. The oil price in 2007 dollars is plotted as black dots connected by a yellow line towards the left hand axis.

The figure above shows that the 1973/1974 oil price shock resulted in a relatively small reduction in OECD oil consumption and a recession.

The 1979/1980 oil price shock with the doubling of the oil price led to a longer recession, but also a deeper decline in OECD’s oil consumption. At this time, alternate fuels, including natural gas and nuclear were brought on line, reducing OECD's need for oil, particularly for electrical consumption.

As oil prices again started their growth in 2004 it started to affect OECD oil consumption and the diagram illustrates that OECD consumption started to decline while prices continued to grow.

Based on Figure 07, oil consumption for China and India was little affected by the oil price shock of 1979/1980. The recent (starting 2004) run up in crude oil prices seems to have had only a small impact on the growth in oil consumption of these countries.

FSU seems also to have been little affected by the run up in oil prices. The exception here is the dissolution of the Soviet Union, which resulted in a major decline in consumption.

The "Others" category includes all the OPEC countries, plus some other countries that have historically had low oil use. This group seems to have had a continuous growth in oil consumption independent of price fluctuations in all the years reflected in the above diagram.

Why is it the OECD economies seems to have a weaker resilience towards big increases in oil (or energy) prices than other countries?




Figure 08 The above figure illustrates oil consumption for OECD split between OECD members production (blue) and net imports (red) for the years 1965 through 2007 plotted towards the left hand axis. The oil price in 2007 dollars is plotted as yellow dots connected by a green line towards the right hand axis.

The figure illustrates that by the 1973/1974 oil price shock, OECD oil production was in a temporary decline. By the 1979/1980 oil price shock, OECD oil production had begun to grow because of additional production from fields in Alaska, Mexico and the North Sea. The availability of more oil within OECD may have contributed to the oil price decline (collapse), and cut the need for imports, thus helping the OECD economies. As oil prices remained in the US$30/Bbl (2007) range, OECD imports started to grow. The recent run up in oil prices that started in 2004 coincided with a sharp decline in OECD production and a corresponding need to increase imports.

This closer look on OECD oil production, which now is in terminal decline, and OECD net oil imports suggests this is not solely about the oil price. The effects seem to be compounded by the volume of OECD net oil imports.

Figure 01 above shows that total world oil supplies grew a little in 2008 and in figure 02 that OECD consumption had (as of November 2008) declined by around 2,5 Mb/d since the average oil price reached around US$60/Bbl.

The data thus suggests that some countries were able to afford the recent higher oil prices better than OECD. This seems to run contrary to expectation, since the OECD countries represent the richest countries in the world. That oil consumption grows in some of the oil exporting countries is no surprise, but it does not explain all the growth.




Figure 09 The above figure illustrates OECD total oil stock changes from January 2000 through November 2008. NOTE: y-axis not zero scaled

The figure illustrates that there has been a stock build within OECD through 2008. In other words, this shows that total OECD supplies have been higher than total OECD consumption.

Using data for 2007 as a base line, it should now be possible to identify changes in oil consumption (or supplies) for Non OECD countries through 2008.




Figure 10 The above figure illustrates Non OECD changes in oil consumption/supplies through 2008

Despite the high oil prices through 2008, Non OECD countries continued to increase their consumption/supplies as they have done as OECD consumption started to decline in 2005.

Could this suggest that an economic decoupling between OECD and Non OECD countries is now gaining strength?

It is currently estimated that OPEC has shut in a capacity of 3 - 4Mb/d. For the next 3 - 4 years many estimates show that new capacity brought on line will at most offset the decline from producing fields. If an economic decoupling now is gaining strength, could it be that the Non OECD countries will eat into most or all the existing spare capacities in the next few years?




Figure 11 The above figure shows the growth in the Chinese oil consumption together with the annual changes. Based on what was portrayed in figure 10 there is reason to expect that China's oil consumption through 2008 will grow are a rate similar to its growth in recent past years. China’s growth is likely to continue in 2009, though at a slower pace than earlier projections called for.

In 2007, each person in the US used 11,5 times as much oil as the average Chinese. GDP for each person in the US at PPP (Purchasing Power Parity) was in 2007, 8,7 times higher than for the average Chinese.
As of 2007 the average Indian had a purchasing power only half of the Chinese, but as this article on the Tata’s Nano and ”India Defies Slump, Powered by Growth in Poor Rural States (From Wall Street Journal) suggests the global bidding war for oil is about to see a growing number of bidders.

One way to look at the data above is that if 9 Chinese (or 18 Indians) pooled together to bid on oil against one person from the US (or a person from any G-7 countries), the 9 Chinese would combined have more purchasing power. The outcome from a bidding war is that one wins, while the other ends up empty handed. This comparison illustrates the challenges which now face the OECD countries and increasingly may face in the future. Because of the challenges in winning this bidding war, OECD consumption looks likely to have peaked, whether or not world production has peaked.

[Nordic Superman]

Anything I can do (or purchase at a cost) to reduce my fuel costs?

[24KT]

Anything I can do (or purchase at a cost) to reduce my fuel costs?

In your particular case, ...you could try blowing into the fuel tank.
Lord knows you blow enough hot air to fuel an entire fleet of Mac trucks!

[Stormspirit]

ive been thinking about fabricating cheap cost effective fuel storage containers, i think it would be a huge hit.

[Nordic Superman]

In your particular case, ...you could try blowing into the fuel tank.
Lord knows you blow enough hot air to fuel an entire fleet of Mac trucks!

No, I don't have time to do that. How about some kind of chemical / enzyme based fuel supplement (maybe in the form of a "pill"), is there anything like this on the market? If so, where do I send my money?

[24KT]

No, I don't have time to do that. How about some kind of chemical / enzyme based fuel supplement (maybe in the form of a "pill"), is there anything like this on the market? If so, where do I send my money?

You wouldn't want to use an enzyme based fuel supplement. The enzymes can degrade rapidly at moderately warm temperatures, before they even enter the tank, ...and the only one I know of has a chemical signature identical to napthalene. As much as I dislike you, I wouldn't even encourage the likes of you to buy it. Napthalene is toxic to human health, and will destroy injectors and valves so quick it's not funny.

As for the only one on the market that's been proven both safe & effective, based on nobel prize winning science, ...I wouldn't sell it to you even if you begged me.

[24KT]

ive been thinking about fabricating cheap cost effective fuel storage containers, i think it would be a huge hit.

How would you be able to maintain octane & cetane numbers in the fuel?

[Nordic Superman]

As for the only one on the market that's been proven both safe & effective, based on nobel prize winning science, ...I wouldn't sell it to you even if you begged me.

Ha ha, you're a joker

[Deicide]

Ha ha, you're a joker

Stop driving. I don't drive. Saves money and time.

[Nordic Superman]

Stop driving. I don't drive. Saves money and time.

Honestly wish I could, sick of the costs... add to the fact I've just received my first speeding ticket... fucking rip off