Beyond Comprehension

If you don't understand what is going on with the price of gasoline and demand for the world's oil supply, then join the club.

Analysts, pundits, government officials, oil ministers, oil executives, and oil traders are all over the board in trying to explain what is happening and more importantly what is going to happen. Some are saying that $30 oil will be with us until the economy recovers while others are talking of a spike to $200 in 2009.

We are currently finishing out an extraordinary year. For several years now, oil prices have been moving steadily higher. They passed $100 a barrel around New Year's and moved on to peak at around $147 in July. By late spring much of the world was in turmoil. Politicians were out in force, bashing speculators, environmentalists, OPEC, additions to the Strategic Petroleum Reserve and you name it. Airlines and car sales were collapsing. The President flew off to Saudi Arabia where he personally appealed to the King to send us more oil. The King held a big oil conference and promised to do what he could.

Then, in mid-July, the great oil panic came to a screeching halt. While several explanations have been offered for this turnabout, I believe the start of the Beijing Olympics the most proximate cause. If 2008 has been hard on America it has been traumatic for China. In the first half of the year the Chinese endured a great earthquake, major snowstorms, and a nationwide panic over readiness to put on the Olympics. All this, of course, was accompanied by some of the worst air quality on earth.

For six months China was in an oil-buying frenzy trying to compensate for lost production during the quakes and storms, and ensuring that there would be no fuel shortages during the Olympics. To clean up the air, Beijing banned half the cars and trucks in and around the capital from operating and shut down every industrial enterprise that contributed to air pollution for hundreds of miles around the Olympic sites. The plan worked, but China's oil imports plummeted and the greatest oil price plunge in history began.

The great plunge was aided by the $4 to $10 gallon cost of gasoline and diesel in the U.S. and Europe which some believe was a primary cause for the world economy tanking in the second half of the year. To the surprise of nearly all observers, once oil prices began falling; they fell, and fell, and then fell some more. From $147 a barrel, prices dropped until they briefly touched $32 last week and are currently sitting around $40. To the delight of motorists, gasoline prices in the US went from $4 - $5 a gallon in July to $1 - $2 in December. Although it went unnoticed, America's economy received a massive stimulus from the billions of dollars that were left in consumers' pockets after each fill-up.

Now we get to the key question of why oil has fallen so low and the corollary of what happens next -- $20 or $200 oil. For the why-so-low question there can only be two answers: either demand has dropped well below readily available supplies or market factors such as speculation, trader pessimism, or the unwinding of hedge funds has caused oil to drop so rapidly.

Despite the lack of good information, it is clear that worldwide demand for oil has fallen in the last six months. U.S. demand is down about 1.2 million barrels a day(b/d). OECD commercial petroleum inventories, including those of the US have increased steadily as importers have taken advantage of lower prices. We know that Japanese imports are down around 500,000 b/d over last year and that Chinese imports have dropped a little. What is missing for now is a good feel for the actual size of the worldwide drop in demand. At one end of the scale is the IEA who recently opined that for 2008 worldwide demand will only be down by 200,000 b/d. Some, however, are saying demand is already 6 or 7 million b/d lower than the peak of around 86 million b/d reached last summer. This will take some time to sort out.

What is important, however, is that oil traders and the financial press continue to repeat over and over again that oil prices are dropping because of the contracting world economy. This has become the mantra of the market. There is also a substantial body of opinion that some component of the fall in oil prices is due to the unwinding of hedge funds and the general deleveraging of nearly all financial institutions.

While U.S. demand for oil products currently is down about 6 percent, this number has been stable for several months. Oil is so deeply ingrained in the fabric of most countries, particularly that of the U.S., that deeper cuts in consumption are unlikely unless the economy really sours.

OPEC production cuts are now approaching 2 million b/d and are scheduled to reach 4 million b/d in the next couple of months. Whether this will be enough to cover the drop in demand is the question of the day. Most commentators are fearlessly predicting a rapid rise in oil prices as soon as economic recovery sets in -- either in a few months or a couple of years. The more interesting issue is what happens if there is no recovery in the next few years or the next few decades. Do oil prices bounce merrily along at rock bottom levels until geological and investment constraints start to massively limit supplies? OPEC is already talking of yet another cut as the last three have had no measurable effect. Will OPEC overcut and cause another price spike within the next year despite the state of the economy?

There is clearly an irreducible minimum amount of oil consumption out there below which our oil-based economies will begin to deteriorate rapidly. If there is anything that is certain as a result of the present low oil prices, it is that investment in new oil production is dropping so rapidly that there will be serious problems three to five years from now.


Published Dec 24 2008 by Falls Church News-Press Archived Dec 25 2008
by Tom Whipple

The peak oil crisis: July 2008 – a month to remember by Tom Whipple

There is a growing consensus among those who follow such things, that the new high of world oil production (87.9 million barrels a day) reached last July is likely to go down in history as the all-time peak.

This is by no means a unanimous opinion.

The official government forecasting agencies, the IEA and the EIA, have devised rather bizarre scenarios that would allow oil production to ease higher for another 20 years or so. These organizations, or course, are not free agents both being bound by political strictures rather than a search for truth. While the world's governments are inching closer to public acknowledgement of peak oil, they have many diverse responsibilities such as maintaining the domestic tranquility, fighting various kinds of wars, and providing some semblance of financial stability. Clearly a sudden admission that world oil production had just entered an irreversible decline would not help with these other responsibilities. Optimists and those unwilling to contemplate the ramifications of rapid change are still maintaining that oil production will grow in some mysterious manner for the foreseeable future.

Most students of the subject at first thought that world oil production was going to peak for geological reasons --- the inability to find and produce enough oil to keep our annual consumption of 30 billion barrels increasing. In recent years, "above ground" factors such as wars, nationalistic governments, and failure to invest have become the popular reasons for constraints on increasing world oil production among those who for one reason or another do not like the geologic (running out of reserves) argument.

While all these factors are contributing to the likelihood that from here on out less and less oil will be produced, it seems that the initial decline in production will come because the world economic situation has deteriorated so much that we simply don't need 87.9 million barrels a day (b/d) of oil anymore.

At the minute, OPEC is scrambling to figure out how to enforce an equitable production cut to drive prices higher again. Current talk is that it will take cuts totaling 3 million b/d or more to balance supply and demand. If reductions on this order actually take place in the near future, then world production which has been declining since July will have started on a downward slope from which it is unlikely to ever recover.

New oil production and refining projects are being cut back right and left due to low prices, lack of demand, and the inability to borrow money. It will take several years for these cutbacks in investment to affect oil production; in the meantime, depletion will take over and cause irreversible declines in oil production in the next five to ten years.

In the three-way struggle among worldwide oil depletion, new oil production projects, and the global recession, we have a pretty good handle on depletion and new projects, but appreciation of the depth and length of the recession is not well understood. What was widely believed last year to be a couple of weak quarters is now generally acknowledged to be the worst economic slump since World War II. Optimists, especially on Wall Street and in Detroit, are saying that by 2010, or 2011, or 2012, the recession should be over and economic growth will return. There is great faith that the world's governments can manage a recovery by lowering interest rates, pumping trillions of government money into the financial system, loaning money to failing corporations, and instituting massive stimulus packages. Some are not so sure.

Whatever the root causes of our new recession - bad lending practices, leverage, too much debt, lax regulations, or as some believe, high oil prices - it is clear that it is going to be worldwide, serious and will take some time, perhaps years, to work itself out. The last recession of this scope went on for ten years and picked up the name of "the great depression" somewhere along the way.

The role of oil in the nature and duration of the recovery from all this will be critical. Should OPEC succeed in driving oil prices back up to $75 or $100 a barrel by imposing serious restrictions on production, then, as we saw last summer, money will be drained from the recovery into oil producers' coffers, but there will be more incentive to invest in new production. Gasoline prices, however, will climb again and consumers will be back where they were last spring.

If the recession deepens over the next year or so, the demand for oil is likely to decline significantly. OPEC may have trouble getting prices back up to "satisfactory" levels. At present, worldwide demand for oil, while slipping, is not yet dropping precipitously. If such a drop should happen, then it is a solid indication of deep and lasting economic troubles for some time to come. Declines in worldwide production over the next few years initially will come from production cutbacks due to lack of demand. If the economic situation gets really bad, these demand-induced cutbacks could continue longer - perhaps for many years. At some point, however, worldwide oil depletion will catch up with new production as expensive investment in new oil fields is likely to shrink under conditions of declining demand.

At this point, the oil age will be closing down. Worldwide production will be declining rapidly through a combination of lower demand and then depletion. In four years sustainable production capacity is likely to be down from 87 million b/d to the vicinity of 80 million. In 10 or 15 years world production is likely to be in the vicinity of 50 million b/d and by mid-century 20 or 30 million. By the end of the century, oil production will be nearly gone and will be restricted to high-value uses for which there is no alternative. Future generations will either adopt alternative forms of energy, far more efficient machines, or do without. And it all started last July.

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Original article available here
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