Monday, November 12, 2007
Will oil prices fall sharply in the week ahead?
Oil prices have almost doubled since their lows early in the year. The question is the extent to which these increases are a function of speculation in the oil markets rather than persistent supply and demand. This week's "Ahead of the Tape" column (sub. req.) in the Wall Street Journal suggests that financial market considerations may, for now, be dominating. Fair use excerpt:
This is shaping up to be a hugely important week in energy markets. The hot oil balloon could rise to $100 a barrel. But don't be surprised if Wall Street -- driven by a mountain of expiring futures and options contracts -- steps up and pricks it.
The sheer speed with which oil has risen could intensify second-guessing as its price hovers near three digits. "Holding that number is going to require a lot more than just a belief in a momentum trade," says Ben Dell, energy analyst with Sanford C. Bernstein & Co. He says the market is hardly acknowledging that amid oil's climb, U.S. gasoline demand has slipped.
Some analysts believe derivatives markets could be making a "Great Unwind" in oil inevitable. Trading desks at big investment banks -- from Goldman Sachs Group and Morgan Stanley to Lehman Brothers Holdings -- have been active players this year in crude-oil options, which give buyers a right to buy or sell the commodity at a set price in the future. The banks' role, and the hedging they do to neutralize their exposure, can have a huge influence on crude prices....
Lehman warns a "free-fall" could follow when the investment banks stop their hedge-driven buying after options expire tomorrow. Futures contracts expire Friday. At the very least, says Lehman's chief energy economist Edward Morse, this week "could be one of the most volatile weeks for oil in years."
How big a deal are these machinations? As of Friday, says Lehman analyst Adam Robinson, 30% of all contracts to buy crude at $100 on the New York Mercantile Exchange were set to expire tomorrow.
Of course, other factors drive oil. The weak dollar supports oil, in part because investors buy it as an alternative to the cheapening currency. Strong demand in developing economies puts upward pressure on oil. And ministers of the Organization of Petroleum Exporting Countries gathering this weekend will shape the supply outlook for crude.
But when oil rises as far and fast as it has the past few weeks, one has to wonder about the role of Wall Street's financial engineers. By the end of the week, you will know a lot better.
We'll check back in on Friday to see whether "Ahead of the Tape" knows whereof it speaks.
Meanwhile, U.S. GDP grew at a very robust 3.9% in the third quarter, notwithstanding surging oil prices and a collapsing housing marketing. And what about the dollar? Pundits and, for that matter, corporate tools such as myself, worry about the declining dollar. It certainly has been a load, especially for companies that import from Europe. That said, the U.S. economy is the most resilient in the world, combining the rule of law with flexible labor and capital markets and an entrepreneurial spirit embedded in the national character. At the end of the day, who really thinks they can generate a better return over the long term investing in Europe or Japan?
15 Comments:
By 
, at
Mon Nov 12, 09:55:00 AM:
I'd add that hurricane season is offially winding down in a few weeks, traditionally a time when oil futures feel more secure and prices tend to drop.
By 
Rick Ballard, at
Mon Nov 12, 10:07:00 AM:
Oil went right through 95 - just before it went right through 94.
We'll see how big the exit door is and whether the crowd can get out in an orderly fashion. Will we see any "bursting oil bubble causes umpty gazillion dollar losses"?
By , at
Mon Nov 12, 12:59:00 PM:
Even accounting for current Forex imbalances due to shifting benchmark currencies, the world demand curve for oils doesn't match up, especially in view of the fact that the pumping capacity still exceeds most refining capacity and that is also taking a hit from biofuel displacement of oils in the refining plants we have for final stages of preparation.
India is getting ready to bring a large refinery online (it may already be, need to check) and refined product will be more available. The second refinery Reliance is building is world scale and all for export demand.
By Charlottesvillain, at
Mon Nov 12, 04:29:00 PM:
Well, oil may well pull back, although given the current supply/demand dynamic it is hard to argue that the long term trend will be anything but up. Worldwide liquid fuel production has been stuck in the neighborhood of 85 million barrels a month, while demand continues to move upward. With many major oil fields in decline, price increases are practically inevitable in a period of economic growth.
Speaking of which, I missed this but apparently during the Saturday night broadcast of the Oklahoma State college football game, Brent Musberger has T Boone Pickens in the broadcast booth for a segment, and got him into a peak oil discussion. I wish I'd heard it, as it sounds surreal and hysterical. (this was posted by commenters over at theoildrum.com, an outstanding site on oil related production and supply issues).
By Rick Ballard, at
Mon Nov 12, 06:08:00 PM:
"it is hard to argue that the long term trend will be anything but up"
Charlottesvillain,
The same could be said for whale oil and tallow in 1875. Leading edge investors in those days saw the profit potential in horse manure removal from city centers. On Friday, this post sounded great. Today with gold off 4% and oil getting tagged (rightfully, IMO), not so much.
"Peak oil" is an inarguable phenomenon which was, is and will be upon us as long as we choose to make it a focal point.
I found the comment (after article cited) concerning the drop in memory costs to be of higher importance than the oil/gold conversation because of its probable impact on productivity. The energy component of transportation costs will force substitution. The tough part is figuring out what form the substitution will take. In 1875 the sure bet looked like a lot more street cars. That was generally correct but not many people were thinking much about them running around without rails.
By Charlottesvillain, at
Mon Nov 12, 07:07:00 PM:
Rick, all you say is true, but not a valid comparison, but I think you know that. The difference between whale oil then and crude oil now is that huge pools of petroleum were available as a ready and superior substitute. No such substitute currently exists for oil, and when when is found (I am optimistic) it will still require a huge retooling and engineering of almost everything we currently use oil for. A little different from substituting kerosene or coal oil for the whale oil in your lamp.
By Rick Ballard, at
Mon Nov 12, 07:41:00 PM:
Charlottesvillain,
I don't know that a substitute fuel (or energy source) will be found - or that it is necessary to find one. What happens if a combination of computer speed/memory with HDTV (for "face" time) allows a 25% increase in the number of people able to remain home and work? By the same token, I now calculate trip cost to shipping cost in order to determine whether to purchase some items on line. What happens to fuel consumption when that tradeoff shifts more advantageously to shipping?
We could build enough pebble bed reactors in ten years to cut off oil from the ME completely - if the political will existed. Conquering the 'potential negative externalities' is as much (or more) of a PR problem as it is an engineering problem.
Focusing tightly on "Peak Oil" and its potential impact just detracts a bit (again, IMO) from being alert to other economic factors which may well turn out to be much more important. Too tight a focus on constraining a cost is akin to leaping over a dollar in order to save a nickel.
I'm still looking for a reasonable explanation of the last productivity increase. That one caught me absolutely flatfooted.
By Purple Avenger, at
Mon Nov 12, 09:20:00 PM:
No such substitute currently exists for oil
Actually is does. Its...[drumroll] oil. The Germans did all the necessary seminal o-chem and process work back during WWII on coal synthesis. I studied some of those original texts (in german) in college in chemistry classes.
All we need is an inclination to go down that path. Domestically available raw materials would fuel this country for at least 300 years at expected usage levels.
By , at
Mon Nov 12, 10:03:00 PM:
Coal gassification and liquifaction are indeed attractive options if oil remains +$90/bbl, but there are problems with this, too, even though current coal-gassification technology is way ahead of what the Germans did in WWII.
1) emissions, air and water
2) you need a lot of water for various coal gassification processes
3) China is going down this road already with their limited domestic oil reserves, but they are having problems, too
4) major capital investment to reach break even scale of production
and of course, the ever present
5) NIMBY!
Like anything, these problems can be overcome by the enthusiasm of the public and sufficient political will (strange how that substitutes for the normal, market driven incentives that used to drive growth in this country). But don't hold your breath.
-David
By , at
Tue Nov 13, 12:39:00 AM:
Lets drill in the ANWR and tell the eco green weenies to TAKE A HIKE. LETS FEED THEM TO THE POLAR BEARS KILLER WHALES AND SKUAS
By , at
Tue Nov 13, 02:06:00 AM:
If ~20 years ago, when oil had dropped to ~$10/bbl, the government had imposed a $1.00/gallon gasoline tax to encourage energy conservation, we might not be seeing $90+/bbl oil today. Any politician who would have proposed such a tax would have been promptly tarred and feathered out of the political arena. Politicians are elected not for long-term thinking, but for satisfying the electorate in the here-and-now. Such a gasoline tax, while in the long-term interests of the country, would not have been accepted.
The harsh reality is that the only motivator for reducing oil consumption is its high price. There will be no one solution, but many: energy conservation, telecommuting, alternate sources of energy, increased drilling, etc. One of the solutions is wind energy, and I am not talking about harnessing Hugo Chávez’s verbiage.
The cost of wind energy went down from 40¢/kwh in
1979 to about 9¢/kwh in 2006 , which is competitive with other sources of electrical energy. Wind turbines became bigger, taller, and more efficient.
Texas, at the southernmost part of the Great Plains wind tunnel, is the first wind energy producer in the country, at 3953 MW installed capacity. Projects under construction are slated to increase capacity by 34 %.
Since 1999, after passage of the Texas Renewable Portfolio Standard , when oilman Dubya was governor, wind energy capacity in Texas has increased over four times, and this exponential growth should continue.
“In July 2007, the Texas Public Utility Commission announced its approval for additional transmission lines that could deliver as much as 25,000 megawatts of wind energy from remote areas in the state to urban centers by 2012, depending on how many wind farms are built.”
Transmission lines will be one of the main issues in increasing wind energy, because the Great Plains, the primary source for wind energy, are far from the population centers in Chicago and the coasts. There is a chicken and egg relationship between building additional transmission lines and installing more wind energy.
We have a long way to go. Wind energy is about 1% of national electrical capacity, but there are indications we are moving in the right direction, at least those of us who are not vassals of the Lord of Hyannisport.
By , at
Tue Nov 13, 02:22:00 AM:
Every time someone proposes a transmission line even if it is just for grid cross connects someone complains.
Due to electricity demand it makes sense to do the cross connects.
You are getting electricity to supplement your local electricity so it's not in your back yard.
The stuff coming across the connect is likely to be cleaner power than the surge capacity plant that will otherwise have to be placed online to generate local power.
Demand curves are softened since transfers across the grids is from an off peak demand zone to a peak demand zone.
By Rick Ballard, at
Tue Nov 13, 10:07:00 AM:
The Skeptical Optimist addresses the possible (probable?) direction that substitution will take. Wind and solar require the advances that MIT is making in order to have any a small chance of "making a difference".
I'll take a flock of pebble beds.
BTW - Oil is bouncing around 93.50 for the moment. It's a nice orderly exit.
By Dawnfire82, at
Tue Nov 13, 10:32:00 AM:
Wind won't power my car.
And putting another tax on gasoline won't make me buy less of it. I need it to get to work, to earn money, to live. It just sucks up my limited resources even further.
By , at
Tue Nov 13, 02:08:00 PM:
@Dawnfire82
Wind won't power my car.
As I previously stated, there will be not one solution, but many.
In 2002, the US consumed 97 quads of energy (quadrillion BTUs). Of the 38 quads used in the production of electrical energy, approximately 27 quads came from fossil fuels. There is the possibility of replacing some of that fossil fuel production with wind energy and nuclear. Some of this fossil fuel use no longer used in electricity production could be freed up for transportation. At the same time, as very little fossil fuel electrical production comes from oil ( 0.9 quads), this would necessitate coal-oil conversion or natural-gas fueled vehicles ( not my macro-level recommendation, though it is good for gas-rich Bolivia.).
Transportation used 27 quads of petroleum in 2002. Some of this petroleum could be replaced with coal-oil conversion or natural gas freed up from electrical energy consumption. To the degree that hybrid or all-electric cars can directly replace some oil consumption in transportation, this would be where wind energy production could have a direct effect on one’s personal car. Because petroleum has long been the best dollar per weight/volume choice for fueling transport, any reduction in using petroleum will not come quickly.
and putting another tax on gasoline won't make me buy less of it. I need it to get to work, to earn money, to live. It just sucks up my limited resources even further.
Several responses. Three decades ago, owners of 10 mpg cars had a similar response.
Do you really think that had there been an additional dollar per gallon tax on gasoline, that SUV sales would have boomed as much in the 1990s? Do you really believe there is no relationship whatsoever between oil price and oil consumption, on neither the micro nor macro level? Back in the 80s, I found out there was a relationship between oil drilling, oil price, and employment of petroleum engineers, when oil hit $9/bbl.
