2011 April 8

The Master Resource Report  2011-04-08

The price of oil hits new record in UK.    (page 1 )

CCS is DOA.    (page 2 )

The cost of food and energy hits consumers.   (page 2 )

Can natural gas fill in for nuclear?   (page 3 )

There has to be someone to blame?

On April 6th Leah McGrath Goodman wrote an opinion article in the Financial Times searching for someone to blame for the rising price of oil. In her article titled “The global oil casino benefits only its players” she said, “The less popular reason is that world energy markets have been carefully designed to profit from the slightest supply hiccup, even if there is little evidence of actual shortages.”

Why is it always assumed that for oil prices to rise there must be a shortage? Markets certainly do not require shortages of a commodity as valuable as oil for the price to rise. Just ask yourself how much would you actually be willing to pay if there was not enough fuel to balance your need? The consequences of an actual shortage would be catastrophic to the global economy and the Brent benchmark certainly wouldn’t be at $122/barrel.

The author highlighted how much the value of the futures market has grown since the second Iraq War in 2003. “Since the second Iraq war, for instance, the value of the speculative oil futures market has grown more than threefold.”

According to the EIA the average all countries spot price of crude oil for 2003 was $27.10/barrel while the average price for the first quarter of 2011 stands at $100.95/barrel. That sure sounds like more than a threefold increase in the price of oil. Even the average price for 2010 which was $75.59 was 2.8 times greater and for part of that year major parts of the global economy were still in recession. Doesn’t that seem consistent with threefold rise in value of the oil futures market? Doesn’t it seem reasonable for the value of the futures market to increase when the commodity it tracks more than triples is total market value?

Continuing in the same paragraph the author confirmed that the supply of crude hadn’t increased much in the seven years since the war. “At the same time the amount of oil actually being produced hasn’t risen nearly as much. Speculators this year have also been predicting future rises in prices by a factor of 3 to 1, according to US government data. Yet this comes as global production hit an all-time high in February – and higher supply typically cools prices.”

That is the point, the “amount of oil actually being produced hasn’t risen nearly as much”.

Between the second Iraq War in 2003 and 2010 world production increased by 4.25 mb/d from 69.43 mb/d (EIA) of crude oil including lease condensate to 73.68 mb/d (Production reached 73.71 mb/d by 2005). During that time demand from the developing world had expanded dramatically. China alone went from consuming 5.58 mb/d of oil in 2003 to 9.17 mb/d in 2010 absorbing nearly all the crude oil production increase since 2003. Estimates for Chinese consumption in 2011 are now settling in at around 10 mb/d indicating the pressures on supply will probably continue.

Clearly unless the higher supply the author mentions above is millions of barrels per day it is not going to shift the relationship between supply and demand resulting in oil price declines. That of course assumes the new supply is compatible with where the refinery demand is. If the new supply is not compatible with refinery demands it will play no part in easing demand pressures or price.

Why is it a surprise that the value of futures contracts traded over that time would also increase by about threefold? Supply is flat and demand for crude is steadily climbing. Why should the price of crude oil and its accompanying futures market be expected to behave any differently in a growing market?

This is not to say that there isn’t a need to regulate the markets more. There clearly is room to improve the regulatory oversight in all the markets. Rather it is important not to let the enthusiasm for finding someone to blame distract our attention from the realities of the global crude oil supply. The supply of crude oil is simply no longer growing fast enough to provide the surplus capacity needed to constrain price increases.

Whether consumers and governments like it or not events surrounding Peak Oil are unfolding. Maybe those evil speculators are among the few who are facing reality. For now at least it appears they believe in Peak Oil by a factor of 3 to 1. Of course being speculators that could change tomorrow, especially if demand falters.

The price of highway diesel just keeps climbing

As readers of this report know attention should be focused on the price of diesel when considering the impact of oil prices on the economy. During the 2008-2009 recession the decline in industrial, commercial oil products and jet fuel accounted for 85% of the decline in U.S. oil consumption from 2006-07 levels. Therefore paying attention to diesel consumption and price is very important. Their consumption and price matter greatly to the U.S. economy.

The graph below is based on EIA data for on highway low sulfur diesel price nationally and distillate supplied. It compares prices and volumes from Memorial Day weekend 2007 thru the end of July 2008 with the parallel period from Memorial Day 2010 thru last week.

The price trend is tracking very clearly on the 2008 line. Volumes supplied however have not reclaimed the levels seen in the 2007-08 period. The volume data is consistent with the very slow recovery in industrial and commercial demand. The pricing might be a surprise to those who are not aware of the level of distillate being exported and its impact on domestic diesel fuel prices. This has been discussed in detail over the last couple of years in the MRR (MRR will look at diesel exports again in a couple of weeks) and will continue to have an impact on U.S. diesel prices even as U.S. demand stagnates.