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The 2014 Oil Price Crash Explained
Submitted by Euan Mearns via Energy Matters blog,
- In February 2009 Phil Hart published on The Oil Drum a simple supply demand model that explained then the action in the oil price. In this post I update Phil’s model to July 2014 using monthly oil supply (crude+condensate) and price data from the Energy Information Agency (EIA).
- This model explains how a drop in demand for oil of only 1 million barrels per day can account for the fall in price from $110 to below $80 per barrel.
- The future price will be determined by demand, production capacity and OPEC production constraint. A further fall in demand of the order 1 Mbpd may see the price fall below $60. Conversely, at current demand, an OPEC production cut of the order 1 Mbpd may send the oil price back up towards $100. It seems that volatility has returned to the oil market.
Figure 1 An adaptation of Phil Hart’s oil supply demand model. The blue supply line is constrained by data (see Figure 4). The red demand lines are conceptual. Prior to 2004, oil supply was fairly elastic to changes in price, i.e. a small rise in price led to a large rise in production. This is explained by OPEC opening and closing the taps. Post 2004, oil supply became inelastic to price, i.e. a large change in price led to marginal increase in supply. This is explained by the world pumping flat out. Demand tends to be fairly inelastic and inversely correlated with price in that high price suppresses demand a little. Supply and price at any point in time is defined by the intersection of the supply and demand curves. 72 Mbpd and $40 / bbl in 2004 became 76 Mbpd and $120 / bbl in 2008 as demand for oil soared against inelastic supply.
Figure 2
Followers of the oil market will be familiar with the recent evolution of oil supply and price shown in Figure 2.
Figure 3
What is less widely appreciated is that a cross plot of the data shown in Figure 2 results in the well-ordered relationship shown in Figure 3. Oil supply and price are clearly following some well established rules. This relationship led to Phil Hart developing his model shown as Figure 1.
Figure 4
Separating the data into two time periods brings more clarity to the process at work. The data define a fairly well-ordered time series beginning at January 1994 at the bottom left rising slowly to January 2004 and then steeply to the Olympic Peak of July 2008. The financial crash then caused the oil price to give up all of its gains returning to 2004 levels by December 2008.
Figure 5
The second time period from January 2009 to the present shows some different forces at work. Starting in 2009 some new production capacity was built. This was not in OPEC and is concentrated in N America where the light tight oil (LTO) boom took off supplemented by steady expansion of tar sands production. Prior to 2009, the production peaks were of the order 74 Mbpd. Post 2009 peaks of the order 77 Mbpd were achieved. About 3 Mbpd new capacity has been added. In May 2011 there is a significant and curious excursion to lower production not accompanied by a fall in price. This coincides with Libya coming off line for the first time and the loss of 1.6 Mbpd production. It seems possible that this coincided with weak demand and the fortuitous loss of production cancelling weak demand leaving price unchanged.
The EIA are always running a few months behind with their statistics these days, not ideal in a rapidly changing world. Thus we do not yet have the data to see the recent crash in the oil price. But we know the price has fallen below $80 and production is unlikely to be significantly changed. So, how do we explain production of roughly 77 Mbpd and a price below $80?
Figure 6
Figure 6 updates Phil Hart’s model (Figure 1) to take account of the oil supply and price movements of the last 5 years. Capacity expansion is achieved by adding 3 Mbpd to the former, well-defined supply-price curve (blue arrow). There is no a-priori reason that this curve should hold in the new supply-price regime, but for the time being that is all I have to work with. The red lines, as described in the caption to Figure 1, conceptually represent inelastic demand where high price marginally suppresses demand for oil. The recent past has seen oil priced at $110 with supply running at about 77 Mbpd as defined by the right hand red coloured demand curve. Reducing demand by about 1 Mbpd brings the price below $80 / bbl (red arrow).
The Recent Past and the Future
Old hands will know that it is virtually impossible to forecast the oil price. The anomalous recent price stability of $110±10 I believe reflects great skill on the part of Saudi Arabia balancing the market at a price high enough to keep Saudi Arabia solvent and low enough to keep the world economy afloat. The reason Saudi Arabia has not cut production now, when faced with weak global demand for oil, probably comes down to their desire to maintain market share which means hobbling the N American LTO bonanza. Alternatively, they could be conspiring with the USA to wreck the Russian economy? But Saudi Arabia is not the only member of OPEC and the economies of many of the member countries will be suffering badly at these prices and that ultimately leads to elevated risk of civil unrest. It is not possible to predict the actions of the main players but it is easier to predict what the outcome may be of certain actions.
- If demand for oil weakens by about a further 1 Mbpd this may send the price down below $60 / bbl.
- If OPEC cuts supply by about 1 Mbpd at constant demand this may send the price back up towards $100 / bbl.
- Prolonged low price may see LTO production fall in N America and other non-OPEC projects shelved resulting in attrition of non-OPEC capacity. This may take one to two years to work through but with constant demand, this will inevitably send prices higher again.
- Prolonged low price may see many specialist LTO producers default on loans, risking a new credit crunch and reduced LTO production. This would likely lead to a major consolidation of operators in the LTO patch where the larger companies (the IOCs) pick up the best assets at knock down prices. That is the way it has always been.
- Black Swans and elephants in the room – with conflict escalation in Ukraine and / or Syria-Iraq and a new credit crunch, all bets will be off.
* * *
And lastly, thanks to The Automatic Earth's Raul Ilargi Meijer, here is an additional comment that warrants attention this week...
via Euan’s friend and collaborator Roger Andrews (check the grey dots!):
Hi Euan:
I put this XY plot of the data together from the data links you supplied. It shows the same trends as your Figures except that I’ve plotted all the points on one graph and segregated them into five periods, with trend lines and arrows showing the overall “direction of travel” for each (arrows in both directions for October 2004-May 2009, which as you noted goes zooming up and then comes right back down again).
I’ve also projected production data for the missing months since May 2014 (shouldn’t be too far off) so that we can at least get an idea of how the latest trend might compare with the old ones.
We seem to be in uncharted territory.
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Nice to see some data on just how inelastic that market can be.
We also have the Saudi peg of $80.00 Brent, which will act as a psychological anchor for a time.
"Cheap OIL is GDP negative, we need to stop oil before it stops us! Burn it, burn it all so we have to find moar!" ~ Krugman
https://www.youtube.com/watch?v=zn-Cab0XRlw
Calling BS
All those tankers of oil JP Morgan had in 2010 must be empty now...time to refill at a lower price
Russian is being squeezed at the same time
Oil is more manipulated than the Spy or Vix or Gold
Oil is cheap in gold terms, which is all that matters. Oil should probably be expensive in gold terms, because gold is cheap in Fed Balance Sheet terms, yet it is not. Therefore, I do not see much more of a drop in oil prices, with the possible exception of a short term shock in response to the start of a large recession.
I just looked at a chart of wti going back to 2003. Every significant decline in price lasted at most 7 months, and that only once. All the others were 3 to 6 months.
Given the current slide started early July, we have one to two months left until the bottom is in, for whatever reason and by whatever means.
Demand Destruction
THANK YOU!!!
People with 29.5 hr/wk jobs can't afford gas......they just can't.
That makes NO FUCKING SENSE. How did demand -- stable for many years suddenly crash the last few months? What changed? If anything demand is up this year, and will go up more as gas goes lower.
2 things changed.
The dollar suddenly spiked higher. Probably due to the problems with the jap and euro economies. US is still the safe haven. Naturally oil and gold in dollars would spike lower.
The war in Ukraine and sanctions against russia. Oil has always been the most manipulated market of all. Don't think the banksters and saudis aren't cooperating to help nato with their side of the chess board.
blah blah......OPEC wants > $50/barrel to make a profit
US demand has been decreasing
China and India are increasing their crude imports
China prints money >>> oil prices go up
$50~$80 is the range folks
Where are the cocksucking banker manipulation schemes reflected in this model?
It's kind of sweet to see this explained in terms of supply/demand fundamentals instead of the push and pull of geopolitics and manipulation.
Add the instability of war into the mix and we can kiss this model goodbye.
Obama messed up. He was supposed to bomb, bomb, bomb Iran, putting a floor under the price.
Now it looks like Exxon will have to buy a new president.
$20
$10
$1.83
http://www.bloombergview.com/articles/2013-05-06/when-the-great-depressi...
http://data.bls.gov/cgi-bin/cpicalc.pl
Input $0.10 to 1933 and see what you get.........
For what you are saying to come true, either trillions of barrels of oil need to suddenly reappear in the ground, or the US dollar would have to magically undo 100 years of inflation. Given that US dollars are based on debt, and there's no end in sight to all the debt, I don't see that happening short of a societal collapse, and in societal collapses, prices seldom have any meaning, let alone predictions of what they will be.
The days of oilfields like these are over: http://www.priweb.org/ed/pgws/history/spindletop/images/boiler-avenue_sm...
I am being outlandish, with historical context, of how bad things could possibly get.
I have spent considerable time talking to people who are in their 90's to 100 years in age about what the prior Depression was like, including memories of what my own grandparents told me of losing ALL of their money in bank failures and even being Hobos in the 30's.
The most common theme that EVERYONE has told me is that NO ONE HAD ANY MONEY, and they had to make do with whatever they had.
Do not forget that there was A LOT of debt in the last depression as well, and a lot of MARGIN. Not anywhere near the levels of today, but, A lot.
http://www.livinghistoryfarm.org/farminginthe30s/money_09.html
http://money.cnn.com/galleries/2007/news/0705/gallery.bubbles/3.html
If one reads the links above, some of that should sound slightly familiar.....
If one views the M2 data, http://research.stlouisfed.org/fred2/series/M2V/, and compare it to a 2010 ZH article here............ One better have a few extra helpings this Thanksgiving......
But yes, I do agree with your points, and I hope you can see my points as well.
And when demand for oil fall 1mb/d?
oil goes to zero by xmas! Ho ho ho.
I never could figure out why amerika is so enamored of arabic oil when we could annex Venezuala and have all the goo we could ever want. Sooo much closer, we could at least have our boots on the ground in this hemisphere.
Heavy oil in Venezuela.
Gotta have that light sweet crude.
Plus the AskaNAZI Zionists wouldn't be able to accomplish their primary main objective of creating the greater, modern Israel.
It would be nice to cruise the Nile and not have to worry about security. Big game hunting in Africa but with working toilets and clean sheets on the bed. Not seeing this as a problem.
Sure are a lot of articles about the price of oil crapping out...I wonder what that means...
The Saudis are squeezing either Russia ( on behalf of US ) or they are squeezing US Fracking, or both. If you think about it is the same squeeze gold hypothications are putting mining firms. Falling demand consistent with high production means lots and lots of storage, I suspect the numbers are bogus somewhere on oil or some big big tanks are overflowing.
Mother Nature will win when the dollar and petrol dollar explode she will set equilibrium once again.
Oil companies, basically oligopolies, can collude to keep prices high(er). Having Venezuela (or like countries) be a co-operative and efficient producer of crude, of any type, keeps prices low(er) and is therefore not a price "friendly" states of affairs for the aforementioned companies producing and selling same.
So apparently cheap oil isn't good enough for the good people of Missouri. What else are their demands?
Oil, Gold, and Real Estate are all weak and declining while Alibaba, Facebook, Twitter, and even the pathetic dog Yahoo soar.
Welcome to the new world sponsored by Wall Street fiat where everything virtual is priceless and everything real is worthless.
Downtoolong
Congratulations for the most insightful post in this tread.
“America’s elites know that capitalism is totally unworkable. We try to impose it in the 3rd world so we can destroy them” — Noam Chomsky
am i missing something?
.
"The trouble with Socialism is that eventually you run out of other people's money" — Margaret ThatcherYes. You are.
Capitalism is another human creation, just like religion and politics. Full of flaws.
"The trouble with capitalism is that eventually you run out of other people's money."
That is exactly what happened in 2008.
Uh huh.....how's things going in Venezuela bitch?
Yeah.....that's what I thought. You're no Iron Lady.
She has a point GetZeeGold.
When we are finished depleting the wealth of other Nations then from whom are we to steal from next?
Our entire economy has been based upon Gunboat Diplomacy for the past Half Century that I DO REMEMBER. That is what EMPIRE is all about. The Vassal States support the central Government and her population. Yes the USA has ruled the World. Now she is in DECLINE.
We produce nothing here but Dollars and Agricultural Goods for export. Then we import the wealth created by other laborers in Foreign lands.
Our country financializes rather than materializes much of value.
Perhaps she needed to use the phrase, "Crony Capitalism" since we are not living in a Capitalist nation and have not been for as long as you have been alive.
So perhaps it would have been kinder to correct her that Crony Capitalism IS SOCIALISM and that the USA IS UNFORTUNATELY SOCIALIST.
So instead of denying that the USA IS SOCIALIST, which is the TRUTHFUL ARGUMENT, instead, you may want to rid yourself of YOUR NATIONALISM and throw off your shackles of bondage.
GetZeeGold
I live in America (DC).
Tom,
Thanks for pointing out 'Crony Capitalism' because it's correct.
I do question the use of 'Socialism' but, we can have this conversation at some other posts.
Cheers!!!
With commodities, the lag time between price(demand), exploration and production seem to result in cyclical price swings that can be predicted. Here is an example using a proxy XOI.X
The Best and Worst Performing Asset Classes of the Past Five Years
http://ebinvesting.com/wp-content/uploads/2012/08/best.png
I've been killing with SCO the last couple months, but I'm going to put in some stop loss plays in case OPEC overrules the Saudis on Thursday.
People, this is a desperate attempt to squeeze oil producers with USD strength. All it does is undermine INVESTMENTS in operational hedging strategies that should be implemented ASAP.
Russia has an oil card they can play. They have 6 to 7 million barrels of oil that they export daily. All they have to do is set the price at $100. At first exports would fall until prices rose globally. My guess is that it would only take a few months brefore they sold all of their exports at $100. Then they could start a REAL economic war and repeat this game by raising oil prices to $110. Eventually the west would go bankrupt.
This is a credible hypothisis and would easily work. I can only wonder why they aren't doing it. They have pushed Putin into a corner. He could easily play this card and show the world who owns barter town.
Maybe the same reason that China doesn't pull the pin. They own too much US shitty treasury paper. Why blow a trillion when you don't have too. Got to exchange that shitty US paper for assets before pulling any pins. I think the same goes for Russia. They can sit back and watch the US implode without looking like the instigators. The US are looking for anyone to blame for their financial misfortunes, why would Russia or China help them in their blame game. Better to sit back, get something real for their US paper and enjoy the show.
Russia has been discussing lowering its production to prop the price up lately.
But don't forget Russia also needs the money (and btw, is also most probably at its peak, second one after USSR collapse).
Same for the Saudis, they need the money to run their budget (mostly on oil revenues).
uh huh, right, and as any econ 101 freshman knows, increasing the supply by 1MB will have the exact same effect..and from what OPEC is saying (a cartel to keep prices artifically high by artificially limiting supplies)...that's exactly whats been happening
OPEC a cartel ...
You mean that if you find a shitload of oil in your backyard, OPEC will come and get ya in order for you not to take it out ?
By the way, did you kknow that the basic reason for the first oil shock was the US oil production peak that occured en 1970 much more than the "Arab embargo" little song ? And that big oil and US diplomacy wished (and pushed for) a price rise after US peak ?
A summary for you :
- end 1970 : US production peak, the energy crisis starts from there, with some heating fuel shortages for instance (some articles can be found on NYT archive on that), or :
http://upload.wikimedia.org/wikipedia/commons/c/c5/US_Oil_Production_and_Imports_1920_to_2005.png
- Nixon name James Akins to go check what is going on.
- Akins goes around all US producers, saying this won't be communicated to the media, but needs to be known, national security question
- The results are bad : no additional capacity at all, production will only go down, the results are also presented to the OECD
- The reserves of Alaska, North Sea, Gulf of Mexico, are known at that time, but to be developed the barrel price needs to be higher
- In parallel this is also the period of "rebalance" between oil majors and countries on each barrel revenues (Ghadaffi being the first to push 55/50 for instance), and creation of national oil companies.
- there is also the dropping of B Woods in 71 and associated $ devaluation, also putting a "bullish" pressure on oil price.
- So to be able to start Alaska, GOM, North Sea, and have some "outside OPEC" market share, the barrel price needs to go up (always good for oil majors anyway) and this is also US diplomacy strategy
- For instance Akins, then US ambassador in Saudi Arabia, is the one talking about $4 or $5 a barrel in an OAPEC meeting in Algiers in 1972
- Yom Kippur starts during an OPEC meeting in Vienna, which was about barrel revenus percentages, and barrel price rise.
- The declaration of the embargo pushes the barrel up on the spots markets (that just have been set up)
- But the embargo remains quite limited (not from Iran, not from Iraq, only towards a few countries)
- It remains fictive from Saudi Arabia towards the US : tankers kept on going from KSA, through Bahrain to make it more discrete, towards the US Army in Vietnam in particular.
- Akins is very clear about that in below documentary interviews (which unfortunately only exists in French and German to my knowledge, and interviews are voiced over) :
http://www.youtube.com/watch?feature=player_embedded&v=fQJ-0jAr3LQ
For instance after 24:10, where he says that two senators were starting having rather "strong voices" about "doing something", he asked the permission to tell them what was going on, got it, told them, they shat up and there was never any leak. The first oil shock "episode" starts at 18:00
The "embargo story" was in fact very "practical", both for the US to "cover up" US peak towards US public opinion or western one in general, but also for major Arab producers to show "the Arab street" that they were doing something for the Palestinians.
In the end, clearly a wake up call that has been missed, especially at a time when we are around global peak and the omerta about it is almost complete.
Note : About Akins, see for instance :
http://www.washingtonpost.com/wp-dyn/content/article/2010/07/26/AR201007...
And his famous foreign affair article :
http://www-personal.umich.edu/~twod/oil-ns/articles/for_aff_aikins_oil_c...
His report to Nixon in 71 or 72 is still classified to my knowledge though, would be interesting to know if it can be declassified now.