Guest Post: The Repricing Of Oil

Tyler Durden's picture

Submitted by Gregor Macdonald, contributing editor

The Repricing Of Oil

Now that oil’s price revolution – a process that took ten years to complete – is self-evident, it is possible once again to start anew and ask: When will the next re-pricing phase begin?

Most of the structural changes that carried oil from the old equilibrium price of $25 to the new equilibrium price of $100 (average of Brent and WTIC) unfolded in the 2002-2008 period. During that time, both the difficult realities of geology and a paradigm shift in awareness worked their way into the market, as a new tranche of oil resources, entirely different in cost and structure than the old oil resources, came online. The mismatch between the old price and the emergent price was resolved incrementally at first, and finally by a super-spike in 2008.

However, once the dust settled on the ensuing global recession and financial crisis, oil then found its way to its new range between $90 and $110. Here, supply from a new set of resources and the continuance of less-elastic demand from the developing world have created moderate price stability. Prices above $90 are enough to bring on new supply, thus keeping production levels slightly flat. And yet those same prices roughly balance the continued decline of oil consumption in the OECD, which offsets the continued advance of consumption in the non-OECD.

If oil prices can’t fall that much because of the cost of marginal supply and overall flat global production, and if oil prices can’t rise that much because of restrained Western economies, what set of factors will take the oil price outside of its current envelope?

Those who still don’t understand the past ten years cling to the antiquated view that prices will eventually return sustainably to levels of 2002 in due course. They believe that a great volume of new global oil production will start to appear and prices will be driven back to the cheap levels of last decade. Many who take this view also believe that market manipulation and inflation largely account for the high price of oil and that once reflationary programs like quantitative easing (QE) come to end, the price of oil will lose its speculative bid.

To be sure, the prospect for significantly higher prices in the near term remains dim. The automobile-highway complex is in full retreat in the West, and the developing world is largely funding its next leg of growth not through oil but via natural gas and coal. Short of war, an oil spike of the kind seen in 2007-2008 will not occur until global growth resumes.

That said, the factors contributing to oil’s present stability are worth considering as the foundation for any crash lower – or spike higher – in the year ahead.

Oil’s Current Price Envelope

Autumn is typically a time for financial market crashes. Should the Federal Reserve or the European Central Bank (ECB) waver from their implied promise of more QE, there is not enough organic demand in the global economy to maintain even the current stall speed of international trade and industrial growth. Any return to austerity or move away from reflationary policy would quickly sink asset prices. And that would quickly flow through to demand for oil.

However, QE does not in itself raise oil prices. If the global economy were “normal,” then QE would certainly flow through more directly to oil prices. (If the global economy were truly normal, there would be no QE). But the global economy, and especially Western economies, exited normal four years ago. During the present phase, therefore, QE is largely a psychological inducement and has few, if any, structural implications. QE functions more as a behavioral trigger, preventing economies from falling below their current level of stagnation. Accordingly, QE does not increase the price of oil during a time of debt deflation. Rather, QE simply maintains the global economy at the drip-feed level, thus allowing the OECD and non-OECD to continue their respective decline and advance. The result is a kind of stasis between oil supply and oil demand.

Unsurprisingly, the price of oil has been stable and has oscillated around $90 for nearly two years. A technical analyst might call this a consolidation of previous re-pricing phase, and fundamentally speaking, this is probably accurate. Recently, Ambrose Evans-Pritchard of the Telegraph newspaper marveled that oil prices could be “so high” during such difficult economic conditions:

Goldman Sachs said the (oil) industry is chronically incapable of meeting global needs. “It is only a matter of time before inventories and OPEC spare capacity become effectively exhausted, requiring higher oil prices to restrain demand,” said its oil guru David Greely. This is a remarkable state of affairs given the world economy is close to a double-dip slump right now, the latest relapse in our contained global depression...Britain, the eurozone, and parts of Eastern Europe are in outright recession. China has “hard-landed”, the result of a monetary shock and real M1 contraction last winter. The HSBC manufacturing index fell deeper into contraction in July...So we face a world where Brent crude trades at over $100 even in recession.


Yes, the price influences on oil that exert upward pressure are mostly balanced by the array of factors exerting downward pressure. But this is all taking place at the new, higher price level for oil. Let’s take two of these factors, just to start. First, OPEC spare capacity, from EIA Washington:

It is axiomatic that if OPEC increases production, then its spare capacity will fall. And that is exactly the trend that’s been unfolding since 2009, when a weak economic recovery began. While total OPEC production has remained largely within a range of 31-33 mbpd (million barrels per day) for years now, spare production capacity in OPEC has fallen for a third straight year and remains below the five-year average in 2012.

Oil markets always have (and always will) firm up prices when spare capacity falls because reductions in spare capacity simply make overall conditions ‘tighter.’ While I disagree with the Goldman analyst cited above that inventories or capacity will cause an imminent higher price squeeze, it’s absolutely the case that the lack of robust spare capacity in OPEC is supportive of price. Briefly, let’s take a look at OPEC production:

The increase in OPEC production since early 2011 has a paradoxical effect: Yes, more oil comes to market, but spare capacity is reduced by an equal amount. Meanwhile, there is no spare production capacity among non-OPEC producers.

Global oil markets are therefore efficient price discounting mechanisms: OPEC spare capacity, whether being utilized or held in reserve, is, at most times, priced in. (The singular wild-card to OPEC spare capacity is now Iraq, which I will address in Part II).

The Other Half of Global Supply: Non-OPEC

The incremental, post-2009 increases in OPEC production (coming from a low near 30 mbpd) along with the ability of non-OPEC to either maintain or slightly increase production – especially from the U.S. – has likely served to keep prices from running away to the upside. Again, these increased volumes of oil from both OPEC and non-OPEC are not enough to meaningfully lower prices. Rather, in a world where emerging-market demand growth balances developed-market consumption decline(s), these incremental additions to global supply are merely enough to restrain prices.

Let’s take a look at non-OPEC production:

The near-mania over the recovery in U.S. oil production continues to run at very high emotional levels, but as we can see, average non-OPEC production in the three years of 2010, 2011, and 2012, (at roughly 42.5 mbpd) is just one percent above the average high of 2004. The fact remains that non-OPEC oil production is composed of very uneven results from various producers. Many of these have long offered the promise of increased volumes but have turned out to be a disappointment. Brazil is a case in point, where oil production is stagnant and not growing. Meanwhile, Canada remains at least 4-5 years behind projected growth rates from last decade, and other non-OPEC producers continue to suffer declines in places such as Mexico and the North Sea.

Marginal Price Realities

The oil market now understands that should prices fall below $90, it starts to make sense for large integrated oil companies to simply buy oil on the open market for refining rather than spending the capital to develop the oil from the ground. The cruel math of the marginal barrel now means that prices must stay above the $90 mark to encourage investment in new supply.

Furthermore, the rate at which this new supply comes to market remains ploddingly slow. Recent forecasts, such as Leonardo Maugeri’s wildly cornucopian report, completely overstate the rate at which new supply will come to market and the rate at which existing supply is in decline.

More broadly, the public still seems not to understand that many of the giant, integrated oil companies are now mostly price-takers of oil, not price-makers of oil. ExxonMobil, Shell, and ConocoPhillips have increasingly become natural-gas-focused companies as they lost their ability to replace their own oil production with new supply over the last decade. The new oil resources which come on-stream now are made possible by the small and mid-sized oil companies, which are more nimble and more suited to the tight, narrow boundaries that define the next tranche of oil supply. Global oil supply was once composed of giant companies extracting huge volumes from singularly giant fields. Now the landscape has fractured into a million little pieces, with specialists far and wide digging up expensive, hard-to-extract oil.

OECD Inventories

When new supply comes online at very slow rate against existing declines, one of the sources upon which the market can draw is inventory.

Based on the number of days' supply, total OECD inventories are back down near their lowest levels of the past four years at 57 days' supply. Readers will recall that the IEA Paris cited these inventories when the Libyan conflict broke out last year, as a reserve of oil that would be sufficient to calm oil markets. Not so. Oil markets were not pacified at all by inventories, which have been in a downtrend for over two years:

For over a year, inventory levels have been below the trailing five-year average. Per the most recent Oil Market Report from the IEA, inventories fell again, counter-seasonally.

Frankly, it is not so much that OECD inventories are at critically low levels, or that inventories are falling rapidly. Rather, the point is that inventories are not building. Indeed, on an absolute basis, OECD inventories at 2,683 mb (million barrels) revisits similar levels from 4-6 years ago (2006-2008). This is yet another reason why stagnating economic growth in the West has not exerted much downward pressure on global oil prices.

Energy Transition and the Next Set of Risks to Oil Prices

Global growth, scarce though it may be, is no longer being funded by oil. OECD economies have rebounded weakly since 2008, and have used natural gas, coal, and renewables like wind and solar rather than oil to build back broken portions of their economies. Meanwhile, in the non-OECD, where oil demand is still growing, the consumption of oil is completely dwarfed by coal consumption. There is no question that energy transition is underway and has been already for at least five years. In my last report, I suggested that one possible pathway for oil was to be finally set free to achieve significantly higher prices as the construction fuel for a world in transition.

In Part II: The March to $200+ Oil, we take a look at the various factors (and the relative influence of each) that are combatting to push oil outside its current price range: lower, as a result of renewed deflation and financial crises, and also higher, as a result of a near-term growth spurt brought on by renewed reflationary operations.

Click here to read Part II of this report (free executive summary; paid enrollment required for full access).

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johnQpublic's picture

i'll take israel attacks iran for 1000 alex

DCFusor's picture

Transitory.  Human stupidity in one form or another is what will move oil longer term.

Like that was news - I'll wait till 11 for that.

Flakmeister's picture

The thing about Peak Oil is that anyone without their head in the sand (or paid to speak otherwise) saw it coming, the thing that no one really got was how it would play out.....

DaveyJones's picture

got or gets? It still has some interesting geopolitical variables based on, well mostly, human stupidity

Flakmeister's picture

I think the aspect that people missed is that the peak would be a much longer drawn out affair... A true slow-motion train wreck with lots of Brownian motion thrown in....

Citxmech's picture

Personally, I agree with Martinsen that the economic/debt implosion was a result of cessation of growth in the energy produciton sector.  I also think that reading about the "bumpy plateau" is WAY different than living in it.  So many are focused on the trees that they miss the forest.  The part that scares me are the steps that the ones with the most to lose will take to try and maintain the unsustainable.

o2sd's picture

LOL. In 1919, gasoline prices were 25 cents a gallon. If you adjust for inflation to present day, in real terms that is $3.49 in present value dollars. According to USEIA( gas averaged $3.83 in September. In other words, the price of gas has only increased by 0.1% in 93 years.

If there is a supply problem, the market has not priced it into the price of gasoline. Meanwhile, the US saw gasoline demand peak in 2007 and has declined since. Demand is expected to fall sharply even as mileage and numbers of cars increase due to increased effeciency and biofuel supplementation.

Lastly, when oil production peaks, 50% of the extractable oil has been taken from the well. The water cut increases, raising the extraction cost and lowering the daily production, but there is still oil in the ground. If we only double the efficiency of our energy consumption, there is enough oil in the ground for another 200 years. 



Flakmeister's picture

Did you pull the 200 year figure out of your ass?

It sure smells like it...

o2sd's picture

No I did not. But your sizzling rebuttal, full of facts and figures has left me with the notion that you really don't know what you are talking about. Do you even know what peak production actually means?

Flakmeister's picture

Would you like to play?

200 years at current production = 423 billion barrels of recoverable oil....  I think it is safe to say that number is utter bullshit...

o2sd's picture

OK, here is the current proven reserves:

If you want to dispute those numbers, go ahead, given me your sources for proven reserves.

Current consumption is 82mio bbl/day. If we only double the energy efficiency, consumption would decline to 41mio bbl/day which is 92 years on proven reserves alone. We have already built cars that can get 200mpg, pumps and fans that are 10x more effecient, buildings that are 9x as thermally efficient.

As production declines, the price will rise and all of the efficiency technologies we have ALREADY developed will be put into place as a demand response to the rising price.

We have 10x the negabarrels on the demand side than the producers have on the supply side.

Flakmeister's picture

You think it is that easy....

Did you assume any growth in demand? Did not think so...

You also make the rookie error assuming that the flow rates for those putative reserves are the same.... Ghawar super-K zones and SAGD heavy oil are not comparable...  

The OPEC ones are overstated by 300 million barrels and the Saudi ones have not changed despite extracting ~9 mmbpd for 30 years... Hell, use Wiki to see the history of OPEC reserves to see what I am talking about....

If you are really interested in the issue, you should read the Hirsch Report for realistic time lines of mitigation....

Finally, I call BS on your claim re: pumps and fans (not that it of any consequence), not to mention that thermally efficient buildings don't rely on oil....

You are in denial.....

EDIT: the 200 yr figure was for the US quoted above was for the US...

o2sd's picture

No, I assume demand will decline. There are those who are fighting the rapid decline in demand, but they will be swept aside by market forces. There are at least 4 sustainable, renewable,scalable, non-food sources of hydrocarbons that are profitable at roughly $5 per gallon,and insanely so at $10 per gallon, so it's unlikely that the black goop that is expensive and dangerous to pump out of the ground will go beyond that price for very long.

Even if the proven reserves are overstated, the market can respond to the higher price of oil (driven by decreasing supply), by lowering demand even faster, especially in the US.

Heating oil consumption has dropped from 942,000bpd in 1973 to 309,000 bpd in 2008, as buildings became more thermally efficient and switched to natural gas and electricity.

I'm not in denial, I'm just in possesion of the facts.

Flakmeister's picture

You are delusional....sorry...

Henry Hub's picture

I don't know what the price of gas was in 1919, but it was approximately 20 cents a gallon in 1965. I had VW Beetle. Drove it everywhere. Total gas bill - $10.00 a month.

Bam_Man's picture

The REAL re-pricing of oil happens when the first producing state says "We don't accept funny money any more. Settlement in Gold only from now on."

It is not a matter of "if", only a matter of "when". And to all the deflationists out there - you will be absolutely correct right up until that moment.

SmittyinLA's picture

Didn't Saddam, Kadaffi try that?


It goes like this "Hey, we're only taking gold, silver and goods in exchange for our oil" .............immediately followed by "boom yer dead, and your nation's water & electricity systems turned off"


This is capitalism, he with the most gold to buy the most guns rules.

ParkAveFlasher's picture

Iran is not Libya, and it is certainly not Iraq.

If anything the US literally inflated her reach to fight a protracted occupation of Iraq (which we are still paying for).  If the dollar blows up any further, it busts. 

easypoints's picture

Great point. However, China can get their oil elsewhere, and don't mind paying in dollars. When that changes, the petro-dollar will die and all that will be left is gold and war.

DaveyJones's picture

Good point, empires never kill to control raw resources

t0mmyBerg's picture

Before that happens, the US will do what is becoming increasingly likely, which is to tell China we will no longer accept their mercantilist approach.  Either they must live up to the promises they made in 2002 in order to gain access to the world trade system and become workshop to the world, or they will be frozen out.  That will drop a bunch of oil demand right out of the picture.  Price drops then.

sushi's picture

Great idea. Freeze out the Chinese.

And then watch as the price of a $400 PRC air conditioner goes up to four times that price. And a huge variety of consumer goods simply dissappear from the shelves. Try and calculate Walmart's revenue stream if all they had to sell were US made or OECD made goods.

Yup, smart move.

And then there are the profits of firms such as GM which sell more cars in China than they sell in the US. Once the US has "frozen" out China do you really believe GM will maintain any profitable production in China? Since most of the Fortune 500 use China as an export platform (heard of APPL?) once that is no longer available where will they source their product. Watch P/E levitate to infinity once the warhoused product dries up.

Of course the other option is to simply bomb the Chinese into submission. That just achieves the same result as above but requires several billion in US defence expenditures. Of course that can be financed. Sure. Just sell the bonds to China!!! Once their economy has been flattened they will be jumping in the street to buy US debt.

The world is such a simple place when you know less than little.


Arnold Ziffel's picture

China's Wen just annouced an almost $200 Billion infrastructure program (roads, trains, etc) which will require lots of Black Gold. I don't see oil falling much below $85 .....more likely rise to $200 in the near future:

1. demand;

2. hedge against inflation; and

3. MENA wars.


Rather then a mere "Black Swan" it might turn out to be a "Black Oily Swan."

Sofa King's picture

Shit was all laid out in the movie "Rollover".

billsykes's picture

I gotta see that I like Kris Kristofferson

Stock Tips Investment's picture

Regarding this issue, I think we should consider three new elements. First in the world are investing large amounts in exploration and exploitation of oil. This will have a major effect on the supply of the next 10 years. Second, the world is growing very significantly the consumption of alternative energy sources. This factor will also have a big impact over the next 10 years. The third is that U.S. will become a net exporter of energy in the next 10 years. The combination of these three factors will generate the biggest economic change in the world since the rise of China as a world power.

Flakmeister's picture

You lost us when you claimed the US would become a net exporter of energy within 10 years...

You should not snort mescaline and post on ZH simultaneously....

ParkAveFlasher's picture

That said, where is that "I trade on DMT" guy today?  Now THAT'S a meme-in-waiting.

Spastica Rex's picture

Nice. All I can ever manage with posts like that is "OMG."


mumbo_jumbo's picture


maybe you should read other blogs than just the hedge.  i've read that 10 year number is quite possibly a reality.

abiotic oil, wouldn't that just put a monkey wrench in the oil/gold bugs view

Flakmeister's picture

Umm... Do you think I would be informed as I am on energy matters if I only hung out at the Hedge?

Let me guess, you are going to quote the flawed CITI "analysis".....

The only way the US is "energy independent" in 10 years is that the dollar and the economy have collapsed and we are using energy at 1940 levels....

Henry Hub's picture

Apparently when Romney talks about the U.S. having oil self-sufficiency, he is counting the Canadian oil sands in this calculation. If he's elected I'll be waiting to hear about massive U.S. troop movements on the Canadian border. Have to protect the oil from the terrorists, don't you know.

DavosSherman's picture

Perhaps the repricing of oil is going to be tied directly to the repricing of water.  

I stumbled upon this in 'The Ripple Effect, the Fate of Freshwater in the Twenty-First Century' (page 288) "The federal Bureau of Land Management (BLM), the agency responsible for managing public lands, estimates that the shale formatioin under the Colorado, Whoming, and Utah could yield as much as 1,800,000,000,000 (1.8 trillion) barrels if oil, an amount three times the size of Saudi Arabia's "proven" (quotes mine) reserves."

That is enough to get even the hard core peak oilers attention.  My take on the PO debate has been simple: BP's global 86 m/bpd production v. 88 m/bpd consumption says it all.  Easy oil is gone.  At the very least this is the erea of Peak Easy Oil.

But aside from the mining/time issues there is the water problem.  One barrel of butumen (synthetic crude) oil takes 5 barrels of water to get.

Flakmeister's picture

Check out the history of Kerogen mining and processing...That "oil" in the Green River formation is the equivalent of really shitty coal....

BTW, don't fall for BP's slight of hand, refinery gains, NGL and ethanol is not C+C.... Real Crude and Condensate production is ~73-74 mmbpd.....

SelfGov's picture

The word to pay attention to there is, "...could..."

You're talking about the Green River Basin which doesn't actualy have any oil in it.

It has stuff that can be converted to oil but the tech to take it out is not there.

Dapper Dan's picture


But aside from the mining/time issues there is the water problem. One barrel of butumen (synthetic crude) oil takes 5 barrels of water to get."

I am not worried about them using water that comes from the ground, I drink bottled water!

DavosSherman's picture

"I am not worried about them using water that comes from the ground, I drink bottled water!"

LOL Dapper Dan.  On page 292 of that book it explained that American's spent $10,600,000,000.00 on bottled water per year.  Someone who drinks eight glasses of water a day from the tap pays 0.49 a year, and if you were really not joking you'd be paying $1,400 a year for those 8 glasses a day.

Oh, one more thing, 40% of bottled water is actually tap water.

prodigious_idea's picture

Don't believe everything you read.  A discussion of bottled water leaves the $/unit element behind very quickly.  And your 40% stat is inaccurate.  Unfortunately an explanation with facts is too time-consuming and off-topic for this thread.

Spastica Rex's picture

Lucky for you.

And.... he's gone.

Henry Hub's picture

***Someone who drinks eight glasses of water a day***

Nobody can drink eight glasses of water a day. Eight glasses of beer, no problem.

sushi's picture

And I don't drink beer that comes out of the ground.

Richard Chesler's picture

Oil prices are not rising, Obanana dollars are falling.


Flakmeister's picture

Relative to what???? Oil?

Define your metric first....

DaveyJones's picture

they are not mutually exclusive. In fact it's the same mathematical principle. More of the latter, less of the first. One has intrinsic value, one doesn't.  

CrashisOptimistic's picture

The price of oil per barrel has not changed in 100 million years.

It is 5.6 million BTUs / barrel.  It always was, it is now, and it always will be.

Until you understand that at a deep, instinctive level, you cannot understand the future.

Citxmech's picture

The BTU yield of oil is the value - not the price.  Big difference.   Demand effectively goes up (increasing the price) as the net BTU yield of oil declines because of the decreasing EROEI that occurs as extraction becomes increasingly difficult.

CrashisOptimistic's picture

That's a very solid bit of thinking that reaches an incorrect conclusion.

The PRICE is 5.6 million BTUs because it is 100% transparent.  If you pay more than 5.6 million BTUs for a barrel of oil in terms of effort, you have overpaid.  The energy content defines its price.  

Under pay in effort expended and civilization gets a great deal.  Overpay and civilization dies.

Racer's picture

If traders, err vacuum tubes, had to take actual physical delivery, the price of oil would be decimated in a phantasecond