Guest Post: Understanding The New Price Of Oil

Tyler Durden's picture

Submitted by ChrisMartenson guest contributor Gregor Macdonald

Understanding The New Price Of Oil

In the Spring of 2011, when Libyan oil production -- over 1 million barrels a day (mpd) -- was suddenly taken offline, the world received its first real-time test of the global pricing system for oil since the crash lows of 2009.

Oil prices, already at the $85 level for WTIC, bolted above $100, and eventually hit a high near $115 over the following two months.

More importantly, however, is that -- save for a brief eight week period in the autumn -- oil prices have stubbornly remained over the $85 pre-Libya level ever since. Even as the debt crisis in Europe has flared.

As usual, the mainstream view on the world’s ability to make up for the loss has been wrong. How could the removal of “only” 1.3% of total global production affect the oil price in any prolonged way?, was the universal view of “experts.”

Answering that question requires that we modernize, effectively, our understanding of how oil's numerous price discovery mechanisms now operate. The past decade has seen a number of enormous shifts, not only in supply and demand, but in market perceptions about spare capacity. All these were very much at play last year.

And, they are at play right now as oil prices rise once again as the global economy tries to strengthen.

The Subordination of Cushing

Through the dominant force of its own demand, the US economy largely controlled the oil price for many decades. For years, it was common practice therefore to gauge world demand through the weekly updates to oil storage at Cushing, Oklahoma as well as total oil storage in the United States. If the US was demanding more oil from the global market, and thus either not adding to oil inventories or drawing them down, then a signal was given, pointing to future oil price strength.

But this dynamic began to break down coming into 2005-2007. That was the period when US oil demand -- because of rising prices -- began its current decline. Now that US oil demand is down over 12% from its mid-decade peak, the fluctuation of oil inventories in the US no longer drive prices.

The chart below shows that US inventories have been on an upward trend since 2005, and are now near decadal highs above 300 million barrels even though oil prices are back above $100:

What we're now seeing is that US inventories and US demand are now subordinate to numerous other factors, ranging from emerging market demand, to market perception of spare capacity.

Lessons of Libya

A useful fact learned during last year's Libyan civil war is that Saudi Arabia does not necessarily posses the 2-3 mbpd of spare capacity which most have assumed for years. Moreover, Saudi Arabia ceded the position of top world oil producer to Russia over 5 years ago in 2006. Indeed, Saudi Arabia made no production response to the loss of Libyan oil last spring. Producing near 9 mbpd, it was only by June that Saudi production was lifted by 600 thousand barrels a day (kbpd). That is a hefty production increase to be sure, but it raised questions as to how quickly spare capacity in the world can be brought online.

By the time Saudi Arabia had lifted production, the OECD countries led by the IEA in Paris had already decided to release oil from official inventories. But this, too, did little to calm oil prices -- and as I pointed out last June, only created further problems. In The Dark Side of the OECD Oil Inventory Release, I explained that, by lowering OECD inventories, the market would correctly deduce that safety buffers had been reduced further. Combined with the Saudi increase in production, this only reduced spare capacity further.

The result was even stronger prices as WTIC ran back to $100 (until all global markets floundered on a flare-up in the EU financial crisis). Indeed, it is no longer US inventories of crude oil but the fluctuations in the emergency cushion of all inventories in the OECD (of which the US is part) that is now the more important factor in oil prices:

The loss of Libyan production caused a dramatic drawdown of OECD total oil stocks, which were already in a downward trend starting the previous summer in 2010. OECD inventories fell on both an absolute basis and on a comparative basis to the trailing 5 Year Average as the above chart shows. Taking these inventories from a high of 2800 mb to 2600 mb only 6 months later, combined with unrest across the entire Middle East, was more than enough support to boost WTIC oil prices from $85 to above $100 last spring. Additionally, as we can see in the chart, the decline in OECD oil inventories was maintained into the end of 2011.

These are important conditions to consider when trying to understand how oil prices now, in early 2012, are once again on the rise. 

The Decline of Spare Production Capacity

The latest global production data shows that Saudi Arabia was producing 9.4 mbpd on average during 2011, an increase of 500 kbpd over 2010. To accomplish this, The Saudis had to increase production from 9 mbpd in 1H 2011 to 9.8 mbpd during 2H of 2011. But paradoxically, this production increase has only made the global oil market even tighter, as spare capacity shrinks further.

Let's recall that nearly 60% of global oil supply comes from outside of OPEC from countries like the US, Canada, Brazil, Mexico, China, Australia, and the big producer---Russia. There is no spare capacity in this non-OPEC grouping and there hasn’t been for years. Sure, there is oil to be developed in non-OPEC countries; but that is not production capacity (meaning it is not supply that can be brought online quickly).

Moreover, Russia, the country that single-handedly saved non-OPEC production from going into steep decline, massively increased its contribution to world supply in 2002. But in the past two years, it has seen its production growth taper off and flatten, to just shy of 10 mbpd.

That leaves the oil market, tasked with the job of pricing, to figure out the ongoing mystery that is the "true" spare production capacity in OPEC. That it took 4-5 months for Saudi Arabia to increase production is a concern. Such delays should seriously give pause to those analysts who’ve regurgitated the belief over years that Saudi has 2-3 mbpd that can be brought on quickly.

Although EIA Washington currently judges OPEC spare capacity to be higher than during the lows of 2003-2008, it's historic figures show that spare capacity has been declining since a 2009 high.

Moreover, the failure of non-OPEC production to increase within last decade counts as a true surprise to the global oil market. The faith in non-OPEC supply over the last decade helped to keep prices subdued, until that faith was shattered by 2007's wild spike.

The problem now is that the oil market has been re-educated. Faith in the non-OPEC countries' ability to increase supply is no more. Meanwhile, the great deceleration in Russian oil supply growth, has spooked the market. Combined, a market with 74 mbpd of production and a theoretical spare capacity of 3 mbpd simply creates too much uncertainty.

And consider this: the amount of total spare capacity is now equal to the 3 mbpd of demand that’s been taken offline in Europe, Japan, and the United States over the past 7 years, as oil prices have risen from $40 to the $100 level. Thus the oil market has quite correctly rationed supply, at higher prices. If prices were to fall to $50 or $60, the world’s lost demand could be rebuilt rather quickly.

Killing discretionary demand is now the proper function of the oil market in an age of flat supply growth.

Quantitative Easing and Granger Causality

We should also remember that the global economy would be mired in a textbook deflationary depression were it not for the continual and gargantuan US$ trillions that have been provided by central banks since 2008.

Early 2009 saw oil prices slip briefly below $40. But, of course, that's the price level appropriate to a world during an industrial crash -- with reduced shipping, halted economies, and dislocated consumer demand. The world can have those prices again, if it chooses. But it must also be willing to accept a global recession to achieve such low oil prices.

Thus, there is a misconception that currency debasement is the main driver of oil prices. However, given the new supply realities, that simply isn't true any longer.

The chart below is helpful in explaining why. There is no question that coming out of 2000, the decline of the US Dollar as expressed by the USD Index was a true component of the rising oil price. During that period, as the USD was falling, global oil supply was still increasing. The descent of the US Dollar was unquestionably part of the repricing process, as the USD Index fell from a high of 120.00 in 2002 to 80.00 in 2005:

But see how the most ferocious part of oil’s price advance started to unfold after 2005, when, as the USD continued falling, the global supply of oil stopped growing.

If we think of this comprehensively, we have to conclude that the debasement of currencies is no longer the primary factor in the price of oil on a valuation basis. Rather, it is that quantitative easing prevents a deflationary industrial collapse, thus keeping the global economy alive and able to consume more energy.

We can therefore say that in our post-credit bubble collapse era, and with global oil supply now flat, that quantitative easing causes higher oil prices (through Granger causality). It keeps economies from collapsing (for now) and thus brings demand up against very tight supply. As we can see from the chart above, the USD Index has for 3 years now been bouncing off the bottom it first reached in 2008. In a way, this is helpful because it brings to light the new dominant factor in global oil prices: supply.

Supply is now Primary

Supply, and the recognition of supply, are now the dominant factor in the oil price. A point so obvious, it hardly seems worth making. However, the developed world is still largely operating on the classical economic view that higher prices will make new oil resources available.

That is true. But, it’s just not true in the way most anticipate.

While higher prices have brought on new supply, these resources have been slow to develop, are more difficult to extract, and generally flow at lower rates of production. As the older oil fields of the world decline, the price of oil must reflect the economics of this new tranche of oil resources. There are no vast, new supplies of oil that will come online in 2013, 2014, and 2015 at the scale to negate existing global declines.

During the entire time that global oil supply has been held at a ceiling of 74 mbpd, since 2005, a lot of new production in the Americas and Africa especially has come online. But it has not not enough to increase total world supply. And the price of oil has finally started to price in that new reality.

Here Comes Volatility in Oil Prices

The pricing dynamic discussed above is accentuated by the crisis cycle: the repetitive oscillation between acute and chronic phases of the ongoing debt crisis, mitigated by central bank reflationary policies.

In Part II: Get Ready for Oil Price Volatility to Kill the 'Recovery', we forecast how today's protractly high recent oil prices are already sending a signal that a new hit to global demand is underway.

Generally, it appears that the oil price is making its move too early in the year -- which will likely serve as a sucker punch to the fragile world economy -- thus making spectacularly high prices before year end less likely, and a sharp market correction and return to economic recession more so.

Investors will be wise to take prudent precautions before this nasty wake-up call arrives.

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

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Yen Cross's picture

 Planes with one huge " TURBO FAN" crossing the Pacific.

whatsinaname's picture

Did not see crude spike to day after the 2:30 JPM announcement while the SP spiked higher.. what was that about ?

Yen Cross's picture

Crude briefly spiked into the low/mid 107's , before retreating into the high 106's. Shall we discuss the 10$ plus contango in Brent?

  The commodity currencies are apeshit sideways. Lack of demand.

Pinto Currency's picture



This article is of some interest however it doesn't deal with the central issue that is monetary base expansion for two decades - not just recent QE.  Crude is over $100 up from $20 during the 1990s because of money printing.  That's it. 


First increasing money ran into stocks, then real estate and derivatives and now commodities.  QE was just a desperate attempt to reinflate the asset bubble, that had already been inflated for decades, with even more more money printiing.  The problem was that this time the money ran into commodities.





Xkwisetly Paneful's picture

Sorry no misconceptions here.

Inflation and all the US has to do is either announce more liberal domestic drilling or a more aggressive stance towards building nukes and the price would freefall.



Pinto Currency's picture



Expect panicked attempts to bring down oil or blame it on Iran.


Watch WPRT - Q and WPT - TSX as oil price containment fails.


Nat gas is at diesel equivalent price of $2.00 per gallon and lots more nat gas on the way with frac drilling technology.


AgShaman's picture

Q: Define monetary demand

A: Gold....the new price of oil

Yen Cross's picture

 Are you smoking " PEYOTE"? I'm talking real time you BUNG HOLE!

GreenPlease's picture

So reserve estimates for the Marcellus Shale get downgraded by 80% by the USGS and you think there's "lots more nat gas on the way with frac"? You drank the koolaid, didn't you?

Here's how I was able to smell the shale gas scam a mile away:

Shale gas industry to investors: "Horizontal drilling is new! Fracking is new!"

Shale gas industry to environmentalists: "Horizontal drilling is old. Fracking is old."

Checks wikipedia.... both horizontal drilling and fracking is old... so is combining them. 


If you diverted ALL of the current U.S. natural gas supply to transport use you'd just barely replace imports. ALL simply isn't going to happen especially when you consider that the U.S. power industry is going to add 4-5TCF of annual demand between now and 2020. CHK et al just need a couple million vehicles to suck up an extra TCF or so of gas to tighten the market and send prices back to $13+/mcf so the good times can roll (for them).

Pinto Currency's picture


The Marcellus Shale formation is one formation in the Eastern US.  Recommend that we don't judge shale gas potential by the exploration geologists at the NYT.


Remember,  with stable currency you only need to affect imported oil demand at the margins to affect the price and the potential is to get away from importing oil from the Middle East.  Now that might not be of interest to the NYT.


With monetary inflation continuing, it is essential to become more energy independent  - and as the energy companies explore, they are going to find more and more of this available gas.  Patience.


Wait until you see what they find in the Caribbean (recognize that is not US territory).

trav7777's picture

lol...nuclear will replace oil, which is primarily used for transportation, huh?

Good lord man, just shut the fuck up.

Spastica Rex's picture

Yay, Trav. I mean Fuck off, Trav.


tmosley's picture

Yo dawg I herd you like conflation, so we pretended that energy and fuel are the same thing, and claimed you can't use hydrocarbons currently used for energy to make fuel when there are other cheaper methods to produce energy.

Think for yourself's picture

classic meme which tmosley tried to adapt to this situation... which was much more complex than the usual Yo dawg meme. Here's an example: "Yo dawg we heard you like batman"

hangemhigh's picture

TO: tmosley '"


"Yo dawg I herd you like conflation, so we pretended that energy and fuel are the same thing, and claimed you can't use hydrocarbons currently used for energy to make fuel when there are other cheaper methods to produce energy."

c'mon, man you making this way too complicated.....all you gotta do is rehypothecate them stinking hydrocarbons and you can use them any way you want to, as many times as you want to and nobody but 'the shadow' will ever know the difference...................

trav7777's picture

fuel IS energy you stupid dipshit

I don't even know what you are trying to say with that 2nd half of the sentence, and neither do you.

STFU idiot.

FeralSerf's picture

Electrically powered locomotives are common in many places.  Trains are a waste of diesel.

Taint Boil's picture



There is nothing that packs the punch of a gallon of gasoline. Nothing can replace it with the same EROEI. Nuclear plants take what – 10 years LOL better get started. Electric vehicles! ROFL not in this century.


I’m getting to lazy too post evidence and / or the basic laws of physics.


Google these:

Volt is a scam

ERORI ethanol

The Oil Drum

Chris Martenson Crash Course

The Hummer Verses the Hybrid


Pinto Currency's picture



On a BTU basis, a gallon of diesel packs more of a punch than a gallon of gasoline.


diesel 129,500 btu per gal

gas 114,000 btu per gal


Factoring in cost, you get 13.5% more energy for 7% higher price per gallon.


Natural gas on the other hand is approximately $2.00 per gallon on a diesel gallon equivalent (equivalent energy per gallon basis (BTU's) to diesel ).


$2.00 vs. $4.12 per diesel gallon - which will the trucking companies choose?


Westport Innovation's technology is going to revolutionize the trucking industry (they also offer the nat gas kits OEM for F-250 and F-350 pickups).

Taint Boil's picture



I said gasoline but of course I meant oil and all its distillates. I was trying to point out the the EROEI for bio-diesel vs diesel for example. Sorry for the poor job and thanks for correcting.

Is your car on fire? LOL

Pinto Currency's picture


I hear you Taint.


The pinto currency is on fire! 


Gold don't burn and Charlie don't surf.

jonjon831983's picture

I'm a fool and deserve it.  Bought an initial position in WPT today... then Natural Gas Act was rejected... again.

However, I am definitely intrigued by the technology... seems they are finally getting a decent cashflow going...............................



Pinto Currency's picture





The market worldwide is going to rule this one no matter what exxon, chevron, shell, bp do to squeeze congressmen. 

Think long-term.  Good luck.



tmosley's picture

And why, exactly, do you think that fuel needs to have a positive EROEI?

Fuel's primary utility is in its energy density, not in the fact that we can pump it out of the ground cheaply.

If you had a robust battery, like, say, a metal-air battery, you could charge it for the cost equivilent of a few dozen cents per gallon off of the grid.

But peak oil doomers don't like that, so they pretend it is impossible.

Taint Boil's picture



And why, exactly, do you think that fuel needs to have a positive EROEI?

riiiiiiiight, so, you would spend 1.1 units of energy to get 1.0 units in return - WOW

Z Beeblebrox's picture

If that one unit is in a more useful form (more portable/dense/stable/whatever) than the 1.1 units were, it's worth it.

FeralSerf's picture

Absolutely; I can't understand why that's so difficult to comprehend.  It's the reason people pay more for diesel or jet fuel per BTU than they pay for coal.

Taint Boil's picture



Arguing on the internet … LOL … even if you win you’re still a retard.


I understand the coal thing – I can’t put coal in my Boeing 747.


When, not now, I have to spend 500 million for my deep water drilling rig to get 500 million in oil then it won’t make sense. Anymore of this nonsense and I am going to release Trav7777 on you guys.

 Never mind I see he is already here - LOL

FeralSerf's picture

Oil has been too cheap for too long.  It's worth more than it costs right now.  I can still waste it on pleasure drives, for example.

Deep water drilling is getting cheaper in real money (IA$) thanks to technology improvements.

Just wait a bit, then it might cost 250 million inflation adjusted dollars for the drill rig and maybe you'll get more than 500 million IA$ for the oil.  It's happened before.  It's happening now.  It will continue to happen if population of Mother Earth keeps growing and some other better fuel source isn't developed (which is not that certain either).

If I were you, I'd start thinking about trading in that 747 for something a little more fuel efficient.  On the other hand, it may be technically possible to burn coal dust in it.   FAA approval may be difficult.  Coal dust was used as fuel in the first diesel engines if I remember right.

Trav7777 is full of shit and his mother dresses him funny (in my humble opinion).

trav7777's picture

NO, it ISN'T.  You CANNOT take a principle that may have limited relevance and EXTRAPOLATE that into a general case.

This is what idiots like mosely-claven do.  If something works in even ONE case, then it simply MUST be relevant as a general premise.  You can run a space program on negative EROI fuel, but you cannot run a large complex society off of same.  There are physical limits in terms of how much energy you use versus how much you have to waste...we call these things thermodynamics laws.

AnAnonymous's picture

riiiiiiiight, so, you would spend 1.1 units of energy to get 1.0 units in return - WOW


US citizens? But absolutely.

Of course it underlines even more that US citizens have launched a race to deplete Earth's resources but it is secondary.

This obvious waste is certainly not something that is going to stop US citizens.

Peak oilers who are primarily US citizens are just paying service to the other US citizens by covering their back.

Good cop, bad cop duo work, if you like.

trav7777's picture

gee, because positive EROI is the underpinning of life itself, nevermind our entire fucking society?

Negative EROI fuels have never been more than excessively costly special applications, like the space shuttle, or a few years' of a desperate nation.

See that is the problem with idiots like you, you see one special case and can't figure out why it's a SPECIAL case and not generally relevant, and you try to say "SEE IT CANZ BE DONEZ, YOU JUST WORSHIP BALE" and shit like that.  It's because you have an IQ of 61.

You think the massively positive EROI of oil is just...irrelevant?  LOL.  That's the stupidest thing you've ever suggested.  You should figure out how energy density relates to EROI.  Or not.  Just keep throwin softballs.

If you want to replace oil with negative EROI fuels, come up with the 100 quads necessary.  AKA, triple present non-oil production combined.  It's fuckin idiotic to suggest such a thing.  which is why you suggested it.

GreenPlease's picture

Let me guess.... you do it for the lolz?


How up to speed are you on nuclear technology? How about the regulations surrounding nuclear power? Let's just say that this was your plan:

Use nukes to replace baseload coal

Use coal to replace mid-peak and peak nat gas (good luck on that last one)

Divert nat gas for use in transportation


It's late so I'm just going to roll with back of the envelope numbers here. Let's say that the U.S. draws 1.5TW constant from coal. If we're using PWRs how long will known global uranium supplies last if we replace all of our coal with nukes? I'm going to say ~30 years. That's not very long. To go beyond that you need to either reprocess the fuel or build breeders. Breeder reactors using thorium would work nicely but, sadly, global regulations don't play nice with thorium. Breeders/reprocessing uranium has the unsettling side effect of producing Pu-239 (bomb fuel). I'd say that's okay but, realistically, the public would be way too scared to allow something like that to fly.

"more liberal domestic drilling"

You're aware we already drill the crap out of North America, right? Let me guess, you want to open up ANWR. That's cool. The rosiest estimates for ANWR predict maximum production of 400,000bpd. What's that? More DWGOM drilling. That's cool, but the region is already in decline so I wouldn't bet on any miracles. Also, it's a hostile environment to operate it. Deepwater Horizon Events will happen again, no doubt. Same goes if you open up the Atlantic seaboard but I wouldn't count on any miracles out there. The geological  history of the region doesn't bode well for reserves. Same goes for most of the west coast of the U.S. unless you get up by the PacNW but good luck getting a drilling permit up there... even if you did you're not going to find enough oil to change the game. Perhaps you'd like to try your hand at the Green River Shale? 1 trillion barrels of oil... er... kerogen... you say? Good luck getting it out.

If you really drilled the crap out of EVERYTHING in NA you might raise production by ~1.5mbpd for a little while. That's far from a game changing amount in the scope of the global economy... hell, that's far from a game changer when your country imports ~9mbpd.

FeralSerf's picture

Maybe if an amount equal to Jamie's and Lloyd's bonuses (I suggest confiscating them for the greater good -- rule of law doesn't mean shit anymore anyway) were spent of trying to fing out if LENR can be made to work, a new source of energy might be found.  It's worth a gamble, I think.

Yen Cross's picture

Are you a FED robot?   "This article is of some interest however it doesn't deal with the central issue that is monetary base expansion for two decades -"

Yen Cross's picture

 As if you understand derivitives?(sp/fun) I'll bet you are Icelandic!

ffart's picture

I think those icelanders understand the game better than we do

Yen Cross's picture

cad or eur? I'm tired dipshit. Let me know when " you", decide the lessor of 2 evils!

palmereldritch's picture

Either one plus some jailed and exiled corrupt banksters is better than most sovereign balance sheets.

SheepDog-One's picture

Exactly, oil is apeshit and locked over $100 thanks to Bernank.

Yen Cross's picture

 The article ASS FACE was based on the precipice of Inflation! I suggested one/if-not the largest denominator!

 IDIOT 3 year old!( +1 sheep dog!)

easypoints's picture

"Crude is over $100 up from $20 during the 1990s because of money printing. That's it"


When it comes to the petrodollar, money printing is a part of the negative feedback loop. You can only print as much money as there is energy to back it up.

Seer's picture

"it doesn't deal with the central issue that is monetary base expansion for two decades - not just recent QE."

Look around you, none of it seems to be affecting much of anything.  The reason?  Because EVERYONE is doing it.  In effect everything is cancelling everything out.  Meanwhile, aside from all this virtual crap, the real world lingers, and IT doesn't much cater to our silly notions of fabricated growth.

It was not me's picture

I read from Armada Markets weekly commentary that one of the best trades currently is to short crude oil futures options and collect the premium. You can also short Japanese yen to make nice profits, or buy EURCHF. These central planners have created an environment where you can find risk-free trades everywhere :)

TheFourthStooge-ing's picture

Just more lame spam from Ingmar.


Silver Bug's picture

The price of oil and other real assets are unfortunately going to go much much higher.

FeralSerf's picture

How do you measure "price"? Fiat dollars? They're a (worthless) moving target. Try pricing it in oz. of gold.