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Guest Post: Understanding The New Price Of Oil
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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Welcome to the real Numbers. I enjoy your " Vanity"!
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thnx gonna watch it
What about complete lack of transparency in trading of commodities. That allows market participants to arficially jack up the prices of commodities like oil for their benefit.
If we make the market transparent and get rid of the huge commodity trading desks that did not exist at the beginning of the century at Wall Street firms, then and only then can we have a real picture of about the real price of commodities like oil.
Well with demand dropping thru the floor, I guess their only possible answer now to get their 'benefit' is $6 $7 and $8 gas....enjoy the recovery folks Ive got a bottle of Jose Cuervo.
Manny , with all due respect! Commodities are mankinds last bastian of freedom!
The dollar is essentially a petrodollar. It only has worth because it can be exchanged for crude. We are on an "oil standard."
With higher oil prices brought about by the supply constraint of peak oil, the entire economy is sacrificed on the cross of crude. The solution? To get off crude. To pay people to use other means of transportation, to subsidize rail, to tax gasoline. To employ people at jobs where they basically walk there and back home.
But we aren't smart enough to figure this out, so we'll kill the currency instead, which is why the metal men are going to win.
'Get off crude' how though. Sure, you can run a clown car on electric, but that takes way more electric generation, somehow.
Now fuel jet aircraft, cargo ships, and trucks that the world really runs on, and then we're talking 'getting off crude'...sorry I dont see it.
We're already doing that, we're subsizing farmers for ethenol, solor panels, etc. We've got Boone Pickens kissing politicians asses at every corner and put the GE CEO in charge of energy. We've done nothing but create more crony capitalism, the last thing we need.
I got some " Pinto Beans" for sale! Ya gotta cross the border for them though ?
Looking thru the comments shows most people believe theyre 'trying to find a solution'...yea sure they are. Nothing could be further from the truth. Anyone who thinks they went about collapsing stocks to create and emergency so they could then pump in about $30 trillion new dollars into the world economy and are now SURPRISED and PERPLEXED that oil is going apeshit has some screws loose.
This perpetual idiocy has no End!
There is no such thing as a "solution," as "solution" means permanence, and nothing is permanent (well, perhaps death, though this is kind of hard to prove).
I really don't believe that TPTB want instability. They thrive on stability, on the status quo.
What's happening is that people are starting to see that this is all a mirage. TPTB are realizing that they can't BS everyone anymore. The ensuing chaos isn't in anyone's best interest, despite what the neocons might believe. Yes, TPTB are doing what they've always done, look to stay on top of the heap, and staying there isn't helped by having instability.
Exploitation of foreign markets are becoming a thing of the past. Doesn't matter what manipulations people might think are or are not happening, there's a global contraction taking place and those that don't have resources (Japan, Germany [nearly all of Europe], Britain, China, India and others) are going to feel big pains. TPTB will have nowhere to run but to countries that have resources: this is where the greater stability will exist (though, this doesn't mean that things will be stable in the sense that they'd been known to be, just that they'll be MORE stable than those places that are lacking resources).
Let's just cut through the bullshit. The oil/gasoline markets are totally rigged. Period. But there is a reality that has to be faced. If gasoline, countrywide average, I don't give a fuck about California, exceeds $4 a gallon then real economy has heart attack and game over. Immediately. Therefore $4 a gallon will not be breached. Especially in an election year as it would mean even a spot of toe jam would defeat an incumbent President. Except, of course, for an actual shooting war. In which case I recommend grabbing your balls and ducking.
The amount of faith and awe some of you people have in the leaders is just bizarre. There is no plan for this pile of shit and it can fall over any second.
The threat of "peak-oil" is what introduced me to the realms and provinces beyond the MSM. I thought I'd progressed beyond the musings of the likes of Mike Ruppert and Richard Heinberg to a place that explained the "in's-and-out's -- "nut's-and-bolt's" analysis of this island Earth when I discovered sites such as this. Seems as though I'd hit on the truth early on after all. In the time it takes for the world to wean itself from the addiction of oil the world we know will have ceased to exist ...
"If prices were to fall to $50 or $60, the world’s lost demand could be rebuilt rather quickly."
If people adapt with better technologies, the demand won't be rebuilt with lower prices. It happens in nature too.
http://www.ncbi.nlm.nih.gov/pmc/articles/PMC545549/
technology consumes energy
sun is hot
no, no, and no.
This entire article, though baqsed on a lot of good statistics and information, is still based on the primary fallacy which is the favourite red herring of the "there is no oil shortage, there is no peak oil, its all the fault of the speculators" propagandists.
Oil price is NOT set by the amount of inventory, not the U.S. inventory nor the worldwide inventory. In fact, totalinventory is paltry, it is tiny, much like the inventory of Wallmart, as the industry operates a just-in-time delivery system. The typical total inventory in the U.S. is around 320 million barrels, which includes tank farms of just-received crude, tank farms in and out of refineries, tank trucks, tank railroad cars, pipelines, gas station tanks, truck farm tanks .... you get the idea ... that's enough, if the production were to suddenly stop, to last the country all of 16 days before everyone was bone dry ...
Oil price is set by supply and demand.
The supply is the rate of production NOT the amount on hand.
the demand is the rate of use.
People require serious motivation to change their habits, to change their amount of use, whether that means replacing their oil heater with a gas heater, or starting to carpool instead of drive to work, or buying a car that gets better gas mileage, or a scooter, or a donkey .... and such cahanges generally require some time to effect.
Because oil consumption is "sticky", a serious change in price is required to begin to affect demand.
Because of that, the price of oil is highly, highly sensitive ... a quite small drop in total production can have a dramatic effect before enough people change their habits of use to bring down demand to match it.
I advise folk here to wander over to the oil drum, which has been accurately and exhaustively covering these sorts of issue for over ten years. While unbiased numbers are simply impossible to obtain, at that website you can at least get a good idea of many of the participants' biases and with extensive reading and expoloration you can eventually gain a perceptive mosaic which, though not precise, will still render a good overall picture of what has been happening with oil and what is likely to happen next.
just-in-time delivery system
____________________________________________________
Most US citizens are in denial of the consequences of just in time systems.
Bear with it.
I watch, in serial, as the people who understand oil and the peak start dropping out of posting wordy descriptions of the problem as you just did, and resort to saying, gdit just STFU.
It's no use...many of the people who say stupid shit on this oil thread will be back to say the SAME stupid shit on the next one. They are utterly impervious to facts. You'll have recalcitrant, committed morons like cliff mosely-claven back trying the same BS that got him manhandled in the last oil thread. He'll just pretend like it never happened.
There will be some morons who slink away only to be replaced by other morons saying the same thing and thinking bc they can post it to the internet that it is to be confused with something of worth. EVERYONE has an opinion, therefore opinions aren't special and any is as good as any other, right? This is the society we live in now.
People who have no business holding an opinion not only do but cling to it like a goddamned lifering in the ocean.
TOD has been there for half a decade at least...I remember it when it was just a few links here and there. I encourage people to go say their stupid shit on TOD and get laughed at. So has every other person who understands this problem.
But the deeper problem is that even TOD won't change these people. The Downing Effect is simply too strong.
You are describing why religion is so poplular, and why TPTB and the media have so much influence. The 0-120 IQ crowd just want to be told how to think, and many of the remaining are too lazy to bother overcoming their training. Cliff heard it on CNBC. Now he can travel the world parroting that.
Very simple explanation for it all., two birds one stone.... Nigeria, Saudi, Iraq, Kuwait, and Venezuela all need the price right now to keep from popular unrest. 90% for the rulers 10% for the peasants, when your talkin billions 10 percent for the peasants goes a long way.... If we didnt have this price point, we would have arab spring in all of them, and revolt in Venezuela....... Any one of those go off for any length of time and the house of cards comes down in earnest. Another way of kicking the can.... The other side benefit is that it puts the Chinese in a very difficult spot, and makes their soft landing a million times more difficult, when they are importing hyperinflation, to start with.....
Absolutely.
How can one not achieve this conclusion, it is a mystery.
US citizens care. They are depleting entire areas of the world of their resources, painting a dark future for the locals.
But hey, they are taking one for the team (which team? Humanity of course) so that some countries avoid domestic unrest.
Here's the list: Nigeria, Iraq, Saudi Arabia, Kuwait, Venezuela.
Very convincing.
Victimology is very high among US citizens.
Simple way to fix the demand part. Let European diesel cars into the US immediately, a Honda Accord Diesel that gets 45 MPG, and some roller skates pushing 70mpg, and the price would drop like a stone, along with CO2 emissions...... When the fix is so obvious, gotta wonder why its not done.... (Hint Guberment Motors (Unions) and Big Oil, Greasing, pardon the pun, both parties, strange bedfellows eh?).....
There is only so much diesel fuel in a barrel of light sweet crude oil, even less in the lesser grades of oil. Gasoline is more abundant than diesel fuel in a barrel of light sweet crude oil.
You are suggesting to fix a problem of supply by replacing a substance in greater abundance with a substance in lesser abundance.
You mention light and sweet, but what the world has plenty of is high sulfur (sour).............
"Simple way to fix the demand part."
I'm scratching my head on this... do you mean "supply" part? When consumption is down due to people being unemployed -not having the money to buy- you cannot push on a string, force consumption/demand. And there's also the issue of there being a LOT of people upside-down on their existing auto loans.
Encouraging greater diesel use would come at the expense of the lobbyists in the US conceding that they were full of shit blaming "environmentalists" for a lack of refinery capacity: looking under the hood would expose the fact that the US is fully roped into light sweet, and that light sweet is in severe decline- OOPS! those environmentalist-bashering lobbyists will be shown for the frauds that they are. Owning up to the FACT that light sweet is in decline would clearly show that there IS such a thing as "peak oil," thus showing that our perpetual growth paradigm is doomed.
Simple way to fix the demand part. Let European diesel cars into the US immediately, a Honda Accord Diesel that gets 45 MPG, and some roller skates pushing 70mpg, and the price would drop like a stone, along with CO2 emissions...... When the fix is so obvious, gotta wonder why its not done.... (Hint Guberment Motors (Unions) and Big Oil, Greasing, pardon the pun, both parties, strange bedfellows eh?).....
ooops!
After reading the brilliant comments above, an oldman wonders 'what if' we as individuals had made not even one UNNECESSARY trip in our personal automobile trip during the past fifty years, what the world might look like today.
All here are much quicker, intellectually, than this oldman, so perhaps some of you might contemplate my question, to myself, and give a thoughtful opinion. I am too concerned with the carbon equation and 'ecology' not to show bias, and I don't know shit about what the economic ramifications have been. As an example, what might lower consumption have meant in terms of gold, the dollar, inflation, etc.
Or you can simply ignore an ignorant question.
thanks for the patience om
Qui-Gon Jinn: He can see things before they happen. That's why he appears to have such quick reflexes. It's a Jedi trait.
Ok, the brent has peaked and is now deciding on what direction to take. We need some serious escalation in the middle east for it to go higher. I am always wary of articles that try to explain things in hindsight. Cause -effect is easy to explain after the effect has been proven, also the article does mention a lot of factors that should affect the price of the Oil. I didn't bother with half of them. The idea that the market is smart and accounting for all of those effects is ridiculous. The market is dumb as a rock and we see that time and again.
Can we stop making rubbishy plastics out of oil ? Why can't we have paper sacks for groceries instead of plastic bags Made in China ? Most Euro producers are now bust thanks to Chinese dumping but we could use recycled paper for paper sacks instead of plastic. Too much disposable plastic tat wasting oil and technology
Simple answer: We must save the trees! Trees don't grow, whereas oil apparently grows on trees. :-/
Shocking! Absolutely shocking! Someones greed is causing another's opression.
When the middle east stops taking fiat (I've actually heard they are starting to prefer gold from some diplomats so please feel free to confirm or deny) then we will have another war or conflict ala Iran.
-- An absolute must read to understand oil prices now. The world is recognizing and pricing in it's newly found awareness that there is absolutely zero spare production capacity anywhere in the world. The markets are affirming their understanding that Saudi Arabia has been lying and has entered serious decline. One way or another, Peak Oil is taking center stage and more directly governing our actions. -- Michael C. Ruppert
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