After long thought, I am coming around to the notion that oil may be in a bubble. Why? Because everyone is acting as if the natural trajectory of prices is ever-upward. Sound familiar?
Oil is a fairly easily storable commodity. If you think that you can get a better price for it tomorrow, the natural thing to do is buy it and store the stuff. This should push the price upwards until there is no remaining arbitrage opportunity in buying now and selling later.
The best estimate of the future price is therefore the current price. For it to move upward, rationally, you need new information--i.e., information that none of us knows now. The basic logic behind the predictions I hear of ever-rising prices--the supply is fixed, oil is neat stuff that helps grow economies, there are a lot of economies that want to consume more of the stuff--is all well known to everyone. You should assume that the price is roughly as likely to fall as to rise.
But people are acting as if the overwhelmingly likely outcome is a continuing increase. This shows not merely in the fact that it's damned hard to find a small car on the lots these days, but also in all sorts of policy debates. This suggests a couple of things to me:
1) There are probably more speculators in the market on the upside than the downside, pushing the price above its natural level
2) We are probably irrationally overinvesting in fuel-saving technology.
Now, as I've said repeatedly, I think the price of oil should be higher, helped along by a carbon tax. But there's no reason to think that the wellhead price is more likely to rise than to fall. If I were brave, I'd short oil and buy an SUV. Instead, I'm timidly sharing my thoughts with you, and investing in a small car. But in my defense, small cars are also easy to park.
Now, as I've said repeatedly, I think the price of oil should be higher, helped along by a carbon tax. But there's no reason to think that the wellhead price is more likely to rise than to fall. If I were brave, I'd short oil and buy an SUV. Instead, I'm timidly sharing my thoughts with you, and investing in a small car. But in my defense, small cars are also easy to park.
I have two compacts and live close to work and have no desire to change either, regardless of what oil prices do, because my limited use of fuel makes me very insensitive to the price swings. The difference to my wallet between $4/gal and $2/gal is $20 in a typical week, which is lost in the noise of a middle-income budget.
I bought the SUV. It was $60K new and I paid under 30 just 2 years later. Don't know if I received a deal or not. But the previous owner took a bath, that's for sure.
In inflation adjusted dollars oil has been this high just twice in my 40 year life time. If I'm out in fly over country, and I don't have to commute, why wouldn't I short the oil market?
$21 per barrel used to be OPEC's target price back in the 90's. The new target on the curve in my meager opinion is probably $80. That's expensive enough to profit but not expensive enough to curb demand.
Of course, If I still lived in DC, I would've taken the small car.
Price of a barrel of oil (adjusted for inflation) in 1980 $97.68. Price (adjusted for inflation) in 1998 $15.70.
Between 1985 and 1986 the price of a barrel of oil fell nearly in half. What drove that. What was the trigger to the popping of the early 80's bubble?
Was it just the fall of the Shah shaking itself out... new production driven by the high prices, something else....?
I expect that I'm just missing the sarcasm, but it doesn't take braveness to buy an SUV, an asset (investment?) guaranteed to decline in value whether oil is $20, $200, or magically turned into cheese.
I've been saying the same thing since oil was at 80$, and the same people keep saying "I told you so!" every time it breaks a new record. The whole oil debate that went on last week in the blogoshpere got a little irreconcilable... with the only consensus really being that speculators were not to blame. What to believe?
A question though? As far as support for a carbon tax goes... that strikes me as odd. I'm assuming that you believe the costs of carbon emitting energy is, as-of-yet, not internalized? How can you come to this conclusion when the entire debate about future cost is shrouded in Knightian uncertainty... and even the most dire predictions would be only offset temporally by carbon cuts. The only justification for spending now (more than we already are) would be an elimination of the discount rate in its entirety. This would imply 100% global, irreparable destruction from global warming. The probability of this happening is as much unknown and unknowable as the p-value for a nuclear holocaust, space aliens or a killer asteroid... all of which are surly deserving of funds (for their investigation and prevention) if we are assuming that we are willing to act in such a risk averse manner so as to justify more spending on global warming by presuming it will decimate the planet.
All I'm saying is that the underlying distribution of potential costs and benefits from climate change are unknowable... along with plenty of other things that we don't spend money on investigating or preventing.
I agree with MM. Over the long term, the demand will rise due to growth in China and India. But for the short term (or spot market) it seems like the price has gone up too fast.
I still wouldn't buy an SUV unless you really wanted the extra passenger and cargo space. There's nothing irrational about wanting to drive a small car even when gas prices are relatively cheap.
You might want to consider a few points in your evaluation of oil prices. The first is that demand in the Asia/Africa markets is climbing substantially. In the decade to 2006 demand in those areas rose from 20 million barrels a day to 30 million barrels a day and there are few reasons to think that there will be a long term secular decline in the uses there. Private cars are being purchased and used in greater numbers. Transport is following the same demand pattern as the US, where 97% of our transport energy is petroleum based. The use of diesel to substitute for inadequate amounts of non-petroleum centrally generated power will become the norm in many areas,like South Africa, for the foreseeable future. Eliminating subsidies will cut consumption, but this will be offset over the decade to come by the expanding passenger vehicle fleet and the growing economies.
And in the Middle East more and more energy is being consumed locally as the petrodollars are being spent on air-conditioned and energy-consuming development.
On the supply side it is clear that many sources are technologically or politically fragile. MEND can affect world prices with just one attack off the coast of Nigeria. Saboteurs can have similar effects in any number of countries. The mature fields in the North Sea and in Mexico and in Russia all are producing less, in part because they suffer from underinvestment in advanced recovery. So more of the supply comes from volatile areas. Just today there is a report on how much production in the Cantarell field of Mexico is down over the last few years. And refineries are really not geared to deal with high-sulfur crudes,given the pressures to produce low sulfur products.
There is a supply/demand imbalance that takes us right back to Mr. Micawber. The pace of energy use reductions in the EU and the US will have to accelerate substantially to really put downward pressure on the market and overcome the upward pressures from growth in the Asia/Africa markets.
So far, little is being done to achieve this quickly.
While Oil may be over-bought and due for some correction, that doesn't mean it's in "bubble" territory. The NASDAQ internet bubble took the ridiculous to zero and the merely over-priced down 50% to 80%; seems unlikely we'll see $20 oil any time soon.
The price of oil on the markets also takes in to consideration the future supply of oil (in the ground and out). The bottom line is, we are running out of oil and we do not have a close substitute yet. In the long-term, this would mean oil prices will increase until we run out or decrease demand. In the short-run, we may be in a bubble but you can’t say how big the bubble is.
Mark,
Did it seem likely in 1980 (again all number are adjusted for inflation) that oil then at 97.68 would be at 28.29 in 1986.
Was there anyone in 1980 who was predciting a nearly 75% drop in oil prices within 6 years?
In a post like this, I can't believe I don't see a single mention of the phrase "smoothly functioning cartel" or a discussion regarding how our Iraq adventure has made Iran the marginal player. And I thought McArdle had some training in economics. Oh, yeah, she has an MBA. Nevermind.
"I think the price of oil should be higher, helped along by a carbon tax."
Please stop calling yourself a libertarian.
I'd short oil and keep my small car. That means that whatever the price of oil is, I save money on gas that I can spend on other things; or use to short oil.
Cars are first and formost appliances. I would suggest that very few drivers in the daily grind from here to there and back, fully exploit the performance potential of their vehicles. That would require full throttle acceleration in every gear; cruising far above the speed limit on the highway; taking corners faster than almost anybody has either the skill (or stomach in the literal sense) for; towing large loads if you have a V8 powered SUV; carrying six to eight people, off-road!!
Yet so many of the vehicles we drive have the capacity, as a function of their size and power to do far more than we'll ever ask of them and the cost of having that unused capacity can be measured in the money we spend driving ourselves, one person per vehicle, back and forth to work at an average of 23 miles per gallon (In Europe it's 44).
I happen to love cars, always have, and dearly want to own a Lotus Elise one day. But that's a toy, a really fun one, but a toy. My appliance, the thing that gets me back and forth to work, needs to cost me as little money as possible. There's too much stuff out there to use my cash on, including getting more cash, to stuff into my gas tank and set on fire, any more than is absolutely necessary.
Jmo,
My rudimentary understanding is that several factors caused the steep decline from the mid-80s to the late 90s.
1. OPEC defectors. Many members of OPEC decided to defect from the price controls and quotas, a typical prisoner's dilemma defect scenario.
2. New sources of oil finally came online. The Northsea oil was a source discovered in the 70s, but didn't come online until the 80s and is still pumping today, though steadily declining.
3. The Rise of Russia. After the Soviet Union collapsed in 1991, many Soviet industries were privatized, including much of the Soviet's underused oil fields. These private industries were able to export Russian oil on a large scale basically for the first time ever (I don't think Soviet oil trades like the ones with Cuba and the like were ever substantial).
These three factors collided and caused oil to tank, and prices to drop to historic lows. Will we ever see them again? It is possible, but unlikely for several reasons.
1. Increasing demand. Not just from the usual culprits like China and India, but everywhere. Russia, Iran, Saudi Arabia, you name it. Everyone is using more oil at a rate much faster than new supplies are discovered.
2. Falling "easy" sources. Don't forget that in the year 2000 the US was probably the 2nd or 3rd largest producer of oil in the world. As US demand continues to increase, its production decreases, and this is just as important as the boom in Chinese drivers or the increasing usage of Iranian oil by Iranians. Sure, new sources are discovered all the time. But it is a heck of a lot easier to pump oil out of the flats of Texas than some godforesaken hellhole in Kamchatka or northern Alaska or ten miles out to sea.
Megan has a point that we are probably in a commodity bubble. That doesn't necessarily mean that oil will crash with the same severity this time around that it did last time. If gas prices dropped to 2.50 a gallon next year, it would surely be a burst in the oil bubble. But that isn't as much as the mid 90s oil collapse. But heck, anything can happen. Just imagine if everyone in Iraq started singing cumbayah and pumped oil at full tilt. That would certainly crash oil now wouldn't it? Its just not very likely, that's all.
Megan:
Okay, maybe I'm wrong here, but it seems like you can make a case that we are getting new information and the rise in price is a rational adjustment to the new information.
Here's the argument:
One of the x factors in pricing oil is how accurately/truthfully oil producers have estimated their spare production capacity. As prices rise, so does the incentive to producers to open up their spare capacity and pump more oil. The higher the price of oil goes without an increase in production from oil producers, the more confident we can be that estimated spare production capacity has been exagerrated or overstated, which means that the actual store of available oil is more scarce than estimated, which in turn makes oil more valuable, which in turn pressures up the price. So the price should rise until the market becomes convinced that there IS no spare production capacity or at least no EFFECTIVE spare production capacity. It'll rise until we're sure that supply is inelastic and we're not getting any more oil out of the producing countries.
Anyway, your original post is asking what new information the market keeps learning that is forcing the price up. When oil hits $150 a barrel and the Saudis don't increase production, what we will learn is that Saudis value barrels of oil in their spare capacity pool at higher than $150 per barrel. That's not a piece of information anyone except the Saudis has now.
Not trainied in economics, so this reasoning may be flawed. Where does it go wrong?
Nate
We do have untapped sources of oil in the US (Eastern Gulf of Mexico, offshore Atlantic and Pacific as well as land-based sources) that could be tapped to bring down the price of oil... but our government is too cowardly to do so.
Another factor that has been increasing the cost of producing oil is environmental regulation. I work in the offshore drilling industry and we constantly have to meet new, stricter regulations. In many cases, these regulations are pointless but difficult to meet.
I'd rather have the carbon tax than our latest Superfriend, Cap'n Trade. Better yet, avoid them both.
It would most likely be cheaper for all of us if the apolyptics simply went to see a good shrink.
I did not know that supply was fixed. I thought it was finite but not fixed? Of course I know what is being meant by "fixed" in economic terms... we economists meaninglessly mean lingerie elastics.
Hmm... why would those many many speculators assume higher prices for tomorrow? Are they predicting that demand suddenly starts growing unexpectedly faster than production? Gosh - who would have seen the tiger states and the two dragons catch up so fast economically. 40+ years really is too short a time to realize all that is happing... This population doubling and consumption^4.. Increasing demand in the East is really really surprising.
Or are speculators generally predicting bad policy making, trade wars and restrictions etc? Are they predicting that oil countries will block foreign investments?
I have talked and listened to the commodity trader about a year ago (pick any commodity) and it did sound as if they assume that trade barriers might kick in to make matters worse ONCE something else commences... or better - when something else ends.
Malthus is not our problem. Copernicus is!
What about the idea that, until recently, oil prices were artificially *low*? For many years various producers maintained excess production capacity for political reasons. Couldn't the recent price rise just be a sign of the return to a normally functioning market where producers pump what they can, and consumers pay what they have to?
It's all a matter of timing. Sure oil is probably in a bubble, but it could take years, even decades before people realize that overcharging and underproducing is harming themselves due to the weakened global economy.
It would seem to me that oil is very easy to store below ground -- just don't pump it. But you've paid the labor and energy costs to extract it, I don't see either the surface storage capacity or the incentive not to sell it. Where's the oil equivalent of Lake Mead?
So it's possible that there's a bubble due to collusion among pumpers not to pump, and the bubble will burst once more oil comes on line. But given the amount of money that can be made in selling oil these days, why not pump flat out?
Paul Krugman has posted some quite sophisticated commentary on why he believes there's very little speculation going on. You, Megan, do not have one shred of evidence to support your position.
Oil is a fairly easily storable commodity.
Sorry Megan, but this is loopy. It might be physically easy, but not economically easy (the sense relevant to your post). The costs of oil storage is high relative to its value (even as high as prices are). So the only feasible storage option is to leave it in the ground, an option only available to field owners.
Btw, I was thinking about the SUV thing. Though I don't want an SUV, I'd be interested in a large (and thus less fuel efficient), classy sedan. I also want Ford Sync. That narrows it to: Mercury Milan or Sable; or one of the Lincolns.
I currently own a very fuel efficient, 3-month old Nissan Sentra ('08). Does anyone here think I'd be able to use the current fuel price situation to get a good deal trading it for one of the above cars? I'm not trolling for an offer, just asking if it's worth pursuing...
Oil is a fairly easily storable commodity.
Sorry Megan, but this is loopy. It might be physically easy, but not economically easy (the sense relevant to your post). The costs of oil storage is high relative to its value (even as high as prices are). So the only feasible storage option is to leave it in the ground, an option only available to field owners.
Btw, I was thinking about the SUV thing. Though I don't want an SUV, I'd be interested in a large (and thus less fuel efficient), classy sedan. I also want Ford Sync. That narrows it to: Mercury Milan or Sable; or one of the Lincolns.
I currently own a very fuel efficient, 3-month old Nissan Sentra ('08). Does anyone here think I'd be able to use the current fuel price situation to get a good deal trading it for one of the above cars? I'm not trolling for an offer, just asking if it's worth pursuing...
I would sooner say that market trading is (possibly) revealing information about the market demand curve itself, and that current changes in prices are the result of all this revelation of information. That's a non-fundamentals account of the recent changes in price, though it may not meet the traditional definition of "bubble" per se.
I know that a friend in the "All Bidness", connected with both the exploration and production sides, says that his multi-national company expects prices to drop. He also says that we could easly add a couple of percent to world oil production by opening the offshore zones of the US and ANWR. Even if prices don't drop much, the money stays in the US - not going to support corrupt regimes abroad. Just corrupt regimes at home :-).
Strange how the news converges, just a few hours before I was nodding my head to the following:
"Arjun N Murti, a Goldman Sachs expert believes we will soon hit $200 a barrel (up from the current $146 level). The CEO of Gazprom has predicted a $250 barrel of oil before long."
"Europe is fortunate in having lived with high energy prices, especially for fuel, for decades because of high excise taxes. While Americans are groaning at the sight of petrol/gas prices of just of $4 an US gallon, equivalent UK prices are above $8 dollars. Petrol/gas reach $10 dollars per US gallon in the Netherlands. In an emerging market like Turkey they are at above $8 per US gallon."
If poor countries are paying $8 a gallon then the until it costs us about $10 a gallon I would not bet against oil for a few more years yet.
Lets just offer Saudi statehood and be done with it.
http://blogs.ft.com/maverecon/2008/07/welcome-to-a-world-with-500-oil/
One big difference between the dotcom bubble and the real estate bubble is that both of those were, at the least, encouraged by government, if not outright propped up.
But government hates the high oil prices. They're imagining all sorts of remediation. Maybe this is proof that Bush is just guarding his oil cronies and all that jazz, but there are enough Congresscritters who are feeling heat from their constituents, and so Something Must Be Done.
I did like the "this is a bubble because everyone thinks prices will just keep on going on" angle, though; I hadn't heard it that way and it has an appeal. But there are limits to the price of oil. At a certain point, it becomes more economical to manufacture gasoline from uranium in a power plant than from crude oil in a refinery. NYTimes. That price is within a factor of 2 of where we are right now, so there is a ceiling.
Carbon Tax? Can you look yourself in the mirror and still call yourself a libertarian?
"If you think that you can get a better price for it tomorrow, the natural thing to do is buy it and store the stuff." Can you name one person actually doing this? One possiblity is the strategic petroleum reserve, but it is not interested in making money. If you want to 'long' oil, you buy futures, then, in the future, sell the future delivery contract to someone wanting to buy today. I don't think futures prices are much more than spot prices today. The one instance I can think where futures have made a company money is southwest, and they knew they were going to be using the oil, not just selling the future as it matured.
Carbon Tax? Can you look yourself in the mirror and still call yourself a libertarian?
Why not? Unless you're an anarchist, you need a way to fund government, and taxes on activities with negative externalities like pollution are far better than taxes on good things like employment and profit.
Yes, as long as I precede it with two words: "Negative externalities"
I just got sent a letter signed by CEOs from a number of airlines. Here in part is what they say and who they blame for prices:
...Since high oil prices are partly a response to normal market forces, the nation needs to focus on increased energy supplies and conservation. However, there is another side to this story because normal market forces are being dangerously amplified by poorly regulated market speculation.
Twenty years ago, 21 percent of oil contracts were purchased by speculators who trade oil on paper with no intention of ever taking delivery. Today, oil speculators purchase 66 percent of all oil futures contracts, and that reflects just the transactions that are known. Speculators buy up large amounts of oil and then sell it to each other again and again. A barrel of oil may trade 20-plus times before it is delivered and used; the price goes up with each trade and consumers pick up the final tab. Some market experts estimate that current prices reflect as much as $30 to $60 per barrel in unnecessary speculative costs.
Over seventy years ago, Congress established regulations to control excessive, largely unchecked market speculation and manipulation. However, over the past two decades, these regulatory limits have been weakened or removed. We believe that restoring and enforcing these limits, along with several other modest measures, will provide more disclosure, transparency and sound market oversight. Together, these reforms will help cool the over-heated oil market and permit the economy to prosper.
The nation needs to pull together to reform the oil markets and solve this growing problem.
the guys signing no doubt all voted for GWBush and his merry Republican deregulators.
I dont mind high oil prices if it finally weans us from opec oil.remember its for the children
I dont mind high oil prices if it finally weans us from opec oil.remember its for the children
If you listen very, very closely, you'll hear that the magic number is $150. That's the price most of the speculators - I mean, investors - are looking for. No one's saying it loudly, though, because no one wants to be the last one on the merry go round when it stops.
sorry bout the double there
A quote I came across recently (from here: http://nalymov.livejournal.com/1260995.html)
"This morning I was on one of TV channels and got a question about oil prices. The last time I dared to make such predictions was in February, when I thought that by mid-year we will see 120 bucks a barrel, and by the end of the year - 150. At that time it seemed brave, but eventually it became clear that even that prediction was very conservative. This time I decided to push it and said that I will not be surprised if by the end of the year oil will be at 300."
Remember is the Cold War, part of the logic, supposedly, was that the Arms Race was driving us to financial ruin, but it was driving our adversary in the Soviet Union to bankruptcy much faster. The Cold War was a lot more complicated than that, but there was perhaps some truth to this in how the Soviet system collapsed.
140 dollar/barrel oil is hurting us here in the US, and the US may not be anywhere as energy-frugal as those smug Europeans or as energy frugal as some developing country without our high levels of personal consumption, but I understand that in terms of barrels per GNP dollar, we are much improved over 30 years ago, and we may even be better than China on this score.
Isn't 140 dollar/barrel oil hurting anyone else, and who is going to blink first? I am not wishing a lack of prosperity on anyone, but the way I saw the last oil-shock cycle, the high price of oil cut into demand -- from a peak oil standpoint, oil consumption plateaued or even started declining, technology of advanced recovery techniques caught up with demand, prices plummeted, production rose, and now we are at a new, all-time peak.
The way I see it, supplies may increase from the current peak 10-20 years from now, but the only way to pop to bubble is for demand to collapse, which is not hard to see happening at these prices.
Funny thing is that biggest response in reduced oil demand is here in the USA. It might speak to how "wasteful" we are that we have a cushion of consumption on which to cut back; it might speak to how market signals are more clear here compared to other societies (China, cough) where prices are controlled to get around the vaguries of "market signals." There was some mention of China reducing the subsidy on their oil usage, but it didn't turn out to be much.
Again, someone is going to go broke paying 140-dollar oil, but my question remains, who is going broke first, and it isn't clear it is the US.
I'm with Megan, I believe oil is in a bubble. Specifically, I don't believe oil will remain at this price or higher. However I don't believe we'll see $20/barrel oil anytime soon, if ever again.
My reasons:
China has been subsidizing gas prices, thereby keeping demand high. They've recently reduced the subsidy and raised the price of gas. This'll dampen demand.
Oil well drilling has exploded. For example, oil drillers have plans to more than double the number of wells in Wyoming over the next few years. This is happening all over. This increases supply as the wells start to come online.
We aren't running out of oil, just cheap oil. These higher prices are bringing a lot of oil online from more expensive sources. This increases supply.
Prices are dampening demand.
The dollar has stopped dropping in value. This stops oil prices from rising due to the currency devaluation. With the right set of circumstances the dollar could even start to rise soon.
I see signs of environmental controls loosening, thereby bringing on more oil (and other dirtier energy sources).
Opec is losing it's control over the oil markets as it's percentage of total oil produced drops. (It has been dropping for some time.)
I don't believe that current prices can be substantiated by the price and demand levels. I believe, like Megan, there is a correction coming as a result.
Must stop, typing too much. :-)
you guys are in a better position to assess whether this has any validity than i am.
http://www.physorg.com/news134646313.html
The authors make the case we are in the peak of an oil bubble.
Megan is correct. The price of crude oil is driven by speculation, in addition, of course, to supply/demand factors and the weak dollar. I have been trading commodity futures contracts for 35 years and have seen/participated in many speculative run ups in prices of everything from corn to sugar to silver to orange juice and a dozen others. These bubbles all have commonalities, foremost of which is that they begin with actual supply/demand situations that drive prices higher. This eventually attracts traditional speculators, the vast majority of whom are 'trend followers' and ride the prices as far as possible and they try to jump off before the party ends, at which point they will 'go short' and ride prices back down. The only difference with the crude oil bubble is the presence of 'long only' index funds who have added (estimates vary) something around $260B to the commodity markets, with most going into crude oil, both at the NYMEX and ICE and into off-market 'swaps' markets. This bubble will pop eventually, just as all the others did, except this pop will be the biggest one ever.
Running out of oil? I don't think so. Do some research - you will see that reserves in places like the Gulf of Mexico are not declining, in fact they are increasing.
Also, new fields are being discovered constantly. Panics over the end of oil go back at least to the 50's in my experience, and are just a part of human nature. The sky is falling, et cetera. So far, the sky hasn't fallen.
Watch for oil to drop to $70 a barrel once it is clear that Israel will back off from attacking Iran.
Well, as a chartist looking at the price chart of oil, it looks like we went below the projected mean in 07, and then went correspondingly above the projected long term mean in 08. The projected long term mean predicts we should regress back to 80 dollars per barrel or so, and pretty soon too, over the next 12 months or so.
If you look at the price of coal-to-liquid processes, it becomes obvious that oil is overpriced. In the long run, a price for oil in excess of $70/bbl (current dollars) is simply unsustainable, at least for the next century. The only question is, does the price of oil drop before or after China runs out of patience, expands coal mining, and builds conversion plants?
Speculation? Absolutely. And there's not a thing bad about that, contrary to all the risk-averse Chicken Littles out there. I was a commodity futures & options floor trader for 15 years. Like Oremus, I've ridden a bunch of bull markets on the way up and tried to time things so I would have plenty to sell to the folks who only got interested in the market after prices had already had their run-up. It was very profitable or very painful, depending on how I did.
That's what speculators do. They provide an essential service by keeping the markets alive and functioning. They have skin in the game, too, unlike the politician types who don't have to take any personal responsibility for their own actions but who can make the rest of us pay for their screw-ups.
The difference this time is the incredible amount of fund money looking to go long commodities as an asset class in order to lower the overall volatility of their portfolios. But hey, there's always a difference each time around. That's what makes the futures business the best brain game in town.
bc, I've been watching the charts too. Reversions to the mean (on the downside) are brutal. I'd guess some of those newbie genius fund managers are going to feel their guts twist very soon.
I think Nate W is on to something.
At each new price point, we do discover new information. We discover information about the (short term) elasticity of supply.
We also discover new information about the (short term) elasticity of demand.
An important point is that supply and demand for a commodity is really a viscoelastic function. i.e. It will have less "give" in it at short times, more give at medium times, and even more give at long times (up to a decade or two).
With poor, but large, countries like Indonesia finally giving in and dropping their subsidies for fuel, the medium term elasticity is starting to kick in. I suspect China may do something similar after the Olympics.
Other sources of medium term elasticity are
-the turnover of national vehicle fleets. Sure everyone who buys a new car will look a lot harder at fuel use than before, but this takes a year or two before it affects overall usage.
-Short term production projects, new wells, improved equipment.
-swapping oil heaters and generators for other sources of power (coal, nuclear, wood, gas)
Then, if the price doesn't collapse ($80 is not a collapse) the long term things will eventually kick in
-new technology for vehicles
-new oil fields and discoveries
-new extraction techniques
-coal to liquid plants
-changes to environmental legislation allowing new fields to be exploited
-new exploration tech
-city restructuring to allow non-oil and more efficient transport methods (bike trails, electric trains (coal, not oil)
as you can see, a lot of stuff requires legal changes, then exploration, then tech development, then actual construction... it will take up to a decade or more. It did the previous 8 or so times this happened.
bc made me aware that I am in desperate need of more timelines here.
Are we all just saying: hey - I bet that eventually, something that is being traded, will experience a decline in prices after a strong rise... Yes - profit-taking will take place and what usually follows is... call it the the life-cycle of indexes? I am no fan of charting but of course prices will come "down" again. Hey - they've dropped back to below $150 already!
I hope that prices stay, naturally, high for long enough to trigger even more alternative energy investments and other substitutions. In contrast to some - I believe that we are late and not too early to invest. This is based on ecological grounds and not economical of course as the current economic system does not reflect ecological costs at all. (we have a negative foot-print which means that right now we are borrowing from the future). The only thing that will lower oil prices substantially is a world-wide decline in demand which eventually exceeds the drop in eventual supply?
btw - the highest estimate I've encountered so far for speculation costs was $60. But we all knows that the true cost of the environmental externalities has not been included yet (CO2 tax or c&t). You do the math.. say: $150-60+60=?
But maybe the environmental costs of oil will also eventually bubble and go down? Sure - just provide me with a time-line when you claim so.
In the 1950's I remember driving past the Capital Building in Oklahoma, and if memory serves, at the time there were at least two oil wells pumping away on the front lawn. Today, and for the thirty years past by way of contrast, the leadership of one national party, along with all manner of assorted fringe groups, have been, and continue to be, seemingly determined to block drilling anywhere and everywhere, no matter how remote.
Now with prices rising to once unimaginable levels, what are we told - it is all our fault because we drive gas guzzlers. There is no mention of the quantity of oil converted into chemical feed stocks or fertilizer or plastics; no mention of the untold quantities require to fly politicians to Paris, businessmen to Maui, or grandma to Disney World, it is all the automobile.
Well, perhaps that is true, but before we swallow the premise, hook line and sinker, perhaps it would be wise to go back to the figures from the 1950's to see just how much of our gasoline in those days was derived, not from oil at all, but as a byproduct of natural gas production. It was called "drip gas" among other things, and it went straight from the well to your tank with only a few additives thrown in. I suspect the answer will absolutely shock most people.
Then, having found those numbers, take a look at U.S. natural gas production figures from, say 1955, and compare that figure with our natural gas production today. The extrapolation may not be a straight line, but it does leave one wondering where all that nearly free gasoline has gone, why the subject has completely disappeared from discussion and why gasoline prices are now tied solely to the price of oil.
Ahh I see many high-power investors, at least self-fancied. Is oil in a bubble? I hope so, but that doesn't make it true. This particular commodity has an issue because unlike farms, coal, etc. This particular commodity seems to trade exclusively on future supplies not current ones. So now that you've added the voodoo that is prognostication to the cauldron it becomes much murkier to determine if the value is inflated.
Furthermore geologiststs that specialize in drilling have been saying for 30 years that due to the aggregate demand increase there is no way that they can come up with the oil necessary to severely dampen prices on the supply side (which means that coastal drilling idea is a sham). This does not give you a precisely static supply, only a supply that can't outstrip demand. Which means that most of the price increases are due to speculators. Their basis for speculation is an unrealized demand in the developing world. So the real question is will the demands of the developing world come true as forecast? Every third world country I've managed to visit twice seems to indicate a tremendous increase in energy, fuel consumption, and plastics. But is it in line with what speculators are saying?
Look I sold most of my stock (I still have some in ETF and Mutual funds) in Oil when it seemed like this was going to be a ride. I would have made a ton more if I had left later, but it didn't make much sense to me to hang on to the tiger's tail anyway. Oil is already taking a big old bite out of people, but lets say its a bubble gas goes to $250 and then bubble pops and gas goes back to $145 yeah it will feel better but it won't be $50 now will it?
We just made a trip along I-80 from Ohio to Iowa. On the trip, we saw seven oversized load ethanol distallation components heading down the highway, and we lost count of all the windmill turbine blades we encountered. While far from a scientific sample, if one afternoon on the highway illustrates such extreme capital activity, there's definitely something larger going on per a hyperactive response.
More instrumental is looking at oil's supernormal growth. Like housing, cashflow-negative dot-com companies, beanie babies and any other bubble, it has encountered a run that is unsustainable statistically and economically. If that doesn't sell you, consider that the economy simply will not give this slice such a large command of its cashflows as a perpetuity. If dairy producers demanded $20 a gallon for milk, they'd probably get it for half a year to a little more than a year, due to constraints in short-term production. However you can bet that manufacturers, bakers, etc. would be dealing with this fixed constraint and moving off of milk.
The result is a complete shift off of dependence on milk in many products and markets, and a post-bubble-bust market that simply needs less milk due to these painful production changes that were made.
I'd suggest that OPEC overplayed its hand, but very likely this has been a signal to the market through a pre-shock to make the expensive changes to long-term production and reduce linkages to oil. Very likely, we'll see the real shock (Iran) in the next 1-2 years which this initial shock may have helped soften.
Dave,
It's true that automobiles are not the only things consuming petroleum.
But of the three petroleum uses you listed (cars, aircraft, chemical feedstocks), by far the easiest and most feasible use to rapidly replace, at least in part, is automobile consumption.
Liquid hydrocarbons are, as of yet, the only known feasible fuel for efficient, commercially-viable aircraft. The energy density, simple storage and light weight of petroleum-based fuels makes them, at this point in time, absolutely indispensable for air travel, barring some totally unforeseen energy development.
Similarly, while it would be possible to replace liquid hydrocarbons in chemical feedstocks with other sources of fossil fuel (coal, say), it would require massive redesigns of our existing chemical production infrastructure.
By contrast, cars do not have to go to the extremes in weight conservation and energy density that aircraft do, nor must they meet the extremes in range and engine power that aircraft must. That allows for more flexibility to support and compensate for the trade-offs inherent in designing with the goal of substantively reducing petroleum use.
For example, a hybrid-electric system adds a substantive complexity, cost and weight penalty to a standard gasoline-fueled passenger car. But the result is a substantively more efficient vehicle with relatively-unchanged handling, payload, cost and comfort. The trade-offs are generally acceptable from an operational perspective.
There is, as yet, no known comparable system for aircraft which dramatically improves on the efficiency of a kerosene-fueled turbofan engine without unacceptable costs to performance. Incremental improvements continue to be made, but barring a major scientific and technological breakthrough, mass air travel will be directly propelled by turbofans for the foreseeable future.
Another issue is the difference in fleet turnover between cars and aircraft. Older, inefficient cars are much more quickly replaced than older, inefficient aircraft, because automobile costs are much smaller and their design lives are generally not as long, among other factors. By contrast, jet airliners represent multi-million-dollar investments, and are not generally replaced for two to three decades. The average age of Delta's aircraft fleet is 13.8 years; American's, 14.7. Northwest, which still operates some 1960s-era DC-9s, has the oldest among major carriers at 18.5, while Southwest's clocks in at a relatively-spry 9.8.
Thus, a move to supplant petroleum use in automobiles will have a much faster "ripple" effect.
I just realized I made a rather unclear statement in the above post, relating to the penalties applied by hybrid technology. The addition of hybrid-electric drive does impose, as I said, a substantive cost penalty - it is more expensive than a simple mechanical gearbox. However, in comparison to the whole scope of the vehicle, the cost increase is not prohibitive - perhaps a 10-15% increase at most. It's not a deal-breaking increase, and as we are seeing, consumers are finding it economical to pay that initial penalty in order to save long-term at the gasoline pumps.
Carbon tax ? ah, a CO2 worshipper ... nuf said ...
oil may be in a bubble but man made GW is truely a scam ... if people put the same thought into looking at the AGW scam as the oil markets they would clearly see that ...
Megan: Stepping aside from the politics of oil and just looking at this thing as a professional observer of markets (I write for a big investing site) for a minute, I don't see how this could be anything but a bubble. It's a classic, right up there with tulips and dotcoms. Like you say, when the experts are telling you that it won't come back down, that it's a new paradigm, that the world has changed... that's a pretty good sign that it hasn't.
I have no idea when -- I leave that kind of analysis to Ken Fisher and his followers -- but this thing is going to pop, sooner or later.
And boy, will that be interesting.
No question Travis, it is a lot easier to economically coerce the individual automobile owner than an entire industry and it's lobbyists. That does not mean however, that the automobile is the sole, or even the most important reason we find ourselves in this predicament. While the amount of fuel consumed by the automobile has been relatively flat for years, the amount consumed by other segments have increased exponentially.
You mentioned aircraft. As a matter of fact, I am old enough to remember when examination questions were couched in terms of "How many pounds of fuel would be consumed by a plane flying from X to Y." Somewhere in the early sixties, the wording was changed to "How many tons," and aeronautical engineers began to brag that, given a large enough engine, they could put anything in the air. Well they succeeded. (Look at how many tons of fuel were on board the planes that slammed into the twin towers.)
In the long term, we need to drill. Nothing should be off limits, not the ocean, not the sage hen's breeding ground, not even my front lawn or the polar bear's back yard. Want to pop the bubble even more quickly? Ground the commercial aircraft industry for thirty days. Even if you have to cover their payroll for the period the economic benefit to the nation as a whole will far outweigh the inconvenience to the few.
Megan said: Oil is a fairly easily storable commodity. If you think that you can get a better price for it tomorrow, the natural thing to do is buy it and store the stuff.
The other issue is the estimate of future supply. As a producer if you think future supply will be short (and prices higher), just leave it in the ground until that future time or when you need the cash. But if supply is thought to increase in the future, you'll pump it now rather than face the uncertainty of that future supply and the effect on price. That's why I believe that just drilling and developing new supply here will start to force prices down now and not when the actual new production reaches the market. We don't really need the supply now, we need the markets to think they are better off getting what they can get now rather than wait for it to actually hit the market.
Dave, for all the talk about it being slow to improve aircraft fuel efficiency, the BTS statistics on energy efficiency by modes of travel show a dramatic improvement in aircraft consumption per passenger mile since the 1970s, with fair improvements after then, similar to or exceeding the rate of improvements in cars.
These are passenger mile statistics, and so heavily weighted by load. An SUV carrying a full load of 7 people is actually pretty energy efficient; it's the solo commute trips with them that really kill things.
Older, inefficient cars are much more quickly replaced than older, inefficient aircraft, because automobile costs are much smaller and their design lives are generally not as long, among other factors.
Yes, but I believe a lot of older, inefficient aircraft have been (or soon will be) parked out in the desert even though their useful lifespans have not been exhausted.
But the interesting point is that there is much less upside in the air fleet than the auto fleet. We could rather easily double the average fuel efficiency of private autos in the U.S. Not so aircraft.
Which means that the cost differences between driving and flying will diverge even more -- if I load up my family for a trip in the 50MPG diesel I hope to be able to buy in a few years, I'll be around 200 seat miles per gallon. No commercial aircraft can come anywhere near that.
I like this post. Not because I agree with it, but because it has made a testable prediction. In other blogs, people have said that if oil falls into the $70 to $90 range, it's just business as usual. But if the price dips below that, a good chunk of the cost right now is due to speculation.
Anybody want to move those numbers around? Remember, prediction is good, and gets you points if you get it right. Postdiction just gets you a place with the guys at the end of the bar still replaying Superbowl XXXI.
Lots and lots of bubblists here. Brave blog posters! So how many of them are shorting oil?
But the interesting point is that there is much less upside in the air fleet than the auto fleet. We could rather easily double the average fuel efficiency of private autos in the U.S. Not so aircraft.
True enough, though it is interesting to note that we did double the average fuel efficiency of commercial aircraft between 1970 and 1980, as the BTS stats note. (Doesn't make it repeatable, of course.) It is hypothetically easier (from an engineering standpoint) to double passenger-mile fuel efficiency of private autos because the load factors are so much lower with cars that there's room for improvement.
Average car and aircraft efficiency has been reasonably close and moved in tandem since 1980; aircraft efficiency has actually seen greater gains, and overall is more efficient (per passenger-mile), due in large part to improvements in load factors (to many passengers' dismay). Any movement towards much greater automobile efficiency (or train corridor usage) unmatched by aircraft would have a dramatic effect on short-hop flights.
Geopolitically, it is interesting to note that the Iranians at the moment have a dual incentive to act out: To jack up the prices they can charge for exporting oil and to jack up prices and hurt the oil-addicted residents of Great Satania.
Okay, this is sort of a "postdiction," to borrow SoV's term. But I'm guessing the Mullahs and Ahminajihad will continue to promote chaos for as long as they realize pecuniary gains from it.
MarkG, would you be willing to predict that _if_ Israel and the US back off, _then_ oil prices will go down? That would be a prediction, though not necessarily the one I was asking for.
Just to contradict the bubble posts, as an engineer at an oil services company, we are building equipment for offshore drilling rigs as fast as we can, as are all of our competitors. The industry is desperate to hire people and our backlogs are all out a number of years. It seems like most of the rigs are going to Brazil right now, but some are going other places as well.
This is indicates that the oil companies and drilling contractors expect the price of oil to stay high or not drop too much over the next 5-10 years. It takes a couple of years to build a rig and our backlog indicates that ultra deepwater rigs will be coming on line at a pretty good pace over the next decade.
As far as jackups and shallow water rigs go, we don't make as much equipment for those, but we have done a few lately.
Lots and lots of bubblists here. Brave blog posters! So how many of them are shorting oil?
Posted by lampwick | July 10, 2008 9:50 AM
I too am a bubblist. I don't think we see prices come all the way back down anytime soon, but I do imagine they will drop in half, eventually.
Especially if our economy continues to slow, which should in theory cause other economies to slow unless the world has truly decoupled.
Am I shorting? Too broke to money up my mouth. Don't even have a job right now. But in my mind the next two money making opportunities will be shorting oil and going long financials. Exactly when to do that is the key question.
I'm sure Crazy Al in Iran is on the phone every morning with five separate brokers at NYMEX before he decides to test launch missiles or to announce that there will not be any military conflict.
lampwick - re: shorting - the oil market can remain bubbly longer than I can remain solvent :)
I'm no good at predictions, but in my estimation, there's no good easy way for Israel and/or the US to back down from their respective positions. For the US, it almost require accepting the Iranian position that that country has an inalienable "right" to produce develop nuclear technology. For the Israelis it would require an admission that Israel will not respond to perceived threats to its own security.
The incalculable factor, though, is the opaque Iranian system of government with its rogueish, unaccountable special military groups like Qods and the Revolutionary Guards, or whatever they're all called. It is also interesting to observe how well the Iranians and Russians cooperate, as the Russians also benefit from higher oil prices. Cf also Venezuela.
Not that I'm trying to make out some sort of conspiracy here, I'm just looking at the obvious incentives. I think these incentives also played a role in the 70s oil shock. But when other oil production comes on line and speculators turn their attentions elsewhere, the rabble-rousers see their influence wane, and in a couple decades we get to read hand-wringing editorials wondering whether the House of Saud will fall, etc.
History doesn't repeat itself, but analogous patterns might.
That's why I emphasized _if_. And no, for the Israelis, it would be an admission that they can't have things all their own way, and they should have thought of this years ago.
It's interesting that just a few posts ago, we had people throwing out the contentless pablum 'Israel has a right to exist', or 'Israel has a right to defend itself', yet now the pablum goes the other way, saying that at least one country has no 'right' to pursue nuclear technology. Since the oil will run out sooner or later, and since the only really viable option is nuclear, this two positions taken together make zero sense.
I'm not going to spend any time boning up on all the relevant NPT details on this. Lots of countries have, however, agreed not to pursue it. Sure, the aging Cold War framework is muddled, in part because nations that otherwise display good will and good behavior are given the blind-in-one-eye tacit approval.
Suffice it to say that the Iranians have been offered plenty of opportunities to bring their ambitions into compliance with the international legal framework. Instead, they have insisted on a go-it-alone approach, which breeds distrust, to say the least.
I don't see the connection between "You can't play with nukes on your own" and "You have no right to exist."
I don't have a dog in the "Israel has a right to exist" fight, but I don't think it "makes zero sense." A reasonable person can claim they have the right to own a gun, while also denying this same right to convicted felons and/or the mentally ill. I think those opposing Iran's nuclear ambitions - whatever they may be - would likely place Iran's government in the "mentally ill" category above. Maybe this will change by the time we run out of oil?
Some decades ago, I realised that oil is, surprisingly, one of the markets where the experts who study the market closely always miss major changes in price levels. Perhaps behavioural economists can be found to account for that observed regularity.
That said, it is not surprising that the key comment above comes from someone calling him/her self "Oildrilling Lunatic". The current oil price is unsustainable in the long term because it is above the cost of a good substitute - oil made from coal. I think the $70 a barrel that our unusually sane friend quotes is a bit low; it probably does not factor in the extra cost of cleaning up the coal to oil process. But look at it how you will, oil at over $100 a barrel cannot last into the medium to long term.
So my reading of the matter is that Megan has correctly called a bubble within months of one starting. It reinforces my view that she is potentially about the best central banker we have.
A complicating factor is that it is probably rational to expect consumer prices to hold up to the equivalent of well over $100 a barrel. The world's Treasuries are on course to to transfer a good deal more of the tax burden that now falls on corporations and on individual incomes onto carbon through tax or through selling tradeable permits. Megan is also calling that one: she bicycles and is also hunting for a small economical car.
A reasonable person can claim they have the right to own a gun, while also denying this same right to convicted felons and/or the mentally ill.
Or, pace Heller, a right to own a gun does not necessarily imply a right to own a machine gun. One may have the right to defend oneself without having the right to do so with an atomic bomb.
I suspect that if Israel did not already have nuclear weapons, and were instead believed to be pursuing their construction today, there would be a considerable outcry over their ambitions.
Sigh. I did not say that the Iranians had a 'right' to atomic bombs. I said they had a right to have nuclear technology[1].
And, MarkG, when the oil runs out, I _really_ hope I really hope they have some alternative source of energy to fall back on. That would go to 'right to exist'.
Oh, and no, wanting to 'go it alone' doesn't particularly connote suspicious motivations. It connotes not wanting to accede to the dictates of the 'already haves'.
[1]I will say ftr though, that maybe if Iraq had had the bomb, everyone else would have played a little bit more nicely, and we wouldn't be in the current imbroglio we are now. Like it or not, having weapons of this sort seems to confer some sort of immunity to attack.
I just wish this opprtunity could be used to transition from a tax code that uses employment and income as the primary taxable events to one that primarily taxed consumption. Oh well, enough daydreaming, I suppose.
I'm waiting for the US or Israel to bomb Iran. Once that happens and oil breaks $250, then I'll short.
There's no natural law that says this must be immutably so.
Also, I don't share your confidence that unaccountable despots, theocrats and similar regimes are the most trustworthy when it comes to our best security interests. As skeptical as our political system might rightfully make us, the amount of subterfuge and double-dealing practiced by unaccountable regimes is potentially much larger. By definition, those nations are unaccountable and inscrutable, with zero press access, right of redress, and free assembly or speech of any kind.
One thing that I am willing to predict is that when (no if here) a nuke goes off in a US or other western city, everyone will know who did it, but the suspect nation will claim no knowledge or complicity. The larger the number of nations with nukes grows, the harder it will be to "prove" guilt.
Am I crazy to want to look at the value of a barrel of oil against an ounce of gold instead of against the dollar?
Anyway, there could be a large shift in demand this winter. I live in Vermont, and most people heat their houses with heating oil. This winter, it will be cheaper to heat with electric heat (generated from nuclear--Vermont Yankee, hydro--HydroQuebec, or you can pay extra and have it guaranteed that your electrons were generated by some hippie from dairy cow manure methane). Any Vermonter who can do math will switch, so maybe I overestimate the effect. If Boston had electricity as cheap as ours, the effect would be more substantial.
Link to good explanation
No one has addressed the link to the dollar. I my passive tracking of the news as the dollar strenghtens oil falls in lockstep. Can anyone explain. IF we want the price of oil to fall what can be done to strengthen the dollar?
Your changing your arguments, MarkG. I didn't say the US shouldn't try to suppress this sort of weapons technology to look out for their own interests; I pointed out the hypocrisy with regards to Israel. Sauce for the goose and all that. Further, I'd suggest you read up on the actual history of Iran. They are not a 'dangerous rogue state' like, say, North Korea. And they also have very, very good reasons not to like the US. Don't even try to pretend that there isn't a very legitmate component to any ant-US sentiment. It's one thing to be 'against the interests' of the US because you are suspicious of a country that ruled behind a thug of a dictator that killed many, many citizens. In that case, you have no one to blame but the US for this defensive behaviour(assuming it even exists.) It's quite another to suggest that 'they don't like us for our freedoms' type of regimes should be discouraged from joining the nuclear club, and with regard to those particular states, I would agree with you.
That being said, you didn't answer the original question: _if_ the US and Israel back off, _then_ the price of oil will go down. Is that a prediction you are willing to make?
Iran-
Will need an alternative energy source to fossil fuels. The most logical step from an environmental perspective is nuclear. However, it is also a most convenient one. We'd be remiss to look at Iran as a benign entity. I do doubt they're posturing is connected with the pursuit of money as the sole objective.
Drilling-
Temporary solution, if you opened up the coasts not every state would allow it. Cutting off massive amounts of the supposed 21 billion barrels of oil. The long-term solution is to shift energy production into other modes.
The bubble-
The final resting place of this will determine what kind of a bubble it may be. Yes I agree it seems at this point that a barrel of oil is greatly inflated due to a devalued currency and overspeculation. But that doesn't mean I'm right. I wouldn't put it out of reach that right now we're seeing the real price of oil. And its going to continue rising and peak out sometime in the next year and it will revert back to a time post $100 barrel of oil. If so it would be the new river after the flood, and it would not be the happy creek we knew before.
Lastly the fast fix for the dollar would be to pay down debt.
There are speculators and then there are speculators. It is possible that part of the run up in oil has been the retreat of the everyday sort of futures speculators, "locals" and such, who would have been taking short positions against rising prices. Commodity ETF's, etc., have been classified by the regulators as hedgers and not speculators, the rationale being that they are "hedging" with futures their responsibility to their investors to match the price of oil. These new speculators--whom the regulators do not treat as speculators--are overwhelmingly coming into the market on the long side. They have lots of moola and have sent the "native" speculators running.
Between 1985 and 1986 the price of a barrel of oil fell nearly in half. What drove that. What was the trigger to the popping of the early 80's bubble?
Ronald Reagan convinced the King of Saudi Arabia to pump a lot more oil. The atheistic Soviet Union was occupying an Islamic country at the time, and Reagan wanted to deny them hard currency from selling their oil to the West. The King went along.
PureGuesswork is exactly right. The Commodity Futures Trading Commission intentionally obscured the data provided in their Committments of Traders reports to disguise the real parties moving the oil market. I am classified by the CFTC as a 'small
speculator' and I won't touch the oil futures market now because of the manipulation of prices by the index funds and others. For a safe play on oil prices, I'm doing delta-neutral spreads on oil company stock options, making money whichever way oil prices go.
Oh. EIA has posted gasoline consumption for week ending July 4th.
Gasoline consumption is way down. Much more than back in March (down ~1.3%). For the last past seven weeks this is how much it has been down from last year for each week (as percentage):
1.180811808
3.854660348
0.801096237
3.544990095
2.516971279
2.092706916
3.27020594
Excel data here. See column C, "U.S. Weekly Finished Motor Gasoline Product Supplied (Thousand Barrels per Day)".
I also looked at the percentage change in miles driven and gasline consumed for each month compared to the previous year for last year and all months data is availible for this year (April). Here.
Fuel efficiency has been declining. It was declining significantly last year up until about June. There were very slight improvements in fuel efficiency in the months of October and December 07. We see declining fuel efficiency in 08. Huge declines in February and March.
Looking at the plot, whenever the blue bar is bigger than the maroon we have losses in efficiency. The bigger the difference, the bigger the decline in fuel efficiency.
Traffic Volume Data
EI, "we are building equipment for offshore drilling rigs as fast as we can, as are all of our competitors. The industry is desperate to hire people and our backlogs are all out a number of years."
Guess that means we should be funding more education to build and man more these rigs faster.
Gooch, "Am I crazy to want to look at the value of a barrel of oil against an ounce of gold instead of against the dollar?"
A little. Yeah the weak dollar is part of how this came about, but gold is part of the same bubble. Basically we have too much wealth and money out there and no one knows what to do with it, so they've parked it in commodities. Once people realize that this is inflationary, slows the economy, and they won't get a return on their money, hopefully they'll move back into companies that actually do stuff to extract these things and make things with them.
Oil is a bubble, but the only reason speculators are in, is because it's a bubble. We saw speculators for the tech bubble, and we saw speculators for the real estate bubble.
If the Fed wants to keep money in the system, that money will maturally be looking for something to inflate. The fundamentals of oil values sure beat those of gold.
The fact that monetary policy is not matching rates to inflation targets, a la the Taylor rule, means that the inflation targets will be missed. I think Milton Friedman's "always a monetary pheneom" holds here oil (while George Stigler's subsidy-inflation conjecture holds for education, healthcare, ethanol, and whatever else is being subsidized).
"Fuel efficiency has been declining. It was declining significantly last year up until about June. There were very slight improvements in fuel efficiency in the months of October and December 07. We see declining fuel efficiency in 08. Huge declines in February and March"
My guess is that long distance driving has been reduced more than the less efficient city driving.
I am not short oil, but I am short oil stocks. I've been doing this a long time and this has the same feel of other bubbles I've been through. My prediction: oil less than $100 this year and less than $50 in three years. Commodity bubbles always solve themselves; high prices are the cure for high prices. We are not running out of oil and every drilling rig on the planet is in use. Supply will be found (actually it already is being found) and technology will enable us to extract it.
Whenever I read about an "expert" predicting $250 oil, I can't help but think they're trying to push more people into long positions for one final rise of the bubble before they switch their own positions to the short side.
At least, thats what I'd do if I were in their shoes.
If I were brave, I'd short oil and buy an SUV.
Or be smart and lease an SUV. Their cost has plunged due to the gas cost rise. Now note...
1) Today's low acquisition cost of an SUV offsets its high gas-price operating cost -- you can buy a lot of gas with a multi-thousand dollar price discount. And the cash flow cost of leasing is less than that of financing a purchase.
So if you want to enjoy big-wheeled luxury it's a lot more affordable to you as a SUV acquirer now than to the unfortunate souls who bought 18 months ago.
2) If you lease a SUV and the price of gas goes up further, you are protected from loss of the SUV's resale value -- it falls on the leasing company.
3) If you lease a SUV and the gas price bubble pops, with gas prices plunging, then the value of SUVs will surge up again -- and your purchase option at the end of the lease term may turn out to be a nifty bargain that gives you a nice profit.
There's how to short oil while riding in big-wheeled luxury in a one-way bet, no risk of loss.
Joe
at $50/bl you would then be below the marginal cost of new production.
Given the inflation in the cost of new oil projects (on the order of 300-400% over the last 4-5 years) the marginal cost of new oil (Gas To Liquids, Alberta Tar Sands, Brasilian and African deep water etc.) is probably around $80-90/bl. Consider the cost of deep shale drilling for gas as an example (and gas prices have not risen anything like oil prices).
Since the world has shown continued appetite for oil at $130/bl, I therefore believe that the price will settle somewhere between $80 and $130, but continue to be volatile.
If it were to drop to $50, the problem of collapse of industry capacity (people and equipment) would continue.
Matt Simmons has some neat charts of the average age of oilfield equipment. Oilfield equipment is made from steel, and steel rusts. Hence a worldwide capacity problem.
My own take is that oil is overvalued in the short term, and undervalued in the long term.
In the short term, there will be conservation and demand destruction, just like 1979-1983. People are unemployed, and they don't drive as much. Incomes are under threat, and they don't drive as much, and buy fewer goods shipped by trucks. The auto industry turns down (see James Hamilton) and so the economy slows.
Very little oil now is used for high price elasticity applications (like power generation) relative to the 1970s, so the switch will be slower and more painful.
In the long run, the emerging economies are on the part of the growth curve that mandates higher oil consumption (more trucks to move more goods, more railways etc.). If China had the same oil consumption per capita as Mexico, it would be 1/2 of all world quantity demanded.
That means that we have to bring in the high cost sources of oil: deep offshore, Athabasca tar sands, Venezuelan oil sands etc. Coal-to-Liquids, Gas-to-Liquids.
To justify those high fixed costs investments, and the high costs of switching away from oil (eg electric cars, or more urban light rail, or fast trains to replace medium distance airliners) the market will need high oil prices.
Structural reduction of oil demand is possible (the UK uses less oil than it did in 1979, despite being an oil producing country) in developed countries, but it is expensive.
Airlines who could have hedged fuel costs starting a letter writing campaign to Congress? This shows colossal gall. The futures markets were created so that the signatories can hedge and lay-off their risk.
They rolled the dice and decided not to hedge. Their choice. What they're really saying that their hedging strategies have either failed or were never established in the first place.
Southwest hedged their risk and had gains from hedging of $291 million for the first quarter this year. Their Net Income for the trailing 12 months was $586 million. Gains from hedging can be passed on to the end user through lower costs for goods and services.
Southwest might be the only signatory with a stock above $10 per share (NYSE: LUV) and the share price says a lot about the company.
A manager of a firm that is in the business of producing or using a commodity who doesn't hedge is either exhibiting reckless behavior or is ignorant.
Taleb is correct in his analysis that most underestimate the frequency, duration, and magnitude of unexpected events. How is it that the oil companies can predict their EPS several quarters in advance and yet be caught flat-footed on oil's rise?
The gasoline companies could have hedged more effectively. They didn't. There are no savings to pass along to us at the pump. That is the issue, not some jammy-dodger speculator jumping through various loopholes. Southwest has been hedged since $51 barrel.
Michael Martin
By and large, the other airlines didn't have the balance sheet strength to hedge fuel costs as much as Southwestern and Ryanair.
Remember you are marked to market, daily, on a futures position. So they could not tie up that much capital (the cost being their borrowing cost) in hedging the oil price.
So they gambled. See the principle-agent problem: the motives of managers are not those of shareholders.
In all due respect this is neither an issue of balance sheet strength nor "marked to market" accounting.
Should a gasoline company hedge, it would in fact make them more credit worthy, as their costs are more predictable.
If they have cash, they have margin. If they post a T-Bill, it's margin too and probably safer than a money market fund at this point.
Hedger margin - the capital they need to maintain the hedge - is between 66 and 90% lower than that needed for professional speculators to hold the same positions. Again, the rules are heavily tilted to benefit the hedger or commercial.
Oil, heating oil, and RBOB gasoline futures have gone up. Marking to the market each day increases the net account balance and frees up cash that can be used to purchase the physical in the spot market asap.
Also, hedgers can pay option premia going out the to the back of the board and know what their max loss is on day one should they prefer options to futures. In this case they would never be called for a maintenance margin call.
Right now, a company can pay $15,000 to hedge against further price increases on crude oil above current levels of $146 through about Thanksgiving using options. That's about 10% of the cost of the physical, so we're not talking about breaking any banks. I look at it like fire insurance on a house.
This is about the CEOs guessing that the prices of crude oil, needed for Jet Fuel A, would be found somewhere within the normal distribution of prices, and it wasn't. Now they're crying foul.
Megan,
Yesterday I -- a complete nobody -- spoke with the CEO of a publicly-traded energy and natural resources company and posted my notes on our conversation on my site. Why don't you use your platform at The Atlantic to interview folks who know something about subjects such as oil and post the results on your blog?
Here's an idea for you: Recently the WSJ had an article about the future of oil supplies and prices that quoted two Saudi Aramco veterans with different opinions on the subject. Why not contact those two experts, interview both, and share your thoughts with us after doing so?
Why not also contact someone like Matthew Simmons (Twilight in the Desert), who of course doesn't think the current high oil prices are a bubble? Hit him with your reasons why you think it is one, and see what he says. Engage with experts in the field. Agree or disagree with what they say but engage with their arguments. Forget about Tom Friedman and other beltway pundits; talk to folks who have gotten some dirt under their finger nails.
Megan, I wish you had just excerpted the good comments or at least told us where to start reading.
Everyone is using more oil at a rate much faster than new supplies are discovered.
And yet proven reserves are higher than ever.
How is that possible?