1. Oil and the Global Economy
Oil prices have had a spectacular two weeks. After trading for a week around $81 a barrel, prices climbed steadily to close just below $90 on Friday, the highest since the great oil price spike of 2008. In London, Brent crude continued to do even better, trading at $91.42. The impetus behind oil price moves is becoming a jumble of fundamentals, currency movements, weather, and muddled perceptions of what is happening in the global economy. Much of the recent move is based on continuing strong demand for oil from China and India, and scattered economic reports spun to suggest that the US economy is "recovering." The value of the dollar which now has much to do with oil prices has been bouncing around in response to the latest twist and turns in the EU’s debt crisis, which sent oil higher then lower in the absence of any overriding economic news. Last week, the euro rose as concerns about the various debt crises abated with the Irish bailout. Concerns that further bailouts will still be necessary abound.
Global oil stocks, which had risen to abnormally high levels during the recession, have been dropping this fall as excess inventories have been worked off, particularly those in temporary floating storage. Last week Brent crude in London switched into "backwardation" in which near term futures contacts are trading at higher levels than more distant contracts. This suggests that global supplies are tightening.
On Friday the US government announced that US employers added fewer jobs than forecast in November. As the Wall Street Journal characterized the event, "A surprisingly weak jobs report cast a shadow over the economy, undermining several weeks of positive data and diluting hopes of an accelerating recovery." This caused the dollar to fall and oil to rise. US fuel consumption decreased 1.8 percent the week before last, the third straight weekly decline. Unusually cold weather across Europe and northern China helped prices.
Wall Street remains schizophrenic about forecasts of much higher oil prices, realizing that very high oil will do serious damage to the US and global economies and almost certainly send security prices lower no matter how much intervening central banks do. Last week JPMorgan joined the chorus of Wall Street investment banks by saying that oil will reach $120 a barrel in 2012. This is not too far from Goldman Sachs who forecasts that oil will average $110 that year.
US gasoline prices are now averaging $2.94, up 8 cents a gallon in the past week.
2. OPEC’s spare capacity
Current conventional wisdom holds that circa 2013-14 depletion from existing oil fields will overtake the oil industry’s capacity to produce oil from new fields and that global production will start down. For this year and the next two or three years analysts see global oil production as flat: with new production and depletion in balance. The IEA, however, is forecasting a 2.3 million b/d increase in global demand during 2010 and another in 1.3 million in 2011. With little growth in world production in store, the question of spare capacity becomes important in determining just how close we are to another economy-killing oil price spike.
The IEA currently says that there is 5.5–6 million b/d of spare capacity in OPEC that can be brought into production within 30 days. Two-thirds of this spare is in Saudi Arabia, which says it can produce 12 million b/d vs. its current production of 8.2, and 77 percent is in Saudi, Kuwait and the UAE. If the growth forecasts prove to be accurate and there really are 6 million b/d of spare capacity tucked away in the Middle East, then the world might be able to get through the next few years with moderate oil prices, say $100–120 a barrel.
In recent months, however, some analysts have started to question OPEC’s claims, which the IEA in many cases takes at face value. They point out that domestic consumption in Saudi, Kuwait, and the UAE has been rising rapidly and that there is a difference between spare capacity and "marketable" spare capacity, the former including oil of such poor quality that it is difficult to sell. At least one analyst believes that the spare capacity available to meet export demand is really so low that it could approach zero by the end of next year assuming that projected demand materializes.
It is interesting to note that as oil prices have gone up, so has OPEC’s (Saudi Arabia’s) comfort zone: the price level above which would allegedly trigger higher production to keep prices from becoming excessive. From $70–80 a barrel earlier this year the official comfort zone now goes up to $90 a barrel, which we seem to have surpassed last week, with many OPEC officials now saying that no production increases will occur until oil passes $100. This school of analysis suggests, but does not confirm, that we could be witnessing the beginnings of a new price spike similar to that of 2008 which took prices well into triple digits.
Last week China’s Purchasing Manager’s Index showed that economic activity in China grew in November for the seventh straight month. While this increase in the face of measures to dampen economic growth may be good for oil imports, other analyses suggest that Beijing’s efforts to slow growth may be taking hold. On Friday China’s governing Politburo announced a new monetary policy of "prudent spending" during the coming year, but will continue the policy of "proactive fiscal policy." In recent weeks statements such as these have been enough to spook the oil markets into sudden drops. But we may be in a different era, for the government appears confident it can continue economic growth at high levels while controlling inflation.
In recent days, analysts have noted that recent jumps in consumer prices may have more to do with food prices, which have been boosted by droughts and floods in the past year and steadily increasing energy costs, than lending policies.
India announced last week that its economy had grown 8.9 percent in the 3rd quarter, once again underlying the growing gap between economic performance in China and India and the growth in the rest of Asia which is essentially flat. The Indians, however, reported a deepening coal shortage as the country is having difficulty developing domestic resources and must increase imports to keep growing at current rates. The Indians may also be facing inflationary pressures that could force tighter lending policies.
4. Offshore Drilling
The announcement by the Obama administration that it had rescinded its decision to expand offshore oil exploration in the eastern Gulf of Mexico and along the Atlantic coast led to the predictable complaints from the oil industry and its allies in Congress. Environmental organizations hailed the move. The Interior Department said it would not auction any new leases in the area until 2017 by which time a new and more stringent regulatory regime would be firmly in place.
Even though most of the Gulf is now open to drilling again, the oil companies are complaining that long delays in issuing drilling permits are making life difficult. New lease sales in the central and western Gulf that were scheduled for next March have been pushed off until the end of 2011 or even 2012.
While there is little evidence that large commercial quantities of oil will be found along the east coast, the oil companies are more concerned about seven- or eight-year delays in the eastern Gulf where extensions of existing oil fields offer more potential.
The impact of the Macondo disaster with the consequent moratorium, stricter regulation, and delays will not be felt for several years with most of the effect coming in the latter part of this decade. By that time global oil production is likely to be contracting with restrictions on offshore drilling adding to the pace of the decline.
Quote of the week
"Oil seems to have everything going for it."
-- Energy Advisor Cameron-Hanover
Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)