Oil Crisis: Your Primer on the Great "Peak Oil" v "Speculators" Debate
Oil prices soared to new highs ($138, up $11) as brokerage firm Morgan Stanley predicted that oil will hit $150 a barrel by July 4th and Israel suggested it might attack Iran. Needless to say, stocks got clobbered (with the exception of ExxonMobil).
In case you haven't been watching CNBC lately, there's a Great Oil Debate going on. On one side is the "Peak Oil" crowd, who believe that the world has now reached its maximum daily oil output and that increasing demand--which is already outpacing supply--will now drive oil prices into the stratosphere.
On the other side are those who blame the problem on "Evil Speculators", and argue that big energy traders are "gaming" the energy markets and adding at least a $30-$40 speculation premium to each barrel (Michigan Rep. Bart Stupak is in this camp).
Who's right? No one knows for certain (and anyone who says they do is fooling themselves). Part of the problem is that no one knows exactly how much oil the world is producing, or what the world's actual daily consumption is. What's more, no one knows what the "intrinsic" value is of a barrel of oil (other than what someone will pay for it--which brings you back to the beginning of the argument again).
But still, it's a fascinating debate, with smart folks (and morons) on both sides. Below are some short articles that lay out the "peak oil" and "speculation" cases. For what it's worth, my answer is that the current crisis is a combination of both influences: a short-term spike driven by sentiment, money flows into commodity funds, and supply/demand concerns...riding on top of a long-term upward trend.
THE LATEST:
PEAK OIL:
Goldman Sach Oil Bull: I'm Not A Crackpot
Boone Pickens: Why Oil's Going Straight to $150
JUST A SPECULATIVE BUBBLE:
Goldman Sach Oil Bull a Nutcase: Crash Coming Soon
Oil a Classic Bubble, Detached From Reality, Like Houses, Dotcoms, and Tulip Bulbs
ARMCHAIR QUARTERBACK:
The Donald Speaks: President Trump Would Tell OPEC Who's Boss, US Screwed at $125 Oil
Follow Henry Blodget on Twitter: www.twitter.com/hblodget
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Some people have been asking what the intrinsic value of oil is.
That's actually quite easy. One barrel of oil has an energy content of 6.1GJ. That's about 1700kWh. If burned in the most modern power plant, approx. 1000kWh can be extracted (at 60% thermodynamic efficiency).
At the industrial price of electricity (8 cents) this amounts to $80 worth of energy. $120, if you assume residential pricing.
If you burn the same oil in form of gas in your car, you get 130MJ/gallon. That's 36kWh. The thermodynamic efficiency of a good car is on the order of 15-20%. So at best, you get maybe 7kWh of useful energy out of a gallon of gas. That is worth 84 cents at residential prices. Of course, an electric car would not be 100% efficient, either. Let's assume a conservative 60% efficiency, then the same energy we get out of 1 gallon of gas can be had electrically for $0.84/0.6=$1.40.
Obviously, if you are paying $4/gallon, you are over-paying by a factor of over 2.8.
In other words: gasoline is close to three times as expensive right now than any other form of energy. It's actually more a factor of five if you look at true cost, not retail prices. If you ever thought that solar energy was expensive, why are you buying gasoline, then? It's more expensive than solar energy.
Another way of looking at that is that a barrel of oil contains the equivalent of 25,000 man hours of work. That is 12 and 1/2 men working for you all year full time. The average American uses roughly 20 barrels a year. That is 250 men working for you full time every year, energy slaves. Washing your clothes, doing your dishes, pulling your plow, driving your car, flying you to grandma or your mistress, lighting your stadiums etc etc etc. So even if you pay the guy $1.00 and hour , that's $500,000 of work you get every year. I agree with KTM to a point, he neglects the cost of the infrastructure that delivers it to you which is considerable, as well as the costs of the machines that use it, again considerable. But we are somewhere in between the 2. Since every government in the world subsidizes energy (which is why gas costs $10 bucks in Holland and .21 cents in Venezeula) it is unknowbale what the intrinsic value of a barrel of oil is. But it's a lot.
My calculation is that by your calculation the whole world economic system has already collapsed. I'm kind of wondering why no one else has noticed it yet.
That, indeed, is wonderful way of looking at it! You should post this more often. Maybe some people will get it.
Mr. Blodget appropriately reminds us that too-rapidly rising oil prices result from a complex set of variables which no one can pin down accurately.
However, while not a lot of immediate control exists over the quantity and quality etc. of available oil, since so much of it is outside the USA, it does seem possible that Congress and the White House could work (with other countries if necessary) to rein in the apparently un-restrained speculation in oil futures and trading. Wall Street could also show a conscience and put a stop or slowdown to the speculation trend. It does not matter how much or how little the speculation contributes to rising oil prices, the point is to DO something about the speculation. Oil should not be like tulips except when the prices drop. :)
Furthermore, Congress and the White House could tell the oil companies to put 70-90% of their OBSCENE oil profits (Blodget has stated herein that ExxonMobil earns $1 BILLION dollars per week) back into the American economy and therefrom back into the world economy. Yes, they need profits to conduct research, development, etc., but it has been readily shown elsewhere (I read it on Al Jazeera) that the oil companies are excessively conservative on investments etc. Nevertheless, the oil companies need to be restrained from taking undue advantage of rising oil prices.
HOWEVER, NO ONE WILL DO ANYTHING. Except talk, talk, talk.
Things will inexorably become much worse than they are now.
Nobody will do anything? Hardly. I bought a Prius last year and since then I am kind of laughing about the issue. And since I am riding buses and trains for most of my life, I don't really need to change anything in my life to be prepared for the time after cheap oil.
I tend to look at it as the greater fool theory. Nobody is a fool to buy an oil contract at $125 per barrel if later on there is a bigger fool who will come along and buy that contract from you for $135 per barrel. The peak oil theory is what gives them confidence that the greater fool will be there when the time comes. I don't know when the greater fools will run out, and it may be a long time. After all I have been scratching my head at Google trading at such lofty P/E territory for some time too.
But honestly I hope the next president will get a clue and launch an apollo program like focus on alternative energy.
Raymond, the greater fool theory is absolutely correct, but it does not take peak oil to apply it. All it takes is a look at 500 million Europeans who are paying $8/gallon and above for their gasoline (including the taxes). This alone gives traders the confidence that 300 million Americans will do exactly the same. That we do not have the smarts to tax gas higher and cheat the traders out of their profits is our own fault.
Those 500M Europeans are getting a lot more for their $8 that we are for our $4. Look at the services that they get for their money. Most of the $8 is taxes for things like health and retirement..
But the greater fool is the right idea. For instance: Let's say that you buy, on the futures market, 100,000 bbls of oil for $100/bbl. You will only have to risk $500k on margin. Along comes the greater fool and pays $101/bbl. Without even seeing the oil, much less taking delivery, you have made $9.6 MILLION profit. The assumption here is that the margin is some incredibly stupid rate like 5%.
If you back out taxes (both ours and theirs) the actual price for the gas is higher in the US than europe. In other words it is worked into the scheme of how they pary of government. If you paid eight bucks a gallon but your income tax was five percent less would that be an adaquate tradeoff? If you paid eight bucks for a gallon of gas but had free universal health care would that be an adaquate tradeoff?
If the ICE futures market were transparent like the NYSE we would have the information necessary because of transparency. That's why the "London loophole" was used. It is an ENRON-style manipulation by controlling the supply.
There is plenty of supply for the developed world in the market at these prices. Unless you have seen gas stations running out of gas to sell, the "not enough supply" hypothesis simply makes no sense. Instead, market mechanism prove that at this time prices can stabilize the balance between supply and demand. This is simply economics 101 at play. That economics can lead to very high prices for a product in high demand is not a sinister plot of cigar smoking men, it is the simple result of the rules we use to sell and buy stuff. All you have to do is to look at jewelery diamonds. They are basically useless, their material value is practically zero (it's carbon, one of the most abundant elements!), we have plenty of them, and yet our women are willing to pay top dollar for the little buggers. This is as irrational as it gets... an oil is no different.
Who is controlling the supply?
Among other things the viscosity of the oil in the rock together with the size of the cracks it flows through. Which makes more viscous heavy crudes harder to produce, transport and refine. And guess what... we have more heavy crudes left than the light sweet ones. Bummer.
Goldman Sachs, Morgan Stanley among others..
As for speculation, remember that Enron was able to run up the price of electricity and produce an apparent scarcity just by gaming the market. Enron's market manipulation cost CA billions because the state had to step in and subsidize utilities to keep the power flowing.
Both sides can be right. Oil is limited. We should be conserving. A car getting 20 mpg is ridiculous.
Exactly. But there really is a simple solution to finding out, and flushing out, the American speculators. It is said that these guys account for about 30 to 35 percent of the current oil price. Instead of $4.30 a gal, we should be paying about $3.10.
Call it the 3 x 10 x 10 solution.
1) Target the three major oil price speculation industries -- hedge funds, investment banks and endowment funds
2) Identify the top ten organizations in each of these.
3) Identify the top ten executives or managers of each the orgs.
4) Take the names of these 300 people and begin the EEP (enhanced exposure techniques, sort of PR torture), which attacks what these people most covet -- their privacy, quiet and peace of mind.
5) But we can change their lives with the EEP program -- after acquiring pictures, home and office addresses, we begin the massive negative publicity campaigns, picketing and F2F visits; of course, we're not out to hurt them, just to make their lives kind of living hells. It's called instigative reporting, perfectly legal and very American.
7) After a relentless EEP of probably about a month or so, we will have an answer. Watch the oil
prices start to drop, and soon the gas prices. When the money men are running naked through the streets of Greenwich begging for mercy, we will be on our way back to a rational market
8) Any volunteers?
You left out step 6: go to jail.
Step 1. they are offshore now!!!!
Why not Peak Oil *AND* Evil Speculators? They're not mutually exclusive, and the former will surely attract the latter like flies on dog shit.
Add devaluation of the dollar to make it a trifacta !
The internal combustion engine is obsolete. Within two years there will be viable all-electric vehicles in full production. People will gladly pay a modest premium for an electric vehicle just to get away from these abusive oil companies. We can generate everything we need domestically from wind, solar, and natural gas. We don't need crude oil anymore. And we don't need coal, either. That's a total scam. So is nuclear. Nuclear power is a total money loser. It's just a way for utility companies to get on the government teat with subsidies. And do you really want Halliburton building a nuke plant? They can't even make a decent Turkey dinner for the Army, for crissakes. How about Bechtel? They've been cashing gummint checks at Hanneford for twenty years without doing anything.
The idealist in me hopes that your exuberant optimism will not be disappointed. Of course, the realist in me knows that it will be. The car market two years from now will be not substantially different from the car market today. We have plenty of oil to burn in ICEs (even Peak Oil predicts nothing more extreme than that the world has still half of its oil left), we will just burn it in substantially smaller ones. It will take a decade to get rid of the SUVs on the road right now. It will take three or four decades to go mostly electric. And that is fine. Changes on this magnitude can not come over night. And they don't have to.
Electric cars can go a long way to alleviate carbon emissions, but batteries still need to be charged, and that requires electricity, and that in turn requires oil to turn the generators (unless they are nuclear powered). The long term answer is nuclear, alternative, and renewable energy for out basic needs and redesign of the internal combustion energy to run on fuel cells.
Actually, less than 5% of our electricity is petroleum powered these days. Oil has very little to do with power generation.
Wake up!.......The bush crime syndicate was put in place to drive oil prices through the roof. Does any one who has a brain think the war in Iraq was nothing more than a destabilization of the middle east? This war was created by the "oil boys" (as L.B.J. liked to refer to them) Just take a moment and research the former positions the maggots in the bush administration held. THEY ALL WORKED FOR OIL COMPANIES! for Christ sakes.............Oil will surpass $200 a barrel by the end of the year and there is NOTHING we can do about it, unless the American people decide to wake up. Nationalize oil and watch the floor drop out from under the oil speculators. The oil belongs to the American people, not the oil companies. Nationalize Oil and you will see, or bend over and hope for a reach around.
I recently come to this same conclusion. Nationalize it. Now. Resources critical for national economic security should not be left in private hands.
I've come to be pretty certain that everything is manipulated. We've got ... Enron-style electricity capacity in CA ... Plunge Protection Team (google it) interference in financial markets ... the Fed manipulating interest to create economic bubbles ... the Fed manipulating interest rates and money supply to manipulate the "labor market" (Google "There's no 'free market' for Labor") ... and also OPEC and oil oligopoly manipulation of supply and refinery capacity.
How are you going to nationalize Aramco? It is national, already...
This strange trip was pre-ordained when we put two unrealistic oil men in the white house. They did not plan on this happening, but now that it has happened they could care less. They and their friends in the industry are literally making more money than they could have dreamed. More profit per quarter than at any time in the 100 year history of the oil business.
But this crazed detour into global economic brinkmanship over oil has done something far worse than inconvenience SUV drivers. It has set a precedent that the US can be faced down over oil prices and will do nothing about it. This impression of weakness is clear to the world and it will lead many nations to face us down in other economic areas at a time when our economy is too weak to do much about it. The rest of the world is now quietly abandoning us and aligning themselves with Russia (which has its own oil) and China (which has the worlds strongest economy). We have neither and we have displayed weakness for the first time in a century. It is ironic that a struting Texas President who values tough talk ("bring 'em on") and hard action (highest number of executions per year of any state) will go down in history as the most cowardly President of all.
Who, exactly, is facing the US down? Oil selling to China, India and Europe goes at exactly the same price. There is no political gamesmanship going on here. Nobody declared economic war on us. This is simply world economics. Speculation by US speculators steals money from China just the way as it does steal it from Denmark. If something is happening, at all, it is the US investors are ripping off the world, not the other way around.
Oil is a finite resource. We may be 5, 50, or 500 years away from exhausting our supplies, but sooner or later we will exhaust it. It does not matter whether or not we are at "peak" oil or whether commodities traders are causing padded prices.
The fact that energy is a commodity that can be traded is symptomatic of the the problem we have.
Energy can be generated in many ways without oil. It can be generated in a highly distributed fashion via solar, and wind. It can be shared, traded or sold by people such as myself. What prevents that from happening is that highly subsidized (via tax incentives and other loopholes as well as protection from competition) energy prices that make it difficult for these alternatives to compete solely on price with existing products.
The other piece of the equation is you and me. Our consumption patterns are regularly used against us in arguments by big oil, and big energy congomerates and their mouthpieces. If we RADICALLY reduced our consumption, the large energy congomerates could not make the claims or demands they make today.
We need to create a WWII type of ethos here - victory gardens, conservation, (voluntary) rationing, recycling, etc, etc..... Mobilize the population to stop this madness and get our country back from the clutches of these companies and their poisonous products. Your parents, grandparents, and Great-grandparents all did this willingly to defeat a bigger threat to our way of life.
You mean we should treat this issue like it was "the moral equivalent of war"?
Hmm where have I heard that before?
Oh yeah, they keep saying HE was the worst president before Bush.
Shows the danger of being ahead of your time.....
Or... you just buy a hybrid and be done with it. People are completely over-thinking this problem. In reality it is trivial.
(Continuation from earlier post -- was too long to put in one)
These low prices led to low investment in replacement reserves. When demand started to rise due to China, India, and America's obnoxious oil addiction, there was no excess capacity in the system to absorb that demand. Then to make it a perfect storm, we add in the horrible policies of the Federal Reserve over the past 5 years that have allowed the value of the dollar to be cut in half (as seen in the doubling in the price of gold).
We are now reaping the whirlwind. Using the 0.085 oz/bbl ratio would bring the price of oil up to $76.50. But in order to spur the investment necessary to find enough reserves to replace what we're using, prices will need to stay well above that price for a few years to bring the long-term average price in line with the 0.085 ratio.
So by my reckoning, neither "peak oil" nor speculation is contributing anything to current prices.
I am glad that you said "by my reckoning". That makes it easier to dismiss your post for what it is: a single and wrong voice in the desert.
Our president (no stranger to the oil industry) and Congress should have seen this coming years ago. With rapidly growing economies like China's and India's, we are not the only game in town anymore for the oil producers and GWB begging the Saudi's for lower prices is humiliating and pointless. Add to this our growing debt, the war in Iraq, etc., and we are now in a big hole, much of which is our own making either through action or inaction.
We need a comprehensive new energy policy for our country that involves a reworking of our current system from top to bottom. Alternative energy sources and new delivery systems need to be mandated. I am not a liberal in the traditional sense of big government controlling everything, but I believe this is a necessary step, and one that President Bush and most likely a President McCain will not take whether Congress wants it or not. I believe our best hope is for Obama to be elected because he seems to think more outside the box than most politicians. Speaking of which, we need to elect some new blood to Congress - people who won't dither around calling meaningless hearings on things like steroid use in baseball, but who will get to work making difficult choices, telling the public the hard truth, and fixing things that truly are broken and affecting the nation as a whole.
Regardless of the validity of the "peak oil" argument, ALL of the move in oil can be explained by the movement in gold prices over the last four decades and the market dislocations that resulted.
Back when we were on the gold standard, oil traded in a very tight price range of around $3 or 0.085 ounces of gold per barrel. The dollar was steady and oil producers could count on stability in both price and cost of exploration. Supply and demand were in balance.
When Nixon abandoned the gold standard, gold shot up and soon so did oil. Despite the sharp rise in nominal prices, oil traded significantly BELOW that 0.085 level for most of the ensuing 30 years, often trading at 1/2 that price. By the turn of the millennium, the price of oil had averaged only about 0.05 ounces per barrel for the previous 15 years.
Google "Petroleum Prevarication" to see some things I didn't know.
Oh, brother... even more nonsense brought to you by the internet.
"Who's right? The truth is no one knows (and anyone who confidently asserts that they do is fooling themselves)."
This is emblematic of what goes for modern US journalism. Pretend that both sides could be right. Since it would be impossible to know the exact amount being produced down to the milliliter, then pretend that it is impossible to even have a meaninfuly estimate of what is being produced. Pretend we don't have meaningful data on past discoveries so we can ignore the fact that oil discoveries have been going down for over 40 years.
But at the same time this writer is claiming that know one knows how much is being produced and how much is in reserve which makes a correct call impossible, he makes a prediction that this is a long term trend up? How did he make that prediction if you can't know what is being produced and what is in reserve and anyone who claims to know the truth is fooling themselves? Oh, I see - they have to CONFIDENTLY claim they know the truth. So he is not confident that this is a long term upward trend and not confident that speculation has added to the price of oil. OK, thanks for giving us your uncondident opinion dude!
Michael Greenberger knows you don't know that's all..!
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