The Era of Cheap Crude Is Ending

by: Joseph Trevisani posted on: May 18, 2008 | about stocks: DBO / OIL / USO    

Since the 1973 when the Organization of Petroleum Exporting Countries [OPEC] unleashed their oil embargo during the Yom Kippur War and engineered the first violent oil price rise, there have been three major oil price spikes. After the first two spikes prices eventually dropped to levels below where the rise began; after the third they fell seventy five percent.

The first spike began in 1979 with the Iranian revolution but prices did not return to pre-revolution levels until seven years later. The 1990 spike was prompted by the Iraq invasion of Kuwait. By early 1992 the price retreat was almost complete, though it did not drop below the pre-invasion price until mid-1993. The third spike, which began in early 1999, peaked in late 2000, and by late 2001 had given back 75% of its increase, but went no lower.

The 1979 and 1990 hikes, like the earlier embargo, were largely supply disruptions. In 1979 the return of the Ayatollah Khomeini, the founding of the Islamic Republic and the Iran Iraq war led to several years of uncertain supply and political and military risk in the Persian Gulf oil producing nations. The 1990-91 spike was closely tied to the Persian Gulf War and prices began a sharp downward run as Operation Desert Storm, the United States led re-conquest of Kuwait began. In both cases, as the supply normalized, prices resumed their pre-disruption levels.

The third spike which lasted from January 1999 until September 2000 was created by a combination of strong worldwide demand and OPEC production cuts. The 2001 recession in the United States and the terrorist attacks in September of that year which sparked fears of a worldwide economic downturn, brought prices to about $17/barrel by the beginning of 2002 from a high of $30/barrel a year and a half earlier.

The United States and global economic expansions which began later in 2002 still have not ceased and neither has the rise in oil prices. This current price increase, far more than the previous three, four if you count the original embargo, is demand driven. But demand is not the only factor driving the price of oil.

Oil is a limited resource. Limited in the sense of the amount that is available at any particular price at any particular time. The world is not running out of oil, but it is running out of immediately accessible inexpensive oil. It has become increasingly hard for oil producers to supplement supply by the 1.4 million barrels a day that is needed annually to keep up with demand. The time lag for bringing new production to the market is long, far too long for the discovery of new sources, as in the Brazilian continental shelf finds, to affect current prices.

The United States, the world's largest consumer of oil is also its third largest producer, behind Saudi Arabia and Russia. America has substantial untapped oil and energy resources, on the outer continental shelf, in natural gas, in nuclear energy and in coal. The United States also has the most technically advanced, environmentally regulated energy sector. By refusing to develop its own resources the US has permitted external producers to determine marginal production. The world's largest oil consumer is hostage to some of the world's smallest. Unwilling to increase its own production it should not surprise US consumers that others refuse to do so for their benefit.

Oil is the industrial world's chief raw material and the entire world's transport fuel. The world is rapidly industrializing, far faster than at any previous epoch, and the model is, whether environmentalists like it or not, the consumer societies of Western Europe and America. The United States today has 250 million vehicles and 307 million people. China has 37 million vehicles, over 1.3 billion citizens and an economy that has grown faster than any other in history. Little imagination is required to predict that these cars will not be powered by wind turbines, biofuels or hydrogen.

Even the currently available hybrid engines add a third to the price of an automobile. Tata Motors (TTM) of India has introduced a basic car for $2,500, it is not dual drive. This is not to say that alternative energy sources will not play an increasing part in supplying the world's energy needs, even in its transport system. Sustained high prices will bring forth more efficient technologies and supply but development takes time and the oil price responds to a short term market.

The third factor in the oil price ascent has been the steady fall in the value of the dollar since 2002. Graphs of the price of oil this decade and the value of the euro in dollars have a striking resemblance. As the dollar has weakened, more greenbacks are needed to buy internationally traded commodities such as oil. But the scale of the decline in the dollar against the euro - approximately 50% since 2002 - and the rise in the dollar price of oil - 640% in the same period - are on entirely different scales.

The last factor is the speculative urge fueling trading profits in the oil and commodity markets. At almost any time in the past six years long crude oil futures was the preferred position. A trading market that has vaulted sharply higher in so short a time as has oil is ripe for profit taking. A ten or fifteen percent rise in the dollar against the euro could be the trigger for traders to reap some of those profits.

But in the long term oil prices are a classic supply and demand question. Demand for oil is rising, supply is not. And, perhaps more importantly for oil prices, the perception of future demand is even stronger. Indian and China are the current industrializers, but there are huge swaths of the world that are waiting their turn to join the consumer future. It is blindness not to see their desire for a better life, and blindness not to understand that the era of cheap natural resources is ending; even if it is a future that only oil traders seem to perceive.

This article has 13 comments! Add yours below...

Joseph Trevisani

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This article has 13 comments:

  •  
    Nate C
    May 18 04:23 PM
    I completely agree with your argument that oil prices will remain high for the forseeable future. The only thing that would lower oil prices is a substantial decline in demand which seems highly unlikely. I believe that oil remain above $100 through 2010 and probably even higher.

  •  
    Ames
    Tiedeman
    May 18 05:11 PM
    My Website
    Agreed.
  •  
    Vikram
    May 19 01:43 AM
    My Website
    A lot of people are writing about the Tata Nano and oil demand. What they miss is that the Nano is a replacement vehicle which gives better mileage than the two-wheelers it will replace. Plus it can carry 2x the load of the two-wheeler. The person buying the Nano will be replacing one or two two-wheelers and is likely to consume less gas.

    Another aspect to keep in mind is that folks in emerging economies spend a significant chunk on food and energy. They are very conscious when it comes to spending on energy and even a 5-10% difference in mileage will sway their choice regaring the vehicle they use. The emerging economies have a lot of demand elasticity built in to the system; consumers there will adapt to higher prices quickly.

    In developed economies the percentage spent on food and energy is much less than that spent in emerging economies and hence the demand elasticity is limited. Further the lifestyle changes needed to reduce consumption are much tougher in the developed world compared to the emerging markets where attitudes and trends are still evolving and can adapt easily.
  •  
    Brian
    Pursley
    May 19 01:45 AM
    My Website
    Petroleum is infinite and renewable. Hydrogen is the most common element in the universe and carbon is the fourth most common element in the universe.

    We should immediately begin drilling offshore in California, Florida, the East Coast of the United States, Alaska, ANWR, and the National Petroleum Reserve.

    oilismastery.blogspot..../
  •  
    SIMPLE d
    May 19 07:18 AM
    Brian, where would we get the energy to combine those hydrogens and carbons to make this synthetic petroleum en masse?
  •  
    Ker
    May 19 09:21 AM
    To scare more people , i will add this link: www.lifeaftertheoilcra.../
  •  
    Ker
    May 19 09:26 AM
    Brian , you should check basic physics laws. To store energy you must spend energy. To join the carbon with hydrogen you have to apply force, that was nature did during million years so you can extract oil almost for free. Wind, solar, hydro are the most inefficient energy sources and that's because we do not value fossil fuels enough. Oil to 1,000 is not crazy.
  •  
    Ker
    May 19 09:27 AM
    And a horror movie:
    <object width="425" height="355"... name="movie" value="www.youtube.com/v/UX_A...;></param><... name="wmode" value="transparen... src="www.youtube.com/v/UX_A...; type="application... wmode="transparent" width="425" height="355"...
  •  
    Ker
    May 19 09:27 AM
    damn, again,
    the horror movie:
    www.youtube.com/watch?...
  •  
    iThinkBig
    May 19 06:34 PM
    My Website
    True, speculative buying has added to the PPB. However, the buying is also based on the fact that money goes where it is safest. It has moved away from direct financials and into commodities. If the U.S. financial system as a whole were more stable (and it is FAR from stable) then I would expect the buying spree and prices to diminish. Continued high oil has had real effects of the U.S. economy.

    The nations of China and India are coupled with the dollar. Sure China and India will be more flexible to react to an energy crisis but stating that demand will not temper based on a U.S. recession, partially caused but oil is not mentioned by the aricle. China and India can want the good life all they want but until the U.S. stabalizes, global recession will likely curb demand and begin causing demand destruction just like here in the U.S.

    I am not afraid of all the doomsday stuff but realize that U.S. politicians will likely be 10 feet from the ground over the cliff before they decide to massively subsidize an energy independence program on a massive scale. Right now, legislators are attempting socialism as the fix to the socialism problem. Bad news for already pinched consumers and our GDP as a whole.
  •  
    cal48koho
    May 20 09:06 AM
    Thank you Joseph for a superb summary of a most important problem. Your writing is especially clear and concise and devoid of flummery and hysteria. Now how do we get information such as this to the nitwits who run our country?!
  •  
    paulk8756
    May 20 12:31 PM
    Thank you for your objective and concise review of the modern history of the price of oil. Barring severe economic dislocation, we will continue to experience a perceived oil shortage for years to come.

    I believe Thomas Gold is correct in his contention that oil is inorganic in nature and not a fossil fuel. While it may be limitless in quantity, it's obvious we won't have the technology to exploit this feature anytime soon.

    It is also highly unlikely some sort of technological breaktrough may occur via some form of alternative energy in a timeframe that could positively impact this dilemma. Our present political and regulatory currents only serve to further diminish this possibility.

    What amazes me is how resilient our ecomomy is to this sudden disruption in the price of energy. While I keep believing the conservative ecomnomic view of energy pricing is going to win out, I see little or no evidence of that presently.

    If the Europeans are surviving $8 a gallon gasoline, maybe that means a dollar adjusted $10-12 could happen here. As impossible as that sounds, this idea becomes more and more realistic as time and events unfold before us.

    While all of this seems perfectly ridiculous to me, what I know for sure is the further this politically inspired economic bubble grows, the more likely it is it will end in calamity.


  •  
    Eric Fox
    May 21 05:20 PM
    My Website
    This article came out yesterday:

    Iraq could have largest oil reserves in the world.

    "Iraq dramatically increased the official size of its oil reserves yesterday after new data suggested that they could exceed Saudi Arabia’s and be the largest in the world. The Iraqi Deputy Prime Minister told The Times that new exploration showed that his country has the world’s largest proven oil reserves, with as much as 350 billion barrels. The figure is triple the country’s present proven reserves and exceeds that of Saudi Arabia’s estimated 264 billion barrels of oil. Barham Salih said that the new estimate had been based on recent geological surveys and seismic data compiled by “reputable, international oil companies . . . This is a serious figure from credible sources.”
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