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Offshore Drilling Isn't the Answer - Supply and Demand Is

by: Dave Sedelnick July 17, 2008 | about stocks: DBE / DBO / OIL / UGA / USO    

Dave Sedelnick

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In my last post I made clear that due to increased demand and a lack of excess capacity, I expect oil prices (and commodity prices in general) to stay high. That being said, I think there’s a strong chance that we could see a pullback in the short term. Such an easing will not come from political rhetoric. Instead, prices will ameliorate when the symbiotic relationship between supply and demand turns favorable. Such a trend is beginning to take place.

Politicians are touting numerous so-called “solutions” to help ease the pain. Mr. McCain, for example, wishes to suspend the tax on petrol and open up the artice wildlife refuge for drilling. These ideas may seem appealing, at least on an artificial level, but after delving into these “solutions” it’s clear that, if implemented, there will be little to no positive short-run effect on energy prices. The development of deep-sea drilling rigs, after all, takes nearly 10 years before oil can be extracted. And placating the burden of high petrol via a tax reduction is counter-productive -- a lower price will just lead to increased consumption. These are not “solutions;” the free-market mechanism of demand destruction is.

$138 oil and $4.00 petrol is clearly starting to temper demand, just as economics textbooks say it should. On a side note, it’s interesting to point out that $4.00 per gallon is relatively inexpensive in the world economy. Nonetheless, Liz Ann Sonders, Chief Investment Strategist at Charles Schwab & Co, highlights that the world expenditure on oil (as a percentage of GDP) is at an all-time high (see chart). Small wonder that last month’s decline in miles driven is the largest on record.

click to enlarge

Fortunately, demand is now falling in developed economies and slowing in emerging-markets. China’s growth, for example, is slowing considerably, acting as a headwind, thereby helping reduce demand.

Another favorable trend is the relinquishment of gas subsidies. Although gas is heavily subsidized in many countries, we’re starting to see reductions in some countries and eliminations in others. To date, Indonesia, Taiwan, Malaysia, Sri Lanka, and Bangladesh have either raised prices or pledged they will. And in a surprise announcement last week, China said that it would raise fuel prices by as much as 18%. This is comforting news, as China has long been reluctant to surrender fuel subsidies.

Even speculators are now betting on a fall in gasoline prices (see chart).

If this reduction in demand continues (and is supported by a stronger dollar), a 20 point move to the downside over the next six months is quite possible. Time will tell. As always, I put my money where my mouth is -- I'm short at $138.

Disclosure: Short USO

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This article has 57 comments:

  •  
    Jul 17 07:45 AM
    I bought DUG @ $31.4 on Tues. Feeling pretty good right now. USO has also broke the up trend line. Uncharted territory now.
    Reply
  •  
    Jul 17 07:51 AM
    I'm long DUG as well, oil to $100 and gold to $750 by year end, and we will turn back up later.
    Reply
  •  
    Jul 17 08:00 AM
    I agree, with one exception. It may take years to develop other sources, but that is not a reason to ignore them. It's time congress showed us that it is there to serve us by releasing land for drilling
    Reply
  •  
    Jul 17 08:10 AM
    Dave,

    you are cultivating the myth that offshore drilling takes 10 years to produce and you make that the only argumnent for your headline. Do you really think that PBR is booking all the deep sea rigs they can get their hands on if the first drop of oil to produce is 10 years away if it takes a couple of $ 100,000,000 to drill a dry or wet hole?

    Here comes Dave and claims it is not worth it because it does not do any good. How credible is that?





    Reply
  •  
    Jul 17 08:31 AM
    Any drop in oil prices sparks more demand.Demand is still high as well.Your short and dont think we need more drilling.Lol.
    Reply
  •  
    Jul 17 08:42 AM
    If your looking for 'Short Term' solutions, then yes the quickest way to curb oil prices is to curb demand. Unfortunately it is 'Short Term' thinking that got us here in the first place. If you want to talk about supply and demand, you must realize that the demand for oil will continue to increase, and without new regions to tap then the future supply will decrease.
    If we want oil to truly drop then not only must we conserve, but we must also discover and develop new supply. That means Offshore drilling, and opening Anwar. The Future's market in oil would drop substantially knowing that oil supplies once off limits could now be tapped, even though they would not be available for up to ten years.
    Reply
  •  
    Jul 17 08:47 AM
    It is people like you that make me a TON of money. You are so far off base it is laughable. 10 years? Did you pull that out of your #%&&??
    Oh and by the way, US demand has to be cut by 25% PERMANENTLY.
    That means 25% percent of THIS country will have to STAY OFF the highway FOR EVER.. You just dont get it, your too young. Grow up, and get real.
    Reply
  •  
    Jul 17 09:20 AM
    This is a very short sighted article. In the short term the US may curb its demand a little bit. However, it still looks like the US will rack up approximately a $500 billion trade deficit this year due to oil importation alone. From an economic sense this is several times the stimulus package in reverse. The US economy cannot afford to have this much money flow out of it year after year. T. Boone Pickens has even predicted a trade deficit of $700 billion due to oil alone this year. Sure the price to consumers is important. However, we a a consumer society. We will continue to consume. We need to move to alternative forms of energy such as solar, wind, and nuclear. This will not happen overnight. In the short term we need to produce as much oil as we can. This will keep the price from rising higher, which is one good thing. It will more importantly keep the US from essentially selling its assets to get more oil to use up. The US economy will keep floundering with a huge negative trade surplus every year. It has a negative growth effect on our economy. No wonder China, India, Brazil, Russia, etc. are all outstripping the US in economic growth. This should be the top priority for the next presidential administration (along with terrorism). We won't have to worry about enjoying our pristine beaches in the future, if we no longer own them. Also the technology has improved dramatically since the time of the offshore drilling ban. The oil spills would now be very minimal, especially along the west and east coasts, where there is a much lower hurricane incidence than in the Gulf of Mexico. Yet curiously we all seem to think its okay to drill in the Gulf.

    From a supply and demand perspective, there are long term fundamentals for oil use that cannot be ignored. Apparently the US uses about 26 barrels of oil per person. Other developed countries such as Western Europe, Japan, Australia, etc. use 13-15 barrels of oil per person per year. China and India use less than 2 barrels of oil per person. That figure is rising all the time. Even slight increases in the figures for China and India mean huge changes in oil demand worldwide because of their relatively huge populations. It is inevitable that the oil demand by China and India will increase in the years to come. The US will be put in a more and more negative economic picture by this if the US does not change the fundamentals of this situation. The US needs to speed the adoption of alternative energies. However, it also needs to produce much more oil so that its economy doesn't suffer dramatically. Recent news that Budweiser was just sold to InBev (a foreign company) should drive home the point that we are essentially selling our country by running these continued deficits. We need to act to change this now. It clearly cannot wait. A large part of this is oil. This part seems likely to get much worse. Further it will have a large effect on our standard of living, if we do not act. Offshore drilling seems a small price to pay. I don't believe there are the huge environmental issues that some are saying. I do believe the american oil companies have to be stimulated to drill and produce this oil. As pointed out by many, they have large US leases already that they have not drilled on. They seem content to let the supply problems drive the prices up, so they can make a bigger profit on their current production. They don't have to drill for more oil. The government needs to implement a strategy, not to impose windfall taxes, but to encourage oil exploration and production by US companies (the fact that they be US companies is important for US economic health not just for the cost of oil). There is clearly not a good enough policy in this respect. Some people have suggested a use it or lose it policy on US oil leases. There may be some merit in this suggestion. There is also probably merit to the idea of giving bigger tax breaks to US companies that are able to substantially increase their oil production. There has to be an incentive for the oil companies. Penalizing them for making money will not make them want to produce more, it will in fact likely have the opposite effect. There need to be tax incentive to produce more. Or there need to be penalties for not using enough of a percentage of profits for exploring for and producing more oil.
    Reply
  •  
    Jul 17 09:23 AM
    Here we go again. Another puppy who got the diluted sanitized politicaly correct history book. Anybody can have a blog, ummm go figure. The american people when backed into a corner have always done some amazining things, You know there are many different quick energy solutions, You all might want to get used to nuculear energy, and T. Boone Pickens is spending money on ads for wind energy. If you dig a little deeper you will find a patent owned by an oil company. I had the the rights to use it in the late 70's . It is a process that runs ethynol thru a catylitc converter and cracks the molecules from ethynol into Hi Octane gasoline, ya thats right GAS from veggies, beets have more suger then corn, however corn mash dried is DDG. Distillers dried grain, thats hi grade cattle feed as a by product. We estimated a cost at the pump of 1.00 might get to 2.00 today. Still cheap and renewable. You beef price gets cheap as well. You see if your just trying to whip a frenzy of fear, and try to drive prices back up. It might work for a little while. If make Americans mad and Fed up. Watch out. Oh by the way oil is just the currant rodeo roundup. Gold next? Silver. It's just about puppies making money. Oh by the way the roads on the last 2 holidays were pretty empty. Smelled a bunch of good cooking on the wind. Guess that is why stockpile are up and the analysts were so very wrong,
    Reply
  •  
    Jul 17 09:31 AM
    Just because opening up the possibility to drill here doesn't solve the problem tomorrow doesn't mean we shouldn't do it. That's the most ridiculous argument I've ever heard. In that case why do anything? Why enroll in college? You don't graduate immediately. Simply having new oil in the pipeline will curb some speculation. At the same time we should be putting all of our intellect toward clean, efficient energy as well. We can do both at the same time, they aren't mutually exclusive.
    Reply
  •  
    Jul 17 09:33 AM
    Actually, short term demand for oil has been proven to be IN-elastic. IF gas prices go to $5 or $6, I'll still have to drive to work in my gas guzzling truck. However, in the long run, people will end up car pooling, driving less, buying fuel efficient vehicles which would then help curb demand -- if not just curb the growth of the demand. Besdies, America's Oil consumption is about the same as it was in 2004. Also, even if supply will increase at a later date, it can have dramatic effects on prices today.

    However, a more importnant point many people refuse to acknowledge is what a Oil is used for. Most of a barrel of oil is used to produce diesl fuel for things like trucks, ships, trains as well as various oil fuels for industrials, jet fuel, asphalt, tar, home heating oil, propane, wax, and other petro chemicals like beauty products, plastics, synthetic fabrics, and pharmaceutical drugs. Thus, less than 45% of a barrel of oil is actually converted into Gasoline.

    Since most of the consumption of oil is Not as a result of driving cars, an economic down turn results in industrials to produce less products, thus curbing their use/demand of oil. This is also why price of Oil has been cyclical - rising during good times, and falling during recessions.

    Here's an interesting fact to consider: 9 of 10 previous postwar recessions began shortly after a big spike in the price of oil. Yet, those recessions always slashed oil prices dramatically. People who have been predicting both a nasty US recession and $250 oil prices are contradicting themselves.

    (To give credit where credit is due, the information I cite is from an article written by Alan Reynolds of the CATO institute. )
    Reply
  •  
    Jul 17 09:41 AM
    If the seismic analysis says it there and the resources to pull it out are avaiable, production can begin within 2 years...start to finish, depending on the depth of the well.

    The long lead times, quoted by the Tree Huggers and echoed by clean energy advocates, are due to all the Environment Regulations and Lawsuits filed by the aforementioned which sometimes halt drilling altogether.

    Anyone remember the Snail Darter which slam dunked a TVA project because the Tree Huggers claimed the area was their last refuge. No one looked for them before, but after, they were found to exist all over the place.

    This type of idiocy is what brought us here in the first place. Yet we continue to allow it to continue.
    Reply
  •  
    Jul 17 09:43 AM
    what Post War recession are we currently in?
    Reply
  •  
    Jul 17 09:56 AM
    Not to quibble with you too much, but wouldn't expanded drilling be a part of the "supply and demand" equation? And, as others have already pointed out, where in the world did you come up with the 10-year figure? There are several offshore geographies that could be online within 18 months. In addition, it wouldn't even take 10 years to bring ANWR online.

    It truly gets frustrating to even attempt to debate people on this issue when there is much bogus info accepted as gospel.
    Reply
  •  
    Jul 17 10:33 AM
    I'm short too but I'm disappointed that so many others are as well.

    There is some sense in the article but drilling or even planning drilling would place huge downward pressure on expectations. It's simply the eco-extreme culture that doesn't care about market forces at the root that are the problem. Bush was 100% right on this point early on in the admin, it doesn't have to make him popular but he was correct.
    Reply
  •  
    Jul 17 10:53 AM
    You are all rookies. You guys actually think this has anything to do with supply and demand then you don't how the crooks work. They sell the stories to retail baggies like they never could before as it's the new trend to play in the once scary commodity complex. When markets jump up and down 5% regularly in a day for a commodity that supposedly is based on supply and demand you have problems. It's nothing more then a casino with a bunch of people trying to post information to support their positions. Take all the crooks out and you got oil at about $60. Demand was going higher last year at this time and where was oil trading then. Nothing goes up 50% in a year. There are no lines and half the time they have no buyers for what's out there. Look at the obvious. You have the crooks GS, Lehman and others padding balance sheets that were hammered with the last bubble they created. All the same things are said in every bubble regardless of what it is. 50% in a year is a bubble nothing more that will pop, and it will not take a year; this thing will crash and wreck many a retail baggie. Just look at the news cycle now you don't think they are going to drive this thing the other way as fast as it went up LOL? Read the headlines and know when it's time to get out.
    Reply
  •  
    Jul 17 11:50 AM
    How about a longer term energy policy than the next two weeks? Oil is no longer under our control, either price or quantity. Some speculation exists, of course. Do what we can to temper this, but let's start rethinking our energy consumption. Drill, sure, for the short term, but why not rebuild our railroads for transport and freight, as well as our river systems. We may not like this reality, but the oil bonanza we've enjoyed for 100 years is coming to an end. Let's prepare for that end.
    Reply
  •  
    Jul 17 11:52 AM
    >>>And, as others have already pointed out, where
    >>>in the world did you come up with the 10-year figure?


    The 10y figure comes from the government.
    www.eia.doe.gov/oiaf/a...


    >>>There is some sense in the article but drilling or even
    >>>planning drilling would place huge downward pressure
    >>>on expectations.

    There's about 18bn bbls of potential oil reserves in the U.S. offshore shelf. The world consumes somewhere north of 85bn bbls PER DAY, with the U.S. accounting for about 25%, or roughly 20bn bbls per day. What we have is a literal drop in the bucket. It's hard to see how producing it would have any impact on prices.

    Reply
  •  
    Jul 17 12:03 PM
    for god's sake and mine lets drill - off shore , alaska or any where we can - i liked the comment about the snail and the tva - right on-
    Reply
  •  
    Jul 17 12:26 PM
    18 billion barrels is close to 3 years worth of oil consumption by the US at 20 million barrels a day. I am not sure why that is not enough to go after and drill for.
    Reply
  •  
    Jul 17 12:42 PM
    LOL @ the title. Offshore drilling = supply.

    oilismastery.blogspot..../
    Reply
  •  
    Jul 17 12:44 PM
    yes let's rebuild our railroads. d.d.eisenhower gave a gift to the trucking industry.
    > jack
    Reply
  •  
    Jul 17 12:45 PM
    Kill the environment and the animals. No more oil spills like last month off the shores of South America. Feed the insatiable demand for oil no matter what it takes.
    Pollute the skies. Blame Bush.
    Reply
  •  
    Jul 17 01:07 PM
    Apparantly any uninformed idiot can write a column on SA. "Dave" writes:

    " Mr. McCain, for example, wishes to suspend the tax on petrol and open up the artice wildlife refuge for drilling."

    Earth to "Dave": John McCain (wrongly IMO) has opposed drilling in ANWR and continues to oppose drilling in ANWR.

    Next time take the time to learn the facts before inserting your size 10 shoe in your mouth.

    Wonder if "Dave" will have the scruples to publish a correction?



    Reply
  •  
    Jul 17 01:33 PM
    Mathman - you're wrong about the use of oil: 70% of burned crude turns into waste heat and 70% of all crude is used in TRANSPORTATION, be it diesel or gasoline. Only 30% of crude goes into feedstocks for plastics, etc.

    The way to immediately lower crude consumption is to address TRANPORTATION.

    Simply: 4 folks in a car instead of 1 is a 75% reduction; 20 folks instead of 10 in existing buses or transit systems is a 50++% reduction; rail transport of goods intead of rubber-tired interstate trucking is a 50% reduction; driving 55 mph instead of 65 is a 10% reduction.

    Study this chart and get smarter, everyone of you:

    static.seekingalpha.co...


    Reply
  •  
    Jul 17 01:48 PM
    jaybird,

    Read my post again. Diesel and jet fuel were seperated from gasoline, and paired up with petro-chemicals. Gasoline, therefore, accounts for ~45% of a barrel of oil, and everything else accounts for 55%. I am correct, you're just not reading what I wrote.
    Reply
  •  
    Jul 17 02:08 PM
    Or, raise the price to $10 gal., or more.

    MAYBE that will finally force us (the US) to do what has happened in Switzerland (100 electrified trains); Germany (40% solar); France (83% nuclear); Brazil (50% biofuel in vehicles); Europe in general (smaller vehicles, electric cars and delivery vans, rails and electrified rails); Holland (tidal and wind power); Spain and China (going solar); and good ole Boone Pickens (going wind; now if we could just get him to go extra wind and also solar and not use that natural gas in cars, but electrify them!).

    You see, until the people get upset enough and then prove that the Government is to be by the people and for the people, we will continue to have lousy LEADERSHIP; the people must lead first, it appears! (proof is how minority voice and sometimes wrong-thinking has out-shouted and out-manuvered wisdom, be it saving owls or whales or salmon; the unborn; traditional marriage; SUV's; Houston to Detroit energy policy; drill, drill, drill Kudlow et.al. types; tear out the dams advocates; and so on).
    Reply
  •  
    Jul 17 02:28 PM
    Madman - I did read your post. Maybe $10 gasoline will finally push you to stop commuting with your gas guzzling truck.

    If you study the chart I suggested above, you will note that 64% of all hydrocarbons (25.7 of 39.8 Quads) goes to TRANSPORTATION, whether gas or diesel doesn't matter. Only 14% goes into non-fuel uses.

    AND, actually 80% of all that energy is wasted; only 5.3 of 25.7 Quads becomes useful work.

    Study the chart. It may give a mathman plenty of new ideas.
    Reply
  •  
    Jul 17 02:42 PM
    Lets not blame Dave's ignorance on his age. There are plenty of bright young Americans that know how completely off base this liberal argument is. They somehow won this short term debate when Bill Clinton vetoed the right to lift Bans during his administration. How long ago was that...hmmm... 10 years ago. It seems if there would have been a little forward thinking back then, we would not be in this current mess. Quit punting the political football and bring the drilling issue to a vote. Americans are sick of the prices. Whether it drops gas now or in 5 years. As long as we know it will not go higher, Americans will start spending and the economy will turn around. Wait... If the economy turns the Dem leaders will have nothing left to run on. Democracy is great, but not when you stop listening to the people simply because of the fear of LOOKING BAD and or being a flip-flopper. Get off the Washington high horses and do your job, or you might just have to find a real job come next election.
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  •  
    Jul 17 02:52 PM
    And, if only 20% (5.3 Quads of 40 Quads) of oil/gas becomes useful TRANSPORTATION work why not electrify it and use ZERO crude. Now that's putting a dent in it!

    We already produce and handle over 12 Quads of electricity with our existing grid - so lets increase it to 18 Quads (which we know how to do). That would require 5 Quads (per year) of new electric generation by wind and solar and tidal and geothermal and new nuclear; all of which is less than we now produce with our current 100 nuclear plants in the US.

    RESULT: Crude consuption in TRANSPORTATION goes to ZERO.

    Now, that's a target; it should become a policy.

    Go Boone. Get that wind going. Stop burning the natural gas.

    And when we've done that, make more solar and wind electricity and stop burning coal to make 50% of our electricity, of which 60% is waste heat (not electrical transmission and distribution losses, which are minimal). NOW WE ARE REALLY MAKING PROGRESS.

    GET IT???
    Reply
  •  
    Jul 17 04:13 PM
    I never saw more evidence of a person who would rather profit from a national problem than really get the facts that will lead to an energy policy that ensures the well being of this country for both the short term and long term. Dave's article talks about demand destruction as the best way to bring oil prices down and because he sees evidence of that he is selling short on oil. Given what happened over the last three days he has made a killing, especially if he only had to put up 5cents on the dollar in order to sell at the lower price. Let's get to actual facts rather than his rationale. First about a little less than half of the oil we import is from a monopoly,OPEC, which will reduce supply if demand goes down. Unless demand goes down by app. 5m barrels/day we will not fix the problem. Second, the 10 year myth is a political number not an actual figure. The oil drillers estimate that the timeline is one to six years. A case in point is the off-shore fields near Florida. The Chinese and the Russians must be stupid to come all that distance to drill in an oil field that we are rejoined from doing by Congress. Third ,no one who is a proponent of alternative energy will commit to an quantitative reduction in our oil usage, Like 3m barrels of oil/ day in x years. Politically I could say that US DEMAND DESTRUCTON through Conservation and alternate energy supply OF 5 MILLION BARREL/DAY WILL TAKE TEN YEARS. Who has the data that will refute this? In reality the threat to the USA is an economic one where we cannot afford to have a negative current account that is approaching one trillion dollars/yr and maintain any thing close to our standard of living for the vast majority of our citizens. Therefore, we must drill for oil in known domestic oil reserves as quickly as possible, Establish concrete goals for alternate energy conversion including energy transport mechanisms on a short time line like four years, Shorten the timeline for new nuclear plants to 6 yrs or less, and make sure that the large hedge funds don't manipulate the oil and gas commodity markets to make large profits like Dave is doing and like Calpers has doone in the last year.
    Reply
  •  
    Jul 17 04:42 PM
    One thing that can't be ignored about oil is that although you can quibble about the exact price where US consumers start to change their behaviors, it's undeniable at at some point between 3.85 and 4 dollars a gallon for unleaded regular people start looking for ways to reduce their energy consumption. OPEC's report on Wednesday cited a variety of factors that are expected to reduce demand for oil in 2009, most notably that projected demand growth is less than projected supply growth.

    As of 3 pm today oil temporarily dipped below $130/barrel, and it's likely that by the end of July US consumers will see unleaded regular pump prices below 4 dollars a gallon. What remains to be seen is if US consumption spikes once a public that's been price conditioned to accept 4 dollar a gallon gas sees a relatively significant dip in unit cost.
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  •  
    Jul 17 04:43 PM
    Amen, old wizzard (except for the drill, drill, drill stuff).

    Build, buid, build alternatives and convert, convert, convert to electric as if time-was-of-the-essenc... a Manhattan Project or Moon Program emphasis for stopping the burning of crude in TRANSPORTAION and coal and natural gas in GENERATION.

    Result 1: Emergency situation solved within 5 years;

    Result 2: Future secured in 10 years.

    In the meantime import, import, import; and if that fails, we automatically conserve, conserve, conserve, just like we did in the 70's: we know how to do that; and it hurts - but apparently not enough to stop using it. DUH!

    The differnce this "meantime" is we wean ourselves off the CONSUMPTION of oil, gas, and coal with methods that provide use of free and readily available energy, forever, at whatever conversion efficiency which is pure gain, and leave the hydrocarbons in the ground - even better than digging the gold or oil to again just store it in the ground - and that not only secures our future, but makes us basically energy independent FOREVER - NOW THAT'S A GOAL. MAKE IT A POLICY. AND, OF COURSE, THEN DO IT!
    Reply
  •  
    Jul 17 04:46 PM
    Oh yes, and in the above process we may also SECURE OUR ECONOMIC AND FINANCIAL FUTURE - UNINTENDED CONSEQUENCES!!!
    Reply
  •  
    Jul 17 04:50 PM
    And possibly SECURE OUR NATION'S FUTURE - now that would really be an unintended consequence.
    Reply
  •  
    Jul 17 05:01 PM
    Solar, wind, nuclear, tidal, geothermal, bio and go totally electric without burning natural hydrocarbons of any sort would be a better use of all our resources than all the manhours and dollars consumed in the complex industry cobwebs of coal, oil, and gas including the regulation, legal, politics, lobbiests, power folks, etc. We should just shut down all of those industries and retrain everyone for alternatives and total electric (no new lobbiests allowed). Hey, at least we don't have to bother with all the manufacturing lost during the past 30 years. And many of the new services, well they are already in India etc. So, create some more old rust belt and new silent underground, while we go electric above ground. We know how to do it all, without drill, drill, drill.

    Reply
  •  
    Jul 17 05:01 PM
    What are we all arguing about?