June 6, 2000 SolarQuest® iNet News Service
Movements in the price of oil may be delivering a message beyond the simple balance of supply and demand. [by C.J.Campbell]
Starting from a low of about $10 in February 1999, price rose consistently in a well defined band to a High of $34 around March 10th 2000. This rise may in fact have represented the unseen iron hand of depletion rather than any particular OPEC action. The High triggered a certain panic in Washington and general outrage in the USA, even with calls for military intervention. The Secretary of Energy then toured the world trying to persuade the producers to produce more. His efforts were met with sympathy, of which the market got wind and started marking down the price in anticipation of the critical OPEC meeting on March 27th. Five days before this, the US Geological Survey made (or was persuaded to make) a Press Release of an unfinished report that not only exaggerated the size of the undiscovered and the scope for reserve growth but increased radically the potential of the three countries of North America. Observers may be forgiven for concluding that this was politically motivated to undermine OPEC confidence.
OPEC did make a conciliatory gesture, declaring a policy to hold price in the $22-$28 band. Significantly, Iran declined to sign. The reason may have been - not so much that it disagreed with the OPEC position - but that it did not want to admit that it could not physically meet its quota, which would have diminished its political stance in the region.
Oil price fell to about $25.50 by the March 27th meeting, but then strengthened briefly because the OPEC offer was not seen as being generous enough. Oil price then plunged again, reflecting the arrival of a large number of tankers, which had been dispatched previously to give weight to OPEC's gesture. Some of these tankers drew their cargoes from floating storage in the Gulf rather than increased production.
Oil price bottomed at about $21.50 around April 10th, when the impact of these deliveries passed, and began to firm hesitantly until the end of April. It then became evident that supply was not going to be enough to both meet demand and replenish depleted stocks. Price then soared to $28, and began to breach the OPEC ceiling, at which point it also entered again the long term band that has been developing over the past 12 months.
So far as the movements over the next few months are concerned, we may speculate as follows.
Price will dither around $28 to see if OPEC will or can increase production to hold its declared range of $22-28. Within a matter of weeks it may become doubtful if it can. Price will then pass through the emotional $30 barrier. That will trigger another political spasm in Washington, and new calls for military intervention will be voiced. There will be pressure on Norway, Mexico and Venezuela to increase production to counter what is wrongly perceived in certain quarters as the Muslims holding the West to ransom. There will be a lot of rhetoric of a very damaging type. It will soon however become evident that these three countries cannot physically increase their production rapidly.
We should also not forget the position of Russia and the Caspian. Russia is now facing serious food shortages, which force it to increase imports. This is a heavy burden on its foreign exchange, almost all of which comes from the export of oil. By the autumn, the harvest will be in reducing the pressure to export oil, which is in increasing demand internally as the domestic economy improves. Falling Russian exports will be further pressure for higher world oil price.
It seems that the Kashagan East well in the northern Caspian has made a discovery of about 10 billion barrel (another Prudhoe Bay) in an immensely expensive operation. It is however a solitary huge structure and does not herald further major discoveries capable of having a world impact. The potential of the Caspian has been generally exaggerated in a pitiful example of wishful thinking as the West dreams of countering Middle East control. Confirmation of this discovery may however cause a temporary emotional fall in oil price. It may also trigger further tensions about the ownership of the Caspian. Russia and Iran have claimed that it is a lake not a sea and that it is owned jointly by the contiguous countries. Kazakhstan and Azerbaijan naturally claim that their offshore extensions belong to them. Russia or other neighbouring countries they have a lever to impose their will as the pipelines have to pass through their territories. The US will likely want to get embroiled in this affair with the carrot of financial help and the stick of military intervention, possibly related to the Chechnyan civil war, but it may end in another failed policy.
Gradually the market will perceive that there is neither an OPEC ceiling nor a roof above it. Prices will soar into the $40s. That in turn will trigger a stockmarket crash and another Asian recession. By year end, all of this may have curbed demand sufficiently to allow oil prices to fall back to the mid $30s. In any event, the days of cheap oil are well and truly over.
The US situation seems to be particularly serious because this oil crisis will coincide with serious gas shortages. Gas depletes very differently from oil due to its higher molecular mobility and recovery factor. Instead of following a bell curve, production is capped by the limits of the pipeline and the market. In an unregulated market, such a plateau runs its course with few signals that it is about to end, it being often cheaper to produce the last cubic foot than the first. The plateau ends not in a slope but in a cliff. The United States may now be looking over the edge of this cliff.
For all of these reasons, the new President will face some kind of economic discontinuity.
We are not running out of oil, merely reaching the peak of production. Peak is not the end of the world. But the perception that the fuel that has driven the economic prosperity of the last 50 years is getting expensive and in short supply will have a radical impact on business decisions and investment strategies.
It takes no feat of intellect to see these patterns and pressures. But it is a picture that no one wishes to see, which explains the scale of denial and obfuscation. In this context, we may note that the President of the American Association of Petroleum Geologists (which is colluding with the USGS) launched an editorial against a study of depletion in the May issue of the AAPG Explorer. He sought to discredit it, but in fact confirmed it when he stressed that the production of non-conventional oil and gas could be stepped up in North America. This is expensive stuff, and no one produces it if there are abundant supplies of cheap conventional oil. In other words, the hoped-for growth of non-conventional oil and gas implies the peak of conventional hydrocarbons and a radical increase in price. But why does the AAPG not discuss the obvious implication instead of pretending that there is a seamless transition? Incidentally, the new USGS study claims that new discovery will amount to 724 Gb between the years 1995 and 2025. It means that it is already short almost 100 Gb, and cannot possibly catch up with its totally implausible target.
We can expect this denial and obfuscation to continue, but while it misleads many, it also offers great investment opportunities to those who are not deceived and have the courage to plan for the inevitable.