The Ambiguity of what's happening in Oil vs. Inflation

[EJ]

Re: The Ambiguity of what's happening in Oil vs. Inflation

Your expertise on this subject is a huge boon to our community.

Earlier this year I was on numerous calls doing due diligence for some local VCs and for myself with groups based in your neck of the woods as well as India and the US looking at the prospect of building a new refinery in the US, the first in 30 years.

In the process a tiny window opened into your world for me. Through it I got the impression that via refineries are the way that oil demand is managed collectively by oil companies independent of the paper oil market, itself more or less independent of the wet oil market.

Did I get that right?

[EJ]

Re: The Ambiguity of what's happening in Oil vs. Inflation

The new policy of “Global Warming” demands and supports change to global current energy usage. Even with oil price fluctuations if oil usage is taxed due to its carbon output then it’s up to the tax collectors to shape future energy policy. I don’t see a lack of support for such a tax, just the other day Mayor Bloomberg supports a national carbon tax.
http://cityroom.blogs.nytimes.com/20...rssnyt&emc=rss


I know current oil usage will not be replaced immediately by alternatives. Alternatives and energy conservation however can absorb future global energy expansion needs and have an impact on current usage.
A good example is China ’s recent 11^th 5 yr economic plan http://en.ndrc.gov.cn/ outlining their future around global warming http://www.ccchina.gov.cn/en/index.asp and energy usage going forward. If anyone is in a panic about conserving energy or coming up with alternatives it would be China .

Uranium is still my favorite as nuclear moves forward.
A few updates:
http://www.cfr.org/publication/14705...breadcrumb=%2F
http://www.cfr.org/publication/14694...daily_analysis
http://www.shanghaidaily.com/sp/arti...cle_336856.htm
http://www.commodityonline.com/newnews.php?id=3428
http://www.canada.com/nationalpost/f...c9f0c6&k=88837

Developing the regulatory and tax framework for an Alt Energy bubble around Global Warming and Energy Security is politically brilliant. Thanks for the research and links.

[Guest]

Re: The Ambiguity of what's happening in Oil vs. Inflation

E.J. -

With considerable respect, it may be that you have "deflected" all of GRG55's pithy observations posted above, with a question about a technicality?

What he hints at is that the petroleum story today is nothing remotely like Y2K. I don't wish to put words in his mouth, but that was my takeaway.

_____________

Your expertise on this subject is a huge boon to our community.

Earlier this year I was on numerous calls doing due diligence for some local VCs and for myself with groups based in your neck of the woods as well as India and the US looking at the prospect of building a new refinery in the US, the first in 30 years.

In the process a tiny window opened into your world for me. Through it I got the impression that via refineries are the way that oil demand is managed collectively by oil companies independent of the paper oil market, itself more or less independent of the wet oil market.

Did I get that right?

[c1ue]

Re: The Ambiguity of what's happening in Oil vs. Inflation

Lukester,

I may be wrong - and it wouldn't be the first time either :p

However, I do caution you to remember that I'm not arguing about peak oil production - I don't know enough one way or the other.

My view is simply that an unconstrained demand growth will devour all supply unless we get the robotic space oil tug traffic going with Titan.

While demand can continue to grow, my perhaps simplistic view is that China simply cannot afford to continue to subsidize their population with regards to oil prices. China doesn't produce anywhere near what they need and the oil kingdoms simply don't have enough people to buy all of the Chinese stuff.

Therefore the very ubiquity of oil in modern living and industry will create a negative feedback loop.

As for the US, we're still the big boy regarding oil consumption.

I personally believe that the only reason we haven't seen oil consumption drop yet is because of the wealth effect from the Y2K, then real estate bubbles.

Now that it is becoming clear that there is no pot of gold at the end of any of these rainbows, people will start to really pay attention to their daily finances and in turn house purchases/location, driving habits, home sizes, et al will start turning back to more reasonable levels.

I for one look forward to removal of 90% of the SUVs off the streets for simple economic reasons.

[jk]

Re: The Ambiguity of what's happening in Oil vs. Inflation

could someone please explain the issue that is supposedly being debated here? i truly don't see more than differences in emphasis. a "peak" in oil means that there is a downslope, not necessarily a cliff, on the other side of the peak. i don't assume that the "peak oil" position implies that the world runs out of oil. it would predict a sharp price spike, however, as the market rations supply. so what, exactly, is the difference between ej's and lukester's positions here?

[jk]

Re: The Ambiguity of what's happening in Oil vs. Inflation

relevant comment from suddendebt
http://suddendebt.blogspot.com/




The Roaring Nineties


Oil prices are going through their very own era of The Roaring Nineties, leaving many rubbing their eyes in astonishment. Prices have now handily surpassed even the inflation adjusted high reached in 1981-82. But unlike previous oil "shocks", the present rise is not a result of unilateral supply restrictions (e.g. embargoes), but spiking consumption. I have produced a couple of charts to show where the demand is coming from (click to enlarge).


The first chart is regional; Asia - Pacific (red line) is obviously the biggest contributor to the increase, but North America (i.e. mostly the US - orange line) is increasing rapidly, too (SUVs+suburbia). Africa and the Middle East (black line at the bottom) are becoming a factor, mostly due to escalating consumption in Saudi Arabia and Iran.

Europe and Eurasia looks like a virtuous player, but the real reason is the collapse in the former Soviet Union after 1990 cutting its consumption in half. With resurgent oil/gas wealth in Russia and the Caspian region, consumption there is rising again even as the EU tries to go green and reduce demand.

Data: BP

Within the Asia - Pacific region the big player is China, with South Korea and India being significant elements as well. Japan's consumption is slowly trending down due to demographic reasons (ageing population).

Furthermore, these charts are a window to geopolitical events past, present and future. For example, Iran and Iraq possess the second and third largest oil reserves in the world (after Saudi Arabia); if really modern survey and extraction technology were to be applied there, they will be able to significantly ramp up production. Iraq may already be "spoken for" by the US, but Iran is still up for grabs and that's why the US, Russia and China are in a three-way struggle over it.

In the short term, we cannot expect a significant drop in oil prices unless the bipolar US-China economy cools off. Longer term, the only way to free humanity from its hydrocarbon shackles is to realize that, ultimately, the only sustainable energy resource is the Sun (plus some nuclear) and to ease off the "high growth" pedal. Of course that's easy to say, but nearly impossible to accomplish given human nature. And it is easier still for us in the West to preach sustainability; we have already reached a high living standard. I believe it will be impossible to ask 2.3 billion Chinese and Indians to stop their quest for a better life.

What will happen? There are two choices: one is laid out by Michael Klare in Resource Wars (see the sidebar). I am afraid that with the Iraq war and the Iran threats we are teetering dangerously close to taking that road. The other choice is for us in the West to embark on the "moral equivalent of war" and go through the economic upheavals necessary to transform ourselves into lower intensity societies.

[zoog]

Re: The Ambiguity of what's happening in Oil vs. Inflation

relevant comment from suddendebt
http://suddendebt.blogspot.com/

....In the short term, we cannot expect a significant drop in oil prices unless the bipolar US-China economy cools off.

Wonder what he means by "significant"? I wouldn't be surprised to see a short/mid-term drop to $60-$70. Doesn't mean it won't go higher first, and I'd expect to see today's prices again further down the road.

[FRED]

Re: The Ambiguity of what's happening in Oil vs. Inflation

Wonder what he means by "significant"? I wouldn't be surprised to see a short/mid-term drop to $60-$70. Doesn't mean it won't go higher first, and I'd expect to see today's prices again further down the road.

Why not start your oil chart back when the US went off the gold standard and project from there?

[zoog]

Re: The Ambiguity of what's happening in Oil vs. Inflation

Why not start your oil chart back when the US went off the gold standard and project from there?

"Significant" takes on a different meaning at that scale. My talk of dropping back to $60-$70 after the current runup would approximate the little downward blip you have between 2007 and 2009. In the long scale of things, it's nothing. But losing 30-40% in three or four months (or however long it might take) would probably appear significant at the time.

[Guest]

Re: The Ambiguity of what's happening in Oil vs. Inflation

EJ's equanimity regarding petroleum and "what comes next" may be unwarranted. EJ referred to peak oil as another scare among false scares such as Y2K and other non-realized former "disasters". But hydrocarbons depletion probably cannot be called a disaster event.

Hydrocarbons depletion falls within "predictable, and measurable events". Marion King Hubbert, the petroleum geologist who "invented peak oil" , accurately modeled peak US petroleum production in the mid fifties, and confounded everyone by being not only correct, but quite accurate projecting a US geological event fifteen years in the future.

The critical component was access to complete mapped petroleum reserves in the US.

75% of global reserves are in countries that refuse any independent audit, and have a history of being "less than straightforward" volunteering reliable information, which makes a global replication of his established method problematic - but the method was vindicated (by resulting peak production in the US) as sound.

So peaking of global petroleum production does not belong in the category of disasters because disasters are by definition unforseen events.

To understand if there's a problem with oil in 2007, look at the relative scales of projected future global production growth, compared to (various) estimates of developing world consumption growth. Lots of differing estimations from different people. Yes, there are big nominal resources. But many factors, not least of which the now evident decline of the small handful of global supergiant fields - are big threats to the ability to maintain global production growth.

Ten and twenty years ago, right across the previous bull and then bear market cycles in oil, global spare capacity was a lot larger than now. Now it is very thin. Ten and twenty years ago SE Asia's energy consumption was also a blip, and so along with much larger spare capacity it was a very different supply / demand picture. The SCALE of latent petroleum demand arising in SE Asia now (3++ billion emerging consumers with western appetities, and an consumption curve just now trending more steeply) increasingly outpaces the potential for meagre production growth. Unlike ten and twenty years ago, the world is still riding on a half dozen super major oil fields, but those fields are now looking increasingly old and tired.

Look at the leverage in mortgage payoff schedules for a similarity. Everybody knows if you add $100 per month to an accelerated payoff of a 30 year mortgage, across the life of the loan, you leverage this into large savings, much larger than the $100 per month you are paying out. There is something stealthy at work here, due to leverage, right?

The global amounts of gearing involved in the increase of SE Asia per capita fuel consumption from just two barrels per capita per year to four barrels per capita per year are larger strains upon global supply than may be apparent.

"Demand destruction" or "the discipline of the marketplace" have been cyclically valid effects in previous cycles, and give the impression the equilibrium can be maintained, sufficient to keep the whole ball of wax together, but this time around there are significant discrepancies of scale that may be present here. The world has never witnessed the industrialisation of 3 billion simultaneously to the depletion of all the world's supermajor fields (their depletion is not now in question). What's occurring now is that the petroleum industry is scrambling out to secondary fields, and secondary and tertiary recovery techniques, to keep global petroleum production stable. Notice - increasingly petroleum senior executives state this is occurring to keep production stable, not to keep it growing.

One reads more frequent speculation from petroleum industry insiders that the growth of consumption in China and SE Asia may exceed future global petroleum production growth. That consumption growth is traveling along an exponential curve, which involves very large numbers of consumers. These could probably do a good job of sopping up all the production growth from the world's supermajor oilfields back when they were first opened in the 1950's and 1960's. Most of those oil fields are now being publicly announced to have peaked production (North Sea, Cantarell Mexico, Burgan Kuwait, and there are hints about Ghawar, which is the swing producing field in Saudi, which is the swing producer for the world). Meantime, we have no supermajor oil field replacements, despite soaring oil rig counts globally and having looked for super major replacement fields for fifty years.

So there is a very good argument to be made that the notional amounts of new oil production needed to bring the world up to the 115 MBPD production which the world notionally needs in ten or fifteen years are simply not there.

The demand growth curves for SE Asia which are so rapidly outstripping sluggish Western demand growth, are very long term secular charts, as they are plotted extending back to the middle of the 1960's. These very long term chart trends should therefore be reliable. The collision between stagnant oil production growth and ramping up of vigorous demand from 3 billion new consumers represents a novel, one-time event in terms of scale without any precedent in the past 100 years. Europe's industrialisation post WWII and Japan / Korea were not even remotely on the scale trajectory of SE Asia today. SE Asia is happening much later in the depletion timeline of global oilfields.

This event does not appear to conform to the definition of unforseen accidents or disasters, but rather, is the most heavily forecast collision, or 'accident' in decades. The fact it's been so heavily forecast, analyzed and anticipated in no way obviates it's actual arrival or occurrence.

When one reads blunt commentary from senior Saudi Aramco executives warning that "petroleum production growth has been flatlining already for four years, and we will quite probably never produce much more than at today's rates" one might ask - "how much more do I know about this subject than this guy?". If the answer is "not much" that means one should probably at least accept his statement as a working hypothesis.

Henry Groppe. T. Boone Pickens. Sadad Al-Husseini. Charley Maxwell. Matt Simmons. These five have over 200 years of collective experience in petroleum - and they are all saying the same thing.

You might think the "wild card" regarding global spare capacity was how sharp a decline petroleum production could see. That's an issue, but not the biggest issue. Thebig issue in this scenario is the leverage to demand which occurs when 3 billion people go from consuming one barrel of oil per capita annually to just 3 or 4 barrels of petroleum per capita annually. That trend growth is not linear. There are some very large meshed gears hidden away in this implicit demand because the number of oil consumers in this emerging bloc is very large - much larger than anything the world has seen in previous industrialisations.

I've read that the supply / demand equilibrium in the petroleum market is so finely balanced today, in 2007, that a mere 2% shortfall in supply can spike oil prices up $50 - $100 USD in just a month or two. Who needs geopolitical risks underpinning today's oil prices, with that kind of razor thin spare capacity?

If you hypothesized what the above Saudi Aramco senior executive Sadad Al-Husseini says were true, and he's suggesting global production growth simply cannot grow significantly higher than today - then China energy consumption growth alone (not even counting the rest of the 3++ billion industrialising, poses a breaking strain on future supply. The IEA, which some consider to be alarmist, actually to me appears unduly optimistic. They suggest the world petroleum production will grow to 115 MBPD in another ten - fifteen years to "meet developing world demand" But while it appears that China alone will require us discovering and developing additional oil equivalent to the entire US current consumption, in less than two decades, an increasing number of highly reputable petroleum insiders are suggesting global production is flat today!.

If you are a die hard skeptic, you can even assume China's future oil demand growth proceeds at 3% annually, although for that particular country's historic growth trend 3% seems decidedly low. Then when petroleum gets to be a little scarce, we must assume China's petroleum consumption will respond to market forces and experience "demand destruction".

The main point is, that this nation's consumer base is so vast, that even 3% annual energy consumption growth will quickly pile up pent up demand as the country naturally grows further, to "break the petroleum supply system stability" if global petroleum production growth is flat! This modest looking 3% is an expressed percentage of 1.3 billion consumers!

It's my view that anyone who cannot see there is a monumental supply / demand disequilibrium approaching caused by SE Asia's barely getting off the ground in petroleum consumption in 2007 is missing a very big issue indeed.

This is not a question of the issue being "emotional" - it's not really, except for a slightly nauseous feeling looking at our collective prospects - it's a question of simply placing the reported global production growth potential next to the exponential demand growth potential of 3 billion consumers and making an informed assessment of their comparative SCALES, to see if they are remotely a match.

If separately they appear orderly and viable, they do not appear so viable when you try to shoehorn another global demand equivalent of the 2007 US global petroleum consumption, into the world's existing production growth capacity over the next fifteen years.

I have a good deal of respect for EJ, and this community is a tremendous service to all people trying to protect themselves from the multiple very bad problems headed our way, but this question in my view remains one which iTulip has not yet adequately addressed.

[jk]

Re: The Ambiguity of what's happening in Oil vs. Inflation

lukester,

this might seem like a strange question, but i mean it in all sincerity: what's your point? you throw around words like "catastrophic" and phrases like "hit a brick wall" without being specific as to the nature of the catastrophe or the crash. aside from the emotional tones, which are worlds apart, i still don't see much difference between what you're saying and what ej is saying. you are both saying that demand growth will outstrip production. this will result in further, likely large, price increases. i think there are potential issues having to do with how fast the transition occurs -- the faster the adjustment, the more wrenching it will be: perhaps this is what you wish to conjure up with the "brick wall." do you think we're headed for james kunstler's long emergency and the breakdown of global civilization? if so, say so, and explain how you think that scenario will emerge. what do you think would be different around here if others shared your sense of urgency? would we be having different conversations? what would we be discussing that we neglect now? other than to say: "yes, the oil issue is terribly urgent," what would we be saying or doing? this may sound like satire, but i mean these questions quite literally.

[bill]

Re: The Ambiguity of what's happening in Oil vs. Inflation

Developing the regulatory and tax framework for an Alt Energy bubble around Global Warming and Energy Security is politically brilliant. Thanks for the research and links.

On Monday two think tanks to release a climate report.

http://hosted.ap.org/dynamic/stories...11-03-03-13-55

Nov 3, 3:13 AM EDT

By ARTHUR MAX Associated Press Writer

AMSTERDAM, Netherlands (AP) -- Climate change could be one of the greatest national security challenges ever faced by U.S. policy makers, according to a new joint study by two U.S. think tanks. The report, to be released Monday, raises the threat of dramatic population migrations, wars over water and resources, and a realignment of power among nations. think tanks: http://www.csis.org/ http://www.cnas.org/energy/ The fuel we burn, especially oil and coal, contributes to climate change, which has the potential to destroy our way of life.

[Guest]

Re: The Ambiguity of what's happening in Oil vs. Inflation

JK - It's important to be accurate - in the post you just read of mine, I only used the word "catastrophic" once and it was to point out the use of the term was in fact inappropriate. Let's not slide into blind stereotypes here. Please re-read it and understand in no way is this reply "emotional", let alone a window dressing for trotting out catastrophe for it's own vulgar attraction.

The above comments were this: a suggestion that we all take a look at comparative scales.

Imagine you and I are standing in a department store, and you pick out a christmas tree you want to buy, which happens to be thirty feet tall. I pick out a ladder with which to climb up the thing to decorate it, but the ladder is only six feet high.

As long as we refer generically to the tree and the ladder as two items that can be used in conjunction, we have no idea that the "scale" of the project is a non-starter.

This was the point.

Now look at that scale. China increasing their per capita oil consumption to four or five barrels of oil per day, would barely enter the ranks of industrializing countries. Lots of upside further from that ultra-low conservative assumption.

But right now they are way below that consumption, and yet they will be consuming ten million barrels per day, fully half of total US consumption, in a mere five years. In ten to fifteen years, they will consume as much oil as the US does today.

Uhm ... Where's all that extra oil supposed to come from?

Answer - it's not coming from anywhere. They will never get that much, but they will damn sure be buying every last spare barrel in the world, with a lot more hard cash than the US, or any other G7 nation.

EJ is referring to a "transition period" to another energy paradigm implying this will be orderly and hence "catastrophe" scenarios are unwarranted (hint - my own use of this word was merely in reply to his use of it).

On the iTulip home page are posted some summaries on petroleum from earlier this year. EJ has summarised there, very clearly, accurately and cogently, how the energy density of any substitute to petroleum is simply not remotely a substitute for oil.

That investigation however stops there, in mid-thought as it were. SE Asia's soaring future energy requirements (3 billion people transition from 2 barrels per year oil requirement to 10 barrel per year requirement - how?) are never analyzed as the wildcard that tips this challenge into the realm of "highly challenging", bordering on "implausible".

The notion we are going to "transition" to powering our present industrial world, let alone a more prosperous future one in ten years, via solar, wind and biofuels risks verging on the highly implausible, not because these sources are not viable - they are - but because of disparities of SCALE (and to ineffectively try to reproduce the oil energy density lost) when this challenge is juxtaposed with the extraordinarily challenging prospect of feeding China's and SE Asia's energy needs, which will be growing exponentially.

EJ sees severe price pressures forcing creative solutions (the market place resolves it) and our existing industrial paradigm surviving. I'm saying "show me where the energy budget exists from all these sources, to shoehorn another energy consumer into this world the size of the US consumption today? Show me where these hydrocarbon reserves are coming from to feed this "USA sized oil consumer Number 2" and then I'll believe you are proposing ideas for serious consideration.

When two dozen people, of the caliber of Saudi Aramco's Al-Husseini, are telling you "petroleum production growth has been flat for four years now and I am suggesting to you seriously that it won't grow much further", any suggestions made in response, that we'll make it due to human ingenuity, need to come up with something more specific to reply to Al-Husseini with corresponding seriousness. Show me where you see another 25% of current global oil output coming from and then I'll believe you".

Please do not label me a catastrophist merely because that's the popular label associated with asking such "awkward" questions. And please be reassured - I'm completely serene putting these questions to you. This is reason talking to you - not emotion. Whether you'll discern the implacable nature of the improbability I suggest above is entirely up to you.

Posted previously :

The innovation fallacy - by John Michael Greer

http://www.itulip.com/forums/showthr...16332#poststop

P.S.

One last thought JK. This community is not about being clubby. It's not about professing loyalty and everlasting admiration to EJ for his work and then looking out at the world as one happy band who's thoughts are unified along any kind of consensus. EJ must surely not want that. This place is to table all the largest issues of the day and scrape away all the BS to find out what the straight goods are. I don't think my challenging anyone's feeling of comfort, ease, or camaraderie around here is anything more than business as usual. We take enough time to show full respect for each other around here. If you want to discuss petroleum, and a potential situation which may severely degrade the quality of our lives in a mere decade, it's quite OK to put it all down as bluntly as necessary to communicate the harshness of the issues.

[GRG55]

Re: The Ambiguity of what's happening in Oil vs. Inflation

Your expertise on this subject is a huge boon to our community.

Earlier this year I was on numerous calls doing due diligence for some local VCs and for myself with groups based in your neck of the woods as well as India and the US looking at the prospect of building a new refinery in the US, the first in 30 years.

In the process a tiny window opened into your world for me. Through it I got the impression that via refineries are the way that oil demand is managed collectively by oil companies independent of the paper oil market, itself more or less independent of the wet oil market.

Did I get that right?

Thanks for the kind words EJ. You certainly get involved in a remarkably broad range of business interests - another sign of an inquiring mind. It's a humbling experience every time I sign into the iTulip Forums; the breadth of knowledge and articulation of ideas in this community is incredible. Many thanks to you and your team for nurturing and supporting that.

On your question our views appear broadly similar. My mental model is that the upstream sector (your "wet oil"?) explorer/producers are perpetually long physical oil by virtue of holding reserves in the ground. The only way they can reduce their physical long position is to produce and sell.

The offset to this physical long are the refinery capacity owners, who are perpetually short physical crude (their raw inventory is irrelevant compared to annual throughput). Being short physical means that rising crude prices hurt their business, and that's exactly what we saw in the 3Q '07 reports released in the past couple of weeks.

I think these are fundamentally different businesses, although there is a long standing school of thought that integrating them somehow makes for a superior business. I disagree completely; so much that in 1997, as the "supermajor" M&A was gathering momentum, I voluntarily left "Big Oil". I firmly believed that integration was a busted business model, that the creation of the "supermajors" was the last gasp of brontosaurus after the meteor hit, and these companies would underperform. Nothing that has happened in the past decade has changed my mind (Integrated oil is like running a long/short hedge fund with all the pair trades in completely independent economic sectors). The reserves problem in Shell, production difficulties in BP, and recent earnings issues in Exxon and Conoco/Phillips (with oil hitting all time highs!) suggest to me that these companies will ultimately be broken up into the independent constituents you listed (with Wall St. making fees coming and going).

As you noted the paper market has long outgrown its original intent, and now has its own FIRE economy dynamic, occasionally seemingly divorced from the realities of the physical markets.

As you know from your work, the economics of refining demands very high capacity utilization rates, so there is a rational tendency by every player to avoid being the one with any surplus. I'm not sure if that is what you meant by "manage collectively". I doubt there's any highly organized effort on the part of oil companies to collectively manage demand, but they're all responding simultaneously to the same signals.

In the latter stages of the 1970's petroleum boom the Kuwaiti's responded to the perceived looming oil shortage by expanding into refining and retailing outside their home market (primarily Europe with their "Q8" brand). I find it rather interesting that Saudi Aramco is now doing something similar, albeit more cautiously through a Chinese JV, in SE Asia. In both cases "demand management", through control of refining & retail capacity, under an expected future constrained crude supply scenario may have been part of the thinking. The situation certainly bears watching.

[jk]

Re: The Ambiguity of what's happening in Oil vs. Inflation

lukester,

my tendency is to think as you do: that there will be a rough transition to a petroleum constrained world, that there will have to be much higher prices to enforce demand destruction, and that oil producers will also use oil in non-economic ways for political reasons both domestic and international. so i see the possibility, and i'd say the likelihood, of severe crisis.

i just don't know what to do about it, beyond allocating about 8-10% of my assets to canadian energy trusts. i choose them because they hold mature reserves and thus i'm just buying oil [or gas] in the ground, along with its income stream.

so what else should i do?