Thursday, December 04, 2008

December 2007: The Coming Oil Crash and $30 Oil?

From the December 2007 article "The Coming Oil Crash" by John Cassidy, subtitled "Crude at $100 a barrel makes good headlines but ignores basic economics. Why oil prices are in for a 50% drop."

The tripling of oil prices since the summer of 2003 (from $30 to about $95 per barrel, see chart above) has unleashed forces that within the next two or three years will bring oil prices tumbling back down to below $50 a barrel. Looking even further ahead, prices could easily fall to $30 a barrel or even lower. So before you trade in your Cadillac Escalade for a Toyota Prius, think twice: $1.50-a-gallon gas might not be gone forever.

The key to understanding where prices are headed is distinguishing between the short run and the long run. In a time frame of anything shorter than five years, the supply of crude is more or less fixed. Drilling for oil is an arduous and unpredictable process. Even after a new hydrocarbon reservoir is discovered, ramping up output takes years. Current production capacities reflect investment decisions made in the late 1990s or earlier.

Today, OPEC has the ability to produce about 35 million barrels of crude a day; the rest of the world can produce perhaps 50 million barrels a day. As recently as 2003, this seemed like plenty. Since then, though, global demand has grown rapidly, and a series of catastrophes—some natural (hurricanes Rita and Katrina), some man-made (war in Iraq and unrest in Nigeria and Venezuela)—have curtailed production, causing supply to dip below demand. In September 2007, the global demand for crude reached 85.9 million barrels a day, whereas global supply was just 85.1 million barrels a day, according to I.E.A. figures.

When shortages emerge in any market, prices spike. If the imbalance is expected to continue, speculators move in and drive prices even higher. Oil is no exception. In the fall, as crude inventories declined and the rhetorical battle between the U.S. and Iran escalated, trading volume shot up.

With prices close to the inflation-adjusted record, energy companies and governments are investing heavily in facilities that generate crude and crude substitutes. Consumers of fuel oil and gasoline are starting to economize, and over time, these changes in behavior will shift the balance of power in their favor. When that happens, an oil glut will emerge, and the price will plummet.

MP: Spot crude oil today is selling for $41.25 per barrel and gas for $1.77 per gallon. Original CD December 2007 post about this here. Thanks to an anonymous comment for pointing this out.

10 Comments:

At 12/04/2008 5:59 PM, Anonymous Anonymous said...

I find this very interesting as the big 3 are promising more electric and hybrid cars to congress today. Nobody in their right mind will be buying these cars with oil prices this low. Hybrids were barely worth it when gas was at $4/gallon, and even then toyota was probably losing money on the prius.

 
At 12/04/2008 5:59 PM, Anonymous Anonymous said...

Yay, you put anonymous comments back.

I keep ribbing you about how wrong you've been all year, but on oil I think you're right. Oil is going a lot lower. However one must remember that oil is the tail, and the debt-laden economy is the dog. Deflation is here and the price of oil going down is a reflection of a global economy under extreme deflationary stress.

 
At 12/04/2008 6:00 PM, Anonymous Anonymous said...

"If the imbalance is expected to continue, speculators move in and drive prices even higher."

What is the free-marketeer response"

 
At 12/04/2008 6:28 PM, Anonymous Anonymous said...

Jason - I don't think you should rule out electric cars. They run at the equivalent of $1/gallon (based on what the EV-1 did). People will buy them, although sure early adopters are always the ones who are not so price sensitive.

 
At 12/05/2008 1:17 AM, Anonymous Anonymous said...

Jason - I don't think you should rule out electric cars. They run at the equivalent of $1/gallon (based on what the EV-1 did).

Electric cars are very economical, as long as you don't care about capital costs. They are also very "green", as long as you believe the lie that they're "zero emissions". The anti-car zealots forget to mention that with modern emissions controls a gasoline-powered car produces substantially all of its emissions when cold. When warm, it's below our ability to measure. Since we measure in parts per billion, that's really saying something. The war on auto pollution has been won, further reductions in emissions standards serve no purpose other than to strangle cars to death, they will have no effect on the environment.

 
At 12/05/2008 3:28 AM, Anonymous Anonymous said...

"When shortages emerge in any market, prices spike. If the imbalance is expected to continue, speculators move in and drive prices even higher."

Speculators! I don't believe it! I read somewhere on the internet that speculation was not the cause of the oil spike.

 
At 12/05/2008 10:21 AM, Anonymous Anonymous said...

I don't think you should rule out electric cars. They run at the equivalent of $1/gallon (based on what the EV-1 did)...sure early adopters are always the ones who are not so price sensitive.

Early adopters are also the ones who don't care that the cars are the size of cracker boxes and don't have a very long range. Real people in the real world need vehicles that can haul stuff or people (e.g. kids) efficiently.

Electric cars won't really be popular until they can show real potential to replace gas powered cars. Until then, they'll be nothing more than an expensive novelty.

 
At 12/05/2008 1:40 PM, Anonymous Anonymous said...

@jrich

The range issue is pure stupidity. 150 mile range is more than 98% of all commuters need.

Hauling stuff is an issue, but there's no reason you can't build an electric pickup or suv that gets 150-200 mile range.

The real issue is capital cost. As mentioned above, even at $4 a gallon, hybrids didn't make economic sense. They were pride badges for those who could afford them. Pure electrics are even more expensive at this point. (not to mention hydrogen cars: each Honda FCX costs several hundred thousand dollars!) Until you can start mass producing these things, a huge percentage of the population won't buy them simply for financial reasons.

 
At 12/05/2008 3:18 PM, Anonymous Anonymous said...

If mass production is the main prohibitive to the electric car, why aren't Honda Civics or Ford Focuses all the rage? Those cars are similar in style and design to what electrics would be and get much better gas mileage than their SUV or mid-size counterparts. (They're also much cheaper in many cases.)

Range is an issue. Maybe a tertiary issue, but a valid issue nonetheless. I can jump in my car and drive to Atlanta (140 miles) without giving a second thought to whether or not I have enough gas to make the trip because I know there will be a gas station or two between here and there to refuel. With an electric car, even with a 250 mile range, I have to plan my trip around recharging my car.

My alternatives are a) renting every time I need to make even a short trip like that to avoid the inconvenience (because renting is economical, right?), or b) have a second car--not electric (which would add a second car payment...which makes perfect sense to me).

When I see an electric P/U or SUV that does things a normal P/U or SUV does (a normal, everyday one, not some souped up version) then I'll believe it. Until then, I gladly bear the label of skeptic.

 
At 12/05/2008 3:28 PM, Anonymous Anonymous said...

"In September 2007, the global demand for crude reached 85.9 million barrels a day, whereas global supply was just 85.1 million barrels a day, according to I.E.A. figures."

I don't think the article was spot on...the price of oil has recently decreased due to de-leveraging...this is a short term deflationary correction in this commodity. Long term, when supply is lower than demand...prices should go up...but we have seen the reverse...they have gone down! That doesn't make sense, unless you factor in all the de-leveraging that has transpired the last few months. I think the author called this decrease, but for the wrong reasons...!

"When that happens, an oil glut will emerge, and the price will plummet!"

Well our supply is still lower than our demand, and oil companies are cutting capital projects due to the lower prices...but the price of oil keeps falling...crazy!

 

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