Transterrestrial Musings

Comments

I heard the original story about the $100 a barrel "right around the corner". It was followed by a comment that the price of gas is at an all time high. I find all this interesting, considering I filled up with Premium at $2.88/gal yesterday. That's a low point for the summer.

As you point out Rand, most alternative oil sources become profitable at $40 barrels. However, that doesn't explain why we currently pay $70. We do need additional refinery, and more importantly lead time to access the other sources of oil. That's expensive upfront, but will drop down to the lower prices. Add in the Ethanol policy, and I just don't understand $100/barrel speculation.

For several years, I think those in the commodities market have been messing with the price of oil. I do wonder if it isn't at a bubble. I'm sure some will take such a comment as a suggestion of Administration allowing Big Oil its way, but I can see either side finding higher price oil as a political advantage. Regardless of advantage, if it is indeed artificially high, we will have problems when the support fails.

Posted by Leland at July 27, 2007 10:36 AM

As you point out Rand, most alternative oil sources become profitable at $40 barrels. However, that doesn't explain why we currently pay $70.

There's a terror/foreign policy uncertainty built into the price, and if the shale and other alternate guys can get $70, why wouldn't they take it? There won't be any downward price pressure until their production capacity starts to exceed demand. They're still ramping up production.

Posted by Rand Simberg at July 27, 2007 10:46 AM

Personally I think those folks who say oil or gas will be X dollars actually work for the oil or gas companies. It's their way of preparing us for the inevitable price gouge. Does anybody seriously believe demand for oil and gas suddenly increased several orders in magnitude overnight? I don't. Does anybody seriously believe oil and gas companies artificially kept prices low out of the goodness of their tiny, black hearts? I don't. Several somebodies are lying through their teeth...it's Enron all over again except on a global scale.

Posted by CJ at July 27, 2007 10:55 AM

Does anybody seriously believe demand for oil and gas suddenly increased several orders in magnitude overnight?

No, and I don't know anyone who has claimed that it has. If this kind of strawman is the best argument you can come up with, perhaps you'd be better off keeping your tinfoil-hat conspiracies to yourself, rather than posting them anonymously on my blog.

Posted by Rand Simberg at July 27, 2007 11:41 AM

It's a remarkably shoddy analysis. The guy may understand investments, but his understanding of economics and history is poor. Two of his top three threats to oil prices are (1) an al Qaeda attack on the Saudi monarchy, and (2) an al Qaeda attack on a US refinery.

Give me a break. What idiot doesn't know that it is Saudi money and tolerance that allow al Qaeda to survive? Surely, Wahhabists hate the Saudi monarchy and would love to take out a prince, but Saudi princes have known this for decades, and they have the money and ruthlessness to defend themselves. Besides, taking out a prince wouldn't do much to oil prices. And why would al Qaeda attack Saudi oil production, when Saudi oil money funneled through sympathetic Saudi middle-class subjects is what keeps them going?

And what idiot doesn't understand that when al Qaeda undertakes terrorist operations, the goal is maximum death and horror, e.g. the ramming of an airliner into a building, not the death of a dozen oil refinery workers followed by a whopping 20% temporary rise in gasoline prices, maybe a few months of gas lines at the pumps, oh the pity and woe of it.

Beyond that, he observes that a hurricane hit on the Gulf Coast would create a price shock -- boy, there's insight for you. He also points out that the supply chain is "tighter" than it ever was, which is just another way of saying it's more efficient than it ever was, and would be equally true of any supply chain in any industry worldwide. No one wants excess inventory eating your cash, and the advances in communications and computation over the last several decades have allowed companies to avoid it more often. This key microeconomic fact of the Internet Age escapes Mr. Analyst, however.

I'm guessing he wouldn't recommend buying Amazon.com stock -- you know, that fantastically profitable company that has the tightest supply chain every seen...I mean, God help Amazon stockholders if al Qaeda decides to blow up one of their totally unprotected server-farm buildings, in order to cause chaos in the American book market and drive up the price of books...

Posted by Carl Pham at July 27, 2007 12:07 PM

Tinfoil conspiracy? I'm wounded.

There...no longer anon...is that better? OK...maybe not overnight, but the demand did seem to come out of the blue.

All I'm saying is the reasons given by some self-appointed analyst interviewed on TV doesn't necessarily have anything behind it to back it up. The background info is NEVER made available. But, I admit, I don't even where to start looking...but I have tried.

What I did see was the public being spoon fed key words like 'Supply', 'Demand', 'India', 'China' and the 'Middle East'. Then they go went into how the US was 'spoiled' from cheap gas prices. After that is was 'gas prices had been kept artificially low for years'. Yeah right, they took a pass on making money for years. That was the reason given on the newcasts, in the papers, on the radio...

Hare-brained? Perhaps. Conspiracy? Maybe so. But after Enron's energy price fixing on a national scale. Why is it inconceivable on a global one?

Just asking.... :-/

Posted by CJ Messick at July 27, 2007 01:08 PM

CJ, the reason such conspiracies do not happen in real life is because the oil industry is not a monopoly. In a non-monopoly industry, what happens when prices are artificially high is that someone sees that and comes in and undercuts the high prices.

For example, Exxon is selling at artificially high prices (in other words, they are decreasing production in order to raise prices, or pricing so that they do not sell out) - so they show a higher profit. But then BP sees that there is excess demand, and sells their oil at a little lower than Exxon so they sell out of oil. BP now made more money than Exxon - so Exxon wouldn't do that, they would have lowered prices to compete with BP.

High profits drive new entrants into markets. That is what we are seeing now. There is a long lead time required to build out the necessary infrastructure, so prices remain high. But it is inevitable that the new infrastructure will come on-line eventually - and then prices will come down to normal profits (If Exxon is lucky), or more likely the industry will lose money because the lag will have attracted too many entrants and investment, and lots of people will lose money and there will be lots of mergers.

Posted by David Summers at July 27, 2007 02:13 PM

This isn't an analysis, it's a sales job. Every section prior to the last one not only ignores any sort of market stabilizing forces, but does so while pointing out the gloom with LOTS! OF! EXCLAMATION! POINTS! All before he tells you which funds he thinks you should give your money to. We're almost into late night infomercial territory here.

Posted by TL at July 27, 2007 02:28 PM

Conspiracy?....Why is it inconceivable on a global [scale]?

Use your own experience, C. Ask yourself how easy it is to run a successful conspiracy -- say, a conspiracy to have a surprise birthday party for a friend, or go out to a strip club without the wives and girlfriends knowing -- and ask yourself how much easier or harder it gets when more and more people are keeping the secret and expected to follow the plan without deviation.

If you can't run a successful conspiracy with more than five people (and I know I can't), what makes you think the CEO of Exxon/Mobil can? Does he have special powers or something?

Posted by Carl Pham at July 27, 2007 02:28 PM

The other thing that bothers me is about the 'risk premium'; as I think about it, it seems to me that the risk premium can only stay as long as we're increasing inventory (filling storage capacity) - at some point, all the tanks will be full, the shortage still won't have hit, and there'll be a price collapse.

Anybody with a better grasp of macroeconomics want to comment?

Posted by Mike Earl at July 27, 2007 02:37 PM

Well...Dave/Carl it would be easier to accept those explanations if the available data didn't show such an odd spike. For instance, I keep a log of how much gas I buy (odometer, gallons, price, date etc...it's just something I do). Here's what I have since 2001.

Date Gas Price
7/28/2001 $1.19
7/26/2002 $1.28 +9
7/22/2003 $1.39 +9
7/20/2004 $1.76 +37
7/23/2005 $2.14 +38
7/28/2006 $2.86 +72
7/02/2007 $2.77 -9

Gas prices before 2001 wobbled around some but the deviation from week to week and thereby year to year was around 10 cents. What happened between 2003 and 2004 to have prices surge 37 cents a gallon? That's a leap that is simply out of character. And then it happened again from 04 to 05 where it jumped another 38 cents (this was just before Katrina). Finally it jumps 72 cents a year later...ostensibly due to Katrina. That one is almost explainable except that it hasn't 'corrected' itself. Just this year the price of gas in my area went from $2.30 to $2.90 (2 Mar - 1 Jun).

It appears to be falling again but just 3 weeks ago those 'analysts' were saying prepare for $4 per gallon and the reasons are always the same generalities. Uncertainty, jitters, instability etc...wonder if the futures speculators have been drinking too much.

Posted by CJ at July 27, 2007 03:54 PM

C...a modern economy is an unbelievably complicated machine, with an enormous web of cause and effect links connecting every price to every other price. You're looking at a tiny portion of this monstrous interconnected web of forces and wondering where some small jumps and wiggles come from (and they are small -- if you want large jumps in price, consider housing prices in New Orleans pre- and post-Katrina, or in Silicon Valley pre- and post-dot-com bubble).

That's nuts. You might as well ask where the random stops and goes in traffic on a busy freeway come from, or where each tick in the Dow Jones comes from. No doubt each bump and wiggle has a subtle chain of causes, but it defies human comprehension, generally, to tease it out.

The rational response is not to get all religious and invent controlling gods or cabals, the way people did when confronted in 2000 B.C. with the disappointing fluctuations in the amount of game around or the water flow from their favorite spring. Just realize that a certain amount of more or less inexplicable fluctuation is a given in any system with zillions of variables.

Posted by Carl Pham at July 27, 2007 04:28 PM

This reminds me of something I saw on TV after Katrina. Wish I'd recorded it, since it left me astonished. Oil and thus gasoline prices had shot up in the wake of the hurricane -- I think supplies from Gulf of Mexico oil rigs had been disrupted. Meanwhile, Bush the Elder and B. Clinton were appearing together in connection with a campaign to raise funds for Katrina aid. Some reporter used the occasion to ask the two ex-Presidents if they would support government price controls on gasoline to keep prices down.

Bush I shrugged the question off, basically saying the decision was no longer his to make. Clinton, however, launched into an impromptu Economics 101 lecture explaining supply and demand to the reporter, pointing out that to legislate gas prices below the point it cost oil companies to supply the gas in the first place would be to guarantee there was no gas at all.

It was impeccable free market doctrine. Also perfect common-sense and inescapable facts of life. Ronald Reagan couldn't have explained it better. And this was coming from the lips of Bill Clinton, a Democrat, a party not exactly popularly associated with gimlet-eyed accountants explaining why you can't have free stuff for everybody.

It certainly left me wondering if there was more stuffed into Billy Jeff's cranium than we'd given him credit for...

Posted by Dwight Decker at July 27, 2007 08:21 PM

No one ever said Clinton was stupid. Just arrogant and also a big showoff. And of course he couldn't resist showing off his knowledge of supply and demand in front of Bush, Mr. Harvard MBA. Though considering the law of supply and demand is something most people learn in high school that wasn't much of a show -- though it seems to have impressed Mr. Decker.

Posted by Andrea Harris at July 27, 2007 08:53 PM

Mr. Decker was "impressed" (amazed is the better word) because Clinton sounded more like a classic Republican than a classic Democrat at that moment. What would I expect a Democrat to sound like? Oh, maybe to complain that oil company profits are excessive and suggest they be confiscated to fund alternate energy research or something like that, without being clear on how much profit is too much. That's what I would have expected somebody named Clinton to say.

Posted by Dwight Decker at July 27, 2007 11:46 PM

Rand: It's the enormous cost of new extraction infrastructure that deters exploitation of the tar sands. It's not enough for oil prices to exceed some critical level, they have to be expected to remain above that level for long enough to justify $billions in sunk costs, and years in lead time, for each refining plant. If current price levels continue, as the futures markets suggest they may, we should eventually see new sources of supply. (BTW, this implies that it's in the interest of the Saudis to keep their production rate high enough for prices to remain below levels that would make tar-sands exploitation a sure thing.)

CJ: Fluctuating prices are characteristic of free markets. If you want to see a real price-fixing conspiracy look at the market for diamonds, where there is a supply cartel or, in the USA, milk, where there are govt price supports.

Dwight Decker: I'm not surprised that Clinton, in the absence of political incentives to do otherwise, says intelligent things. His problems have always been ones of character rather than intelligence.

Posted by Jonathan at July 28, 2007 06:00 AM

One of the few policies on which I agreed with Bill Clinton (and on which he went against his own party, as Bush has on immigration) was on free trade. The man actually did understand economics and comparative advantage.

Posted by Rand Simberg at July 28, 2007 06:08 AM

On the large investment problem, that can be partially alleviated through the futures markets. Sell a few billion in oil delivered 3 years from now, and then build your factory with the guaranteed sales. Not sure how far out you can sell futures, though.

Posted by David Summers at July 28, 2007 08:23 AM

It's even worse than we thought!

If you take the years 2003-2006 (excluding 2007, of course, which was merely an aberation), the price of gasoline is going up by an average of 27% a year.

This means that by 2060, gasoline will cost more than $1M per gallon! No one except Al Gore will be able to afford it - and even he will only get to drive a few miles a year!

Posted by David Summers at July 28, 2007 08:28 AM

What I did see was the public being spoon fed key words like 'Supply', 'Demand', 'India', 'China' and the 'Middle East'.

What, CJ, you don't believe there are such things as supply and demand or such places as India and China? The Chinese economy is expanding at nearly 10%/yr. Chinese car ownership is advancing even faster. India isn't far behind. There are large, new and growing demands for petroleum. The rest of the world craves the American lifestyle and that ain't gonna change.

But mainly you seem to assume that prices should rise linearly with a linearly rising demand. They don't. When demand significantly exceeds supply - or anticipated supply - for more than a very short period, prices rise quite nonlinearly. This is not unique to oil. It has happened to various farm commodities over particular periods in recent decades as well. Look at current corn prices reacting to the spike in demand caused by "ethanol fever" for example.

But, in the U.S., as others have pointed out, the key constraint is refinery capacity. The newest U.S. refinery was built when Gerald Ford was President. Most are much older. Some pre-date WW2. Demand goes up, capacity is difficult to increase to keep pace. Existing facilities are forced to run flat-out for longer periods. Rust never sleeps. Old machinery breaks down more than new machinery. Refinery machinery can't be replaced without cutting capacity, at least temporarily. Left to run past its design life, machinery eventually breaks, accidents increase and result in production losses anyway.

These refinery capacity-related price spikes tend to be sharp, but temporary. Two months ago, regular unleaded was $3.25/gal. around here (L.A.). Now it's down to $2.85 at the station I use. Overall, both crude and retail gasoline prices have been fairly flat over the course of the entire past year. Exxon/Mobil had a huge increase in revenue between 2004 and 2005, but from 2005 to 2006, their revenues were up only about 2% and their profits are nothing special.

If there's a conspriacy going on, it's not a very effective one.

Posted by Dick Eagleson at July 28, 2007 12:14 PM

David Summers: It's not that capital isn't available, it's that it's too risky to invest the capital without a reasonable expectation that prices will remain above your breakeven price for long enough to build AND amortize your oil-extraction project. Also, the nature of futures markets make them unsuitable as sources of investment capital; however, they are good speculative vehicles if you think oil prices might decline if someone builds an extraction plant.

Posted by Jonathan at July 28, 2007 12:25 PM

Another thing to consider. A lot of the price hike was the devaluation of the dollar.

Posted by Karl Hallowell at July 28, 2007 08:53 PM

I just paid $1.05 per litre, lowest it's been for almost three years. The US dollar taking a dive most certainly helps.

Posted by Adrasteia at July 28, 2007 11:58 PM

Nah, If oil prices fall too far Exxon can just have us invade another middle east oil exporter.

Posted by Adrasteia at July 29, 2007 12:03 AM

The Saudis (and other OPEC) countries have had a fairly open policy of keeping the oil price low (*over time*) enough to prevent alternatives taking a big share of the market for a long time.

The big question in the oil industry at the moment is do they (OPEC et al) have the capacity to drop prices. If they don't and the Chinese economy keeps growing, then you will see the current expansion in to alternatives snowball very rapidly. No one wants to build expensive infrastructure and then discover that it will make a loss for the next 20 years...

Posted by anon at July 29, 2007 01:22 PM

(BTW, this implies that it's in the interest of the Saudis to keep their production rate high enough for prices to remain below levels that would make tar-sands exploitation a sure thing.)

Tar sands capacity is expanding, however. There is even serious talk of building nuclear reactors to supply the steam needed to process the tar (rather than burning expensive natural gas as is currently done.)

Posted by Paul Dietz at July 30, 2007 07:53 AM

Of course I believe in supply and demand. And China and India. Perhaps I'm just going off the deep end...wait! Is that the bot [splat]

Posted by CJ at July 30, 2007 12:52 PM

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