Saturday Oil Report -- February 12, 2011

The good news is that I almost nailed the Nymex oil price in my previous Saturday oil report. The Nymex came in at $85.28 yesterday following a sell-off after Egypt's long-time dictator Hosni Mubarak resigned. I had predicted oil would be trading in the $86-$88 range. The bad news is that the Nymex price is totally out-of-sync with the price of oil in every other important world market.

Brent is selling at $99.85, Tapis is at $104.75, the Urals blend goes for $97.42, and so on.  What's going on? Let's look at the evidence.

1. I am not aware of any story (or even plausible rumor) providing solid evidence that the world oil markets are not well-supplied. OPEC nations have been exceeding their production quotas, and OPEC (Saudi Arabia) just boosted their output—

   In a monthly report on Thursday, the Organization of the Petroleum Exporting Countries said its January production rose by 400,000 barrels per day (bpd) to 29.72 million bpd, the highest since December 2008 when the group announced a record production cut.

2. Oil demand in the United States is stagnant, and inventories are well-above their average range.
3. The dollar index (DXY) stands at 78.46, down from it's 1-year high of 88.43 in June, 2010. Oil must be purchased using dollars.
4. Fed bond-buying (QE 2) has resulted in higher commodity prices worldwide. The FAO's food index just reached a new record high. In effect, when the Fed chases dollars out of Treasuries into riskier assets, they are exporting inflation by flooding foreign markets with these dollars. Investment and speculative money is not flowing into the United States, although these new dollars are printed in the United States. There's little doubt that some of these dollars are going into oil (and commodities generally).
5. Commodities demand in emerging markets (China, India, and the rest) remains robust, but these markets are also beset by unacceptable levels of inflation.

My view based on all of the above is that Nymex oil is underpriced, and oil in the other markets is overpriced. My best guess, based on market fundamentals (demand, inventories, etc.) is that oil should be trading the $88-$92 range everywhere, although there will always be a premium for light, sweet crude. This is why that I am keeping the alarm level at last week's level.

Oil Alarm Level — Orange

Despite large fluctuations in the Nymex price, gasoline prices continue to rise (Yahoo) —

Closer to home, U.S gasoline prices are the highest ever for this time of year. Since Jan. 1, pump prices have averaged well above $3 per gallon. They hit $3.127 per gallon Friday, 3.4 cents higher than the same time last month and 49.1 cents more than a year ago, according to auto club AAA, Wright Express and Oil Price Information Service.

The dramatic jump brings back memories of three years ago, when pump prices rose above $4 a gallon, forcing many drivers to join car pools and trade in gas-guzzling SUVs for more fuel-efficient cars. But "it would be a mistake to think we're going to have that all over again," OPIS chief oil analyst Tom Kloza said.

Gasoline prices have climbed this year for a number of reasons; including a rise in oil demand from China, a frigid winter and tensions in Egypt, Kloza said. Crude demand will slide in the U.S. by May, as U.S. refineries slow down fuel production to purge stocks of winter fuels as they switch to summer blends.

Kloza said the biggest difference between now and 2008 is that oil traders are much more cautious. After rising above $147 per barrel three years ago, oil prices tumbled to below $33 per barrel in 2009. The market remembers that, he said, and even the most bullish traders no longer think they can chase commodity prices ever higher without any risk.

Whatever you think of Kloza's analysis, I agree that 2011 is not like 2008. I've still got the next oil price shock coming in 2013 ± 1 year. So in my view, 2013 will be like 2008, but we might see a price shock in 2012. I think Nymex oil prices will average about $92/barrel this year. The timing is very dependent on what happens to China's economy and oil demand.

My prediction for the oil price on February 26? For Nymex, I think the price will be in the $87-$89 range. For Brent and several of the other varieties, I think the price will remain in the $97-$101 range. Thus I expect the price disparities to continue.

Bonus Video — Stephen Leeb is selling his books

 

Comments

[Greg Hickey]

Dave, I also have been watching the spreads between Brent and WTI. I've read reports that the lower prices in the US are due to oil coming down from Canada.
Usage in the US may be lower than normal, but I believe it is rebounding, as evidenced by the uptick in gasoline price at the pump.
One point I would like to make is that the US may enjoy a "comparative advantage" in the price of energy for some time. If our next door neighbor can sell us energy cheaper than the rest of the world, we may see a pick-up in our economy. Even as we devalue our currency. This should increase exports, put price pressure on imports and maybe bring some jobs back to this country as banks restart lending as economic activity improves. My hope is that we will not squander this window in time, and will use the opportunity to invest in renewables and conservation.

[BJ]

The truths those wishing to make a buck, or two, don't want you to know.

The first gas-fired internal combustion engine was produced in 1860. The world's population at that time was around 1.3 trillion people. Meaning there are 4 times as many people on this planet as there was before fossil fuels were used in place of manual labor. This gives you an idea of how many humans our planet can actually support, without access to fossil fuels.

http://en.wikipedia.org/wiki/History_of_the_internal_combustion_engine
http://en.wikipedia.org/wiki/World_population

Something that is seldom mentioned in regard to alternative energy is, is the efficiency of energy production. That is how much energy is consumed versus produced by the process. No energy conversion is 100% efficient. Every action or process step requires energy. All our energy originates in the sun. Many overlook the energy required by the human body, even though we are like any other machine.

Little truths like this:

"For example, electricity at 10 cents per KWH is equivalent to burning barley at $7.49 a bushel. Accounts for efficiency of the burning."

http://www.builditsolar.com/References/fuelsrs.htm#HeatContent

Another thing to consider, can the means of alternative energy production be produced in the absence of fossil fuels? Which basically boils down too, could it be produced, transported, assembled, and maintained prior to 1860? Do they require fossil fuel based lubricants, plastics, etc?

Another thing to consider, what is the life span of these alternative energy production methods? All moving parts wear out, glass gets pitted and scratched, things get dirty, contaminated, etc.

The biggest question of all, could mega amounts of cheap food be produced prior to 1860?

Why is this significant, the supply of fossil fuels is expected to be depleted within the lifetime of our children. Long before then, the price will be greatly increased, and rationed. Wars over oil reserves will likely increase consumption of said oil. How much oil has been used by the US military in Iraq, Afghanistan? Not a real concern, then why is China arming itself?

For the optimists out there, there is a chance scientists will rewrite the laws of physics as we currently know them, and the world will be saved, at least until global population meets the limits of that new technology.

Can science find that miracle? I don't know, but a lot of scientists are more concerned with "life out there" than life here on planet earth. A lot of American simply don't get it, and our policy makers don't want them to get it.

[BJ]

In response to Stephen Leeb's interview:

The US represents 5% of the world's population. Despite this, the US has set the bar for consumer consumption. All the talk is about developing consumer consumption in China and other 3rd world countries, to be less reliant on the US consumer. Is that consumption going to occur in the absences of oil? How millions if not billions of cars are they "hoping" to sell in China and India?

Americans still believe the world, if not the universe, revolves around them. Boy, are we ever slowly waking up to a whole different reality.

[BJ]

For those who are big supporters of alternative energy, which costs more than energy produced from fossil fuels, consider this:

"President Obama's 2012 budget will propose cutting $2.5 billion from a program that helps low-income people cope with high energy costs in the cold of winter and heat of summer, according to a source familiar with the budget process. The reduction is steep, and might impact millions of families. In 2010, the program received $5.1 billion in federal funds, which were then distributed to states that have both low average incomes and high energy costs."

http://money.cnn.com/2011/02/11/news/economy/obama_heating_cuts/index.htm

Yet:

"Obama is expected to include a $78 billion reduction in defense spending over five years [$15.6 billion per year]. But most of those proposed cuts are likely to be slated for 2014 and 2015. And his funding request for 2012 is expected to be higher than the Pentagon's current funding."

http://money.cnn.com/2011/02/11/news/economy/obama_budget_debt/index.htm

(Given that there will be a republican elected as president in 2012, what are the chances the defense budget will actually be cut?)

Change you can truly not believe.

How long before there will be riots in American cities? Well, that all depends on when the poor can no longer feed and shelter themselves. Given there is no intention of creating jobs for millions of Americans, who are no longer employable in today's reality, it probably wont be too long.

If you aren't going to employ people, nor feed and shelter them, then you had better be prepared for the consequences.

But hay, how is that search for life hundreds of billions of light year away going?

[Tony Weddle]

Dave,

Take a look at the EIA's short term energy outlook (STEO):

http://tinyurl.com/4vfhnp5

Although January's estimate shows a stock build, the previous seven months, on the trot, showed stock draws (from worldwide stocks). Obviously, stocks are part of supply but doesn't this indicate that, generally, production has not been keeping up with demand?

I checked the previous edition of the STEO and found that it estimated stock builds (from significant to slight) for the three months up to December, so their estimates have been significantly revised. Maybe January will turn out to be the 8th straight month of stock draws, after a couple of revisions.