The price of oil has dropped like stone since my last biweekly report, dipping into the middle $70s (Nymex) and below $100/barrel (Brent). There was a slight bounce yesterday after a terrific jobs report—103,000 jobs added, with 45,000 of them Verizon workers who had been on strike. Nymex stands at $82.98 and Brent at $105.87. Prices are extremely volatile, reflecting the volatility of stocks, which reflects fears about Europe. See my mid-week post Another Day On Planet Stupid. The alarm level remains the same.
Oil Alarm Level —Yellow
Where are oil prices headed? Your guess is as good as mine. The general trend in the near-term is down. That might hold for another few years if the global economy blows up again. It sure wants to.
We can not see the future, so let's take another look at the past. I have long maintained that the price shock of 2007-2008 was due to both supply & demand considerations and speculation in the futures market. I have written several articles (e.g. this one) justifying that view. Now two economists working at the St. Louis Fed have confirmed what common sense told me in a paper called Speculation In The Oil Market (pdf warning). You can look at that paper, but unless you enjoy "identifying oil shocks from a large dataset using a factor-augmented autoregressive (FAVAR) model", you will be sorely disappointed. Wrting at the Washington Post, Brad Plumer explained the paper's conclusions.
Back in 2008, when the price of oil was zooming up to $140 per barrel, there was a lot of chatter about whether Wall Street deserved the blame. And that debate hasn’t vanished. Last month, Sen. Bernie Sanders (I-Vt.) cited a report from the Commodity Futures Trading Commission as proof that “Wall Street speculators dominated the oil futures market.” Economists like Paul Krugman, meanwhile, have argued that supply and demand were the chief culprits. Oil was getting pricier because China, India and Brazil kept using more and more of it, and production couldn’t keep up. So who was right?
A new paper from the St. Louis Fed finds that both camps were [right], in a way. The authors, Luciana Juvenal and Ivan Petrella, combed through a wealth of economic and oil data to tease out various factors affecting the price of crude. Their conclusion? The sharp rise in price from 2004 to 2008 was primarily driven by supply and demand. Asia’s thirst for oil was growing, and the ability of countries like Saudi Arabia to keep up was declining. But a decent portion of the price increase, about 15 percent, could be chalked up to “financial speculative demand shocks.”
In the past decade, the authors note, the oil market has changed in a striking way: Large financial institutions, hedge funds and other investors have started pouring into the futures market to take advantage of oil price changes. In 2004, there was just $13 billion invested in commodity index trading strategies. By 2008, that had ballooned to $260 billion (though it collapsed for awhile after the financial crisis struck).
Large financial institutions, hedge funds and other investors continue to take advantage of oil price movements today. Not only do they profit from extreme volatility, but they create it as well. See my post Who Benefits From Bogus Oil Prices?
Those who believe "peak oil" played a major role in the 2007-2008 price shock are vindicated by this finding. Three years later the world has changed. There appears to be more spare capacity than there was in 2008, but almost all of it is in Saudi Arabia. Overall production has flatlined since 2008, but almost 1.6 million barrels-per-day is out of commission in Libya. If that oil were being produced, global supply would top 75 million barrels-per-day (crude oil + condensate only). On the other hand, if the Libyan oil was flowing again, OPEC would no doubt cut its production, keeping us on a plateau. In fact, if current oil prices go any lower, we can expect OPEC cuts very soon. These cuts would thus add to current spare capacity. See my older post Peak Oil: Where Do We Stand?
I am not among those who believe peak oil will cause the End of the World sometime soon. I expect global oil production (as defined above) to remain on a bumpy plateau through 2020, which is as far out as I am willing to look. I also expect American oil production to stay on a bumpy plateau over the same period. A global production plateau will not result in civilization's demise, but it will certainly constrain economic growth if another demand shock occurs. I've been thinking of calling off my prediction that we'll have another oil price shock next year. A global depression seems to be imminent. We'll see.
What will the oil price be in two weeks? The trend is downward. I expect prices to stay on trend. Look for Nymex to be in the $70s, and Brent to be in the mid-$90s.
Well, peak oil has already caused (or been a contributing factor to) the end of the world - or, at least, the end of the world as we know it. As you have said in the past (and as Richard Heinberg argues, well, in his new book), we're seeing the end of growth. The last 3-4 years haven't been what people had come to regard as "normal" and for many people it may well feel like the end of the world.
Peak oil was the most prominent limit that we've hit but it's not the only one. No one can see the future so we don't know how everything plays out but I'm pretty much convinced that the world will never be like it was 4 years ago.
Posted by: Tony Weddle | 10/08/2011 at 05:46 PM