$500 oil?

An interesting blog post from Willem Buiter of the LSE at the Financial Times web page.

So how high are oil prices likely to go once we get through the cyclical global slowdown that is now under way. Arjun N Murti, a Goldman Sachs expert believes we will soon hit $200 a barrel (up from the current $146 level). The CEO of Gazprom has predicted a $250 barrel of oil before long. Dr. Robert Hirsch, a Senior Energy Advisor at MISI and a consultant in energy, technology, and managemen, says that oil will peak at $500 within the next 3 to 5 years. While your guess is as good as mine (likely better), none of these figures seem outlandish.

Fundamentally, this means that the most effective energy policy (including the most effective energy security policy) is conservation. The only way to encourage conservation is higher prices for the user, that is prices that fully reflect the long-run social marginal cost of energy. We are just beginning to see more realistic prices for energy, even in parts of the world where low-cost energy is seen as a social entitlement.

Reporting on IEA Medium Term Oil Report

For those of us that can't afford it, there's a long article in the Financial Times.

In related rumour and speculation I found this one very interesting

I have been told by a reliable source that the IEA has been forbidden by the US administration from updating their absurdly cornucopian oil supply and demand scenarios until the report that comes out late this year (after the election); that report, which will publish the result of a "bottom-up" analysis (ie a summary of all existing oil fields, their production and/or prospects) is expected to show that oil production is unlikely to reach the levels that so many have blithely assumed - notably on the basis of previous optimistic IEA reports.

Hat-tip: Andrew Sullivan

Oil Market

Speculation seems definitely to be going out of fashion as a reason for high oil prices.

The IEA has just released a medium term oil market report that is far too expensive for me to purchase. In press releases and talks supporting the release they seem to be trying to damp down talk about speculation by noting the current contraction in oil stocks. The Executive Director comments:

Speaking at a press conference at the World Petroleum Congress, Mr. Tanaka emphasized that market fundamentals were the main underlying factor behind high oil prices. “OPEC production is at record highs and non-OPEC producers are working at full throttle, but stocks show no unusual build. These factors demonstrate that it is mainly fundamentals pushing up the price,” he added.

Obama's Petrol Populism

I am with Ryan Avent, Obama is wrong (very very wrong) on ethanol and wrong on "windfall profit taxes" for oil companies. But he is still better than McCain on almost every issue.

Ethanol subsidies are a disastrous policy that has been an important pander in presidential politics for some time because of the Iowa caucuses. The rural parts of Obama's home state Illinois would also be difficult to hold without the ethanol policy but the centrality of Iowa to his primary strategy made it pretty much inevitable.

Watchers of The West Wing will remember that the inspiring young Latino candidate Matt Santos makes the ethanol pledge in Iowa prior to the caucuses, and sort of regrets it, while the McCain-like Republican candidate stands firm. The parallels between the last two seasons and current US politics are somewhat spooky but apparently not entirely co-incidental. I learned recently (maybe from the NYT?) that David Plouffe, a key Obama operative, was already working for him when his friend Eli Attie was developing the Santos character and they corresponded on the matter.

Saudi Energy Conference

It appears that the Saudis promised no new oil in the short term (just the 200,000 barrels a day promised last week) but have made some ambitious claims about increases in the long term. This is the kind of thing that would seem to require major new oil finds.

"I am afraid that we are going to see the big fields [now in production] top off at 12 million barrels a day or so," said Edward Price, a former president of Saudi Arabian Oil Co., or Aramco, who keeps up with developments there. "Even in Saudi Arabia, there are resource limits."

Saudi Arabia to increase oil production: but by how much?

Firstly the recent increase in Saudi production has pushed current production to 9.45 million barrels a day, nearly equal to the level reached a few years ago.

Now the Saudis have moved to further increase their production and call a major meeting of oil producers and consumers later this month. This will of course put downward pressure on prices but the magnitude of the Saudi efforts is presented very differently in major international papers.

According to the New York Times

The increase could bring Saudi output to a production level of 10 million barrels a day, which, if sustained, would be the kingdom’s highest ever.

This would prove wrong my ill-informed predictions about future Saudi production by July. The article emphasizes an ambition to limit volatility in the markets, a marked change from OPECs effort to maintain a definite price band only a few years ago.

The Wall Street Journal's article on the same development is much less upbeat. They suggest a rather smaller increase in production.

U.N. Secretary-General Ban Ki-moon said Sunday after meeting with the country's oil minister that the kingdom will raise production by 200,000 barrels a day in July. It wasn't immediately clear whether that rise would be permanent or a one-off response, as was a Saudi boost of 300,000 barrels a day in June.

While the Financial Times never puts a definite figure on the proposed increase, noting that

The kingdom has dismissed ideas it would boost production all the way to 10m b/d, up from the 9.45m b/d it pumps today, which is already 300,000 b/d higher than last month.

Journalism today!

Demand outstrips supply in oil market but OPEC raises production

I have been regretting my long-winded last post on oil supply difficulties. I'm not going to comment on this any more except to say that firstly I am watching moves by India in the near future to lower subsidies which will damp demand (and surely China must follow soon?). Secondly I'm awaiting with interest the IEA review of world oil stocks due in November.

In Christchurch for family reasons I have been arguing with my brother over concerns about oil supply. I should note that these concerns apply only to conventional crude oil reserves, there is an awful lot of tar sand, shale oil and that sludge in the Orinoco to go around. Higher oil prices will continue to drive further utilization of these resources particularly in Canada. However mining those resources is much more costly and the environmental consequences deserve serious attention.

Anyway the IEA has updated it's Oil Market Report for May. Andrew Leonard gives an account here.

The bottom line is this: Although demand for oil is declining in the U.S. and Europe, overall global demand is still rising, fueled primarily by China and India. Overall demand growth has slowed, to be sure, but still totals 86.8 million barrels per day. And that's 200,000 barrels a day greater than current supply -- 86.6 million barrels a day, according to the IEA. Perhaps most alarming -- although global supply rose by 490 kb/d in May, the added production came primarily from OPEC. Non-OPEC oil production is down.

The fact that non-OPEC oil production is slumping, with oil prices setting new records nearly every week, is just another datum of proof indicating that no matter how high prices go, you can't squeeze ever more oil out of a peaking oil field. To a certain extent, the world is returning to where it was in the 1970s, when OPEC ruled the market. But back then, high prices encouraged the development of non-OPEC sources of oil and broke the back of the cartel's pricing power.

The decline of those newer non-OPEC oil fields is one reason why U.S. politicians are now begging OPEC to boost production. OPEC is back in the driver's seat. But is the OPEC spigot as potentially free-flowing as it was 30 years ago? That's another question everyone wants to know the answer to. One imagines that it would not be in OPEC's interest to precipitate the kind of global recession that sustained record-breaking oil prices will inevitably deliver. And according to the IEA figures, OPEC has been boosting production.

But whether OPEC is still holding back to keep prices high, or facing the same cold realities of depleting resources that the non-OPEC world is slamming into, the fundamental dynamics of the supply and demand equation are unchanged. A difference of just 200,000 barrels a day between demand and supply doesn't seem like all that much when measured against the total energy consumption of the world, but as long as that disjunction exists, as long as there are more buyers than sellers, there will be long-term support for high prices.

Oil Price Poker

The current feverish state of the international oil market could be due to many factors. How you would bet on future prices depends on how you read the hands of the various players, and in particular on whether you think OPEC is bluffing.

The market was reminded on Friday of the (hopefully small) possibility that either Israel or the US could attack Iran before the US presidential elections later this year. This is bound to lead to a short term leap in oil prices.

Until Friday The Hive was canvassing the notion that the current price is a bubble created by speculators. There are very good reasons to believe this may be the contributing to current prices, including lax regulation of US energy futures markets.

Speculation was however the fourth reason George Soros gave in Senate testimony on oil prices last week. In listing major factors he said "First, the increasing cost of discovering and developing new reserves, and the accelerating depletion of existing oilfields as they age. This goes under the rather misleading name of peak oil."

Now everyone seems to agree that there are currently serious constraints on supply. The International Energy Agency's monthly Oil Market Report says of the month of April that "Effective OPEC spare capacity stands at 2.3 mb/d on paper, although refinery outages, crude quality and high prices mean much of this oil would be difficult to market under current conditions". It also lists several issues in Nigeria and the North Sea that have contributed to reduced supply. (Figures for May are not free so I do not have them.)

Many people hope that these constraints are largely caused by temporary political instability and temporary shortfalls in drilling infrastructure, refinery capacity and so on.

A more pessimistic view is that these difficulties will increase over time due to "the increasing cost of discovering and developing new reserves, and the accelerating depletion of existing oilfields as they age".

A rule of thumb, based on on the historical development of very many mineral resources, suggests this would be expected to be a factor if Middle East countries have already mined a large fraction, say roughly half, of their total crude oil resource. Don't consign yourself to the internet debates on "peak oil", read this considered piece by David Goodstein a physicist at the California Institute of Technology. Goodstein has been urging scientists, engineers, politicians and the general public to prepare for the end of cheap crude oil for several years now.

Goodstein is not a crazed millenairian, his expectations are based on the historical trajectory of a large number of mineral resources. If you look at the historical production from, to name a few, anthracite coal in Pennsylvania, British coal, North Sea oil, French uranium, US oil, there comes a time when the quality of ore declines, the location of remaining ore becomes inconvenient, production costs rise and production slows. I'd also recommend you take a look at the public lecture by Goodstein's Caltech colleague, engineer David Rutledge. He has also collected data on most of the resources I have mentioned here into an Excel spreadsheet that you can play with for yourself. (Full disclosure: I used to work at Caltech and Goodstein was the Ph.D supervisor of a good friend so maybe I am biased.)

There are many people, including Goodstein and Rutledge, who believe that Middle East oil supplies are near the point at which they will not be able to sustain current daily production. Based on the stated Middle East oil reserves you will usually see this does not seem very likely. However lets take a look at those reserves


Over the 25 years shown world oil consumption has exceeded announced oil discoveries by about 200 billion barrels of oil and non-OPEC reserves have remained roughly constant. Yet the OPEC reserves look remarkably constant year to year except for very sharp increases adding up to about 400 billion barrels of oil in the late 80s. (This plot is from Rutledge's talk.)

This jump coincides with an OPEC rule change that associated the amount of oil a country was allowed to sell each year with the size of its reserves. As Goodstein puts it "politicians discovered 400 billion barrels of oil without ever drilling a hole in the ground!" It seems to me likely that OPEC reserves are hugely exagerated, possibly by a factor of a few.

One other piece of simple available evidence. If you subtract Kuwaiti production since 1980 from reserves in 1980 you get about 50 billion barrels rather than 100 billion barrels of official reserves. This strangely enough is about what a recent leak from the Kuwaitis suggests they think they have.

The US Geological Survey, the US Energy Information Agency and the International Energy Agency all take these stated reserves at face value but on the face of it this does not seem credible.

So, finally, lets have a look at recent Saudi oil production (taken from the International energy agency.)



During the Iraq war in 2003 the Saudis were able to very rapidly increase production about 1.5 million barrels of oil a day to about 9.5 million barrels of oil. At this point they were certainly still operating as a cartel artificially restricting supply. Around April 2004 they were able to do the same again in response to oil prices rising out of the price bracket OPEC was attempting to protect (about $40US I believe). At this time Saudi Arabia's production quotas were increased to "legalize" this increased production and it was maintained at roughly this level for several years. Prices however continued to increase. At this point either the Saudis are unable to fulfill their stated goal of keeping prices low by increasing supply or they realise that the value of their oil assets is increasing with rapidly rising demand and are quite happy to sit tight at a comfortable production rate. This possibility is another of Soros's four factors affecting world oil prices. Alternatively they are simply unable to convince the rest of OPEC to further increase quotas despite both wishing to and being able to increase production.

Saudi production dropped significantly after April 2006 to as low as 8.5 million barrels of oil a day, this figure was significantly below their quotas at the time which is consistent with suspicions that some of their older fields are getting tired. However, this year production has been increased again to 9 million barrels of oil a day, presumably in response to increased prices. Production is once again roughly the same as the OPEC quota. Once again, either the Saudis and OPEC are quite happy with the current trajectory of oil prices or they are unable to increase production significantly. In recent weeks the Wall Street Journal has reported that the US has asked the Saudis to increase production and that the US was dissapointed with a Saudi response that they would supply only an extra three hundred thousand barrels a day. (The comparisons to quota come from here)

It is tempting to look at this plot and ask yourself if you feel lucky, how would you place a bet on future Saudi oil production/

Can the Saudis still increase production to 9.5 million barrels of oil a day?

I suspect not but I have to concede the evidence I have given is not compelling. I am just expressing an overall distrust of the Saudis and the feeling I get from reading around the issue. Ideally one would carry out a detailed study of everything that is publicly known about the various Saudi oil fields. Matthew Simmons has been arguing for this pessimistic view of Saudi oil reserves for years on the basis of just such a study, he seems well informed and has been a consultant on energy issues since the first oil shock. On the other hand I have not read his book and lots of people just think he is plain wrong.

Will the Saudis ever be able to increase production above 10 million barrels of oil a day?

Despite many official predictions to the contrary I would be willing to bet a large sum against this.

Oil Prices in Real Terms

The big news of the weekend is definitely the unprecedented crude oil price hike on Friday.

There have until recently been reasons to be complacent about rising oil prices. I am old enough to remember both Muldoon and carless days pretty well. So I am well aware that in real terms oil prices have been nowhere near the levels they reached in the second oil shock in the early 80s. Moreover oil supplies have been less important to the economy than they were in the 70s with the price of oil consumed being a relatively small fraction of GDP. Thirdly high oil prices seem like the most straightforward way to contain carbon emissions.

James Hamilton points out that the first two are not the case anymore, at least in the US. As the price went over around $100US per barrel earlier this year it went over the previous peak in oil prices (in 2008 $US) at around 1980. On the other hand, the value of oil consumed in the US peaked at around 8% of GDP in the early 80s and went as low as 1.1% in 1998. At an average price for the last year of $98US it's now about 5% of GDP.

Now the weakness of the US dollar may mean these figures are not so dramatic outside the US. If I was the Treasury gnome responsible for the oil price projection in the budget I would be trying to work out what the equivalent figures are for New Zealand.

(I saw the Treasury oil-price projection on an NZ blog in the last week but I can't remember where, and couldn't find it just now, so whoever you are I owe you a hat-tip.)