Oil breaks new records. Again. Is it a demand bubble?
Oil touched a new high over night, but that wasn’t very exciting. What is interesting is the cacophony of voices trying to explain it.
So, what will be the price of oil ten years from now? Any takers? A Bloomberg article a couple of weeks ago was full of explanations for the rise, from the threat of a falling dollar to those damn speculators. While these are all factors, I liked one quote in particular:
The market “is underpinned by demand, which is totally different than 1973 and 1979” when supply cuts caused prices to surge, said Ray Carbone, president of Paramount Options Inc. in New York. Oil’s rise is linked to “supply and demand. Nobody wants to admit it. Too bad.”
I thought that the fuel price adjustments in price controlled India, China and Indonesia in recent days would help lower the price, or at least keep it steady. I will buy into the argument that we have a bubble, but it’s a demand bubble not a speculator’s bubble.
As long as India, China and other developing countries maintain price controls on fuel, there will be no significant demand destruction in the developing world, which will only exacerbate the supply issues that the globe is facing as a whole. On the other hand, what developing country’s government is going to let the fuel price float while food prices are also surging? None. The backlash would be horrific. The longer this demand bubble continues, the more ugly the consequences when it bursts.
June 27th, 2008 at 9:33 am
We have heard speculators are to blame. We have heard demand is exceeding supply. If the oil market is finely balanced between demand and supply, the lack of liquidity could make it possible to “corner” the futures market and drive prices up. It would be easiest to do that if you were one or more of the countries - swimming in an ocean of cash - and other other hand on the tap the oil comes from. Work your way back from there to think of other possible people, groups and countries who may have an interest in driving up the price of oil.
Let’s not also forget the rising tide of threats against Iran from Israel and the US. Official israeli rhetoric is now in the “When, not if” category when talking about attacking Iran.
Each time that happens, oil prices leap. Higher oil profits via Israeli and US market manipulation? Or a market response to a genuine threat?
June 27th, 2008 at 10:07 am
“what will be the price of oil ten years from now?”
That needs to be phrased differently, more along the lines of: “is there still going to be a global economy in ten years?”
June 27th, 2008 at 10:40 am
Don’t forget that oil prices fell sharply after the US attacked Iraq, both in 1991 and 2003. In 1991 they did rise sharply with the threat of war, but in 2003 they didn’t.
June 27th, 2008 at 10:55 am
I think demand is an issue, but not the main driver of the price increases.
I read someplace that Iran has tankers full of heavy crude moored off the coast that they can’t sell - there being little demand for heavier crudes as there’s a bottleneck at the refining stage. Very few new refineries have come on line in the last couple of decades while oil has been cheap. In particular, there’s a lack of refineries with the hydrocracking gear to turn out the higher octane product from heavy crudes.
That creates a high demand for light sweet crudes and means speculation has ample opportunity to ramp up the price (it’s pretty hard to talk up prices of a commodity unless there is at least a perception of possible supply difficulties). Since the futures market works on perceptions, and perceptions of perceptions, rather than realities, a minor disruption in Nigeria or some sabre rattling from the States or Israel means a vicious circle of price rises as buyers get edgy. Add in lots of spare capital fleeing sub-prime mortgages and looking for a home, zillions of dollars sitting in Gulf State accounts (there being only so many new airlines or cheesy luxury apartment schemes to spend it on) and you’re heading for a perfect storm.
That’s unless I’ve got it all wrong, which I suppose I might have.
June 27th, 2008 at 11:12 am
Bubbles are almost always driven by a symbiotic interaction between a misfit between “Supply and demand” forces and speculation against the outcome of such a misfit.
Sometimes the “Bigger fool” dominates as in the Tulip bubble. The growers produced millions of bulbs to satisfy the demands of the speculators rather than demand from customers. This is why the collapse of the Tulip Bubble was so rapid. It truly burst when the “windtraders” lost their faith.
IF I invest in fine wine or fine art I am assuming that the supply is limited and my investment will improve over time. Does that make me a speculator? Or a patron.
Given high food prices I am planting more seeds, plants and fruit trees than I might be at this time. Am I speculating or promoting a sustainable life style?
There are some real constraints on oil supply especially in refining and because of a long run of low prices there has been little exploration and you cannot turn on an oil tap overnight.
But we should note that ALL commodities, including oil, milk and aluminium are bubbling and attracting speculators. There is no doubt that the collapse of property markets in the richest markets (a bubble which has been driven by Smart Growth and other mad planning theories) has now left billions or even trillions of dollars looking for another home - and they have to find a home quickly.
Bubbles beget bubbles.
Those who enthused for a capital gains tax on houses should ponder the fact that millions of people now seeing a collapse in their assets would be having to pay a tax on last year’s gains. And they would not be able to burrow the money.
June 27th, 2008 at 11:31 am
Sam, from what I can find, the discount price between sweet light and heavy sour crude is quite modest. Surely problems refining heavy crude vs light crude should result in a big differential in price between them? (I gather is differential has increased but is still only around $10 - 17)
“There are some real constraints on oil supply especially in refining”
A bottleneck in refining is not a constraint on oil supply, it’s a constraint on oil consumption. With a bottleneck in refining surely it would be the price of the refined product rather than the raw material that increases? At the moment it is clearly the price of crude, rather than the cost of refining that is pushing up fuel prices.
June 27th, 2008 at 11:37 am
Oil has been at an artificially low price for some time. Essentially speculators have now moved it somewhere closer to a price that actually reflects its scarcity. (although not its externalities) Because all other products must be shipped, the rise in oil is cascading along into the price of other goods- ones with small margins, like food, are already rising in price.
Refining bottlenecks were a big problem a few years ago, but I think the problem now is that production is peaking on many of the cheapest oil fields. Even The Economist is talking about peak oil now
(although they’re basically saying: “don’t worry, electricity will sort it all out! We just need to build a ton of extra wind and solar generation! Never mind that we’re not planning for that yet!”)
June 27th, 2008 at 11:48 am
Owen - The current price of oil isn’t down to the futures market. Oil for this date was selling at $60 per barrel only two years ago. Also - refinery capacity has nothing to do with crude oil price, obviously.
Another thing “oil bubble theorists” can’t explain is that this kind of sustained and sharp oil price spike has never occurred before without there being substantial and sustained cuts to production.
http://media.hoover.org/images/oil-pricesLarge.gif
The Iraq war, and threats issued to Iran, and subsequent speculation just can’t explain it.
June 27th, 2008 at 11:56 am
Ahhggg! Oh for god’s sake I keep saying this over and over:
It can’t be speculators driving up the spot price (the price of actual oil). It’s bloody supply and demand.
To have speculation people have be able to buy and hold. You get a bubble when everyone’s buying and holding at once. Oil isn’t durable asset: comparatively little is stored, storage capacity in the vast, vast, vast quantities you’d need is not cheap or easy to create. So it’s unlike durable assets like houses or stocks or fine art or wine or Tulips.
You can have some speculation in oil futures (promises to buy or sell oil in 6 or 9 or 12 months time). Because a futures contract is just a piece of paper and can be easily stored. But an actual price for actual oil - a “spot price” - isn’t like that.
More details:
Okay, let’s suppose it is speculators driving up the spot prices. If so the only way to do it is to buy up oil. That’s how markets work: you drive the prices up by buying lots) - and then take it off the market and stash it somewhere.
First objection: there isn’t enough storage capacity in the entire world to do this. The entire world’s stores of oil is less then a couple of month’s supply, and most of it is en route from one place to another or a govt’s strategic reserve. Millions of barrels are produced and consumed every day. You can’t just stash a few million barrels of oil somewhere without people noticing - much less the hundreds of millions of barrles you’d need to stash to run a speculative bubble this big.
But let’s get past the impossibility of stashing that much oil somewhere over the months the price has been rising and pretend this is possible.
Okay, if what we’ve got is speculation on the spot prices based on storage of oil, then we’d expect the futures market and spot prices to be in contango. That is, we’d expect the price of a 3-month future of oil to be the same as the spot price plus the cost of storing oil for 3 months, less the interest you could have earned instead. But we haven’t seen prices in contango while this has built up: instead we’ve see backwardation.
Now the supply issue could be to do with limits on refining the stuff rather than limits on pumping it out of the ground. Or if you prefer conspiracy theories, it could be a supply shortage because of a conspiracy by the producers, like Enron did to the California electricity market where they drove prices sky-high by shutting down power plants. But the one thing this is NOT being caused by is “speculation” and what this is NOT is a “bubble”.
June 27th, 2008 at 11:59 am
“That is, we’d expect the price of a 3-month future of oil to be the same as the spot price plus the cost of storing oil for 3 months, less the interest you could have earned instead.”
Oops. Clearly I meant “plus” the interest you could have earned instead not “less”.
June 27th, 2008 at 12:03 pm
roger nome,
That was because before no one was able to afford to pay higher prices.
China is now setting the threshold for prices, because over the last 10-15 years its amassed a MASSIVE amount of foreign currency reserves, which its now spending on oil to keep its economy going. If a Chinese company needs extra cash to pay for resources it merely opens a credit line to its bank, which were effectively bankrupt beforehand, because they were so badly managed. Unlike the United States it can afford to. Thats why you’re not seeing the demand destruction, characteristic of previous Crisises
China isn’t a free-market economy, its a neo-merchantalist like the United States and Britian were prior to the 1860s. Not to mention that theres so much more money than any period in world history.
The global fractional reserve banking system, allows banks to create an effectively limitless supply of money as long as people are willing to go into debt and banks have faith that they will be paid back.
http://www.rgemonitor.com/blog/setser/148112/
Prices aren’t determined by supply and demand, they’re merely meant to reflect it. Speculation is merely the discovery mechanism by which a market participant attempts to determine the price, but that doesn’t take into account that some people are more able to afford it than others. As E.F. Shaumacher said, when people say leave it to the price mechanism to sort things out, you’re effectively saying that the poor should be rationed.
June 27th, 2008 at 12:32 pm
For yonks now, theres been this mantra: when oil reaches $nn per barrel, then demand destruction will occur, and the price will drop. Yet despite oil rising through probably dozens of these predictions, there is no sign of either oil prices ceasing to rise, or large scale demand destruction occurring.
Therefore, I forced back to simple economics (the only kind I understand) and the principles of a free market: one of the jobs of a market is to determine the right price of a good, and clearly, we still don’t know how much a barrel of oil is worth, only that its more than $140.
Thus I’m still not happy with “spikes” or “bubbles” when there is no evidence - yet - that there is a plateauing and/or downside. Currently, the only way is up. How can a rising trend be described as a bubble?
June 27th, 2008 at 12:39 pm
“Surely problems refining heavy crude vs light crude should result in a big differential in price between them?”
Yeah, but ultimately prices are set by the seller. Presumably Iran could choose to discount it’s spare oil until it finds a buyer, but it seems to have chosen not to do that. Why? Beats me, though Saudi seems to be starting to take the attitude “why pump more oil? We’ve got all the money we can use.”
Obviously the speculation is in contracts, not in actual oil that physically changes hands. But if a three-month futures price is skyrocketing, isn’t the current price going to be affected by that? How much oil is traded as a spot price compared with the futures market?
Supply and demand seems to function if a product is something you an easily do without - too expensive, don’t buy, price falls. In the case of oil though, the sellers seem to have buyers over a barrell.
And what’s the impact of vertically integrated companies that are selling crude to their own refinery then marketing the finished product?
June 27th, 2008 at 12:43 pm
SleepyTreehugger:
“That was because before no one was able to afford to pay higher prices.”
Prior to the last 5 years oil supply had grown consistently at about 2-3% per year for nearly the entire 20th century. The exceptions occurred during the 1970s and 1980s OPEC cut supplies. Subsequently the price of oil sat at an inflation-adjusted $10-$20 for close to one hundred years (baring some of the the 1970s and 1980s)
What makes now different is the fact that many of the largest non-OPEC producers (Norway, Britain and Mexico) are in terminal decline because their largest fields have recently (in the last 10 years) passed peak production.
So while Russia, Brazil etc have been able to increase production it’s only just been enough to offset declines. So non-OPEC supply has been stagnant for the last 3 years.
http://www.eia.doe.gov/emeu/steo/pub/gifs/Fig9.gif
OPEC production has also been flat, because it’s a cartel and they want to see prices increase. So don’t expect OPEC to save us from expensive oil.
Meanwhile, the global economy has been growing at 4-5% over the last 5 years - which has meant increasing demand for energy. It’s basic economics. When supply stays flat and demand increases, price must go up.
http://www.mikeonads.com/wp-content/uploads/2007/05/supply_demand_11.J PG
June 27th, 2008 at 12:51 pm
“For yonks now, theres been this mantra: when oil reaches $nn per barrel, then demand destruction will occur, and the price will drop.”
Yeah, I think demand destruction occurs in mature/saturated markets like the US and Europe, because there’s a lot of discretionary energy use there (i.e. driving around the country on holidays) but China and India are in the throws of and industrial revolution. There is little discretionary energy use occurring because it’s being used to build new infrastructure. Also, economies of China and India have been growing at 10-12% and 5-6% respectively over the last 5 years, keeping demand hot.
June 27th, 2008 at 12:59 pm
Owen McShane: Any capital gains tax I’ve ever seen on residential investment property is only paid when the property is sold and the tax is on the difference between purchase price and sale price. The gain. If you bought a property for $300,000 two years ag oand was notionally worth $350,000 last year, but this year you sold it for $310,000, the tax would only be on the real $10,000 gain. A capital gains tax on the book value of held assets would be utter madness.
June 27th, 2008 at 1:09 pm
Sam Buchanan: Canada used to sell itself its own oil at a fraction of the worldprice and consumers piad a lend of the local and imported prices. This goes back to the Trudeau years and the first oil shocks. Of course, Alberta, the province where most of the oil was located, considered this to be theft and wanted all Canadians to pay the global price. Good for Alberta, screw everyone else. We’re seeing the same debate here about milk and dairy. Why should we pay a price set in a market where farm land is expensive, winters cold, cows live in barns for months and eat expensive stored grain that could have been used for biofuels? Our cows eat grass and live outside 365 days a year. Our costs are a fraction of those of US and Canadian dairy farmers. Why should we pay THEIR market price?
It’s a debate as old as time. Those who stand to benefit hate fairness while everyone else sees fairness as a good thing.
Individual vs community
Communities usually win the argument when selfish interests prove to be actually harmful (as opposed to merely inconvenient) to community interests.
June 27th, 2008 at 1:10 pm
Roger,
“The exceptions occurred during the 1970s and 1980s OPEC cut supplies. Subsequently the price of oil sat at an inflation-adjusted $10-$20 for close to one hundred years (baring some of the the 1970s and 1980s).”
I’m not arguing that theres no tension between supply and demand at the moment, but what I’m saying is according to all experts the current prices doesn’t reflect the underlying fundamentals. Whats changed in the last couple of years? Nothing save the fact that investment banks need to recoup their losses from the subprime debacle and have lots of hot money recycled from the oil producing countries. Oil consumption growth has actually slowed in China and no doubt will continue to since they reduced their fuel subsidies. GDP doesn’t necessarily reflect oil consumption either. China has massive amounts of room to increase its energy efficiencies. It uses about 4 times as much energy per $1 than the world average and 7 times as much as Japan.
http://uk.reuters.com/article/oilRpt/idUKPEK27141120080313
June 27th, 2008 at 1:33 pm
“Whats changed in the last couple of years?”
Demand has increased at a faster rate than supply, so prices have increased.
“Nothing save the fact that investment banks need to recoup their losses from the subprime debacle and have lots of hot money recycled from the oil producing countries.”
Perhaps somewhat. Another explanation is that the market has woken up to peak oil, which is now being reflected in the price. This hypothesis is supported by the fact that oil is trading at above $100 per barrel for 2012 on futures markets - that is the market predicts the fundamentals to stay tight.
Also projected demand growth in Chinas has slowed, but it’s still huge (10% per annum).
So, I think that there is possibly some aspect of a speculative bubble, but is there is it’s only small (perhaps $20 out of the current $140 per barrel). But the trend is clear. The global economy continues to grow, as does demand for oil, and supply is relatively stagnant.
June 27th, 2008 at 1:33 pm
In case anyone’s interested in oil production/consumption trends in different countries:
http://mazamascience.com/OilExport/
“Whats changed in the last couple of years?”
Production has stopped rising.
All the maths covering trend in oil discoveries, production, geology and technology I’ve looked at over the last couple of years points to an imminent peak in oil production.
If anyone can show me evidence against this I’m interested.
June 27th, 2008 at 1:45 pm
3 years ago dad sold his house for a cool $300,000. I told him to buy up oil futures for 2010. At the moment it looks like he would have increased his pot by a multiple five. But dad never listens to me. Silly bugger.
June 27th, 2008 at 1:58 pm
Two years ago I was walking around Moke Lake (near Queenstown) with a friend who is “something in the City” (of London). We talked about oil, and my view that it was a one way bet. He told me about a class of shares closely linked to the crude oil price (they’re based on an Alaskan field), and suggested I put my money where my mouth is.
Wish I had.
For what it’s worth, the price of carbon is also (long term) a one-way bet. Not quite suitable for superannuation reserves yet, but I wouldn’t be surprised if carbon futures products offered interesting returns as global trading becomes a reality.
June 27th, 2008 at 2:09 pm
>>But dad never listens to me. Silly bugger.
>>Wish I had.
So do it now. Go on…..
June 27th, 2008 at 2:18 pm
BP- That would entail having money.
Also, futures markets have oil at over $100 for the next 10 or so years, where as 3 years ago it was more like $30 for the next ten years. As I said, the market has woken up to peak oil. My formerly specialised knowledge is now mainstream opinion.
June 27th, 2008 at 2:25 pm
>>That would entail having money.
Re-mortgage your house. Work. Borrow. Take on a second job.
If it’s a one way bet, then you’ll almost certainly make money. Or are you expecting a plateau at $100 for…how long, exactly?
Personally, I don’t know enough about oil to bet on the futures, but you guys are obviously experts, but, curiously, have never actually had any skin in the game.
June 27th, 2008 at 2:30 pm
roger nome,
Most experts willingly acknowledge that the current prices don’t reflect the fundamentals. U.S. oil companies and Saud Arabia say the situation doesn’t warrant oil the current oil prices. They say the prices shouldn’t be any more than US$70-90 pb. What “the markets” have woken up is to the fact that they can make a killing, because theres such tension between supply and demand. Its a sellers market, when one group isn’t price descrimatory.
My employer’s brother is a currency trader in Australia and someone he knows made $1 billion dollars.
The United States massively miscalculated in their economic planning over the last 30 years by shifting production offshore and allowing China create such a massive reserve of US currency. Now its being used to actually pay for something useful.
Andrew W.
Iraq’s announced that they have massive oil reserves, claims which have been corraborated by a Brazillian Senator. Imagine the production that would have been possible had the United States not destroyed Iraq’s oil production infrastructure through their bombing campaign and Trade Embargo over the last 15 years.
Massive new oil reserve have been discovered in Iraq.
http://www.tinyurl.com/5vr3y5
“He stated that Iraq had surpassed Saudi Arabia and is now the first country in the world in terms of known oil reserves. From the top 12 places in the world where higher quantities of oil are found, 9 are in Iraq, he emphasized.�
Eduardo Suplicy
http://www.usbig.net/papers/182-Suplicy–Iraq.doc
As of May 2007, companies like ExxonMobil are not making nearly the investment in finding new oil today that they did in 1981.[25] Nor are they using state of the art extraction technologies.
http://en.wikipedia.org/wiki/1980s_oil_glut
June 27th, 2008 at 2:30 pm
In some respects, BP, I already have. Just not in terms of shares or futures contracts. That’s why my friend in the City is a great deal wealthier than me…
June 27th, 2008 at 2:30 pm
BP - don’t have a house. Work? Sure, I’ll see what’s left over after paying the bills. Also, I don’t think oil’s a one-way bet over the next 2-3 years, only over the next 5-10 years. China and India will quickly soak up any extra supply that happens to come by..
June 27th, 2008 at 2:35 pm
I used to live in London. Lived in a very down market closet, and was working as many hours as I could in IT. I also invested during the tech bubble. Made a lot of money.
Hard work? Yep. Risk? Yep. Luck? Yep.
Talk is cheap.
June 27th, 2008 at 2:35 pm
“So do it now. Go on…..”
I’m choosing to invest in the security of farmland, and to reduce debt because of the reason outlined in my first comment on this thread.
June 27th, 2008 at 2:45 pm
Sure BP. Good on ya. When I have money/finish my masters i’ll be researching and investing for sure.
June 27th, 2008 at 2:46 pm
Good for you…
June 27th, 2008 at 3:03 pm
When oil reaches $300 a barrel:
i32.tinypic.com/208wgnq.jpg
June 27th, 2008 at 4:21 pm
@SleepyTreeHugger: “but what I’m saying is according to all experts the current prices doesn’t reflect the underlying fundamentals.”
Not all the experts agree that there are no fundamental issues here, though everyone I guess agrees there is some speculative element in the pricing; how much varies by opinion.
June 27th, 2008 at 8:48 pm
Donkeys! heh
June 28th, 2008 at 6:09 am
Mr McShane - a person who knows capital gains tax would be due from any gains in an asset’s sale price v buying price, and doesn’t account for it in their planning, would be a fool. Also to have to borrow to pay it would be madness. It’s called financial planning.
Why should not capital gains tax be due from a profit (ie income) from speculation in property as it is or should be from any other income from say, speculation in stocks and shares.
After all the ‘market’ has put housing in the same realm as any other ‘asset’ held for profit (or loss) ie a commodity, and then market speculators complain when asked to pay a tax on that particular commodity gain. If there is a loss then a tax rebate would be due. You can’t have your cake and eat it !
Either residential property held for gain is a commodity,(and should be taxed) or it is not, (and therefore should not be held for gain).
June 29th, 2008 at 9:16 am
The question is not necessarily the price of oil but the price of dollars.
What if the folks doing the speculation are actually trying to hedge dollar risk rather than consumption and supply in oil???
Consider that in the past month 3 major Eurozone financial houses have issued warnings of massive problems in the US economy. Which is in recession NOW if you look at the real books instead of the cooked ones… and one revisits the run-up to “the great depression” and sees similar warnings being ignored.
http://www.jessescrossroadscafe.blogspot.com/
If the US economy actully goes in the tank there’s a lot of risk for dollar holders. People holding oil futures, gold bullion or other commodities are not in so much danger. Still in danger, but complete loss is unlikely and that makes commodities more popular than dollars.
“Foreign” currencies (ours for instance) would have to go up relative to the fiat green slime that has flooded the coffers of the banks and nations of the world and the history of fiat currencies ( 100% abject and disastrous failures through all of recorded history ) doesn’t lend itself to any increasing degree of confidence. So people are buying commodities… and they aren’t likely to quit. Our economy is commodity based. We produce “stuff” and so we will likely get a boost out of the changes, but the money available to pay us will be in short supply.
Troubles ahead for sure. Not even the “blair witch” can get such systemic problems to dissipate.
respectfully
BJ
June 29th, 2008 at 11:15 am
“What if the folks doing the speculation are actually trying to hedge dollar risk rather than consumption and supply in oil???”
I worked that out early on. It just seemed awfully convenient that the price of oil spiked, precisely after the subprime market collapsed and the US dollar started tanking.
Not that I’m completely discounting the possiblility of Peak Oil, but I don’t believe it has yet arrived.
That shouldn’t of course mean that we don’t take steps immediately to prepare for it.
June 29th, 2008 at 12:55 pm
This article written in 2001 brings the issue into a whole new light.
We are sooo doomed.
http://www.guardian.co.uk/business/2001/jan/14/globalrecession.oilandp etrol
June 29th, 2008 at 6:55 pm
I’ll guess what the petrol price is in ten years, in todays dollars (ie before inflation):
NZ$6 per litre.
Don’t ask for justification for this guess, I can’t give you any. If I were betting a crate of beer on the price, this is what I would choose.
June 29th, 2008 at 9:40 pm
Here’s a useful summary that I can’t fault: http://europe.theoildrum.com/node/4224#more
June 30th, 2008 at 3:38 pm
“Most experts willingly acknowledge that the current prices don’t reflect the fundamentals.”
It’s hard to know what you mean by “fundamentals”, or whether you mean anything coherent at all. This isn’t like buying stocks where we compare price to earnings, or housing where we compare prices with the cost of building and income from renting, or a currency where we compare likely interest rates with value of the currency.
As for “hedging dollar risk”: nope, can’t see it. You can’t hedge dollar risk on the spot oil market. You can on the *futures* market. But futures prices don’t set spot prices. That’s the underlying flaw in all this talk about speculators driving up oil prices: speculating in oil futures does not drive up the spot price.
Because those who buy oil futures as speculators must bail out of the market and sell before the contract falls due, since they don’t want to have a million barrels of oil dumped in their boardroom. Only if there was sufficient demand for actual oil to actually support the current spot price would spot prices be that high, irrespective of the acts of speculators.
Speculative bubbles occur when people buy an asset expecting the price to go up, and then hold the asset until they sell to someone who is buying it at an even higher price because they expect the the price to go up even more. The profits made by the few can then cause herd behaviour where everyone piles in and buys some, creating a self-fulfillng prophecy that prices will rise until it gets out of hand and the bubble bursts. This involves lots of people buying AND HOLDING the asset. You can do that with a currency easily, or with housing or technology stocks. You can do it with oil futures. But you cannot do it with spot oil contracts - ie actual oil - unless you’ve got space in your backyard to put a million barrels of oil and people just don’t.
July 1st, 2008 at 9:55 am
My guess is about US$35 a barrel, if there is substantial investment in drilling over the next decade. If environmentalists have there way, and there isn’t, then there will presumably be at least substitution for other energy types. In that case I would guess perhaps US$70 a barrel.
For petrol in New Zealand, I predict it will be about 30 cents per litre, plus tax, i.e. around $1. Bear in mind that even with our current power prices, an electric car can be run for the equivalent of about 30 cents per litre. Given that it looks highly likely that electric cars will be part of the mass market in 10 years, petrol will need to be competitive with that.
Taking a more extreme view, if there is widespread substitution, then oil might fall to $5-10 a barrel, with only Saudi Arabia and a few others still pumping. I think this is unlikely in the 10 year timeframe, since the 3rd world demand will still be high. In the longer term, however, oil is likely to be a niche product, a bit like parafin.
Don’t bet on $300 a barrel. Environmentalists are going to have to find another way to wean us off energy.
July 2nd, 2008 at 1:19 am
OK,
Here are some of my reasons for choosing a pessimistic price of $6 per litre for petrol in 10 years:
1) Global demand for oil will continue to increase
2) Existing oil fields will be depleted, and new discoveries will not be able to keep pace.
3) Wars over oil will become more common, disrupting production and transportation of oil.
4) Countries with oil will deliberately limit production for political purposes.
5) Environmental taxes etc will add to the price
Maybe my $6 per litre (whatever that works out as per barrel or oil) is optomistic?
July 2nd, 2008 at 8:53 am
Well unless the federal reserve stops printing money then the price of oil will continue to rise, so who knows the sky is the limit.
Of course at some point the Oil nations will have to start pricing oil in something other than USD so we may get some stability again.
July 2nd, 2008 at 9:25 am
The optimist suggests that a move to oil alternatives such as electric vehicles could bring the demand for oil down, thus reducing the price. The figures I’ve found for NZ suggest that for us to power the transport network and shut down out coal and gas stations to reduce GH emissions and meet overall power demand from normal growth we’d need another ~8000 MW capacity.
If that’s right, how is that shortfall to be met, or do we sacrifice economic growth?
turnip, the oil price rise is real, not nominal.
July 2nd, 2008 at 9:34 am
Thats not entirely true Andrew,
The oil price rise is part real and part nominal.
Supply is increasing faster than demand, but at the same time the unit used to value oil (USD) is having its value trashed.
Price oil in something other than USD and you would see that it hasn’t risen nearly as much as you think it has.
July 2nd, 2008 at 9:41 am
No turnip, supply is not increasing faster than demand. Whatever the strength of whatever currency oil in primarily traded in is irrelevant to it’s price in real terms. A weaker US dollar simply means that Americans are hit harder than people in countries with stronger currencies. The fact that oil has increased in price in all currencies demonstrates a (huge) rise in price in real terms.
July 2nd, 2008 at 10:11 am
Sorry I had that round the wrong way i mean’t to say demand is rising faster than supply.
And yes the Americans are being hit harder along with all the Gulf states who have their dollars pegged to the US.
As too your other point i don’t understand “price in real terms”. What are you calling real terms?? The only price for oil is in USD, not NZD or CAD or AUD. Iran will sell you oil in EUR’s, but who knows for how long that will last.
Now if your country’s ccy isn’t USD then the exchange rate between your country and the USD is VERY important in determining the price of oil at the pump. If the NZD/USD exchange rate went down to 0.37 then the price of oil would rise a lot, yet the real price of oil could go from 140 to 142.
Add to the fact that many countries around the world including New Zealand are not letting their currency’s rise against the USD and you end up with huge rises in all currencies.
To conclude the rise in oil price is not tied to just supply and demand all though that is a factor you can’t ignore what is going on in the US economy and the effects its having on the world oil price. One of the reasons we like having oil priced in USD is because the US used to be one of the most stable economy’s. That stability appears to be changing, here in the US we have talk of deflation, inflation and even hyper-inflation, All of those conditions if they happen will impact the price of oil that people in NZ pay at the pump. The only way NZ could remove its self from that loop it to produce and sell its own oil.
July 2nd, 2008 at 10:13 am
I think in the short term oil will come down as it makes no sense to cool off the western economy to much, and the Saudis know this. I rekon we will have up to 2 years of more bearable fuel prices and then the price will hit $300 + a barrel as supply becomes the main issue. You can’t export western culture to developing countries and still have all the pie for your self, these guys all want a car and every thing that goes with it, there is simply not enough to go round.If we take the current situation as a wake up call there is enough time to minimise our energy use and maybe prepare our economy a bit, but alass, as soon as the price drops again most people will probably stick their heads back in the sand.
July 2nd, 2008 at 10:35 am
Turnip, Real terms simply means inflation adjusted.
Lets say oil was traded in Yen rather than $US, what would the price in US dollars be? Well because Yen and dollars (and most other currencies) are traded freely, you’d still be paying about $140US to buy the yen to buy a bbl of oil.
July 2nd, 2008 at 11:06 am
Inflation adjusted against what and compared to what, if you are talking about the USD where are you getting your inflation numbers from since the US hasn’t published true inflation figures in years.
Well if Oil was traded in Yen then you have no idea what the price of it in US dollars would be. The strength of the USD is very dependent on the fact its the world reserve oil currency. What this means is that if your scenario was true the spot price for USD against all the worlds ccy’s would be a LOT different. One of the biggest fears for the US would be if the oil producing countries decided to sell oil in something other than USD.
I think you may be confused about oil, its not just priced in USD its purchased in USD. This means that when NZ buys oil from the Saudi’s we don’t hand over NZD we hand over USD. Where do we get those USD well we sell goods to the US and they give us USD, where does the US get the USD’s from to buy our goods, well thats easy they print it.
Now if New Zealand tried that little trick of printing NZD to buy other countries goods we would get laughed at by the rest of world and our ccy would quickly become worthless since no one needs the NZD, however because we buy oil in USD we need USD this then keeps the USD higher than it really should be.
But in conclusion you can’t make the statement if oil was traded in Yen then we would still be paying $140US because you have no way to know what the spot rates to the USD would be for all the world currency’s and their is absolutely no way for you to know unless you lived in a world where that was actually the case, Your alternate realitiy probably would have resulted if the Japanese had won the second world war.
You have to understand there is a reason oil is traded in USD, we didn’t pick the ccy by chance well actually NZ didn’t pick the CCY at all, we had no say in the ccy, the Saudi’s picked it in exchange the US promised to defend the Saudi king and keep him in power, don’t you find it strange that the US this great supporter of democracy supports one of the worlds most despotic countries in Saudi Arabia.
July 2nd, 2008 at 11:26 am
Turnip, in oil trading the US dollar acts simply as a medium of exchange, we buy US dollars on the markets, hand those dollars to the Saudi’s the Saudi’s then hand those dollars back to the markets and buy whatever currencies they need. The cycle is neutral, our $US purchases are equaled by their $US sales.
July 2nd, 2008 at 12:32 pm
The cycle isn’t neutral the Saudi’s are left with large amounts of USD which they cycle back into the US by buying US assets like US T Bonds.
If the cycle was neutral then the US wouldn’t be able to print so much money and export their inflation to the rest of the world.
Calling a monetary system neutral is weird especially fiat money since it can be created and destroyed at will. I would never use the word neutral in fact if it was neutral then their wouldn’t be any inflation or more to the point inflation would be 0%. But inflation isn’t 0% is it so the money supply is obviously not in a neutral state it is either in an increasing state (inflation) or a decreasing state (deflation).
What you are ignoring in your simple system is that the supply of the USD is increasing all the time and this creates an inflation effect on the price of oil.
Money is a medium of exchange and it should hold its value and act neutral like what you are saying, except the USD isn’t money, its fiat paper and i think you might be confusing the two.
July 2nd, 2008 at 1:01 pm
They are left with the same number of $US as the oils purchaser bought in the markets, if they want to invest those $ in the US that’s their business, they can just as easily invest the money in Japan or Saudi Arabia.
If the US prints lots of money the value of the $US declines relative to the currencies of other countries, so what? If we print lots of $NZ our currency will likewise decline, Zimbabwe does print money with the observed consequences.
All currencies these days are termed “fiat” this term simply means that the issuing government no longer guarentees the currency is backed with stored gold, rather the backing is in the form of confidence in the issuing state.
July 2nd, 2008 at 1:03 pm
Fiat money:
http://en.wikipedia.org/wiki/Fiat_money
July 2nd, 2008 at 1:41 pm
>>If the US prints lots of money the value of the $US declines relative to >>the currencies of other countries, so what? If we print lots of $NZ our >>currency will likewise decline, Zimbabwe does print money with the >>observed consequences.
The US has printed lots of money in the last year so the value of the US dollar has declined.
If the Saudi’s buy goods from europe with usd and the euro gets stronger against the usd the Saudi’s require more USD to buy the same number of BMW’s. How can they get more USD by selling oil at a higher price.
So some of the price of oil is coming from the Saudi’s trying to handle the exporting of the US inflation.
There is a major difference between the NZD and the USD. You must buy USD dollars to purchase the oil at a price that can be raised to soak up the excess USD dollars being created.
So the US can print money contrast that with the NZ example where nobody needs NZD thats the major difference there is no demand for NZD.
Its simply supply and demand economics of the USD.
So when you talk about the oil price you need to include the supply and demand of the oil and the supply and demand of the usd. Changes in either of these will result in price changes in oil.
Since a fiat currency isn’t backed by anything the supply is in theory infinite.
July 2nd, 2008 at 1:58 pm
Last comment, if the US dollar was stronger oil would cost less in $US - yes, but in that case it would have little impact on how much you or I in NZ or people in Europe would pay at the pump; while oil would cost less $US, we could buy proportionally less $US with our $Kiwi, Yen, or Euro’s.
In fact a weaker US dollar if anything inhibits Americans ability to buy oil relative to the rest of us, therefore in theory suppressing US oil consumption (oil demand is very inelastic, so not by much) and by reducing their demand - if anything- reducing the cost of oil for other nations.
“nobody needs NZD”; obviously you don’t mean that literally otherwise the $NZ would have no value.