Whither the Oil Markets
“Global Demand for Oil to Plummet,” screams a recent Financial Times headline. Huh? No it won’t. Who are they trying to kid?
Global oil demand is not going to “plummet.” And for the FT to say so is just plain silly, if not irresponsible. OK, I know. There’s an old saying that they teach in journalism schools. “You have to sell newspapers.” But this declaration by the FT highlights the perils of letting a headline-writer do your thinking for you. It’s what I call “arguing a screaming conclusion.” And a wrong conclusion at that.
Oil Demand – Down, Then Up
But let’s move past the headlines. The Financial Times article explains that the World Bank has just issued a new study. The World Bank believes that the world is entering into the toughest economic times “since the Great Depression.” Thus overall world oil demand may fall by about half a million barrels per day in 2009. That’s what the World Bank states in its report.
Only half a million barrels? Heck, the total world demand for oil in the past year was about 87 million barrels per day (a fact that the FT article fails to note). By comparison, the Saudi oil tanker that was hijacked off the coast of Somalia held two million barrels of crude oil. And despite this act of piracy oil prices still fell over the next couple of weeks, even without that tanker plying its route across the deep blue seas.
So if the world experiences the next “Great Depression” (Release 2.0, I guess), a reduction in overall oil demand of half a million barrels per day is down in the statistical noise. And what the World Bank is saying about the grim future of the world economy is not the equivalent of “plummeting” demand. At least, not half a million barrels of lower usage.
How Bad Is It?
How bad is it out there? Well, according to this week’s MasterCard Spending-Pulse data, U.S. retail gasoline demand is back to about the same levels it showed earlier in 2008. That is, high gas prices hurt demand over the summer and into the fall. (I drove less. Didn’t you?) But the current low fuel prices have evidently allowed demand to recover. People are driving more. It’s basic Economics 101.
I was talking with an economist for the American Petroleum Institute about two weeks ago. He told me that overall gasoline demand in October was down 3%, year-to-year. But diesel fuel usage was up by the same amount. Overall U.S. oil demand is down about 8%, but that reflects the slowing use of oil in industry. Out on the road, people are still driving and trucks are still hauling.
For all the sound and fury about the run-up in oil and fuel prices through July, and then the fall in prices after that, the aggregate demand for oil is only changing at the margins.
Built-In Oil Demand
In both the developed and developing worlds, there’s a lot of oil demand built into the economic and social energy system. That’s what modern development is all about. That’s how the system was built over the past 100 years or so. Yes, you can wish that the system were different. You can even try to change the system – and risk collapsing it in the process.
Whatever you do, you can’t change the system very fast. To paraphrase a former Secretary of Defense, “You live in the world with the energy system you have. Not the energy system you might wish you had.”
So at best, if you want to change things you are looking at a generational shift. If you have a generation. Do we have a generation?
What Will OPEC Do?
Let’s try looking at some different numbers. How about 7 million barrels of oil per day? That’s the amount of output that OPEC might have to shut-in if it wants to get prices headed back upwards in to the range of $75 per barrel or so. At least, that’s according to Philip Verleger, a long-time industry player as quoted recently in Platt’s industry newsletter The Barrel .
Current daily oil output from OPEC is about 32 million barrels per day. Verleger thinks that OPEC’s output ought to be more like 25 million barrels per day. There’s the 7 million barrel shift. Easy, right? It would be as if Iran, Iraq and Qatar simply stopped exporting oil. How likely is that to happen? Umm… yes. Clearly, Verleger has a radical take on things.
One way or another, can OPEC cut production significantly? Does OPEC have the discipline to manage its own affairs to cut 2 million barrels, or 4 million, let alone 7 million barrels per day? The issue is that numerous OPEC nations cheat on their production quotas. Hey, they need the money. Thus they lift the oil and sell it. Really, cheating on OPEC quotas is not a problem. It’s a tradition.
What of the Future?
Looking ahead by more than about two years, world oil demand is certainly going to grow. It almost does not matter what we do in the U.S. or Europe. When you look at the numbers of young people who are already born and living and growing up in the developing world, the demand will be there. Many of these young people already have a cell phone and a laptop computer. When they finish school, they will want an apartment and a car.
And at the rate things are going, the energy industry is still under-investing in the necessary systems of the future. Depletion is still ongoing. It gets back to the very basic point that every barrel you lift from the ground leaves one less barrel down there. And the overall global depletion rate is 6% at best. Maybe it’s 8%. It might be 10%. To replace that depletion, the general trend is for the energy industry to go further away, to deeper waters or more remote sites, to drill deeper wells, with hotter temperatures and higher pressures. Those little hydrocarbon molecules are just plain tough to catch.
And keep in mind that nobody can produce oil that has not been discovered. Or developed. Or for which there are no handling facilities. That takes investment, and lots of it. Which requires money and finance, which is in rather short supply just now. So there are just a few years in which the world can reorder the way it does oil, let alone the big picture on energy. And there are a lot of moving parts in all of this.
The Moving Parts of Oil Production
One of our fellow (sister, actually) readers is deeply involved in monitoring the world oil situation. The other day she sent me a thoughtful list of “ifs” that have to happen just to begin to get future oil production on firm ground. Here it is:
- IF oil price rises above the marginal cost of new non-OPEC supply in time to get new production back on track;
- IF oil-producing countries and China stop subsidizing prices to their own populations;
- IF OPEC gives international oil companies (IOCs) like Exxon, Shell, Chevron, etc. access to explore and develop their reserves;
- IF the trillions in exploration and infrastructure capital are invested;
- IF OPEC invests seriously in increasing their own capacity;
- IF enhanced oil recovery (EOR) processes can really increase the recovery rate as much as hoped;
- IF the reported reserves are really there;
- IF the U.S. Geological Survey predictions of “yet-to-find” oil in the Arctic, offshore and elsewhere are correct;
- IF the Saudis can are capable of reaching and sustaining 15 million barrels per day of output;
IF, IF, IF …
“And,” adds my correspondent, “virtually all of these are outside the control of any policies that might be set by the oil-importing nations of the West.”
So unless a lot of things happen — pretty soon and in the right sequence, and competently — we’re going to be faced with the prospect that there’s not going to be enough oil to go around. So oil prices are going to head back up. People and governments are going to get desperate over supplies. And much of the usual and predictable bad stuff that you’ve heard before is going to happen. Which gets back to that Financial Times headline. “Plummeting” demand? Really.
A Few More Dots to Connect
President-Elect Barack Obama made a major announcement last weekend. It was along the lines that his administration would work to invest in infrastructure. Congress loved it because it means that the politicians can appropriate money to spend on concrete and steel. That’s what I’ve been saying would happen. But it’s nice to hear it.
The announcement was good in the short term for a couple of the OI stocks, like Alcoa (AA: NYSE ) , Cemex (CX: NYSE ) and General Electric (GE: NYSE ) . They all have things to sell into an infrastructure buildout, as do more recent additions like Koppers Holdings (KOP: NYSE ) and Allegheny Technologies (ATI: NYSE ) .
Where will the U.S. government get the money to pay for the infrastructure buildout? Same place it gets all the money to bail out the banks and Wall Street, I guess. It’ll borrow it. And in the process the U.S. borrowing will soak up most of the nation’s “spare” capital, such as it is. U.S. government borrowing will crowd private borrowing.
The U.S. government can borrow money for the time being. For some strange reason, people still want to buy U.S. Treasury bills, bonds and notes. Don’t ask me why. The interest rates are just about zero (safety sells, I suppose). And the dollar is strong.
Actually, the dollar is much stronger than it ought to be. I expect a major dollar-correction in the first quarter of 2009, which will be good for foreign-denominated stocks that trade on the Toronto Exchange. (Although Canada is having some surprising political issues right now. I’d appreciate hearing from Canadian readers about their take on what’s going on with Prime Minister Harper.)
In the longer run, the U.S. expenditures will come back as inflation. That means that you want to look at owning gold and shares in the best-run gold miners. If I had to pick just one gold miner with the best prospects, it would be Kinross Gold (KGC: NYSE ) . It’s well managed. Kinross just completed a series of mine expansions. And it’s ramping up production to sell increasing levels of output into a generally rising gold market.
Until we meet again,
Byron W. King
December 29, 2008