Inquiring minds want to know -- why isn't oil down around 20 or 30 right now with the depressed levels of economic activity we're seeing. Domestic demand is down significantly; inventories are relatively high around here. On the other hand Chinese demand seems to be up huge over last year, with refinery volume at a plus-twenty percent this November over last (Bloomberg). The (alleged) surge in consumption from China, India and elsewhere in Asia, Africa and South America probably makes up for the drop in consumption in the US. (To review: The pro analysts thought that Chinese demand for petroleum would stay high when American demand tanked last year. It didn't. Then they said Chinese demand would stay low along with depressed American demand this year. It didn't, surprising to the upside. Note that since people have been using the trendy term 'de-coupling' they've been exactly wrong about the actual de-coupling of which they yammer.) In the meantime, the depletion of the world's biggest oilfields continues to put pressure on supply.
As with any market in the known universe, oil doesn't trade purely on fundamentals like supply and demand. Never has, never will. So people can stop shaking their heads in wonder when markets go off the chain, like the stock market is right now. There will always be elements of fear, ignorance, greed, thrill-seeking, herd-following, wishful thinking, lying, cheating, mass manipulation, you name it, in the asset price. And when assets are bubble-high-priced (or unnaturally low-priced, as the case may be) the government which has helped get them there will endeavor to keep them there through various schemes. The Fed's purchasing of toxic mortgage-backed securities from banks and the current crop of real estate tax credits are obvious examples of the government working to prop up asset prices at bubble levels. These schemes steadily crush the dollar, which leads directly to higher oil prices.
Ultimately the market is composed of humans, human interactions (and is also the playground for their software and machines which algorithmically purchase and dispose of great amounts of said assets in response to predetermined triggers, but never mind that). The markets then are composed of the same smarmy molecules that compose traffic. It is innocence and folly to expect either the markets or the streets to behave according to some rational set of rules, inscribed on the surface of distant planets by Gods or Mother Nature or Hayek or whichever all-knowing spirit. We're talking about human beings here. We make up the rules as we go along, by definition. In school one of the themes you always heard is how the markets tend toward equilibrium and the 'correct' price of assets, which is an obvious lie. Pricing is often wacky and wrong. The tendency is toward extremes, with a drive-by past Equilibrium Town every once and a while for good measure.
Anyway, moving on. For those keeping score, the consensus prediction of big important outfits like Merrill Lynch and the EIA for the price of oil in 2009 -- a $50 average for the year -- was a bit of a clanker off the side of the rim. Not quite an airball. Most expert analysts were wrong about oil in '09, as well as in '08.
As 2010 approaches, WTI is back under $70 for the first time in two months, but a light rumbling of bulls can be heard over the prairie. Today's general bullishness is encouraged no doubt by the surprising rebound in developing markets, and the simple fact that oil's been more expensive than people thought it would be for a few years (a.k.a. momentum, or 'self-fulfilling prophecy'), but also by the increasingly frequent acknowledgments of production issues from official and mainstream sources. The depletion problem is increasingly obvious and undeniable, as the following snippet illustrates.
The head of the International Energy Agency (IEA), Fatih Birol, announced a few days ago that the peak in global oil production will probably arrive by 2020 [The Economist, December 10, 2009] unless some game-changer deposits are discovered real soon. This represents something of a tire-squealing one-eighty for IEA predictions, which held until a few years ago that global production of liquid fuels would climb to around 130 million barrels per day (from our current plateau at around 86 mbd). Naturally you will want to ask yourself, if an official mouthpiece like the IEA, an organization whose very mission is to produce happy-talk to calm the oil-related worries of the masses, is all of the sudden calling Peak Oil in a decade, how close are we really? Or has it already passed, as the current five-year production plateau might suggest? Not very soothing, IEA. Organizations like the IEA and EIA are funded with public money to mollify the public mind, so if their reports aren't sufficiently soothing, maybe the organizations have outlived their usefulness.
Predictions from out in the World tend to be bullish, even with lingering economic breakdown in the United States.
The state of Alaska thinks oil will be around $67 next year. [Rachel D'Oro (AP), "Alaska Revenue official says oil future stable."]
Greg Chornoboy at Jennings Capital says 'we're expecting an average of $75.50.' Not just 75 but 75.50. You know this guy was called Greg Chernobyl Boy in high school.
Morgan Downey, author of Oil 101, notes in his blog that there had been an incentive to dump oil on the market from floating storage in recent months, a dynamic which stalled the price rally. But as contango returns the incentive to dump stored oil is ebbing and will be replaced again by the incentive to store and hold for a future date, which will support prices. He writes, "Quite frankly it is quite an impressive sign of a strong underlying market that oil prices have not collapsed and that consumers have readily lapped up every barrel that has come out of floating storage -- even at close to US $80 per barrel." Downey is quite a smart fellar and makes no specific predictions, but the call is clearly for oil to continue near these levels or higher. He also mentions that the marginal cost of production for non-OPEC oil is $80 per barrel. That's serious business.
Among the more familiar voices, T. Boone Pickens is right there calling for $80 average in 2010, with a view toward much higher prices in coming years. Of course he is 'talking his book' but so are a lot of these folks.
The EIA, the American official mouthpiece, predicts a 2010 average around 80 bucks (Reuters). The IEA, the international mouthpiece, is somewhat more bullish on the global demand outlook than the EIA (WSJ). They are revising their forecasts upward as the numbers from China come across.
Various OPEC representatives have stated that they like oil around 80 bucks and will try to keep it there.
Mexico has purchased put options at $57 per barrel, according to Bloomberg, not a particularly bullish action there. Insurance in case the price drops. They made billions off their $70 puts for 2009.
Let's look at the predictions of Goldmine Staxx, the firm with the Midas touch. When oil was climbing the beanstalk in June '08 Government, er, Goldman Sachs threw out a bold call for a $150 average for 2009-2010, after talking up the prospect of $200 in the near term. Well, it tumbled the opposite direction soon thereafter. Made them look a bit shrill. Now late in '09 they are seeing an average of $90 in 2010, which is significantly higher than most other calls. Ah, Goldman. Even if they knew where it was headed next, they wouldn't tell you.
You may notice something funky-monkey about these predictions, for both '09 and '10. Early in '09 predictions tended toward $50, and the spot price for crude was around $50 at the time. Today most predictions gather around $70 or $80, and the price was around $70 or $80 when the predictions were made. It gives the impression that forecasters are playing it ultra-safe and/or have no clue whatsoever. How much you want to bet that predictions for 2011 spouted around Christmas of 2010 will run roughly near or a bit higher than the spot price at that time?
Particularly striking, in my opinion, is the general lack of calls for oil to tumble into the 20s or thereabouts and stay there for a while, not unlike the dynamic which followed the last significant spike in oil prices which occurred decades ago -- because that would seem like a distinct possibility as well if the economy exhibits further characteristics of a small drowning rodent. The economy is worse now than it was in the early 1980s. The numbers out of China could be bunk, after all. Or they could be the product of a bubble ready to burst.
Economists and pundits have really enjoyed the line of thought that oil is abundant and rightfully cheap, but seem to have been scared off of this tack in recent months, even as oil company bigwigs are bracing for years of depressed demand and relatively lame earnings, according to one survey. (So-called Big Oil is getting less and less oil out and paying more and more to get it.) Even market ideologues like George Will seem to have accepted that oil will be much more expensive, if not scarce ["Oil's Expanding Frontiers," November 22, 2009]. In a recent Post column he ridicules Peak Oilers and touts fantastic-sounding numbers for reserves -- par for the course -- but then notes that drilling rigs can cost a billion dollars, and that the cost of producing from the Canadian oil sands (the product of which is piped straight into Denver, cooked into gasoline and eagerly consumed by our drunken teen drivers) is at least $79 per barrel. I wonder if there will ever come a day when George Will sits bolt upright in bed with the sudden realization that his concept of 'abundance' is indeed irrelevant, if the world's daily fix of oil can only be satisfied with increasingly difficult methods like cooking sand and pumping sour crude from miles beneath the ocean floor at a production cost of $80 per barrel and rising.
So let's see. Oil could go up big or down big from here. Anyone who can say with any certainty which way it will go can write their own lottery ticket. I won't gamble on it myself but I'll be watching to see if Greg Chernobyl Boy and his buddies get it right. Or rather, how wrong they are.
Image by Leroy Quet, www.prism-of-spirals.net.