Saturday, December 06, 2008

A Recent History of Oil Prices.

In January 1999 the price of a barrel of oil reached a low point of $16 when Iraq increased its oil production at the time of the Asian Financial Crisis when demand for oil fell. Prices then increased rapidly, reaching $35 in September 2000, and after a temporary fall reached $40-50 by September 2004. Crude oil prices surged to a record high above $60 in June 2005, and by early August 2005 hit $65 as consumer demand was maintained. In September 2007, the price of US crude oil broke the $80 barrier. In October 2007 a barrel of US light crude oil exceeded $90 for the first time, due to a combination of tensions in eastern Turkey and a fall in the value of the US dollar. The next psychological watershed of $100 was briefly breached in early 2008, but the price fell again until the end of February after which it remained and rose well above this new setting. Then a visible ramping effect became evident and so the price exceeded $110 on March 12, 2008; $125 on May 9, 2008; $130 on May 21, 2008, $140 on June 26, 2008 and $145 on July 3, 2008. The record was reached on July 11, 2008 at $147.27 as a consequence of geopolitical tensions over Iranian missile tests.

The above data stress the point that the price of oil is highly sensitive to the world political situation and to a general sense of confidence, including that in the stock markets. When the $147 barrel appeared, it did appear there would be no stopping the escalating price of oil, and that by December 2008 a barrel of oil might cost around $150 or more, amid speculation that by the end of 2009, it would be nearer $200. However, oil prices declined by more than $20 over the next two weeks in July 2008, and seemed to stabilise at near $125 a barrel on July 24, 2008. A forcing factor came into play, which was that the very high price of oil had changed people’s behaviour and they were now driving less with a reduced demand for oil. Oil prices then dipped further, reaching $112 a barrel, on August 11, 2008.

On September 15 the $100 psychological barrier was again broken, but in reverse, when the price fell below $100 for the first time in seven months. On October 11 there occurred a massive crash in the value of global equities, with a barrel of oil falling by 10% to $77.70. In consequence of further economic slowdown the price continued to slide and today (December 4, 2008) it is trading at around $45 a barrel. Rather than the $200 predicted last summer some analysts are now predicting a $20 barrel sometime during 2009. I must stress, however, that even if this does happen it will be a short-lived event, because the facts of geological limits to production, increased production costs to obtain more difficultly recovered oil and that demand is still rising (demand is simply rising less steeply during this economic recession, but it is still in the ascendant).

The upshot will be a gap between the demand for crude oil and the limits of how much of it can be produced, a quantity that must inevitably fall beyond the point of arrival of “peak oil”, which will force the price up again. Thus oil will become a commodity that is both increasingly scarce and relentlessly expensive. The price of oil (and that of all commodities), is subject to major variations over time, since they are inextricably linked into to the overall business cycle. When the demand-supply gap is reached, oil prices will soar, but the commitments and habits that determine the energy use of oil-users will take time to adjust. It is time-consuming and expensive to introduce more production capacity in the near term, but in the longer run, both businesses and individuals will act to cut back their oil use in response to the driver of high prices. An optimistic economist might argue that high prices promote new investment in production and so new sources of oil will emerge on the market, gradually restoring a supply-demand balance.

The remarkable hike in the price of oil in the summer of 2008 was driven partly by a period of brevity when global demand for oil outran its supply. The OPEC nations were encouraged to ramp-up their production to get the price down for western nations who would be unable to maintain their demand for oil if its price remained at such high (and relentlessly increasing) levels. My suspicion is that the summer-spike in oil prices, led to a fall in oil-use and a significant curb in demand for cars and other goods, which became notably more expensive, and precipitated the present economic downturn. Job losses and less disposable income then meant that many in the low-income bracket would be unable to pay-back their mortgages and a credit-crunch ensued, with a lack of confidence in and among banks who had lent money rather carelessly. The increased output of oil by OPEC along with a contraction and the threat of further slowdown in the business sector, hence less oil being used, has created a minor glut, thus forcing down the price of oil, and increasingly so along with the declining value of all equities. While a low oil price should help businesses to invest and expand, the credit crunch and fear by the banks to lend money has acted in the reverse of this, and prompted a recession.

On the basis of microeconomic theory, when supply exceeds demand, the price of a commodity should reduce to the nominal cost of production of the most expensive source. In the case of oil, as its price drops, the most expensive wells become uneconomical and are shut down, at least temporarily. A price equilibrium is met at a point near the production cost of the most expensive source required to meet global demand. The variation between what the market can bear in the first days of shortage to the marginal cost of the last well in times of surplus can be enormous. Indeed, the price of the majority of commodities including metals and food are subject to equivalent large swings over time. As global oil production begins to decline, following “peak oil”, oil prices are likely to become increasingly volatile than before the peak, because the range of production costs among all sources supplying the market will be much wider. Major oil fields exist where the cost of production is comfortably below US$10 per barrel, and for decades their output was sufficient to meet the whole of global demand for oil. Indeed, many such cheap wells still provide a substantial proportion of the world’s oil .

The shortages and high prices that are inevitable in the future will render viable the extraction of oil sources that cost $50, $70, or $100 or more, a barrel, including offshore/deep water fields, oil sands, oil shale, and enhanced/secondary recovery from depleted fields. As couched in the jargon of microeconomic theory, the supply curve will be much steeper than in past years. Shifts in demand, either up or down, will hence cause swings of relatively greater amplitude in the market price. Nonetheless, even the most expensive sources of oil will be unable to provide anywhere close to the 30 billion barrels of crude oil that the world currently depends on each year. It is the rate of supply (variously termed rate of flow, rate of conversion or rate of recovery) that is at issue. Put simply, it doesn’t matter how big the volume of the resource is, if oil cannot be recovered at a rate of 85 million barrels a day to meet present demand (and rising), we must learn to live by using less oil. This poses a challenge that is simple but not easy, since it must involve curbing our reliance on personalised transport, mainly cars, which most of the world’s crude oil is currently used to run. The corollary to this is the need to develop rapidly, more localised communities, that depend far less on cheap oil-based transportation, which will no longer exist.

Related Reading.

This is the final section to an article entitled: The Oil Question: Nature and Prognosis" which will be published in the popular science journal "Science Progress", probably before Christmas. I thought I would put it as a posting on here for any general interest and/or comments.


Anonymous said...

Hi, Chris, and thank you for this remarkable analysis explaining the observed variations of oil prices.
I add an information : a graph plotting the variations you are talking about (hence illustrating your text) is posted on the ASPO December 2008 Newsletter.

Professor Chris Rhodes said...

Hi Andre'!

Thanks very much for this link! Yes, a picture paints a thousand words!



Anonymous said...

Hi Chris

I come again, to inform you and your readers that I have drawn, as an illustration, a full screen graph plotting the ASPO-December-2008-Newsletter oil-price curve (1999-2008) with added annotations related to your text and with a link on the left leading to the ASPO page showing the original curve.

I also have to report a correction to be brought : you write “The record was reached on July 3, 2008 at $147.27”. But you know, of course, that this record was reached on July 11.

Being well aware that our world is “obviously in a transitional period between the old profligate energy economy and the new economy of relative scarcity” (Kunstler words), I am in full agreement with your analysis, although I am less affirmative about the fact that “the shortages and high prices that are inevitable in the future will necessarily render viable the extraction of oil sources that cost $100 or more, a barrel”. I suspect there may be some inherent insurmountable problem with money-lending capability (and, consequently, investment capability) maybe coupled with excessive volatility and rising instability, when growth reverses into contraction.



Professor Chris Rhodes said...

Hi Andre,

yes thanks for spotting that typo, it was $145 on July 3rd (as noted) and then on July 11th it hit £147.

I was interviewed on his radio show by the M.P. George Galloway on June 6th, when oil had risen by $11 to $139 in a single day and it just kept climbing!

Your graph is a good accompaniment to this text.

Yes, I agree, and I might be being optimistic, as is Richard Pike the CEO of the Royal Society of Chemistry who thinks that there is no immediate peak-oil problem because there is more oil in the ground than the cautious figures offered by the oil companies indicate.

However, if that oil does eventually cost $100 a barrel to extract then the economic situation may well not allow the development to get at it. Then we have a "rate of recovery" problem and a demand-supply gap.

The credit crunch has caused the putting on hold of numerous development projects across the world in all sectors, including oil and without an upturn it is hard to see a near change in that.

As I have commented before, my fear is that the oil-problem will bite hard on the tail of the recession, leading us into a "Long Emergency" situation as Kunstler has termed it.

Much regards,


Anonymous said...

Yes, I also believe that the "rate of recovery" problem will probably hit before geological Peak Oil (1) and will be the main acknowledged limiting factor in oil production, in the near future, coupled with a shrinking investment-and-money-lending-capability problem affecting all world economies. It seems very likely, today, that both components of this newly emerged “problem couple” will reinforce each other by exerting on one another negative retroactions.

I got aware that such negative synergy might settle in, at some point in the future (then reversing growth into contraction), preceding the arrival of geological Peak Oil, after I had attentively considered an article (2) in which Yves Mathieu (a French engineer, Institut Français du Pétrole), was saying : « Le pétrole pourrait connaître le début de son déclin, non par manque de réserves, mais surtout par manque d’investissements financiers … » (“Oil could begin to decline not because of shortage of reserves but mainly because of shortage of financial investments …”).

And I am also aware, now, that our present global financial system has recently become looped on itself since major industrial nations on one hand are heavily indebted to the private bank network and, on the other hand, lend money to that same network, whenever required, so as to keep it viable.
Looks strange and very much like a snake feeding by eating its own tail, does it not? (4)
Well, how can such crazy system exist and survive, at least temporarily?

Very simple : The set of interface institutions through which these nations lend (let us call it “Point A”) and the one through which they borrow(“Point B”) stand opposite to each other within the two-side leverage system allowing private banks to lend much more money (usually nine times more) than they own as deposited assets in some world-central-bank-network institution.
[This leverage system is the very process by which the private bank network creates money on its credit side by creating debts on the liability side of borrowers, most of them investors. The process of creating money out of debts is remarkably well explained in a video entitled Money as debt, by Paul Grignon. (You Tube)]
As “Point A” stands on the “before-multiplication side” of the leverage system whilst “Point B” stands on the “after-multiplication side”, the industrial nations can borrow much more than they have to lend and hence get plenty of money from this marvellous multiplicative machine.

That sounds as miraculous as Jesus multiplying bread and fish, does it not ? … But what has to be done so that such miracle be accomplished?

Very simple, too : You just have to take advantage from the existence of markets in expansion allowing a sufficient number of investors to borrow money, reimburse their debts (+ interests), make profits and reinvest part of them in such a manner that economic growth be sustained. The faster growth, the better miracle perpetuation.

The only problem is that economic growth feeds with energy produced at low cost and sold at low price while at the same time being able to satisfy growing demand. The bank’s high money-lending capability generally observed since a few years after World War II and until the beginning of the present financial crisis stemmed from the industrial world’s ability to increase year after year its annual energy production, as show the energy production curves drawn from the “Schilling & Al. (1977), IEA (2002), Observatoire de l'Energie (1999)” data (3). Now, in the face of relentlessly high energy production costs and shrinking recovery rates, over-indebtedness will probably go relentlessly inflating while solvent borrowing investors become fewer and far between…

(To be continued, twelve month from now, after having examined next year’s events.)

(1) I do not think that geological Peak Oil can be precisely defined, as it depends on what kinds of crudes are considered and which production cost we are prepared to pay. I do not think, either, that its date of arrival can be accurately foreseen.


(2) Article entitled « Du pétrole, jusqu’à quand? » (“Oil, until when?”) in the French magazine “La Recherche”, Mars 2008, cahier special, n° 417).


(3) I believe such curbs (and future updated ones) will be considered with great interest by the future historians who will first describe the meta history of the whole industrial civilisation before considering its detailed sequences of events.
These same historians will also consider with great interest your “Recent History of Oil Prices”… if, by chance, it does not belong to the 99 + almost 1 % of present-time written texts that will have been thrown away or lost. Why such interest? But of course because it concerns, on one hand, a very important and characteristic commodity and, on the other hand, a crucial transitional period connecting two different epochs within the Oil Age … an Age that will no doubt appear to them as the culminating episode of human evolution.


(4) I recently perceived that image, at night, around dawn, in a dream in which I saw my banker changed into a snake. As it began to contort, I got very uneasy. At some point, the contorting snake folded on itself and its mouth began to eat its tail … Then I awoke, relieved to observe that it was just a bad dream… but kept awoken and began to think … and after a while’s pondering got the vision of the leverage system with points A and B.

I am not kidding, really, not plagiarizing Kekulé’s story… Believe it or not.

[You surely know this story : after having unsuccessfully tried to vision benzene as a linear molecule, the German chemist Friedrich August Kekulé (1829-1896) had a dream, one day.

He had the dream that… No, not that one, concerning some famous speech, by somebody else …

I try again.

Kekulé just dreamt about a circle-shaped snake biting its own tail. From that dream he drew the idea that benzene was a cyclic molecule.

And it was later proven that he was right.]


I will now try to stop thinking so much, for a while, about the newly born brave world that just begins its first year of existence … Oh, by the way, I wish you, Chris, a merry Xmass and a happy New Year.


Professor Chris Rhodes said...

Hello Andre'!

Yes, I think we agree on these matters. Might I ask you if you would mind if I include the graph you drew the other day about oil-prices - with acknowledgement to you for your kindness of course! - in my forthcoming book, "Growing Our Way to Hope" which is based on some of the topics on this blog?

My first novel is due for publication next March, called "University Shambles" but I want to try and promote the second one on the back of the first.

The combination of the oil problem and the credit crunch is really quite lethal, and the newspaper headlines this morning are not good for Britain. 2009 will prove a very testing year, I fear.



Anonymous said...

Hi Chris !

Of course, you can display that graph in your book. If you do, I will feel very much honoured.

I fear, too, that 2009 may be a very testing year, not only for Britain, but also for the whole world.

Much regards.


Professor Chris Rhodes said...

Hi Andre'!

bless you. The honour is mine!

Right, I shall just need to finish writing the book now!

I think we are in that (Kunstler) Long Emergency situation now...

Better hold-on tight!

Much regards too!


Unknown said...

The ethanol situation is a moving target that bears watching says Shawn Bartholomae, CEO of Prodigy Oil and Gas Company in Irving, Texas. The financial impact on US citizens has not all been good, with the price of corn dramatically driving up the cost of beef, cereals, etc. The battle goes on as engine manufacturers say damage will be done to cars at higher level of ethanol mixed in with gasoline. Now it is even beginning to be a State vs. Federal legal battle. Where will it all end?