The energy analyst returns! One of Slope's readers, a very experienced energy analyst, has been kind enough to once again pen a guest column. As before, if you'd like me to forward a note or simply your email to the Energy Analyst, just drop me a line. Enjoy!
The post on oil received several interesting follow-up questions, which I will briefly address. The first question was on the concept of peak oil. This is a fascinating topic and I have spent several years researching the topic with some of the key proponents. My own view is that the world is not at peak oil yet, but the roof is not that far away, perhaps only 5 ? 10 million barrels per day (b/d) of additional output from an all-in base of approximately 85 million b/d. This is not a lot of up-side. Moreover, the cost of extracting these incremental barrels has sky-rocketed due to a host of constraints including land, skilled labor and materials, all the classic economic inputs, and it takes time to develop these massive projects. For example, the current cost for expansion of Canadian oil sands is projected to be over $125,000 per barrel of daily capacity and can take 5-7 years from start to finish. The only plentiful input is money, but money can?t change time or geology and it can easily be wasted on the wrong projects. It is safe to say that the era of ?cheap? oil is over.
The central problem the world faces is that demand growth is out-stripping supply growth. For decades this was not a problem as there was significant spare capacity. It is clear that demand crossed the supply equilibrium several years ago. If new supply is not the answer, then the only solution to high oil prices is demand destruction. Unfortunately, the price required to kill global consumption may be even higher than $120. So far, only US demand has shown any weakness. The rest of the world continues to consume more oil y/y, and it?s not just China. Even at $100 plus oil, I project global demand will be up another 1 million b/d this year. Part of the problem is that as US consumption moderates, demand in the Middle East has soared. Makes sense given the financial flow. Moreover, almost all emerging economies (China, India, Mexico, Middle East, Russia, Asia) actually subsidize energy prices. Therefore, there is a greatly delayed global consumer response to higher prices ? the market feed-back mechanism is broken.
If the rest of the world does not cut oil consumption because retail prices are artificially low, then it will be up to the US consumer to cutback because this is the only large market with real-time prices. Ironically, it could take a huge oil price for the US to cut enough demand to off-set growth in the rest of the world ? we might have to experience a lot of pain. Think airlines and truckers. Note that we have provided China with $2 Trillion in US dollar reserves to subsidize low oil prices in that country. So it?s more complex than just a simple emerging market secular demand growth story, which is pretty powerful in itself. I can safely predict that world oil demand would go down if retail prices actually went up, but it is not happening right now. I can also safely predict that China will not raise the price of diesel fuel in that country before the Summer Olympics. Even then, increases will be halting as social harmony is more important in China than is the cost of fuel subsidies. Unfortunately, I think the US consumer will crack before the Chinese government.
One writer suggested that ?something else was going on in the oil market? and, that perhaps a potential issue with Iran was the answer. All I can say, is that there are multiple aspects to the problem ?it is not a ?single?, convenient issue that can be addressed and it all goes away. The market has tried the single answer explanation (inventory levels, hurricanes, Iran, dollar etc) and none of them have worked. Interestingly, global oil inventories do not reflect evidence of hoarding, or preparing for a US issue with Iran. I do agree that it makes no sense for the US to continue to fill the strategic reserve, but I conclude that it is another example of one arm of the government not understanding the ramifications of its policy actions. Another example is the ethanol policy.
