Our brother Fabius, who evidently writes about oil was courteous enough to inform me that he has posted the following in his blog. I thank him for his help in explaining this complex phenomenon. So many have sought to help in similar ways. I am especially grateful to the army of social scientists who "lent a hand" in so many ways. pl
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"Colonel Lang shows us why the 21st century might prove difficult – even painful – for America"
An especially clear example of this appears in the posts about oil by W. Patrick Lang (Colonel, US Army, retired) at his blog, Sic Semper Tyrannis. His observations about military and geopolitical affairs are IMO consistently interesting. About oil, however, he confidently tells us of things outside his area of training and experience, about which many of the world’s top experts speak tentatively — as there are alternative explanations with strong supporting evidence. As the IEA states in its ”Medium-term Oil Market Report“, 1 July 2008 (see the free slideshow here):
Like alchemists looking for a way to turn basic elements into gold, everyone wants a simplistic explanation for high prices … often it is a case of political expediency to find a scapegoat for higher prices rather than undertake serious analysis or perhaps confront difficult decisions.
These posts are worth reading, as I believe they illustrate many of the cognitive errors hindering America’s adaptation to the changes looming ahead in the 21st century. To repeat, they are interesting because of the quality of their source (Colonel Lang). They are another bit of evidence showing that America’s broken Observation-Orientation-Decision-Action loop is not just a function of the wrong President — or the wrong Party in office — or influential neo-cons. Its causes perhaps lie within us, collectively.
These are all short posts, which I believe these excerpts adequately represent. For discussion of these issues see the links in the text or those at the end of this post. Note: this site has no short-term forecasts of oil prices. The experts have done poorly enough at it during the past few years; my amateur errors will contribute nothing to that debate.
“King Abdullah and the speculators“, 15 June 2008 — This illustrates over-simplification. The Saudi Princes are playing a complex game, seeking to maximize their oil income without antagonizing their chief ally — or destabilizing their domestic political situation. Lang notes their pleasant words and token gestures (tiny short-term production increases) which have proved effective in soothing Americans as oil prices have risen from $20/barrel to over $100 — a 5x increase in 8 years. Given Lang’s background, we might expect a more subtle and broad analysis of the Saudi’s actions.
Sooo, the Saudi king is going to increase production at the margin on crude oil going into the spot market and this is expected to lower the market price on deliveries of crude to refiners. That, in turn, is expected to cause a failure in confidence in the whole nasty complex of capitalist hedge fund managers, index fund managers, bankers, advisers to same, and individual mega-investors. It is hoped/believed that this failure in confidence will cause the players to lose faith in their ability to pass the risk along to the greater fools waiting somewhere in speculator limbo. After that set of developments the price per barrel is supposed to fall, a lot. I believe this to be true. We will assemble here afterwords to gloat, or not.
“‘Speculators accused of dictating oil prices’“, 18 June 2008 — One distinguishing aspect of Lang’s posts about oil is the lack of reference (or even apparent awareness) of the vast expert literature about these issues (for a small sample see here). Everyone gets to have an opinion, but he makes little effort to support it with evidence. This is a common characteristic of blogs.
I offer the opinion that the “fundamentals” of supply, demand and all the other undergraduate economics concepts that we all remember from long ago do not adequately explain the pricing process that now prevails in the oil and financial markets.
“The Oil Meeting at Jeddah“, 21 June 2008 — Here we have “ignoring the big news”, one of the most powerful and frequent cognitive errors of American leaders. Lang’s comments about the Saudi’s are hilarious, given their announcement in April (after hints over the past few years) that they will not be increasing oil production as expected over the next decade or so. This initiates of “political peaking” of global oil production (see here for more evidence). This has resulted in increasingly alarmed forecasts by the world’s major government energy agencies (e.g., the EIA and IEA).
We are about to enter a period in which a major lesson will be taught to the world regarding the fact that market prices are more a product of mass perception and a form of hysteria than they are of “hard data.”
Greed feeds greed. Prices in oil have been rising because there was money to be made in the atmosphere of “casino” gambling fostered by the impatience of the young and ruthless adventurers who dominate the derivatives markets.
… The Saudis are going to lend a hand in that process this weekend. The amount of the increase in their production is not significant as an incremental rise in the world’s oil supply. Its significance lies in their stated intent to cripple the process of parasitic speculation in a vital commodity.
“The Oil Meeting at Jeddah -2“, 22 June 2008 — Good reporting.
“The oil bubble is leaking“, 19 July 2008 — Here we see the triumph of an amateur making a successful single short-term market forecast, made with 50-50 odds. Investment professionals do this for a living, and the market teaches them to do so only with caution — and expectation of a low batting average. His confidence that it is a long-term problem — not today’s — is extraordinary, given the fact that global oil production has been flat since early 2005 (which explains the rise in prices since then).
I told you so! Ah, that’s not very mature. Yes, but it feels sooo good. Down how much last week? What’s that again? I couldn’t hear you…
It is true that there is a severe supply and demand problem in crude oil supply, but it is a long term problem. As is often the case, the time-scape of this problem is one of the most important parts of it. There clearly is not enough oil in the ground for humanity to continue using it in the ways that we have been doing. Growing demand in newly industrialized places like China and India exacerbates that problem. The solution to the supply problem in energy lies in new reliance on different ways to produce electricity. Cheap electricity would enable short distance drivers to use electric cars and could eliminate the absurd reliance on fuel oil to heat buildings in the deep north. That would produce a very different situation. Al Gore is calling for windmills, etc., but the real solution (as he says) is nuclear power. The Greenies will have to “suck it up” and accept the idea. Hey, the French get most of their electricity from nuclear power. The Francophobe crowd should take that as a challenge.
The short term problem is not the same. This is and has been a bubble generated in the ways that have been discussed in previous articles. Short term investment in the futures and spot markets have driven prices to levels unrelated to present supply and demand. The markets have recently been a fantasy world without real limits for movement on the up side.
The bells are now tolling for that fantasy. The smart people who stand to lose from this festival of childish greed have been kicking the psychological props out from under the process of finding bigger and bigger fools.
You don’t think so? Good. It will be amusing to see how much money is lost in your disillusionment. Sometime in the next few months the price per barrel will fall below 100/barrel. It will be interesting to see how far it falls below that level.
“More oil leaking from the barrel“, 22 July 2008 — The world is so simple when one has a master narrative explaining events — that rendering one superior to experts who see the world in terms of many complex dynamics! This is one of the most common sources of error — often folly — on blogs.
The last month or so I have been watching the various TV financial market networks. Marvelous! These “analysts” by and large have no idea at all as to what really moves the various markets. They just mouth the received wisdom and describe what happened as a forecast of what will happen.
“The oil “head game” is collapsing – for now“, 24 July 2008 — Peak Oil is described by experts as a process taking place over years — or decades. Lang calls it off based on a few weeks decline in prices, what might be (who knows?) just a correction in the rise of prices extending back to 2001 (or 1998, depending on one’s perspective).
What happened to all the babble on the 24/7 news about the end of western civilization as we knew it? What happened to the images of Ali Velshi (aka – “the bald headed prophet of doom”) trudging across the Alberta tar sands, gloating over the pain?
“Kudlow – “Drill, drill, drill, so that the futures traders will flee“, 4 August 2008 — The confidence Lang’s exhibits in the first line below is classic Americana. Such confidence has worked for us in the past when tempered with the knowledge and judgement. Has our great successes in the 20th century resulted in us losing this precarious balance? The next line exhibits the ancient but enduring dream of easily manipulating markets so that they better meet our needs — to the detriment of those on the other side, in this case oil producers. Excerpt, quoting the economist Larry Kudlow:
He gets around enough in the right circles to know that short term traders in oil futures are the fire behind the crude prices we see now.
“… Ah,” he said (roughly). “Approval of drilling will frighten the futures traders out of the market and the price will go a long way down.” “They are already leaving the oil futures market” he went on. “This will push them out even faster.”
“The price per barrel – down, down, down.“, 15 August 2008 — Like most people not familiar with the operation of markets, Lang shows no awareness of the normal volatility of markets, nor the need to describe their direction on the basis of long-term trends — not short term movements. Every professional working with markets — both as investors or commercials — often finds short-term movements to be incomprehensible. Excerpt:
The TV business channel 24/7 crowd have more or less lapsed into sullen quietude over the continuing fall in the price of the oil commodity. Why? They can’t explain it in terms that they are willing to accept. Some of the anchors are restive and asking embarrassing questions that are “slapped down” as quickly as they arise.
“How to burn the speculators” – Galbraith“, 20 August 2008 — In my opinion, nothing illustrates America’s dysfunctional thinking better than calls to tap the Strategic Petroleum Reserve (SPR) in hopes of a short-term decrease in oil prices. Filled at vast expense when oil prices were far lower, it is our best protection against any one of the thousand events — natural or deliberate — that could interrupt the supply of the most vital input to the global economy. As Chet Richards notes, the SPR is the closest thing America has to a national savings account. Tapping it other than in an emergency is like eating one’s seed corn: it feels good but has long-term costs. Not only can the SPR be re-filled only slowly (to avoid pushing prices up), we might consider it too expensive to do so. Many respected analysts forecast substantially higher prices in the next few years, as new sources continued be delayed and production declines from existing fields (e.g. Cantarell, North Sea) continue at horrific rates. Excerpt, quoting from “How to Burn the Speculators”, James K. Galbraith, Mother Jones, September/October 2008:
Finally, the federal government should burn the oil speculators by selling up to 4 million barrels a day from the Strategic Petroleum Reserve. And as economist Tom Palley has pointed out, consumers can help too. An awful lot of gas is stored in cars. If people stop topping off and make do with half a tank, they’ll back up supply and lower demand. It’s a brilliant suggestion and definitely worth a try.
Advising us to fill to only half a tank is bizarre. Since auto manufacturers recommend keeping at least a quarter tank, this means lines at gas stations as people make frequent visits. The effect will be to decrease gasoline demand while we draw down our inventory — and increase prices when we refill them. The net effect is a period of increased volatility to the long, complex energy “pipeline.” Meanwhile, the date of Peak Oil comes ever closer, while we play games that do nothing — absolutely nothing — to prepare for it.
The Hirsch “Mitigations” report — the closest thing America has to a sensible proposal for an energy policy — shows that it will take two decades to prepare/adapt to Peak Oil. The clock is running.
Afterword
Lang’s posts are among the best – informative and well-written) on the Internet about geopolitics (defining the term broadly, as I do on this site). As evidence, read some of these.
About the Presidential candidates
- “Biden is a fighter, and a screamer.“, 23 August 2008
- “Frank Rich on ‘Change’“, 24 August 2008
About Iraq
- “Will Maliki “torpedo” the peace?“, 22 August 2008
- “Can outsiders manage change in alien cultures?“, 17 July 2008
Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For more information about Peak Oil
Here are some of my posts about Peak Oil.
- When will global oil production peak? Here is the answer!, 1 November 2008
- Links to articles and presentations of some A-team energy experts, 11 November 2008
- The most dangerous form of Peak Oil, 8 April 2008
- The three forms of Peak Oil (let’s hope for the benign form), 23 April 2008
- The world changed last week, with no headlines to mark the news, 25 April 2008
- Peak Oil Doomsters debunked, end of civilization called off, 8 May 2008
- When the King of Saudi Arabia talks about oil, we should listen, 2 July 2008
- The secret cause of high oil prices, 6 August 2008
Here is an archive of all my articles about Peak Oil.
Here are other resources to learn more about Peak Oil.
Colonel:
Michael Klare is the author of Blood and Oil, an outstanding exposition of the evolution of our military to an “oil production and transportation service.” Here’s a recent article of his from the London Review of Books.
http://www.lrb.co.uk/v30/n16/klar01_.html
While I would agree with the long term truth that “Peak Oil” is coming, and sooner than anyone wishes to face, basic supply and demand fundamentals can in no way explain the price rise in either oil, or its refined products, over the past few years.
As someone who has done financial analysis for now 2/3rds of my career, and still has to drive rather sophisticated financial planning models, my complaint is threefold. One, most people who claim to know “markets” are closer to being qualified to bag groceries than to comment about markets. Two, most people who comment about capital and operating costs can’t read an income statement or the Notes to the Financial Statements. Three, most people who comment about prices, know less about foreign exchange dynamics than they do about quantum mechanics and the unified field theory.
In regards to the first point, Col Lang’s recent commentary of the futures markets had much validity. I can assure you that a goodly portion of the price rice has been due to such speculation and manipulation. In regards to the former, it is difficult to run an analysis of buy / sells and money flows since there has been no transparency in the market. Blame Phil Gramm, his wife and the Enron loophole. Having met with and seen the operation of the old Enron folks, as well as the people from the Goldman Sachs trading desk, well, these folks would push their 80 year old grandmother in front of a bus for a quarter. As with the circa 2000 California electricity shenanigans, the recent partial closing of the loophole, along with increased visibility, prices have started to abate, notwithstanding all the talk that the price rise was almost wholly demand driven. The obvious caveat is correlation does not insure causality, but if these folks could manipulate the market they would and will manipulate the market. Regarding the concept of “market power”, I would point to two interesting metrics: (1) refining output as a percentage of capacity is actually down; (2) US exports of refined products are at their highest levels ever. Again, economics 101 calls that market power or the ability to generate higher profitability by deliberating generating less output. In other words, US refiners are operating their plants at reduced levels than in the past while simultaneously shipping more product out of the domestic market. Again basic economics, less domestic supply of refined product, results in higher price retail price since as well noted, demand is very inelastic in the short term.
Regarding, capital and operating costs, just once please just once, I wish someone would differentiate between the two. Regarding capital costs, remember first, at least for US taxpayers, that at the most basic level the capital expenditure generates a tax shield roughly equivalent to the effective tax rate. So, that 1 billion dollar oil platform in the Gulf of Mexico or the North Slope, really only costs 65% of that. Now take into account all the other bennies that are sprinkled throughout the IRS code for drillers and refiners – to which admittedly I am not an expert – and I’d wage that the USG is picking up more than ½ the cost. Roll that into a full blown net present value analysis, and I’m sure none of us need to shed a tear. In regards to operating costs, while it’s a nice buzz word – “operating costs” – it is essentially meaningless without additional information. Talk about gross profit, talk about gross margin, on a product by product basis, talk EBITDA margins. Talk about when margin in important and when absolute dollars are important (hint: while high margins are necessary with low volume and high overhead, low margins are perfectly acceptable with low ”unit overhead” and high volume.)
Finally, in regards to Foreign Exchange, I will readily admit that every time I have to wade into that pool it gives me a headache. I’ve come to realize that it is principally due to the fact that as a American, I’ve never had to learn it intuitively since the USD was always the worlds reserve currency. However, one could do what I did a couple of months ago with easily available statistics from the DOE and historical FX rates pulled from Yahoo. Run the correlation between the price of refined products over the past 6-7 years between the US and the EU. You’ll find that while the retail price in the US has gone up by approximately 150%, the price in Europe has only gone up approximately 50%. While admittedly this is simplistic and doesn’t account for all the inputs, it does strongly imply that the collapse of the value of the dollar vis-à-vis other currencies represents a huge component of the overall price increase of a barrel of oil since oil is priced in USD. After running these and other numbers I roughly estimated that 2/3rds of price rise was speculation and FX effects (with the FX effect being larger than speculation) and one third being supply and demand fundamentals. Your mileage may vary.
While this is overly long, let’s take a quick look at Exxon Mobile, to see if we need to cry for them. From their 2007 10-K to the SEC, they had $390 billion in revenue, 70.5 billion in income before tax, paid $30 billion in income taxes resulting in 40 billion of net income. Now you might say that, well look at how much they paid in taxes and a 10% net income margin ain’t too hot. But they had only 12.2 billion of depreciation and depletion on that 390 revenue or only 3% – I just ran that number and still don’t believe it. Also don’t be fooled by the net income number, look to the cash flow statement: $52 billion in income from operations. Also from that cash flow statement, only $15 billion in capital expenditures or 4.8% of revenue. I could find you almost any rural US elec coop or telco that spends triple that as a percentage of revenue. Finally, while that Income tax number of $30 billion seems mighty impressive, – again looking at the notes to the financials you’ll find that only $5 billion was taxes paid to the US government – the rest was foreign income taxes. I do have more than a passing familiarity with Subpart F of the IRS code so I have full sympathy for all the foreign income taxes they pay, but one has to realize, that when we offer tax breaks and subsidies to – ostensibly US companies – who pay the vast majority of their taxes overseas, we are really subsidizing overseas governments and consumers.
Wow! What a great comment by dcgaffer. Very helpful. Maybe part of the explanation is that between the 2008 and 2028 election most of the top 10 US domestic oil companies will be long gone from the energy business. So no reinvestment required. As the world moves well above 80% of proven (and unproven)reserves held by NOCs (National Oil Companies) the liklihood of US major oil companies finding countries willing to allow the majors to exploit those countries oil and gas reserves will be de minimus. Question is what will US policy be when oil and gas reserves are held 95% by NOCs. Certainly Putin has already announced publicly long ago that he would view oil and gas production and distribution as an arrow in the quiver of Russian national security. Just playing out more and more each day now. Certainly more than likely by 2028. Remember the 1917 Mexican revolution was an “Oil” revolution ending up with PEMEX.
Col., I commend you for posting this link and analysis. More than the subject under discussion, it shows what sort of a person you are, how this blog is so different, and so superior to most others.
While agree with Fabius, I must say that his analysis is also rather thin on facts and references that he faults you for omitting. I believe that your commenters, myself among them, have raised points that Fabius identifies in his piece.
Fabius also errs in not referring to the comments. One of the great innovations of blogs is the ability to continue, refine and advance the argument and discussion through comments, where all sides of the topic may be aired and examined. Ideally, this can lead to an ‘intelligence of crowds’ where the ‘hive mind’ arrives at better answers than the average individual. Though this is not guaranteed.
The oil market is not a pure or perfect expression of Adam Smith’s capitalism. Like all investing, there is an element of wagering, and the opportunity for gaming by various parties. However, this is the long-established method by which commodities are bought and sold, and investment in companies working in this area raise substantial amounts of capital. No one complains about the workings of commodity markets when prices are declining.
None of us like having to pay more for gasoline and fuel. But in the absence of a coherent and functioning national program to move towards energy independence, it is only rising prices that produce any tangible action and improvement.
As dcgaffer suggests above, we are to be blamed in not properly overseeing energy companies, and not properly accounting for their activities and taxing their profits and operations. As with Enron, we are socializing the costs while privatizing the profits. That is nothing to be happy about, and it is not in the public’s or the country’s best interests to continue in this way.
jon et al
My comments on the movements of the oil markets are made on the subject of the psychology of the financial markets.
I have never attempted an analysis of the economics of the underlying commodity market in oil.
Since thatis so, I do not think it is correct to say that my analysis lacks data. pl
So far as long term & short term & medium term & trying to figure out when the top or bottom may arrive, or how the various cycles repeat,
I have books & books & books on my shelves that claim to do exactly that. Charts & graphs & analysis from experts of all stripes. Both self-appointed & self-deluded. The best analysis that I have seen are astral, but astral is not socially acceptable.
On the other hand, I have seen many books on how to invest in the markets. Few of these books were intellectually stimulating, and for a reason. The average market trader is not a Great Thinker. He simply wants money. Lots of it. Simple, clean, pure ideas are the only ideas he understands, wants or needs. He is emotionally volatile, he is easily swept up in the herd mentality.
Which, by the way, is why astral analysis will always be better than intellectual. One analyst, an astral-libertarian, declares flatly that by 2016 we will have abandoned markets altogether, which I think horrifies him, but I digress.
It is sometimes true that amateurs, standing outside the pack, may actually get things right. Sometimes a cigar is just a cigar. Sometimes greed is just greed. Just as Microsoft Windows has been repeatedly gamed by a handful of intensely-focused virus writers, the markets are, from time to time, gamed by a handful of intensely focused speculators. They enter the market when they are ready, and if they have judged correctly they will make their money and then move on.
When they are wrong – which I suppose is most of the time – you will never know they were there.
Excellent comment by DCgaffer.
My only question:
What are we to make of Paulson when he goes to the UAE, as he did in early June, and tells the Arabs that “speculation” and the “weak dollar” are only “minor factors” in the high price of oil?
PS: this is a leading question that relates back to some of your well-taken points.
Cheers.
Three quick comments:
1. I did not read the comments to these posts. Thanks for the good idea; I will do so in the future.
2. re: “his analysis is also rather thin on facts and references ”
At 2300 words, my post was far too long (far longer than any of Col. Lang’s on this topic). There were some links in the posts to supporting material; links at the end wemt to extended discussion of these complex issues.
3. I do not understand dcgaffer’s point. I repeatedly said that there was debate among experts about these points, which IMO Col Land did not represent.
Trivia note: While Klare has an impressive background, is he an expert in the market-related dynamics discussed here? From Wikipedia:
“Michael T. Klare is a Five Colleges professor of Peace and World Security Studies, defense correspondent of The Nation magazine, and author of Resource Wars and Blood and Oil: The Dangers and Consequences of America’s Growing Petroleum Dependency. … Klare also serves on the boards of directors of Human Rights Watch, and the Arms Control Association. He is a regular contributor to many publications including The Nation, TomDispatch, Mother Jones, and is a frequent columnist for Foreign Policy In Focus.”
Kudos Colonel for posting and hosting this discussion including Fabius’s posting. I find myself in agreement with both yourself and Fabius, too. Here’s why:
IMO, there are several issues at play here, the first being long-term and related to peak oil, a second, also long-term being the collapse of the dollar and the rise of all commodities and prices of imported goods (even official statistics on inflation levels suggest are bouncing between 5 and double digit values and there is good reason to think are understated), and the third being short term variability such as the recent run up (and run down).
An excellent analogue to understand what is likely to happen in a market system when near its peak is to look at whale oil. Here I summarize from the story of whale oil:
http://europe.theoildrum.com/node/3960
Whale oil increased from tens of dollars in the 1810s to over $1000/gallon at its peak in the 1860s. What is very interesting is that the price is quite stable and follows a reasonably smooth, increasing curve during the initial phase – where production can relatively easily increase to match increased demand but once peak whale oil was neared, began to fluctuate wildly – factor of two in a few years time up and down!. These short-term fluctuations results from speculation and a captive (inelastic) market – i.e., there are many consumers who have no alternative but to buy at the price offered or declare bankruptcy (or sell the exurb house). Once alternatives became widespread, the price returned to low levels and stability (1870s).
Petroleum is far more important to the functioning of the world economy and more likely to trigger resource wars, etc. In this regards, making speculation less profitable (more risky) could smooth these fluctuations, which is one of the functions of cartels. Using the SPR in this function is IMHO an appropriate strategic use.
With regards to the peak oil angle in this thread, I encourage you to to read the latest update to the Oil Megaprojects initiative via The Oil Drum Note their projected decline in production beginning in 2012. But this is not equivalent to supply. Supply will equal production minus the oil removed from the market by nationalist policies and by the increased demand for oil by exporting nations. Oil will be in very short supply as we come out of this economic slump.
Fabius gets half-credit for his work here, because he got half of his assertions right, namely this one:
His observations about military and geopolitical affairs are IMO consistently interesting.
On the other stuff, Colonel Lang is not writing about long-term price behavior, as he has made abundantly clear here. So when Fabius points out in his posts (yes, I’ve read them) that he’s discussing long-term price behavior, one can only suspect that he’s in violent agreement with Colonel Lang.
And anyone who believes that Peak Oil (the aggregate reservoir production physical response, not the mass hysteria induced by the term) is the reason for the recent wild swings in crude oil prices ought to “show their work”, because the math just doesn’t add up.
Here’s the summary version of mine…
Peak Oil is a term that captures the aggregate production-vs-time response of world oil production. If oil is a finite resource (and all the serious science tends to indicate that it is, some Russian “experts” to the contrary), then eventually any form of extraction technology will induce peaking (in every reservoir, and thus in aggregate for world supplies), so the production-vs-time curve for individual wells, or for the planet itself, tends to be modeled by bell-shaped curves much like those found in statistics (or made fun of in Taleb’s book).
In reality, the production curves are not of the shape postulated — they tend to decline faster than they increase, which means that we are likely overestimating the ease by which we can extract oil from individual, or collective, reservoirs.
Which is part of why Hirsch’s report suggests doing something early on, because we’re already on the unsafe side of our fundamental assumptions.
There’s more to Peak Oil than that, e.g., the price per barrel makes the resulting math nonlinear because extraction margins depend on crude oil prices, so we improve technology for extraction as oil gets more expensive, etc, etc.,… but none of these other issues changes the fundamental truth, that we need to be dealing with the peaking of our available oil supplies. We really do…
But this is what we call a “secular” or “slow-time” phenomenon, because said peaking is something that takes place over decades. Its effect on the oil-price-vs-time curve is to induce a slight positive slope, so that even after one corrects for inflation, value of the dollar, foot-pounds per man-hour, or whatever, the price-vs-time curve still rises slowly with time.
But that’s not what the posts at SST are about! We are discussing fast-time fluctuations in price of crude oil, and those simply CANNOT be created by the physical phenomenon known as Peak Oil. Reservoirs and extraction infrastructure don’t operate in fast time — and hence these cannot produce such changes by themselves.
Peak Oil can influence the market in fast time (i.e., recent events), by psychological means that every student learns about in ECON 101A. If all of us believe that oil is suddenly more dear, then we’ll pay more, and if demand is inelastic, folks at various places in the supply chain can make a killing.
Including speculators.
Daring to point out the key role of mass market psychology in setting prices (or how markets can be manipulated when supplies are tight and demand is inelastic) is not a denial of the problem of Peak Oil.
It is simply assigning blame for the short-term behaviors of the market.
The secular behaviors are due to many things, including Peak Oil reservoir extraction problems. But that’s not what Colonel Lang has been writing about, so there really is no problem here, beyond what I find to be an inaccurate characterization of the Colonel’s intent.
Sorry for the length of this, but at least I didn’t start trying to expand partial derivatives of price via comment text! Thank your lucky stars for that…
Great discussion above. For more info that is easily accessible, check out the following links.
Former Oilman/Shell exploration geologist Dr. Jeremy Leggett explains the market, the ‘debate,’ fudging of official numbers a BP, etc. (highly recommended)
http://www.independent.co.uk/environment/what-they-dont-want-you-to-know-about-the-coming-oil-crisis-523830.html?service=Print
The Independent: “Fade to black: Is this the end of oil?”
http://www.independent.co.uk/environment/green-living/fade-to-black-is-this-the-end-of-oil-845092.html
Michael Klare on “The End of the Petroleum Age”:
http://www.fpif.org/fpiftxt/5326
“Michael Klare, The Pentagon as Global Gas-Guzzler”
http://www.tomdispatch.com/post/174810/
“The Pentagon as Energy Insecurity Inc.”
http://www.tomdispatch.com/post/174943/michael_klare_the_pentagon_as_energy_insecurity_inc_
This is a 15 minute news segment from The Australian Broadcasting Corporation http://video.google.com/videoplay?docid=-2125452324977038599
This is a the longer, three-part documentary on the story of oil, from its creation, to its implementation, to the future along with implications of climate change. http://www.abc.net.au/science/crude/
Then there is this RTE documentary from Ireland that is good as well http://www.rte.ie/tv/futureshock/av_20070618.html
LJ,
Leaving aside for a moment the question of how far speculation affects short-term price movements:
If the long-term expectation is for prices to rise (both for oil and for gas), and if moreover an exporting country knows that its own reserves are liable to be exhausted quite rapidly — may it not then be a rational strategy for such a country to pursue ‘nationalist policies’ and limit the amount of its dwindling resources it makes available to the market?
If moreover the importing countries (such as, for example, gas importers in Europe) appear to be either themselves deeply concerned to constrain the power of a major exporting country (such as Russia), or to be allied with a power so concerned:
Might not such an exporting country have particularly strong incentives to limit supply, drive the prices up, and look for alternative export markets that will become far more promising in the context of such higher prices?
Fabius Maximus,
I had always thought you were William Lind draped in a toga. Doubtless I am wrong. Anyhow, it is good to have you appearing on this blog.
I would also second jon’s recommendation that you read further among the comments.
Sometimes, I think it is fair to say, we really do get to an ‘intelligence of crowds’ where ‘the “hive mind” arrives at better answers than the average individual.’
Perhaps because of the Colonel’s somewhat awe-inspiring presence, one finds people from all over the world, with a wide range of experience and beliefs, finding elements of common ground.
(Ironically, this may be a demonstration that sometimes — even if rarely — ‘benevolent dictatorship’ works.)
This is a graph of gasoline prices in Ohio over time:
Ohio gas prices
All that I would add to the discussion is that this graph can probably be superimposed on Obama’s chances of winning the Presidency, and that things don’t look good.
In other words, putting peak oil to one side, the price of gasonline is about to elect the next President of the United States. None of the electrons expended in this post or the comments are wasted.
“In the short run, the market is a voting machine but in the long run it is a weighing machine.” – Benjamin Graham
This is the essence of what Pat’s posts were on the short term prices of oil, in my opinion.
Two points need to be made:
1) Speculation and peak oil are not mutually exclusive. In fact, a rising market is an ideal time for speculation. Heck, even I made 40% on the oil stocks and funds I invested in in 2004.
2) The coronel attributes the speculation to market psychology. However, the only difference between “market psychology” and manipulation is the intent of the participants. As the number of trader consolidates (which it has), the propensity to engage in “oligopolistic pricing” increases.
“CFTC Chairman Reuben Jeffrey recently stated: ‘The Commission’s Large Trader information system is one of the cornerstones of our surveillance program and enables detection of concentrated and coordinated positions that might be used by one or more traders to attempt manipulation.’
In contrast to trades conducted on the NYMEX, traders on unregulated OTC electronic exchanges are not required to keep records or file Large Trader Reports with the CFTC, and these trades are exempt from routine CFTC oversight.”
http://www.engdahl.oilgeopolitics.net/Financial_Tsunami/Oil_Speculation/oil_speculation.HTM
In conclusion, it is mere speculation to attribute the recent rise in prices to either manipulation or “market psychology.”
I imagine one component of speculation has been the roulette game of Peak Oil–when will the supply crunch come and how big will it be? If you bet the right time the profits will be huge.
With regards to NOC and Russia using oil as a weapon, in response we will revert to coal, being a short-sighted and dis-functional country and continue poisoning ourselves.
DH, Yes. I think we agree. I have been in consistent disagreement with PL about the significance of speculation in the oil markets. Whatever place speculation has in driving the price of oil, real supply and demand concerns will continue to play a significant part in the pricing of oil. IMO it will take a severe recession to keep oil below $100 for any significant time. Your points are in part what I am saying.
A follow-up to Habakkuk’s commment — I agree, the advantage in many fields of collective judgement over expert opinion cannot be too often mentioned. The classic text here is “The Wisdom of Crowds” by James Surowiecki.
Wikipdedia: http://en.wikipedia.org/wiki/Wisdom_of_crowds
Cieran — you raise many good points. Responding here is probably not appropriate, but if you email me at fabmaximus at hotmail dot com I will send some thoughts about your comment.
These Oil points are all well taken.
My Summary:
Peak oil has come and gone in America. Peak oil has hit Saudi Arabia. OPEC is unable to pump the world economy out of the current demand destruction recession.
There is a statistical correlation between fall of the US dollar and the rise in the price of oil. The fall of the dollar is due to deficit federal war spending and the US trade deficit.
The Iraq Invasion increased the war risk price of Persian Gulf oil. The second largest reserve of oil is sitting in the ground due to Iraqi resistance to the American occupation.
Speculation on commodities without any regulation inherently results in wide swings in prices. Corn ethanol increases food prices.
The lack of a national transportation or energy independence programs insures that America will be increasing be dependent on volatile foreign energy sources. Long distance trips will soon only be afforded by the wealthy and the few who have skills in demand by global corporations. More and more US dollars will be spent only on energy and food.
As I said in my post, there are a host of alternative explanations for high oil prices. This was the point of the quote from the International Energy Agency.
For example, here is an analysis by the noted oil expert Philip K. Verleger, Jr — as explained in ”Explaining the 2008 Crude Oil Price Rise“, June 2008.
http://www.pkverlegerllc.com/TIE0807.PDF
Note, by “market” he is not refering to specualtion, but supply.
Excerpt:
“Start from a very simple fact. The price of crude oil in the summer of 2008 should be $70 per barrel, not $140. The rise from $70 to $140 has not been caused by a shortage. Instead it has resulted from bad policies, bad luck, and incredible inattention to market details by certain officials.
“… In these circumstances, policymakers have very limited alternatives.
* First, they can relax environmental standards. There are supplies of higher sulfur diesel that would address Europe’s current needs.
*Second, governments can release strategic stocks. The U.S. and other IEA members hold significant sweet crude inventories. Release of these crudes (perhaps in a swap) would relieve pressure on prices while preserving environmental restrictions.
* Third, the U.S. can suspend the renewable fuel mandate. This action would allow refiners to boost runs and produce more diesel fuel. Suspension of the renewable fuel act would also take pressure off food prices.
“Regretfully, none of these actions will likely be taken. The failure of policymakers to diagnose the causes of the crude price increase properly makes the adoption of rational policy improbable. Prices will continue to rise.”
Very interesting discussion. I am not qualified to weigh in heavily, but as far as I understand the opposing views, it is something like this: Either the prices of oil reflects a coming structural crisis in supply, and are indications of a coming longterm crisis or B) The pricefluctuations are caused by speculants and indicates a crisis in the market mechanism. Is that about it?
If so, I would suggest that its a combination: The underlying awareness of the “impending crisis”, wether real or not, as well as the instability in the international political scene has given rise to a psychological climate that lends itself perfectly to speculators. When the herd is already scared, a “boo” sound creates a much bigger panic, and panic is the bread and butter of speculators. That there is a crisis in the hyper-liberalistic voodoo market is a fact I think nobody can escape, however. A market that absobs billions and billions of illegal money every year yet doesnt reflect it seems to me to by necessity be built on several flaws. Enron is/was another example on how the paper-money machine has gone out of wack.
“Ironically, this may be a demonstration that sometimes — even if rarely — ‘benevolent dictatorship’ works.)”
As any industrial worker or military person will tell you, benevolent dictatorship is the only thing that works.;-)
This thread contains hints, faints, and occasional hits, at two subjects that are basically verboten in the MSM…and in many parlors in America. i.e. Conspiracy and class. As to dcgaffer’s point that ‘… correlation does not insure causality”, I would respond ‘ensure’, which I assume he meant, is a far too extracting standard for me. Preponderance of evidence works well for my tastes. In a nation dominated by oil interests, and financial speculators, and in a govt dominated by said same, the rise in price of oil et al comes as no surprise to me. Whether I can completely and competently describe manner of the swindle is one thing….whether I can see and sense the fix is in is another. And Fabius, just out of curiosity, what credential/s makes one an “… expert in the market-related dynamics”?
1. I have not seen an empty gas pump or line of cars at a service station in the US for years – either at $40 per bbl or $130.
2. Price does impact consumption and the cars we buy very quickly whether in Hollywood or Darfur. Big oil may be in liquidation mode, but we still need to drive to work and our choices range from a hummer to a prius. Consumers react to price.
3. With 80 percent or so of the world’s oil controlled by national governments, and given that many of them are not inclined to be kind and generous to the west – Russia, Venezuela, Iran, Iraq, Saudia Arabia, Indonesia… How can one not expect a correlation if not causation between political turmoil and pricing? Strait of Hormuz and other issues aside, there are simply huge inefficiencies created by chaos. Look at how inefficiently oil is produced and driven to market from Iraq and Iran not to mention Russia.
4. Would a more rational foreign policy combined with a determined long term effort at maximizing domestic energy resources – renewable or otherwise – not be a prudent national policy direction under any of a hundred scenarios?
When Paris Hilton’s video spoof political ad makes more sense than McCain or Obama, you know we’re in trouble.
Col., you say that psychology is present in commodity and financial markets and responsible for price movement. That is undoubtedly true. Nothing that humans do is ever entirely removed from the effects and influence of psychology.
But the issue that you have posed and pursued, if I understand correctly, is that large and recent movements in the price of oil is largely the work of speculators, as opposed to other factors. This is where I must differ.
I am certain that speculation has been responsible for a portion of the recent runup in oil prices, but only a minority of that movement. Much more of the price movement can be attributed to supply and demand, political risk, weather, production, transport and refining factors. Market movements correlate closely to changes in these factors in the short term as conditions and risks change and are reassessed.
Financial and commodity markets are speculative, and at root games. Therefore they are inherently susceptible to being gamed. They can become more transparent, and manipulative effects lessened, but they will never be entirely rational or just.
Oil is now about six times more expensive than it was before the Iraq War, five years ago. In the past two months the price has dropped approximately one sixth or seventeen percent. These are substantial movements, and the daily and weekly changes have been more abrupt at times. If this is a bubble, it is a pale reflection of Tulip mania.
I think that there is a valuable discussion to be had about the relation of psychology and manipulation to other factors, and the weight, impact and importance of each. I will continue to maintain that one saber rattling speech by Dick Cheney, or Iranian missile launch does more to move the oil market than does financial manipulation. Of course, Cheney’s behavior may be a calculated form of financial manipulation…
We should always be mindful of Zanzibar’s pithy quote of Grahamr.
Col. Lang was likely correct to some degree when he pointed the finger at speculators in the short-term.
“The CFTC…now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency. That figure may rise in coming weeks as the CFTC checks the status of other big traders.”
Washington Post
The rub lies in who is classed as a “speculator” or not, and why, by the CFTC. A highly clueless “regulator” to rely on, this is the agency that had no problem with Enron’s actions in the electricity markets in California, to name one glaring example.
Some real economist Blogs who disagree with that WaPo story, in detail:
EconBrowser
Economists View
They are not so supportive of the “evil speculator” theory. Some great comments to those Blogs too.
Another factor not mentioned in the MSM is the collapse of ‘SEM Group’, a huge Tulsa, OK, energy trader (and 12th largest US private corporation), on July 17. This caused a vast amount of un-winding of futures and related contracts. Apparently they were hugely ‘short’ and sunk when the price did not fall…ironically, they likely would have been fine had the price collapsed a month earlier than it did. Some ‘traders’ who did not ‘trade’ very well, too many one-way bets, it seems.
We have to make a distinction between volatile short-term price actions, and long-term fundamentals. From my own lengthy readings at The Oil Drum and many other places, I see no major flaws in The Peak Oil theory as postulated. Their ‘Export Land Model’ is not comforting reading if you are in an oil-consuming nation.
Sorry, forgot link to the ‘SEM Group’ story:
IHT
I too found Fabius’ lengthy post rather thin on supporting facts to his arguments. And I tend to agree with him in general. It sounds good, but personal observation is not proof. More links to supporting facts/articles/analysis please.
Especially if you are going to criticize the Col., who usually has his ducks all in a row before he starts talking (my personal observation from reading this Blog). Or most of the commenter’s here, who are top rank.
Col. Lang deserves credit for publishing such a critical work on his own Blog, something most Bloggers ego would not permit.
This Blog has one of the highest level and most informed discourses found anywhere on the net. The quality is consistently high. Keep on keeping on.
The whole idea of Peak Oil is a myth. There is no such thing. I have been involved in the oil industry for 49 years. When I started US oil was $3/bbl and production was limited by the Texas Railroad Commission by allowing wells to produce only 8 days per month. Foreign oil was $1.40/bbl but you needed import certificates from the US Govt to bring into the US. These certs led to much corruption in the 50s and 60s. As the price of oil rose during the last 50 years so did the amount available. In 1973 when oil went to $12/bbl the North Sea and Alaska became economically feasible to produce. When the price of oil went to $35/bbl, production offshore at water depths of 5000 ft became economic. Oil at $100/bbl make very deepwater wells profitable. At $125/bbl the North Pole is in play.The amount of oil available is price dependent with a lag of 5-10 years.NOC’s can stand this lag. IOC’s cannot. At some point the US has to create an NOC- The United States Oil Co. to compete on the world stage.
David Habakkuk:
This is a very important question that you ask, because it touches on a number of the discussion threads we’ve seen here of late, including some related questions that Dr. Kiracofe has asked about refinery capacity:
If the long-term expectation is for prices to rise (both for oil and for gas), and if moreover an exporting country knows that its own reserves are liable to be exhausted quite rapidly — may it not then be a rational strategy for such a country to pursue ‘nationalist policies’ and limit the amount of its dwindling resources it makes available to the market?
Again, pardon the length of this, and feel free to skip to the next comment!
The obvious answer to your question is “yes”, but there is an assumption underlying that apparently rational strategy, namely that the nation’s oil reserves will be worth more to their citizens in the future than they will be in the present.
And while phenomena such as peak oil would tend to support that strategy (as it will invariably tend to add value to remaining reserves), it may be that the assumption is entirely wrong, so that perhaps a new disruptive technology (e.g., hydrogen fuel cells) or perhaps a market-driven response (e.g., demand destruction caused by economic collapse) will drive down the long-term price of oil faster than peak oil drives it up, so that the net effect is that nations that hold onto their reserves may ultimately find that they bet wrong.
This is in fact closely akin to the situation that refiners find themselves in 24/7/365. Refinery infrastructure is extremely expensive (to build and to operate), and since oil comes in all kinds of shapes and sizes (more on that below), adding refinery infrastructure to handle new products or new supplies can turn out to be a poor bet if demand does not materialize for those products (or if current demand diminishes for whatever reason).
If crude prices stay high, people switch from gas-hogging SUV’s to fuel-sipping hybrids, and so successful refining companies like Valero must constantly attempt to make accurate predictions about future demand, and then adjust production (including building new facilities) accordingly in the hope that short-term events don’t negate their best long-term predictions. They have to constantly bet the farm on these predictions, so there’s lots of inherent risk to the corporate bottom line.
And since most of these energy-supply companies are publicly held (Koch is the main exception I can think of), if the officers of the corporation determine that they can make a better return on investment via stock buybacks (as Exxon has done), or by shorting supplies to drive prices up enough so that aggregate profit increases even as output decreases (as BP has done), then the corporation must act in these manners, because the corporate management is responsible only to make the most money for the stockholders, not to create parts of a de facto national energy strategy!
And finally, the last point here about near-term fluctuations in oil prices is that crude oil prices are reported in dollars per barrel of a form of oil that is getting scarce remarkably quickly (i.e., light sweet crude, often sold out of Cushing, OK), with other forms of oil (i.e., heavier and sourer, or more sulphurous) sold at a discount measured relative to the light sweet crude case.
We tend to think of “oil” as a commodity like “pork bellies”, but oil comes in a lot of forms, and only the light and sweet variety is best-suited for our current refining infrastructure (and really, no one demands oil — we demand those products, like gasoline, that are derived from oil, so this refining aspect is a really important part of the oil-price puzzle).
Without sufficient well-situated refinery infrastructure to do extra work required before processing to make diesel or gasoline (e.g., removing the poisonous sulfur residues from non-sweet varieties), then these other, less expensive and increasingly more plentiful forms of oil are not of as much use as they might seem, and that’s a part of why some experts claim that we’re awash in oil, while others claim that we’re not (with both sets being correct on some level).
And since the light-sweet stuff is getting rarer quite rapidly (by dint of diminishing supplies, but also because of the kind of insurgencies that Duncan Kinder has been writing about here lately), its price tends to swing more wildly than it ought to, since its supply is the tightest relative to refinery demand.
We could likely remove some of those oscillations in price by investing more in refinery infrastructure to process the more common sour and heavy oil supplies, but that takes some substantial investments by refining companies that may or may not pay off, in the exact same manner that it may or may not pay off for a nation to hoard its oil.
Hence the question applies not only to how a nation can best use its energy capital, but also how a key part of the oil products supply chain can best use its precious financial capital.
The whole thing is complicated enough to make my head spin, but each of the factors can be analyzed with some degree of independence, and then hopefully re-assembled into a coherent whole. That’s where the multivariable differential calculus comes in very handy.
So you ask a darned good question! Sorry if I put you to sleep, tho…
Wonderful comments. I do so like this site. Paraphrasing what someone said recently, there often really is a cumulative refining process underway here at SSC, if you’ll pardon the pun.
Before offering a few thoughts on speculation vs fundamentals prompted by some comments on the previous page, one quick aside. I do think the good Colonel is occasionally being slightly misrepresented. Unholy though his glee may have been at times(!), I certainly never took him to be suggesting that speculative activity was the primary driver in anything but the short term.
Now, to those few comments. Fnord, no argument that the financial system is in crisis. It’s one that’s been building for decades. Like you, I also have no doubt the recent moonshot in oil was born of some combination of shifting long term fundamentals and speculator/investor activity. As you say, uncertain financial and geopolitical times set against a growing backdrop of Peak Oil fears makes for fertile speculative soil. Indeed, although the odds that the top is in for a fair while are probably quite good, I certainly don’t feel confident in ruling out a resumption of the blowoff.
Where I feel much less comfortable is with what seems to be a fairly common view that speculators (or for that matter the “oil interests”) comfortably run the game. Both were also around in late 2001 when oil languished under US$20, or early 2003 when it dipped to US$25. Or (rather more spectacularly) in the mid 80s when oil plunged from well over US$30 to US$10 in a little more than four months. Truth is I don’t think anyone’s in charge of the game, not even close. Even if you’re big enough to push a market around, you’re still faced with the challenge of getting out profitably. The bigger you are, the greater the chance you’ll end up getting in your own way if you’ve misjudged your market, in addition to being set upon by other players who then smell the blood in the water. Look at Amaranth a few years ago. Really big money is harder to run than smaller sums.
What is qualitatively different this time around is the movement of long term, long only money into the commodity markets, both through ETFs and OTC instruments. The amount apparently passed the US$250 billion mark this year and there’s every chance that estimate misses quite a lot. This is of course across all commodities but Verleger (thanks, Fabius) estimates the amount devoted to energy markets would probably have been close to US$100 billion at the peak. The impact of this investment money has, I’m sure, been even greater on some smaller commodity markets but this is almost certainly a big enough sum to have a substantial impact, even on a market as deep as crude.
While plenty of opportunistic or trend following speculative money would have piled into the game as the move became ever more pronounced, its influence on prices on the way up is (as always) going to be pretty much mirrored by its downside effect when speculators decide to (or are forced to) bail out. Exciting though their effect can be in the short to medium term, the net effect of traders, in the bigger picture, is effectively nil.
The object of speculation in petroleum futures is NOT control of petroleum or petroleum products, it is money. The volume of traded promises and their affect on money are the relevant facts. Riches gained this way are the ultimate proof to speculators that they are far more clever than those who believe the market had something to do with it.
Ingolf: Agreed to a certain extent on the point of wether anyone is in control. Much to the concern of our Norwegian finance department, none of our analysts were able to foresee this top.I am not a finance-expert by far, but I do know something of logistics. So against the argument of pure speculation being responsible, I am wondering if certain factors are left out of the equation in the real-cost side of the pricecalculation, though.
One would be the fact that there is a war on in two places, and so much of the resuply capacity of *carriers* etc. will be longterm hired by now and making milk runs for the gulf. Another factor I know no data on is the capacity of the shipping-lanes, in other words how much of the produce is in movement towards the free markets at any given time contra the volume available pre-Iraq.
Another factor is to what extent emerging economies without oil are building *their* oil reserves, so that the commodity goes into storage and is not in play on the market. A third would be about possible chokepoints in the processing-line, how much refinery capacity is bound up by long term contracts. A war sharpens the markets fiercly due to these factors, I would think? So I think these and propably many others may be some real structural factors in play, wich of course leads to a much leaner & meaner speculators market for the product that is freely available.
And I second that the US should have a staterun oilcompany, its magic 😉
Jonst: “What credential/s makes one an expert in market-related dynamics”?
I said expert, but rather than credentials I prefer to look at training (which need not be academic) and experience.
IMO the most relevant fields are trading, finance, and economics. Of course, not everyone in those fields works with markets — and these are just the largest relevant fields, not an exclusive list. Nor does this cover fields unrelated to markets, but which provide a good foundation to understand them. For example, Wall Street hires experts in quantitative methods (e.g., mathematicians, physicists), and then trains them.
Fnord, I’m sure you’re right that a multitude of structural factors are at work. Still, it’s part of the market’s business to adjust to shifts of this nature.
FWIW, although I think there are very good grounds for resource rich countries exacting rents (whether via royalties, taxes or partnership arrangements), I have mixed feelings about state run oil companies, even though Statoil has by all accounts done a very good job. In any case, I doubt the political culture in the US would allow anything similar to work. Or even to be established. It’s much too partisan. (Given your little smiley, I suspect you may well share my view on this.)
By the way, I don’t see the fact that no-one is in control as a bad thing.
About supporting evidence
This was a survey article, not an discussion of a specific point. Spelling out the evidence for each section would have extended the post beyond its already long 2600 words, so I provided links.
My primary point was supported by the two studies referenced at the start (by one of the two major energy agencies in the world, plus a well-known expert), and the 10 links in the text. Most of the things mentioned were discussed at length in one or more the 30 articles about peak oil on the FM site, most of which focus on a specific question, supported by the 20 major studies whose links appear on the reference page. Links to both appear at the end of each post for those who would like more information.
I have found that no matter how extensively documented an article, I always hear the cry “not sufficently documented” — usually without asking any specific questions that would demonstrate a real issue. Since only 3% of visitors click on even one link, I am sceptical that additional documentation would provide more value.
I will answer questions, preferably on the FM site — but here if you prefer.
Fabius Maximus:
I will answer questions, preferably on the FM site — but here if you prefer.
Thanks for your offer. And let me congratulate you for your publicizing the Hirsch report, as it was buried for entirely too long, given its importance. I’ve long recommended it (including here at SST) as essential reading for informed commentary on this topic.
I have one question, implicit in my earlier post, namely “how does peak oil operate in fast time, i.e., over periods measured in days or weeks instead of years or decades?”
The only way I can see for physical extraction processes to operate in fast time is in response to transient hazards, e.g., the hurricanes approaching the Gulf Coast can cause near-term fluctuations in production for specific reservoirs, and in this case the effect on global supplies would be mediated by the cumulative production in other unaffected regions.
It’s clear that peak oil operates on secular time scales (the various case studies in the Hirsch report document this very well), and it’s highly likely that the rate at which peak oil causes crude prices to increase with time will itself increase with time, so that its effect on price-time curves is to induce positive first and second derivatives (i.e., upward trends that increase in magnitude with time).
I can even see how some singularities might occur in the price-time curve as oil supplies run out, but that’s clearly not happening today.
So what kind of coupling mechanism do you see (besides the obvious one of market psychology, as Taleb has written so eloquently about in The Black Swan) that permits the secular physical response of peak oil to drive the near-term market oscillations that Colonel Lang (and his army of correspondents) has been discussing here?
Without such a coupling mechanism, some of your assertions about these SST posts risk becoming unsupportable, hence the question.
Thanks in advance for your consideration.
Cieran,
You certainly did not put me to sleep. There is a lot of food for thought here — I had not followed this whole sequence of threads as closely as it merits, and need to do some boning up. It seems to me that we have been moving into a more ‘mercantilist’ world, that the Georgian war is likely to reinforce this, and that the dynamics of such a more ‘mercantilist’ world are very difficult to assess.
As to the strategic questions facing an energy exporting nation (particularly if it is largely dependent on such exports), as you say, the uncertainties surrounding technological change and demand destruction mean that estimates of the future value of resources are subject to quite extraordinary margins of error.
What I would add is that energy security considerations may in certain circumstances increase the incentives to hoard supply — although technological change may reduce or eliminate dependence on oil and gas, if energy security is at issue it may be sensible to give the downside if it does not much greater weight than the upside if it does.
This may apply in Russia — but I also think back to North Sea oil and gas has been handled.
We British are now getting vociferous about the possibilities of Russia using energy as a weapon. Such fears have clearly been exaggerated — it really is absurd to treat Russian expectations that the Ukraine and Belarus should pay market for gas as an instance of political pressure. Moreover, both Russia and Europe have an enormous amount to lose by the disruption of historically rather stable energy trading relationships.
However, as we seem to be heading into some kind of new Cold War, the possibility of energy disruptions has to be given greater weight — and the intensive exploitation of North Sea oil and gas does not perhaps look, in retrospect, very wise.
Your observations about the tensions between the maximisation of shareholder value and the requirements of a coherent national energy strategy fit very well with one of points that Jérôme Guillet has been hammering away at in his posts on the European Tribune site. Looking at the matter from the point of view of an investment banker financing alternative energy projects, he stresses that the much-touted energy liberalisation in Europe actually intensifies our dependence on Russian gas: because gas-fired plants, having lower initial costs, are much easier to finance.
My own views are in part a product of the reaction against ‘statist’ solutions in the economy which in Britain both produced and was produced by the Thatcher government, and has been carried forward by the Blairites. This was, initially at least, the product of bitter experience of the gap between hopes that the British state would act as a ‘rational actor’ in the economy, and how it actually behaved.
But if — particularly given the vast margins of uncertainty about future energy prices — the maximisation of shareholder value by energy companies is incompatible with the kind of investments necessary for the long term in the context of dwindling energy supplies, a larger role for the state becomes indispensable.
One is then left with two problems 1. overcoming ideological resistance based upon ‘market fundamentalism’, and 2. devising relationships between the private and public sectors which seek to make best use of the strengths and avoid the weaknesses of both — while also seeking to avoid or mitigate some of the problems associated with close interdependence of public and private (such as corruption.)
Cieran – That is a complex and difficult question, and illustrates my earlier point about the length of articles necessary to answer questions in this field. My newest post discusses a more simple peak oil question, takes 2300 words to do so (although a better writer could do it in less!), and relies on links for evidence (which I could increase 2x or 3x and still be insufficient).
Little research is being done about peak oil, so that many vital questions today can be answered only by guesses. Like yours about the nature of the peaking process, this should be the subject of a multi-disciplinary team doing extensive modeling.
Since there is no literature to lean upon, think of this as a crayon sketch.
Peak oil is a multi-year transition of energy sources. The connecting link between this long-term trend and short-term events (e.g., market prices) is information. Think of it in term of the late John Boyd’s (Colonel, USAF) OODA loop. We Observe changes, slowly Orient ourselves to changing circumstances, make Decisions, and then Act.
This process works slowly, as information drips out. Geological peaking of fields has usually been recognized only after the fact. (e.g., the US 48 states, UK North Sea). Political peaking, which it appears the King Abdullah announced in April, may be more slowly recognized.
The speed of this process is driven not just by flow of information, but by the crowd psychology by which insights and emotions spread. This is more granular, often with discontinuous changes.
There are other factors. To mention just two…
(1) The amount and quality of information flow. In energy, tiny and poor. Does anyone here know the source of the Saudi production numbers that you see in the media and reports? Of information about consumption and inventories of emerging nations?
(2) The size and skill of the relevant institutions. With respect to energy, we have only tiny funding to collect and analyze information. Hence our reliance on inspired guessing by experts. As David Halberstan said in The Best and the Brightest: the elephant was great and powerful, but preferred to be blind.
I apologize for the length of this comment (370 words). But there are few brief answers about these matters. {I have cross-posted this to the FM site, so please delete if it is too long.}
Fabius M:
Thanks for your informative reply. I appreciate your thoughts here, e.g., how the quantity and quality of information contribute to the general question. I especially like the OODA interpretation — I believe that approach, perhaps coupled with the viewpoint that the loops are being practiced by organisms that occasionally behave like lemmings, explains much.
As far as this:
this [peak oil] should be the subject of a multi-disciplinary team doing extensive modeling.
I’m a member of a similar team, actually. I’ve published in the open literature on poromechanics, and am currently working with a few national energy companies on more extensive modeling techniques for simulating mainstream and advanced recovery methods for oil and natural gas. The physical modeling will be combined with financial modeling to permit these firms to better manage their resources for their stockholders.
About twenty years ago, several teams of international researchers independently re-discovered some visionary and pioneering post-war work in reservoir mechanics that had been performed for Shell Oil by the brilliant physicist Maurice Biot. Biot’s theories, when implemented in a more general framework amenable for high-speed computation, are now among the best ways to try to predict peak oil and related physical phenomena.
I was lucky enough to be a principal of one of the teams that rediscovered and successfully implemented Biot’s work, and hence have enjoyed a front-row seat for the resulting exciting developments in poromechanics, petroleum engineering and in geology.
Hopefully, multidisciplinary efforts such as this can help pin down the details of peak oil, so we can better prepare for the inevitable transitions in energy resources.
Thanks for sharing your thoughts here, and for pointing out your new post on the subject.
Cieran: I am glad to hear about your work.
I was thinking about a different level of analysis. We need data and tools for energy modeling like those used to manage the US economy – compared to which the resources allocated to this kind of energy research are tiny. These draw on vast time series of data, run through hundreds or thousands of equations. They are not perfect, but the economy might quickly crash if economists had to rely on the sketchy tools used by energy analysts.
Making the comparison worse, economists first developed the predecessors of these tools, the National Income Product Accounts (NIPA), in the 1930’s. Since then their worth has been well demonstrated, so the failure to apply these tools to energy research is especially odd (aka daft).
With these we could model different scenarios of oil supply, demand, and pricing — running scenarios for different public policy mixes. This might work better than the inspired guessing that is the basis for today’s energy policy.