Oil: The rise and fall . . . and rise

Oil's surge to near $70 a barrel has stoked fresh debate about what's driving the market -- and where prices may be headed if the economy is turning up. Edward Silver, a former Times staff writer who keeps a close eye on the energy market, offers some context on the latest price action, and the global supply/demand equation:

The world consumes 30 billion barrels of oil a year. Without it, our food doesn’t make it to the supermarket and our flights to Hawaii are grounded.  Too bad the price is set by such a moody bunch.

Crude gained 3.2% to $68.44 a barrel in futures trading last week, but prices seesawed along the way. Again, bulls won the tussle. An $85-a-barrel yearend forecast from Goldman Sachs and more hints of economic recovery -- including surprising strength in Chinese manufacturing -- overshadowed  flush oil stockpiles and other dismal data indicating a weak appetite in the United States, which still devours almost a quarter of global output.

Even before the economic signs turned more encouraging, oil was sizzling. Prices have more than doubled since crude visited the low-$30s in February. The falling dollar has helped, as some investors have turned to raw materials as a hedge against the greenback's slide.

Clearly, instability is in the DNA of our primary energy source. Only a year ago, oil was on an epic ascent, driven by exuberant traders to a peak of $147 a barrel in July. The industry was vilified. Priuses were sold out. Some analysts set targets of $200 a barrel.

Yet in short order, the recession and credit crunch rewrote the script for the rest of 2008. Those traders turned morose, vaporizing almost 80% of the commodity’s value in five chaotic months. In the aftermath, big oil companies and the petrostates of the world have been grappling with a surplus and paring production to shore up the market.

Demand for crude, however, is considerably less volatile than the price. Even as the rally unfolded this spring, commentators often repeated the view that the price strength made no sense because  fuel use had collapsed. But "collapsed" doesn’t describe a world market that will shrink a measly 3% this year to 83.2 million barrels a day, according to the International Energy Agency.

Though fewer Americans took long car trips over Memorial Day weekend, China’s 8-million-barrel-a-day habit will see a dent of only 70,000 a day this year, the IEA says. In fact, the Asian giant burned more oil this April than last April. And all those tankers filled with surplus crude that bearish observers point out? Combined, these floating warehouses hold just over a single day’s worth of global use.

Wall Street, bullish oil traders and the Obama administration all are betting that the U.S. economy will look better in the second half than the first, of course. In its mid-May report, the Energy Department assumes the beginnings of a recovery in consumption. It forecasts only a slight pullback in U.S. oil use this year, to 18.9 million barrels a day from 19.4 million in 2008, and an uptick in 2010.

Even if U.S. oil demand doesn't rebound -- and greener cars, biofuels and conservation measures boost the chance that it won't -- the action is in the developing world. Masses continue to leave the land for the cities, where they become bona fide fossil fuel consumers. Fortunately or unfortunately, entrepreneurs and governments are trying to make that status affordable for them. Tata Motors, for its part, intends to put India’s Everyman behind the wheel of its $2,000 Nano car.

An internal-combustion engine in every Asian garage? To put it mildly, that would more than make up for the gas Americans didn’t use over Memorial Day.

Where the crude will come from to satisfy these new wants is a puzzle. Most of the cheap and easy sources have been mined. For much of this decade, when demand already was pushing the supply envelope, drillers ventured into fields and waters that required high expense and high technology to yield their riches. Now, many of those projects have shut down.

At the same time, OPEC has taken oil off the market, and some analysts believe worldwide drilling has dwindled more than 30% from a year ago. On the face of it, that seems out of whack with the modest scale of the current oversupply, and could worsen a squeeze in the years ahead.

Even a glut doesn’t change the nature of a finite resource, just how fast it’s depleted. One reason oil companies journeyed to second-tier sources is that formerly prolific fields are drying up. The most spectacular example: Mexico’s relatively young Cantarell field. Only a few years ago, it provided more than 2 million barrels a day, but 2009 estimates have tumbled into the 600,000 range.

If the realities of geology are disturbing, geopolitics present another kind of risk. In Nigeria, a guerrilla war poses a chronic threat to exports, and saber rattling in the direction of Iran still dependably hikes the price of crude.

Thinking about the future puts oil's price swings in perspective. Few commodities are as vital, and none are as problematic. (Does that make it priceless, or worthless?) To investors seeking a natural or "fair" value for the stuff, wake up and smell the exhaust: As a practical matter, there is none, largely because of the immense uncertainties in the outlook. And if there were, the momentum players who rule this murky market would pay it no mind.

But this much seems clear: The move from $33 to $68 a barrel -- during a time of surplus -- offers just a whiff of what will happen when supply tightens again. If the recession passes and scarcity sets in, the return of energy angst will make for giddy prices in the oil market.

-- Edward Silver

Comments

[H. Craig Bradley]

It sure looks like $3.50/gallon gas this Summer, possibly by the Fourth of July, is coming. It has been said the price must hit $4.00/gallon before consumers change their habits (drive less, buy fuel efficient cars).

If this is the pricing structure for oil during a long recession, think of what it could be during the recovery phase. Problem is, there won't be much of a recovery if oil hits $120 Barrel in a couple more years. High oil prices kill the stock market and the economy, leaving poor consumers with less after tax dollars to buy goods and services. With an ever depreciating dollar (more deficit spending) we are headed for a possible currency collapse at some point in the midterm future.

[A 360 Friend]

Just quit cold turkey and ride bikes everyone! You feel so much better, keep more money in your pocket and help our planet.

[Jonathan Callahan]

The rise of oil consumption in developing nations is, indeed, an extremely important issue worthy of further study. Interested readers may wish to have a look at the data themselves, presented as a series of graphs at the Energy Export Databrowser:

http://mazamascience.com/OilExport/

The plots at this site are based on data from the highly respected British Petroleum Statistical Review and present timelines of production, consumption, imports and exports for each nation. From these histories it is easy to see emerging trends in the production and consumption of coal, oil and natural gas.

Even a quick peruse of the data will clearly demonstrate that rising consumption in nations like China, Brazil, Indonesia and Mexico will quickly overtake any production gains elsewhere in the world. The story the data tell is clear and I would encourage everyone to study the issue themselves rather than just listen to the opinions of "experts".

[Mark]

I hate to break it to you "A 360 Friend", but riding bikes is not the solution. Oil is used for a lot more than just gasoline. Have a look at this link and see if you're willing to let go of all of these things cold turkey.

http://www.anwr.org/features/oiluses.htm

Expect oil & gas to skyrocket when the economy starts to recover.

[Jon]

Mark,

I agree that lots of things are made from oil and that prices will skyrocket soon, but doesn't that argue for, rather than against, reducing consumption?

You ask if people are willing to give up the things made from oil, but won't that happen anyway? The Earth is large, but finite. There is only just so much oil and it is used at an ever increasing rate. At some point we are all going to quit oil cold turkey whether we want to or not. The question is just going to be whether or not we used some of that oil to build an alternative energy structure first.

And if oil prices are going to skyrocket, don't we want to hoard our resources as long as possible? When oil is running out I think it will be better to be a seller than a buyer.

[Mark]

Jon,

I was mainly trying to make the point that everyone switching to bicycles is no magic bullet. Reduced consumption would help if we could actually do it.

Let's say that we all go buy cars that get better gas mileage. Great, now we're using less gas, right? Not necessarily. There is an interesting phenomenon known as Jevon's Paradox. It says that as efficiency is improved, we actually use more fuel. Seems backwards doesn't it? Here's a link to an article on Wikipedia on it.

http://en.wikipedia.org/wiki/Jevon%27s_paradox

I hope it doesn't make your head explode. :-)

Mark

[Doug]

Everyone has seen a steel drum. Let’s make an oil pipeline representing the 2008 daily demand for oil by stacking 55 gal drums end to end.

• 85 million barrels of oil per day was being consumed by the global market place before the recession.
• 42 gallons equals one oil barrel
• 55 gallon steel drum: 22” wide by 3’ tall
• A mile is 5,280 feet long
• Circumference of the earth is 24,901 miles
• Speed of sound 768 mph

Using those numbers let’s do some math:
Take the 85,000,000 bbl of oil & times it by 42 gal in a barrel = 3,570,000,000 total gallons of oil used everyday.

Divide those gallons by steel drums
3,570,000,000gal / 55 gal steel drum = 64,909,090 drums of oil consumed each day.

At 3 feet tall 1,760 drums placed end to end would make a pipeline one mile long: 5280’/3’ = 1,760 drums

Daily consumption of oil in drums divided by the number of drums in a mile:
64,909,090 drums/1,760 drums in a mile = a 36,880 mile long pipeline worth of drums laid end to end being consumed every day

Circumference of the earth is 24,901 miles

At 85,000,000 barrels per day, in one year’s worth of consumption enough oil drums could be filled to make the trip around the world 540 times: (36,880 miles * 365days)/24,901 = 540

36,880 miles / 24 hours in a day = 1,537 miles each barrel of oil would need to travel every hour to cover the 36,880 mile distance in a 24 hour period.

1,537 miles / 768 mph speed of sound = 2 or twice the speed of sound.

In other words, at 85,000,000 barrels of oil per day worth of consumption you could build a pipeline out of steel drums 36,880 miles long (or approximately 1.5 times the circumference of the earth), and since you’d be replacing this pipeline’s volume every day, the oil flowing through it would be traveling at twice the speed of sound, and in one year you could use enough drums to encircle the earth 540 times!

Now, how much of that volume will ever be replaced with biofuels?