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Oil prices

A New View of Oil

Several entries in this blog have focused on oil prices. It’s an overarching driver of future factors that range from consumer behavior to geopolitical influences.

Lately I’ve studied oil prices more carefully and drilled into (forgive the inadvertent pun) the data that looks ahead. I’ve been a forecaster of a long-term rise in prices due to supply and demand pressures for a commodity with declining output.

I’m now adjusting my views in line with advice I give clients. A forecast is foresight that takes into account uncertainty and adjusts with time and new information. Time has passed since I began forecasting a rise and new information is available.

Frankly, the Bakken is making me a believer that more oil that will be available over the next two decades than we’d been able to forecast before. There’s been evidence of this in the past but now it’s being put into practice to a greater degree.

For many years I lived and worked throughout California’s Central Valley. The oil-producing fields to the west of Bakersfield were a constant source of amazement to me as someone who minored in geology in college. The estimates of the field and its productivity continued despite the forecasts of depletion. The Kern River Field was supposed to have fallen off in production in the 30’s, 40’s, 50’s and especially the 70’s and 80’s.

Today Kern River still forms a foundation of the strategic national reserves. Chevron began injecting steam underground in the 60’s and today the formation still yields about 80,000 barrels per day. It was a harbinger for what we see today as the unprecedented emergence of “tight oil” – petroleum that is brought to the surface through new technology both in new discovery fields and old fields that were thought to be defunct.

That’s what’s going on in the Bakken which I doubted was a significant or long-lived contributor to oil production. Today we know that it is and while so-called “cheap oil” – where you punch a hole and oil and gas flow to the surface – could be gone the creation of new reserves is going to be with us on an increasing basis.

Oil over $200 a barrel? Less probable if geopolitical events don’t cause problems in the Gulf. But I think the planet may have been blessed with some more time to use fossil fuel reserves while it makes the transition to sustainable sources of energy.

Energy Prices: Why Have They Moderated?

It’s seldom that I work with a client not affected in some way by energy prices. Whether it’s the shipping costs of manufacturing, input costs of agriculture, or even the impact of higher transportation expenses on business to consumer organizations this question about the future often plays into strategy and preparation for the future.

Everyone wants to know the future price of a barrel of oil or of a kilowatt of electricity. Like most forecasts the calculation is complex and the range is wide depending on the timeline. OPEC policy, supply, demand, new discoveries, emerging technology, consumption behaviors, geopolitical events can all have a bearing or effect on energy price.

For several years I’ve been tying the price forecasts to global economic performance. This has been especially true as the globe goes through the most dramatic economic cycles since early in the last century. In fact, I’ve been forecasting a semi-permanent rise above a $100/barrel price floor sometime between 2011 and 2015. I still hold to it.

Many will ask what’s driving down short term spot prices in oil. Good question. Typically these short term fluctuations are driven by buildup in supply and the hidden effect of economic downturn and consumer behavior. That’s what’s been going on lately. I believe it also has to do with the discoveries of fairly large but very expensive sources of oil in the Western Hemisphere. Bakken oil (or “tight oil”), Alberta tarsands, and offshore Brazilian potential are all examples.

These “tight” and “dirty” sources have put off the depletion of other sources in the recent past. Eventually, however, the inexpensive oil sources are going to wane further and the price is going up. I believe to a fluctuating, often volatile range from $100 to $150/barrel.

Whether I’m right or wrong about the forecast is less important than preparation. I’m fond of the statement denial is not a strategy. That’s why I’m bemused, surprised, or sometimes frustrated by organizations that find reasons to deny any possibility of what would be painful developments. Those that believe the relatively inexpensive energy we enjoy today is going to be with us for the foreseeable future are in that denial.

The Middle East and Us

Almost 3 months into the wave of unrest in the Middle East and we’re staring at events like a deer in headlights. It might be a good time to take stock of how events might play out.

The best case scenario for an American economic recovery, avoidance of inflation, and $6 gasoline?
Moderation. Ghadifi quietly leaves Libya. A compromise between the separatists and the former cabinet and military. Eqypt remains somewhat quiet and their military fulfills promises of Mubarak crony removals and elections.

But those two possibilities are far less than certain. I’d give them less than 40% probability right now. Libya’s important production of light sweet crude oil will come offline for some time. Today I passed my first sign for $5.00 gasoline in San Diego, CA.

The more troubling events could occur in Saudi Arabia. The mere fact that government troops are firing rubber bullets at crowds is chilling. Despite the royal family throwing billions at the less advantaged citizens the groundswell from the educated population could destabilize the largest exporter of oil in the world. Crux facts: there is a huge concentration of the Shia minority around the Saudi’s oil production and shipping locations. Just like Benghazi in Libya, it’s strategic.

So what?

Think
1979.

Oil prices spike to $200 or perhaps beyond.

Oh yeah, you might not have been born then or you are too young to remember. Lines around blocks at gas stations (and there were almost 3 times as many as we have today with a population half the size). Declaration of a national crisis. Rationing. Price controls. Gas cans in auto trunks. Third world stuff.

Then, in the years that followed, runaway inflation coupled with a recession and double-digit interest rates. I was running a business in a market with real resistance to price increases when my operating line of credit went to 22%. It’s one reason I never, ever again want to make payroll for more than 40 people.

Worse, the US government can’t absorb a huge spike in what it pays to service the debt. The dollar will be wiped away as the world’s reserve currency, capital will leave the country, and the 1930’s will repeat and potentially be even more catastrophic.

I’m not saying the scenario is likely. I think it is still less than 30% probable but that probability increases daily to the point where we want to think through implications and actions.

In a recent Twitter post I pointed out a NY Times article on a fellow who’s gone “off the grid” in Texas by living in the desert on solar and wind power and capturing rainfall for water. Funny thing is that it’s both one of the most read and most e-mailed articles on the publication at this writing.

More in the days and weeks ahead. Hope for moderation in the Middle East and some leadership in our country. This could become a perfect catalyst for us to take steps to begin resolving our financial, energy, and world dominance issues.

The Oil Forecast

For the last three years, ever since it became obvious that the world was slipping into a recession and commodity prices would come down, I’ve forecasted an inevitable return to rising oil prices.

My logic: the recession reduces demand but only temporarily. Recovery from recessions is uneven globally. Some regions recover months, perhaps even years before others. A robust economy in Asia and to a lesser extent in Latin America will create demand that will drive prices up despite a slight fall in use in the U.S. and the EU.

Speculation or unexpected geopolitical events – “triggers” – will create volatility. Speculators will enter the market on supply shortages. No regulating body can keep them away from the opportunity to make money.

My forecast from mid-2008 forward: 75 to 85% confidence that an oil price spike and permanent plateau above $100/barrel will come sometime in the 2011-2014 time frame.

It’s been of interest to clients in, well, almost every field. Because as one CEO said to me on being asked what energy prices affect, “Everything!”

As the economic recovery has forged ahead strongly almost everywhere except the North Atlantic the price of a barrel of oil has risen back through the $50, $70, then $90 levels. Now the unprecedented events in the Middle East have taken Brent futures over $111. West Texas will follow.

Will it stay there? Of course it depends on a complex array of factors. Economic effects, how high the price spikes, volatility, whether the Saudi’s can really make up most of the shortfalls, refining bottlenecks, and more. In the weeks ahead I’ll place more information here on the implications of this important trend.

In the meantime I’m getting a lot of queries from clients who quickly remember my forecasts and are running through their Plan B strategies to react to the development or are confident because they planned for the high probability of this years ago.

Trouble to the South

A typical segment when I’m doing a forecast for a client is a listing of 50-50 possibilities in a 5-year or longer time frame. I find it expands perspectives, provokes thought, and prompts a discussion of impacts.
A situation that gets a lot of comment is the emerging crisis in Mexico. When a huge trading partner is facing loss of control of large areas of its nation it signals bad news to come. The current government in Mexico is facing the convergence of several forces:
The powerful drug cartels have not only gained control of several provinces but face up readily to federal troops. They have equivalent if not better armament and intelligence sources.
The wage gap vs. the United States continues to drive illegal border crossings. Much of the revenue paid by Central and South Americans now flows directly to the drug cartels. It’s a multi-billion dollar business.
A precipitous drop in oil field productivity. The country has already become a net importer of oil. A key source of revenue and economic base is fading away.
The Calderon administration is wavering on the use of force to fight the cartels. The cartels get media coverage on their own terms at will. Public perception is the government is impotent.
Some of the impacts:

  • Which party wins the next election? Will the US eventually be dealing with a cartel-controlled government?
  • When will the violence spill over the border? Will we see massacres of undocumented immigrants on the US side of the line? The deaths of 72 migrants recently hardly raised a ripple in the US press but how much longer will that last?
  • What is the long term effect on the Mexican economy? Will there be a leveling of income across the border or will the wage pressure continue to send a flood of immigrants north?
  • What is the effect on drug legalization deliberations in both countries? Will marijuana be legalized in both countries? Who will control the production and distribution?
  • When will the issue make its way into US politics and elections? Will a war being waged just south of the US border affect the next presidential election in 2012?