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Sunday, 1 June 2008

Oil bubble or trouble?

I refer to 3 articles I came across in the latest issue of The Economist, May 31st-June 6th 2008:
  1. Recoil - Painful though it is, this oil shock will eventually spur huge change. Beware the hunt for scapegoats
  2. Energy - Double, double, oil and trouble
  3. Fuel subsidies - Crude measures

Oil bubble?

Believers of peak oil (a point in time when oil production rate hits the maximum and go decline from there) would doubt the current surge in oil price as a bubble, pointing to the sluggish crude production last few years while demand from emerging economies (esp. China and India) powers ahead.

In contrast, others believe the high oil price would had dampened demand (signs are showing) and the current surge is just the act of speculators (traders of crude future contracts, funds and other investment institutions).

If it really is the act of speculators that result in the price surge, I'll not be so worried, since all bubbles must come to a spectacular burst one day.

Oil price --- sustainable?

Whether or not its the act of the speculators, after reading the 3 articles above and doing a bit of research myself, I do believe current sky high prices cannot be sustained for long. It would have been better if the speculators are indeed responsible because the eventual price correction when the bubble burst would be substantial and swift. Otherwise, it will be a long and painful journey ahead before any respite occurs when the demand and supply curve rebalances again.

Less demand or more supply?

Sustainability of demand

According to the 3rd article,

...
Emerging economies accounted for more than the whole increase in world oil consumption last year—because demand in the rich economies fell...


While US and Europe are fighting slowing growth (analyst, experts etc kept saying US is in recession but its GDP always manage to scrap through with a positive figure), the emerging economies continue to power ahead.

Growing economies resulting in growing demand for crude oil comes as no surprise. But most of the fuel sold in these countries are heavily subsidised. As the crude price escalates, the government subsidies balloons, diverting resources from areas that the money could have been better spent (education, health and infrastructure). Subsidies as such cannot grow indefinitely and many are already cutting back. The eventual result of a rising crude price will see a plunge in demand, even in emerging economies, either a direct result of more conservation or slowing growth.

I- Increase in supply --- more aggressive search for oil fields

The runaway price of crude oil already spur a surge in oil explorations. Announcements of oil field discoveries are not uncommon nowadays, given such intensive search. However, even with these, supply will not jump suddenly because it takes years before the first commerical drop of oil is extracted, more so for new fields that are found in deep waters or difficult locations, .e.g. the Arctics.

II- Increase in supply --- alternative sources of fuel

As the price of crude oil climbs, alternative sources of fuel become viable. A google search for "alternative sources of fuel" easily turn up 800,000+ results. Research into these areas are already underway ever since the first oil shock.
  1. Tar sands
  2. Oil shale
  3. Coal & gas conversion
  4. Thermal depolymerization
  5. Biofuel (from sugarcane, rapeseed, soya bean, palm oil and even algae!)
These alternative sources of fuel are not cheap and requires a sustained crude oil price to remain feasible. If crude prices remain sticky for a sustained period (a few years???), supply from the above sources would obviously jump.

Other factors

Continue weak USD

While the plunging USD was blamed for the initial surge in crude oil price from USD $80++ per barrel to $100++, not one article mentioned about the USD devaluation now. Seems like the search for the scapegoat have moved on. I would wonder when the USD eventually strengthens, would oil price come down? I doubt so, because strengthening USD should be a result of a recovering economy, brining along an increase in fuel consumption again -- another excuse to keep the crude price up.

What this means to me

While I have no choice but taking a much passive reactive approach in my life, i.e. tighten my belt with the current oil spike induced inflation (food, transport etc), I can continue to be active in my investment.

Market sentiment is obviously bad right now and the only remaining sexy sector are the oil and gas (or related) sectors. Thus I would think the Great Singapore Sale on SGX should not come to a close anytime soon, even though it had lasted so long, from August 2007. While I'd avoid the oil and gas sector, I believe there are still bargains to look out for.

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9 Comments:

Anonymous donmihaihai said...

Hi Market uncle,

Before I continue further, I must say I happen to be a believer of peak oil.The reason behind it is simple, crude oil, Tars sands and oil shale are finite resources, which mean one day, the production of oil will peak and we have been pulling them out of the ground for almost 150 years.

When reading articles on oil, one must be careful not to follow the short term mindset cause by the price of crude oil. Is Crude oil at USD130, 100 or 80 high? Most say yes. Many cheer when it drops a few dollars. But that happened when crude 1st reached USD80, just like when it 1st reached USD60, 50, 40. As long as the world keeps moving on, it seems to be ok.

So is it sustainable? Sustainable at what price or at a high price? Remember, 3 to 4 years back, it was considered high when crude oil was at USD50. So at USD50 crude oil is considered low for now?

The recent discoveries are not big or alot. The question to ask is "And then what?" After deep sea, where to find oil? Deeper sea or going back to land? E&P is also moving from Alaska upward to place where not suitable for human which is believe hold huge crude resources. And the what? Well, what is expensive yesteryear become cheap today.

Alternatives you written are not helpful because they does not have the scale, strong(octane) and cheap. An alternative that can replace crude oil must have the same quality of crude oil.

I am looking forward for alternatives like solar and ocean.

Not sure if you read it, I penned it about 4 mths back.

http://illdoitmyself.wordpress.com/2008/01/16/it-is-supply-and-demand-as-easy-as-abc-ahmed-zaki-yamani-once-said/

2 June 2008 at 02:02  
Blogger Market Uncle said...

Hi Donmihaihai,

Read your post. (Added your blog to my links too, didn't know you have a great blog!)

I'll give my view in similar structure like yours:

i) supply
ii) demand
iii) alternatives

i) Supply

I do understand that oil is a finite resource, hence the "Peak oil" is theoretically sound but I think it is practically flawed. It is understood that the resource will run out one day and thus supply must peak and fall from there. However, I do not think it will happen in our life time.

1) Oil supply is not just a market driven commodity but also politically motivated. Similar to food, its not a problem of supply, but a problem of distribution.

2) Most of the oil supply now comes from low hanging fruits, easily extractable fields. Many more difficult fields have yet to be extracted, or discovered. As oil price climbs, these will be viable. Though it will take time.

ii) Demand

1) Each oil shock forces the developed countries to be more conservative and more efficient in energy usage. Already their demand is falling. The oil shock haven't hurt the developing countries yet. Not because they don't care, but because their oil is heavily subsidised. Subsidy always leads to wastage and a diversion of limited resource away from other needed developments. Growth (and demand) will have to slow one day.

2) If the demand or conservation, efficiency improvement is not fast enough, its not that the people don't bother, but more that the price is not expensive enough to hurt. Its just like ERP, people complain that what's the point of having ERP when the road still jam? Its because the ERP is not expensive enough. Lets see whether one can travel at 90 kmh on CTE at 9am if its $50, $100 per gantry?! Habits will change but it will take time.

iii) Alternatives

1) As oil price continue to aim for the moon, more expensive (or even dangerous) solutions become available. The last oil shocks saw more wind power, tidal, hydroelectric ... even nuclear power generation. Now, we have biofuel (at the expense of rising food prices), solar power etc.

2) I think we need to recall that before the invention of gasoline engines, crude oil is still a heating alternative. Human resilience and creativity in invention and problem solving is unparalleled in the animal kingdom. When resources become scarce, gods knows what they'll come up with next.

Conclusion

I think oil price is not a one way street to the moon. You can take a look at the following historical site on oil: (http://www.wtrg.com/prices.htm)

While it will take time for the demand and supply to find a new balance, human reaction to uncomfortable conditions will always lead to progress and improvements, though the journey will not be smooth sailing.

2 June 2008 at 23:34  
Anonymous donmihaihai said...

hi market uncle,

Nothing much to say about demand and alternatives because we are heading toward the same direction. Agree that oil price is not a one way train to the moon because it can't happen just like a suddenly change of ERP charges to $50 or 100. there are the consequences..

As for supply of oil not going to peak in our life time. I know where you coming from and making an opinion without any facts backing...( I don’t need opinion I need facts, that was one of the reason I started to look for facts about 3 years ago because everywhere in the news were opinions) The chances of you changing your opinion if you look into what happening at the supply side(if you are interested) is very high.

Anyway for what is the impact on company is pretty clear by now. 2 to 3 years back when oil price 1st reached the $50 region, companies were unable to pass the increase down the supply chains or consumers as raw material inflation was still at the back page of the newspaper, now it is relatively easy. So the stronger ones that were doing relatively well back then are going to do well now. What going to happen forward is that consumer will accept it(willing or not) until one by one we break and that is a slow process that going to hit companies slowly too.

7 June 2008 at 10:58  
Blogger Market Uncle said...

Hi Donmihaihai,

As far as supply is concerned, you are right to say I'm just voicing my opinion. My conclusion on supply not peaking in our lifetime is derived merely from common sense and reasoning.

But common sense and reasoning might not make sense in short term dynamics of not uncommon irrational market conditions.

After your mention, I tried to research a little on oil production:

Hopeless:

1) Oil production had literally stalled since 2005, either due to political reasons or under investment in facilities due to earlier low prices of oil.

2) Oil production equipment, oil rigs demand had only recently picked up and the time to build these will take a few years.

3) Even if alternatives are available, e.g. shale oil, its not being produced due to political reasons again:
http://money.cnn.com/2008/06/06/news/economy/birger_shale.fortune/?postversion=2008060617

Hopeful:

1) Looking at the orders for oil rigs (looking at just Singapore orders since we account for 70% of the jack up oil rigs market), almost every week I see a new order being clinched. The sign is in 3 to 5 years (it takes about 3 years to build an oil rig, from order to delivery), hence there could be another surge in oil supply 5 to 10 years down the road.

Meanwhile, people (and businesses) will just have to cope with current surging oil price. From the papers, we are already seeing changes in habits:

Singapore:
http://news.asiaone.com/News/the%2BStraits%2BTimes/Story/A1Story20080608-69542.html
US:
http://feeds.creditcards.com/cobrand//?aid=f7847fb7&action=view_article&article_id=1438

As far as businesses are concerned, the weaker players will be weeded out, part and parcel of survival- world economics theme.

8 June 2008 at 11:32  
Anonymous donmihaihai said...

Hi market uncle,

Habits are changing but don't see big changes yet.. at least in Singapore. Recent news suggests that more changes are coming..

Rigs and offshore vessels contain 2 demand and supply. 1) Demand and supply of offshore oil and 2) demand and supply of rigs and offshore vessels. Supply side of rigs and offshore vessels can be solved even when supply side of oil remains unsolved.

Like I said earlier in my blog, in supply we should look at oil fields, giant oilfields to be specific.

Some facts.
14 giant oilfields(able to produce 500,000 barrels per day and above) contributed about 20% of crude oil production. 4000 plus oil fields produce just over 50% of crude oil production. Only 4 oilfields produce >1,000,000 barrels per day with Ghawar from Saudi Arabia (giant of the giant) produce about 4,500,000, > 3 X more than the next giant oilfield.

These are 2000 data. It is likely to remain unchanged except the percentage of contribution from the 14 giants is lesser. There are no giant oil field that can produce >1,000,000bpd discovered after 1976 and > 500,000 bpd after 1985. Can the recent deep sea discoveries able to produce >500,000 bpd is still a question mark, not to say when.

With Burgan, Daqing and Cantarell giant oilfields in decline after peaked, what happen if Ghawar peaked? Ghawar has been producing for almost 60 years. All kind of data from other oil fields say that it is unlikely that a single oil field can keep producing and not peak after 60 years.

The crazy part is no one knows what is happening in Middle East because they are not providing the data. If Ghawar has not peaked, how many more years can it keep it current production?

The day when Ghawar peaked and appear in the news is the day when crude oil price really go crazy.

Try reading on the oil sands in Canada and despite the huge reserves available, it will always remain a small contribution.

9 June 2008 at 02:13  
Blogger Market Uncle said...

Hi Donmihaihai,
I'd think it suffice just to discuss the supply issue, especially on oil field discoveries.

A check with the wikipedia (http://en.wikipedia.org/wiki/Peak_oil/Table_of_largest_oil_fields) turn up the following:

1) Ferdows/Mound/Zagheh Field in Iran (38b Barrels) in 2003

2) Azadegan field in Iran in 2004 (26b Barrels)

3) Sugar Loaf field in Brazil (25 to 40b Barrels) in 2007

4) Tupi Field in Brazil (5 to 8b Barrels) in 2007.

According another article in wikipedia:
(http://en.wikipedia.org/wiki/Giant_oil_and_gas_fields)

The recent decade (2000 to 2010) reflects an upturn in oil and gas fields discoveries, particularly gas fields. This is a reveral in trend of consecutive 3 decades of declining discoveries. The experts also predicted that more giant fields would be likely be found in existing areas of giants.

The past abundance of oil led to languishing oil prices in the 1990's, right up to 2003, resulting in little incentive for more oil and gas exploration. However the surge in oil price, particularly after 2003, could have led to more aggressive search for oil fields, big and small. Going ahead, more should be discovered.

But discoveries is one thing, production is another. Other than the unpredictable political reasons, the long gestation period between finding that first drop of oil and producing the next drop for sale, it will be a while before oil supply exceed demand again, exerting downward pressure on the oil price.

On the contrary, the more I read and research, the more optimistic I am about oil price coming down within the next decade.

1) More giant oil/gas fields discovered
2) By the time the next drop of oil from additional oil fields come online, current conservation efforts would have mature, (just like how the developed countries dealt with the past 2 oil spikes, bandishing oil fired power generatoring statons)
3) Most of the alternative energy sources will be a sizable option.

9 June 2008 at 22:58  
Anonymous donmihaihai said...

Hi market uncle,

Before I continue, I must say, I really respect u.
My face is full of smile..:)

While I knew that that area in Iran(cause by the treaty) there has huge potential, I din know that it is so huge. And it may hold the keys or the main variable going forward, i.e delaying peak oil.

And those offshore fields? Give me a break. At that kind of depths(under sea and under the rock)These are unknown and unknown fields. Beside Tupi, no confirmation wells are being drilled for the other.

The question mark still stands. Can they produce more than 0.5million bpd. What is the cost like to pull those crude oil out? The current giants are basically right under the ground. Someone(forget who) said pulling oil from Ghawar is like pulling water from well when Ghawar was young. In fact, Ghawar production jumped from almost 1 billion to > 5 billion bpd from 1969 to 1981. You know how crazy was that? Just look at all the projection of future projection for all new oil fields. Ghawar was god send. In fact, most giants found before 1970s were god send.

I don't know what the price of oil is going up or decline except that it is going to be high but let me borrow a quote , “ I am right and you are smart, someday you will see that I am right.”

I am enjoying myself.. :)

11 June 2008 at 00:08  
Anonymous donmihaihai said...

Sorry, "about 1 billion to > 5 billion bpd" is incorrect. It is about 1 million to > 5 million bpd

11 June 2008 at 00:31  
Anonymous Penny Stock Investing said...

I don't believe theirs an oil bubble. But I do believe that natural gas can not remain at current depressed levels for much longer.

12 December 2011 at 03:06  

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