Archives For Oil

Crude Oil’s Down Again!

August 8, 2008

Crude Oil’s down another $5 per barrel so far today, which puts it about $32 below the high set last month.

How low will it go?

Take a look at the chart of the five-year history of the U.S. Dollar’s relationship with the Euro:

Back in August 2003, one U.S. Dollar purchased .9184 Euros. As of last Thursday, one U.S. Dollar only purchased .637 Euros, a decline of 30.64%! To put it in perspective, imagine you are going to take a trip to Europe. You reserved a hotel that is €200 per night or $313 per night (€200 ÷ .634 = $313). Leaving out inflation, that same hotel room would have only cost you $217 per night back in August 2003. That’s quite a difference. This is why other countries are griping about the falling dollar: it makes their goods and services more expensive compared to the U.S. Dollar.

Of course there’s another side to this: goods and services purchased in the U.S. with Euros are now cheaper. Using the example from the previous paragraph, a hotel that is $200 per night will cost a European tourist €127 per night. That same hotel would have cost them nearly €184 per night back in 2003 (again, ignoring inflation), or 44% more.

The dollar’s fall also makes imported goods and services more expensive here in the U.S., which means U.S.-produced goods and services are now more affordable when compared to imports and it also makes our goods and services cheaper overseas. This is good for us but bad for other countries.

There are negative aspects to the dollar’s fall. The biggest in my opinion, is with the price of oil. According to OPEC’s President, Chakib Khelil, each 1% drop in the value of the dollar against the Euro, means a $4 increase in the price of a barrel of oil. (I’m not sure how he came up with those numbers.) The dollar is down about 7% against the Euro so far this year. Based on that, about $28 of oil’s $50 price rise can be attributed to the falling dollar.

These trade-offs (and lots of others) are what make the study of economics so interesting.

I’m not saying the dollar’s fall is a good thing, but it does have some benefits.

I read a very interesting opinion piece in the Wall Street Journal titled, We Can Lower Oil Prices Now. The author of the editorial is Martin Feldstein, who was chairman of the Council of Economic Advisers under President Reagan and is a professor at Harvard and a member of The Wall Street Journal’s board of contributors. What he says makes a lot of sense. Especially this (I hate to cut and paste so much of the article but I need it all to illustrate his point):

Unlike perishable agricultural products, oil can be stored in the ground. So when will an owner of oil reduce production or increase inventories instead of selling his oil and converting the proceeds into investible cash? A simplified answer is that he will keep the oil in the ground if its price is expected to rise faster than the interest rate that could be earned on the money obtained from selling the oil. The actual price of oil may rise faster or slower than is expected, but the decision to sell (or hold) the oil depends on the expected price rise.

There are of course considerations of risk, and of the impact of price changes on long-term consumer behavior, that complicate the oil owner’s decision – and therefore the behavior of prices. The Organization of Petroleum Exporting Countries (the OPEC cartel), with its strong pricing power, still plays a role. But the fundamental insight is that owners of oil will adjust their production and inventories until the price of oil is expected to rise at the rate of interest, appropriately adjusted for risk. If the price of oil is expected to rise faster, they’ll keep the oil in the ground. In contrast, if the price of oil is not expected to rise as fast as the rate of interest, the owners will extract more and invest the proceeds.

The relationship between future and current oil prices implies that an expected change in the future price of oil will have an immediate impact on the current price of oil.

Thus, when oil producers concluded that the demand for oil in China and some other countries will grow more rapidly in future years than they had previously expected, they inferred that the future price of oil would be higher than they had previously believed. They responded by reducing supply and raising the spot price enough to bring the expected price rise back to its initial rate.

Hence, with no change in the current demand for oil, the expectation of a greater future demand and a higher future price caused the current price to rise. Similarly, credible reports about the future decline of oil production in Russia and in Mexico implied a higher future global price of oil – and that also required an increase in the current oil price to maintain the initial expected rate of increase in the price of oil.

That would explain why OPEC isn’t falling all over themselves to produce more oil. Why would they want to do anything that would lower the price? I do think it’s almost criminal for OPEC’s president to come out and make predictions on the price of oil. What does he think is going to happen when oil is trading at $140 and he says it’s going to $170? Surely he knows he has the ability to drive prices!

Anyhow, read the entire editorial. He makes a lot of sense.

OPEC’s starting to tick me off. First they say they are ‘unhappy’ about high oil prices. Then, reported recently that OPEC’s President is predicting oil to go to $170 per barrel by the end of the year:

OPEC President Chakib Khelil predicted that the price of oil will climb to $170 a barrel before the end of the year, citing the dollar’s decline and political conflicts.

“Oil prices are expected to reach $170 as demand for fuel is growing in the U.S. during the summer period and the dollar continues to weaken against the euro,” Khelil said today in a telephone interview. The leader of the Organization of Petroleum Exporting Countries also serves as Algeria’s oil minister.

I’m skeptical of this assertion because oil is up over 54% so far this year, while the dollar is down about 7.5% against the Euro. Unless I’m not understanding exchange rates, the dollar’s fall can only be attributed to a 7.5% rise in the price of oil. The rest is either due to supply and demand or speculation (though as Meg wrote this morning, that might not be the case). I doubt that the Fed will continue to allow the dollar to fall. I’m also skeptical of Khelil’s claim of rising demand in the U.S. throughout the summer. I bet we’ll see a drop in demand as some people just can’t afford to drive anywhere.

It bugs me when these guys come out and say stuff like this. It almost seems to be a self-fulfilling prophecy.

I’m getting sick of talking about oil. Why? Because NOT ENOUGH is being done. Oh sure, congress dragged in the oil executives and berated them over high fuel prices and threatened to slap them with windfall profit taxes (what the heck is that supposed to accomplish?). It was a great PR stunt to make it look like our elected officials give a flip about what the average American is going through.

Sadly, most politicians don’t have a clue and they don’t care that they don’t have a clue.

If they cared, they would be trying to strike a balance between meeting today’s needs with tomorrow’s needs. But, they aren’t doing squat. I mean, why the heck aren’t we drilling in America?

While energy “independence” is an impossible dream, there’s no doubt the U.S. has vast undeveloped fossil-fuel deposits. A tiny corner of the Arctic National Wildlife Refuge contains an estimated 10.4 billion barrels of oil and would be the largest producing oil field in the Northern Hemisphere. Yet the Senate blocked that development as recently as last month. The Outer Continental Shelf is estimated to contain some 86 billion barrels of oil, plus 420 trillion cubic feet of natural gas. Yet of the shelf’s 1.76 billion acres, 85% is off-limits and 97% is undeveloped.

Engineers recently perfected refining solid shale rock into diesel or gas, which may amount to the largest oil supply in the world – perhaps as much as 1.8 trillion barrels in the American West. That’s enough to meet current U.S. oil demand for more than two centuries. Yet as late as 2007, Democrats attached a rider to the energy bill that prohibits leasing the federal interior lands that contain at least 80% of America’s oil shale. The key vote was cast by liberal Senator Ken Salazar from Colorado, of all places.

Source: $4 Gasbags, WSJ

Granted, the Wall Street Journal’s editorial board is usually going to side with business, but if what they say is true, then we owe it to ourselves to at least consider drilling in the U.S. Surely we have the technology to drill without jacking up the environment.

I think drilling along with developing biofuels is the way to go. Surely that’s got to be better than sending all that money to the Middle East.

What are your thoughts? How do we solve our energy needs? Do you think our government is doing enough?

Have no fear, this isn’t becoming an oil blog. I promise! It’s just that I tend to think about certain subjects for days at a time and one thought leads to another and before you know it, I’ve blogged about the same thing for several days in a row.

This week’s Barron’s had an interesting interview with Arjun N. Murti, Energy Analyst, Goldman Sachs ($) about where he thinks oil prices are headed. Here’s some of the interview that I thought was interesting:

Murti sees energy in the later stages of a “super spike,” in which prices rise to a point where demand drops off. In a note last month, he wrote that “the possibility of $150-to-$200-per-barrel oil seems increasingly likely over the next six to 24 months.”

Barron’s: What do you make of Friday’s big surge in oil prices?

Murti: There have been a number of bullish fundamental data points recently that contributed to the rally. These include further declines in U.S oil inventories announced June 4, the announcement of a decline in Russian oil production in May, and recent comments that Mexico expects further meaningful declines in oil production over the rest of this year.

Barron’s: So, essentially, there is constrained supply, along with increasing demand?

Murti: Demand has been consistently growing. On the supply side, we don’t subscribe to the peak-oil view. We don’t think the world has run out of oil.

We do think that the places that have large quantities of recoverable oil, notably Saudi Arabia, Iraq, Iran, Venezuela and Russia, aren’t on track to grow their supply aggressively. It is growing at a very moderate rate, and so the remaining oil resources are concentrated. And, to some degree, high prices are disincentivizing some of these countries to either open up their industry or spend the money themselves. [emphasis mine]

Barron’s: What actually is keeping them from producing more?

These countries don’t need the incremental revenue. They’re getting the revenue through price; they don’t need it through volume. It means they have sufficient capital to try and develop their oil industry on their own. With high prices, they don’t need Western capital. Venezuela, where Western companies’ assets have been expropriated, is a good example.

This is WHY we need to be doing all we can to reduce our need for foreign oil! These countries have no desire to increase output that will drop the price of oil!

Murti goes on to say that he expects oil to spike at somewhere around $200 per barrel, which means gas prices at around $5.75 per gallon. This is a spike and not something permanent. In fact, in the long run (like 20 years or so), they expect oil to go back to $75 a barrel. I’d like to know where he came up with that number and unfortunately Barron’s didn’t ask him to clarify.

Anyway, at $5.75 a gallon, my family would be spending $700 per month on gas. OUCH!

Gas stations will be all over this:

Crude Oil Going Through the Roof

Just imagine what will happen if a hurricane enters the Gulf.

UPDATE: I just got back from running some errands. Sure enough, the gas station I passed had raised their price to $3.89. They never dropped the price when oil fell earlier this week to $122 a barrel. Go figure.