The Oil Drum: Europe

Jeff Rubin, Chief Economist at CIBC World Markets, in a recent report, is now saying that the current recession is caused by high oil prices. Defaulting mortgages are only a symptom of the high oil prices. We should be blaming the underlying cause--higher oil prices--rather than the symptom. These higher oil prices caused Japan and the Eurozone to enter into a recession even before the most recent financial problems hit. Higher oil prices started four of the last five world recessions; we shouldn't be too surprised if they started this one also.

The long forgotten 'oil crisis' of just a few months ago has been replaced by a full blown 'credit crisis' - related events that represent the unravelling of half a century of unsustainable trends in oil consumption and debt. These two ingredients have been used in a special 'compound growth formula' to finance the construction of suburbia and fuel the (un)happy residents on their long journey to work and home again via the shopping mall, so they could spend more than their earnings on stuff to put beside the TV and inside the microwave oven.

A few days ago, I wrote a post titled Why Are Oil (and Gasoline) Prices So Low? Since then, OPEC has voted to cut oil production 1.5 million barrels a day. In spite of this, the price of oil is about 5% lower. The purpose of this post is to add an update, with a little more of the story about why the price of oil is dropping more than some of us would expect.

One of the issues I mentioned in that story was

4. Rising value of the dollar

I noted in that post that the price of oil seems to drop as the price of the dollar rises against currencies such as the Euro. As I delve into the question more, I am starting to learn more about why the value of the dollar has recently been rising. It seems that the rising value of the dollar is tied to a combination of things--one is the flight to the US dollar for safety, another is the unwind of the carry trade, and a third is margin calls on hedge funds and other borrowers. The rising level of the dollar because of these issues seems to be a major contributor to the recent decline in oil prices.

We all know that oil prices are lower than they were in the recent past because supply is greater than demand. In fact, OPEC oil ministers are meeting this week to try to fix supply, so it will be more in line with demand.

All of this seems a little strange, though. We are going into the winter months, when demand for oil normally rises because many people around the world heat their homes with oil. We are using somewhat less gasoline in the United States, but apart from the hurricane disruptions, not very much less than earlier this year. While we are going into a recession, it doesn't seem to have hit with full force yet. What other factors may be involved in the current lower prices? In this post, I will discuss factors besides those we usually think of as supply and demand that may be involved.

One of the classic ecological modeling problems is the oscillating populations of predators and their prey in an ecosystem--as prey population rises, predator population follows suit until prey population begins to fall off, resulting in a subsequent drop in predator population (illustrated below). The same dynamic also applies, to some degree, to the relationship between oil price (prey) and marginal production/demand destruction/energy policy (predator). This post will explore that relationship and its ability to help us avoid poor energy policy choices.

We're in the middle of an interesting few weeks in the Australian oil market, so it's worth capturing these charts of international and regional oil prices from the Australian Institute of Petroleum for posterity.

An important Dutch energy institute, the Clingendael International Energy Program (CIEP), recently published a report that confirms most of the conclusions about the oil market reached over the years at the oildrum. That the floor price of oil is now 110 dollars per barrel, that supply will not rise beyond 100-105 million b/d in the coming decades, that there will be an oil supply constraint for most of the next decade, that there are insufficient quantities of alternative fuels available and that thus demand destruction is inevitable. CIEP is especially important because it is endorsed by amongst others BP, Shell Netherlands, Total E&P Netherlands, three Dutch Ministries, Wintershall, Vopak Oil Europe Middle East and several Dutch energy companies. The report in english can be downloaded here (PDF 2.8 megabytes, 108 pages).

'This outlook of new scarcity is now exacerbated by the fact that not only available supply will determine what amount of demand can be satisfied; it will also bring about a new allocation of the available oil due to a lack of adequate supply growth compared with demand. In practice this means that demand rationing will be required in the OECD countries and particularly in the US, in order to accommodate growth in the newly developing countries, notably China and India. Different fuel prices for end-consumers in the different countries will be the dominant factor behind this ‘oil redistribution’. (emphasis mine)

Now that oil is over $100 - and in my opinion will be much higher in 5 or 10 years (T. Boone Pickens predicts $300/bbl in 10 years) - we will have tightened our belts a good deal by the time any of this oil could actually reach the market. Therefore, I think now is the time for Congressional hearings on opening up these areas. Let's have an open debate on the issue. However, if these areas are opened for drilling, I have a compromise that should be very attractive to those in opposition.

This is a guest post by A Siegel, who blogs on a range of energy issues at Get Energy Smart! NOW!!! and works with TOD European Editor Jerome a Paris on Energize America, a blog-driven effort to develop innovative and holistic energy policy options in the face of peak oil and global warming.

Earlier today, someone asserted that well over half (or more than $2) of America's $4.10 gallon of gas is due to the war. Another person asked "Is that right?" And, after pulling out some hair from my head, my response was both short and then long.

The short:

Two dollars a gallon is, perhaps, as good a swag as anyone's.

...

I think.

And, the long? well, it's under the fold. :)