Oil Blog

Alternative Energy 5/1/06

US can't afford to ignore alternative fuels
Baltimore Sun - United States
... smarter to develop and use alternatives in an increasingly unstable world, even if it means taxing oil products to finance a transition to alternative fuels. ...

Lawmakers look at bills to boost alternative fuels
WOOD-TV - Grand Rapids,MI,USA
LANSING, Mich. State lawmakers are looking to give motorists an incentive to buy alternative fuels that could lessen the country's dependence on foreign oil. ...

Interesting Market Reactions

The markets had an interesting reaction to Katrina today.  As expected, the price immediately climbed to $70, but backed off when it appeared Katrina was not going to be as catastrophic as originally anticipated.  It appears the market is playing a wait and see game.  As the damages are assesed the market will react accordingly.  The mention of releasing some of the oil reserve by President Bush did have the necessary chilling effect on the market, so this could weigh in on the price throughout the week as well.

High Oil Prices a Good Thing in the Long Run?

Could it be true?  Hard to say. 

The higher prices give impetus to developing alternatives, which is a good thing.  We are seeing increased investment in wind farms, a refocus on nuclear energy, and motivations to develop alternative automobile power plants. (i.e hybrids, and hydrogen) 

The consequences may be too much of a shock to the system in the near term.  Is it possible that the increased drain on capital, and the shift of capital to the oil producing nations, is causing a delay in bringing these technologies to market? 

This may be the case.  Energy policies in the consuming nations should have been focusing on the development of alternatives ever since the oil scare of the 70s.  Incentives and research dollars should have been in place for the last 25 yrs, especially when the consuming nations were able to import oil at a low price.  But, as they say, hindsight is 20/20. 

The capital drain on the consuming nations is a serious consequence, which by last measure $64+ per barrel, is becoming alarming.  This is draining needed capital across the board and straining our resources. 

It is not in the best interest of the nations receiving the capital shift to develop alternatives.  The capital shift is moving more and more of the world’s capital to the oil rich nations.  What are they going to do with the capital?  Well, lets looks at the nations; Iran, Saudi Arabia, Venezuela, Kuwait, Algeria, Libya, Qatar, UAE, Indonesia, Iraq, and Nigeria.  Do you honestly expect any of them to take the increased capital flow and invest it in petrol alternatives?  I don’t think so. 

There in lies the problem.

E&E TV

For everyone's information.  I received an email from Brian Stempeck, the Editorial Director of E&ETV, informing me of the availability of flash based video casts from their OnPoint program.  If you are interested, the link is http://www.eande.tv/main.  The OnPoint interviews are very informative and can help anyone broaden their knowledge in the energy markets.

As with the supply of any raw material, a disruption in its supply can trigger uncontrollable spikes.  This is always an inherent danger, and once again it becomes one of the focal points for the market to correctly interpret those risks into short and long term future pricing. 

Why this boom is going to bust

There are a couple of basic economic factors at play here.  That is why this is symbolic of the Internet Boom in the late 90s.  What are those factors you might ask?

Let me tell you, then you can make your own judgment call.

1) There is excess supply in the near term.  How do we know this?
    * Increases in production have no impact on price; case in point the recent increases by OPEC (link)
    * China and American usage is not rising at the predicted rates
            - This is due to the increase in price and the implementation of other energy techs and higher efficiencies
2) Refineries are at or over capacity with the demand
    * The world's consumption reached a point where it did not outstrip demand of raw product (Crude), but outstripped the available capacity to generate end product (gasoline, diesel, etc)
    * Refineries have not tacked on a surcharge to take advantage of increased demand, they still take their same float, though the market would allow it, and governments may not.
    * Increased capacity is a ways off, a refinery is a huge investment, and in the long run they may create capacity that is not needed because efficiencies and alternatives have dwindled demand . The last thing a refiner wants is to be producing at 50-60% capacity.  That is a money loser.  Hence the slow uptake in creating new capacity. (link)
3) New Rig Orders are still at a low (link)
    * Typically the wildcatters will seek new reserves when oil prices are high.  Look what happened in the late 70s and early 80s.  Rig demand exceeded supply so contractors built one new rig after another.  We don't have that happening right now.  That is because the contractors don't expect this to last, and they don't want to invest the capital. 

Looking into the crystal ball of Rig Orders, Refinery capacity vs. Supply I can't see anyway out but down.  Once the hysteria blows over, the market bubble will burst.  The question is not will it, but when?  I can't honestly tell you.  But I can tell you where there is going to be significant landscape changes.

1) Increased investment in alternative energy resources.  Hybrid cars, GM is betting the bank on hydrogen, nuclear plant building initiatives, wind production, etc, etc. (link)
2) The middle east will get extraordinarily rich over the next 20 years.  The higher prices, $30+ per barrel will add enormous amounts of capital to the already rich oil producing states.  By the way, this includes Russia!
3) In some ways the US will be better off, less reliance on foreign fuels. 
4) In some ways the US will be worse off, the enormous amounts of capital generated by oil producing states can be invested to take advantage of areas other than oil.  Look at Dubai.

Think about it.

Oil Bust?

I happen to agree with an article written by Matein Khalid on MENAFN.COM.  Matein highlights a couple of fundamental problems with the current price escalation. 

• Chinese imports are dropping

• OPEC production is up

• Alternative energy sources are trading at $18/barrel

The two parts I don't agree with are; oil trading below $20, I peg it in the 30s, and Bush making a play for Iran.  We (Americans) just don't have the patience for another Iraq, and Bush would be out on his ear.  Not to mention that the GOP would have a tough time being reelected next time.

But that not withstanding, the current price escalation is taking place at the wrong point in the supply chain.  Refining capacity problems should not drive up the price of crude. As I have stated before the end product price should be affected, and the suppliers of crude should be fighting over each other to get to that refining capacity, therefore driving the price of crude down, not up.

Where do prices go from here?

We are in an interesting place right now.  Borderline overproduction, and undercapacity to consume.  You would expect the price of a barrel of crude to go down with the oversupply, and the price of refined oil to rise, generating enormous profits for refiners.  This in turn would cause refiners to invest more capital in upgrading capacity.  But what is happening is that the speculation on the barrel, has caused a pinch, and actually lowered the available capital. 

Think of retailers like Walmart, etc sucking up extra transportation costs, until they get to the point that they eventually have to raise prices.  This is what may happen for gasoline.  We may have a super-spike, not on the cost of crude, but the cost of refined products.

Agree, or disagree?

Apology

I was traveling yesterday and was unable to post.  I will update the price graph with the current price as of this morning (6/17/05), and once again at close tonight.

Offshore Rig Utilization

Offshore Rig Utilization is a clear indicator of speculation increase.  Since offshore wildcatting and development costs far exceed the costs incurred on land, the utilization rates typically lag behind their onland counterparts.  The following utilization rates were supplied by Rigzone, a great resource for Oil Industry information:

The interesting figure to note is the lack of new rigs coming on the market.  The spike has been quick enough to catch the contractors off guard, and very few rigs remain in cold stacked.  Currently only 5 firm orders exist for semi-submersibles, 0 for drillships, and 4 semi rigs have been delivered in the past 2 years, and no drillships.  This information is courtesy of the Colton Company Site. 

It will be interesting to revisit the order numbers in a month or two.  This may be an indication that the contractors do not believe the current price levels will remain. 

18 - 19 Billion Dollars

As of today (June 3rd), the Strategic Petroleum Reserve stands at 694 million barrels.  The maximum capacity of the SPR is approximately 727 million barrels.  The average cost per barrel for the oil stands at $27.25 per barrel.  By the way, you can find all this information at the DOE.  Given the average market price today stood around $54 per barrel, this is a difference of almost $27 per barrel.  That means that the total valuation of the SPR is almost 37 billion dollars, double the acquisition cost.  Selling off the SPR today would generate a profit of almost 19 billion dollars.

Just food for thought.  No one has ever gone through the trouble of valuing the total sellable asset base of the United States, SPR and land included.

Important Market Note

People must not forget that the oil futures quoted in the news are a short term buy.  We are not predicting the supply of oil 3, 5 or 10 years from now.  We are predicting the supply of crude a month from now.  That is why items in the news, such as inventories, falling consumption, can have a dramatic effect on the futures market. 

Price Crash?

Are we headed to a price crash? 

The inability of prices to self correct in the midst of increased reserves and output suggests that at least in the near term we will head to a larger than normal price correction.  Speculation that crude oil is in short supply in the near term has pushed the price of a barrel to the $50+ region, but moves to add to the reserves, greater user conservation, and increased output should eliminate the near term speculation buying. 

So, what do you think? 

Also, increased speculation on leases that were looked over in the past may lead to finds that will help ease the long term price.  Remember what happened after the last crunch in the 70s? The higher prices helped spur increased speculation.  The price of oil plummeted with the new reserves coming online.  The one thing that we have today that we didn't have then is the emergence of the Indian and Chinese markets.

Once again, don't hesitate to add your thoughts.

Rig Count - Big Opportunity?

The rig count actually dropped in the month of March.  Why?  Can't really explain it other than the statistics show that the drop was experienced mostly in Canada.  You would expect the current steep increase in the cost of crude to be reflected in a rise in the rig count.  The truth is that there is an increase, but not one that most people would expect. 

I believe that where the lack of a steep increase lies in two factors.

1) Lack of new leases
2) Lack of New Rigs

Ever since the hey day of the early 1980s, drillers have been reluctant to invest in new rigs.  Instead most of the rigs built during that time period were mothballed or retrofitted.  Very few new rigs are coming online. 

Will that change?  The sharp increases in oil experienced during the late 70s for the most part translated to the opening of new leases, and the followup of new rig production. 

Who here remembers Western, Zapata, and Rowan among others?

Will this occur again?  It may, but the capital costs are enormous, and few have the stomach for sinking that much capital in a remote possibility.  I think at some point in time we will see an explosion of new leasing opportunities, and the follow on of new rigs being built. 

I cannot honestly tell you when, but I do believe it to be inevitable.

By the way I have added a new chart to the site. (Rig Count) 

I know it is small, but you can right click and zoom.  I believe its real value lies in determining trends, through eyeballing the slopes.

Taxes Lessen the Impact

Guess what?  Taxes are actually helping America cope with the increased cost of crude oil. 

Yeah right!  That is what most people would say, but impact is traditionally measured not in totals, but in percentages.  If I told you that milk prices were going up 100%, that would have a greater impact on your buying behavior, than if I told you milk was going up $1.50. 

The reality here is that gas prices at the pump have jumped since last year roughly 70 cents per gallon.  The percentage impact is about 50%  over the previous years price.  Now compare that to the situation if taxes didn't exist.

Gas prices have gone up roughly 70 cents per gallon, or 70 % over the previous year.  Assuming gas without taxes would have been approximately $1.00 per gallon a year ago, and $1.70 now. 

Relationally, the impact is greater without taxes, so in some sort of warped way, the additional burden of taxes has lessened the impact on consumption.

Oil Policies

Before you read this, I want to make one thing clear.   I am not a socialist, and nor do I believe in the long term views of the Socialist movement.  That being said, I wanted to post the following quote from a recent article at Socialistworker.org, because I felt that it had validity and should be heard:

Instead of pursuing research into alternative energy strategies, which would infringe on the immense profits of the oil and auto industries, U.S. energy policy is largely devoted to maintaining U.S. dominance in oil-producing regions.

One very serious consequence is that competition between states for control and access to oil remains a central issue for the world’s major governments--the U.S. most of all--and one that will only increase in importance in the years ahead. Oil is the single most important and profitable commodity in the world. As author Michael Collon writes in his book Monopoly, “If you want to rule the world you need to control the oil. All the oil. Anywhere.”

Faced with a growing reliance on imported oil, the Bush administration has been determined to ensure that governments in oil-producing regions continue to allow a steady flow of oil to the U.S.
            -socialistworker.org

I do believe that what we (US) are doing is a futile attempt to maintain control over the world's oil markets.  This is shortsighted and will ultimately hurt the US economy with long term detrimental effects that can potentially never be resolved.

Geopolitical Wealth Shift

What are the long term effects of gross amounts of capital shifting from the industrialized west and east, to the oil rich countries of the middle east?

After all, these countries don't produce anything, at least in the traditional sense of taking raw materials and fashioning some sort of finished product. 

In the past the producers of raw materials were exploited by the countries that had the means to apply production.  Now that the demand for the raw material has significantly outstripped the pacing of supply, a paradigm shift has been enforced.  Now the market is dictating a higher premium for the raw product. 

The only way to lessen or re shift back to the old paradigm is to devalue the raw material, in this case oil.  Oil can only be devalued through reduced consumption, and therefore alternative means. 

The bottom line here, is that the US is spending billions of dollars in a attempt to stabilize an unstable region.  The problem with this philosophy, that even if successful, is short term at best, and the long term problems of supply and demand will still take hold.  Especially with the maturing entrance of India and China in the world petroleum market. 

What we have here is a losing battle, regardless of whether or not we do in fact stabilize the region and gain greater access to oil.  In the long term, we will still be battling it out in the market place for the oil that is entering the market. 

In order to regain control of the market, we must refocus the dollars to research alternative fuels.  Only when the dependence of crude is lessened to the point where the producers are in search of a market, will we be back in control of our own markets outside of the oil market.

Question: Refining Capacity or Supply?

What is the primary driver behind the increase in Oil futures?  Is it concern over refining capacity? or is it supply concerns?

Generally one would expect the lack of refining capacity to have a greater effect on the price at the pump, but not on the crude future market.  But in this case, I believe it being used as a smoke screen for long term supply concerns.  What we have here is a serious market correction.

Another interesting long term effect is the squeeze on gas station operators.  Personal opinion here, is that we will see greater closures as the price moves up.  Reduction in demand, even margins, generates fewer profits.