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March 12, 2008

Oil Supply Up, Relative Demand Down, Price Is Soaring - I'm Confused

Yes I am indeed confused. What's going on?

Ronald Bailey explains at Reason Magazine:

Oil prices climbed to their highest level ever, reaching over $108 per barrel this week. And Americans are feeling this price spike at the pump, with gasoline averaging $3.22 per gallon. An analysis released by the investment firm Goldman Sachs suggested that oil prices might soar to $200 per barrel. Does this make sense?

Not really. Although U.S. crude oil inventories have fallen, gasoline inventories are at their highest since March, 1993, notes Tim Evans, an energy futures analyst at Citigroup's Futures Perspective. World oil production was up 2.5 percent in the first quarter of 2008 over the same period in 2007 while world oil consumption rose by just 2 percent. In fact, world production is projected to be 3.3 percent higher in the second quarter and 4.1 percent higher in the third quarter than the same periods a year ago. On the other hand, world demand is projected to rise by just 1.6 percent over the next six months.

In fact, demand is falling in some countries. According to economist John Kemp at the commodities firm Sempra Metals, the U.S. consumed 4 percent less petroleum in January 2008 than it did the year before. Evans agrees, noting that the U.S. demand for petroleum products began falling off last July. Interestingly, this drop in U.S. oil consumption began before crude prices turned vertical and before we began to see weakness in the broader economy. Even China's thirst for oil is abating somewhat. Its demand for oil, which once rose at 10 percent per year, has now dropped to 6 percent per year. In addition, world surplus oil production capacity has gone from a very tight 1.5 million barrels per day a couple of years ago to more than 3 million barrels today, says petroleum economist Michael Lynch.

So supply is up; relative demand is down and yet, the price of oil is soaring. What's going on? Last week, Exxon Mobil CEO Rex Tillerson blamed a third of the recent run up in oil prices on the weak dollar, another third on geopolitical uncertainty, and the rest on market speculation.

Hmmmm..., a third from "market speculation"? I'm not convinced - most of us would believe that market speculation rates a hell of a lot more responsibility for oil prices that just a third. So let's cut to the chase, what in the hell is really going on? Are we destined to see oil prices continue to climb in an ever-expanding bubble?

Bailey believes not - prices can fall as steeply as they've risen. In fact, based on input from Tim Evans, an energy futures analyst at Citigroup's Futures Perspective, and others, Bailey writes that we just might be saying over the next few years: Oil bubble? What bubble ?

All I can say is that the damned bubble can't pop too soon for me. Of course with all this bio-fuels crap going on and corn being used for ethanol, we might just be seeing a food bubble soon that makes the oil bubble small potatoes.

Related readings:
Oil Price is a Bubble Waiting to Pop:

"World consumption totals around 86m barrels a day, yet trading volume based on price speculation is 15 times that amount. So when will it end? Gheit doesn't know but he's confident it will. "This is a bubble, and it will burst.""

Posted by Richard at March 12, 2008 10:42 PM