Why Oil Prices Will Tank

[sifuwong]

http://money.cnn.com/2008/06/06/news/econo...sion=2008060610

[RedScare]

While the price of oil may indeed drop, to use the housing and tech stock bubbles as his proof is misleading. Those two bubbles occurred because there was too much of a good thing, not too little. In the case of oil, the only way the price collapses is if we are suddenly flooded with cheaply produced oil, or demand collapses.

Cheaply produced oil is no longer occurring at these production levels (85 million bpd). Easy to find and pump oil is simply not available in the quantities currently needed. This is not to say we are running out, just that it cost more to get to the deep stuff.

That leaves demand. A worldwide recession could cause declines in demand, thereby causing price declines (not sure if it causes a collapse). But, it would need to be a pretty big recession. Worldwide oil production has not been rising much, if at all, since 2005. Demand declines would have to go below 2005 levels to really get a big decline in price. But, I don't think that is impossible. In fact, at $200 oil and $6 or $7 dollar gas, I think a worldwide recession actually becomes likely.

[memebag]

While the price of oil may indeed drop, to use the housing and tech stock bubbles as his proof is misleading. Those two bubbles occurred because there was too much of a good thing, not too little. In the case of oil, the only way the price collapses is if we are suddenly flooded with cheaply produced oil, or demand collapses.

I agree that the comparison to housing and tech bubbles is simplistic.

There's another way for the price of oil to drop (for us, at least), and that's if the dollar strengthens. Or I guess we could switch to the euro...

[Subdude]

We've been having this protracted "Is it a bubble?" discussion at work and can't really come to a good consensus. On the one hand markets are clearing at the high prices, there is no reports of stockpiling or shortages, and forward curves are still higher. That said, my spidey sense says that the article is right and there is a bit of a bubble. It is always that way when all the conventional wisdom announces that the world has changed. Fundamentals simply haven't changed enough in a year to justify a doubling of prices. My guess is that at some point oil prices will fall, but will keep a large portion of the gain taken over the last year.

If markets ever believed the US was serious about strengthening the American Peso, that would help too.

[RedScare]

We've been having this protracted "Is it a bubble?" discussion at work and can't really come to a good consensus. On the one hand markets are clearing at the high prices, there is no reports of stockpiling or shortages, and forward curves are still higher. That said, my spidey sense says that the article is right and there is a bit of a bubble. It is always that way when all the conventional wisdom announces that the world has changed. Fundamentals simply haven't changed enough in a year to justify a doubling of prices. My guess is that at some point oil prices will fall, but will keep a large portion of the gain taken over the last year.

If markets ever believed the US was serious about strengthening the American Peso, that would help too.

Good point. Since much of the "bubble" is due to the weak dollar, it would take a strong dollar to burst it. But, no one will take the politically difficult steps to strengthen it. The one that claims to be a fiscal conservative, McCain, is promising to continue the war, lower taxes, and even get rid of the gas tax, all measures that will add to the deficit and weaken the dollar further. Obama might be more inclined to raise taxes and end the war sooner, but he also wants to expand healthcare, which isn't free. Even if he were to attempt to balance the budget, it would take several years to get the troops out, and he would likely increase domestic spending to spur the economy, keeping the dollar weak for several more years.

[Mark F. Barnes]

Another thing to understand that our demand is outgrowing our ability to get it out of the ground fast enough. Red is dead on with the expense of getting at it, but we also are at huge shortages in available iron. (i.e. drilling rigs and pipe) in 1980 when things were booming out of control, we had a lot of different factors involved in the industry. Iran was in the middle of a revolution, which was a loss of 2-3 MMbpd production, the industry had overgrown itself. We had an over abundance of rigs and pipe and personnel. These days we are short on everything, rigs are hard to come by, rig hands are hard to come by, and pipe is in the worst shape of all. I addressed this in Puma's thread once before. At the moment for instance, 4 1/2" P-110 casing is almost none existent. They cannot mill it fast enough. I pre-bought acres of it, because I knew this was going to happen, and I get calls daily from people begging for pipe, promising they'll replace it once theirs comes in, only problem I won't run Chinese pipe, because it doesn't all grade out API, and that's about all that you can find right now. I bought miles of it from Lone Star foreseeing this shortage coming, in fact Lone Star still owes me pipe. Nothing they will mill for they next several years is up for sale, they are still trying to meet pre-paid orders. Shell has 1200 acres in Wyoming at Chickasaw Distribution covered with pipe. The 60% of the pipe out of Lone Star Steel goes to Shell. Companies are being forced to run N-80 or less in High Pressure gas wells and relying of high end completion jobs to support the lower grade pipe in place. There are brokers out there that did as I did and bought up pipe early, knowing this was going to come in to play, and are selling it for three times the normal cost. And sad thing is, they know they'll get it because there are cases when you just have to have P-110 for the higher burst and tensile strength. Lone Star's output was cut in half when Toyota built the plant in San Antonio, then paid for Lone Star to re-tool to produce chassis stamped out in Lone Star Texas. The pipe business was slow at that time and it was a smart move by LSS at the time, but it's hindered the pipe business in the long run, for those that don't want to run foreign pipe.

Drilling rig day-rates are three times what they were eight years ago. It's a half million a day to operate in deep water GOM, and those wells take several months to drill and complete each. Some of the least expensive places to drill in the US are unavailable due to Environmentalists. And the places that are available on BLM land, cost double because of all the extras that are thrown in to comply with the environmental restrictions. Bottom line it just cost more to drill these days, and there is no shortage of places to drill, just a means to get it done.

It's no bubble folks, best just get use to it. Until the demand drops severely worldwide, just like Red said, it's here to stay, but will never fall out like it did before. We learned our lesson last time, and not over build our Industry. The real estate market should have done the same, however greed will make you do strange things at times.

[CDeb]

How much of a part does commodities trading practices have in the inflated price? What do you guys think of this article?

http://planetgore.nationalreview.com/post/...jExYmU0ZjFhNzY=

Also, the decisions by India and Malaysia to decrease their fuel subsidies could have an effect on demand as well.

[westguy]

There isn't enough in the US to make much difference in the world's supply.

[20thStDad]

People are smart. It may not be quick or easy, but we'll come up with something to lessen or eliminate the dependence on oil. I just hope it's in the next 10 years. I'm sure 150 years ago people wondered whether we could breed enough horses to do all of our work. Ok maybe not.

In the mean time, gas/car expenses account for about 4% of our total budget. That's not a huge amount. We spend twice that on food (some of that cost is due to oil prices too), and oodles more on the house note. So even if it doubles again, we'll just take steps to curb our usage, and can make some adjustments to find that other 4% if needed. It won't end my world. It'll just make everyone else mad enough to find an alternative, which is great.

[crunchtastic]

In the mean time, gas/car expenses account for about 4% of our total budget. That's not a huge amount. We spend twice that on food (some of that cost is due to oil prices too), and oodles more on the house note. So even if it doubles again, we'll just take steps to curb our usage, and can make some adjustments to find that other 4% if needed. It won't end my world. It'll just make everyone else mad enough to find an alternative, which is great.

Yesterday the NYT had a very eye-opening story on the impact of gas prices in poor rural areas, especially the south and the west, where gas costs as a percentage of income are 3 times more than in urban and suburban areas. For the poor in, for example, the Mississippi delta, it's beginning to make more economic sense to not work and get food stamps or some type of welfare, than spend most of your day's pay to fill up your old clunker truck to drive 50 miles roundtrip to work the fields, which is the only job to be had.

Imagine $7 gas and the impact on the rural poor. Very thought provoking, I thought. http://www.nytimes.com/2008/06/09/business...&ei=5087%0A

[cottonmather0]

It's not ever going back to $30 or even $40 or $50, but yeah, there will be a major correction within the next 12 months, I think. I can see the near month contracts heading back towards $80 someday soon. When the dollar strengthens (and it will) and when foreign governments decide that they simply can't afford to subsidize so much domestic consumption (which is mentioned in the article), it will happen, and once that starts then a lot of these long-only funds and directional traders will get CRUSHED and start liquidating, which itself will cause the price to go down even more.

There are a lot of guys who were trying to pick the top for a while and were writing $80 and $100 and $120 calls and had to cover those, and there were quite few traders who just went outright short at those spots, too, and got squeezed, the net result of it all being upward force on the price... but the opposite can and will happen just as easily once some of the guys who've just been buying and buying start getting pressure from the other direction.

Not dramatically, and not permanently, but it will happen. Demand is still rising much faster than supply, forward prices will continue to be stronger and that will translate into the nearer periods, but yeah, what's happening now is going to reverse, eventually, at least for a little while.

[cottonmather0]

Imagine $7 gas and the impact on the rural poor. Very thought provoking, I thought. http://www.nytimes.com/2008/06/09/business...&ei=5087%0A

This is exactly why China and India subsidize fuel so much - they have even poorer people who certainly can't afford $7 gasoline on their own. It's creating artificial demand from those countries. Once they cut out those subsidies, that demand will start to subside and the worldwide price will start to ease.

[Pumapayam]

http://money.cnn.com/2008/06/06/news/econo...sion=2008060610

I read that last week, it aint gonna happen, the minute it gets remotely cheap, "the People" will buy it like tuna and bottled water pre-hurricane and it will go right back up. I accept it. Just waiting for alternate fuel to become feasable.

[crunchtastic]

This is exactly why China and India subsidize fuel so much - they have even poorer people who certainly can't afford $7 gasoline on their own. It's creating artificial demand from those countries. Once they cut out those subsidies, that demand will start to subside and the worldwide price will start to ease.

But how much would prices realistically subside? Has the standard of living in those countries risen enough to end subsidies without fuel reverting to a luxury for the very wealthy, and impeding overall economic growth?

[Mr. Chenevert]

Another thing to understand that our demand is outgrowing our ability to get it out of the ground fast enough. Red is dead on with the expense of getting at it, but we also are at huge shortages in available iron. (i.e. drilling rigs and pipe) in 1980 when things were booming out of control, we had a lot of different factors involved in the industry. Iran was in the middle of a revolution, which was a loss of 2-3 MMbpd production, the industry had overgrown itself. We had an over abundance of rigs and pipe and personnel. These days we are short on everything, rigs are hard to come by, rig hands are hard to come by, and pipe is in the worst shape of all. I addressed this in Puma's thread once before. At the moment for instance, 4 1/2" P-110 casing is almost none existent. They cannot mill it fast enough. I pre-bought acres of it, because I knew this was going to happen, and I get calls daily from people begging for pipe, promising they'll replace it once theirs comes in, only problem I won't run Chinese pipe, because it doesn't all grade out API, and that's about all that you can find right now. I bought miles of it from Lone Star foreseeing this shortage coming, in fact Lone Star still owes me pipe. Nothing they will mill for they next several years is up for sale, they are still trying to meet pre-paid orders. Shell has 1200 acres in Wyoming at Chickasaw Distribution covered with pipe. The 60% of the pipe out of Lone Star Steel goes to Shell. Companies are being forced to run N-80 or less in High Pressure gas wells and relying of high end completion jobs to support the lower grade pipe in place. There are brokers out there that did as I did and bought up pipe early, knowing this was going to come in to play, and are selling it for three times the normal cost. And sad thing is, they know they'll get it because there are cases when you just have to have P-110 for the higher burst and tensile strength. Lone Star's output was cut in half when Toyota built the plant in San Antonio, then paid for Lone Star to re-tool to produce chassis stamped out in Lone Star Texas. The pipe business was slow at that time and it was a smart move by LSS at the time, but it's hindered the pipe business in the long run, for those that don't want to run foreign pipe.

Drilling rig day-rates are three times what they were eight years ago. It's a half million a day to operate in deep water GOM, and those wells take several months to drill and complete each. Some of the least expensive places to drill in the US are unavailable due to Environmentalists. And the places that are available on BLM land, cost double because of all the extras that are thrown in to comply with the environmental restrictions. Bottom line it just cost more to drill these days, and there is no shortage of places to drill, just a means to get it done.

It's no bubble folks, best just get use to it. Until the demand drops severely worldwide, just like Red said, it's here to stay, but will never fall out like it did before. We learned our lesson last time, and not over build our Industry. The real estate market should have done the same, however greed will make you do strange things at times.

Actually what you just described is a bubble. I am no expert in drilling for oil, nor will I pretend to be. However, it sounds like there are some significant shortages in the industry, one being pipe. In the long term, people will realize there is money to be made in milling pipe and more pipe will be made at a lower cost. This may take years, but eventually it will happen.

So in time, pipe will not be in shortage. Then there will the next shortage, and in time that will be solved, etc. Again, this all may takes years and years to get back to equilibrium, but it always does.

Unless the shortage is actually the oil, which I am hearing you say is not the problem, the rest of the resource issues can be fixed. Once they are fixed, the market price will fall.

[cottonmather0]

Actually what you just described is a bubble. I am no expert in drilling for oil, nor will I pretend to be. However, it sounds like there are some significant shortages in the industry, one being pipe. In the long term, people will realize there is money to be made in milling pipe and more pipe will be made at a lower cost. This may take years, but eventually it will happen.

So in time, pipe will not be in shortage. Then there will the next shortage, and in time that will be solved, etc. Again, this all may takes years and years to get back to equilibrium, but it always does.

Unless the shortage is actually the oil, which I am hearing you say is not the problem, the rest of the resource issues can be fixed. Once they are fixed, the market price will fall.

Eh, true, but even if we can't agree on exactly what the number may be, it's axiomatic (mostly) that the supply of oil is fixed at some point. If demand continues to increase, then the price can't help but go up in the end. In other words, yeah, they'll make more pipe (and derricks and mud and all that stuff) and the marginal cost of production (which is all a supply curve is) will reduce and we'll find a new equilibrium point that may or may not be lower relative to today's prices. But in the long run the price is going up no matter what we do because we're going to eventually run out of oil.

[TJones]

There isn't enough in the US to make much difference in the world's supply.

That's because any oil we drill HERE, will go to US, not the rest of the world. Mark will confirm, there is lots of oil underneath the U.S. soil, we just can't get to it. We wouldn't need to even think about buying Arab oil for about 100 years before having to think about reserving our surplus. The biggest problem is that China could care less about alternative fuel sources. They will take what is avialble NOW, so their demand has come to be just as great as ours, and now you have a supply and demand equation.

I see that Saudi is going to have a pow wow, perhaps there is some light at the end of the tunnel here. Perhaps a miraculous discovery that Saudi mis calculated the supply and they actually have 25% more than they originally projected ? This coupled with a temporary gas tax cut will eleviate alot.

[Mr. Chenevert]

Eh, true, but even if we can't agree on exactly what the number may be, it's axiomatic (mostly) that the supply of oil is fixed at some point. If demand continues to increase, then the price can't help but go up in the end. In other words, yeah, they'll make more pipe (and derricks and mud and all that stuff) and the marginal cost of production (which is all a supply curve is) will reduce and we'll find a new equilibrium point that may or may not be lower relative to today's prices. But in the long run the price is going up no matter what we do because we're going to eventually run out of oil.

In the long term, housing prices in California will exceed pre-crash prices. That doesnt mean that housing wasnt in a bubble.

[Mr. Chenevert]

... This coupled with a temporary gas tax cut will eleviate alot.

How exactly will a reduction in the gas tax affect the price we pay for gasoline?

Demand for gas so far has been very elastic, meaning that even as prices increase, we dont see a large drop off in demand. However, even with such an elastic commodity, there is a certain segment that is inelastic. Whether they want to or not, they cannot purchase gas when it exceeds a certain price.

Lets assume for a second that we get a temporary reduction in the gas tax. If gasoline was priced at $4 with taxes, lets assume it goes down to $3.60 without taxes. Multiple things would happen:

A) The demand would increase from people who were previously not able to afford gasoline.

The demand would increase from people realizing that this tax break is temporary and will whord gasoline to sell off in three months.

A + B will push demand up. Supply would not have changed at all, therefore gasoline will not actually sell for $3.60, it will easily go back to $4, if not higher.

However, now the government isn't getting the needed money to build roads and bridges.

[memebag]

I see that Saudi is going to have a pow wow, perhaps there is some light at the end of the tunnel here. Perhaps a miraculous discovery that Saudi mis calculated the supply and they actually have 25% more than they originally projected ? This coupled with a temporary gas tax cut will eleviate alot.

I figure OPEC likes the high price, but they don't want it to get so high that it pushes the development of alternatives. They have to find a price that makes everyone delicate flower without actually doing anything to reduce demand.

[RedScare]

That's because any oil we drill HERE, will go to US, not the rest of the world. Mark will confirm, there is lots of oil underneath the U.S. soil, we just can't get to it. We wouldn't need to even think about buying Arab oil for about 100 years before having to think about reserving our surplus. The biggest problem is that China could care less about alternative fuel sources. They will take what is avialble NOW, so their demand has come to be just as great as ours, and now you have a supply and demand equation.

I see that Saudi is going to have a pow wow, perhaps there is some light at the end of the tunnel here. Perhaps a miraculous discovery that Saudi mis calculated the supply and they actually have 25% more than they originally projected ? This coupled with a temporary gas tax cut will eleviate alot.

It is far more likely that the Saudis have LESS oil than they claim, than more.

I don't know about you, but all these claims that there is plenty of oil, but that it is harder to get to, and therefore more expensive to produce, sure sounds a lot like Hubbert's peak. When rigs in the Gulf must drill 5 miles to reach the oil instead of the one mile that they used to drill, you're going to have shortages of pipe. And, even using the author's poor analogy to housing and tech stocks, he still states that the most expensive oil is costing $70 per barrel to produce. Factor in the weak dollar at $1.57 to the Euro and that $70 oil would be $110, only $25 under its current trading price. So, it would appear that the "collapse" might only be $25, enough to drop the price of gas to about $3.75. The only thing that would seem to cause oil to drop further would be a strengthening of the dollar, or, as stated earlier, a drop in demand.

The drop in demand would need to be fairly substantial. Worldwide oil production has been stagnant since 2005. Production in 2005 was 84.5 million bpd. In 2006, it was 85.25 mbpd. In 2007, it DROPPED to about 85 mbpd. With stagnant production and increasing consumption, the price will only go up. Only when the price causes a noticeable drop in consumption will upward price pressures diminish, and the "collapse" occur. By that time, we will have dumped most of our inefficient vehicles for smaller ones, cut down on unneeded trips, and increased usage of mass transit. If THAT is what the author means by a collapse, then, yes, I'd have to agree with him.

[Mr. Chenevert]

he said the most expensive oil is costing $50, not $70 to produce.

The actual number is irrelevant. The fact that its substantially less than what we are actually paying supports his theory of a bubble.

[westguy]

That's because any oil we drill HERE, will go to US, not the rest of the world. Mark will confirm, there is lots of oil underneath the U.S. soil, we just can't get to it. We wouldn't need to even think about buying Arab oil for about 100 years before having to think about reserving our surplus. The biggest problem is that China could care less about alternative fuel sources. They will take what is avialble NOW, so their demand has come to be just as great as ours, and now you have a supply and demand equation.

You missed the post in here or the other thread about Alaska oil being sold to foreign buyers (presumably in Japan and Korea). I think the oil Mark was referring to was in ANWR, which could also reach the same fate if it is drilled. Basically oil from US soil does not belong to the nation.

[RedScare]

he said the most expensive oil is costing $50, not $70 to produce.

The actual number is irrelevant. The fact that its substantially less than what we are actually paying supports his theory of a bubble.

Be sure to mark this thread, so that you can remind me of the "collapse".

Note: I put quotes around "collapse", because as I reread the article, he appeared to get increasingly vague about what his definition of "collapse" is. I have a suspicion that his definition of collapse is a lot higher price than what our definition would be.

[TJones]

You missed the post in here or the other thread about Alaska oil being sold to foreign buyers (presumably in Japan and Korea). I think the oil Mark was referring to was in ANWR, which could also reach the same fate if it is drilled. Basically oil from US soil does not belong to the nation.

westguy, I am talking about ANWR, not what we currently pull from Alaska. Oil is traded on an open market so whoever is willing to buy it gets it. ANWR is going to be a different scenario. There are other problems besides ANWR though. The fact that we haven't built a refinery in 20 years to help refine the crude is a MAJOR part of the problem also.

[RedScare]

The fact that we haven't built a refinery in 20 years to help refine the crude is a MAJOR part of the problem also.

How so?

[TheNiche]

How so?

It is a problem, but it isn't part of the problem with oil prices. Actually, having excess refining capacity would create lower refined products prices and induce people to use more of those products. The more refined products are used, the more oil is used, actually contributing to the oil price problem.

With oil prices having spiked and thus driven refined products prices to new heights, people have started to cut back on their use of those refined products, in so doing freeing up refining capacity and causing refiners' margins to fall, with their future being much more in question.

[TJones]

How so?

As it pertains to GAS prices ? Supply and demand come into play dramatically when you can't get the product out to the consumer. As you have seen, price of gas keeps going up even when price of oil goes down a little.

Just between you and me, I don't see a "bubble" bursting on oil. I see a further influx in the price of oil, and the reason being is because SOMEBODY wants to open up ANWR. I won't say who, as I am not 100% sure, but I am sure that is the reason the leash on oil has been let go.

Once ANWR is opened though, I expect to see at least a 25% decrease in price as some oil reserves will be let onto the market in the expectation of ANWR being able to replenish those reserves within the next 4 years.

[plumber2]

The fact that we haven't built a refinery in 20 years to help refine the crude is a MAJOR part of the problem also.

Who is We?

For the last 20 years all the oil companies have been concerned with is buying other oil companies. They have been keeping their earnings to themselves. Let's see Chevron bought Gulf and then they bought Texaco, but not before pissing Getty and Pennzoil off in the process and sueing each other. Exxon bought Mobil after their tanker sunk in Alaska. Amoco bought Atlantic Richfield only to then be bought themselves by BP. El Paso buys Tennoco. Diamond Shamrock buys Valero. Phillips buys Conoco.

The list goes on. They really accomplished alot with all their earnings over the past 20 years. Couldn't one of them at least build one refinery?

They need to be re-regulated. We need Teddy Rosevelt to come back.

[Mark F. Barnes]

That's actually a good point, on the definition of "collapse". (typical damn lawyer ), dropping $25/bbl for those that got in late, and to them it could be a collapse, but for an industry wide collapse like 1986, that I sincerely doubt. I just don't consider this a bubble, more like a balloon. Bubbles pop and go away, balloons just go down. There was so much going on behind the scenes in the '86 collapse, that many people were unaware of. That was a true bubble, with false shortages being built upon in the 70's, and then the power struggle within OPEC itself, that started rocking the boat, and the ripples soon became waves, and the ship sank. False margins were met with sharp declines, then in a mass panic the market got flooded with foreign suppliers trying to save themselves from bankruptcy, only to drive nails in their own coffins. You see they had pushed the margins so far in the late seventies, and basically built castles on sand, instead of rock. The false high demands of crude eventually came to light, the production went from 10 MMbpd to less the 2.5 MMbpd, the thing was spinning out of control. Greed greed greed, it shut down the economy locally and we ventured to foreign sole to replenish our exploration needs. by the early eighties the biggies were trying to cover their selves by making more false margins, by offering price margin guarantees, that were nothing more than piling the BS higher until it all fell apart in '86. We paid for the energy crisis of the 70's with the crash of the 80's. And every bit of it self induced.

Another big factor in our stability now days, is we don't rely on paper investments to try and over-stretch our spending ability. We, being oil companies, remain more liquid and don't go looking at all the long term borrowing of the past to boost exploration. Basically we stay within our means, which our means are a lot better now, instead of living on paper waiting for the next shoe to drop, aka Enron Scam. Checks and balances are much more scrutinized internally these days than ever before. It simply amazed me that Enron made it as long as they did on false paper. It's unfeasible for anyone with any sense, to think that all those so called people had no idea. I mean we know now, but that was the biggest scam, I would have sworn Billy Sol Estes was in charge instead of the likes of Lay, Skilling, and Fastow. Now that was huge. You should have tried to walk into a Smith-Barney looking to borrow 50 million dollars after that to do a wildcat venture down somewhere. A colonoscopy is more pleasant. They tighten the purse strings after that for a bit.

To be honest, we will be lucky IMHO if we ever see crude below $90/bbl ever again.