OPEC’s crude oil cuts utterly ineffective

Yesterday, crude oil futures prices closed at nearly a 17-month low. Bulls talking up an OPEC cut just couldn’t silence the drumbeat of falling demand growth and a sagging economy.

Light, sweet crude for December delivery settled down 93 cents, or 1.5%, at $63.22 a barrel on the New York Mercantile Exchange, the lowest settlement price since May 29, 2007. December Brent crude on the ICE futures exchange settled down 64 cents, or 1%, at $61.41 a barrel.

The price of crude oil will continue in a downward spiral based on expectations that worldwide demand growth will be drastically lower in 2009 as economies cool worldwide. It’s not that demand is shrinking. To the contrary, it demand for oil is still growing, simply not at the pace it has been for the last decade. While little new happened to deepen demand worries Monday, the market didn’t receive any signs that it had hit bottom, either.

OPEC Secretary General Abdalla Salem el-Badri said they could hold a second emergency meeting before its regular session in December, causing a brief and utterly unsustained rally. El-Badri raised the prospect of another crude oil production cut, on top of the 1.5 million barrels/day reduction announced Friday, at OPEC’s first emergency meeting.

OPEC

The OPEC move only addresses supply. Supply is not the problem here, it’s demand. The funny thing is, the western world has already put the train on the rail toward energy diversification. OPEC’s disasterous policies in the 70’s haunted them in the 80’s and 90’s. Now, OPEC’s policies in the new millenium could prove to change the course of energy history forever, driving alternative fuels, domestic production and energy efficiency.

Now, OPEC thinks a supply move will solve their problem and bring prices to where they have been. They have been undone - demand rules, supply follows.

Market participants have also raised doubts that OPEC members will even comply with the ordered cuts. It seems that the members of the cartel have a problem with authority.

The U.S. is moving toward an oversupply of crude oil, with analysts anticipating a 1.6-million-barrel build in crude stocks in weekly data due Wednesday from the U.S. Energy Information Administration. Oil inventories are already above the five-year average, as refiners hold down runs in response to weak demand.

“Refiners aren’t in a real hurry to start making a lot of product that they’re not selling much of,” said Phil Flynn, an analyst with Alaron Trading Corp. “Crude oil should continue to build for a while.”

Analysts surveyed by Dow Jones also gave an average forecast of a 1.8-million-barrel build in gasoline inventories and a 500,000-barrel build in distillate stocks, which include heating oil and diesel.

Front-month November reformulated gasoline blendstock, or RBOB, settled 10 points, or 0.1%, lower at $1.4769 a gallon. November heating oil settled 3.21 cents, or 1.7%, lower at $1.9144 a gallon.


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The economy is crumbling beneath our feet - but at least we can travel on the cheap!

With the market still doubled over from economic gut punches this week and last, many of our readers feel like their 401K’s may not ever carry them to a sunny retirement in Florida. Well, with the way Crude Oil prices have been falling, maybe you can still travel there from time to time.

Crude-oil futures sank below $75 a barrel today on fresh signs that a recessionary economy will slow, and possibly reverse, world crude oil demand growth.

   Light, sweet crude for November delivery settled $4.09, or 5.2%, lower at $74.54 a barrel on the New York Mercantile Exchange. Brent crude on the ICE futures exchange closed down $3.97 at $70.56 a barrel. Brent settlement prices weren’t immediately available.   For Nymex crude it was the first close below $75 since Aug. 31, 2007. Crude oil prices are down 22% this year!


Crude Oil Prices Party Supplies
Don’t break out the party supplies just yet. 



  The price decline comes as analysts align demand forecasts with an increasingly dark economic outlook. The Organization of Petroleum Exporting Countries on Wednesday cut global demand estimates for 2008 and 2009, and said demand for its oil will fall sharply next year.  Analysts at JPMorgan Chase & Co. now see oil demand contracting next year.

World oil demand last shrank in 1983. (Return of the Jedi in theatres, a year before Dell made it’s first PC)

   The bank now sees oil prices averaging $74.75 a barrel next year, about $25 lower than its previous forecast, on the assumption the world is in recession.  U.S. gasoline demand last week was down 9.7% from a year ago as the economy flags, according to a division of MasterCard Inc.  “Add all these things together, and it paints a very bad picture for energy prices,” said Philip Gotthelf, president of Equidex Brokerage Group Inc. in Closter, N.J. 

  Hedge funds once speculating on energy prices have also had to pull out of commodities amid the credit crisis and demands for collateral, Gotthelf said. “This a monumental amount of money coming of the market,” he said.  In response to oil’s steady fall, OPEC may curtail output at an emergency gathering Nov. 18. Iraq’s oil minister said Wednesday that the group should trim production at the meeting, becoming the latest official to suggest a cut is in the cards.

As it always seems to go with OPEC, they bent to political pressure to increase Crude Oil production after the economy had already slowed down. Had OPEC dramatically increased production early on, it could have had a mitigating effect on our current economic worries, thereby keeping crude oil prices relatively high, compared to where we will see them in 2009.

Now, the economy will slow, oil prices will fall and so will OPEC’s revenues. Demand never returns 100% to adjusted pre-slowdown levels. The country has already swallowed the man made climate change pill leading toward alternative fuels. That, combined with efficiency measures already taken will ultimately mean much less dependence on foreign oil. Now there is some bright news everyone can smile about!


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The Domestic Crude Oil Revolution - The bottom is falling out of Crude Oil Prices

The bottom is falling out of the price of crude oil, Nancy Pelosi and the Democrats are caving to the public’s demand for more drilling and now, finally, we’re seeing a revolution in domestic oil production with even more fallout in crude oil prices on the way.

In a recent appearance on The Daily Show, House Majority Speaker Nancy Pelosi joked that in the congressional battle over offshore drilling, if the Republicans “want Alaska, we’ll give them Alaska.”

Haha - too late. The fact of the matter is, Alaska drilling has already been set in motion.

In 2004, Congress quietly lifted the moratorium on oil drilling in the ecologically sensitive Northern Aleutian Basin. On Aug. 1, the U.S. Interior Department’s Mineral Management Service completed the first major step toward selling the leasing rights to oil and gas drilling companies by publishing a notice in the Federal Register calling for public comments. Apparently there weren’t enough angry liberals to halt our march toward energy freedom.

Slightly north of the Aleutian Islands in the Bering Sea on the southwestern tip of Alaska, the North Aleutian Basin straddles the Gulf of Alaska and Bristol Bay. Despite the relatively high environmental and safety risks associated with offshore Alaskan drilling compared to offshore mainland drilling, oil producers are pushing forward with little or no opposition. While Alaska boasts of having nearly half of the 88,633 miles of tidal shoreline that surround the U.S., not a single mile of it will be affected by Congress’ decision on offshore oil drilling.

The Aleutian Basin (Alaska’s “breadbasket”) has abundant stocks of pollock, cod, red-king crab, halibut and salmon, which supply 40% of the entire U.S. seafood catch. Commercial fishing generates more than $100 million a year in revenues for the region. Sport fishing and related tourism throughout southwest Alaska provides an additional $90 million a year to local economies.

“The Aleutian Islands are home to natural resources found nowhere else in the world, and the regional economy is dominated by commercial fishing,” the nonpartisan National Research Council, a part of the National Academy of Sciences, recently said in a report about the risks posed by oil spills. “Protection of the region’s natural resources is therefore a paramount public concern.”

Former Interior Secretary James Watt first leased federal offshore drilling rights in the Aleutian Basin in the 1980s over the fishing industry’s objections. A subsequent bipartisan congressional drilling ban was placed on the region as a result of the 1989 Exxon Valdez oil spill in Prince William Sound.


Naleutian Basin

In 1990, President George H.W. Bush declared a moratorium on oil drilling projects in the Aleutian Basin by executive order. In 1998, President Clinton extended the offshore oil drilling ban until 2012. The moratorium remained unchanged for more than a decade until Alaskan Sen. Ted Stevens spearheaded a successful effort to suspend the moratorium in 2003. In January 2007, President George W Bush lifted Clinton’s moratorium on leasing the drilling rights in the Aleutian Basin.

Unlike other offshore areas off the coast of northern Alaska, the Aleutian Basin has relatively small amounts of estimated oil, and some of the worst weather in the nation, which is what brings much of the risk associated with Alaskan drilling. It’s in the cross hairs of a major Pacific storm track, and three to five storms batter the area a month.

So why not drill in the much calmer and less risky offshore areas of Alaska or Texas’ and Florida’s Gulf? Alaska has one thing none of the others do: shallow waters. The Aleutian Basin is the only shallow-water leasing area currently offered by the Interior Department. Roughly 80% of the area’s waters are less than 200 feet deep. The most promising drilling prospects are located in water depths of about 300 feet.

The cost of developing deep water oil fields is an order of magnitude larger than the costs of developing fields in shallow water. It costs about $600,000 a day to rent an offshore oil rig capable of drilling in the deeper waters of the Gulf of Mexico. Shallow water rigs cost only a quarter of that price, or about $150,000, to rent daily. The total cost of a large shallow-water project would be roughly $200 million, while a big deep water field would cost closer to $3 billion to develop.

In fact, the Aleutian Basin is so shallow in many places that Congress allows oil transport in small single-hull vessels–banned after the Exxon-Valdez investigation revealed the design flaw in those vessels–to operate in the area. Currently, the Aleutian Basin is among the few places where single-hull tank barges weighing less than 1,500 gross tons, which can carry nearly a million gallons of cargo, continue to operate.

Ironically, oil isn’t the only energy to be found in the area. The Aleutian Islands have the best wind-power resource potential in the U.S., according to the U.S. Department of Energy. In every season but summer, wind speeds exceed 50 mph and frequently rise above 100 mph. The westernmost Aleutian Islands experience wind speeds too high to measure–most measurement devices cannot record wind speeds higher than 128 mph. The problem with Alaskan wind energy is, where are you going to take it? Anchorage? You would have to build thousands of miles of transmission lines at an enormous cost for a few hundred thousand residents. It would take decades to pay for itself. I doubt T. Boone Pickens will make a bet on Alaska wind power like he has on West Texas wind power.

The bottom line is that as a nation we are finally moving closer to energy independence. Many flabby lips have wagged with the argument that this or than individual production project will not amount to much increased production and therefore will have little impact on the price of crude oil. The fact is though, production in most or all of our untapped oilfields will have a huge impact on price and our own energy security - much needed if the world economy is to continue making the leaps it has in the last few decades.

Look forward to continued downward pressure on oil prices (sub $100 before 2009) and even more downward pressure on natural gas, as gas production increases exponentially.


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Crude oil prices plummet on demand erosion (’told ya so’)

NYMEX crude oil futures plummeted today as gasoline inventories were discovered to be much larger than expected AND demand continues to erode, along with the U.S. economy.

But, there is light on the horizon. Much of the blame for the worsening economy can be laid on the price of crude oil. With that price coming down, the economy will react and get stronger. The nice thing that history teaches us is that oil prices don’t recover near as consistently as the resilient U.S. economy.


Oil Rig

Today, September light, sweet crude futures settled down $3.98 (3.1%, lower) at $124.44, the lowest settlement price since June 4.

Crude oil futures continue to falter, posting a second consecutive day of losses in the wake of an 11% crude oil price drop last week. The front month futures contract is now $20.74, off its Nymex record close of $145.18 reached on July 3.

The U.S. EIA reported Wednesday that gasoline stocks posted a 2.8 million barrel increase in the week of July 18, far exceeding the 200k barrel increase forecast by many analysts.

Many traders saw this as a sign of eroding U.S. demand in the face of scalding energy prices. As The Price of Crude Oil has been predicting for some time, exuberantly optimistic oil speculators have created a bubble that cannot be sustained. This bubble was recognized by OPEC (who has been burned before) who refused to increase demand in the obvious face of such a temporary increase in prices.

A LaSalle Futures trader stated “For years people have never considered giving up their cars for their daily commute and we really are at that point,” and “People are actually making an effort to consume less energy to make it easier on their pocket books.” History teaches us that when consumers increase efficiency and conservation, demand never recovers - people don’t rush up to the attic to pull insulation out of the attic.

However, larger than expected increases in product inventories were tempered by a larger than expected draw from crude stocks. Oil inventories fell by 1.6 million barrels, compared with an average analyst forecast of a 400,000 barrel draw.

The product and the crude numbers offset each other in the eyes of most of the market place, according to Peter Donovan, VP at Vantage Trading. So what we have is long term demand decreasing with short term supplies also decreasing. The Oil Tycoon speculates that this will lead to much lower prices in the next few months.

Over the last six weeks, the increase in crude oil prices was supercharged by production interruptions in Nigeria and obvious diplomatic problems between Iran and Israel. With these concerns fading, traders have been discounting the “fear premium,” and begun to consider whether the latest leg of the upswing was overblown.

“We had a very explosive run up to the upside without really having true fundamental reasons,” said Peter Van Cleve, president at T.W. Energy Consulting. 

Can anyone say “DUH!”?


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Peak Oil is a Myth - High Oil Prices Govern New Exploration and Production

Plenty of credible sources have claimed for decades that oil supply is nearing it’s inevitable end. When I started drinving, I paid $0.91/gallon for gasoline. That incredibly high price was evidence that we had nearly drained the ground of black gold. Decades later, with millions of more barrels being produced daily than back then, the myth persists.

Peak Oil Panic

This peak oil myth is based on purposeful ignorance of basic economics. The formula that “Peak Oil” nuts typically use is something like:

Barrels of oil left in today’s oilfields using today’s extraction technology / annual demand = years of oil bliss left

Basically, if we estimate that there are 200 million barrels of oil left in today’s oilfields and the world uses 13 million barrels of oil per year, we have about 15 years left before we’re tapped dry. Anyone interested enough in the subject though is lying by ommission. There is no doubt that the person making that type of assesment about our oil supply is aware that we are constantly developing new drilling technology that allows us to more efficiently and economically extract oil from existing fields and previously inaccessible fields. Also, as supply dwindles and demand increases, oil companies are consistently discovering new oil fields. The very expensive and speculative nature of exploring for new oil fields justifies the windfall profits earned by oil companies being demonized by today’s media, but that is a subject for a different article.


A Peak Oil nut might also make their doomsday prediction even scarier by incorporating population growth and reporting that with that growth oil demand per capita will grow as well. I would argue that all of these precepts are flawed:

It’s possible we will run out of cheap oil, but there are mind boggling lakes of oil in the basement. Whether you are a pessimist or optimist, the world will never put oil on the endagered commodities list.

Let’s run a little scenario - we’re at “Peak Oil”, and supply is running low. When supply dries up and wells run dry, new wells will be drilled that either have a higher cost of extraction. Also, we could see wells run dry and no new wells drilled. Either way, you get higher oil prices. When oil prices rise, demand for oil goes down. Prices are correlated to demand - basic free market economics. It happened with the 80’s oil crises and has never completely recovered. People insulated their homes, auto makers manufactured more efficient vehicles, and OPEC suffered. Prices fell, but people didn’t rush up to the attic to pull their insulation out. Demand had been permanently stunted.

Even a college freshman has learned that with decreasing supply curve comes a correlated decreasing demand curve. Gasoline is a consumer product that with price increases will experience reductions in consumption. Ultimately, prices will be so high that only a small group of consumers will purchase it, with everyone else having moved to an alternative fuel. In this scenario, world demand has slowed to a sip, leaving an ocean of oil that will likely never be tapped.


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Crude Oil Prices, Iran, U.S. covert operations and an Indian Pipeline

That’s a lot of title to swallow, but it’s such an interesting puzzle. The media tends to simplify things and lately that has manifested itself in the reporting on the booming oil industry. Oil prices are at all-time highs, producers are defending the price of crude oil, countries where oil is in high demand are complaining, but one topic is deafeningly quite - the covert U.S. operations in and about Iran and the Iranian progress toward mitigating U.S. influence in the region.

What could Iran possibly do to undermine U.S. influence? Well sure, we all know Iran is responsible for thousands of Iraqi civilian and U.S. military deaths and injuries. But did you know that Iran is working to open a new oil Bourse (a Bourse is a market like a stock exchange)? The Iranian Oil Bourse (IOB) will compete with WTI, NYMEX and IPE. Why is this significant and why would anyone want to trade oil on an Iranian Bourse?  Easy - Dollars…or Euro’s, rather. The IOB will be the only oil market that trades barrels of oil in Euro’s. Many oil producing nations have been struggling to get out of the declining Dollar, in favor of other stronger currencies like the Euro. The IOB provides that opportunity.

Declining Dollar

This is a crushing blow to the already declining U.S. Dollar. If oil prices are in Euro’s, that means the Fed isn’t printing Benjamins to pay OPEC, and as a result oil producing nations aren’t buying U.S. treasury bills, propping up our burgeoning deficit. It’s all a delicate balance, and the IOB threatens to spoil that.

Oh, there’s more! You may be aware of the January 31st Internet outage in the mid-east. I was surprised that it was even reported. Internet outages seem to be the least of the worries in that region, but there is a sinister conspiracy theory lurking beneath the murky waters of the straight of Hormuz.

Submarine Communications Cable

The IOB was all ready to get going, but just days before the scheduled opening, poof went the backbone of the new exchange - the Internet. The culprit? Cut Internet lines under the sea, thus delaying the inevitable opening of the OIB until February 17th.

There’s yet another front that Iran is fighting as the antagonist in the current War on Terror via the price of crude oil. In addition to Iran diversifying its accepted payment method into Euro’s, it is now building a direct pipeline to India to supply that booming (and soon most populous) civilization with natural gas.

The U.S. has strong diplomatic ties with India, and Pakistan (through which the pipeline would be built), and is pressuring both parties to nix the deal to bring billions more in revenues to one of the two remaining Axis in the Axis of Evil.

India seemed reluctant to quickly agree to pouring billions into the the Iranian economy until the threat from Pakistan came to build the pipeline to China. This threat of losing precious fuel to China helped India quickly give in and agree to this agreement frowned upon by the U.S. because of it’s inevitable negative impact to our interest in Iranian containment and curtailment.

IPI Pipeline

Never without alternatives, the U.S. still hopes that the alternative of bringing Turkmenistan gas through Afghanistan and Pakistan seems to languish on the back burner as a less attractive alternative to the Iran deal. It seems that the goals of both keeping Iran out of the deal for now (until after a regime change) and simultaneously diminishing Russian influence by propping up an ex-Soviet state with transport revenue isn’t as attractive to them as it is to us, thanks to the doubts about the alternative’s (”TAPI”) output.

The failure of U.S. diplomacy in this Iran/India/Pakistan/Turkmenistan conundrum shows diminishing U.S. clout in the region. The bright news is that it shows positive collaboration between feuding neighbors India and Pakistan.

The bottom line - despite the best efforts of the American media to cast doubt on the administrations commitment to foreign policy, the U.S. government is working on many fronts and in many capacities to address multiple critically important strategic objectives such as maintaining the Dollar, dealing with Iran, curtailing the rising price of crude oil and maintaining diplomatic relevance in the mid-east.


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Regulating Crude Oil Speculators - Is legislating prices the answer?

US Representative Bart Stupak (D - Michigan) cited the harmful impacts record high crude oil prices are having on consumers when introducing his bill to close regulatory loopholes that he said have allowed commodity speculators to push oil prices upward and profit from the increase.

Before introducing his gimmicky bill that pundits believe has no chance of passing, he told reporters “For the past 3 years, I have been looking into the excessive speculation occurring on the energy markets. I have done more than just scratch the surface; I’ve really delved deep into this issue to understand the extent to which market speculation is inflating the price of crude oil”.

Stupak, the chairman of the Energy and Commerce Committee’s Oversight and Investigations Subcommittee, said he has more than 50 cosponsors, including several Republicans, for the legislation, which would place all energy commodities under the Commodity Futures Trading Commission’s oversight. “This effectively would end exemptions allowed under the 2000 Commodity Futures Modernization Act.” In the opinion of many free-market analysts, it really just tries to regulate market speculation, one of the driving factors of the free market.

According to Representative Stupak, It also would stipulate that if an energy transaction provides for a US delivery point or is traded on a computer terminal located in the US, it would be subject to the same rules that currently apply to commodities trading on the New York Mercantile Exchange, including large trader reporting, record-keeping, and prohibitions against fraud and market manipulation. This would apply to designated contract markets, energy trading facilities in the US, bilateral trades, and trades transacted on a foreign board of trade.

The bill also would amend sections of the Commodity Exchange Act by extending federal regulatory authority to swaps involving energy transactions and to energy transactions on foreign boards of trade. In addition, it would require the CFTC to establish aggregate position limits on energy contracts for a trader over all markets.

A larger initiative
“We’re not saying ‘end speculation.’ We’re saying end ‘excessive’ speculation,” Stupak said, adding that he has been in touch with House Speaker Nancy Pelosi (D-Calif.) and that his bill, which he said is the broadest introduced so far, may become part of a House Democratic initiative following the Independence Day recess which could include other bills dealing with oil product price gouging and oil and gas producers not developing their federal leases.

With little chance of the bill passing, is this just another attempt by our elected representatives to get media attention for a piece of legislation that everyone involved knows has little chance of even coming to a vote? Hot button issues come up each election cycle to stir up a media frenzy, but rarely do they bear fruit.

Stupak was joined at the briefing by two of the bill’s Democratic cosponsors, Jay Inslee (Wash.) and Peter Welch (Vt.), who said that the legislation’s enactment would be the best immediate step Congress could take to cool off overheated energy markets. “The day this bill passes, it will signal the markets that excessive speculation won’t be tolerated. It won’t be the only thing we can do, but right now it’s the best thing,” Inslee said.

Welch said oil companies have consumers “coming and going” by not only refusing to drill leases but also by speculating in commodities markets. “This bill asks if Congress will squeeze speculators or let speculators continue to squeeze us,” he said.

Stupak and Inslee both said that recently soaring crude oil prices reminded them of dramatic increases in Western US wholesale electricity prices in 2001 that were later traced to manipulation by traders at Enron Corp. “I’ve seen this bad movie before. It’s the Enron movie, which hit the West Coast power markets like a bomb because the federal government was asleep at the switch. It has happened again with oil prices,” Inslee said.

Numbers back this up
Stupak said that while Treasury Sec. Henry M. Paulson and the CFTC won’t acknowledge that excessive speculation is part of the high oil price problem, others from the International Monetary Fund to Saudi Arabia’s oil minister (who have much to benefit by laying blame elsewhere) have said that it is.

“The numbers back this up: Between Sept. 30, 2003, and May 6, 2008, contracts held by traders jumped from 714,000 to more than 3 million, a 425% increase. Since 2003, commodity index speculation has increased 1,900% from an estimated $13 billion to $260 billion invested,” the House member said.

He said CFTC data shows that in 2000, physical hedges that airlines and other businesses use to ensure a stable price for fuel in coming months and actually imply delivery, accounted for an estimated 63% of the total futures market, while speculators represented about 37%. “By April 2008, physical hedgers only controlled 29% and speculators had taken over a whopping 71% of the oil futures market,”

Representative Stupak said 85% of the futures purchases tied to commodity index speculation comes through swap dealers—investment banks that serve as intermediaries for their pension fund and sovereign wealth fund customers. One report found that $55 billion of total worldwide commodity trading over 55 days came in as swaps, according to Stupak. “The CFTC has allowed 117 exceptions to swaps. When that many exceptions are allowed, they are not really subject to oversight. We have a CFTC that’s supposed to be doing its job. I’m not certain that it is,” he said.

Acting CFTC Chairman Walter L. Lukken is among the witnesses scheduled to testify on June 23 at the latest hearing on oil markets and speculation by Stupak’s subcommittee.

Inslee said many energy commodity trades take place beyond the CFTC’s oversight. “If you don’t have transparency, you have excessive speculation. We learned from Enron that if you don’t have transparency, you have the potential for manipulation,” he said.

Asked if he still intends to press his legislation if crude oil prices start to drop, Stupak said that he does. “We have not spent 3 years looking at this not to. Rep. Inslee and I were here for the Enron debacle and we’re tired of seeing it happen. There’s clearly a bubble here that’s about to burst. This bill will do more to make it happen than anything the Chinese government could do,” he said, referring to China’s announcement the previous day that it would raise domestic fuel prices by as much as 18%.

One might ask the Democrats who wrote this legislation to make their minds up. A decade ago, when oil was still relatively low, many save-the-earth Democrats were wishing for Euro-level gasoline, saying that with a higher price would come lower consumption. Now, with U.S. fuel prices closing in on Euro fuel prices, they want it the other way.

Source - Nick Snow


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The History and Analysis of Crude Oil Prices - Part V “The Impact of Crude Oil Prices on Industry Segments”


Crude Oil Drilling and Exploration Boom and Bust

The Impact of Crude Oil Prices on Industry Segments
click for larger image

The Rotary Rig Count is the average number of drilling rigs actively exploring for oil and gas. Drilling an oil or gas well is a capital investment in the expectation of returns from the production and sale of crude oil or natural gas. Rig count is one of the primary measures of the health of the exploration segment of the oil and gas industry. In a very real sense it is a measure of the oil and gas industry’s confidence in its own future.
At the end of the Arab Oil Embargo in 1974 rig count was below 1500. It rose steadily with regulated crude oil prices to over 2000 in 1979. From 1978 to the beginning of 1981 domestic crude oil prices exploded from a combination of the the rapid growth in world energy prices and deregulation of domestic prices. At that time high prices and forecasts of crude oil prices in excess of $100 per barrel fueled a drilling frenzy. By 1982 the number of rotary rigs running had more than doubled.

It is important to note that the peak in drilling occurred over a year after oil prices had entered a steep decline which continued until the 1986 price collapse. The one year lag between crude prices and rig count disappeared in the 1986 price collapse. For the next few years the economy of the towns and cities in the oil patch was characterized by bankruptcy, bank failures and high unemployment.

After the Collapse

The Impact of Crude Oil Prices on Industry Segments
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Several trends established were established in the wake of the collapse in crude prices. The lag of over a year for drilling to respond to crude prices is now reduced to a matter of months. (Note that the graph on the right is limited to rigs involved in exploration for crude oil as compared to the previous graph which also included rigs involved in gas exploration.) Like any other industry that goes through hard times the oil business emerged smarter, leaner and more conservative. Industry participants, bankers and investors were far more aware of the risk of price movements. Companies long familiar with accessing geologic, production and management risk added price risk to their decision criteria.
Technological improvements were incorporated:

In spite of all of these efforts the percentage of rigs employed in drilling for crude oil decreased from over 60 percent of total rigs at the beginning of 1988 to under 15 percent until a recent resurgence.

Well Completions - A measure of success?

The Impact of Crude Oil Prices on Industry Segments
click for larger image

Rig count does not tell the whole story of oil and gas exploration and development. It is certainly a good measure of activity, but it is not a measure of success.

After a well is drilled it is either classified as an oil well, natural gas well or dry hole. The percentage of wells completed as oil or gas wells is frequently used as a measure of success. In fact, this percentage is often referred to as the success rate.

Immediately after World War II 65 percent of the wells drilled were completed as oil or gas wells. This percentage declined to about 57 percent by the end of the 1960s. It rose steadily during the 1970s to reach 70 percent at the end of that decade. This was followed by a plateau or modest decline through most of the 1980s.

The Impact of Crude Oil Prices on Industry Segments
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Beginning in 1990 shortly after the harsh lessons of the price collapse completion rates increased dramatically to 77 percent. What was the reason for the dramatic increase? For that matter, what was the cause of the steady drop in the 1950s and 1960s or the reversal in the 1970s?

Since the percentage completion rates are much lower for the more risky exploratory wells, a shift in emphasis away from development would result in lower overall completion rates. This, however, was not the case. An examination of completion rates for development and exploratory wells shows the same general pattern. The decline was price related as we will explain later.

Some would argue that the periods of decline were a result of the fact that every year there is less oil to find. If the industry does not develop better technology and expertise every year, oil and gas completion rates should decline. However, this does will not explain the periods of increase.

The Impact of Crude Oil Prices on Industry Segments
click for larger image

The increases of the seventies were more related to price than technology. When a well is drilled, the fact that oil or gas is found does not mean that the well will be completed as a producing well. The determining factor is economics. If the well can produce enough oil or gas to cover the additional cost of completion and the ongoing production costs it will be put into production. Otherwise, its a dry hole even if crude oil or natural gas is found. The conclusion is that if real prices are increasing we can expect a higher percentage of successful wells. Conversely if prices are declining the opposite is true.

The increases of the 1990s, however, cannot be explained by higher prices.

The Impact of Crude Oil Prices on Industry Segments

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These increases are the result of improved technology and the shift to a higher percentage of natural gas drilling activity. The increased use of and improvements to 3-D seismic data and analysis combined with horizontal and and directional drilling improve prospects for successful completions. The fact that natural gas is easier to see in the seismic data adds to that success rate.

Most dramatic is the improvement in the the percentage exploratory wells completed. In the 1990s completion rates for exploratory wells have soared from 25 to 45 percent.

Workover Rigs - Maintenance

The Impact of Crude Oil Prices on Industry Segments
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Workover rig count is a measure of the industry’s investment in the maintenance of oil and gas wells. The Baker-Hughes workover rig count includes rigs involved in pulling production tubing, sucker rods and pumps from a well that is 1,500 feet or more in depth.

Workover rig count is another measure of the health of the oil and gas industry. A disproportionate percentage of workovers are associated with oil wells. Workover rigs are used to pull tubing for repair or replacement of rods, pumps and tubular goods which are subject to wear and corrosion.

A low level of workover activity is particularly worrisome because it is indicative of deferred maintenance. The situation is similar to the aging apartment building that no longer justifies major renovations and is milked as long as it produces a positive cash flow. When operators are in a weak cash position workovers are delayed as long as possible. Workover activity impacts manufacturers of tubing, rods and pumps. Service companies coating pipe and other tubular goods are heavily affected.

Part I - The History and Analysis of Crude Oil Prices
Part II - The History and Analysis of Crude Oil Prices
Part III - The History and Analysis of Crude Oil Prices
Part IV - The History and Analysis of Crude Oil Prices
Part V - The History and Analysis of Crude Oil Prices

Sources for this series include:

WRTG Economics
NYMEX.com
Oil & Gas Journal
Forbes


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The History and Analysis of Crude Oil Prices - Part IV “OPEC’s Failure to Control Crude Oil Prices”


OPEC's Failure to Control Crude Oil Prices
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OPEC has seldom been effective at controlling prices. While often referred to as a cartel, OPEC does not satisfy the definition. One of the primary requirements is a mechanism to enforce member quotas. The old joke went something like this; “What is the difference between OPEC and the Texas Railroad Commission? OPEC doesn’t have any Texas Rangers!” The only enforcement mechanism that has ever existed in OPEC was Saudi spare capacity.

With enough spare capacity at times to be able to increase production sufficiently to offset the impact of lower prices on its own revenue, Saudi Arabia could enforce discipline by threatening to increase production enough to crash prices. In reality even this was not an OPEC enforcement mechanism unless OPEC’s goals coincided with those of Saudi Arabia.

OPEC's Failure to Control Crude Oil Prices
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During the 1979-1980 period of rapidly increasing prices, Saudi Arabia’s oil minister Ahmed Yamani repeatedly warned other members of OPEC that high prices would lead to a reduction in demand. His warnings fell on deaf ears.

Surging prices caused several reactions among consumers: better insulation in new homes, increased insulation in many older homes, more energy efficiency in industrial processes, and automobiles with higher efficiency. These factors along with a global recession caused a reduction in demand which led to falling crude prices. Unfortunately for OPEC only the global recession was temporary

OPEC's Failure to Control Crude Oil Prices
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– Nobody rushed to remove insulation from their homes or to replace energy efficient plants and equipment — much of the reaction to the oil price increase of the end of the decade was permanent and would never respond to lower prices with increased consumption of oil.

Higher prices also resulted in increased exploration and production outside of OPEC. From 1980 to 1986 non-OPEC production increased 10 million barrels per day. OPEC was faced with lower demand and higher supply from outside the organization.

From 1982 to 1985, OPEC attempted to set production quotas low enough to stabilize prices. These attempts met with repeated failure as various members of OPEC produced beyond their quotas. During most of this period Saudi Arabia acted as the swing producer cutting its production in an attempt to stem the free fall in prices.

OPEC's Failure to Control Crude Oil Prices
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In August of 1985, the Saudis tired of this role. They linked their oil price to the spot market for crude and by early 1986 increased production from 2 MMBPD to 5 MMBPD. Crude oil prices plummeted below $10 per barrel by mid-1986. Despite the fall in prices Saudi revenue remained about the same with higher volumes compensating for lower prices.

A December 1986 OPEC price accord set to target $18 per barrel but it was already breaking down by January of 1987 and prices remained weak.

The price of crude oil spiked in 1990 with the lower production and uncertainty associated with the Iraqi invasion of Kuwait and the ensuing Gulf War. The world and particularly the Middle East had a much harsher view of Saddam Hussein invading Arab Kuwait than they did Persian Iran. The proximity to the world’s largest oil producer helped to shape the reaction.

OPEC's Failure to Control Crude Oil Prices
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Following what became known as the Gulf War to liberate Kuwait, crude oil prices entered a period of steady decline, until in 1994, inflation adjusted prices attained their lowest level since 1973.

The price cycle then turned up. The United States economy was strong and the Asian Pacific region was booming. From 1990 to 1997 world oil consumption increased 6.2 million barrels per day. Asian consumption accounted for all but 300,000 barrels per day of that gain and contributed to a price recovery that extended into 1997. Declining Russian production contributed to the price recovery. Between 1990 and 1996 Russian production declined over 5 million barrels per day.

OPEC continued to have mixed success in controlling prices. There were mistakes in timing of quota changes as well as the usual problems in maintaining production discipline among its member countries.

OPEC's Failure to Control Crude Oil Prices
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The price increases came to a rapid end in 1997 and 1998 when the impact of the economic crisis in Asia was either ignored or severely underestimated by OPEC. In December of 1997, OPEC increased its quota by 2.5 million barrels per day (10 percent) to 27.5 MMBPD effective January 1, 1998. The rapid growth in Asian economies had come to a halt. In 1998 Asian Pacific oil consumption declined for the first time since 1982. The combination of lower consumption and higher OPEC production sent prices into a downward spiral. In response, OPEC cut quotas by 1.25 million b/d in April and another 1.335 million in July. Price continued down through December 1998.

Prices began to recover in early 1999 and OPEC reduced production another 1.719 million barrels in April.

OPEC's Failure to Control Crude Oil Prices
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As usual not all of the quotas were observed but between early 1998 and the middle of 1999 OPEC production dropped by about 3 million barrels per day and was sufficient to move prices above $25 per barrel.

With minimal Y2K problems (big surprise!) and growing US and world economies the price continued to rise throughout 2000 to a post 1981 high. Between April and October, 2000 three successive OPEC quota increases totaling 3.2 million barrels per day were not able to stem the price increases. Prices finally started down following another quota increase of 500,000 effective November 1, 2000.

Russian production increases dominated non-OPEC production growth from 2000 forward and was responsible for most of the non-OPEC increase since the turn of the century.

OPEC's Failure to Control Crude Oil Prices
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Once again it appeared that OPEC overshot the mark. In 2001, a weakened US economy and increases in non-OPEC production put downward pressure on prices. In response OPEC once again entered into a series of reductions in member quotas cutting 3.5 million barrels by September 1, 2001. In the absence of the September 11, 2001 terrorist attack this would have been sufficient to moderate or even reverse the trend.

In the wake of the attack, crude oil prices plummeted. Spot prices for the U.S. benchmark West Texas Intermediate were down 35 percent by the middle of November. Under normal circumstances a drop in price of this magnitude would have resulted an another round of quota reductions but given the political climate OPEC delayed additional cuts until January 2002.

OPEC's Failure to Control Crude Oil Prices
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It then reduced its quota by 1.5 million barrels per day and was joined by several non-OPEC producers including Russia who promised combined production cuts of an additional 462,500 barrels. This had the desired effect with oil prices moving into the $25 range by March, 2002. By mid-year the non-OPEC members were restoring their production cuts but prices continued to rise and U.S. inventories reached a 20-year low later in the year.

By year end oversupply was not a problem. Problems in Venezuela led to a strike at PDVSA causing Venezuelan production to plummet. In the wake of the strike Venezuela was never able to restore capacity to its previous level and is still about 900,000 barrels per day below its peak capacity of 3.5 million barrels per day. OPEC increased quotas by 2.8 million barrels per day in January and February, 2003.

OPEC's Failure to Control Crude Oil Prices
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On March 19, 2003, just as some Venezuelan production was beginning to return, military action commenced in Iraq. Meanwhile, inventories remained low in the U.S. and other OECD countries. With an improving economy U.S. demand was increasing and Asian demand for crude oil was growing at a rapid pace.

The loss of production capacity in Iraq and Venezuela combined with increased OPEC production to meet growing international demand led to the erosion of excess oil production capacity. In mid 2002, there was over 6 million barrels per day of excess production capacity and by mid-2003 the excess was below 2 million. During much of 2004 and 2005 the spare capacity to produce oil was under a million barrels per day. A million barrels per day is not enough spare capacity to cover an interruption of supply from most OPEC producers.

OPEC's Failure to Control Crude Oil Prices
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In a world that consumes over 80 million barrels per day of petroleum products that added a significant risk premium to crude oil price and is largely responsible for prices in excess of $40-$50 per barrel.

Other major factors contributing to the current level of prices include a weak dollar and the continued rapid growth in Asian economies and their petroleum consumption. The 2005 hurricanes and U.S. refinery problems associated with the conversion from MTBE as an additive to ethanol have contributed to higher prices.

OPEC's Failure to Control Crude Oil Prices
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One of the most important factors supporting a high price is the level of petroleum inventories in the U.S. and other consuming countries. Until spare capacity became an issue inventory levels provided an excellent tool for short-term price forecasts. Although not well publicized OPEC has for several years depended on a policy that amounts to world inventory management. Its primary reason for cutting back on production in November, 2006 and again in February, 2007 was concern about growing OECD inventories. Their focus is on total petroleum inventories including crude oil and petroleum products, which are a better indicator of prices that oil inventories alone.

Part I - The History and Analysis of Crude Oil Prices
Part II - The History and Analysis of Crude Oil Prices
Part III - The History and Analysis of Crude Oil Prices
Part IV - The History and Analysis of Crude Oil Prices
Part V - The History and Analysis of Crude Oil Prices

Will post the final section, Part V tomorrow - “The Impact of Crude Oil Prices on Industry Segments”


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The History and Analysis of Crude Oil Prices - Part III “Middle East Supply Interruptions”


Yom Kippur War - Arab Oil Embargo

Crude Oil prices Middle East interference
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In 1972 the price of crude oil was about $3.00 per barrel and by the end of 1974 the price of crude oil had quadrupled to over $12. The Yom Kippur War started with an attack on Israel by Syria and Egypt on October 5, 1973. The US and many countries in the western world showed support for Israel. As a result of this support for the victim of a multi-state surprise attack, several Arab exporting nations imposed an embargo on the countries supporting Israel. While Arab nations curtailed production by 5 million barrels per day (MMBPD) about 1 MMBPD was made up by increased production in other countries. The net loss of 4 MMBPD extended through March of 1974 and represented just 7 percent of the free world production.

Opec Oil Production
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If there was any doubt that the ability to control crude oil prices had passed from the United States to OPEC it was removed during the Arab Oil Embargo. The extreme sensitivity of prices to supply shortages of only 7% became all too apparent when prices increased 400% in only six months.

From 1974 to 1978 world crude oil prices were relatively flat ranging from $12.21 per barrel to $13.55 per barrel. When adjusted for inflation the price over that period of time world oil prices were in a period of moderate decline.

Crises in Iran and Iraq

Iran Oil Production
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Events in Iraq and Iran led to another round of crude oil price increases in 1979 and 1980. The Iranian revolution resulted in the loss of 2 to 2.5 MMBPD of oil production between November, 1978 and June, 1979. At one point production almost came to a halt.

While the Iranian revolution was the cause of what would be the highest prices in post-WWII history, its impact on prices would have been limited and of relatively short duration had it not been for subsequent events. Shortly after the revolution production was up to 4 million barrels per day.

Iran, weakened by the revolution, was invaded by Iraq in September, 1980. By November the combined production of both countries was only a million barrels per day and 6.5 million barrels per day less than a year before. As a consequence worldwide crude oil production was 10 percent lower than in 1979.

Iraq Oil Production
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The combination of the Iranian revolution and the Iraq-Iran War caused crude oil prices to more than double increasing from from $14 in 1978 to $35 per barrel in 1981.

Twenty-six years later Iran’s production is only two-thirds of the level reached under the government of Reza Pahlavi, the former Shah of Iran.

Iraq’s production remains about 1.5 million barrels below its peak before the Iraq-Iran War.

US Oil Price Controls - Bad Policy?

US Oil Controls
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The rapid increase in crude oil prices from 1973 to 1981 would have been much less were it not for United States poorly executed energy policy during the post Embargo period. The US imposed price controls on domestically produced oil in an attempt to lessen the impact of the 1973-74 price increase. The obvious result of the price controls was that U.S. consumers of crude oil paid about 50% more for imports than domestic production, and U.S producers received less than world market price. In effect, the domestic petroleum industry was subsidizing the US consumer.

Did the policy achieve its goal? In the short term, the recession induced by the 1973-1974 crude oil price rise was less because U.S. consumers faced lower prices than the rest of the world. However, it had other effects as well.

In the absence of price controls U.S. exploration and production would certainly have been significantly greater. Higher petroleum prices faced by consumers would have resulted in lower rates of consumption: automobiles would have had higher miles per gallon sooner, homes and commercial buildings would have been better insulated and improvements in industrial energy efficiency would have been greater than they were during this period. As a consequence, the United States would have been less dependent on imports in 1979-1980 and the price increase in response to Iranian and Iraqi supply interruptions would have been much less.

Part I - The History and Analysis of Crude Oil Prices
Part II - The History and Analysis of Crude Oil Prices
Part III - The History and Analysis of Crude Oil Prices
Part IV - The History and Analysis of Crude Oil Prices
Part V - The History and Analysis of Crude Oil Prices

Will post part IV tomorrow - “OPEC’s Failure to Control Crude Oil Prices”


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