The Oil Drum: Europe | Oilwatch Monthly

61 comments on Oilwatch Monthly - March 2008

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sreeb on March 19, 2008 - 7:14pm

I, on the other hand, might offer only 1/2 the service since I don't need the extra money and I would value more spare time.

If I don't need the money today and expect the oil to be worth more tomorrow, why pump it today. Oil in the ground which is increasing in value may be more attractive than dollars in hand which are depreciating. I may also lower my extraction costs if I don't rush. What higher prices will do is inspire my neighbors to see if they have any.

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s_yajaman on March 20, 2008 - 2:36am

I think some control charts would help see if the day to day or month to month fluctuations are really statistical or if they have an assignable cause. On the face of it, we are on a plateau as far as production goes.

Economics 101 says that in a perfect market, suppliers would be willing to supply more when prices are high. But this is not a perfect market (finite suppliers, information asymmetry). I'm sure papers are being written in the economics circles on how to model current oil prices.

What TOD needs to do is add on Game Theory to the ELM to get a better model on how exporters and importers will behave once production starts to fall in the exporting countries.

Consumption is increasing in the producing countries to some (how large I don't know) extent because of increased inflows due to exports of oil. They subsidise internal consumption (not just fuel) hugely through artficial petrol prices and zero income tax (in most Gulf countries). If revenues from exports go down, how do they keep this system going?

Srivathsa

P.S. One Israeli to another - "When Moses brought us out of Egypt, why did he bring us to the only place in the Middle East without oil?"

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wkwillis on March 20, 2008 - 3:09am

Moses brought the Israelis to the Sinai, not to Palestine. The Sinai has oil.

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Kiashu on March 20, 2008 - 3:58am

And then they went and gave it back to Egypt, so... :)

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PeakPlus on March 20, 2008 - 4:45am

"Economics 101 says that in a perfect market, suppliers would be willing to supply more when prices are high."
Coming from the patch myself, it's obvious that this statement is not true. The problem is called "time". If a well is pumping oil, I sell it regardless of the price. It's almost impossible to change production.

If a well is not pumping, on the other hand, or if I've planned drilling a well, then I wait until the price suits me to fix up or drill. And then I can't do all at once. One after the other, once the rig is free again and my wallet allows it.

Yergin, Lynch et al. were not wrong with their price predictions because they assumed that production can be increased. That may or may not be true (I'm in the "basically not true" camp myself.) They were wrong because of the assumption that the spiggot can be turned on or off at will to effect price. It takes (lots of) time to ramp up production.. In the 70s it took over 10 years!!

I don't think that any Eco101 class would claim that there are no time lags..

Cheers, Dom

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xuewen on March 20, 2008 - 5:28am

I don't think that any Eco101 class would claim that there are no time lags..

...and that's really the heart of our problem, isn't it. Economics predicts equilibrium behaviour and peak oil is fundamentally a problem of kinetics.

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s_yajaman on March 20, 2008 - 5:44am

Dom,

The oil market with its cartel is hardly a perfect market to start with. I was talking about suppliers being willing to increase supply.

Eco 101 says nothing about suppliers' ability to increase output in the short run. As long as the marginal revenue is greater than the marginal cost, it makes sense to take out one extra barrel and sell it. In theory therefore, supply should follow such high prices (unless of course the cost of the next incremental barrel is not making it worthwhile to do so). If it is not, something else is at play. I don't know what it is. I am trying to figure out what it is that has driven oil prices up 3 or 4 times in 5 years, when demand is growing 2-3% per year (don't ask how me what difference that knowledge will make to my life):). Peak oil seems a likely candidate.

Someone (Lester Thurow?) said that economics can predict most things well, but is horribly wrong on timing. If you've sat in an Eco 101 class, you will rarely hear anything on time lags or their magnitude. Only two terms are uttered - short run and long run . The supply and demand curves shift on the blackboard as if by magic :).

It's possible that we've run into the limits of supply in the short run as far as oil goes and the long run marginal costs are much higher than today's price (marginal revenue) and so more supply will come in at higher prices.

It's also possible that we're running into long term physical constraints on how much demand the earth as a whole can support.

With 3 or 4 years of data it is hard to come to a definite conclusion (at least for me).

Srivathsa

In the long run we're all dead.

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sreeb on March 20, 2008 - 5:32pm

"As long as the marginal revenue is greater than the marginal cost, it makes sense to take out one extra barrel and sell it."

This is true if your goal is maximizing income today or your have an infinite resource. If you are planning long term, have a finite resource, and expect rising prices, then it is false.

You also have producers, Mexico for example, that have concluded that the best way to maximize income today is to minimize investment in new capacity.

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JonFreise on March 20, 2008 - 10:22am

Consumption is increasing in the producing countries to some (how large I don't know) extent because of increased inflows due to exports of oil. They subsidize internal consumption (not just fuel) hugely through artificial petrol prices and zero income tax (in most Gulf countries). If revenues from exports go down, how do they keep this system going?

I asked my friend Excel this exact question. I used two elasticity of demand values for oil, a short run value -0.26 and a long run value of -0.47. Elasticity of demand lets you calculate the % price increase caused by a % shortage of supply.

I calculated price versus declining supply which gives us this graph:

None of these prices get outside a reasonable boundary as a barrel of oil generates about $600.00 in GDP.

Then I calculated the net revenue to oil exporters. You notice that eventually the total revenue does fall below the starting level, but not until exports have fallen 3/4 of the way to zero. The lower the elasticity value, the longer the delay.

(the graph should say Total Revenue, not net). Recent calculations have shown the US elasticity of demand is -0.06 (much lower than my values). Which would give an even higher peak to total revenue and longer delay until break even is reached.

The results yield this interesting tip to the world's importers: Mass transit and other alternatives to oil that lower the elasticity of demand will pay for themselves because they keep the oil price low & they keep the oil flowing faster, longer. The more desperately a nation clings to oil, the less there will be.

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s_yajaman on March 20, 2008 - 12:38pm

Thanks. Helpful to see it in terms of numbers. Some questions and comments

a. When you say elasticity of demand of -0.47 it would mean for every 1% increase in price, demand would drop by 0.47% - correct? At a price elasticity of -0.1, to hit an import volume of about 10Mbpd, prices would have to about $750 - correct?

b. Based on a global GDP of about 48 trillion USD and a global oil consumption of about 25 billion barrels of oil annually, GDP/barrel would be closer to USD1900, wouldn't it? Or am I missing something? It is not completely relevant to the arguments you have put forward, but just for the sake of accuracy...

c. At 10Mbpd, some serious GDP destruction ought to have happened in the importing countries. Their GDP would be in the order of $7trillion vs. 27 trillion or so based on today's consumption (40Mbpd) assuming no efficiency increases. Allowing for a 50%(!) increase in efficiency and substitution - about $10 trillion (at constant dollars). Exporting countries (based on a USD/barrel somewhere between 300 and 750 USD - say 500USD) would enjoy revenues of about $1.8trillion each year. They better set aside a substantial amount of that on some serious diplomacy and weaponry (more the latter) :).

d. Given that oil has increased by about 50% over the last 1 year and assuming an elasticty of (0.06), we ought to have seen a demand destruction of about 3%. We have seen a supply growth of 2-3% (am I correct?) Would it be fair to say that demand growth is actually in the range of 5-6%? Given that we can only measure how much is being bought/sold how do we estimate demand in a sticky supply situation? And how accurate are the numbers reported on production and inventories?

Thanks,
Srivathsa

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JonFreise on March 20, 2008 - 1:46pm

a. Yes, that is my understanding. http://en.wikipedia.org/wiki/Elasticity_of_demand

b. You are missing all the other fossil fuels. My number was from memory of calculating the value for the US in $2006 using all fuels from BP statistical review BOE (barrel of oil) equivalent. It should be taken as a very, very rough estimate of what is possible.

c. Yes, I don't expect that oil will ever reach higher than $300.00 (in 2006 $). Instead, I think it would be more efficient for the exporter to just use the oil locally creating goods and selling them at much higher profits than can be realized by oil exports.

d.I took the value from Gail's post here: http://www.theoildrum.com/node/3531 She explains how it was calculated.

As far as accuracy? I don't know. But the rough curve shape is still true. And that is enough to know the exports will fall for some time.

One wild brainstorm is that the sigmoid curve shape is used to predict the elasticity of demand as the price of oil approaches the energy content of the oil. When the energy being traded for a barrel of oil is low relative to the energy content of the oil, then we can expect that the elasticity of demand will be very small. Because it will always be a good idea to make that trade. But as the price rises and the energy given back for a barrel gets higher, then the elasticity of demand should get larger, which bends the price curve into a sigmoid hitting somewhere between $300 and $600 or so. We need to account for efficiency losses in converting oil into trade goods and I am not sure what that value would be.

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alan on March 20, 2008 - 5:06pm

It has been a while since I took microeconomics but IIRC a fixed elasticity should produce a curve on a price vs quantity demanded graph.

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JonFreise on March 20, 2008 - 8:49pm

I agree it will curve, but I have only a guess as to how to predict the shape. Do you remember how the curve was calculated?

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s_yajaman on March 21, 2008 - 6:35am

This is what I think it will look like. I used a constant price elasticity of -0.6 So for each 10% price drop, quantity demanded will increase by 6%

Q
1000.00
1060.00
1123.60
1191.02
1262.48
1338.23
1418.52
1503.63
1593.85

P
10.00
9.00
8.10
7.29
6.56
5.90
5.31
4.78
4.30

Sorry I posted it one below the other. I don't know how to make a table.

I plotted this but could not paste the chart here. Not sure how to do it.

Srivathsa

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JonFreise on March 21, 2008 - 11:07am

Hi Srivathsa,

If you click on one of my graphs it should take you to the free photo site flikr where you can upload images and then link to them from the oil drum. A little awkward, but a picture is worth a thousand words they say.

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dubina on March 25, 2008 - 12:04pm

"The results yield this interesting tip to the world's importers: Mass transit and other alternatives to oil that lower the elasticity of demand will pay for themselves because they keep the oil price low & they keep the oil flowing faster, longer. The more desperately a nation clings to oil, the less there will be."

Corollary to what you say:

Resource nationalism ("above ground risk" / "access risk") may be having somewhat the same effect.

In April 2000 the United States Geological Survey (USGS) released results of the most thorough and methodologically modern assessment of world crude oil and natural gas resources ever attempted. This 5-year study was undertaken 'to provide impartial, scientifically based, societally relevant petroleum resource information essential to the economic and strategic security of the United States.' It was conducted by 40 geoscientists (many with industry backgrounds) and was reviewed stage-by-stage by geoscientists employed by many petroleum industry firms including several of the multinational majors."

"The above facts prompted the Energy Information Administration (EIA) to take the next logical step by providing the first Federal analysis of long term world oil supply since that published by Dr. M. King Hubbert of the USGS in 1974. The results of EIA's study as presented at the 2000 AAPG meeting and published in July 2000, remain online in slide show format at:"

See charts at
http://www.eia.doe.gov/pub/oil_gas/petroleum/presentations/2000/long_ter....

The EIA oil forecast charts indicated 12 scenarios based on three estimates of ultimate recovery and four estimates of supply/demand growth. Except for the zero percent supply/demand estimate, supply peaks and subsequent falls were precipitous. Estimated supply growth was robust, seemingly unconstrained.

More recently, (11/07) Jim Mulva of COP opined total world production might not reach 100 million bpd.

More recently still, others here detect a peak oil plateau now at roughly 87 million bpd with prices around $100 pb. If this is the peak (or the beginning of the lumpy plateau), imagine this.

The high growth / high URR scenarios identified in the 2000 EIA analysis of long term world oil supply correspond to situations in which IOCs have unfettered access to oil reserves and develop them swiftly and efficiently. In those "optimistic" scenarios, supplies increase and prices remain relative low.

If NOCs and states achieve relatively more control (because high prices encourage resource nationalism), supplies increase more slowly (or not at all) and prices increase more than they might otherwise have done.

Thus, high prices foster resource nationalism and have the unintended consequence of flattening the eventual peak, extending the period of oil and gas utility and avoiding precipitous decline. In effect, high prices and resource nationalism would do what the Koyoto Protocols have been unable to do, namely, inhibit supply/demand growth and enforce a useful conservation regime.

Might IOCs now see that handwriting on the wall? If so, how will they spin it?
http://articles.moneycentral.msn.com/Investing/CompanyActionDyn.aspx?cp-...