The Oil Drum

To the greatest extent in the history of oil futures trading, oil prices are now in continuous contango--that is, oil futures get progressively more expensive each year into the future. Does this mean that Peak Oil, as a meme, has "tipped"? Our latest oil price poll suggests that well over 70% of the sample (N>3000 now) thinks that oil will at least stay above $114 a barrel for the next two months--and almost half think it will hit $140 a barrel in that timeframe. Search volume on Google for the term is up dramatically in the past month, as is traffic at The Oil Drum. The following graph shows the dramatic swing from backwardation to contango over the last 6 weeks:

Has Peak Oil, as a meme, "tipped"? Our latest oil price poll suggests that well over 70% of the sample (N>3000 now) thinks that oil will at least stay above $114 a barrel for the next two months--and almost half think it will hit $140 a barrel in that timeframe. Search volume on Google for the term is up dramatically in the past month, as is traffic at The Oil Drum. One indicator of a "tipping point" for acceptance of Peak Oil may be the state of backwardation in oil futures. I first raised this idea over 2 years ago, but recent market movements, coinciding with attention in the press, may be validating it: when the markets accept Peak Oil, we will see the end of backwardation in crude oil markets, and possibly even Contango. Here's what has happened over the past 6 weeks:

UPDATE: Graph updated with data as of 10:00am EST on May 19th to show significant contango

This is a guest post by Shunyata. Shunyata is a manager of financial derivatives with training in financial engineering, actuarial science, statistics, and mechanical engineering. While he does not work directly with commodity markets, his background in financial engineering gives him insight into the operation of oil markets that may be helpful.

The observations below represents Shunyata's opinions based on his study of commodity derivatives to protect his personal interests. Commodity derivatives are exceedingly complicated, and his direct expertise is with respect to financial derivatives. This post is not intended to represent investment advice.

What Can the Commodity Market Tell Us about Peak Oil?

Market Consensus

A common view is that market prices reflect the market consensus about future prospects. This is a dangerous misunderstanding from several standpoints.

Consensus is an equilibrium statement, but equilibrium is non-existent in reality. There is the obvious problem of new information constantly disrupting the market. More importantly, the market contains a hidden, complex structure of players:

• There are large, in-the-know entities who act opportunistically, seemingly at random;

• There are hedgers who react to market moves mechanically and in unison (no disparagement intended);

• There are diverse small players who respond slowly in diverse ways, etc.

This is the second (the first can be found here) in a series of guest posts by Robert Smithson, a portfolio manager at a London based investment fund.

Introduction

The world’s oil supplies are not unlimited. Unless the abiogenic theory of oil is correct, then reserves will one-day dwindle, and production will decline. New barrels cannot be “magic-ed” by some trick of economics. Extraction of any fossil fuel extraction is limited. Peak oil is inevitable. Of course, there is debate about when production hits its highs; it may have already happened, perhaps it will come in the next few years, and just possibly, it will be in 2020 or later. But make no mistake about it, we are not endowed with infinite amounts of the stuff.

Sceptics rightly point out that this bell has been rung before. In the mid 1980s, world oil reserves were forecast to last about 20 years; and yet here we are in 2007, with near record production levels. Historically, we have always found new sources of oil – in Alaska, in the North Sea, in the Gulf of Mexico, and off the coast of Africa – to satisfy our addiction. There are prospects in the future too: there may well be (very substantial) new discoveries in the Middle East, ultra-deepwater drilling holds promise, as does the development of new areas such as the South Atlantic, and increased enhanced oil recovery will certainly play a role. This misses the point: finding new oil reserves may push out peak production, but it does not invalidate the concept. Our planet does not contain an unlimited amount of oil.

Many – particularly on this site - argue that economics has little that is intelligent to say about peak oil. Yet the very definition of economics is the study of scarcity, and in particular, the study of the efficient allocation of scarce resources. What more relevant subject could there be for studying the effects of peak oil?

The following is from guest contributor Jeff Vail. Jeff is an intelligence analyst focusing on energy and infrastructure-related issues. He is a graduate of the US Air Force Academy and a former USAF Intelligence Officer. Jeff previously wrote on the The Oil Drum about the increasing violence in Nigeria.

He discusses an interesting phenomenon with respect to energy futures prices, that long dated futures are limited in how much they can go up (but not down) based on arbitrage principles. Because the price of distant oil futures quickly rise alongside spot market prices when spot markets are moved by short-term events, we can infer that major producers such as Saudi Arabia think that the future price of oil will be much higher than the price at which distant futures are currently trading. This provides further support to the theory that they don’t believe their own statements on their future production or on the future price band for crude oil. Jeff's post is under the fold.

On October 24th, Dr. James Hamilton of Econbrowser commented on The Tragic Consequences of the High Discounting of Oil Extraction [1] in his story Is peak oil irrelevant?

Figure 1 -- Click to enlarge

If Dave had gazed not at a century of prices but rather at just the last 15 years of the price of oil relative to the PCE deflator, would he have drawn the same conclusion? If all we had was the graph above, it would seem quite natural to conclude that a rising scarcity rent could well be one factor in the recent behavior of this commodity price...

... I am not at all prepared to dismiss the hypothesis that scarcity rents have indeed started to make a contribution to oil prices over the last five years, and will become more apparent over the next five...

Admittedly, if the oil price should fall from here down to $30, then I'll have to conclude that scarcity rents have had nothing to do with the recent price moves.

But if Dave is right about the geology, oil is not going to $30.

Not knowing of any good evidence to contrary, I'll just make the simplifying assumption that I'm right about the geology.

We'll return below to some of Hamilton's other observations as we consider what meaning to draw from the history of oil prices over the last several years.

Jeff Vail asks the question: Is it possible that a shift in the crude futures market from backwardation to contango indicates that the markets have "tipped" and accepted Peak Oil?

More interesting ideas (and explanations) under the fold.