Option Investor

Never A Dull Moment

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U.S. ships shooting at Iranian boats, Nigerian attacks and strikes, Scottish strikes and U.K. pipeline shutdowns. What else could go right for oil prices on a Friday morning? Crude futures were declining nicely at $114.25 before the news began to break. Once the Iranian news hit it was an almost instant $5 ramp in prices right back to $119. Good news for energy stocks but bad news for our USO short.

I don't know which way to turn this weekend. The shutdown of the 700,000 bpd British Forties pipeline could put a real crimp in global inventories "IF" the strike lingers for several weeks. The Nigerian strike against Exxon could take another 200,000 bpd offline but I doubt this one will last long. Workers are conducting an orderly strike demanding better wages. Elsewhere in Nigeria MEND rebels blew up another Shell pipeline. The attacks in the prior week had already knocked another 169,000 bpd off line but there was no word on the damage from Thursday's attack.

With all these problems the upward pressure on prices could continue. If the Forties pipeline is restarted we could see a return to declining prices. We are never going to get rid of the violence in Nigeria and traders have pretty much become immune to the daily news from there.

Crude inventories rose by 2.4 million barrels but gasoline inventories fell for the sixth consecutive week. On the bright side refiner utilization spiked +4 percentage points to 85.6% from 81.4%. This is a massive jump and suggests refiners have started to produce the May fuel blends in quantity. That also suggests we could see crude inventories fall next week while gasoline inventories should rebound.

EIA Inventory Table

Reality warning: Skip to the play section if you don't want to read some disturbing news.

The last two weeks have seen a very large uptick in news items discussing the arrival of Peak Oil or at least the conditions similar to peak oil. That name seems to have polarized many people. They have been fighting against the peak oil scenario for years and now that it is coming to pass they can't afford to admit they were wrong. Instead they are penning articles referring to economic disruptions due to civil violence or nationalism of reserves. Instead of "geologic peak oil" they are calling it a political peak in oil production. The difference is only the reason for the declining production. In a political peak scenario the reserves to solve the problem still exist but are not being produced for various political reasons. In a geologic peak those reserves don't exist or cannot be extracted fast enough to keep up with demand. In both scenarios the results are the same. Oil prices soar along with gasoline and diesel and an eventual global inflation/recession/depression cycle of immense proportions will begin.

On Thursday CIBC World Markets released a report saying the price of oil is likely to hit $150 by 2010 and $225 by 2012 as supplies become increasingly tight. CIBC said the IEA's current oil production estimates overstate supply by about 9% since they wrongly count natural gas liquids, which are not viable for transportation fuel. 9% of 88 mbpd equals 7.9 million barrels per day that cannot be used for transportation fuels. Since the majority of our increasing demand growth is for transportation fuels this is a recipe for disaster.

The CIBC analyst, Jeff Rubin, also noted accelerating depletion rates in many of the world's largest and most mature fields. He estimates total production growth will barely exceed 1 mbpd between now and 2012. During that period oil demand is expected to grow between 1.6 and 1.8 mbpd. That means we are going to quickly be running short on oil. The falling demand in the U.S. because of higher prices, increasing biofuels and the shift to higher mileage cars will be offset by increases in emerging economies like India and China. India's Tata motors announced a $2500 car and that puts a car in the reach of tens of millions of Indian consumers. He also noted that car sales were up 60% in Russia in 2007, 30% in Brazil and 20% in China. Consumption is moving aggressively higher but production is not. Jeff said, "Whether we have already seen the peak in world oil production remains to be seen but it is increasingly clear that the outlook for oil supply signals a period of unprecedented scarcity. Despite the recent record jump in oil prices, those prices will continue to rise steadily over the next five years, almost doubling from current levels."

I reported last week that the Saudi Arabia ruler said they were not going to add to production over their 2009 target of 12.5 mbpd. The plan is to keep production steady as prices rise in order to secure the future of Saudi Arabia. Why bust their butt to ramp up production when they will get increasingly higher amounts for their oil as supplies in the rest of the world decline? I have suggested this would happen for several years. Why spend billions to pump your greatest asset out of the ground today to sell for $120 when you know you can get $200 a couple years from now? It does not make economic sense if your bank is already overflowing with billions from prior oil sales.

On April 23rd Goldman Sachs said the window for a seasonal spring decline in oil prices is closing fast. "Looking into the second half of this year, given the fundamental tightness, we believe the risks are substantially skewed to the upside."

Several prominent Russian oil officials and investors said last week that Russia's oil production has peaked. At 10 mbpd Russia is the worlds second largest producer. Leonid Fedun, the president of Lukoil, Russia's largest independent oil company, told the Financial Times that last years Russian production of just under 10 mbpd was the highest he would see in his lifetime. Fedun compared Russia to the North Sea and Mexico where large easy to reach fields have gone into steep decline and no amount of new discovery would ever make up for the steep depletion. Until just recently Russia was considered one of the most promising regions where new production growth might appear. Now those hopes have been dashed with revelations about depletion rates and rundown fields. Russia was never big on spending money on technology or implementing the latest methods of production. Drill, pump, cap has been the pattern.

I could literally go on with 100 other articles but the key is the common thread. The optimism about future production has faded and reality is slowly sinking into the projections. OPEC even admitted last week that there was little spare capacity and little hopes for producing new capacity from countries other than Saudi Arabia. Saudi oil minister Ali Naimi said, "limited capacity along the entire supply chain is the REAL source of current supply tightness and represents the greatest threat to ensuring adequate energy to fuel future growth." Shokri Ghanem, head of Libya's national oil corporation said there was little OPEC could do in the case of a shortfall. "Very little can be done by anyone, there is not enough spare capacity to help." William Ramsay, deputy director of the IEA warned, "Potential to expand production within OPEC: there is none, except in Saudi Arabia." Saudi has now said they would not increase production any more to preserve wealth for future generations.

Is the current price hikes the result of peak oil? I don't think so but they are the result of the fears over peak oil. We may not see the peak until 2010, my current target, but that does not mean demand cannot outstrip supply before we reach the peak in global production. That will have the same impact on prices as if we had begun to produce more oil. Insufficient supply to meet current demand will cause an explosion in prices to levels where many consumers simply will not be able to pay. What is that level? $6 gasoline in America, $10 in Europe? Many nations still subsidize gasoline at ridiculous prices like 25-50 cents per gallon to either stimulate their economy or to prevent economic collapse from high prices. They will not be able to continue this practice as the price of oil doubles. Civil unrest and economic disasters will be appearing worldwide. We are already seeing food riots in 33 countries because the price of rice and flour went up. What if gasoline doubled or tripled or worse because the countries government could no longer subsidize 50 cent gas? The world is about to become a very troubled place and there is little we can do about it. I predicted the food riots along with a significant reduction in population due to starvation once peak oil arrived. The signs are beginning to be seen and we are still a couple years from the real disaster.

Jim Brown

Sign of the times cartoon

June Crude Futures Chart - Daily

May Natural Gas Futures Chart - Daily

May Gasoline Futures Chart - RBOB Daily


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