Option Investor

Volatility Still With Us

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Crude prices rallied from the prior week's low of $61.30 to trade at $71.77 on Tuesday before plunging back to a new 18-month low at $59.77 on Friday.

Obviously the volatility from the summer is still with us with $10 price swings becoming the norm for crude. Prices rose on a falling dollar and news that several more OPEC nations had notified buyers of a cut in the amount of oil available. The rising dollar and a stubborn refusal by Russia to join in the OPEC cut sent prices back to $60 on Friday.

OPEC president Chakib Khelil said on Saturday OPEC nations could further reduce oil production if the move last month failed to produce a rally in prices. He also said a report being prepared for the end of November would show if all OPEC members have enforced the October quota cuts. Khelil said a reasonable price for crude would be between $70 and $90 per barrel.

Khelil said the predicted recession in the U.S. and Europe would continue to slow demand and India and China growth would not consume enough extra oil to keep pace with recession declines in the rest of the world. "OPEC countries will therefore probably continue to reduce their production, in order to maintain a balance between supply and demand, at least through the beginning of 2009," according to Khelil.

OPEC's yearly summit is scheduled for Dec-17th and production cuts will again be discussed. Price stability is critical for many OPEC nations who depend on revenue from oil exports for the majority of their budget. For instance 95% of Algeria's revenue comes from energy exports of oil and gas. Sharp drops in prices produce hardship on these dependent countries.

Russia's Finance Minister, Alexei Kudrin, said Russia would defy calls by Venezuela's President Hugo Chavez to join OPEC in cutting production to support prices. Kudrin said, "Russia will pursue an independent strategy." Chavez had hoped his recent increase in cooperation and trade with Russia had given him some influence over Russia's energy policy. Nothing could be further from the truth and Chavez's only connection with Russia is dependent on the size of the checks he writes to buy arms from Russia. If Chavez runs out of money he will find his calls to Russia unanswered.

The 2008 World Oil Outlook report from the IEA is not scheduled to be released until Wednesday but the advance highlights suggest the IEA has taken a sudden turn towards peak oil. They do not call it peak oil and do not claim the world is running out of oil. They do claim that insufficient investment in exploration and production will lead to shortages sooner rather than later.

Previously the IEA had claimed production would continue to grow to well over 120 mbpd by 2030. That would require the addition of six more Saudi Arabia sized oil discoveries and that is simply never going to happen. The IEA is now saying that "conventional oil production" will effectively remain static, rising from 70.4 mbpd today to 75.2 mbpd in 2030. This is a monster decline in estimates and shows the severity of the coming problem.

Six More Saudi Arbias
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The IEA also reported data from the world's 500 largest fields showing depletion has risen to a whopping 9.1% per year. This is twice prior estimates and also shows the magnitude of the coming problem.

The IEA says to prevent a future shortage oil companies and governments must invest a minimum of $360 billion a year in finding and producing new oil. Much of that investment must be in the Middle East according to the IEA because they control the last untapped conventional oil reserves. The IEA wants Saudi Arabia to increase production to 15 mbpd from their current 9.6 mbpd and 12.5 mbpd 2010 targets. The Saudi ruling family has already said they would never increase production above 12.5 mbpd in order to preserve the oil for future generations. That will also insure prices will continue to rise for their oil.

The full report will be out on Wednesday and I will summarize it next weekend.

Jim Brown

December Crude Futures Chart - Weekly
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December Natural Gas Futures Chart - Daily
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December Gasoline Chart - Daily
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