Prediction: Sub-$100 Oil

Is the drop in oil prices this week a trend? Will motorists get to stop spending the grocery money to fill their tanks?

One thing is sure and that is that oil prices are in a bubble. I wrote a story on this topic for the issue of Business Week that came out today.

It's a profile on Ed Morse, chief energy economist for Lehman Brothers, who has spent much of the last several months explaining why the year-long runup in oil prices is temporary, and will ease starting in the fall. Next year, he says, the average will be $93 a barrel, which would drop prices at the pump considerably. The on-line version includes a fascinating video of Morse.

Morse's basic argument is that there is no shortage of oil. The market is going to notice a buildup of stored oil around the world starting in the fall. And a plummet in prices will follow.

He makes a convincing case. I myself think that any plunge could end up being a dip, with prices rising again as Chinese and Indian demand go back up. As written previously on O and G, Christophe de Margerie, the chairman of France's Total, seems the most sensible voice on the state of Big Oil.

What $100 Oil Means

Yesterday's runup in oil prices was a mere blip -- two publicity-seeking traders appear simply to have sought barroom talk as the guys who made history's first buy over $100, then quickly sold at a small loss. But, coming the first business day of the new year, it's dramatized the new energy world in which we live.

I recommend an excellent piece today by my former colleagues at The Wall Street Journal -- Neil King, Chip Cummins and Russell Gold -- that sums up the themes we've been discussing on this blog, and takes them further.

In the hundred-dollar carbon fuel world, Big Oil is no longer in charge. Exxon, Shell and Chevron have been overtaken by Gazprom, Aramco and Qatar Petroleum. If you're an investor, the best long-term bets are some of these majority state-owned energy companies, and the technology-rich oil services companies being hired to work for them.

One takeaway point from the Journal piece is that Exxon -- the most successful of any of the Big Oil giants -- has only the 13th-largest oil reserves among the world's oil companies. The twelve biggest are all state-owned. This is a hugely important factoid -- Wall Street bases its valuations of oil companies on the reserves they own. So, logically speaking, they are headed for lower valuations. "Western oil companies now control only about one in ten barrels of the world's proven reserves," the piece says.

Another point is the enormous shift of wealth to these petro-states from consuming nations such as the U.S. At current prices, the Middle Eastern and Central Asian producers will earn around $750 billion this year.

For motorists, all of this means that, short of a recession, gasoline prices aren't likely to go down this year, but only up. If there's a hard hurricane season, they're likely to go extremely high.

The causes are an enormous increase in demand from China and India, along with only slowly rising production from the petro-states. There's actually a lot of oil sloshing around the world, but much of it is the wrong kind. It's heavy and sulfur-laden crude, which most refineries can't process. New refineries that can are on the way, but it'll be three or four years before they come on line.

Photo: gjofili
Rights: Creative Commons

For Motorists, 2008 Starts Out With Bad Omen

For motorists, the good news could be if former Treasury Secretary Larry Summers is right and we're headed for a huge, deep, global recession. Otherwise, 2008 looks like another expensive year on the road.

An uptick in violence in distant Nigeria helped to send crude oil prices through the roof today. A couple of crudes meant for delivery next month are at or near triple digits -- West Texas Intermediate rose to $100 a barrel, and Brent to $99.35. (Wall Street Journal piece)

This again highlights the global shortage of the types of light crude that most refineries can process into gasoline, something that won’t change until more flexible refineries come on line in three or four years. Unless demand drops -- the Summers scenario -- we're going to continue to have the tight supplies that are keeping gasoline prices high at the pump.

Meanwhile, an article in a journal published by OPEC says the world shouldn’t expect long-term relief from the Middle East. Ayoub Kazim, executive director of Dubai Knowledge Village, a government-run education center, wrote the article in the December issue of the OPEC Review. (abstract)

Carbon fuel optimists usually point to Middle East reserves as evidence that the world needn't worry about declining production in other leading petro-states, including Russia. But Kazim says that, between 2024 and 2048, OPEC countries like Saudi Arabia, Kuwait and others will be unable to satisfy their part of global demand.

If true, Kazim’s analysis would conform with the notion of an “oil plateau,” in which various constraints on production, such as equipment, manpower and expense, put an effective ceiling on total daily supply.

I’ve spoken with a number of plateau advocates, and their arguments are rational.

Photo: gothick matt
Rights: Creative Commons

Explosion: The Age of Pipeline Power

The explosion on the Canada-to-U.S. oil pipeline should help people close to home grasp why the big powers are spending so much time these days worrying about the oil and natural gas flow from the Caspian Sea.

Yesterday's explosion in Minnesota shut off the flow of about a million barrels of oil a day from Canada to the U.S., and that temporarily sent crude oil prices up by $4 a barrel. Even though they settled down fast, the AAA says the accident may push up U.S. gasoline prices in the northeast and midwest for several weeks.

That's just a million barrels -- one-twentieth of the daily U.S. oil diet.

Further afield, NATO is helping to secure the Baku-Ceyhan oil pipeline, the million-barrel-a-day line carrying Caspian crude to the Mediterranean. The U.S. applied enormous diplomatic pressure to get the line built. It came on line last year. Within a decade, the Caspian will be exporting between 4.5 million and 5 million barrels of oil a day.

Now the U.S. and Europe are pitted against Russia to secure natural gas from another part of the Caspian -- the republic of Turkmenistan, which has the world's fourth-largest supply of the fuel.

Again, the matter is pipelines. Russia has actually obtained a contract allowing it to buy much of Turkmenistan's gas supply, move it north through new and refurbished pipelines, and ship it on to Europe and elsewhere at a huge markup. The U.S. and the European Union haven't given up, though. They are championing a competing pipeline that would take Turkmen natural gas West, skirting Russia.

They aren't the only players -- China would also like to grab a big share of Turkmenistan's gas and ship it east.

These countries understand that one big dimension of power and influence today is control not necessarily of oil and natural gas supplies themselves, but over their flow to the market. Similar to the long battle over sea lanes in prior centuries, they are doing all they can to take control over the pipelines that carry former Soviet oil and natural gas to the rest of the world.

Photo: Gothickmatt
Rights: Creative Commons