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Why are oil (and gasoline) prices so low?

Gail Tverberg, The Oil Drum
We all know that oil prices are lower than they were in the recent past because supply is greater than demand. In fact, OPEC oil ministers are meeting this week to try to fix supply, so it will be more in line with demand.

All of this seems a little strange, though. We are going into the winter months, when demand for oil normally rises because many people around the world heat their homes with oil. We are using somewhat less gasoline in the United States, but apart from the hurricane disruptions, not very much less than earlier this year. While we are going into a recession, it doesn’t seem to have hit with full force yet. What other factors may be involved in the current lower prices? In this post, I will discuss factors besides those we usually think of as supply and demand that may be involved.

… 1. Credit problems of oil intermediaries

The oil industry has many more players than most of us are aware of. The International Oil Companies use contractors to do many functions that we think of as oil company operations. Oil is shipped by oceangoing vessels and by pipeline. Refiners are often separate from the oil company that produced the oil. Gas stations are often independently owned.

One of the issues is that sellers want to be sure that they are going to be paid for their product. They are unwilling to sell to buyers with poor credit. This is removing some players–and some demand–from the system.

… 2. Liquidation of positions by hedge funds and other speculators

Hedge funds have been under pressure from several directions to liquidate their positions in oil:

• Investors in the hedge funds have been disappointed in their performance, and are liquidating their positions. Oil futures are easy to sell, so the may be sold first.

• Hedge funds are highly leveraged. In the past month, many of them have received margin calls because of declining values of the securities they held (oil futures, stocks, bonds). Again, oil futures are easy to sell quickly.

… 3. Hedging of future oil prices by oil companies

Once oil prices reached high prices (say, > $120), even for long-dated futures, it made economic sense for oil companies to lock in future sales at those high prices. To the extent that oil companies locked in future sales using long-dated future contracts, this would add sellers to the long futures market, changing the balance in the futures market. The addition of sellers to the market would tend to bring down futures’ prices.
(22 October 2008)

… 4. Rise in the value of the dollar

…. Basically, the higher the dollar, the lower the price of a barrel of oil (measured in dollars). The dollar is high now, so the price of oil is low.

… 5. Trend Trading or Systematic Trading

Many investors use computerized programs that attempt to analyze an investment’s momentum, either up or down. These programs are designed to buy more of an investment, when the price of the investment seems to be heading upward, and to sell the investment short, when it is heading downward. If a large number of hedge funds, pension funds, and other investors have computer models that do the same thing, the simultaneous buy and sell orders will tend to reinforce the upward or downward trend in prices. These programs may have contributed to the unusually high oil prices seen earlier this year, and the big drop in the past month.

6. Drop in Asian growth

One of the reasons for the run-up in prices earlier this year was the concern that Asian demand was growing rapidly, and that world oil supplies could not keep up. There may have also been some stockpiling of oil prior to the Olympics. Now there are indications that growth in Asia is starting to cool

… 7. Small size of the oil (and other commodities) market, relative to the rest of the market

The amount of commodities for sale is tiny in comparison to the dollar value of stocks, bonds, derivatives, and other investments. If investors get the impression that commodities are a good source of diversification, or are likely to rise more than other investments, it doesn’t take very many of these investors to raise (or lower) prices in oil markets. Investors tend to read the same investment advice, and hear the same forecasts, so may tend to make similar decisions.

Research by Morgan Stanley indicates that commodity markets tend to move together. In the past, commodities have tended to follow long cycles, but “peak everything” may change this pattern.

… 8. Increased volatility when supplies are very tight

When supplies are very tight because of peak oil, both the supply curve and the demand curve are nearly vertical. A small change in demand (or supply) can result in a huge difference in price.
(22 October 2008)

Canada: End to moratorium on offshore drilling urged

Scott Sutherland, Canadian Press via The Globe and Mail
Two former premiers warned Monday that British Columbia’s economic survival may rely heavily on the federal government scrapping a moratorium on development of offshore oil and gas resources.

“The moratorium ought to be lifted,” Dan Miller, former B.C. New Democratic Party premier, said of the federal ban that’s been in place for more than three decades.

His comment followed a postelection panel in the B.C. capital featuring three former premiers from Canada’s three major political parties: Mr. Miller, former Newfoundland Liberal premier Brian Tobin and former Ontario Conservative premier Mike Harris.

Mr. Miller told a chamber of commerce lunch crowd that B.C.’s once-dominant forestry sector is in its worst shape in history.

…“What’s going to drive growth in the B.C. economy?” he asked, noting that residential construction and consumer spending are already decreasing.

Mr. Miller made it clear he feels the development of offshore petroleum resources coupled with new pipelines to the coast to help move Alberta oil to Asian markets could be the best way to foster investment in coming years.
(20 October 2008)

Africa’s Potential to Sate World’s Oil Demand Dims

Peter Fritsch, Wall Street Journal
The petroleum potential of Africa, a key contributor of oil barrels to thirsty markets, is beginning to look dimmer because of the credit crunch and a host of endemic challenges.

Certainly, Big Oil’s continental land grab will continue. Countries such as Angola and those around the Gulf of Guinea continue to lease tantalizing exploration blocks in the deep waters off the Atlantic coast. That region has been the hottest play in a scramble that has doubled the acreage under exploration licenses in sub-Saharan Africa to an area 10 times the size of France in the past three years.
[Africa Oil]

But the astronomical costs involved in developing those fields, combined with escalating violence in the oil-rich Niger Delta, the relatively short life span of West Africa’s producing basins, unpredictable market prices, and an expected culling of cash-poor small players means Africa’s days as a reliable supplier of additional oil may be numbered.

“We have benefited from additional oil volumes from Africa, but given the production profile of offshore fields, we need to see significant new discoveries to sustain that trend,” says Fatih Birol, chief economist for the International Energy Agency in Paris. “It’s not clear that will happen.”

Declining production will deprive a host of developing nations of sorely needed revenue. For countries such as Nigeria and Angola, oil exports account for the vast majority of government revenue and foreign-exchange earnings.

The continent is responsible for about 12% of global oil production of around 85 million barrels a day.
(22 October 2008)

Gas Supplies: Prepping for a Repeat of 2006/2007?

Robert Rapier, The Oil Drum
At this year’s ASPO conference, I was twice asked about the gasoline supply situation – once at a panel session and once by a reporter. At the time, there were gas shortages throughout the Southeast, and some of the speakers gave the impression that this was the beginning of the end: Gas shortages are here to stay, and we are on the verge of the entire country running out of gasoline. There were a number of predictions along the lines of “It’s going to get a lot worse before it gets better.”

While first discussing the source of the gas shortages – low inventories followed by a hurricane that sidelined a significant source of refining capacity – I answered the question as follows: “This is a temporary event. We will see imports start to pick up and fill the shortfall. We will see refining capacity start to come back online, and I predict that a month from now gasoline inventories will be higher than they are today.”

Of course that doesn’t mean that we won’t find ourselves right back in this position, nor that it won’t be worse next time. But I think failure to understand how the refinery/pipeline/import system works – sometimes by people in positions of authority – can cause premature predictions of imminent disaster. I think we have far too many people who can’t identify a wolf telling the villagers that the wolf is here. Many know that this is a pet peeve of mine.

So what has happened since ASPO?
(21 October 2008)