 |
Posted on 05/09/2011 6:53:01 AM PDT by SeekAndFind
Like a roller coaster ride, 2011 saw oil prices climb gradually, only to fall dramatically this last week. Here I offer my thoughts on some of the key contributing factors.
Let's begin with the relation between oil prices and the exchange rate. If the dollar depreciates by 1%, the dollar price of oil would have to go up 1% to keep the price paid outside the United States constant. This is a bit simplistic, one reason being that there is usually some third factor, such as a rise in incomes outside the United States, that is causing a change in both real oil prices and the exchange rate. Different factors affect the two series differently, so one might see a 1% depreciation correspond to an increase in dollar oil prices of more or less than 1%, or sometimes even an oil price decline. Between September 2009 and September 2010, a 1% depreciation of the exchange rate was associated on average with a 1.3% increase in the dollar price of commodities like oil or copper. The dollar rose about 3.5% against the euro between Wednesday and Friday, and the 4.5% decline in the price of copper could be pretty well explained by the exchange rate alone based on the recent correlations (3.5 x 1.3 = 4.5). But something more is involved in the 11% drop in the dollar price of crude oil observed those same two days.
Looking at the broader trend, the price of oil shot up 19% in February and March, during which the dollar depreciated against the euro by only 3%. The exchange rate can account for only a small part of recent movements in the price of oil.
|
What I believe should instead be the first place to begin any discussion of recent oil prices is the broader global trend of supply and demand. The graph below plots world oil consumption over the last 15 years. This increased by 7.3 million barrels per day between 2000 and 2005, but by only 1.2 mb/d between 2005 and 2010. But very importantly, consumption by China increased by 1.7 mb/d between 2005 and 2010.
 |
Please note the necessary implications of this arithmetic: if China is consuming 1.7 mb/d more, but the world as a whole is only consuming 1.2 mb/d more, that means that people outside of China, as a group, have decreased our consumption by 500,000 b/d over the last 5 years. And the first question to ask anybody who claims that the price of oil has been "too high" recently, is, how much of a price increase do you think would have been necessary to persuade consumers outside of China to reduce consumption by a half-million barrels per day over a five-year period?
I've been talking about global consumption, though the EIA also reports data on world production. It's not accurate to conclude that if reported production exceeds reported consumption, then there must be excess supply with the difference going into inventories somewhere. The two series are collected from different sources, and the difference between reported production and reported consumption is often just reflecting errors in measuring the two series. But it's interesting to note that, from production data, it looks as if we're finally lifting above the five-year plateau, with the latest production figures showing significant increases relative to 2005 in countries such as the U.S., Brazil, Russia, Angola, Iraq, Azerbaijan, China, and Canada far in excess of the declines in the North Sea, Mexico, Venezuela, Indonesia, and Saudi Arabia over that period.
 |
We can also look at direct oil inventory data for the United States. The black curve in the figure below plots the average seasonal behavior of U.S. crude oil inventories. The green curve gives the values for 2008. Inventories were significantly below normal in the first half of that year, making it difficult to insist that the price at that time, though rising quickly and very high by historical standards, was higher than it needed to be to keep demand from outstripping supply. By contrast, the orange curve (2011 data) indicates that current inventories are currently well above normal, suggesting that, particularly given the recent production gains, a lower price would likely be consistent with the quantity consumed being equal to the quantity produced.
 |
I believe that events in Libya had been a key driver of the price of oil over the last few months. The country produced about 2% of total world supplies last fall. If one assumes a short-run price elasticity of demand of 0.1, that would warrant a 20% price increase if those supplies were knocked out and no one else had the excess capacity to replace them. Not all of Libyan production has been lost, but on the other hand, I have heard some analysts claim that Libya accounted for 15% of current light sweet production, where the real crunch has been recently.
The political currents recently manifest in North Africa could still easily spread to other key oil-producing countries. But if that does not happen, then with the likely response of consumers to the still-high price, and the promising near-term production gains, it is possible that this week's dramatic oil price declines are only the beginning.
In terms of what this means for American consumers, each $1/barrel change in the price of oil usually translates into 2.5 cents per gallon of gasoline at the pump. With the price of oil now down $16 from its peak, that might mean a drop of 40 cents per gallon in the retail price of gasoline.
I don't know what chart he was looking at?
Mike
In recent weeks the pump price has risen on the order of 8 to 19 cent PER WEEK. I’d call that a price spike.
OTOH, I do think that QE2 is the underlying force that is driving the higher cost per barrel.
Now that QE-2 has ended, the effects of the rising dollar will probably be replaced by inflation. The 1/4% interest rates have not risen yet and inflation is a very real threat.
The biggest, most frustrating thing is, we have never been in this dangerous of a position before. NOBODY knows what to expect. Looks like we are about to learn the hard way!
Agree....
And oil is much more sensitive to reduced demand than most other things simply because the system is just big enough to handle what it's adapted itself to handle, based on demand. If the demand suddenly drops, even a few percentage points, the product starts backing up throughout the system. Gas stations can't take as much, depots will soon fill up all their tanks, refineries will have not be able to ship their product, product and unrefined oil will back up at their facility, tankers en-route more oil will have no place to put it and be forced to anchor someplace and wait, shipping points will soon have all the oil they can store since they can't load it onto tankers, and finally the drilling site will have to stop drilling because there's nothing to do with the oil they pump out of the ground.
They tell us we can't conserve our way to a drop in prices. BS. They say that because they know it's one place where we can have a an effect on their ability to make money. If everyone paid attention to reducing their use of gas, and diesel, the price would fall as facilities became overloaded.
Do the math. There are 3,500 counties in America. If every county simply cut use by 1,000 gallons a day that would be 3.5 million gallons nationwide. Times 7 days that over 20 million gallons a week, 80 million gallons a month. And a lot of counties have the potential to conserve a whole lot more than 1,000 gallons a day. The system simply can't handle that much excess product.
I know it's not as simple as outlined here, but a determined effort to put OPEC in its place with good, solid conservation efforts would be SO satisfying!
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.