No Way Out
Comedian Rob Newman used to do a routine about the world’s dwindling supplies of oil, the essentially doomed nature of the petrochemical economy, and the increasingly desperate attempts governments and oil companies would employ to keep the lights on. But whichever way they turned, however hard they tried to escape from the inevitable, eventually they would have to face up to the fact that there was no way out – fossil fuels would run dry. In the routine, this sobering fact was epitomised by a cackling Baron Samedi figure in a gloomy stairwell.
It is still possible to find people who cite the supply argument in favour of a decline in the oil price – perhaps they’re banking on those Canadian tar sands coming up trumps. Others argue that even if a recession reduces demand in the West, any fall in price is likely to be modest and short-lived, as India and China keep industrialising.
The historical oil consumption per capita charts certainly make for grim reading. Whilst India and China are still at the usage level of the US in 1904, the experiences of Japan and South Korea are instructive. The charts show that whilst consumption is low in the early years of industrialisation, the following decades see a sudden exponential increase per capita. For Japan it happened in the 1960s, for South Korea, in the 1990s. It will be interesting to see how such a spike in usage by China and India will affect the market for oil in the next 20 years.
Energy crisis
Newton Investment Management, for one, is worried. In a recent research note it commented: “Unlike previous oil price spikes, there appear now to be few options to ‘get out of jail free’. We are witnessing not simply an ‘oil problem’, but rather the first stages of what could become a global energy crisis. The challenge now is the dearth of inexpensive, available energy sources to permit the reduction of oil demand through fuel switching.”
Ah yes, if only we had started investing in alternative energy back in the 1980s, then perhaps we wouldn’t be in this fix. Unfortunately, election cycles are too short to incentivise governments to take the tough decisions that are necessary to deal with such issues. And the longer we delay, the more expensive the bill when it finally falls due – which discourages subsequent governments from making themselves unpopular by stepping up investment.
“Failing to take tough decisions will lead to an extended period of energy inflation,” warned Newton. “This will prevent OECD economies from stimulating growth through monetary policy, while developing economies, burdened with subsidies, will be forced into trade controls and commodity hoarding.”
It suggested that governments should consider adopting mandatory investment in hydrogen networks, carbon sequestration and the development of second generation bio-fuels that do not compete with the food chain: “The real cost and impact of energy prices must be tackled, or the lights really will start to go out.”
Unfortunately, such Cassandra-like cries are rarely welcomed. Demand will fall in the West, the oil bears insist, and supply will start to come through, then the oil price will tumble. The bulls respond that once the industrialisation genie is out of the bottle, it can be hard to stuff it back in again.
Although most analysts have tended to be behind the curve in predicting the oil price, insisting that it must come down because that’s how it behaved in previous cycles – you remember, when the two most populous nations in the world weren’t industrialising – Global Insight recently revised its forecasts. It now believes that oil, food and raw materials costs will keep rising throughout the first half of 2009, and expects the price of West Texas Intermediate crude oil to peak at $160 a barrel in December 2008, up from $124 in its previous forecast.
“Growth in both real GDP and energy demand in emerging markets is likely to remain strong for some time,” said Nariman Behravesh, Global Insight’s chief economist, and Sara Johnson, economist, in a forecast alert. They pointed to a combination of stimulative monetary policies and fuel subsidies, which weaken the incentive to conserve energy.
“While some countries are beginning to tighten monetary policy and some are cutting fuel subsidies, these moves have been modest and are unlikely to have any significant impact until late 2009 or 2010,” they said. “In the meantime, strong energy demand growth in emerging markets will outstrip additions to non-OPEC supply and will offset the declines in demand that have already occurred in the US and Europe.”
Fuel subsidies
The question now is how long non-oil producing nations can afford to maintain fuel subsidies. India is already facing a ballooning fiscal deficit, but Vinay Gairola, manager of the Atlantis India Opportunities Fund, doesn’t see fuel subsidies being ditched in an election year. “There are 500 million poor voters who won’t allow this subsidy to be cut – the government doesn’t dare tinker with this,” he said. Instead, he sees the possibility of a windfall tax on Reliance Industries and Cairn Energy to help plug the gap. And Tata’s plans for an affordable runabout are likely to keep oil demand ticking along for a while yet.
Meanwhile, countries like Russia and the Middle East are simply using the receipts from their oil revenues to fund domestic fuel subsidies. Newton points out that in previous crises, natural gas has taken up the slack, but recently liquefied natural gas prices have risen faster than crude prices. “In the Middle East, a shortage of natural gas is having a direct impact on the oil supply: first because oil products are being burned instead of natural gas, and secondly, because reduced gas injection into oil reservoirs is curbing the production of crude oil.”
But isn’t it just the activities of those naughty speculators that have pushed up the price, say the oil bears. Well, Newton believes that the rise in price to $135 per barrel in May owed much to capitulation by commercial buyers, such as airlines, who had been waiting for the price to fall – as had been forecast by most commodity specialists in light of an impending slowdown in global economic activity: “Even the bullish, and widely-followed Goldman Sachs commodity team suggested a near-term correction in the oil price.”
Buying the curve
So when Goldman Sachs increased its forecast for the end of 2008 oil price from $115 to $149 a barrel, commercial buyers scrambled to ‘buy the curve’. “The rise in the oil price was exaggerated by the actions of hedge funds, which as the true speculative buyers, reversed the time spreads, which had entailed their betting on the short end of the curve, against the long end,” said Newton.
Even if the oil price does eventually roll back, it is likely to do so to a price well above previous plateaus. Global Insight is now predicting a fall in the oil price by the end of 2009, to $130, compared with $111 in its prior forecast, and to $105 by the end of 2010. But it warned that geopolitical events, such as conflict between Israel and Iran and more supply disruptions by rebels in Nigeria, could easily push prices higher.
If you want to read more about oil demand and supply dynamics and how the oil price is impacting earnings at energy companies, please visit:
http://www.thomsonimnews.com/story.asp?sectioncode=3&storycode=43565
