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Crude Oil, The Terror Of The 100-Dollar Barrel

Commodities / Crude Oil May 05, 2010 - 12:08 PM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleWAR ON TERROR
News reports focus a slightly damaged, propane-charged Nissan four wheel drive abandoned in Times Square, and a well-managed trail of clues leading from the Gulf emirate of Dubai, to Islamabad and the NW Frontier. News from another Gulf, this time the BP rig explosion in the Gulf of Mexico, suffers the same heavy-handed news management and hype.

The common theme, along with the failed climate conference in Copenhagen, is that action to wage war on the 100-dollar barrel is multifarious and polyvalent. We could say that even if windmills are going out of fashion, and solar power stations are a high priced green energy vanity tech struggling to get fashionable before losing that status, the war on terror never ceases. Whether it is bringing Iraq to civilized nation status, that is producing 10 million barrels a day, or developing green energy to save us all from unimaginable climate catastrophe, that is building mega windfarms and square miles of solar power stations, the struggle goes on.

In the wake of the BP rig blow out, US Nymex crude oil futures for delivery only 8 years ahead, in 2018, surged above $100 a barrel this week. Market players figured the BP event had already cast a shadow on hopes the USA can produce more domestic oil, or slow the rate of decline in output. The 2018 oil futures contract crossed the magic 100-dollar threshold as president Obama said no new offshore drilling will be allowed until after a “thorough review” of the April 20 rig explosion. The leak is pouring anywhere from less than 5000 to more than 10000 barrels a day into the Gulf.

Showing a healthy disconnect with not-distant past oil trading at far above 100-a-barrel, in midyear 2008, oil trader conferences debating oil prices "around 2016 or 2018" now announce that thanks to BP and bad luck, plus the fragile recovery and Obama, it is credible the 100-dollar barrel could someday return. New drilling is the official and only antidote to depletion, but world demand is the real price driver. If depletion increases, demand has to fall, but this message does not figure on the news shows.

As Obama knows, BP is one of the world's most profitable corporations like other international majors in the oil patch, and as Obama says BP will pay everything and anything the best lawyers can label oil pollution across the USA's Gulf states. Damages could go to $10 billion, a handy slice of the annual US oil import bill, that BP by superb irony is a leader in inching down through raising US national production from super-deep, super-risky fields several miles below the sea's surface in the Gulf.

Much further up the coast, near Cape Cod, US regulators took their time to approve the USA's first large offshore windfarm. This new fad in Europe, with some countries like the UK and Germany saying these mega projects could be expanded to tens of thousands of MegaWatts in power capacity "by about 2035", does not come cheap. Present per-kiloWatt capacity costs are above 5000 US dollars, compared with a kW of capacity from gas-fired turbines costing as little as 500 dollars. Unlike the wind turbines operating perhaps 33% of the time, the gas ones can operate 85% or 95% of the time, like coal-fired, nuclear powered or oil-fired power plants.

To be sure, the wind is free and gas, coal, uranium and oil are not, but borrowing 10 times more to produce the same amount of electricity when the wind blows is not enticing to financial players. These demand and get a profit margin running at 18% a year or more on offshore windfarm ventures, meaning big government has to be there with big subsidies. Technical problems and risks also add their part to costs, from laying the subseas cables, finding the heavy lift seagoing cranes, maintaining the farms, and battling saltwater corrosion and storm surges. Lifetimes of these mega projects may be as low as 20 years.

Almost the same doubts hang over grandiose and equally expensive solar photovoltaic power stations producing electricity at over 5-times the cost of fossil fueled plants. If they are built, we will not know how long they could operate, leaving the advocacy and rationale for this green energy in the domain of national energy security, low environment impact, and saving the world from overheating by CO2 emissions. The few jobs created are expensive in this high-tech industry and government subsidy is the real key to their fragile attraction. Like the ill-fated biofuels boom and bust, the same future shock could strike offshore windfarms and solar power stations, before we move on to the electric car boom and bust firming up on the 2011-2012 horizon.

Like the easy-to-remember 100 for the barrel price in dollars, we have a shift to equally easy near-term future currency values and relations. The Euro and US dollar can attain parity, along with the GB pound, and 100 Yen will be equal to all three. Adding the 100-dollar barrel we have a future commodity and currency pack, possibly including a slightly shrunken but fixed-value gold standard of 1000 dollars an ounce, although this is less sure.

At that time of facilitated trading, the move towards a single world money will be all the easier. It could come sooner rather than later if the European sovereign debt crises become continent-wide and migrate back to the USA and Japan. Taking the immense and fantastic debts the small Greek economy was able to lever up, it is no surprise untold further hundreds of billions of Euros in hard-to-service debt are out and about, in Europe. The US sovereign debt mountain is of course a lot bigger, but just as fragile. Whatever oil prices do in this context is a small side dish to a massive feast, suggesting the price jump to attaining the 100-dollar barrel will come soon after we have Euro and USD parity.

Other parts of the puzzle, like the GB Pound at 100 Yen and 1 Euro, that is 1 dollar, and the 1000 dollar ounce of gold could be delayed or never arrive. Keeping the GB Pound in existence was a New Labour bet of Gordon Brown, when rational thinkers already advised its abandon through joining the Eurozone - like Greece, Ireland, Portugal or Spain. With Brown out of the way, and despite a few ritual brave words, the coming UK coalition government can simply wait a little before saying the context was so adverse they had to accept GBP-EUR parity, and join the debt party. For the 1000-dollar ounce of gold we may have to wait some while, but any sharp double dip in the global economy following the sovereign debt crisis will quicken its arrival. 

The double dip would tend to heftily devalorize the 100-dollar barrel, also. Stern action would be needed by OPEC, Chinese and Indian oil consumers, and the oil major corporations to stop this trend. To be sure, BP is ahead of the pack in arranging a big question mark on future extreme depth, extreme cost, and extreme risk offshore oil projects. Facing a wall of costs and worries, big oil will be increasingly adverse to the 40-dollar barrel. Adding the currency factor - of former World Moneys being telescoped into a single transferable unit - the role of oil and gold in mapping out future "real value" will be as critical as the first version of the present crisis.

This was the crash of 1979 and a long downward spiral for the US dollar mirrored by an upward gold and oil price spiral. In a context where all the former World Money are revalued, or devalued to being interchangeable, each with a massive debt ball and chain attached, gold and oil prices could be an off balance sheet commitment to a future that is changing in front of our noses. Put another way, they could have special value, not able to gauged by the NWM or New World Money - that we could also call the WDU or World Debt Unit. Tinkerers at the IMF and BIS working quietly on launching the single world currency are, to be sure, Keynesian minded and could appreciate the idea of Bancoil and Bancgold joining in to back this brave new money.

By Andrew McKillop

Project Director, GSO Consulting Associates

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

© 2010 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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