Best of the Week
Most Popular
1.BrExit House Prices Crash, Flat or Rally? UK Housing Market Affordability Crisis - Nadeem_Walayat
2.Stocks Bull Market Climbs Wall of Worry, Bubble? When Will it End? - Nadeem_Walayat
3.Gold Price Is Now On Its Way To All-Time Highs - Hubert_Moolman
4.Deutche Bank Stock Price Crash - The EU Has Problems Far Beyond the Brexit - Harry_Dent
5.UK interest Rate PANIC CUT! As Banks Prepare to Steal Customer Deposits - Nadeem_Walayat
6.Gold and Silver Bull Phase 1 : Final Impulse Dead Ahead - Plunger
7.Central Bankers Fighting An Unprecedented Global Economic Slowdown - Gordon_T_Long
8.Putin Hacking Hillary for Trump, Russia's Manchurian Candidate? - Nadeem_Walayat
9.Stock Market Insiders Are Secretly Selling, Cycle Top Next Month - Chris_Vermeulen
10.Gold Sector - Is it time to Back up the Truck? – Mortgage the Farm? - Peter_Degraaf
Free Silver
Last 7 days
Stock Market - All Is Calm, All Is Not Right - 27th Aug 16
Gold Junior Stocks Q2 2016 Fundamentals - 26th Aug 16
Buy Gold’s August Dip? Gold’s Monthly Sweet Spot In September - 26th Aug 16
The IMF’s Internal Audit Reveals Its Incompetence and Massive Rule Breaking - 26th Aug 16
Commodities Are the Best Bargain Now—Here’s What to Buy - 26th Aug 16
Why I Left Canada and Became A Citizen of the Dominican Republic - 26th Aug 16
The GLD vs GOLD - 26th Aug 16
Can Stocks Survive Without Stimulus? - 25th Aug 16
Why Putin Might Be on His Way Out - 25th Aug 16
Bond Guru Gary Shilling - The Bond Market Rally of a Lifetime - 25th Aug 16
A Zombie Financial System, Black Swans and a Gold Share Correction - 25th Aug 16
OPEC’s Output Freeze: What Has Changed Since Doha? - 25th Aug 16
Merkel Prepares For a Deliberate Crisis While White House Plans For a Disastrous Succession - 24th Aug 16
Suspicious Reversal in Gold Price - 23rd Aug 16
If Trump Can’t Pull Off a Victory, Expect a Civil War - 23rd Aug 16
Ceding ICANN and Internet Control to Globalists - 23rd Aug 16
How to Spot an Oversold Stock Market - 23rd Aug 16
Gerald Celente Sees Worst Market Crash, New Military Conflict, Gold Spike to $2,000/oz - 23rd Aug 16
EU Olympics Medals Table Propaganda Includes BrExit Britain - 22nd Aug 16
BrExit Win's Britain Olympics Success Freedom Dividend, Economy Next - 22nd Aug 16
Stock Market Top Forming, but Slowly - 22nd Aug 16
(Really) Alternative Banking Systems - 22nd Aug 16
Vauxhall Zafira Fires - Second Recall Issued - Inspection Before Bursting into Flames? - 21st Aug 16
Will the Stock Market Bubble Pop Regardless if the FED Never Raises Rates? - 21st Aug 16
US Government Spending - 3 Big Stories Not Being Covered – Part III - 21st Aug 16
Silver Analysis - 20th Aug 16
SPX New Highs, Correction Next? - 20th Aug 16
Housing Bubble - The Marginal Buyer Holds The Pin That Pops Every Asset Bubble - 20th Aug 16
Gold Miners Q2 2016 Fundamentals - 19th Aug 16
Which Price Ratio Matters Most in a Fiat Ponzi? - 19th Aug 16
Big Policies, Bigger Failures - 19th Aug 16
Higher Crude Oil’s Prices and USD/CAD - 19th Aug 16
Here’s Why You Should Look for Dividend Stocks and How - 19th Aug 16
Deglobalization Already Underway — 4 Technologies That Will Speed It Up - 19th Aug 16
These 6 Charts Show Why the Average American Is Fed Up - 18th Aug 16
SPX Easing Lower - 18th Aug 16
Low / Negative Interst Rate’s Legacy - 18th Aug 16
The 45th Anniversary of The Most Destructive Event In Modern Monetary History - 18th Aug 16
USDU - An Important Perspective on the US Dollar - 17th Aug 16
SPX Completes Wave 1 Decline - 17th Aug 16
How to Quickly Spot Common Fibonacci Ratios on a Chart - 17th Aug 16
When Does a Forecast Become a Trade? - 17th Aug 16
Kondratiev Wave - The Financial Winter Is Nearing! - 17th Aug 16
Learn "The 4 Best Elliott Waves to Trade -- and How to Trade Them" - 16th Aug 16
Stock Market Bears Turning Bullish At New All Time Highs - Time to Get Worried? - 15th Aug 16
Job Seekers Sacrificed to the Inflation Gods - 15th Aug 16
A Look At Commodities and Financial Markets Trading Week Ahead - 15th Aug 16
Stock Market New Top Forming? - 15th Aug 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

How to Trade Elliott Waves

The Coming Oil Price Shock

Commodities / Crude Oil May 08, 2010 - 05:20 PM GMT

By: Andrew_McKillop

Commodities

Best Financial Markets Analysis ArticleFatal Difference - Fatal Indifference - We need only to recap the experience of the 1970s and 1980s to understand why massive public national deficit financing of Keynesian-type spending to restore global economic growth will almost surely end with a 1970s style oil shock. That is oil price explosion, falling consumer confidence and corporate investment, falling economic growth, finance sector panic, competitive devaluation of world moneys and a catastrophic slump back into recession. Like the 1970s experience, the recession will be very inflationary.


Then and Now

The 1970s delivered two short-sharp oil shocks, with never-known-before massive rises in the oil price, unlike the slow but permanent oil shock that operated through 2003 to the collapse of the global economic growth surge in 2008. Rising oil and commodity prices until 2007-2008, neither ironically nor magically, surely levered up global economic growth in a process I call Petro Keynesian Growth and the IMF and Federal Reserve Bank of New York calls fast, near complete recycling of windfall gains by major capital surplus oil and gas exporter countries - including Russia, for example. The petrodollars and petroeuros are quickly recycled to the global economy, raising solvent demand. This didnt happen in the 1970s.

This growth levering process operated in the Petro Keynes interval of 2004-2007, before the traditional model, Deficit Keynes, was called in to rescue the imploded finance, bank and insurance sector of most OECD countries, from midyear 2008. While the petrodollar recycling stimulus was figured in the high giga dollar range, the new debt racked up by OECD political deciders rushing to save the banks and slow the plunging economy was tera dollar sized, with peta dollar ultimate wipeout no longer a fantasy notion when or if Weimar Republic hyperinflation surges as a result.

For students of history we can note the oil price rises in the 1970s shocks were about 295% in 1973-1974, about 115% in 1979-1980. Through the 9 years from 1999 to Q2 2008 prices rose about 950%, all measured in nominal dollars not inflation adjusted.

Now and the Near Term

In 2010 another 100% hike, or doubling from the current price level around US$75 a barrel is possible or probable if there is any kind of global economic recovery. It is also possible or probable if both the Euro and the US dollar fall in value, following the present panic, inciting oil and gas exporters to cover near-term risk of further devaluation and/or inflation in the countries emitting these moneys. In a worst-case scenario, where we also have a rise in geopolitical insecurity as the USA finally quits Iraq and the Afghan war is declared an unwinnable high cost vanity project, and Israel runs a bungled regime change attempt against Iran, prices could triple from current levels very fast.

The big difference between the 1970s shocks and what has happened since around 2005 or 2006, is that the 1970s oil shocks were caused by short and sharp oil supply cuts for political reasons. Since 2005 or 2006 it is clear that global oil output simply doesnt respond to rising prices, in the exact same way gold production plays dead in response to record prices. Among the factors causing this we have the no-no for government friendly media, called geological depletion. Asking why BP drills 5 kilometres into the Earth's crust in 2 kilometre deep water instead of seeking "highly abundant" land-based oil reserves is a useful question: perhaps BP does this for technological kudos, to keep offshore rig builders in business, or for ecological experimentation with toxic dispersants ?

In the 1970s and 1980s world oil production capacity kept growing on the back of accumulated and large discoveries. Any prospect of physical supply shortage was removed from the scene for at least the next 20 years. Time then ran out.

Now we have a guaranteed short fuse, low ceiling, fast feedback on oil prices when global oil demand recovers. When we get to real Post Peak Oil and a net annual capacity outturn of zero, with any new capacity added only replacing lost, the price linkage will be even closer - and the splendid 75% price crashes like late 2008-midyear 2009 will be a thing of the past. The tilt to permanent high prices is totally predictable in the next 3 - 5 years.

With the Slump Dividend gone, we can focus on permanent high priced debt joining permanent high priced oil in the new inflation party. Ironically, this could save the party in the early lead-in phase, through 2010-2011.

The Coming Recovery

Due to the Slump Dividend of sub-critical oil prices, barrel prices below about US$ 125, the Petro Keynesian lever is alive and well, and working to the benefit of China, India, Brazil, South Korea, Australia and other countries. Below the critical level, oil and energy prices are not high enough to impact food prices, industrial materials, sea transport and construction costs, and consumer confidence in those economies able to run with the

Petro Keynes lever.

Global economic growth can or might pull the most-affected (that is most debt riddled) OECD countries out of their semi-structural slump, during the rest of 2010 and into 2011. By then, however, oil prices can again go critical leaving us with the 1970s default solution. Through 1974-1979 the response was to print money, like today, but to also accept the inflation caused by printing money. Today's political deciders in the debt riddled OECD countries maintain a herd facade of "struggle" against inflation being second only to "struggle" against Al Qaeda, and sometimes even in front of it, in the big list of national salvation quests.

Keeping the party going beyond end 2010 will mean accepting inflation. If this is linked to slow-or-no economic growth, it can tilt to hyperinflation. The coming economic recovery, if it comes, will be inflationary. In the famous slogan of Thatcher, parroted by generations of other great leaders: "There is No Alternative".

Geological shortage is not responsive to regime-change of oil exporter countries, as the Iraq situation shows, despite the brave words of its Chi'ite leadership bragging they can outproduce Saudi Arabia. Economic policy regime change is a lot easier, and is coming in the debt riddled OECD countries of Europe quite soon.

Inflationary growth, growth at any price, any cost, is the only way out. World oil demand will recover, oil prices will then again spiral as in 2007-2008 and with or without the help of Goldman Sachs structured products.

Coming Oil Demand Cuts

Using IEA and OPEC data, world oil demand in 2008-2009 declined at around 3.5% a year before stabilizing late in 2009, and showing low growth from the start of 2010. The bad news is that long-term contraction of world net export supply or "offer" (also caused by oil exporter countries actually consuming oil themselves) is likely already on a downslope of about 1% a year and will soon move up to 2.75% to 3% per year. Permanent recession becomes the default solution if oil prices are the bogeyman. Put another way, the present recession, described by the IMF as the worst since 1945, and the present OECD debt crisis the IMF tends not to talk about (because unprecedented) delivered a temporary cut in global oil demand at somewhat less than the coming long term trend rate for cutting global economic intensity of oil demand.

Demand compression will be difficult to set for India, China, Pakistan, Brazil and the main oil exporter countries like Russia, Saudi Arabia, Iran, Venezuela, UAE and others. This signals oil demand capping, and programmed year-on-year oil demand cuts will have to come from the OECD countries, essentially the (unacknowledged) basis of the European "20-20-20" plan, dressed up in climate-change frills. On average, the OECD countries use about 5 times more oil per head of population than China and 9 times more than India.

The main danger is that nice intentions on long-term oil intensity cuts will be shortcircuited by real world energy demand growth due to economic recovery in the real world near term. Previous instant remedy solutions of the Bush-Blair model, regime change of targeted oil producer countries to improve their export performance, are too slow and are always bungled, meaning that controlled cuts in oil intensity become the No Alternative.

Put another way, attempts at regime change to improve oil export performance will be decreasingly attractive due to very slim spare capacity margins for oil export supply. The sharp rise in oil prices through 2010 will have to be swallowed, because progress in restoring OECD economic growth is no longer an option - but a life or death need. Time is now short and oil intensity cuts are now urgent. Achieving perhaps a 75% reduction of oil, gas and coal intensity of the economy by around 2035 will need large investment, industrial restructuring, economic restructuring, legislative action, lifestyle change and consumer communication. Dressing this up as saving the world from climate catastrophe has not worked making the coming shaky economic recovery a period of epochal change

The challenge of energy transition is very clear. Organized dialogue between oil exporter and oil importer countries, aiming for stable and high but tolerable oil prices, in a transparent supply and pricing framework linked to energy transition. This will be vastly more productive than heroic attempts at printing money to beat the debt bulldozer or trying out new regime change adventures in oil exporter countries.

By Andrew McKillop

gsoassociates.com

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.


© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Negvex
23 Aug 10, 21:59
China at the mergin

Oil demand/prices over the next decade will to a large degree be driven by emerging economy demand at the margin. Here is another thought experiment using Chinese demand to generate some rough back of the envelopeĀ€ forecasts:

- China moves from 3 bbls/person/year to the South Korean per capita consumption level of 17 bbls/person/year over the next 30 years

- No peak in global production

Result: In next 10 years we must find 44 million BOPD - 26 million BOPD to maintain supply and 18 million BOPD to keep up with demand increases.

If you superimpose peak production on top of this demand profile using the following parameters oil prices would increase approximately 250% in real terms over next 10 years - most likely something would give far before that price level:

- Oil demand elasticity of -0.3

- Current production 84 million BOPD

- Current price US$ 80

- Peak production 100 million BOPD

- Post peak decline rate of 3-4%

If you want to try the china oil demand or the peak oil models for yourself using your own assumptions they can be found at Enquirica in the "Research" section: http://www.enquirica.com/index.php?option=com_content&view=article&id=11&Itemid=13


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife