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Crude Oil Prices, The Coming Event Horizon

Commodities / Crude Oil Jan 03, 2012 - 12:01 PM GMT

By: Andrew_McKillop

Commodities

Best Financial Markets Analysis ArticleIn a UK 'Guardian' interview, 10 November 2011, the IEA's chief economist Fatih Birol once again outlined how radically the IEA sees the oil price outlook. He said: "If fossil fuel (energy) infrastructure is not rapidly changed, the world will lose for ever the chance to avoid dangerous climate change", but more to the point he provided the IEA's estimate of what oil price rises in 2010-2011 had done for the OECD group of countries, saying annual oil import costs had risen by 30% to about $790 billion from around $625 billion in 2010.


For year 2011, Brent grade oil import prices to the 3 largest world importer countries and regions - USA, Europe, China - averaged $111 a barrel.

Birol added that oil imports to the United States are expected to stagnate or decline over the coming years because of new fuel efficiency standards for cars and trucks, and an increase in domestic oil and natural gas production, but oil import demand in Europe, and especially China and India would continue growing. The IEA therefore continues forecasting high oil prices - very high oil prices.

Certainly since 2009, the IEA deliberately confuses the subject of limiting global average temperature rises to 2 degrees celsius by 2025 through cutting OECD fossil energy consumption enough to prevent CO2 levels rising above 450 ppm (0.045%) in the Earth's atmosphere - with the real issue of how to prevent oil prices hitting $150 a barrel by as soon as this year, 2012. The IEA presents what it calls unfavourable scenarios, which Birol's researchers and analysts claim as able to bring $200 a barrel oil by as early as 2015-2017 - without any special geopolitical tensions or pressure. The IEA signals little respite for energy consumers.

The OPEC link is clear: in November, Birol repeated warnings of the "clear need" for more OPEC oil this year, and every year forward to 2017. While the US EIA's end year forecasts for oil prices in 2012 range through a more than generous $49 to $192 a barrel, underlining the critical level of uncertainty that exists in oil price forecasting, both the IEA and EIA assume that year-average oil import prices will steadily rise. Current IEA forecasts range from an unrealistically low $114 a barrel in 2015, to $212 in 2035, in current dollars. This implies 2015 prices well above $125, and 2035 prices in dollars of the day which could exceed $275 a barrel.

CAN WE KEEP PRICES DOWN ?
The IEA has given stark and repeated, but little-reported forecasts on energy infrastructure and E&P (exploration-production) spending needs for world oil. These are usually presented as needed to head off Climate Change Armageddon, but the the real threat is oil prices spiraling up to $150 a barrel and staying there - even during low level or "contained" economic recession of the type operating in the US, Europe and Japan at this time.

IEA studies and reports, since July 2011, claim that for every $1 of energy sector investment in recent years, from the "vanity tech renewables" to oil, gas and coal, electric power and the flagging low-profile nuclear industry, we must raise this spending to $4.30 by 2017. This is a 330 % increase but the chances of this massive boost in energy sector spending happening are zero.

We can start by looking at energy sector investment through the most-recent golden years of 2004-7 during which oil and gas E&P attained about $400 billion-a-year, then fell to an estimated $275 to $300 bn annual average in years 2009-11.

In part, this was due to recession, but was also driven by a large rise in green energy vanity tech investment and spending, reaching its most recent peak of about $350 bn in year 2010 according to Bloomberg New Energy Finance. If we take the IEA forecast of energy sector spending needs, this says that oil and gas sector spending must attain as much as $1.6 trillion-a-year by or before 2017. This growth process must start in 2012, and the spending deficit through 2009-11 should in theory be covered. The chances of this happening are zero.

The implication for oil prices is easy: without deep and sharp, global scale economic recession we can only have Oil Shock defined as oil prices rising to previously unknown high levels. And when we have sustained Oil Shock of that type we will likely have global economic recession: the closed loop is so simple that even average political deciders can understand what is threatened !

OIL PRICES AND ECONOMIC GROWTH
The relation is complex and a subject of controversy for at least 35 years. The probable relation is like climate change, involving sills and tipping points: slow annual changes of oil prices, interacting with other energy costs and non-energy economic factors including the energy economic structure of national economies and factors as hard-to-gauge as consumer confidence, can continue until a tipping point is attained. Attempts at making before and after studies of oil and energy price changes and the economy are theoretically possible, but these studies are always unsure due to the economy changing, because of and due to raised or reduced oil and energy prices.

A Google check with my name and 'Petro Keynesian growth' will give hits for the facts-based real world impact of rising oil prices up to certain ceilings - which themselves are changing. Put another way, rising oil prices through 2000-2004 probably boosted the global economy growth surge of 2004-2007, and put in yet another way as many analysts do, including leading academic and bank analysts and OPEC Secretariat analysts, oil prices at around $75 a barrel in today's dollar terms are likely at worst growth-neutral and and at best pro-growth. The real question, here, is what was the impact of oil prices peaking in year 2008 ?

Like we know, sudden oil price rises and sudden falls are not symmetrical in economic impacts, and the real impacts of "oil shocks" in price terms - not physical supply terms - are usually slow or surprisingly low. Global inflation in the second half of the 1970s and until about 1983 is often attributed to the single driver of oil price rises during the two oil shocks of the 1970s, but why did record high oil prices in 2007-2008 not produce an inflation outburst ?

These technical considerations are less important for us today, faced with near-certain oil price rises except and unless there is a steep fallback of global economic growth, which is far from impossible. Also, we are faced with oil price rises from an already high level, not the bargain basement price levels of the late 1990s. Because oil demand is so inelastic to price rises, unless there is recession, we might this time around have a real world "experiment" of what impact high oil prices have on the economy. One thing is likely certain: prices around $150 a barrel are a threat to any sustained global economic recovery and oil prices at this level are unlikely to not have a major inflationary impact.

Contributing reasons for why it is so difficult to fix and set the oil price tipping points for the global economy include the several-decade-long policy driven attempts in major oil intensive economies to reduce oil intensity, for example US CAFE car fleet average fuel standards, overwhelmed by the growth of car fleets, and the highly successful abandonment of oil-fired electricity generation in OECD countries. This reverse side of this coin is that whittling down oil dependence makes each successive percent cut in oil intensity more difficult, more complex, but these cuts will come.

THE GEOPOLITICAL FACTOR
Far more than any other basic commodity, with a very few and small scale exceptions oil remains "The Prize" of potboiler oil crisis book writers like Daniel Yergin. For the threatened oil shocks of the near term future, we can be certain that Arab Spring revolts, the Iran nuclear crisis, threats to Putin's power, and ever rising Chinese and Indian oil demand can or will play a major role in advancing the arrival of an economic event horizon.

With the possible but unsure exception of Libya's regime change in 2011, military action to ensure oil supply security and push down prices has been a long story of failure, but this does not prevent it happening again. The major problem in the present context is time: surplus oil production capacity has continually fallen for as long as 7 - 10 years, according to the IEA and other sources, making it high risk to operate regime change military adventure in major oil exporter countries, due to loss of export capacity during the hostilities, certainly further raising world oil prices.

This re-shifts the focus to non-oil energy and oil-saving initiatives and programs in the major oil consuming, oil intensive economies, which is likely the "hidden agenda" of the climate crisis and green energy quest or crusade in recent years. Here we find a direct relation with oil prices - green energy development without heavy and permanent government subsidies needs much higher oil prices. For many reasons however, including geopolitical relations with oil exporters, political deciders are not willing to engage in raising oil prices due to this encouraging oil exporters to seek higher prices. Likewise, oil saving programs operated either through raising oil prices, or only on a voluntary basis have usually failed, due to a global economy context where fear of limiting economic growth is stronger than the fear of high oil prices.

By Andrew McKillop

Contact: xtran9@gmail.com

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

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2011 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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