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Trading Lessons

The Godmother Ran Out Of Luck: Saudi And Global Oil

Commodities / Crude Oil Jul 04, 2012 - 10:03 AM GMT

By: Andrew_McKillop

Commodities

Best Financial Markets Analysis ArticleIn a recent (29 June) Market Oracle article, Andrew Butter writes: "One suspects that behind the Saudi rhetoric about keeping oil prices fair for the sake of the world economy and world peace…like a modern day fairy-godmother-of-last-resort, there is the thought that if prices stay above $120 or so for long then some serious E&P investment is going to get directed into that area, rather like the investment in the North Sea in the 1970’s which kept prices a long way lower than “fair”…until that oil ran out".
Quite right, but the not-so-new Saudi Nice Price of $75 is now cheap oil, and itself proves we have Peak Oil in a wholly unexpected way.


THE CLASSIC ANALYSIS IS WRONG
Checking this chart from Petrostrategies Inc, below, the total claimed recoverable reserves - on an oil energy plus gas energy basis - firstly shows how downsized the old time Seven Sisters have become:



This Petrostrategies chart and linked table provide us a useful first cut for understanding how things changed: http://www.petrostrategies.org/Links/worlds_largest_oil_and_gas_companies.htm

The dowsized 7 Sisters - call them the 5 Anxious Dwarfs - have little oil and (seemingly) not so much gas, either, but this is already rearview mirror: checking companies like EnCana Corp, Chesapeake, Anadarko, Pertamina of Indonesia, even Petroleos Mexicanos and PetroChina wakes us up to how the gas pile is growing. Checking especially Shell, but also Exxon and BP the gas numbers are growing much faster than the oil numbers shrink. Comparing the once-king of gas, Russia's Gazprom with the gas piles of a string of OPEC state companies, and with the near-term future combined total of stranded gas + shale gas reserves of the 5 Anxious Dwarfs and a fast growing number of "unheard of players" (like ENH the national oil company of Mozambique), we begin to get an idea of how things have moved in at most the last 4 years. And will go on moving.

All oil-gas energy companies, not just the Western majors can move, and are moving to cut risk and increase their total energy reserves and production capacity: necessarily oil has to lose. A company like Exxon Mobil can eliminate the technological risk of developing unconventional gas and oil, and can possibly use GTL (gas to oil conversion) to produce liquid fuels, but it was hard to eliminate the risk of a Saddam Hussein, Muammar Gaddafi, Vladimir Putin or Hugo Chavez. Win twice, lose twice.

The new way of looking at risk is at the heart of the transformation. International oil companies traditionally faced a simple choice: They could either invest in oil that was easy to produce but located in politically volatile countries, or operate in harsh, difficult and high cost environments in stable countries where the oil was hard to extract and can only be expensive. To be sure, this was great for Saudi Arabia, Russia and other OPEC and NOPEC states sitting on large amounts of "conventional" oil, imagining they could "fine tune" prices and keep the(ir) party going.

The Big Picture background to this global energy transformation away from oil is easy to explain: comparing 1973 and 2009 using IEA data, the OECD countries depended on oil for 52.6% of their total energy consumption in 1973. By 2009, this was down to 36%. The future trend of the energy mix is 100% sure and certain: oil's share of total energy will go on shrinking - possibly fast. Conversely, gas energy will grow - probably fast.

WHO BELIEVES THE CLASSIC ANALYSIS: GOLDMAN SACHS
Like we also know or can rapidly find out, GS continues to bleat that $130-oil is coming, because GS wants it to come, only for defending its trading strategy and Wall Street cred(ibility), and quite a large amount of customer cash, plus a little bit of its own. To create any kind of "rational basis" for prices spiking that high - which was possible in 2008 but that was 4 years ago - we have to believe that firstly the OECD groups's oil demand can recover and grow and secondly that China and India will neither trend down in GDP growth nor cut their oil need per unit of GDP. Most of all, we also have to beleive that shale gas and oil do not exist and that only since 2009 stranded gas finds, worldwide, were not vastly immense in the true meaning of that word: immense.

Accessorily and to be sure, the oil price boomers and manipulators like GS have to hope and pray for Iran-type crises to pop up in the crosshairs of the Free World's fighting forces, a game that is also played by Iran, Russia and other oil exporters the other way round: occasional sabre rattling has a predictable way of spurring prices. Their national oil companies and broker-fixers like GS can conspire to create V-profile price surges and collapses, with nice pickings for insider trading.

Possibly Goldman Sachs can believe that oil demand will always recover and Iran's mollahs will always play scary - after all they employ folks who can invent win-only trading algorithms while supping a single Coca Lite, but the rest of the world can't.  If GS also believes in old time and classic Peak Oil, which only concerns conventional oil (and nothing else), they also made a big mistake. Even more extreme, the antique thinking of oil price boomers is totally decoupled from what has happened to world oil demand - not since 2008 and "the crisis" but from as far back as 2005 in a string of countries.

Old time growth of oil demand, close coupled with GDP growth, has broken up and broken down. Firstly the rate and even nature of economic growth has been changing, but secondly its linkage with energy - especially oil energy - is changing as it shrinks. This mega change, since at latest 2007 has been migrating East, to China and India, as oil prices start migrating South. The net result of this mega change is that plenty of countries in the OECD groups are today in their sixth straight year of oil demand decline at around 2.5% per year: even GS can work out what that means, if they want to.

The classic analysis needs us all to to believe that "oil is vital to civilization", making plastics and fighting wars, keeping the Donald Duck rechargeable flashlights crossing the oceans in massive container ships because - gosh! - there really is no alternative to that. This kind of thinking was fine in 1973, but times really have changed: GS can check out what happened to its partners in crime, Bear Stearns and Lehman Bros., who kept on going in Olde Tyme style.

BACKING OUT OF OIL
Behavioral attitude change also operates: in 2008 the GS spike of oil prices, hitting $147 a barrel, helped trigger the collapse of General Motors, and its massive state bailout. Nobody in 2008 wanted to buy a gas guzzling clunker - even if they still had a job. Today's short-term attempt at spiking prices beyond $125 a barrel, through Q4 2011 and Q1 2012, sent US car drivers flocking into showrooms to buy a new car consuming 25% less fuel than their previous clunker. Whether they continue buying cars at all, now, is another question but the cozy conventional idea that US car drivers can only roll in a V8 has gone down the tube. Today, a string of major Chinese cities (including Beijing) have set and fixed allowable maximum rates of city car fleet growth - and if car fleet growth shinks at the same time each car gets more fuel efficient we do not need math PhDs to tell us the outlook for oil demand.

Much further upstream - at the level of oil and gas major corporations like the 5 Anxious Dwarfs who are now anxious to get out of oil - we also find price elastic behaviour. Any cut in oil prices to below the new Cheap Oil price level of $75 a barrel will see a rapid shrink in their E&P spending on oil, while their gas E&P spending holds firm. Each time this happens (the most recent was 2009-2011), future oil output growth will tend to be low or even zero, oil prices can bounce if there is any demand growth, and this will further drive consumers away from oil. Maybe too complicated for GS to understand, but the oil and gas corporations know this!

Using IEA data, Emerging and developing countries including African low income countries burned about 2.2 billion barrels of oil in 2011 to produce electricity. This target market for backing oil out of the global energy mix is now poised for rapid penetration of solar power, windpower and gas-fired power generation. The timing is specially good, due to global overcapacity in the solar and wind sector, already driving company after company into receivership - and prices ever downward. Given that oil demand growth in nonOECD countries was the last rational base of the "classic theory" of oil demand always rebounding due to oil dependence, with high oil prices always around the corner, this new target market for energy transformation is likely to be the final tipping point for oil.

In 2011, the US obtained about 1% of its electricity from oil, but in many nonOECD countries we still find that 50% or more of national power is oil based: shrinking it to 1% is entirely feasible and will happen. Only the speed of change is open to debate, but for the future we have to undertand that high oil prices - over the new Cheap Oil price of $75 - are a thing of the past. This will be bad for Saudi Arabia, and really bad for Russia, but now they can really conserve their oil resources, like they so often talk about.

By Andrew McKillop

Contact: xtran9@gmail.com

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

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

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.

© 2012 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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