Wall St and peak oil
July 15, 2010 11:00amby Kate Mackenzie | Share
One of the enduring lines about peak oil is that authorities keep it a secret because there would be some kind of financial havoc if it were revealed. A recent example is a claim that Steven Chu, US energy secretary:
“… knows all about peak oil, but he can’t talk about it. If the government announced that peak oil was threatening our economy, Wall Street would crash.”
Is it really possible that oil traders, investors and analysts haven’t heard of peak oil?
Or that they have decided to ignore it altogether?
First, peak oil is hardly shunned by the financial world; just Google ‘peak oil funds’ to see how many investment managers are basing their strategy around this. Oil market traders can’t ignore the question of peaking oil production either, because the supply/demand balance is intrinsically bound up with oil prices. So they follow it as though their livelihoods depend on it. If the supply of other liquid fuels such as bioethanol proves inadequate to make up the shortfall of demand, then the price of oil will inevitably go up. In fact that’s what some believe happened in 2008 when crude prices did reach $147 per barrel: Saudi Arabia, the world’s biggest source of oil and its only significant “swing” producer, ran out of spare capacity.
Morgan Downey, author of ‘Oil 101', made that very argument. Though in his personal capacity, he was at the time a senior commodities trader at Standard Chartered.
He was hardly alone in being concerned about capacity. True, some financial analysts have faith in the potential of technology to overcome the problem of increasingly scarce supplies of easy oil. But they know this is an unknown. On the whole, market traders and analysts do talk about the risk of demand outpacing supply. Quite a lot, in fact — as John Kemp of Reuters wrote last month, many oil market analysts spent much of last year focusing on an imminent tightening of supply. They may couch it in terms of “supply crunch” rather than “peak oil”, but the basic concern is the same.
Goldman Sachs famously predicted during 2008 that oil would hit $200 a barrel. Despite being a little wide of the mark (prices peaked at $147) commodities analysts at Goldman were talking in 2009 about a looming energy crisis and a shortfall as early as the second half of 2010. Although they attributed this to lack of investment and geopolitical constraints, the message was still that oil supply was at risk. Bernstein Research is another one we wrote about last year, warning about flow rates, particularly on newer oil plays.
Of course there are others who argue that supply-side risks in general are overblown, pointing to Iraq or slowing world demand. Deutsche Bank analysts, for example, wrote last year about ‘the end of the age of oil’, arguing that oil demand looked increasingly like peaking before supply did.
Sceptics of this argument will point out that information about global reserves is opaque, particularly from Saudi Arabia and other Opec nations. That is a very good point. But market participants know this. Their jobs involve poring over reports such as the IEA’s 2008 oil field survey, which made clear that its decline rates were estimates based on a sample of fields. Markets price that uncertainty in. Look at prices: crude oil has remained well above $70 for much of the past 12 months, a price point that baffled many commentators. Why should oil prices reach what are historically high prices at a time when emergence from global recession was far from assured?
Concern over investment in new production and recognition of Asia’s growing demand are part of it, but so is the decline of conventional oil supplies.
A long but very illuminating paper from the Oxford Institute for Energy Studies (which we wrote about earlier this year) comes up with a very plausible theory of what has driven oil markets in the past few years.
The author, Bassam Fattouh, points out that there are significant time lags in changes to oil supply capacity. Prior to 2002, expectations were that high oil prices would eventually be corrected by responses such as oil-induced recession or an increase in supply. But faith in these “feedbacks” deteriorated during the past eight years, he writes. Key reasons included changing notions of how oil prices affect the broader economy, but also concerns about oil production capacity — both due to declining fields, underinvestment, and increasing reliance on Opec to meet growing demand.
Another point is Opec itself. The cartel insists it needs to see oil at between $70 and $80 a barrel to guarantee adequate investment in new supplies. Yet for the most part, Opec members can reap a profit on far less than this (although the price levels required to satisfy their domestic budgetary needs is another matter).
But if the market prices oil at the cost of the most expensive barrels - such as those from say, tar sands in Canada - why not take that price? What incentive does any Opec member have to provide more reassurance about its supplies? Meanwhile Opec itself seems genuinely concerned that oil demand itself will fall away.
None of this is to say that increasingly scarce and difficult to obtain oil won’t affect markets and the wider economy. And large parts of the analyst community have missed other looming problems, like the 2007-08 subprime crisis. But the likelihood of Wall Street being completely blindsided by oil supply problems seems remote.
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