Analysis: Peak Oil or Peak Prices

Peak Oil or Peak Prices

World oil prices finally dropped by $4 per barrel May 29 when there seems to be no end to the surge in oil prices.  Is the volatility of oil prices caused by Peak Oil or Peak Prices?

Vol. VIII, No, 17, June 1-7, 2008

Relief is seemingly in sight for consumers as the price of oil has dropped an average of $4 to $ 126.73 for light, sweet, crude traded at the New York Mercantile Exchange (NYMEX) and to $127.40 for London Brent oil , which is traded at the ICE futures, last Thursday May 29.  The drop in oil prices came just a week after it reached a peak price of $135 per barrel, which is about twice its price last year. Until May 29, there seems to be no end to the soar in oil prices.

One of the reasons being cited for the drop in prices was the slowing down in global energy demand. The US oil demand in March was said to be the lowest for that month in the last five years; while the April demand for oil in the Britain reportedly fell 7 percent compared to last year. This was seen as a sign that oil consumption is starting to strain under the pressure of high prices. There were also fears that the move of Asian countries such as India, Taiwan, Indonesia, and Sri Lanka to reduce fuel subsidies would also push demand downwards as pump prices in their respective countries increase.

The appreciation of the US dollar was also cited as one of the reasons for the drop in oil prices as it supposedly diminished the purchasing power of buyers that are using other currencies in commodity futures markets. It is interesting to note that when oil prices surged last May 21, one of the reasons cited was the weakening of the dollar supposedly making oil cheaper for some buyers.  They can’t seem to make up their minds whether it is the strengthening or the weakening of the dollar that causes oil prices to surge.

What could also not be explained satisfactorily by analysts is that oil prices dropped despite a US Energy Information Administration report showing a 8.8 million barrel drop in US oil stockpiles –  reportedly the biggest supply drop since a hurricane in 2004 forced the closure of offshore oil platforms – which was released on the same day.  This was simply dismissed as insignificant.  But when the US Department of Energy reported a 5.4 million barrel drop in US stockpiles last May 16, oil prices surged to its peak price of $135 per barrel.

It makes one wonder, what is really causing oil prices to surge and what made it drop by $4 per barrel recently?

Peak Oil

Many analysts are pointing to “Peak Oil” as the underlying reason for the volatility in oil prices. M. King Hubbert, a Shell geophysicist from San Saba, Texas, came up with the Peak Oil theory in the 1950s. He put forward the prediction that oil production is nearing its peak as the output of old oil wells would decline, as oil, a fossil fuel, is a non-renewable resource. It was reported that he accurately predicted that US oil production would peak in 1970. The oil crisis of 1973 was attributed to this.

But Peak Oil theorists could not agree when global oil production would peak and eventually decline. Nevertheless, many analysts believe that the growing oil demand, especially from India and China, and declining oil production is the fundamental reason for the surge in oil prices.

Elizabeth Souder of the Dallas Morning News wrote that T. Boone Pickens, a Texan pushing for the Peak Oil theory, is accurate in his predictions regarding the movement of oil prices.  He reportedly predicted last May 20 that oil prices would reach $150 per barrel by the end of the year.  And sure enough, oil prices reached $129 per barrel that day, $130 the next day, and $135 per barrel the day after.  But Pickens is not merely an analyst or a Peak Oil theorist.  He is an oilman running a multibillion dollar commodities hedge fund. In other words, he can make his predictions a reality by bidding for oil futures contracts.

Richard Heinberg wrote for AlterNet that while speculation is currently driving oil prices up, it is merely a symptom, the fundamental reason being the growth in demand amid declining supplies. Other subscribers of the Peak Oil theory attribute the spikes in oil prices to a combination of factors to include declining production, growing global demand, the weakening (or strengthening?) of the dollar, the refusal of the Organization of Petroleum Exporting Countries (OPEC) to increase the supply of oil in the world market, and speculation.

In a May 22 report of the Philippine Daily Inquirer regarding the surge in oil prices, Tony Nunan of Mitsubishi Corporation’s international petroleum business reportedly said that concerns over supplies are driving prices up. But he was also quoted as saying that the oil “market is technically and fund-driven right now,” meaning investors in oil are driving current prices up.

Even Peak Oil theorists admit that oils futures traders (read:speculators) are making a killing with the oil price spikes.  One trader was quoted as saying that he made a fortune in oil during the last two months. And if oil futures traders are making a fortune more so are the big oil producers.

Which is then the cause and which is the symptom?

Peak Prices

It is true that fossil fuel is non-renewable and global oil consumption is increasing; and eventually oil would become scarce.  When? Nobody knows for sure as even Peak Oil theorists face a blank wall when gathering data about oil production and reserves.

But this should not cause the current volatility in oil prices as there has been no shortage in supply for the last three and a half decades, despite the numerous predictions of supply disruptions because of wars, political instability in oil producing countries, and natural calamities.

The last time the world experienced a shortage in supply was in 1973 during the oil crisis.  And as far as I know, it was caused by the decision of OPEC to control production and raise the price of oil from $7 to $11 per barrel, not by the decline in US oil production.

Peak Oil should make people think about cutting down on oil consumption.  It should result in a serious effort to search for alternative sources of energy. But it is too early to cause demand or supply shocks.

Oil futures traders are buying oil not to save for a rainy day or prepare for a shortage. They gobble up oil futures contracts in the hope that when they are ready to sell it, prices have gone up more thereby giving them higher returns. The bids for contracts goes higher and higher until the market overheats: meaning real demand goes down as the pressure of high oil prices becomes too much to bear.

Thus, if demand continues to go down, so will oil prices.  Then, we could say that finally oil has reached its peak price. Speculators could no longer push the prices higher.

Economists could not believe that mere speculation could drive prices up.  But international mobile capital lodged in banks and hedge funds have become so large that it can influence not only prices of commodities and stocks but also the state of economies.

In 1990, there was $1.2 trillion in international mobile capital, with $468 billion in syndicated bank loans and $756 billion in stock and bond markets. By 1993, international mobile capital almost tripled to $3 trillion, $555 billion in bank money and $2.3 trillion in stock and bond markets. Currently, international mobile capital has reached a staggering $160 trillion.

Another proof that speculation is the main driver of oil prices?  Have you noticed that the benchmark in oil prices is derived from the prices of future deliveries at NYMEX and ICE Futures and not current ones? Dubai crude may be the regional benchmark but it follows the direction of the NYMEX and ICE Futures.

We just hope that the relief caused by the steep drop in oil prices becomes a reality by resulting in a reduction in pump prices.  The problem is oil companies are quick to the draw in increasing pump prices when prices of oil in the world market go up but are slow and conservative in reducing prices. In fact, domestic pump prices even increased by P1.50 ($0.03 at an exchange rate of $1=P43.75) per liter this week. By the way, it is worth noting that India, Taiwan, Indonesia, and Sri Lanka have been subsidizing fuel prices to cushion the impact of oil price spikes on their citizens but our government is not. Bulatlat

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