Very clearly, the financial and mass media finds it is not ‘politically correct’ to explain high oil prices as due to oil simply depleting and running out. 

It is still preferable to cite storms, technical problems, refinery accidents, pipeline blowouts, the weak US dollar, rebellion and wars in Nigeria, Chad and Sudan, the Iraq war, al Qaida, Vladimir Putin and the ‘anti western Kremlin’ now menacing pipeline routes in Georgia, the Kazakhs or Chavez of Venezuela applying ‘resource nationalism’ to oil reserves and production plants, and demanding higher taxes and shares of profits. We also have the energy wasteful Chinese importing too much oil to make and throw away 3 Bn plastic bags per day, and produce and export a plethora of oil and energy-intense, but still cheap industrial goods to fill supermarket shelves in the “postindustrial” consumer societies of the OECD. The Indians and other Emerging Economies do the same. Very hot weather in summer or very cold weather in winter, climate change, and why not earthquakes (?) can also be used to lever up daily traded oil on the Nymex, ICE London and Singapore, or Dubai exchanges.

But the bottom line is simple: anything will do so long as no mention of Peak Oil is made !

It is however politically OK, and also profitable for the “finance community” when traders engineer a V-shaped blip in the generally upward price trend, to cite and forecast generally declining or shrinking crude oil and product inventories in the US, and elsewhere right across the globe as an explanation of why oil prices are generally high and set to stay that way. Whenever inventories rise, which is rare, and with the right media treatment, the trading community can have a “24-hour miracle” of falling oil and product prices. Soon after, to be sure, the price growth track returns. 

Due to Petro Civilization and the no alternative Global Economy, to be very sure, any serious fall in oil burning will be bad news for regular equities perfomance – dealing a heavy blow to general or composite index numbers. Too much decline of oil consumption is not welcome news to guardians of stock exchange-linked pension funds that really do have an obligation to perform, or in a general sense to all financial market operators. Just a little compression of oil demand growth, every so often, frothily moving prices around, delivers nice short selling and bargain hunting opportunities during the V-shaped blip. Business as usual..

The only missing link in this cozy situation is that oil, and natural gas quite soon, really are depleting resources. When markets are structurally undersupplied, as the world oil market likely is already, prices have to reach extreme exotic highs before anything (usually bad) happens.

Why are Stocks Falling ?

The most basic reason for declining stocks is Peak Oil, but the explanation takes a little time, and of course effort for the reader. The oil stocks picture, as already mentioned, is a key ‘proxy’ for Peak Oil, and is also respectable. We are forced to use OECD country crude oil and petroleum product stock data, for one reason because we have relatively reliable, not extremely manipulated data on these stocks, noting the qualifiers ‘relatively’ and ‘not extremely’. For many nonOECD importer countries, where stocks are often extreme low (eg about 10 days consumption), reliable or unmanipulated data is hard to come by. China has been making efforts both to increase oil stocks, and the reliability of its unreliable data. In other countries, oil stocks still remain state secrets.

For the OECD as a group and for nearly each individual country, stocks tells the same story. 

Demand Side Delirium

The above charts already give reasons for being quite sure world oil demand growth is still alive and well, if perhaps menaced sometime soon. Motor gasoline and RFO-residual fuel oil stocks have a lot of lead in their wings – probably meaning demand is strong, or very strong. Gasoline is what fuels the approximately 70 million new passenger cars the world car industry produces each year – with output rising around 6.5% in 2007. The few thousand non-oil and non-LPG (liquid petroleum gas) Green Cars produced, of course do not need gasoline, just the other 69.5 million new cars, renewing and increasing the world car fleet of around 850 million units, 98% oil fuelled and growing at about 55 million-per-year after scrapping of used cars. World production of heavy and midweight trucks, buses, tractors, combine harvesters, bulldozers, scrapers, diggers and mobile cranes, and about 27.5 million new motorcycles and scooters, per year, also takes quite a bit of diesel fuel and gasoline. Currently, there is no shortage of gasoline demand – supply and stocks are a different story.

RFO is the heaviest and dirtiest, highest sulfur and heavy metals-containing fuel used in industry, marine heavy cargo transport and electric power generation. It is also the oil fuel delivering the most Megajoules per dollar. Unsurprisingly, demand for RFO is growing very fast in China and India, and is more than comfortable in ‘pollution conscious’ and ‘climate change concerned’ OECD countries, too. Anybody talking about recession should first check RFO demand trends for the country or economy they discuss.

This is what we can call “buoyant demand” and one big reason we are getting to Peak Oil, faster. In other words oil demand is tight-linked to growing output of key consumer and industrial equipment. Talk about another kind of decoupling, not Emerging Economy decoupling but de-linkage of oil from economic growth may be fine, but the real world-real economy features very strong growth of the world transport fleet – road, off-road, rail, air and marine. It is no surprise at all that global economic growth at ‘vintage’ rates of around 5%pa since 2005 drives growing demand. The surprise is to deny this. The surprise continues with the energy agency guardians of oil supply data and energy policy for the most oil-intense and oil-wasteful country in the OECD, and for the OECD group as a whole, the USA’s EIA and the OECD IEA, go on to claim this ‘buoyant’ world oil demand is almost zero, or at least weakening, constantly. The paradigm offered by these two agencies is: global demand growth is both low, and falling.

It is easy to understand why the EIA and IEA persist with this argument: if world oil demand growth really was low, and really was falling from that already low level, oil prices should ‘moderate’ and bear some resemblance to the luridly unreal “price scenarios” both of these agencies occasionally publish.

Both the EIA and IEA have, through 2006-2007, published “price scenarios” for the 2020-2025 period, sometimes beyond, where the oil price in nominal dollars, not ‘backtracked’ for inflation and purchasing power, is never above 50 to 55 US dollars per barrel.

Quite often the fantasy price number, a sort-of “wish list” price no doubt, is given with amazing precision to the nearest cent, for the year average price in 2025 or beyond. Perhaps these agencies know something we don’t about US dollar appreciation, and inflation, from now to 2022 or 2032 ? In any case, the one way to achieve such “moderation” for oil prices of around 20 years forward, is to achieve extreme demand moderation. If not in the real world then at least on paper.

The real growth rate of world oil demand is likely close to 2% pa, or about 1.7 Mbd in 2007-2008 but growth of net production capacity (after coverage of annual depletion losses) is now very close to zero. The basic reason, on the supply side, is Peak Oil.

Extreme Low Rates of Demand Growth

Like the 5 international energy majors, formerly called the 7 Sisters and formerly the world’s biggest oil producers, the EIA and IEA stubbornly predict that world oil demand is growing at ever-slower rates. Each year the music is the same. In early 2008, BP’s Chief Economist went a little further with this delirium, saying that BP now believes in Peak Oil of a Special Kind: world oil demand growth will soon fall to zero, then become negative, and stay negative because there is so little demand side pressure or economic need for oil. In this fantasy view, oil is now priced out of world energy “but we didn’t know it”. Price elasticity is alive and well, and waiting to act, as global car drivers switch to peanut oil biodiesel or hooch whisky-type ethanol fuel, because it is so cheap compared to oil ! 

For the present however, this price elasticity is a little slow-acting and we still have some ‘residual’ demand growth in the pipeline, refinery and filling station - and elsewhere too, for example producing 3 Bn ‘recyclable’ plastic bags every day in China. World oil demand forecasts from the EIA, IEA and most of the 5 oil majors are luridly moderate. For 2008, forecasts in late 2007 were around 1.6 or 1.7 Mbd growth on a daily average for world oil demand in 2008 of about 87.5 or 88 Mbd, this number also being somewhat flexible and “subject to revision”, downward of course.

By the end of Dec 2007, as oil prices seriously threatened the 3-digit “ceiling” in dollars-per-barrel, then broke it in Jan 2008, the agencies and oil majors vyed with each other to see who could slash most – forecasts were revised down to about 1.4 or 1.5 Mbd growth. Later on, as we move forward in the year, with 120 USD/bbl being threatened quite seriously, most forecasts are now well below 1.3 Mbd growth. The most recent from the OECD IEA is now cut back to an extreme modest 1.1 or 1.2 Mbd growth for calendar year 2008.

We can note the agencies may get lucky this year – if there is a very hard landing to the world economy, slashing air travel, world container and bulk cargo shipping, and world car production to zero growth or worse. Rates of growth for the key oil-intensive transport industries, in 2007, were in the 6% to 10% (for shipping) ballpark. To seriously cut oil demand growth in 2008 we first have to install a fast-acting and savage cut in activity of three industries that are the lynchpins of the Globalising Economy. Maintaining severe global economic recession is then needed if we seriously want to cut oil demand

Doing this needs global economic recession at least equal to the 1980-1983 recession, with cuts in activity and employment at the entry to the recession, in 1980-1981, of up to 15%pa in many industries, and later on the simple disappearance of those industries. To be sure, other solutions are theoretically possible. World leaders might or could, theoretically, come to their senses, note that Kyoto Treaty effort is having precious little impact on the world energy mix – is not shifting energy demand away from the fossil fuels – and set up an International Energy Transition Plan. We can dream.

Today, subprime or not, we are a long way from intense and global economic recession. Nothing is impossible, however. Due to rocketing inflation and a now very fragile world banking, credit and finance system, plus extreme and unreal currency valuations symbolized by the Euro at close to, or above 1.60 USD, scenarios for a crash landing are less unreal than previous. The role and staying power of “Asian and Emerging Economy decoupling” will be one of the key deciders whether or not the world economy has a very hard landing.

The Decoupling Dream

Usually talked about in terms of Asian and Emerging Economy decoupling, from US and European recession and supposedly acting as some kind of ‘bulwark’ for the global economy, limiting any fall in global growth through the sheer exuberance of nonOECD growth trends, the oil handle to decoupling is clear and evident. As oil prices have soared through the “100 dollar barrier”, that traders betted for and against as recently as Dec 2007, switching of crude oil and petroleum products cargoes to Asian buyers at the last moment – because they pay more – is now well installed as yet another, Peak Oil related, oil price driver. This process will surely decline to zero if decoupling disappears, but this oil-only decoupling is unlikely to happen. Financial and economic decoupling, however, is heavily menaced and can fall apart, to zero, anytime soon. 

Why the possible decline of economic but not oil decoupling ? In major part this is due to cumulative energy economic and historical economic trends. The emerging economies, specially China and India, have an awful lot of of lost ground to make up in oil and natural gas consumption intensity, relative to the OECD countries. In 2007, average per capita oil demand in China and India was around 2.5 and 1.3 barrels/capita; in the OECD countries it was above 10. With natural gas demand the gap was even bigger: both of the ‘Asian economic superpowers’ used less than 0.6 barrels equivalent per capita in 2007. In the OECD countries the average is above 6.5 barrels equivalent/capita/year, in the USA about 12.8, and in Holland about 18 barrels equiv natural gas/capita/year..China and India have a lot of ground to catch up. Bringing in the major and perhaps untreatable problems faced by their very strained coal mining and supply systems, the ‘Asian economic superpowers’ are condemned to go on raising their oil and natural gas import demand, even if their economic growth declines and they seek more autonomous or self-dependent economic development in the event of a sharp fall in exports growth.

Decoupling as presented almost daily in the US and international finance media, in 2007, was a fragile mix-and-match of hopes and dreams for a rigorous continuation and prolongation of 2007 global economic trends. FX reserves of the emerging economies would of course only grow, and almost as certainly their sov nat wealth or national investment entities guarding the FX piles would do the nice thing and massively buy into Citigroup, Merrill Lynch and why not Bear Stearns, Northern Rock or Societe Generale ? Large parts of this wish list are now completely unreal or at best unlikely, but oil decoupling may be a lot more resilient than many like to imagine. 

Another reason for a negative outlook on ‘sharp falling oil demand growth’, even if or when global economic and trade growth falls out of bed, is the very fast-growing Indian, Chinese, Russian and East European segment of the world car and land transport industry. This industry, in particular, can ‘go local’ quite fast and easily, and as yet is little dependent on export sales. Oil dependence, contrarywise, is almost total and perfect. Other oil-intensive and oil-dependent industries likely to grow fast, or even faster than present in the Emerging Economies, and well-insulated from the global economy, is agricultural and construction equipment, including tractors, harvesters, dozers, scrapers and cranes. In the case of agricultural and food production-driven oil demand, this sector is now a national priority for the ‘Asian economic superpowers’, confronted by runaway food price inflation, in part due to ‘benign neglect’ of domestic agriculture.

200-dollar Oil?

If 200-dollar oil arrives it will likely be quick rather than slow. Through Q3 or later in Q4 2008 world recession, driven by a host of convergent factors now at play, may well be acting. The recession could be a lot deeper than many predict, and feature heavy coupling of recession trends for world trade and exports from the ‘Asian economic superpowers’ but continued oil-decoupling or little weakness of import demand growth in nonOECD countries. OECD oil demand will fall. Since oil imports by the OECD countries is still well above 65% of world import demand, this will relieve supply-side pressure, allowing oil prices to fall, but not crash. We can have a deep economic recession, in the OECD countries, but only a shallow recession for oil demand and oil prices.
Before that, the combination and convergence of all current trends, and the current extreme under-appreciation of geopolitical risk, can at any time propel oil prices to those exotic realms beyond 150 USD/barrel.

This will be hard not to interpret as a warning of ‘Things to Come’. When the global economy pulls out of recession, even if it takes 2 or 3 years, the Peak Oil crisis will not go away or be pushed out to the Further Realms of 3 or 5 years down the line. Anytime world oil demand grows, the menace and then reality of 150-dollar oil can return. Before that time, maybe in Summer 2008, we can have a preview of that ET world where oil costs 200 USD-per-barrel.

Copyright Andrew McKillop for Vertus Sustineo, Apr 2008

© 2008 Andrew McKillop
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