Crude Oil rallied to a new intra-day high of $126.98 today, before pulling back to close the session close to $126/barrel. The trigger for the rally was a International Energy Agency
report that the stockpiles of distillates in Europe were down 6.7% in
March over the same time year ago. Last week's EIA's report had shown a
similar reduction in US distillates stockpiles, with a 2.6% year to
year decline. Heating oil, a proxy for distillates, rallied to a new high, with the June contract closing at $3.6989; heating oil prices have doubled over the past year and are up 40% year to date. All the News is Bullish
It
is clear that the market has an incredibly bullish tone after Goldman
Sachs' call for a super-spike which could take oil to as high as
$200/barrel in the next 6-24 months. The market is focusing only on the
good news and ignoring anything bearish.
Today's rally came in spite of news that IEA had again cuts its forecast
for demand for crude-oil (to 1.03 million bpd); the current estimates
for growth of oil demand are more than 50% less than the forecast put
out in July, 2007 (2.2 million bpd). The IEA expects a further
reduction in the forecast as high crude prices, and a slowdown in the
developed economies are likely to cut demand further. There is even
talk of reduced demand projections in the non-OECD oil importing
countries (emerging economies), since the cost of subsidies is
sky-rocketing and can no longer be sustained by their respective
governments.
Even in oil exporting countries, where gas often
sells for less than a $1/gallon, the government is bearing the cost of
lost export revenues at prices which are almost an order of magnitude
higher. Iran, OPEC's second largest oil producer, imports 40% of its gasoline.
Iran & Venezuela: Flag Bearers of the $200 Oil
Another
factor contributing to the rally was a news report which suggested that
Iran was seeking a cut in its crude oil output. This news of impending
cuts was later refuted, though the Iranian spokesman did confirm that
some discussions had taken place.
Earlier this month, Iran's oil minister
had made statements that disruption in Nigeria and the weak US dollar
meant that crude oil could reach $200. Not the one to be left out, Mr.
Chaves of Venezuela had declared that oil would hit $200 if the US
attacked Iran.
Both Iran and Venezuela rely on their oil exports
to fund their local economy; a fall in oil revenues can have a drastic
effect on their ruler's ability to continue to rule.
Goldman's Long Term Projection: $75 in 2012?
Lost
in the bullish talk of $200 oil was Goldman's notes about demand
destruction. The same report which predicted the super-spike also said
that by 2012 the price of crude oil would fall to $75 normalized.
Goldman expects the current euphoria to lead to a spike in crude oil
prices, which will spur new supply development and also lead to
permanent demand destruction.
OPEC has been using volatility in
the oil market as a tool to limit the development of new oil fields.
Volatile oil prices discourage investments in new oil fields if the
cost of extracting the oil is significantly more than the current
fields. Volatility keeps the average price of crude reasonably high,
but the sharp dips in oil price make big investments in more expensive
fields risky.
However, with oil projected to remain close to the
$100 mark, a lot of these undeveloped fields will now become
financially viable. Advances in technology also mean that oil sources
like oil sands, shale oil and deep-sea oil, which were once considered
too risky can now be harvested at a competitive cost.
In this
article I shed some light on how high oil prices are resulting in a
dramatic change in the energy industry and politics. High oil prices
are accelerating the adoption of alternative energy resources and may
signal the emergence of a new kind of peak oil fever: Peak Demand.
Political Rumblings: Congress Acts
The United States Senate today voted to approve a bill which will prevent any new additions to the Strategic Petroleum Reserve until crude-oil falls to $75,
and stays below that level for 90 days at a stretch. The bill passed in
the senate with a 97-1 margin which puts beyond any presidential veto.
Though
the impact of the 70,000 barrels per day which are put into the SPR
everyday is going to be minimal, it signals a shift in the political
landscape where President Bush' significant opposition for any
interference with the SPR is being steam-rolled. The vote comes at just
as President Bush begins a tour of the Middle-East and sends a message
to the oil exporting countries of the region to take his requests to
increase supplies seriously.
The vote is significant because
it signals a shift in oil politics, and may be a harbinger of a
complete overhaul of US energy policy after the Presidential election
is over and the Corn Belt vote becomes less important.
Emerging Economies: Subsidies under Scrutiny
In
the emerging economies of India and China, the cost of oil subsidies is
becoming a significant economic issue. There is a limit to which the
governments can subsidize petroleum products and like the developed
economies higher fuel prices are likely to result in demand destruction
or at least much slower growth than what may be priced in.
In
China subsidies given out to oil companies for imported oil were at
$45B and accounted for 5% of the government's total revenue; they were
as high as $87B if domestic production was also accounted for. The
government of China is reluctant to pass on the increase to keep a lid
on inflation. They also want to ensure that the summer Olympics do not
suffer from any Energy shortages. But once the show is over, expect the
Chinese government to start taking measures to increase the elasticity
in the demand of oil by passing on the price increases.
In
India, the price of gasoline (petrol) is close to what we pay here in
the USA, but the price of distillates like diesel and kerosene is
subsidized. Though it is unlikely that the subsidies on diesel will
disappear, the gasoline and jet-fuel prices are likely to move higher.
New Discoveries and Supplies Coming On Line
A
big contributing factor to the current bloom in the oil complex is the
fear of peak oil production. There is a lot of talk about the gap
between available spare capacity and demand narrowing, with demand
likely to exceed supply soon. A lot of these forecasts tend to discount
the discovery and harnessing of newer oil fields in non-traditional
regions of the world.
Case Study: Brazil Deep Sea Fields
Amid
the oil patch euphoria last week, Brazil's state-owned Petrobras
announced that it will start producing oil from the 8-billion barrel
Tupi oil field in 2009, a year ahead of schedule.
Brazil which is already a leader in ethanol harvested from sugar-cane
(which does not come with the baggage associated with corn based
ethanol) now wants to join OPEC!
The news about the production from the Tupi fields was a pleasant surprise since a lot of the peak oil proponents were very skeptical
of the massive deep-sea finds off the coast of Brazil. The nearby
Carioca oil fields could contain 33 Billion barrel equivalents and
could be the world's third largest oil field.
Case Study: India's Deccan Traps
India's state owned Oil and Natural Gas Corporation [ONGC] reported that it has found oil and gas bellow the Deccan Traps. The Deccan Traps, considered to be 65 million years old,
consist of marine sediments uplifted during the formation of the
Himalayas which were subsequently covered by hard volcanic rock. Most
of the world's oil is found in Mesozoic formations, and geographical
surveys have found sub-trappean Mesozoic-Gondwana sediments with a
maximum thickness of 3 km (2 miles) in this area.
This is the
first time ONGC decided to explore this region which has long been
considered to have huge potential but never explored since it lies
below layers of deep and hard rock. The research paper about this study
is available online. According to the former Indian oil minister, Mani S. Aiyer, this area can have more oil than the Gulf.
Though
it is clear that harvesting deep-sea or Deccan Trap oil is going to be
a lot more expensive than harvesting oil from the deserts of the
Middle-East, at a $100/barrel, these ventures can be commercially
viable.
Alternative Sources
High energy prices are also
driving investment in alternative sources, especially renewable carbon
neutral resources like wind, solar and hydro-electric power. Since most
of the oil consumed in the US goes into transportation, electricity
from renewable sources cannot be pumped in directly into the
transportation network. Though electric cars are also coming they still
have limitation when it comes to range and performance, which limits
their utility.
On the other hand ethanol can easily replace gasoline in cars and will require a less drastic change in our lifestyle.
Ethanol: Getting over Corn
Ethanol
is widely being touted as a renewable fuel which can replace petroleum
when it comes to transportation needs. In the United States ethanol is
being produced using corn as the input. Since corn is starch and needs
to be converted into sugar before being fermented to alcohol, the cost
of producing corn based ethanol is high.
It is estimated that the energy produced
by corn-ethanol is just 1.3 times the energy consumed. In contrast
sugar base ethanol produces 8 times the energy used to produce it. The
use of corn for ethanol has driven up food prices and is being blamed
for inflation.
After the election is over, there is
expectation of big changes in US ethanol policy. It is likely that the
high import-duty on sugar cane based ethanol (54c/gallon) will see its
end, making Brazilian sugar-ethanol a viable alternative in the USA.
The
following table taken from Wikipedia shows how sugar-cane ethanol is a
cost-effective alternative to oil. One important item to note is that
Brazil has 23% of the world's arable land and at least 40% of that land is not being used
and this is without any rain-forests being destroyed. Sugar cane is one
of the most efficient crops when it comes to capturing solar energy and
can be grown in a large part of Brazil and other semi-tropical regions.
| Comparison of key characteristics between
the ethanol industries in the United States and Brazil |
| Characteristic |  Brazil
|  U.S.
| Units/comments |
| Feedstock | Sugar cane | Maize | Main cash crop for ethanol production, the US has less than 2% from other crops. |
| Total ethanol production (2007) [32] | 5,019.2 | 6,498.6 | Million U.S. liquid gallons |
| Total arable land [45] | 355 | 270(1) | Million hectares. |
| Total area used for ethanol crop [45][51] | 3.6 (1%) | 10 (3.7%) | Million hectares (% total arable) |
| Productivity per hectare [45][35][51] | 7,500 | 3,000 | Liters of ethanol per hectare. Brazil is 727 to 870 gal/acre (2006), US is 321 gal/acre (2005/06) |
| Energy balance (input energy productivity) [37][51][73] | 8.3 to 10.2 times | 1.3 to 1.6 times | Ratio of the energy obtained from ethanol to the energy expended in its production |
| Estimated greenhouse gas emission reduction [44][51][74] | 86-90%(2) | 10-30%(2) | % GHGs avoided by using ethanol instead of gasoline, using existing crop land. |
| Ethanol fueling stations in the country[35][36] | 33,000 (100%) | 873 (0,5%) | As % of total fueling gas stations in the country. U.S. has 170,000 (see Inslee, op cit pp. 161) |
Fuel ethanol used by the road transport sector [39][38] | 20%(3) | 3.6% | As % of the sector's total on a volumetric basis for 2006. |
| Cost of production (USD/gallon) [35] | 0.83 | 1.14 | 2006/2007 for Brazil (22¢/liter), 2004 for U.S. (35¢/liter) |
| Government subsidy (in USD) [45][36] |
| 0.51/gallon | U.S. as of 2008-04-30. Brazilian ethanol production is no longer subsidized. |
| Import tariffs (in USD) [37][35] |
| 0.54/gallon |
As of April
2008, Brazil does not import ethanol, the U.S. does
|
|
Notes: (1)
Only contiguous U.S., excludes Alaska. (2) Assuming no land use change. [74] (3) Excluding diesel-powered vehicles, ethanol
consumption in the road sector is more than 40% [35][36]
|
Brew your Fuel @ $1/gallon and Run your own Station!
A Silicon Valley start-up, EFuel100, has come with a washer sized
fermenting machine which you can use to brew your own ethanol using sugar. With
Federal tax breaks and E-Fuel carbon credits, they estimate that you can brew
your own ethanol at about a $1/gallon. Their machine can also take discarded
alcohol and generate ethanol at 10c/gallon! The machine costs less than $7000
after Federal rebates, and if gas continues to be close to $4.00, can pay for
itself over 2300 gallons (or 46,000 miles @2mpg).
The machine comes complete with a 50 ft pipe and a fueling
nozzle which allows you to pump as much ethanol as you would like to use. The
company expects users to blend ethanol into regular gas. For those who want to
kick the gas habit completely, conversions kits are available which can allow
your car to run on 100% ethanol.
click to enlarge
Pre-production prototype (Picture taken from www.efuel100.com)
OPEC: Who is in Control?
In the past decades Saudi Arabia was the leading voice in
OPEC and helped manage supply and demand. With their immense reserves, the
Saudis had the ability to suppress any
dissent when it came to supply increases. Over the past decade, the maverick
regimes of Iran and Venezuela have become vocal powers within OPEC. These
nations' economies are strongly dependent on oil revenue and short term
spikes in oil prices help them strengthen their power. However, this approach
is short-sighted. The oil spike is likely to accelerate the development of
alternative fuel technologies, energize efforts to develop new fields, and
eventually result in a peak in the demand for oil; especially exported oil.
Iran has run out of storage capacity and is hiring tanker
ships to store oil
off-shore. They cannot find buyers for their crude production at the
current price, and the rental rates for oil-tankers is spiking. Perhaps this is
a sign of things to come which other OPEC members should pay heed to.
Disclosure: Author holds equity, equity options and
futures positions (both long/short) in oil and energy related industries.
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