Archives for October 2009

The “Black Eagle” and the Price of Oil.

By chutay | 10/28/2009 | 1:24 PM

In the last blog I forecasted that oil prices would be in the $65-$75 range until mid- 2010 and end the year in the $80-$90 range. When I wrote that forecast on October 1, oil was trading at around $65 a barrel. Less than a month later, oil topped $81 a barrel, already in the range  predicted for the latter half of 2010. What happened? Did I miss something?

Many would say I am missing the imminent crash of the U.S. dollar or a "Black Eagle". According to the Chicago Mercantile Exchange, October aggregate bets against the dollar rose to the highest levels since July 2008.

Oil is traded globally in dollars and the fate of the dollar is a major factor in the price of oil and consequently the price of transportation. Generally, as the dollar declines, oil prices increase.

The International Monetary Fund estimates that in the long term a 1 per cent depreciation of the dollar correlates to gains of more than 1 per cent for oil. Hypothetically, if the dollar suddenly dropped 25%, oil would surge over $100 a barrel.

There is no oil supply/demand reason for a 25% increase in oil prices in one month. There is plenty of oil in the world right now. The proximate cause of this increase is this extreme negativity about the dollar and speculation it will soon crash and push oil prices much higher.

Granted, it is hard to imagine a happy future for the dollar. Debt, bailouts, deficits, unemployment, bankruptcies and money printing lead eventually to currency depreciation or taking the painful cures of fiscal and monetary discipline.

The Fed views deflation, not inflation as the most immediate danger. Currency depreciation is a powerful and proven way to stimulate the economy out of a liquidity trap e.g. pays the debt off with cheaper currency in the future and makes U.S. exports more competitive.

The U.S. government and citizenry have a low tolerance for the painful, but more effective long term cures. So currency depreciation is the unofficial and unspoken policy of the U.S. Government and the Federal Reserve. It is a risky, but so far successful.

The last time there was this much pessimism about the dollar was right before the world economy began to crash in 2008. In that panic, a "Black Swan" not a "Black Eagle" showed up and the dollar's value jumped 20 per cent between July 2008 and March 2009.

When the world panicked, investors rushed back into the currency of the country with the richest stable democracy and strongest military. They did not demand Rubles, Reals, Renminbi, Rupees or even Euros. They demanded the perceived safety of the dollar. As confidence and risk taking have returned, this has reversed and the dollar is back down to pre-crash levels.

In my opinion, the rumors of the dollar's imminent death are much exaggerated. This perceived "safety", warranted or not, will not change quickly. Asians and the Persian Gulf States will continue to subsidize U.S. debt and growth to maintain their export markets and military protection.

Most recognize that relying on the U.S. and the dollar to ensure global stability is in the long term best interest of no one including the U.S. However, this precarious "balance of terror" of economic mutually assured destruction will continue for now because there is nothing readily available to replace the dollar.

My oil price forecast assumed no sharp declines in the dollar. In fact, I see a strengthening of the dollar through early 2010 which will lower oil prices back to $65 to $75 range. The world economy is not out of danger and the slightest signs that the nascent recovery is faltering will send the dollar higher as investors again seek safety.

The real crisis for the  dollar will come as world petroleum production falters and demand outstrips supply. This will be the topic of my next report.

2010 Oil Price Forecast

By chutay | 10/01/2009 | 10:23 AM

Forecasting is hazardous. Just ask Michael Lynch, whose New York Times Op-Ed, "'Peak Oil' Is a Waste of Energy.” was discussed previously. Lynch is an economist with a background in political science and the former director for Asian energy and security at the Center for International Studies at MIT. He is currently an energy consultant.

In April 2004, oil was around $37 a barrel. Lynch predicted a fall to $25 by summer. By mid-August, it was $47. Undaunted, Lynch wrote in September 2004 that by September 2005, the price would be under $30. In September 2005, it hit $67.

In March 2006, with oil at $62 a barrel, he forecast a drop back to the $30 - $40 range before year end where it would remain for at least the next two decades. Instead, oil climbed as high as $76  before finishing 2006 at $61.

In April 2007, Lynch predicted a gradually drop from the current $65 a barrel to the mid-to-low $40's in 2008. It climbed steadily to $147.

He did get short-term vindication when the price hit the mid-$30’s as the world economy ground to a halt in the last quarter of 2008. Now with prices back around $70, he confidently predicts $30 again soon.

My price forecasting history is not as documented, but I always tell audiences that the only thing that will cause a significant downward impact on oil prices is severe and sustained worldwide recession, depression or general economic collapse. My long standing and continuing message is that oil prices are heading inexorably higher with occasional wild price swings as the world attempts to adjust to a growing supply/demand imbalance and the end of the Oil Age.

I do admire Lynch for putting his predictions out there for everyone to see – wrong as they are. Since now is budgeting season for supply chains, I want to do the same. So here is my forecast for the price of oil in 2010.

There are many issues that impact the price of oil, but the two biggest are, as always, supply and demand. Since 2005 world oil supply has been on a plateau of 83 to 87 million barrels per day. The 87 million barrels per day recorded in July 2008 was the highest production ever and the price also hit the all time peak of $147 in the same month.

In July 2008, every oilfield in the world that could produce was producing. Some estimated that the Saudi’s had about one million barrels per day in spare capacity, but that was it. This means that with all out production and the Saudi spare capacity, the world was capable of producing 88 million barrels per day in mid – 2008.

New production in 2009 plus oil flow projected to come on line in 2010 will be slightly less than the estimated 5% depletion in currently producing fields. This then leaves world production capacity through 2010 at 88 million barrels per day.

The financial crisis caused ‘demand destruction', but not as much you might think considering the severity of the meltdown.  Barclays Capital Weekly Oil Review showed 2008 demand at 85.5 million barrels per day down only 500,000 barrels a day from 86 million barrels per day in 2007. The Department of Energy (DOE) estimates world oil demand bottomed at 83 million barrels per day in the first quarter of 2009.

This month DOE reported that United States oil demand is starting to pick up. Also this month, the International Energy Agency predicted an increase in oil consumption by mainly emerging economies of 1.4 million barrels a day increasing projected demand in 2010 to 85 million barrels a day.

Assuming demand in 2010 will reach 85 million barrels per day and potential supply is 88 million barrels per day, the oil market should be well supplied through mid – 2010. Using these assumptions my prediction through mid – 2010 is that oil pricing will remain under OPEC (read Saudi) control in the $65 - $75 a barrel range.

Toward mid - 2010 the picture gets hazy. One can make a case either way on the shape of a global economic recovery. U, L, or W are all possible.  If recent nascent growth turns out to be government sponsored bubbles, then it is unlikely oil demand will increase in 2010 and could fall again.

In this scenario, prices weaken and possibly bring Lynch’s $30 prediction closer to reality. Too bad he is only right if the world economy grinds to a halt. Certainly the world still has a backlog of economic problems, but I don’t see the recovery faltering and oil prices falling for two main reasons.

First, governments around the world will not just stand by; they will stimulate again if needed. Second, the 83% of the world’s population that are just starting up the prosperity ladder have the resources, intelligence and drive to continuing climbing.

These 83% only use 44% of the world’s energy, while the 17% in the developed economies use 56%. They want a life like we have and their energy appetite will only grow. E.g. China is now the world largest auto market.

In my forecast, the second half of 2010 will see continued economic upside led by the emerging countries – Brazil, China, India, Russia and the Middle East – with further stimulus from the developing countries if the recovery falters.

I forecast that oil prices will reflect the demand pickup and steadily increase from the $65-$75 level early in the year and end the year in the $80-$90 range. The average price for the year will be around $80 a barrel.

This assumes no “Black Swan” event e.g.: war in the Middle East; revolution or civil war in a major oil producing country;  excess capacity is over estimated; a successful terrorist attack on a key oil processing facility or transport choke point; collapse of a significant oil field; etc.  Any event like this makes forecasting irrelevant until the situation passes.

In summary, the economic meltdown has bought some time, but we confront a paradox and a cycle that will be repeated until the transition from the Oil Age is well along.

Rising oil prices will signal a return to growth and increased demand. However, depletion of existing fields, like rust, never sleeps and finding and bringing enough new supply to meet increased demand and avoid prices climbing into economy-damaging territory is highly unlikely especially after 2011.

Eighty dollars a barrel is not economy crushing. It gives companies time to begin the serious supply chain changes needed before the next oil crisis arrives.

I have developed a Peak Oil Checklist as a guide for preparing supply chains for the “Inevitable Surprise” of Peak Oil.  If you would like a copy, let me know.

The opinions expressed herein are those solely of the participants, and do not necessarily represent the views of Agile Business Media, LLC., its properties or its employees.

About Chuck Taylor

Chuck Taylor

Chuck Taylor has held senior management positions with Nabisco Brands, Ryder System Inc., Burlington Northern/Santa Fe Railroad, Mercer Management Consultants, Tri Valley Growers, American National Can, ServiceCraft Logistics, and Norbridge Inc. and recently founded an organization called Awake! He founded Awake! out of concern the supply chain profession is not informed about the critical changes facing it with the end of cheap oil. One goal is to raise awareness so supply chain professionals will understand the stakes and take an active role in shaping energy policy.

Video: Chuck Taylor talks about the impact of oil prices on the supply chain.


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