Fusion: National Ignition Facility

The US$3.5billion US National Ignition Facility (NIF) in California was dedicated last Friday (May 29, 2009). NIF researchers will use the world's strongest lasers to study nuclear fusion.

“If fusion energy works,” he said, “you’ll have, for all intents and purposes, a limitless supply of carbon-free energy that’s not geopolitically sensitive. What more would you want? It’s a game changer.” (NYTimes/Ed Moses)

Storms on the Horizon

Hurricane Season begins on June 1 and lasts until November 30. The peak is generally in the first week of Semptember. A large portion of US oil and gas production, refining, storage and importing facilities are located along the US Gulf Coast where many hurricanes and tropical storms pass through. Seasonality of all types is described in Oil 101.

Floating Storage Barrel Count

As expected today, OPEC members decided not to change output and crude oil (NYMEX WTI) hit a new high for the year of $65.44.

Some have said that equity market sentiment, dollar weakness or speculation have caused the recent run up in oil prices.

The relationship between equity markets and oil markets is mostly coincidental rather than there being a causal relationship (wealth effect of equity price movements may have a little causal effect). Equity market sentiment is driven by consumer and other demand-side activities which also impact oil demand.

Dollar weakness is a legitimate factor that can move oil prices in dollar terms. However this effect has been given too much credit for recent oil price moves (more on oil and dollar movement in a coming post).

Blaming speculators for oil price movements has become the most common face saving way of saying "I don't know." Speculation has been proven to have minimal impact on oil prices but is essential in generating liquidity and reducing transaction costs (bid/offer spreads) which reduces prices for consumers.

The main reason for the rally in oil prices has been quite simple. Oil is driven by fundamental physical supply and demand. Currently physical demand is greater than physical supply globally. Above ground oil inventories are no longer increasing and are beginning to fall. Now that we are coming close to the end of the weakest seasonal period for oil demand (second quarter of each year) we should see this oil inventory destocking pace rapidly increase.

Following is a chart of oil stored on floating tankers around the world. Floating storage is a leading indicator in the oil world as it is the most expensive place to store oil and the first to react to changes in fundamentals.

Floating storage beginning to empty is evidence that OPEC members' actions are having their desired effect. Storing oil on floating tankers is described in both the storage chapter and the transporting oil chapter of Oil 101.

[ Update June 7, 2009: A week after my analysis above showing crude floating storage declining a number of articles (DJN and Bloomberg for example) appeared confirming the analysis. ]

OPEC Meeting

OPEC oil ministers are meeting in Vienna tomorrow (Thursday May 28, 2009). Ahead of the meeting the Wall Street Journal quoted me:

"OPEC won't cut output as long as crude remains above $60 a barrel, said Morgan Downey...."They've taken more oil off the market than demand has fallen," he said. "It's just a matter of time before we see higher prices."

Repeal or Amend the US Gas Guzzler Tax

The US gas guzzler tax was created in the Energy Tax Act of 1978 and designed to discourage the purchase of inefficient vehicles. It had precisely the opposite effect.

The tax is paid by a vehicle buyer at the point of purchase. The tax is posted on the same window sticker as the EPA MPG rating at a new vehicle dealership. The gas guzzler tax only applies to cars. As SUVs and light trucks are not affected, the tax has created a major incentive since 1978 to purchase heavy vehicles. Light truck and SUV sales have gone from around 20% of total non-commercial vehicles sold in the US in 1978 to around 50% today (other factors have also played a part, but these have not been government related).

Gas guzzler taxes apply to cars that get less than 22.5MPG, with taxes beginning at $1,000 and increasing to $7,700 for cars which get 12.5MPG or less.

Want to immediately improve the incentive to become more efficient?  Amend the gas guzzler tax to eliminate the exemption for non-commercial light trucks and SUVs or repeal the law entirely and replace with a novel solution like a Vehicle Efficiency Market.

(Oil market environmental regulations are described in Oil 101)

Let the Dog Days of Summer Begin

A pal of mine

US Memorial Day, which is the last Monday of May each year (next Monday, May 25 this year), is the start of US summer driving season. School's out, the weather is good and everyone takes their vacation. With gasoline ($2.30/gal) a lot less expensive than this time last year ($3.20/gal), driving is expected to be higher than last year. Seasonality of all types is discussed in Oil 101.

(Source: DOT and Oil 101 Page 285 Fig 13-2)

US Inefficiency Standard

Need to start thinking outside the box

The US Administration announced today that by 2016 US vehicle efficiency is to be raised to 39mpg for cars and 30mpg for light trucks/SUVs. These new efficiency levels will keep US motorists at least twenty years behind Europe in terms of automotive efficiency. Today's announcement (my emphasis in red):

"...simply allows the United States to match today’s European fleet efficiency (vehicles on the road now) some time after 2030." (NY Times/Lee Schipper)

US car buyers rather than the government need to create demand for ultra-efficient vehicles. A market solution which pushes efficiency aggressively and operates independent of oil price cycles is the vehicle efficiency market. A vehicle efficiency market is fully compatible with the goal of today's announcement - greater efficiency. However, a vehicle efficiency market uses a carrot rather than a stick.

Oil versus...well, almost everything

Knowledge of physical oil supply, demand and inventories is essential to understanding oil values and price formation. However, oil markets do not operate in isolation. General economic conditions and market sentiment link all markets. The skill is determining why cross-market links are occasionally strong and anticipating when markets should decouple. It is also important to not put too much value on random coincidence of price movements in what may otherwise be unrelated markets.

To show the temporary nature of inter-market links, let's take a look at two markets which sometimes move similarly to oil. Let's look first at oil (NYMEX WTI) versus the stock market (US S&P500) over the past twenty years.


Now, let's take a look at crude oil (NYMEX WTI) compared to gold over the past twenty years.

Drilling Crew

What do a derrick man, tool pusher, roustabout, roughneck, driller and company man do?

If you are having a difficult time remembering what the various oil rig hands do (described in Oil 101, Chapter 6: Exploration and Production), then perhaps the following song will help:

Whale Hello There

What is the probability of capturing a whale on video swimming by an oil well? The following video shows a sperm whale checking out a subsea oil well off Norway. It is not too rare to see whales at subsea completions (see another video here).

Big Whale

Historical touchstones can humble us by marking how far we have come in such a short period of time. What now seems obvious was quite recently not so.

The following table from the New York Times of January 8, 1862 shows the number of North Pacific whaling ships and barrels of whale oil taken. You can see the pattern of more scarce whales.

(source: The New York Times, Jan 8, 1862. Click excerpt for full article)

In the same article there is a table describing the relatively steady climb of whale oil prices until the birth of the modern petroleum industry in 1859. Increasing whale oil prices were the primary drivers in the search for a new alternative lower cost lamp oil.

As you will know from Oil 101, petroleum had been used almost exclusively as a lamp oil from 1859 until the early 1900s. The following letter to the New York Times of February 8, 1891 shows that although widely used for lighting, the use of petroleum for transportation had been considered early in the history of the modern oil industry. The US government "pronounced it a failure". In the 16 years following the letter below there were mass produced automobiles and the first powered aircraft.

(source: The New York Times, Feb 8, 1891. Click excerpt for full article)

IEA to Oil Market: Gotcha!

Two days ago the head of the IEA mentioned that the IEA would not be reducing its 2009 global oil demand forecast.

Today the IEA reduced its 2009 global oil demand forecast.

Lonely bulls

On oil prices reaching $60/bbl today it is a time for reflection. The rally from the low of $32.40 on December 29, 2008 has had a lot of detractors. Now that we have almost reached the Saudi's 2009 budget balancing price level of $60, higher prices may face stiffer winds. (My photo above later become the FT Energy Source Blog "Image of the week". Thanks, Kate Mackenzie).

US DOE Ends its Hydrogen Vehicle Research

(above: Governor Schwarzenegger and his hydrogen-powered Hummer)

The US DOE is halting research on hydrogen fuel cells for cars. Honda, GM and Toyota have announced that despite the government decision they will continue development of hydrogen vehicles. Honda announced it may shift its efforts more toward batteries and plug in hybrids. (Hydrogen as a transport fuel is discussed in Oil 101).

Twist in the US Ethanol Saga

Widespread use of ethanol (an alcohol produced mostly from corn in the US) in gasoline is relatively new to the US. Legislation in the US (EPACT-2005 and EISA-2007) mandates minimum gallon amounts of ethanol to be added to US gasoline. The amount of gallons mandated increases each year.

Most gasoline in the US now contains some ethanol. If you live in the US and look closely at a gasoline pump you will likely see a little notice saying "contains up to 10% ethanol". 10% ethanol and 90% petroleum gasoline is the blend level at which most modern gasoline powered vehicles require no modification (check your vehicle owner's manual).

The minimum mandated gallons of ethanol to be added to gasoline was not a blending percentage issue until US motorists began to buy less gasoline in the recession of 2008 (annual declines in oil consumption are quite rare - the last major declines occurred in the early 1980s). Now gasoline blenders have minimum gallons of ethanol to add to gasoline, but because of the recession these minima may require blending up to 15% ethanol into gasoline.

You may not care about ethanol blend percentages, but you should as the guys who made your car and gas stations are worried.

Automobile manufacturers are expressing concern that their vehicles may not be able to cope with greater than 10% ethanol in gasoline. Retail station owners are also objecting to the higher blend percentages which could damage storage and pump systems.

The US EPA is investigating how to handle the issue and a ruling is expected later this year. The law is clear and so the EPA has to somehow finesse the ethanol into gasoline or hope for a swift recovery and growth in US gasoline demand.

(Note that ethanol is not widely used as a gasoline additive outside the US and Brazil. Oil 101 describes ethanol in detail)

Great Wall, Currency Fall

People I met in China (the final country on my Asian tour) earlier this week are optimistic about growth. Chinese stores are bustling and general economic activity appears to be quite healthy. The Chinese have turned bearish on the US dollar and have slowed their purchasing of dollar assets such as US Government Treasury and Agency debt, as well as US equities and corporate debt. This is bullish for oil in dollar terms and a reason for recent strength in oil prices (in addition to the global physical oil market beginning to tighten and a recovery in equity markets).

The chart above shows the fall in the purchasing power of the US dollar since the 1920s. A chart of most other paper currencies would show a similar if not greater declines. As Anatole Kaletsky says in an interesting article in today's Times:

"The currency game is not a beauty contest but an ugly contest, in which investors must choose the currency that is least ugly."

Oil is a currency itself, a hard currency floating stronger against these more ugly paper currencies.

Transport Observations in Asia

Singapore: Yesterday in Singapore I had an interesting chat with a taxi driver. His taxi runs primarily on CNG (compressed natural gas) but it is bi-fuel in that it can run on gasoline also. The driver said that his main beef with CNG is that the city currently only has 3 public refueling stations. The CNG stations are all located in the west of the city and service hundreds of CNG taxis. Refueling with CNG in Singapore can currently take up to 30 minutes if you are unfortunate enough to run into one of the occasional 25 minute waits in line at a station. A fourth refueling station is being built to meet growing demand.

The vast majority of Singaporean taxis run on regular gasoline and not CNG. CNG was introduced to a portion of the Singaporean cab fleet within the past five years. The driver mentioned that the slightly slower acceleration of a CNG vehicle compared to a gasoline vehicle didn't bother him much. Cruising on highways he observes no discernible performance difference. He said that during the oil price increase in 2008, the cost of CNG was lower than that of gasoline, but that now that oil is $50 per barrel he doesn't think there is much of fuel cost difference.

Oil 101 outlines why CNG is suitable for city taxi and mass transit fleets but is not practical to use as a fuel outside of urban areas. The Singaporean experience shows that CNG service station roll outs can be a challenge even for ultra-well managed urban areas.

Vietnam: I am in the scooter capital of the world today: Ho Chi Minh City (Saigon), Vietnam. Cars are second class vehicles here and I don't see many push bicycles (which is a big change from 10 years ago). I ride a scooter and motorcycle in New York and am familiar with the benefits and hurdles such vehicles face in a city. Scooter owners in Vietnam drive aggressively. You can tell they are used to ruling the road over cars. There is a lot of scooter-pooling. By my estimation over half of the scooters here carry two passengers. It is the rainy season in Vietnam but that doesn't deter scootering. Drivers and passengers sport a vast assortment of ponchos. Beer delivery even takes place, somewhat precariously, on scooters (see the video below I took earlier today).

Vietnam is a still a net oil exporter with very low but rapidly growing per capita oil consumption (approx. 1.5 barrels per person per year compared with around 24 in the US). There is no sense of anyone in Vietnam cutting back on oil consumption as a result of high oil prices and from the level of economic activity here (5%+ yr/yr growth is generally expected in 2009) one doesn't feel we are in the midst of a global recession.

(above: video I took in Ho Chi Minh City, Vietnam this morning)