Brazilian Exceptionalism

Brazil is exceptional with its beautiful beaches, vast lush land mass and optimism (sounds like the US). I am currently in the center of the scaled biofuels world and it literally smells sweet - at least for Brazil. That sweet smell is alcohol in the air. The alcohol (ethanol) is being derived from sugar cane which rich rainforest cleared land and climate permits. Ethanol produced from sugar cane is used as a fuel for vehicles here on a scale no other country has ever been capable. No other country can replicate Brazil's unique cleared rainforest climate and soils.

Brazil has also recently discovered a lot of relatively high cost conventional hydrocarbons a ways offshore - although this oil is at least five to ten years away from production.

Brazil is an exception in so many way that one wonders if it should be used as an example. I will be posting some observations over the next few days. The first is how well the economy appears to be doing here. Factories are producing, office workers are optimistic, restaurants and stores are busy, the woes of debt laden developed nations and consumers are far from consideration. Demand is good for everything Brazilian.

Financial Times and Floating Storage

I was quoted in a Financial Times story today on floating storage barrels coming ashore being an oil price lid for the moment: 

“The contango has come down,” said Morgan Downey.....“There’s no incentive to keep it offshore any more.” (Financial Times)

Increasing Diversity of Transportation Fuels

As you will know from Oil 101, natural gas has been finding an increased use as an alternative to oil as a transportation fuel in a particular niche: natural gas is particularly suited to urban bus and trucking fleets as vehicles can be refuelled at the same spot each day and the distances vehicles can travel on a single refuelling is slightly more limited than with diesel.

Until relatively recently compressed natural gas (CNG) had been used mostly for buses and other urban people carriers.  Now that natural gas fundamentals have changed such that natural gas prices are extremely low relative to oil, it makes not just environmental sense, but has also become economically sound for private businesses to convert.

An interesting and well researched story today by Brian Baskin at Dow Jones describes how most beer in New York City is being, or will shortly be, delivered with natural gas powered trucks rather than diesel.

Ahoy Ahoy: Floating Storage Coming Ashore

The chart above (Chart 1) puts this week's bearish US oil inventories (released each Wednesday) in perspective. Oil prices dropped by US$4 to almost US$68 per barrel (NYMEX WTI).

Chart 1 shows total US oil inventories by week. Total US oil inventories increased by 8.5 million barrels.  The second chart (Chart 2 below) shows US oil demand which looked as if it may have reached an inflection point over the past month (US gasoline demand is strong, offsetting weak diesel and jet demand).

The big question is now: has something changed that has suddenly derailed the recovery in demand and decline in US oil inventories seen over the past 2 months, or is the past week an anomaly?

One thought is that the increase in inventories could be oil in floating tankers coming onshore now that the forward curve is flattening which removes the incentive to store. So either the forward curve goes into steep contango again or flat price oil is about to fall (or a combination of both) as this floating material comes onshore. Or perhaps extrapolating a single week’s counter trend data point (the trend being falling inventories and higher prices) is not such a wise decision?

The last few weeks of September are always quite a volatile time for US demand and inventories. We are in the low demand shoulder period between driving and heating oil seasons.  This week's numbers could be reflecting the data noise during this seasonal transition.

Oil Discoveries Up...Still Not Enough

Although new oilfields are discovered every year, it is unfortunately a fact that the number of large oilfield discoveries has been in a multi-decades long decline (see Oil 101 for a fuller description of discoveries and reserves).

The few larger discoveries over the past ten years with potentially economically recoverable oil of 3 to 10 billion barrels (Gb) have been warmly greeted, but are insufficient in the grander picture.

To put everything in perspective with these large numbers, bear in mind that there are around 30 Gb of oil consumed each year worldwide and this number grows by 1-2% per year. So, in order to stand still, oil companies around the world have to discover at least 30 Gb of oil each year.

Discoveries of approximately 3-5 Gb of potentially economically recoverable oil off the US Gulf Coast in 2008, 5-10 Gb off Brazil in 2006, 9 Gb in the Caspian Sea off Kazakhstan in 2000, and 6-8 Gb in Iran in 1999 and 2003 were among the largest over the past ten years. There were of course other smaller discoveries in addition to revisions to the sizes of fields previously discovered. 

Two newspapers are giving somewhat different perspectives on the long term decline in discovery rates.

The New York Times today states that despite insufficient new oilfield discoveries, one oil industry consulting group believes that higher prices are making up the difference by allowing for reserve expansion in oilfields which are already in production:

"New oil discoveries have totaled about 10 billion barrels in the first half of the year, according to IHS Cambridge Energy Research Associates. If discoveries continue at that pace through year-end, they are likely to reach the highest level since 2000....oil companies have found more oil than they produced for the last two years through a combination of exploration and field expansions." (NYTimes)

Meanwhile, the Financial Times (FT table of some major recent discoveries here) states that while the ability to workover fields as a result of higher oil prices has improved recovery rates, it doesn't change the growing deficit between the lack of discoveries and demand:

"Game-changers locally, the finds do not alter things globally. They are much smaller than the supergiants of the last century, still producing at dwindling rates today ....while the industry is getting better at finding and producing oil – seismic surveys are more accurate and recovery rates higher – these are often incremental improvements rather than technological leaps. The world is still heading for an oil crunch.." (Financial Times)

CNBC Commodities

On CNBC's Closing Bell live today I spoke with Maria Bartiromo about commodities.

(click here to view on CNBC's site if it doesn't open below)

Raising Retail Taxes on Oil is a Bad Idea

An article by Thomas Friedman in the NY Times today calls for the US government to raise retail taxes on oil. In the past I have discussed why imposing European oil tax regimes in the US is not appropriate.

Even if such a tax could be imposed in the US, Mr. Friedman suggests paying down deficits and funding other non-transportation goals. This would be a bad idea. To avoid negative externalities to the economy, any money raised should be spent improving mass transit, freight rail, and shipping. Otherwise it would be a hugely negative tax on trade and commerce.

There needs to be a US solution which meets the particular challenges of US transportation patterns. and which is politically tenable.  Such a a politically acceptable solution could be a Vehicle Efficiency Market.

Oil and the White Swan Non-Event

The expected continues not to happen.

Black swan events tend to be thought of as low probability events which occur. There can also of course be events which are highly expected (White Swans ?) but which do not occur.

As a result of the 2005 hurricane season, 166 million barrels cumulatively were shut in. That was an extreme year for tropical storms. The 2009 hurricane season is now looking as if it will be the other extreme with no oil and gas production shut ins so far.

The US EIA carried out an analysis earlier this year and assigned a 4% probability to the 2009 hurricane season resulting in no shut ins. The EIA forecast a total cumulative shut in value of 4.5 million barrels of crude to be shut in. So far there has been no US Gulf Coast shut ins. The following chart of Google searches for the word hurricane (updated to Sep 13, 2009) nicely reflects the benign nature of the 2009 hurricane season to date.

Chinese Oil Demand Shock

Running through many historical scenarios for other developing nations such as Brazil and Thailand I have come to the stark conclusion that the market could be underestimating Chinese oil demand growth by a huge amount over the next 2 to 4 years.

China is at a major inflection point in terms of oil demand. This has been borne out by many other countries at similar development stages. If anything, China is 2-3 years overdue an oil demand growth spurt given its income growth. The August 2009 82% year/year jump in annual Chinese auto sales is a harbinger of what is about to come. That 82% is not a typo. China has skipped its traditional seasonal summer decline in vehicle sale entirely so far in 2009 (see chart below).

Chart: Chinese Total Monthly Vehicle Sales in Millions

(click to enlarge)

If China follows a similar pattern to other developing nations then Chinese demand is likely to not just grow by its past 5 year rate of around 5% per year over the next 2 years. Chinese oil demand is on the precipice of a significant jump in annual growth over the next few years. The absolute barrel volumes of oil are enormous.

What is it about 4.6 barrels per year?

Cats are curious
(a friend of mine behind the computer screen)

Since 1982 the number of people in the world has grown by almost 45% or 2 billion people (chart 1).

Oil supply has been unable to outpace population growth since the 1970s and has from 1982 until recently just been able to keep pace with demand (chart 2). What can one person do with 4.6 barrels (193 US gallons) per year? With a vehicle getting 30 miles per gallon one can drive an average of around 16 miles per day.

Why has per capita consumption been so stable since 1982 having grown at an increasing pace for the prior 120 years (chart 2 again)? The answer is that a new method of rationing demand emerged in 1983: benchmark pricing linked to transparent free liquid markets (see chapter 1 of Oil 101). Free markets and necessarily volatile oil price became the adjusting factor matching available supply to demand.

To put the global average of 4.6 barrels of oil consumption per year in perspective, the number of barrels consumed per person in 2008 in India was 0.9, China 2.2, Brazil 4.6, Germany 11.1 and the US 23.3.

Build your own chart of consumption patterns over time by clicking here (click the 'Play' button to start and the individual country to track over time - set X axis to 'Time' and Y axis to 'Oil Barrels Consumed per Person').