Oil Data Defines Recession Shape

It is widely accepted that the recession has ended.  Now the debate centers on the type of recovery. I wondered whether the shape of the current recession could be described with oil, or more precisely with oil demand via the number of miles driven on US highways.

Will the recession and recovery be classified as a V (sharp slowdown and equally sharp recovery), U (long trough between entering and exiting the recession), W (two V-shaped recoveries over a short period of time), or L (economic recovery takes a long time or perhaps never occurs) shaped recovery?

The chart below appears to indicate that the US is not going to suffer an L-shaped recovery, but instead is either in a U-shaped recovery or is perhaps on the first leg of a W-shaped recovery. The number of miles driven by US motorists would put the start of the recession at December 2007 and the end at April 2009. In fact, using oil demand data, one can pinpoint the precise nadir of US economic activity during the recession as the first week of October 2008.

Data for above chart from FHWA.  Grey bars indicate recessions defined by NBER.

Happy 150th Birthday Oil!

Exactly one hundred and fifty years ago today, the oil well which started the modern oil industry began producing.

I have been kindly allowed a guest post on The Oil Drum which is the most widely followed energy blog in the world (thanks Gail).

China and Commodities

I appeared on CNBC's Closing Bell live with Maria Bartiromo today to discuss the impact of Chinese demand on commodity markets.

In the piece, I mentioned the 90 days oil import coverage that the International Energy Agency (IEA) requires member nations to have in storage.

The Chinese government now has 86 days of net oil imports in storage (25 of which are in its strategic stockpile). China needs to build inventories to 90 days in order to join the IEA.

The US meets the 90 day requirement with a combination of its Strategic Petroleum Reserve (SPR) and private storage.

China is following the example of the US and other developed nations in building a buffer of oil to cope with supply shocks.

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

NY Times Op Ed on Oil: Reality Check

The New York Times published an Op Ed piece by a Mr. Michael Lynch arguing that the inability of oil supply to meet demand between 2005 and 2008 is nothing to be concerned about.
I agree with Mr. Lynch that alarmism helps nobody, but his solution is to stick our heads in the sand and ignore reality.

The reality is that global oil production will eventually decline. Oil is a depleting, non-renewable resource. Why shouldn't we plan and prepare for a world of declining oil supply? To do otherwise would be foolish.

Lynch argument: 1a. Oil discoveries are not declining and are keeping pace with consumption.

Rebuttal: 1a. The discovery records from almost all sources show a declining pattern of discoveries since the early 1960s, particularly after adjusting for reserve revisions. I don't know Mr. Lynch and don't know if he has access to global oilfield databases which tend to be quite expensive.

Lynch argument: 1b. Oil is not becoming more expensive or difficult to find and produce.

Rebuttal: 1b. The easy oil has already been found and produced. How do we know this? The resources (energy and funding) required to find and develop incremental oil today have been steadily increasing. This is why the breakeven price of oil for producers has been rising.

Lynch argument: 1c. Advanced production techniques increase oil production rates without reducing total oil produced.

Rebuttal: 1c. Advanced production techniques can increase the daily rate at which oil is produced from a field, but often this comes at the expense of a shorter production lifespan and less total oil produced.

Lynch argument: 2. The politics of the 1970s and '80s is being blindly replayed.

Rebuttal: 2. Mr. Lynch tries to tie the current debate to the oil embargoes from 40 years ago - but tellingly doesn't mention one person, other than himself, making such connections.

The disruptions to oil supply in 1973-74 and the early 1980s were political. What is so disturbing today is that disruptions are not coming from temporary political sources, but an unusually protracted inability of the industry to find sufficient inexpensive oil anywhere.

Lynch argument: 3. Consensus among geologists is that 2.5 trillion barrels of economically recoverable oil is available out of a total remaining endowment of 10 trillion barrels.

Rebuttal: 3. Mr. Lynch's final argument about total resources available being enormous mentions "some geologists" and "consensus". Again, he tellingly doesn't mention one name or organization to substantiate his claims.

There is no such consensus of geologists.

As you know from reading Oil 101 (see chapter 14: reserves), the most commonly cited numbers from BP, 'World Oil' and 'Oil and Gas Journal' put global reserves at around the 1 trillion barrel level. This 1 trillion number is itself comprised of questionably inflated figures, but it is still less than half Mr. Lynch's "consensus" of 2.5 trillion.

Lynch price forecast: Oil will settle below $30 due to offshore oil and other high cost oils.

My view: Mr. Lynch ends with a prediction of US$30 per barrel oil due to increased supply, but then tries to back this up with deep offshore and other high cost sources of oil.

US$30 is not out of the question for brief periods of time such as we saw at the beginning of 2009 when demand collapsed; but when the required price for global marginal oil production is more than US$60 per barrel and increasing, how can US$30 be sustained?

A strange article indeed.

OPEC to Burn the Midnight Oil

OPEC members' next meeting is on September 9, 2009 at their headquarters in Vienna. At current prices in the mid to high US$60s per barrel they are expected to make no change in quotas and to talk of tighter compliance with existing quotas.

It was announced earlier today in Saudi Arabia that the Islamic month of Ramadan will begin on Friday August 21st (HT: JP Spinetto from Bloomberg).

For the oil market this means that the OPEC meeting on Wednesday September 9 will start after sundown in Vienna, with a decision announced perhaps early in the Vienna morning. Vienna is 6 hours ahead of New York and 1 hour ahead of London.

Ana - First Tropical Storm of 2009

This morning at 4am EST the first tropical storm of the season, Ana, was named by the US National Hurricane Center (NHC). We haven't had any hurricanes yet this season. The sequence of hurricane development is:

Tropical Depression -> Tropical Storm -> Hurricane

Topical depressions are given numbers. Tropical storms and any subsequently developing hurricanes are given names in alphabetical order which switch from mens to womens names every other year. There are six lists of names (3 mens and 3 womens) which cycle every six years. The names were exhausted once in 2005. Tropical storms and hurricanes are given letters from the Greek alphabet when the list of names runs out.

Hurricanes are important to the oil market as they can shut down production and refining located in the Gulf of Mexico.

Updates:
1: 4pm EST Sat. the second Tropical Storm, Bill, named.
2: 12:15pm EST Sun. the third Tropical Storm, Claudette, named.

(click on graphic above to obtain the lastest NHC update)

Oil Prices a Bubble? No.

I appeared on CNBC TV's Closing Bell live this afternoon with CNBC's Michelle Caruso-Cabrera and Addison Armstrong. The debate was whether investors should be bracing for a commodity bubble. As you know, I am a fundamental supply and demand guy and am sceptical of blaming anything on bubbles. Monetary bubbles do occur, but often bubbles are used as an excuse.

Clear evidence of a bubble (such as that which occurred in housing) is where there is a increase in prices in addition to an increase in unsold inventories.

Oil, copper and sugar inventories are all low and supply is restrained. This is why prices are rallying. The global inventory evidence clearly shows real fundamentals and not a monetary bubble are the reason for higher prices. (click here to view on CNBC's site if it doesn't open below)

The Waiting Game

Crude oil prices are stuck in a range between US$55-$75 per barrel. Today I was quoted by the Wall Street Journal:

"We'll stay in this range until will get a weather event or we get a change in supply from OPEC," said Morgan Downey. (source: WSJ)

Floating Storage Holds Oil Price Key

(chart 1: model based on tanker data. click to enlarge)

Floating inventories should typically decline as demand picks up seasonally moving through the third and fourth quarter. Yet floating storage is increasing (see chart 1 above) to a new record high. Anecdotal evidence lends support to the above analysis.

(chart 2 above: AG to USGC VLCC in US$ per barrel. click to enlarge)

Low freight rates (see chart 2 above) result from OPEC not using tankers they had been using last year when they were producing flat out. This provides the first and most important of a few key incentives to increase floating storage. Another incentive is the shape of the forward curve which needs to be in sufficiently upward sloping contango (see chart 3 below). Future prices have to be above today's price plus the cost of the tanker. There are also financing costs which need to be covered.

(chart 3 above: NYMEX WTI Crude forward price curve. click to enlarge)

As OPEC increasing production will be the supply factor which ends the current oil price rally, changes in the above three charts may provide leading indicators to determine when oil prices have topped out and will begin to move sideways or fall.

Bear in mind that the above analysis is of the supply side of the oil market. As mentioned previously, above US$80 per barrel (oil spending equivalent to 4% of GDP) demand is likely to fall. OPEC may be able to created supply-driven price spikes above US$80 per barrel, but these are unlikely to last.

Blue Skies...But Not For Long

Two months have passed since Hurricane Season started back on June 1. We haven't had any hurricanes or named tropical storms yet. Hurricane season peaks in the first week of September before ending on the last day of November. Oil markets keep a keen eye on any storms or hurricanes because they disrupt oil production off the US and Mexican gulf coasts.

Warm up your hyperlink to the US National Hurricane Center. There are usually 2 named tropical storms in August and 3 in September.