London Oil Traders Maybe Humming “Let it Snow”

As some of the heaviest snowfall in history blanketed most of the UK and shows no sign of abating, traders with positions on Brent Crude Oil Futures in London would surely be in the mood for one of Dean Martin’s most famous songs.

On the back of the cold weather, ICE Brent crude oil contract for February delivery was trading at a 14-month high of $80.55 a barrel on the London-based ICE Futures Europe exchange earlier today; the highest this part of the world has seen since October 9, 2008.

Furthermore, it seems the chill and snow is likely to prevail across the British Isles, Scandinavia, much of Europe and parts Eastern United States and East Asia as well for some time yet. Hence, the price spike is likely to go further. A quick call to a contact of mine at Sucden Financial revealed that February ICE Brent crude contract’s discount to the comparable front-month U.S. crude contract was at $1.25 per barrel.

Looking ahead, my contact who wasn’t humming Let it Snow till I put the jingle in his head, said the February versus March Brent spread was at 64 cents. On technicals front, Brent support is at $75 a barrel while resistance is at $82 a barrel. His overall assessment is that the market would more than take a +$80 settlement on the back of a temporary spike provided by the cold weather, given the current “uncertain and fragile” recovery of the global economy.

Most in the City echo the sentiment. Harry Tchilinguirian, head of commodities derivatives research at BNP Paribas, said in a TV interview that the weather has helped to give crude prices a boost. However, he felt the supply situation, especially in the U.S. was more than adequate. Separately, Mike Wittner, Head of oil market research at Société Générale, also expressed a similar opinion.

Both commentators feel that once the snow blasts have disappeared, after having added their couple of dollars worth to the crude price, corrections could be sharp. Nothing lasts forever, until then Let it Snow!

© Gaurav Sharma 2010. Photo Copyright © Gaurav Sharma 2010

IEA Belatedly Joins the “Peak Oil” Debate

As 2009 drew to a close, the International Energy Agency (IEA) finally and formally admitted that projections on the timing of oil production reaching its peak were no laughing matter and seriously joined the debate. Previously, the IEA, which advises 28 OECD nations on energy issues, had never really been specific about when it thought conventional sources of oil would peak.

I personally recollect having met someone from the IEA in September 2008 on the back of an OPEC summit that year, who talked at length about the matter in private, but refused to discuss the issue on-record. Over the years, some observers have even alleged that the agency was fudging oil production projections.

This clamour, which had always been lurking in the background, gained traction following a report by Dr. Robert L. Hirsch for the U.S. Department of Energy in which he analysed the possible effects of Peak Oil (Viz. Peaking of world oil production: impacts, mitigation, & risk management). A truncated version of his thoughts was later published by the Atlantic Council of U.S.

Hirsch noted: "The peaking of world oil production presents the U.S. and the world with an unprecedented risk management problem. As peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented. Viable mitigation options exist on both the supply and demand sides, but to have substantial impact, they must be initiated more than a decade in advance of peaking."

In the four years that followed the Hirsch report, many stories in the popular press ran along the lines that all the easy oil and gas in the world had pretty much been found and that tougher times lay ahead. It is an argument which is not hard to dismiss in its entirety. Curiously enough, as an advisory agency to 28 leading economies, the IEA was somehow was not all that keen on discussing it.

All of that was laid to rest over a dramatic few weeks last month. On December 9th, the agency’s eagerly awaited World Energy Outlook 2009 (WEO) noted that conventional oil, from straight-forward to extract sources, is “projected to reach a plateau before” 2030. In the publication, the IEA is seen to have conducted a serious supply-side analysis including the largest oil fields, their rate of production and decline in its research.

Published material suggests that the IEA sees a decline of 7% in year over year terms over the coming years at these extraction site, nearly double the rate of earlier forecasts. Based on the projected rate of decline, the agency estimates that the world would need four new “Saudi Arabias”, a country which has 24% of the world’s proven crude reserves, by 2030 to meet demand. This too is based on the assumption that global demand remains flat at existing levels as does the rate of production decline.

However, quite frankly the agency still prima facie declined to say that the world has currently entered the era of peak oil. Furthermore, in order to perhaps soften its hard assessment, it pointed out that the first half of 2009 saw 10 billion barrels of new oil discoveries; an annual rate previously unheard of! It also said non-conventional sources such as the Athabasca Tar Sands (Canada) should not be discounted either.

Just as sceptics were rounding up on the agency, IEA Chief Economist Dr. Fatih Birol, set out to paint a more pragmatic picture. Having visited some 21 cities in the run-up the WEO’s release, Birol told several media outlets, most notably The Economist and The Guardian newspaper, that the crude production plateau which the agency mentions in the publication, could potentially arrive as early as 2020.

In a much more detailed conversation with The Economist, Birol also made another interesting observation. He said that a worldwide effort to restrict increase in global temperatures to 2 degree centigrade will restrict the increase in global demand for oil to 89 million barrels per day (bpd) in 2030 as opposed to 105 million bpd if no action is taken. That could, in theory, push back peak oil production scenarios as more time would be needed to produce lower-cost oil that remains to be developed.

Watch this space then - for next two decades that is! This argument is far from over. At least the IEA can now dodge accusations that it is not being realistic its assessments and shying away from debate.

© Gaurav Sharma 2010. Photo Courtesy: Martin Rhodes, Essex, England

Fresh Takes on The Resource Curse Hypothesis

The hypothesis that oil damages countries it comes from, in more ways than one, has been with us for some time now. Industry observers and critics perhaps do find common ground in noting that discovery and extraction of crude oil, especially in case of developing economies exporting the stuff, has failed to provide the bonanza and even spread of prosperity that it should for these nations.

On the contrary, oil has stirred up troubles and conflicts. Furthermore, wherever one looks there is a political dimension to the dominance of this single commodity which is limited and will run out in the future, though not as dramatically as sometimes portrayed.

Adding to the debate are fresh thoughts contained in two very interesting books that I have read in recent months. The first is titled Crude World: The Violent Twilight of Oil by Peter Maass. The second is titled False Economy: A Surprising Economic History of the World by Alan Beattie, the fourth chapter of which dwells on the subject (viz. Natural Resources: Why are oil and diamonds more trouble than they are worth? – Pages 95 to 120).

In his book, Maass opines interestingly that the commodity is itself the real villain here. His central argument is that oil has damaged nations it comes from as it artificially strengthens their currencies and makes the rest of the economy uncompetitive. More critically, while wealth creation occurs as a result of oil exports – it does not create what developing economies need most in appreciable numbers – jobs. Furthermore, he offers arguments that oil wealth removes the need for wise spending.

What I liked about this book is that it does not look for fall guys or hammers oil companies, who in the author’s opinion are like any other business seeking the maximum possible returns on investment. Rather, he opines that corruption, greed and strife are also by-products of the oil trade. It is an interesting and unique book though not rich on the economic analysis front.

Along this tangent, the aforementioned chapter in Beattie’s book offers more detailed economic insight. Like Maass, he agrees that it is in the nature of the oil business to benefit fewer workers, as oil and gas extraction is equipment intensive and not labour intensive. Experts believe it is labour intensive mass production industries that do more to lift people out of poverty in the form of job creation with more wages for more people. Hence, oil creates a unique problem for oil-rich developing economies.

Beattie also notes that a significant portion of the return on extraction is used by oil-exporting developing economies to purchase drilling equipment which they cannot manufacture. Throw in the geopolitical permutations and corruption that Peter Maass alludes to, add in the concept of Dutch disease, and we soon arrive at a self-inflicted tragic hotchpotch which may be labelled as a resource fuelled curse that both authors describe in some detail.

No one is discounting the fact that where managed well, oil as a resource has been good for economies exporting it. Norway is often cited as such a nation, but Beattie says it struck oil meaningfully only in the 1970s, by which time it was already a rich economy. Russia is criss-crossing between becoming a meaningful democracy and going down the old Soviet autocratic way. Oil and gas wealth ensures that it may well be, some say already is, heading in the latter direction.

Four of Africa’s longest serving autocrats are from oil exporting nations. More convincing details, especially on Equatorial Guinea, can be found in the work of Dr. Ricardo Soares de Oliveira published in 2007. For lack of a better metaphor, he aptly brands such nations as ‘failed successful states.’

Both these books, especially as they are aimed at a wider readership base rather than academia, rekindle the resource cruse discussion. I particularly like Beattie’s witty observation that oil is bulky, murky and harder to extract, but “like Visa or MasterCard, also widely accepted!”

© Gaurav Sharma 2010. Photo Courtesy Cairn Energy PLC