Monday 30 June 2008

C R A S H [Corrected]

This blog doesn't usually venture into the lalala-land aka economics and finance, but the recent weeks have been, well interesting to to say the least.

If you don't usually follow the economic news, take a quick glance at the following news from the past two weeks:

Bank of International Settlements Warns of Deepening Contraction (Not for the Fainthearted)
"The current market turmoil is without precedent in the postwar period. With a significant risk of recession in the US, compounded by sharply rising inflation in many countries, fears are building that the global economy might be at some kind of tipping point," it said.

"These fears are not groundless. The magnitude of the problems yet to be faced could be much greater than many now perceive," it said. "It is not impossible that the unwinding of the credit bubble could, after a temporary period of higher inflation, culminate in a deflation that might be hard to manage, all the more so given the high debt levels."

American financial fiasco could take down world economy

"According to the LEAP think tank, based in Europe in the next six months all factors affecting the economy will converge, and create a perfect socio-economic hurricane.

The root of the problem is always money, basically the US dollar of which there are trillions too many in circulations, so many that its value is decreasing, and the world doesn't know what to do with them. It's this flood of money that drives up the price of all commodities, including oil, of course. Nobody wants more US dollars, unless its value increases."

Royal Bank of Scotland issues global stock and credit crash alert
"The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.

"A very nasty period is soon to be upon us - be prepared," said Bob Janjuah, the bank's credit strategist. "

Back to the Great Depression?
"Few are gloomier about that prospect than Albert Edwards, strategist at Société Générale in London. “America is leading the way, diving into deep recession as a collapse in consumer confidence induces the great unwind,” he said. Edwards compares the economy with a pyramid scheme that is poised to crash to earth and interest - rate changes can do nothing to avert it. "

Barclays warns of a financial storm as Federal Reserve's credibility crumbles

Barclays Capital has advised clients to batten down the hatches for a worldwide financial storm, warning that the US Federal Reserve has allowed the inflation genie out of the bottle and let its credibility fall "below zero".

"They will have to slam on the brakes. There is going to be a deep global recession over the next three years as policy-makers try to get inflation back in the box."

Correction: Fortis did not prediction correction in the market

The Fortis story appears to have been a hoax!

It is customary to get a chicken little warning from one or two smaller sources.

Things have changed. Now all of the banks are screaming bloody murder.

Thing are going to turn ugly soon.

If you have assets in a bank that has a big mortgage backed security exposure (most big banks in US/EU/UK), is hugely leveraged in any over-priced asset category which of there are too many to mention (most banks in the world), or has otherwise a huge level III category mark-to-funny-value asset pool (most major US/UK banks), well let's just say that prepare for a very high probability of a lot of hurt.

Saturday 28 June 2008

Off-topic - Great Song

For completely no reason whatsoever, except that the track and the movie are both great fun :)

Motörhead - Ace of Spades

Oil in pictures - Flows, Choke points, Producers

New Scientist has a useful map of Oil producers, consumers, pipelines, shipping routes and pinch points:

Videos - Kunstler, Moyers, Rubin, NBC, Heinberg, Simmons

James Kunstler on End of Cheap Oil and Future of Food & Transport (8 min.)

Bill Moyers on US military as oil protection agency (6 min)

Jeff Rubin (CIBC) on expensive gas AND US demand reduction (4 min)

NBC on Saudi Arabian spare capacity (2 min)

Richard Heinberg on future need of more farmers and farming skills (2 min)

Matthew Simmons on price of oil (10 min)

Thursday 26 June 2008

Even more on Airlines

Airlines have gotten some tough love recently, both in the real world and in the media.

However, are the some additional things that pundits should be looking at, when thinking of the near future of aviation?

Here's a quick checklist to go through.
  1. Hedging. Derivative fuel price protection hedges may work as long as oil futures curves are inverted. They are now normal. This means that it is difficult to hedge effectively via futures contract and it also makes subsequent derivatives sold by 3rd parties much more expensive for any airline to buy. That is, the price of the hedge may negate much of the price rise in oil. Example: Qantas fuel hedges incurred a loss of -$39.8M and derivatives a loss of -$71.4M. These are significantly worse from 2006, when the hedges results in positive gains.

  2. Fuel efficient fleet. Airlines which have planned to renew their fleet with fuel efficient planes: A380, Dreamliner 787, A350XWB and the like can offer -20% to -30% savings in fuel usage, depending on existing fleet (other things staying the same). This can significantly reduce fuel costs. For instance, Qantas 2007 flee consists mostly of 717 to 747 aircraft and some A320/A330 series. The improvements of earlier mentioned aircraft on fuel savings are significant (on order of -10% to -30% for kerosene), even if they are not guaranteed to negate the effect of fuel price changes. A380 and 787 become operational in 2009 for Qantas, but of course only part of the fleet is switched over to the new craft.

  3. Revenue seat factor. When this goes down, so do the profits, rapidly. A Change of -1% can be significant, when the airline is already operating near profit-loss margin. This is not yet the case for Qantas, but it is reality for almost all US operators. The more pruned down the operations are, the harder it becomes to cut more. As such, the effects of revenue seat factor loss become progressively more severe IF airlines are forced to keep cutting expenses year after year (i.e. price of oil keeps going up steadily). Also, see recession for extra effects.

  4. Fare price changes. An important portion of the recent growth in air fares is not just from business travel, but from middle class flying further and more frequently. This demand is highly price elastic and adjusts rapidly as fare prices increase, again bringing down the revenue seat factor. Thus, airlines are constantly optimizing how much can they even theoretically increase fare prices (which causes a loss in demand), because fuel prices have increases. Currently this theoretical increase is not possible for many, due to overcapacity in the industry. However, below this easily adjusting demand there is demand that may not be cut as easily (e.g. bulk of business demand in a non-recession scenario), which may offer a period of support for profitable fare price increases, but only up to a point. In a recession scenario, this support can rapidly fall apart.

  5. Recession. During recession people fly less. Revenue seat factors go down and so do fare prices, both can incur great losses. This may also happen before the fuel prices drop due to shrinking demand, causing a short period of extreme financial losses. Personally if we go to recession and Asian demand growth for oil doesn't significantly drop while bringing down the oil prices, we can expect a lot fewer airlines, with a lot less routes and much lower frequency of flights.

  6. Emission trading. If EU emission trading starts in 2011 for airlines (doubtful), then this will eventually spill over to other areas and at the very least to operations to Europe for any airline, including Australian airlines. The effects can be significant. In 2007 the EU airline industry was able to make a combined profit of €3.7 billion in a time of extreme growth and fairly high economic growth. The emission trading scheme for EU airlines alone is currently estimated to cost €15 billion a year. This would totally wipe all the profits and force many airlines bankrupt in a just a few years. Thus, it is unlikely that airline emission trading scheme will start in 2011, the year when even the conservative IEA assumes a major oil supply/demand crunch, much worse than what we are experiencing now. BTW, Chris Skrebowski's (of Petroleum Review) current estimate is that we'll be peaking globally roughly by that time.

  7. Kerosene Crack spread. Kerosene has risen in price faster than crude oil (i.e. kerosene crack spread). This has been probably due to refinery mismatch and the very rapid rise in demand for diesel (a mid-distillate like kerosene). Until the refinery balance is restored or demand for diesel drops (unlikely, as it is used in electric power generation, not just cars), kerosene crack spread may remain well above the historical averages, or may even rise. This incurs an additional price increase of c. $25USD/per barrel over the crude oil price currently.

  8. Fuel delivery disruptions. This is the bogey nobody wants to talk about. Everybody assumes that the markets will operate without disruptions, and that only the prices will fluctuate. Readers of this board however are aware that when spare capacity is as tight as it is, unexpected disruptions anywhere in the fuel chain can easily cause temporal geographic losses in either crude or fuels. It's not generally known how well airlines are insured against these, but a loss of operations fuel for even days would be severe to many, both on financial and reputation level. If the margin remains tight for supply/demand, the likelihood of disruptions increases as a function of time. Again, barring worldwide recession, which may bring us more spare capacity, but which will bring different kind of pain to the airline industry.

It would be very interesting to find out if there are any additional upside factors that are already on the horizon for the aviation industry. Syn-fuels and bio-fuels are unlikely to make any significant impact in the next few years (too low volume, too high cost). Wing tips and weight reduction in planes is mostly already in use and the effects are marginal (a couple of percentages at top).

The only positive big event for the airline industry would be that the price of oil would plummet to $70-$90 per barrel (current dollar value) and the kerosene crack spread would normalize, both for some unimaginable reason (a black swan). If this was to happen without a worldwide economic slowdown, then airlines would at least get a breather. However, whether it would be anything more than a breather is in serious doubt. Things look pretty severe beyond 2011 and by 2015-2017 we are probably into uncharted territory.

Now, if things got really severe, what additional developments could happen?

Consider the potential of (re)nationalization. Shareholders don't like losing money, so they will abandon sinking companies. Historically most countries have had a national airline. It wouldn't be impossible they were re-nationalized again if things get ugly enough. Somebody needs to fly all those business suits all over the world for loss. And it sure isn't going to be private owners, so they could demand that the government picks up the tab for them. When/if things pick up again, airlines can again be privatized. Remember this may not be an on/off matter, it can be a matter of how many shares each party owns and who covers the losses in the end.

Oil Prices and Speculation - One more time

Why is oil so expensive?

Let's look at the fundamentals.

Oil is expensive, because of reserve production capacity has diminished and continues to diminish:

...and because oil exports available to oil consuming countries are shrinking:

...and because demand mainly from Asia is outstripping global oil supply:

...and because tight refining capacity is causing distillates to rise in price even further:

That much is certain and undisputed.

However, some seem to think there is also a speculative bubble on top of the fundamental supply-demand crunch causing the initial price rise. George Soros is one of these people, so if you believe this yourself, you are certainly within esteemed company.

So, who are the people making this bubble?

Are they the commodity speculators, who buy up oil? At least index fund shares are going up, look at this graph!

Certainly the positions of index funds has grown for oil futures. However, oil futures do not create the spot price, which is the price paid by those who actually use the oil. That is created by demand/supply balance on the market.

So, speculators would need to store the oil they bought into inventories to cause a global shortage, which in turn would raise the price, allowing them to speculate with crude oil futures contracts.

But inventory levels show this is not the case:

Same for OECD:

So, if the inventory data is correct and there is no significant difference in the Asian inventory data, commodity hoarding is unlikely to have a great influence on the price currently. In fact, the only big inventory rise in the Asian market has been for the Chinese market, for which the official explanation is building stock for the Beijing Olympics.

Thus, low inventory levels indicate that while speculation in general may have some effect, but it is unlikely that it accounts for $80/barrel out of the current price, like some are claiming.

Now, if not oil hoarding speculators, then who could it be?

Maybe those 'evil' (sic) Arab OPEC countries are behind it? They are an oil cartel after all, right?

That theory is again hypothetically possible, were it not for the fact, that they all publicly say that they are uncomfortable with the price, they do not want demand destruction, which is already happening:

Further, considering the infighting amongst OPEC countries, it seems unlikely on the surface at least that they would act in unison to raise the prices by not producing what they can, especially when it would be to their detriment by causing diminishing demand in the future.

Historically oil prices have always crashed, if they rise much too fast. This has never worked to the advantage of the oil producers, but has in fact put them in debt. They have publicly stated they will do anything to avoid this scenario repeating.

So, what other possibilities are there?

Those big oil corporations! ExxonMobil, Shell, BP and the rest. Maybe we should tax them, because they are behind this?

Not so fast. This is the amount of oil flow in the world IOCs control:

While it is theoretically possible that in a very tight demand situation (like now), they would be able to raise the price somewhat by not producing that which they've got, it doesn't really make economic sense in the long run (cf. above). However, they are not a cartel and as such do not act in unison.

So, in the end, the only thing left is to accept that the fundamentals and acceptance of most probable things to come are the reasons driving the price:

If not, we can of course conjure up strategic conspiracy theories, which are always nice, but very, very hard to prove:

"Maybe the price rise doesn't reflect cost structure fundamentals"

"Saudis themselves prefer a lower price"

"Saudis are cutting production to put a squeeze on the new US president

While ideas like presented in the last three slides are perhaps possible, there really isn't fundamental data to back them up. As such, I would leave them for what they are - possible, but highly unlikely. As to refuting the argument itself, it can only be done by waiting till the new president comes to power. If KSA suddenly starts pumping oil from some hidden reserve capacity and crashes the price of oil after the first visit by Obama to KSA, then this theory might be true. Or not. As a theory is impossible to prove, it can only be refuted if the prices do NOT crash.

Is the guilty party for rising oil prices staring us in the mirror?

It may take a while to accept, but in the end it will sink in.

We drive up the price of oil, by using more and more of it (us humans, globally). And it doesn't help blaming the Indians or the Chinese, because they are using the oil, in order to build us all the goods (and much of the food) we consume.

Blaming others in this situation is neither truthful nor helpful. Only accepting the facts of oil depletion and acting on it is going to help.

Fun of the Day - Chrysler $2.99 gas price guarantee

How moronic can the American automakers get in their futile attempts to cling to the past?

Chrysler is offering a price guarantee of $2.99 for gasoline in US. Pay more at the pump and they refund you the difference. The catch? You have buy one of their gas slurping monsters, of course.

Here's Slate's take on the issue.

Monday 23 June 2008

[FIN] Mitä tehdä öljylämmitykselle?

Pari kuvaa kaikille öljylämmitystä talossaan käyttäville, jotka eivät ole jo nähneet valoa.

Fakta: uusi kattila auttaa hyvin marginaalisesti

Fakta: Maalämpöpumppu maksaa itsensä takaisin nopeasti.

Fakta: Vaihtamalla vähäpäästöiseen talonlämmitykseen, vaikutat tehokkaalla tavalla khk-päästöihin.

Kannatta myös muistaa, että useiden tahojen mukaan ja jopa EU:n sähkömarkkinoihin verrattuna, Suomen loppukäyttösähkön hinnassa on 50-200% korotuspotentiaali tai -paine, riippuen siitä keneltä kysyt.

The Great Saudi Smoke Screen

"Fear not. We will save you."

By now everybody and their grandma have heard about the weekend's oil producer/consumer meeting at Jeddah. The deal was for the leaders of the consuming economies to look good, while the leaders of the producing economies could re-state what they have already said several times, namely that they will increase production. Really they will, this time it's true. Please believe them. They were just kidding for the past three and a half years, when they didn't.

So, what was the outcome of the meeting? Let's see:
  1. Saudi will raise their output to 9.7 Mbpd. A Figure they had already promised almost a year ago. This is not new capacity, but capacity on which the world has already been counting on. It will offer very little relief.
  2. Financial speculators are to blame for the high oil price. Really. Somebody is hoarding oil. Please don't look at the inventory figures, or the lie falls apart.
  3. Other Arab OPEC oil producers do not think the world needs more oil at this time, hence they will not boost production. Could they, if they wanted? If so, by how much and for how long?
  4. Saudi's are saying they can increase their high sulfur content crude that almost nobody wants, to 12.5 Mbpd by 2009. Funny that. They've been saying the same since 2005, but the production is yet to materialize. Fatih Birol of IEA surely doesn't believe it. Neither does Chris Skrebowski of the Petroleum Review. But all the analysts eat it up like cup cakes.
  5. OPEC has started a miniscule crack dealer's Buy-Now-Pay-Forever loan fund for the poor nations. Even if they can't afford the oil at the current prices, they can get 'cheap loans' and be in debt forever, as the prices are just going to go higher in the long term.
The news are neither comforting nor assuring.

In order for the world to come out of this for a breather, OPEC would need to increase their production significantly for a while, esp of the lighter and sweeter variety that all refineries are after. That would crash any and all speculation on the market, if it existed and would normalize the prices for both crude oil and fuel products.

Further, the refinery utilization rates would need to get back to the 90+ level.

And finally, the countries heavily subsidizing their domestic oil consumption and therefor growing in demand the fastest would need to remove the subsidies.

None of these is going to happen anytime soon. Producers don't want the price to crash. Refineries can't retool for every swing in the market and subsidies while being cut slowly, are the backbone of the public support for leaders and as such are unlikely to be removed.

So, what remains is the eternal hope. Hope that the demand will destruct by the rising prices without destroying the economy. That the speculative bubble was bigger than anybody imagined, and that Iraq oil production will shoot through the ceiling in a couple of years and save the world. For a short period in time.

What everybody keeps forgetting that the natural decline rate is 3-4% p.a. We need that amount of new production every year just to keep production at level. The more we produce in absolute terms, the more of a challenge that 3-4% represents. The more time goes by, the worse those figures get, as more and more fields go into natural decline. The more we need to pump, the more we have to tap into the heavy crude oil. The more heavy crude oil we pump, the more it costs, the less likely it is for refineries to be able to process it, and the more time it takes - slowing down the production again.

This is a race that cannot be won. It can only be prolonged, while using the time a allotted wisely for a transition that will last a few decades.

A Sober Warning

If you are too busy to watch (running time 6:30), here's a capsule summary:

  • We have been on an oil production plateau since 2004
  • All oil and derivatives likely to start declining in production in a few years
  • Oil could hit $300-$500 in 3-5 years in the worst case scenario
  • We need 20 years time to prepare, we don't have enough time to prepare
  • Oil price may dip down for a while (as price volatility increases), but the price is headed up, up and up
  • Good luck and good night!

Wednesday 18 June 2008

A longer look at Aviation - Pre and Post Peak

We've covered airlines here also earlier, but now it's time to take another quick, but more long term look at some of the issues of aviation industry.

Jet fuel Crack Spread

Airline fuel costs are rising faster than crude oil price

Jet Fuel premium over Gasoline

The refineries are geared for gasoline (it seems) and the premium for jet fuel over other distillate products is increasing.

Fuel vs Labor costs

Fuel costs have surpassed labor costs some time ago. Even if oil would stabilize at avg. level of $100 for 2008 (completely hypothetical and impossible, imho), that would still represent a c. 35% rise in fuel costs over their 2007 costs (year to year). This cannot go on for long, 2008 will be ugly for the airline industry, but wait till recession really hits in 2009 and if the jet fuel price does not crash.

Fuel costs have climbed over 200% in 8 years

While fare costs are going down in nominal terms and
quite a lot in real (inflation adjusted) terms.

Airlines are sacking people at rapid rate

Delta just let 4000 go. Analysts are saying 22 000 need to go this year alone. But it's still not enough to control costs, which are making the industry lose c. $10/passenger (US). USA's seven largest airlines lost $1.32 billion in Q1 alone. The same trend is going on elsewhere in the world. This is not unproblematic, as the satisfaction for airlines is going down, causing contradictory pressure to lower prices, in order not to lose customers.

Lots of airlines have gone/are going bankrupt already

That's just H1 and USA only! Alitalia, Mesa Air, etc. The risk watch is growing. 24 airlines gone bust in the past 6 months alone worldwide. And that's just the beginning according to many.

But there is still too much over-capacity on many areas and the demand is highly price elastic, so one cannot easily transfer fuel costs to prices. For one fairly small airline, a drop of utilization ratio of 1% cuts revenues c. 10%. The same applies to avg price of fares. Nobody wants to lose customers, so we are beginning to see airlines start to death spiral in unison while waiting others to crash first. US airlines have now started raising prices slowly, but fuel costs have far outpaced both fare hikes and conservation efforts.

Lots of more bankruptcies are predicted, unless kerosene fuel price drops rapidly. It's not enough to crude oil to correct some. It needs to be a big correction and also mirror in the kerosene price.

Share of fuel cost of all costs is nearing 40%

It's getting so desperate, that airlines are stripping everything out of the planes to save on fuel costs (drinks, jump seats, carts, etc). I have read that the only thing they've not allowed to take out is the pizza oven (only in America, lol).

Further, Boeing and Airbus are already seeing their orders go down. Many airlines can't afford to order/lease the new fuel efficient planes, even though they could bring an additional -20 to -30% fuel cost savings (at max). Besides, the planes are still too far off into the future to save them now, even if they had the financing.

Now, that's just now, before we've gone past the peak (a mere plateau) and with no fuel supply disruptions and a fairly moderate oil price rise, if you ask Matt Simmons.

So, what are the analysts saying that will happen after this first round of cleansing:

I'm not all too convinced of that. Skrebowski/IEA/et al prediction for the major oil crunch is coinciding at 2011.

That can't mean good for the aviation industry anywhere in the world.

Fuel efficient planes like A350XWB will go into service 2013-2015. At about the time when IEA says we will go into uncharted territory in production. According to Skrebowski, we are already at peak and probably past by that time.

Post Peak oil is predicted to make aviation a sunset industry

Of course there are many small 'positives' out there: too big to fail, politically important, alternative fuels may help a little at some point in the future, etc.

However, for the next few years, unless both crude oil and kerosene prices really crash 50%, I don't see a lot of hope for the airline industry. Sure, it'll continue to operate, and prices may not rise abruptly, but once they do, I don't think we will go back to the merry days of yore.

As such, barring any unforeseen events, I remain quite pessimistic about the aviation industry and about any ordinary business/tourism travel that relies on such a cheap form of travel as we have become accustomed to.

It probably will survive in some form even after post peak, barring a really catastrophic overshoot cliff type drop-off. However, most of us mere mortals will be priced out of the market.
As a postscript it is worth noting that all of this does not take into account the risks that aviation faces from being forced to play real level fuel tax and becoming part of the emission cap & trade system.

If that were to happen and the price of emission contracts would rise to the predicted level of four times of the current price or more, well let's just say that the personnel aviation industry would cease to exist for all practical purposes. Of course, those who could afford it, would continue to fly. That excludes you and me, though.

So if you are a risk taking enterpreneur, perhaps it's time to start thinking inventive new uses for all those aircraft hulls that will otherwise litter some unnamed airplane graveyards.

Oil in Pictures - Price vs API

Today's picture is a bit technical, so perhaps an explanation is due.

Crude oil is sold in various varieties, based on it's lightness (API is a measure of this). The higher the API, the higher quality and lighter the crude.

As we know, the world is running out of the good stuff, the high API light oil. The second half of the oil is trying to use the heavy, sulfur rich and harder to refine oil we have left.

So, how are the prices of high and low API crude oils developing now that we are nearing the peak of the high API crudes?

As the image above shows, the price premium for high API crude (i.e. Malaysian Tapis) is rising over the low API variety (i.e. Mexican Maya).

The low API sets the floor for prices and the high API sets the ceiling. Now that we are pumping less and less of the high API oil, there is a more significant supply problem with that variety.

There is still more of the low API crude, but a bulk of refineries are not set up to handle that currently. Also, it has a lower usable energy content and takes much more time & money to distill into usable petroleum products.

This situation we now find ourselves in can lead into peculiar situations, where over a dozen of tankers full of Iranian heavy oil float on the Persian Gulf waiting for buyers, who in turn try to outbid each other on the more preferred varieties like Brent, WTI and Tapis.

Further, Arab Opec nations keep telling us that the markets are well supplied. Well, perhaps to some degree yes, but mostly with the kind of variety that the buyers do not want nor can use.

So, until the refeneries retool and buyers move over to heavier crude, there is very little temporal relief in stock for the fundamental issue driving the up the prices.

Now if there is a speculative part in the prices on top of the fundamentals, that may give in sooner, but only time will tell. Even if it does, it is unlikely to bring the price down to the level of $65/barrel like some people think. Whatever the drop, if it ever happens, it is also unlikely to last for very long.

Nothing changes the most profound fundamentals. For all liquids, we are on a production plateau, from which we may get temporarily up, but after which we face the inevitable decline.

Tuesday 17 June 2008

Oil in pictures - Production vs price

What does this image from Deffeyes tell you:

As we produce more oil, the price goes up, not down. The horizonal levels are percentages of GDP at that level of production (i.e. certain year).

The share of oil of total world GDP is going up rapidly. It's price rise multiplied by increase in number of barrels.

Something's gotta give.

Monday 16 June 2008

Daddy, can I still fly?

The aviation industry after peak oil would not fair very well, according to Roger Bezdek (MIS) who's studies the situation.

Regardless, he does not think that aviation will just stop. It is too important to fail. Much of the middle class will just be priced out. The trips will be fewer and not as far.

Still, the current estimates for aviation growth within the industry seem greatly exaggerated. They assume a standard 2-3% annual growth for the next 20-30 years, with no hiccups.

It does not require an Einstein to see where the problem is.

Many investment bankers are predicting a wave of bankruptcies for 2009-2010, if oil doesn't fall to c. $80 and kerosene crack spread down to $5. Some analysts are saying that prices of fares need to double this year, if oil hits $150 for a longer period.

As that is unlikely to happen, even the airline industry is saying that there will be a fall out.

However, unlike so many others, they believe the current run up in prices is mostly speculation. They are joined by a group of analysts and bankers:

"What has driven the market so far, so far, in our view, is that such a high percentage of the speculative trade has become aligned in one direction.” - Tim Evans, PM Energy News

"The increasing prevalence of futures contracts has transformed the nature of oil markets. It is no longer only about the value of oil as an energy commodity, but also… oil as a financial asset." - Goldman Sachs

"Our study indicated that for every $100 million in new inflows, WTI prices increase by 1.6%... Our conclusion from this study is that we are seeing the classic ingredients of an asset bubble." - Lehman Brothers

"There may now be upwards of $25-$30 of speculation in the price of crude." - MF Global Energy Risk Management

"So, is this a bubble? The answer is that the bubble is super-imposed on an upward trend in oil prices that has a strong foundation in reality." - George Soros

"Demand and supply fundamentals argue for oil priced well below $100 per barrel." - Mark Zandi

Even if there were a $30/barrel predium on oil and $20 premium on kerosene, that would still mean a price of c. $100/barrel - a rise of 35% for fuel costs year-to-year from 2007.

That is something that the airlines cannot stomach. Fuel costs have already jumped from being c. 10-15% of their operating costs to being 40% of their operating costs. Fuel has long since passed labor as the primary cost element, which is the reason why we haven't seen the last of layoffs in the industry.

Now why don't the airlines just raise the prices? Well they could, but as airline travel react fairly elastically to price rises, they would just get less passenger kilometers, thus not getting that much extra for the rise. Further, they would risk losing market share in an industry that is ridden with overcapacity.

So, they do not raise the prices, but swoon into a death spiral in unison. Eight airlines in USA alone have gone bankrupt in 2008. Alitalia is in the ropes. SAS is not fairing very well either. This is just the beginning if prices stay at near current levels.

So, if you want to air travel and care not for our precious climate - the time to go is now. Killoil Travels - What a Way to Go!

Wednesday 11 June 2008


Sometimes understanding is hard. Sometimes words of wisdom help one to get onto the right path. Here are some.

"If liberty means anything at all, it means the right to tell people what they do not want to hear."
- George Orwell

"Reality is that which, when you stop believing in it, doesn't go away."
- Philip K. Dick

"To see what is in front of one's nose needs a constant struggle."

- George Orwell

"For a successful technology, reality must take precedence over PR, for Nature cannot be fooled."
- Richard Feynman

“We're in car heading towards a brick wall and everyone's arguing over where they're going to sit.”
- David Suzuki

"The biggest problem in the world could have been solved when it was small."
- Lao Tzu

"There are no passengers on Spaceship Earth. We are all crew."
- Marshall McLuhan

"In the end ... success or failure will come down to an ethical decision."
- Edward O. Wilson

"First they ignore you, then they laugh at you, then they fight you, then you win."
- Mahatma Gandhi

Who Are Saying Peak is Now or Near?

So you are coming around to the fact that Peak Oil is not a mere theory, but a physical/geological fact of life.

The next question after the first phase of admittance for most is: Are we there yet?

The opinions vary a lot, but are clearly converging. Below is a list of some well-known people, inside and outside the oil industry, who have called peak oil now or in the near future (a few years).

The usual culprits

Kenneth Defeyes
Geologist (ex-Shell), Princeton University

James R. Schlesinger
Ex-secretary of energy (US), ex-secretary of defense (US), ex-chief of CIA

Ali Samsam Bakhtiari
Now sadly passed away chemical engineer and oil production expert at the National Iranian Oil Company

Jim Buckeeex
CEO, Talisman Energy oil company

Chris Skrebowski
Editor (Petroleum Review), ex-editor (Petroleum Economist), consultant to KSA

Matthew Simmons
Investment banker, chairman, Matthew Simmons International

Then there are the people who think we are running into Peak Lite or a supply crunch. Peak lite happens when we hit a production plateau and demand outstrips supply. Supply crunch is the same in different words, although some believe it may only be a temporary state of affairs.

Sada Al-Husseini
Former production chief for Saudi Aramco

Jeroen van der Veer
CEO, Royal Dutch Shell
"Easy oil is at production peak about now or within a few years."

Warren Buffet
World's richest man, every now and then
"Peak oil within 5-10 years"

Robert Hirsch
Energy consultant for US government, researcher on peak oil mitigation
"We are on production plateau now"

Christophe de Margerie
CEO, Total oil company
"Demand to outstrip suplly within 10 years"

Fatih Birol
Chief economist, International Energy Agency (of OECD)
"Demand to outstrip supply during 2012-2015. Beyond 2015 we are in uncharted territory"

Alan Greenspan
Former head of Federal Reserve (US)
"Global oil supply peaks lower and sooner than had been contemplated earlier"

Wall Street Journal
"Oil Exporters Are Unable to keep up with demand". See ELM to understand this issue

Of course there are plenty of other clear headed thinkers who have put their money where their mouth is: Richard Rainwater (investor), T. Boone Pickens (investor), Richard Heinberg (ecologist), Colin J Campbell (geologist), Clifford J. Wirth (analyst), Jean Laherrère (oil industry expert), Dick Cheney (vice-president USA), David Strahan (journalist), Kjell Aleklett (researcher), Ugo Bardi (prof of chemistry), Jeffrey Brown (petroleum geologist), ... The list goes on and is increasing at an accelerating rate.

Of course, from purely theoretical point of view, ignoring all the data, it is possible that all of the above people are wrong.

That we will not hit a peak in oil production near term and we will recover from the current plateau in production.

However, to anybody who poses such a possibility there are a few important questions to ponder:
  • What is this magical thing that enables this increase in oil production to sustain (when no known technology can do it)?
  • What does it matter if we can pump oil faster for a few more years and increase production, when the only thing it results in is a much faster decline (we will drop off the proverbial cliff)?
  • What if you are wrong and the oil peak is now and depletion even faster than forecast?
These questions do not have sensible and easily actionable answers. They only lull people into a false sense of security through historicism: "things were solved earlier, they are going to be solved again" Voila! No explanation of underlying mechanism or reasoning through causal effects. Things just work.

The only sensible choice is to act now and worry about being wrong in the minds of naysayers later - and most likely never.

Advice? E L P

Tuesday 10 June 2008

Oil - How High Can You Go?

A collection of news headline clippings from two weeks:

Spot a trend?

The world is hurting: producers and finance banks are saying the price is going up.

The users and addicts are saying the price must go down.

In theoretical supply-demand economics with sufficient available alternatives and price elasticity of demand, prices do react accordingly.

However, in the real world of ever dwindling resources, geopolitical resource grab, rising demand and high price inelasticity, things are not so clear cut.

Who will win?

Supply wins. If supply isn't fixed or demand isn't reduced, the prices will rise.

The poor countries importing oil are already beyond hurt.

Now the rich OECD countries are being hit.

Analysts are saying that if oil doesn't fall to $75-$80 by end of 2009, we will see a much bigger wave of bankruptcies in the airline industry.

Oil probably still has a ways to go, before it crashes. And when it does, take a deep breath, as it will only go higher the next time.

Wednesday 4 June 2008

The New World Order of Energy

Fatih Birol of IEA was interviewed in the latest issue of Foreign Policy magazine.

Some excerpts:

FP: Can you tell us a little bit about your preliminary findings?

Fatih Birol: "We are entering a new world energy order. Today, demand for oil is dominated by China, India, and even by the Middle East countries themselves. The main actors of the recent past—namely the OECD countries, rich countries, the United States, Europe, Japan—their time is passé. It’s over."

FP: Do you believe in peak oil?

Birol: "Of course, but the question is when? .... When we look at oil outside of the OPEC countries, when you put all of them together, I think it is going to peak very soon."

"There is definitely financial speculation, but the main reason for the high prices is the growing perception in the markets that the future demand growth may not be met by the supply growth."

Tuesday 3 June 2008

Oil fields in pictures: Effect of new marginal fields

Some new videos: Hirsch, Simmons, Koppelaar, Udall...

Some videos snipped from TOD:

Dr. Robert Hirsch (MIS/SAIC/RAND) on Mitigation (download presentation)

Matthew Simmons on Saudi's oil reserves & can we find more (dl Simmon's latest presentation)

Rembrandt Koppelaar (ASPO-NL) on meaning of Peak Oil (dl latest Oilwatch monthly)

Amory Lovins (RMI) on new car efficiencies
Randy Udall (CORE) on unconventional oil like bitumen, tar sands [8 mins]

What do the Economists say?

A scary illustration thrown in to catch your attention

A comment often voiced about oil depletion is that surely the economists modeling the markets know about this and have something to say.

Unfortunately, barring a few physically minded economists (e.g. Ayres, Georgescu-Roegen) the number of economists trying to understand the issue has been relatively small. Most have been merely studying price elasticities, market substitution price levels and world economic growth impacts as black boxes with no input from the physical reality. That is, they have tacitly assumed without proof that markets will fix the issue and find a new equilibrium without a single hiccup.

However, the exceptions to the rule are coming to the surface now more frequently. A couple of noteworthy examples are:

Fueling Growth when Oil Peaks, Garcia, Smulders (2008)
"We also arrived at the conclusion that some important economic trends in
energy use and prices, which we observe in reality, are likely to be reversed in the
future. First, the model predicts that per capita energy use will start declining at some point in the future, and will keep declining in the long run."
Strategic Oil Dependency, Reyer Gerlagh, Matti Liski (2007)
"When moving to renewables and unconventional oil, the market becomes more capacity constrained when facing short run shocks, potentially increasing market power of those holding the remaining conventional oil stocks."

While the findings are not necessarily anything new to people following the oil depletion discussion, it is noteworthy that these are post-doc economists talking oil depletion and noting at least three interesting points that the mainstream economy watchers and the media seem to completely miss:

  1. We are likely to move into an energy constrained future (less energy/capita)
  2. Supply shocks become more likely (whatever the transition type)
  3. Most importantly: it is probably within the interest of OAPEC to keep the markets supplied and deny the peak, until it cannot be avoided anymore. At that point, the rapidly rising prices due to shrinking supply, and lack of alternative fuels due to lateness of new energy technology adoption ensure continued profit for AOPEC nations, even in the face of decreasing net exports. Or to put it in other words, the last remaining oil exporters will try to delay the rest of the world moving off oil to any other energy technology, because doing so will maximize the cumulative profits for such oil exporters (possibly at the expense of the security/price paid/stability of the oil users).
The last point is a worthy one. If a couple of European economists are able to model that, then surely the few dozen thousand investment bankers and economists working in Riyadh can manage the same. Oil producers are not stupid. They have their own people and future to think of.

Yes, it is just a model and model is not reality.

However, if in this case the model roughly approximates reality, then we're in for a ride of our life, when the last remaining giant reserve countries finally announce they've hit the peak. However, we are likely to get the same information via the markets, long before the countries admit it publicly.