First oil-related post

Crude prices ‘could be poised for rapid fall’

Found some oil news, waiting for my wife’s bus (actually I waited for several buses, but stopped doing so with the one carrying my wife).

First, someone at the Financial Times insisting oil prices could be about to plunge:

Crude prices fell more than $1 a barrel Monday as hedge funds took profits after their rise to near-record levels.

Frederic Lasserre, head of commodities research at Société Générale, said that some hedge funds were sitting on huge gains and that profit taking could start a rapid downward spiral for oil prices.

Indications are that speculation on appreciating oil prices is also drying up. This is not, to my mind, evidence that a sell-off is about to begin, nor is it evidence that hedge funds will dump their oil in a depreciating market. Do the writer actually need to be reminded that oil is running out? Faster than we appear likely to come up with a replacement?

I became immediately fond of a quote later in the same piece:

Pressure is mounting on the Organisation of the Petroleum Exporting Countries to raise production quotas at its next meeting, in September.

“Opec is quite simply not producing enough oil,” said analysts at the Centre for Global Energy Studies. “The world is short of crude and Opec needs to relax its output restraints immediately if it really wants to ensure a balanced market with prices around $60 a barrel.”

This sort of thing is beginning to do me in (the price reference is to another story about OPEC’s preferred crude price being USD60 to 65 per barrel – further evidence that, if they could fix it with increasing their quotas, or even meet increased production quotas, which is doutbful, they would).

Globally, demand is simply too high for the prices people ‘want’. Supply and Demand is quite simple to apply. If Demand increases but Supply does not increase, the price goes up:

oil graph 1

Giving higher prices (from P1 to P2) and higher quantities at equilibrium (from Q1 to Q2). What the people apparently in charge (or those behind the voices in the ears of the first), keep trying to wish into existence, is a counter-acting increase in supply:

oil graph 2

Which would still give us those higher quantities (Q3, this time), but prices stay at P1. The trick is the assumption that (i) supply is reasonably elastic in the short run, and that (ii) supply can be increased. Their wishes-that-aren’t-horses fail when supply of oil is something like this:

oil graph 3

which, near as most can agree, it more or less is, both in the short run and the long run. Notice in this version that the Quantity does not increase. Now, supposing Supply does look like this, and Demand is constantly increasing (and at a fairly significant rate, to boot), what do you think will happen to prices? Hedge funds may very well dump their speculative stock – ‘plunge’ is not likely to be the word I’d use to describe it.

Mind you, from what I read in the newspapers, editors these days seem to have a team of Bears and a team of Bulls writing for them, releasing each on alternating days. What would I know?

The value of the dollar is a potential factor here, as well. A falling US dollar means declining values of wealth and income for OPEC members, in the face of appreciating Pounds, Euros, etc. Given the above (i.e. demand is easily above supply, meaning what you produce is guaranteed a market), why would they increase production and cut prices, even if they could?

A quick characteristic of elasticity. With relatively inelastic demand/supply, price increases/decreases have little effect on quantity. Ergo, a shift in supply will affect a bigger drop in price than the increase in quantity – meaning a loss in revenue and profit. Meaning, also, that they’d hardly go for it out of their own self-interest.

Given the problem is demand-based, and in the US refined-supply-based (which is a US, not an OPEC, problem), there’s really no reason for OPEC to bend to the demands of the rest of us (again – even if they could). I could be wrong, of course. Come September we could win in Iraq and finally get all of their fields on-line. The drunkards’ luck of President Bush might come to his aid on this one.


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