Price of oil

From Wikipedia, the free encyclopedia

Oil prices, 18612011 (18611944 averaged US crude oil, 1945

1983 Arabian Light, 19842011 Brent). Red line adjusted for
inflation, blue not adjusted. Due to exchange rate fluctuations, the
red line represents the price experience of U.S. consumers only
(linear graph).

Long-term oil prices, 18612011 (logarithmic graph)

Brent barrel petroleum spot prices since May 1987. Due to exchange
rate fluctuations, the real price line is only relevant to the United
States and countries with a currency tied to the U.S. dollar at a
constant rate throughout the period.

Weekly reports on crude oil inventories or total stockpiles in storage

facilities like these tanks have a strong bearing on oil prices
The price of oil, or the oil price, generally refers to the spot price of
a barrel of benchmark crude oil.
In North America this generally refers to the WTI Cushing Crude Oil Spot Price West
Texas Intermediate (WTI), also known as Texas Light Sweet, a type of crude oil used
as a benchmark in oil pricing and the underlying commodity of New York Mercantile
Exchange's oil futures contracts. WTI is a light crude oil, lighter than Brent Crude oil.
It contains about 0.24% sulfur, rating it a sweet crude, sweeter than Brent. Its
properties and production site make it ideal for being refined in the United States,
mostly in the Midwest and Gulf Coast regions. WTI has an API gravity of around 39.6

(specific gravity approx. 0.827) per barrel (159 liters) of eitherWTI/light crude as
traded on the New York Mercantile Exchange (NYMEX) for delivery at Cushing,
Oklahoma, or of Brent as traded on the Intercontinental Exchange (ICE, into which
the International Petroleum Exchange has been incorporated) for delivery at Sullom
Voe. Cushing, Oklahoma, a major oil supply hub connecting oil suppliers to the Gulf
Coast, has become the most significant trading hub for crude oil in North America.
The price of a barrel of oil is highly dependent on both its grade, determined by
factors such as its specific gravity or API and its sulphur content, and its location.
Other important benchmarks include Dubai, Tapis, and theOPEC basket. The Energy
Information Administration (EIA) uses the imported refiner acquisition cost,
the weighted average cost of all oil imported into the US, as its "world oil price".
The demand for oil is highly dependent on global macroeconomic conditions.
According to the International Energy Agency, high oil prices generally have a large
negative impact on global economic growth.[1]
Organization of the Petroleum Exporting Countries (OPEC)
[edit]
Main article: OPEC

The Organization of the Petroleum Exporting Countries (OPEC) was formed in

1960[2] to try to counter the oil companies cartel, which had been controlling posted
prices since the so-called 1927 Red Line Agreementand 1928 Achnacarry Agreement,
and had achieved a high level of price stability until 1972.
Chronology[edit]
During 1999-mid 2008, the price of oil rose significantly. It was explained by the
rising oil demand in countries like China and India. [3] In the middle of the financial
crisis of 20072008, the price of oil underwent a significant decrease after the record
peak of US$145 it reached in July 2008. On December 23, 2008, WTI crude oil spot
price fell to US$30.28 a barrel, the lowest since the financial crisis of 2007
2010 began. The price sharply rebounded after the crisis and rose to US$82 a barrel in
2009.[4] On 31 January 2011, the Brent price hit $100 a barrel for the first time since
October 2008, on concerns about the political unrest in Egypt.[5]

For about three and half years the price largely remained in the $90$120 range. In
the middle of 2014, price started declining due to a significant increase in oil

production in USA, and declining demand in the emerging countries. [6] By 12

December 2014 the price of benchmark crude oil, both Brent and WTI reached their
lowest prices since 2009. Brent crude oil dropped to US$62.75 a barrel for January
delivery on the London-basedICE Futures Europe exchange and futures for West
Texas Intermediate (WTI) for January settlement slid to $58.80 a barrel in electronic
trading on the New York Mercantile Exchange (NYME) This represents a 40 per cent
decrease in 2014.[7]
History[edit]
Further information: 1967 Oil Embargo, 1973 oil crisis, 1979 energy
crisis, 1980s oil glut, and Oil price increase of 1990
Price history from 2003 onwards[edit]

Main article: World oil market chronology from 2003

Further information: 2000s energy crisis
Benchmark pricing[edit]
Main article: Benchmark (crude oil)

After the collapse of the OPEC-administered pricing system in 1985, and a short lived
experiment with netback pricing, oil-exporting countries adopted a market-linked
pricing mechanism.[8] First adopted by PEMEX in 1986, market-linked pricing
received wide acceptance and by 1988 became and still is the main method for pricing
crude oil in international trade.[8] The current reference, or pricing markers,
are Brent, WTI, andDubai/Oman.[8]
Market listings[edit]
Main article: Commodity market

Oil is marketed among other products in commodity markets. See above for details.
Widely traded oil futures, and related natural gas futures, include:[9]
Petroleum
o Nymex Crude Future
o Dated Brent Spot
o WTI Cushing Spot

o Nymex Heating Oil Future

o Nymex RBOB (Reformulated Blendstock for Oxygenate
Blending) Gasoline Future
Natural gas
o Nymex Henry Hub Future
o Henry Hub Spot
o New York City Gate Spot
Most of the above oil futures have delivery dates in all 12 months of the year. [10]
Speculation[edit]
Business Week reported (2008-06-27) that the surge in oil prices prior to 2008 had led
some commentators to argue that at least some of the rise was due to speculation in
the futures markets.[11]
2008 CFTC investigation[edit]
The U.S. Commodity Futures Trading Commission (CFTC) announced "Multiple
Energy Market Initiatives" on May 29, 2008. Part 1 is "Expanded International
Surveillance Information for Crude Oil Trading." The CFTC announcement stated it
has joined with the United Kingdom Financial Services Authority and ICE Futures
Europe in order to expand surveillance and information sharing of various futures
contracts.[12] This announcement has received wide coverage in the financial press,
with speculation about oil futures price manipulation. [13][14][15]

The interim report by the Interagency Task Force, released in July, found
that speculation had not caused significant changes in oil prices and that
fundamental supply and demand factors provide the best explanation for the crude oil
price increases. The report found that the primary reason for the price increases was
that the world economy had expanded at its fastest pace in decades, resulting in
substantial increases in the demand for oil, while the oil production grew sluggishly,
compounded by production shortfalls in oil-exporting countries.
The report stated that as a result of the imbalance and low price elasticity, very large
price increases occurred as the market attempted to balance scarce supply against

growing demand, particularly in the last three years. The report forecast that this
imbalance would persist in the future, leading to continued upward pressure on oil
prices, and that large or rapid movements in oil prices are likely to occur even in the
absence of activity by speculators. The task force continues to analyze commodity
markets and intends to issue further findings later in the year.
2014-2015 global oversupply[edit]
By 12 December 2014, the price of benchmark crude oil, both Brent and WTI reached
their lowest prices since 2009. Brent crude oil and accordingly to all type of Crude Oil
dropped to US$62.75 a barrel for January delivery on the London-based ICE Futures
Europe exchange and futures for West Texas Intermediate (WTI) for January
settlement slid to $58.80 a barrel in electronic trading on the New York Mercantile
Exchange(NYME). This represents a 40 percent decrease in 2014. [7] The CIBC
reported that the global oil industry continued to produce massive amounts of oil in
spite of a stagnant crude oil market. Oil production from theBakken formation was
forecast in 2012 to grow by 600,000 barrels every year through 2016. By 2012
Canadian tight oil and oil sands production was also surging. [16]

In June 2014 crude oil prices dropped by about a third as U.S. shale oil production
increased and China and Europe's demand for oil decreased. In spite of huge global
oversupply, on 27 November 2014 in Vienna, Saudi Oil Minister Ali al-Naimi,
blocked the appeals from the poorer OPEC member states, such as Venezuela, Iran
and Algeria, for production cuts. Benchmark crude, Brent oil plunged to US$71.25, a
four-year low. Al-Naimi argued that the market would be left to correct itself, this
decision will result to shut down the small companies in US & to slow Shale
Fracturing operations in US. OPEC had a "long-standing policy of defending prices."
OPEC is ready to let the Brent oil price drop to $60 to slow down US shale oil
production.[17] In spite of a troubled economy in member countries, al-Naimi repeated
his statement on Saudi inaction on 10 December 2014. [18] By the end of 2014, as the
demand for global oil consumption continued to decline, the remarkably rapid oil
output growth in light, tight oil production in the North Dakota Bakken,
the Permian andEagle Ford Basins in Texas, while rejuvenating economic growth in
"U.S. refining, petrochemical and associated transportation industries, rail &
pipelines, destabilized international oil markets." [19]
In early 2015, the US oil price fell below $50 per barrel dragging Brent oil to just
below $50 as well.[20]

Steve Briese, a commodity analyst, who had forecasted in March 2014 a decline to
world price to $75 from $100, based on 30 years of extra supply [21] in early December
2014 projected a low of $35 a barrel.[22] On Jan 8, 2015 commodity hedge fund
manager Andrew J. Hall suggested that $40-a-barrel is close to an absolute price
floor, adding that a significant amount of U.S. and Canadian production cant cover
the cash costs of operating at that price. [23]
In mid-January 2015, Goldman Sachs predicted the U.S. oil benchmark to average
$40.50 a barrel and Brent to average $42 a barrel in the second quarter. For the year,
Goldman sees Brent prices averaging $50.40 and for the U.S. benchmark, $47.15 a
barrel in 2015, down from $73.75.[24]
America's paradox: Hydraulic fracturing shale oil is still profitable[edit]

According to Bloomberg Business, the efficiency of [25] of newer shale oil wells that
use hydraulic fracturing in the United States, combined with the US$12 million dollar
upfront well drilling and construction costs, provide incentives to oil producers to
continue to flood the already glutted market with under-priced oil in spite of crude oil
storage limitations.[25] Many less efficient and less productive older wells were shut
down but these shale oil wells continue to increase production while making a profit
in a market where crude oil is priced as low as US$50 a barrel. [25]

Oil-storage trade (Contango)[edit]

Main article: Oil-storage trade

The Knock Nevis (1979-2010), a ULCC supertanker and the longest

ship ever built.
The strategy works because oil prices for delivery in the future are trading at a
premium to those in the spot market - a market structure known in the industry as
contango - with investors expecting prices to eventually recover from the near 60
percent slide in oil in the last seven months.
Reuters 2015
The oil-storage trade, also referred to as contango, a market strategy in which large,
often vertically-integrated oil companies purchase oil for immediate delivery and
storagewhen the price of oil is low and hold it in storage until the price of oil
increases. Investors bet on the future of oil prices through a financial instrument, oil
futures in which they agree on a contract basis, to buy or sell oil at a set date in the
future. Crude oil is stored in salt mines, tanks and oil tankers. [26]
Investors can choose to take profits or losses prior to the oil-delivery date arrives. Or
they can leave the contract in place and physical oil is "delivered on the set date" to an
"officially designated delivery point", in the United States, that is usually Cushing,
Oklahoma. When delivery dates approach, they close out existing contracts and sell
new ones for future delivery of the same oil. The oil never moves out of storage. If the
forward market is in "contango"the forward price is higher than the current spot
pricethe strategy is very successful.

Scandinavian Tank Storage AB and its founder Lars Jacobsson introduced the concept
on the market in early 1990.[27] But it was in 2007 through 2009 the oil storage trade
expanded.[28] with many participantsincluding Wall Street giants, such as Morgan
Stanley, Goldman Sachs, and Citicorpturning sizeable profits simply by sitting on
tanks of oil.[29] By May, 2007 Cushing's inventory fell by nearly 35% as the oil-storage
trade heated up.[29]
"The trend follows a spike in oil futures prices that has created incentives for traders
to buy crude oil and oil products at current rates, sell them on futures markets and
store them until delivery."
Financial Post 2009
By the end of October 2009 one in twelve of the largest oil tankers were being used
more for temporary storage of oil, rather than transportation. [30]
From June 2014 to January 2015, as the price of oil dropped 60 percent and the supply
of oil remained high, the world's largest traders in crude oil purchased at least 25
million barrels to store in supertankers to make a profit in the future when prices rise.
Trafigura, Vitol, Gunvor, Koch, Shell and other major energy companies began to
book booking oil storage supertankers for up to 12 months. By 13 January 2015 At
least 11 Very Large Crude Carriers (VLCC) and Ultra Large Crude Carriers (ULCC)"
have been reported as booked with storage options, rising from around five vessels at
the end of last week. Each VLCC can hold 2 million barrels." [31]
In 2015 as global capacity for oil storage was out-paced by global oil production, and
an oil glut occurred. Crude oil storage space became a tradable commodity with CME
Group which owns NYMEX offering oil-storage futures contracts in March
2015.[26] Traders and producers can buy and sell the right to store certain types of oil. [26]
By 5 March 2015, as oil production outpaces oil demand by 1.5 million barrels a day,
storage capacity globally is dwindling. Crude oil is stored in old salt mines, in tanks
and on tankers.[26] In the United States alone, according to data from the Energy
Information Administration, U.S. crude-oil supplies are at almost 70% of the U. S.
storage capacity, the highest to capacity ration since 1935. [26]

Comparative cost of production[edit]

In this table based on the Scotiabank Equity Research and Scotiabank Economics
report published 28 November 2014,[19] economist Mohr compares the cost of
cumulative crude oil production in the fall of 2014.

Plays

Cost of production in northern

hemisphere autumn 2014

Saudi Arabia

US$1025 per barrel

Montney Oil Alberta and

US$46
British Columbia
Saskatchewan Bakken

US$47

Eagle Ford, USA Shale+

$406 US$50 (+ Liquids-rich Eagle Ford

plays, assuming natural gas prices of
US$3.80 per mmbtu)

Lloyd & Seal

US$50
Conventional Heavy, AB
Conventional Light,
Alberta and
Saskatchewan

US$58.50

Nebraska USA Shale

US$58.50

SAGD Bitumen Alberta

US$65

North Dakota Bakken,

Shale

US$5479

Permian Basin, TX Shale US$5982

Oil sands legacy
projects

US$53

Oil sands mining and

US$90

infrastructure new
projects
This analysis "excludes "'up-front' costs (initial land acquisition, seismic and infrastructure
costs): treats 'up-front' costs as 'sunk'. Rough estimate of 'up-front' costs = US$510 per barrel,
though wide regional differences exist. Includes royalties, which are more advantageous in
Alberta and Saskatchewan." The Weighted average of US$60-61 includes existing Integrated Oil
Sands at C$53 per barrel."[19]

Future projections[edit]
Main articles: Oil depletion and Peak oil

Peak oil is the period when the maximum rate of global petroleum extraction is
reached, after which the rate of production enters terminal decline. It relates to a longterm decline in the available supply of petroleum. This, combined with increasing
demand, will significantly increase the worldwide prices of petroleum derived
products. Most significant will be the availability and price of liquid fuel for
transportation.
The US Department of Energy in the Hirsch report indicates that The problems
associated with world oil production peaking will not be temporary, and past energy
crisis experience will provide relatively little guidance. [32] The 2014 United Nations
World Economic Situation and Prospects report notes that "Oil prices were on a
downward trend in the first half of 2013 (after a spike in January and February caused
by geopolitical tensions with Iran), as global demand for oil weakened along with the
deceleration in world economic growth overall." [33]
Impact of declining oil price[edit]
A major rise or decline in oil price can have both economic and political impacts. The
decline on oil price during 1985-1986 is considered to have contributed to the fall of
the Soviet Union.[34]

Declining oil prices may boost consumer oriented stocks but may hurt oil-based
stocks.[35][36] It is estimated that 17-18% of S&P would decline with declining oil prices.
The oil importing countries like Japan, China or India would benefit, however the oil
producing countries would lose.[37][38][39] A Bloomberg article presents results of an
analysis by Oxford Economics on the GDP growth of countries as a result of the a

drop from $84 to $40. It shows the GDP increase between 0.5% to 1.0% for India,
USA and China, and a decline of greater than 3.5% from Saudi Arabia and Russia. A
stable price of $60 would add 0.5 percentage point to global gross domestic product. [40]
Katina Stefanova has argued that falling oil prices do not imply a recession and a
decline in stock prices.[41] Liz Ann Sonders, Chief Investment Strategist at Charles
Schwab, had earlier written that that positive impact on consumers and businesses
outside of the energy sector, which is a larger portion of the US economy will
outweigh the negatives.[42]

Ten Reasons Why High Oil Prices are a Problem

Posted on January 17, 2013 by Gail Tverberg

A person might think from looking at news reports that our oil problems are gone,
but oil prices are still high.

Figure 1. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data)
converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.

In fact, the new tight oil sources of oil which are supposed to grow in supply are still
expensive to extract. If we expect to have more tight oil and more oil from other
unconventional sources, we need to expect to continue to have high oil prices. The new
oil may help supply somewhat, but the high cost of extraction is not likely to go away.
Why are high oil prices a problem?
1. It is not just oil prices that rise. The cost of food rises as well, partly because oil is
used in many ways in growing and transporting food and partly because of the
competition from biofuels for land, sending land prices up. The cost of shipping goods of
all types rises, since oil is used in nearly all methods of transports. The cost of materials
that are made from oil, such as asphalt and chemical products, also rises.
If the cost of oil rises, it tends to raise the cost of other fossil fuels. The cost of natural
gas extraction tends to rises, since oil is used in natural gas drilling and in transporting
water for fracking. Because of an over-supply of natural gas in the US, its sales price is
temporarily less than the cost of production. This is not a sustainable situation. Higher
oil costs also tend to raise the cost of transporting coal to the destination where it is
used.

Figure 2. US Energy Prices as % of Wages and as of GDP. Ratio to GDP provided by EIAShort Term Economic
Outlook Figure 27, converted to Wage Base by author, using same wages as described for Figure 3.

Figure 2 shows total energy costs as a percentage of two different bases: GDP and
Wages. These costs are still near their high point in 2008, relative to these bases.
Because oil is the largest source of energy, and the highest priced, it represents the
majority of energy costs. GDP is the usual base of comparison, but I have chosen to
show a comparison to wages as well. I do this because even if an increase in costs takes
place in the government or business sector of the economy, most of the higher costs will
eventually have to be paid for by individuals, through higher taxes or higher prices on
goods or services.
1

2. High oil prices dont go away, except in recession.

We extracted the easiest (and cheapest) to extract oil first. Even oil company executives
say, The easy oil is gone. The oil that is available now tends to be expensive to extract
because it is deep under the sea, or near the North Pole, or needs to be fracked, or is
thick like paste, and needs to be melted. We havent discovered cheaper substitutes,
either, even though we have been looking for years.
In fact, there is good reason to believe that the cost of oil extraction will continue to rise
faster than the rate of inflation, because we are hitting a situation of diminishing
returns. There is evidence that world oil production costs are increasing at about 9%
per year (7% after backing out the effect of inflation). Oil prices paid by consumers will
need to keep pace, if we expect increased extraction to take place. There is even
evidence that sweet sports are extracted first in Bakken tight oil, causing the cost of this
extraction to rise as well.
3. Salaries dont increase to offset rising oil prices.
Most of us know from personal experience that salaries dont rise with rising oil prices.
In fact, as oil prices have risen since 2000, wage growth has increasingly lagged GDP
growth. Figure 3 shows the ratio of wages (using the same definition as in Figure 2) to
GDP.

Figure 3. Wage Base (defined as sum of Wage and Salary Disbursements plus Employer Contributions for Social
Insurance plus Proprietors Income from Table 2.1. Personal Income and its Distribution) as Percentage of GDP,
based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

If salaries dont rise, and prices of many types of goods and services do, something has
to give. This disparity seems to be the reason for the continuing economic discomfort
experienced in the past several years. For many consumers, the only solution is a longterm cut back in discretionary spending.
4. Spikes in oil prices tend to be associated with recessions.
Economist James Hamilton has shown that 10 out of the last 11 US recessions were
associated with oil price spikes.
When oil prices rise, consumers tend to cut back on discretionary spending, so as to
have enough money for basics, such as food and gasoline for commuting. These cutbacks in spending lead to lay-offs in discretionary sectors of the economy, such as
vacation travel and visits to restaurants. The lay-offs in these sectors lead to more
cutbacks in spending, and to more debt defaults.
5. High oil prices dont recycle well through the economy.

Theoretically, high oil prices might lead to more employment in the oil sector, and more
purchases by these employees. In practice, this provides only a very partial offset to
higher price. The oil sector is not a big employer, although with rising oil extraction
costs and more US drilling, it is getting to be a larger employer. Oil importing countries
find that much of their expenditures must go abroad. Even if these expenditures are
recycled back as more US debt, this is not the same as more US salaries. Also, the United
States government is reaching debt limits.
Even within oil exporting countries, high oil prices dont necessarily recycle to other
citizens well. A recent study shows that 2011 food price spikes helped trigger the Arab
Spring. Since higher food prices are closely related to higher oil prices (and occurred at
the same time), this is an example of poor recycling. As populations rise, the need to
keep big populations properly fed and otherwise cared for gets to be more of an issue.
Countries with high populations relative to exports, such as Iran, Nigeria, Russia,
Sudan, and Venezuela would seem to have the most difficulty in providing needed goods
to citizens.
6. Housing prices are adversely affected by high oil prices.
If a person is required to pay more for oil, food, and delivered goods of all sorts, less will
be left over for discretionary spending. Buying a new home is one such type of
discretionary expenditure.
US housing prices started to drop in mid 2006, according to data of the S&P Case Shiller
home price index. This timing fits in well with when oil prices began to rise, based on
Figure 1.
7. Business profitability is adversely affected by high oil prices.
Some businesses in discretionary sectors may close their doors completely. Others may
lay off workers to get supply and demand back into balance.
8. The impact of high oil prices doesnt go away.
Citizens discretionary income is permanently lower. Businesses that close when oil
prices rise generally dont re-open. In some cases, businesses that close may be replaced
by companies in China or India, with lower operating costs. These lower operating costs

indirectly reflect the fact that the companies use less oil, and the fact that their workers
can be paid less, because the workers use less oil. This is a part of the reason why US
employment levels remain low, and why we dont see a big bounce-back in growth after
the Great Recession. Figure 4 below shows the big shifts in oil consumption that have
taken place.

Figure 4. Percentage growth in oil consumption between 2006 and 2011, based on BPs 2012 Statistical Review of
World Energy.

A major part of the fix for high oil prices that does takes place is provided by the
government. This takes the place in the form of unemployment benefits, stimulus
programs, and artificially low interest rates.
Efficiency changes may provide some mitigation, as older less fuel-efficient cars are
replaced with more fuel-efficient cars. Of course, if the more fuel-efficient cars are more
expensive, part of the savings to consumers will be lost because of higher monthly
payments for the replacement vehicles.
9. Government finances are especially affected by high oil prices.

With higher unemployment rates, governments are faced with paying more
unemployment benefits and making more stimulus payments. If there have been many
debt defaults (because of more unemployment or because of falling home prices), the
government may also need to bail out banks. At the same time, taxes collected from
citizens are lower, because of lower employment. A major reason (but not the only
reason) for todays debt problems of the governments of large oil importers, such as US,
Japan, and much of Europe, is high oil prices.
Governments are also affected by the high cost of replacing infrastructure that was built
when oil prices were much lower. For example, the cost of replacing asphalt roads is
much higher. So is the cost of replacing bridges and buried underground pipelines. The
only way these costs can be reduced is by doing lessgoing back to gravel roads, for
example.
10. Higher oil prices reflect a need to focus a disproportionate share of
investment and resource use inside the oil sector. This makes it
increasingly difficult maintain growth within the oil sector, and acts to
reduce growth rates outside the oil sector.
There is a close tie between energy consumption and economic activity because nearly
all economic activity requires the use of some type of energy besides human labor. Oil is
the single largest source of energy, and the most expensive. When we look at GDP
growth for the world, it is closely aligned with growth in oil consumption and growth in
energy consumption in general. In fact, changes in oil and energy growth seem to
precede GDP growth, as might be expected if oil and energy use are a cause of world
economic growth.

Figure 5. Growth in World GDP, energy consumption, and oil consumption. GDP growth is based on USDA
International Macroeconomic Data. Oil consumption and energy consumption growth are based on BPs 2012
Statistical Review of World Energy.

The current situation of needing increasing amounts of resources to extract oil is

sometimes referred to one of declining Energy Return on Energy Invested (EROEI).
Multiple problems are associated with declining EROEI, when cost levels are already
high:
(a) It becomes increasingly difficult to keep scaling up oil industry investment because
of limits on debt availability, when heavy investment is made up front, and returns are
many years away. As an example, Petrobas in Brazil is running into this limit. Some US
oil and gas producers are reaching debt limits as well.
(b) Greater use of oil within the industry leaves less for other sectors of the economy. Oil
production has not been rising very quickly in recent years (Figure 6 below), so even a
small increase by the industry can reduce net availability of oil to society. Some of this
additional oil use is difficult to avoid. For example, if oil is located in a remote area,
employees frequently need to live at great distance from the site and commute using oilbased means of transport.

Figure 6. World crude oil production (including condensate) based primarily on US Energy Information
Administration data, with trend lines fitted by the author.

(c) Declining EROEI puts pressure on other limited resources as well. For example,
there can be water limits, when fracking is used, leading to conflicts with other use, such
as agricultural use of water. Pollution can become an increasingly large problem as well.
(d) High oil investment cost can be expected to slow down new investment, and keep oil
supply from rising as fast world demand rises. To the extent that oil is necessary for
economic growth, this slowdown will tend to constrain growth in other economic
sectors.
Airline Industry as an Example of Impacts on Discretionary Industries
High oil prices can be expected to cause discretionary sectors to shrink back in size. In
many respects, the airline industry is the canary in the coal mine, showing how
discretionary sectors can be forced to shrink.
In the case of commercial air lines, when oil prices are high, consumers have less money
to spend on vacation travel, so demand for airline tickets falls. At the same time, the

price of fuel to operate airplanes rises, making the cost of operating airplanes higher.
Business travel is less affected, but still is affected to some extent, because some longdistance business travel is discretionary.
Airlines respond by consolidating and cutting back in whatever ways they can. Salaries
of pilots and stewardesses are reduced. Pension plans are scaled back. New more fuelefficient aircraft are purchased, and less fuel-efficient aircraft are phased out. Less
profitable routes are closed. The industry still experiences bankruptcy after bankruptcy,
and merger after merger. If oil prices stabilize for a while, this process stabilizes a bit,
butdoesnt really stop. Eventually, the commercial airline industry may shrink to such
an extent that necessary business flights become difficult.
There are many discretionary sectors besides the airline industry waiting in the wings to
shrink. While oil prices have been high for several years, their effects have not yet been
fully incorporated into discretionary sectors. This is the case because governments have
been able to use deficit spending and artificially low interest rates to shield consumers
from the real impacts of high-priced oil.
Governments are now finding that debt cannot be ramped up indefinitely. As taxes need
to be raised and benefits decreased, and as interest rates are forced higher, consumers
will again see discretionary income squeezed. New cutbacks are likely to hit additional
discretionary sectors, such as restaurants, the arts, higher education, and medicine for
the elderly.
It would be very helpful if new unconventional oil developments would fix the problem
of high-cost oil, but it is difficult to see how they will. They are high-cost to develop and
slow to ramp up. Governments are in such poor financial condition that they need taxes
from wherever they can get themrevenue of oil and gas operators is a likely target. To
the extent that unconventional oil and gas production does ramp up, my expectation is
that it will be too little, too late, and too high-priced.
Note:
[1] Wages include private and government wages, proprietors income, and taxes paid by
employers on behalf of employees. They do not include transfer payments, such as
Social Security.

The Reasons for High

Oil Prices
By Gail Tverberg
Posted on Mon, 27 February 2012 23:11 | 6
Rising oil and gasoline prices are of concern to many people today. I see three basic
issues involved:
1. Stalled out growth in world oil supply
2. Concerns about Iran
3. Artificially low interest rates
Stalled Out Oil Supply Leads to Five Million Barrel a Day Shortfall in 2011
In my view, the biggest contributor to high oil prices is the first onestalled out oil
supply. At this point, the interaction between oil demand and oil supply does not work
in the way most people expect it would. Even if the price of oil rises, world oil production
doesnt increase by very much (Figure 1), if at all.

Figure 1. Brent oil spot price and world oil supply (broadly defined), based on EIA data.

In the words of economists, world oil supply is relatively inelastic. This is true, even
though the oil supply shown in Figure 1 is what is sometimes called All Liquids, so
includes substitutes for crude oil, such as biofuels, natural gas liquids, refinery gain,
and any fuels from coal-to-liquid and gas-to-liquid processes. These substitutes are not
growing by enough to make up for the shortfall in crude oil growth.
If we compare recent oil production with that in the 1980s and 1990s, we see that about
2005, growth in world oil supply suddenly slowed down (Figure 2).

Figure 2. World oil production (broadly defined) based on EIA data, with exponential
trend line fitted by author to 1983 to 2005 values.
Between 1983 and 2005, world oil supply rose by 1.64% per year. If world oil supply had
continued to rise at that rate, oil production would have been about 5 million barrels a
day higher in 2011 than it actually was. The fact that oil production has remained
relatively flat since 2005 is the primary reason oil prices have continued to rise, except
during the 2008-2009 recession. (This recession was to a significant extent caused by
high oil pricesI wrote an academic article on this subject, published in the journal
Energy called, Oil Supply Limits and the Continuing Financial Crisis, summarized in this
post. Economist James Hamilton has also written on this subject.)
The amount of the oil shortfall is huge. It is far more than the amount of oil taken off-line
by Libya, and more than Saudi Arabias supposed spare production capacity. Given the
high price of oil, most of the missing oil seems to be oil that we do not have production
capacity for.
In recent years, emerging markets such as China and India have been increasing their
demand for oil. If anything, it seems as if their huge additional demand would ramp up

required oil supply even more quickly than predicted by a trend line from the 1983-2005
period. Instead actual production (and consumption) is lower since 2005.

Is This The Most Lucrative Investment In Modern History?

A new type of investment just recently became available to individual oil & gas
investors. Because of the recent crash in oil and the timing of a new law, it could be the
most lucrative investment in modern history. I want to give you a step-by-step guide (at
no cost) on how you can get started and potentially retire from it.

Other Reasons Oil Prices Are High

Iran. Clearly concern about the Iran situation is having an impact on oil prices. As long
as there is worry about instability in the Middle East, there is likely to be pressure on oil
prices. Iran produces about 4.2 million barrels a day, and consumes about 1.8 million
barrels a day, leaving about 2.4 million barrels a day for exports. Of this, 2,156,000
is reported by the EIA to be exports of crude oil; the remainder is exported as refined
products.

Figure 3. Iranian oil production and consumption. Figure by EIA.

According to the EIA, Irans top export destinations are China, Japan, and India. The EU
and Turkey are said to import 650,000 barrels of oil a day, with one source in Turkey
accounting for 200,000 barrels of the total. France and Britain are reported to account
for very little of Irans oil exports.
Besides concern about exports, there is also concern that oil that might be delayed
passing through the Strait of Hormuz. Currently 17 million barrels a day of oil passes
through the Strait of Hormuz, with 85% of these exports headed for Asian destinations.
While other routes are available, there would be delays and higher costs involved. Even
if the delays do not directly affect the US and the EU, there would likely be indirect
impacts on world markets.
The world clearly cannot get along without 2.4 million barrels a day of exports from Iran,
although perhaps losing only the EU portion of those exports (about 500,000 barrels a
day) might be tolerable for a time. While some oil from Libya is coming back on line, oil
prices are still very high. In a world where oil production is not rising by much, any loss
of production is a problem because of the adverse impact high oil prices have on
economies of oil importing countries, including those of the EU, Japan, and the United
States. Any loss of production also leaves us more vulnerable to disruptions if another
oil exporter suddenly has difficulties.
Low interest rates. Low interest rates should theoretically not directly affect oil prices,
but if alternative forms of investment do not provide a reasonable yield, this fact may
affect oil decisions as well. For example, if prices are trending upward, there may seem
to be a premium for holding oil off the market. If interest rates are very low, this will
make the comparison seem even better. Thus artificially low interest rates would seem
to reinforce an upward oil price trend.
Furthermore, if artificially low interest rates actually induce businesses and individuals
to invest in durable goods, production of these goods will require more oil, as well as
other types of commodities. But we have already seen that oil supply does not really
increase by much, even with large price increases. Thus, because of this effect, low
interest rates will also act to increase oil prices, at least until recession (because of high
oil prices) hits again.
By. Gail Tverberg
Gail Tverberg is a writer and speaker about energy issues. She is especially known for
her work with financial issues associated with peak oil. Prior to getting involved with
energy issues, Ms. Tverberg worked as an actuarial consultant. This work involved
performing insurance-related analyses and forecasts. Her personal blog is
ourfiniteworld.com. She is also an editor of The Oil Drum.

Why the oil price is falling

Conclusion
Ten Reasons Why High Oil Prices are a Problem
It was very interesting to read your take on the impact on discretionary industries, as
exemplified by the airline industry.
Id like to see a similar analysis on non-discretionary industries, such as food and
agriculture.
While it is possible for some segments of the population to move down the food chain
doing more cooking of raw foodstuffs, rather than buying processed food, for example,
the fact remains that we all eat for a living. I dont have any good mental models for
what happens when a declining resource meets inelastic demand.
I think how agriculture fares depends on how well the current system will hold
together. As long has we have the major parts of the system that we are used to (banks
that can be used to pay employees; operating farm machinery; a system of making and
distributing hybrid seed, fertilizer, and herbicides, and pesticides) then we can have
business as usual. If something happens to break the system, such as the US dollar
losing its reserve currency status so that interest rates skyrocket overnight and the value
of the dollar drops, then we could find serious breaks in the system quite quickly. So far,
things have held together amazingly well. It would seem likely that if a break does come,
it will relate in some way to all of the debt problems around the world.
Maybe what I should say is that current levels of natural gas production at these prices is
unsustainable. I agree that it is difficult for natural gas prices to go up. If nothing else,
coal prices tend to act as a cap for natural gas prices in the US (although we have seen a
lot of spikes in the past). With so many small companies with use or lose leases, there
tends to be a lot of natural gas overproduction.
There will continue to be some natural gas production at these low prices, because some
natural gas (particularly that associated with oil that fully covers both natural gas and oil
costs) is cheap to produce. But I doubt that there will be enough of this for very long.

These folks dont seem to understand the idea that oil does far more than what its dollar value
would seem to suggest. It really is like another employee, that is able to take on tasks humans
cant handle by themselves. The oil employees have now demanded a raise. The total amount
produced wont increase, so it is hard to give oil employees a raise, without either reducing the
amount other (real) employees are paid, or reducing profits for the company. The one approach
that might work, if there is some demand for higher priced products (but not the full amount of
demand for the current price of the products) is to close down the least profitable part of the
company. (It this were an airline, it might mean canceling flights that often were not completely
full, and laying off employees of all types for those flights.) With the scaled-back size of the
company, it might be able to go forward, and charge the higher price needed because of the
higher energy cost, but to a scaled back group of customers. The net result would be similar to
what I suggested in my post How is an oil shortage like a missing cup of flour?If oil prices are
too high, it becomes necessary for make a smaller batch, just as the situation that happens if
you dont have enough flour to make a full batch of cookies. This is pretty the situation that
happens in recession.

Let me turn the question around and ask if there are any advantages to high oil prices.
Most obviously, of course, is that to the extent that high oil prices reduce the size of the
money economy, they have all sorts of ecological benefits.
But over a longer term, high oil prices and a reduction in the size of the money economy
also selects for humans who are capable of living more efficiently. If we take as examples
of the most inefficient we can consider the very rich people that Nate Hagens describes
having worked forno matter how much they had, they wanted more, and were unhappy
if they didnt get it. Furthermore, happiness did not last if they did get what they
wanted. High oil prices probably select these people right out of the gene and meme
pool. When we look around for examples of people who are capable of living a good life
with simple physical requirements, the question gets a little more complicated. Those of
these kinds of people that we hear about are likely to live both a public and a private life.
If their public life involves making extravagant use of travel to spread their message, we
might cut them a little slackbut not too much.
If we focus on the private lives, each of us can probably find people to admire: Thomas
Merton at Gethsemani monastery in Kentucky; Thich Nhat Hanh at Plum Village in
France; Ralph Nader in New York City; Thoreau at Walden Pond; an old hippie farmer I
know who says that if a man cant be live well on $30,000 a year, hes just not trying.
Some of these people also live very frugal public lives. We can also find examples of
people with large public lives achieved frugally, such as Sharon Astyk. And I have heard

about a mild-mannered actuary who ducks into alleys, strips down to her leotards, and
flies through the air without benefit of fossil fuels, slaying errors.
If high oil prices select for these kinds of people, and against the people Nate was working for,
then the world will be a much better place. What we are talking about here is meme selection, as
opposed to physical changes such as metabolic efficiency selection. Memes spread, but are also
subject to decay (as we can see if we examine the differences between the dominant memes of
the Depression generation and the Baby Boomer generation). Continued high oil prices would
tend to keep the new memes in place.

The Reasons for High Oil Prices

It is good, peoples to understand what is happening around the world.
The world actually is addicted with cheap oil. Unfortunately, cheap oil era has gone and cannot
returned back.
The low interest rates are intended to accelerate the new investment on oil and gas industry. The
new investment, if the investitures will agree to invest, will increase the production, or at least will
decrease the decline rates on liquid production.
It looks that the new investment are not enough to keep peace on oil demand, then it is only the high
price of crude oil that will decrease the demand, and will increase the possibilities for more
investments on upstream.
It is not that the western countries, the governments do not want to have cheap oil. The problem is
that actually, the market does not have cheap oil. On these circumstances, the solution is to destroy
the high demand, and bring it on the level to match with oil supply.
The end of the cheap oil era does not mean the end of the mankind. The balance of oil demand with
the supply can be done only by decreasing the oil consumed on transportation.
Increasing the car efficiency is good, but this cannot be done without investment. Imagine, that this
is possible, let say we will have the money to by the high efficiency cars today, we will have the
problem that the market do not have a billion cars. The temporary solution, even it is not satisfying
us, is increase the oil price, increase the pump prices, and decrease the oil demand to the level of oil
supply.
This will affect mostly the low income peoples, but if there is not any other solution on the table, this
will be done automatically. These low income people have the right to increase their standard of
living, and more important for them is not having a car, but having a job.
Increasing the oil price, will increase the investment on exploration and development and will open
new jobs. The high oil price will effect and other goods prices, but this is the general trend on a
system where the currency changes by inflation deflation etc. The main problem for a society, I
believe, is having jobs for everybody, and increases the standard of living within their possibility. A
society with unemployment is a society that needs changes. I cannot continue the discussion on this
direction, I am not a politician, I am a technocrat, and I see more my job. My job is haw I can
contribute the society with more energy.
Let I close the discussion, that for the moment, the oil price increase is a thing that will balance the
demand with supply. Hopefully, other energy sources will be available on a short time.