Will 2011 be a rerun of 2008? (Longer version)

A post similar to this is in today’s ASPO-USA Newsletter.

We all remember the oil price run-up (and run back down) of 2008. Now, with prices similar to where they were in the fall of 2007, the question quite naturally arises as to whether we are headed for another similar scenario.

Of course, we know that the scenario cannot really be the same. World economies are now much weaker than in late 2007. Several countries are having problems with debt, even with oil at its current price. If the oil price rises by $20 or $30 or $40 barrel, we can be pretty sure that those countries will be in much worse financial condition. And while governments have learned to deal with collapsing banks, citizens have a “been there, done that” attitude. They may not be as willing to bail out banks that seem to be contributing to the problems of the day.

If we look back at what happened three years ago, there was a huge run up in the price of oil, but very little change in oil supply.

Figure 1. Production of oil (crude and condensate) for OPEC and Non-OPEC countries, compared to West Texas intermediate oil price, in September 2010$. Based on EIA data.

Oil price roughly corresponded to today’s price in October 2007. Between then and July 2008 (the peak in both prices and production), OPEC increased its oil supply by 1.3 million barrels. Non-OPEC actually decreased its supply by about 0.3 million barrels a day between October 2007 and July 2008, providing a net increase in oil supply of only about 1 million barrels a day, despite the huge run-up in prices.

A person can see from the above graph that the supply of OPEC oil has tended to increase, as oil prices increase. Non-OPEC supply has been much less responsive to price. This is another way of graphing the relationship between oil price and oil production:

Figure 2. Relationship of oil production (crude and condensate) and West Texas Intermediate price, expressed in September 2010 $, based on monthly EIA data from January 2001 through September 2010.

In Figure 2, as oil price increases along the horizontal axis, we see that non-OPEC oil production remains virtually flat. As oil price increases for the OPEC 12, we see the kind of supply curve we might expect to see for a supplier that has a small amount of more expensive capacity that it can put on line when prices justify it. The catch is that the amount of supply added as prices rise isn’t really very much–as we just saw, 1.3 million barrels a day, between October 2007 and July 2008.

Eventually, the economy could not handle the high oil prices, and prices dropped. Credit availability began dropping and recession became a greater and greater issue.

Will this time be different? It seems to me that OPEC has done a good job of convincing the world that it has a lot of extra supply, but it is less than clear that it has much more excess capacity than it had in the 2007-2008 period. OPEC shows this image on its website, but this may just be a long-standing approach aimed at convincing the world that it has more oil (and power) than it really does.

Figure 3. OPEC’s view of its own spare capacity.

Spare capacity, like oil reserves, is not audited. The higher the numbers proclaimed to the world, the more powerful OPEC appears, both in the eyes of its own people, and in the eyes of people around the world. OPEC shows lists of new projects and investment amounts, but it is not clear that the new capacity being added is more than what is needed to offset declines in other fields. The new production amounts listed come to something like 6% of production – this could simply represent offsets to declines in fields elsewhere. The problem is we really don’t know, because no auditing is ever done. We are just expected to trust Saudi Arabia and OPEC, on a matter of importance to the world.

OPEC tells us it is acting as a cartel, but when a person looks closely at the data, only three countries appear to be pumping at less than full capacity: Saudi Arabia, United Arab Emirates, and Kuwait. Production rises and falls with price for these countries. It is not all that difficult to coordinate the activities of three countries, especially when one of them–Saudi Arabia–is doing most of the adjustment to oil supply. So all of OPEC’s marvelous abilities may not be all that marvelous. If Saudi Arabia knows it can sell oil it withholds from the market at a higher price later, it is not a bad move to hold a bit of oil off the market, and claim that the amount being held off the market is much higher.

In the next year, there is a significant chance that oil demand may rise. While oil supplies are at this point adequate, if demand continues to grow, we could very well see another surge in oil prices, and another test as to whether there really is spare capacity. If the supply curves shown in Figure 2 are any indication, we won’t be getting much more oil, perhaps another 1.5 million barrels a day, even if prices spike.

The one possibility that would seem to postpone such a price run-up is if world economies in the very near term start heading into major recession. Such a recession might indicate that even the current oil price is too high for economies to handle, in their weakened state.

To me, the limit on how much oil will be supplied is not the amount of oil in the ground; rather the limit is how high a price economies can afford.  This in turn is tied to the true value of the oil to society–whether oil can really be used to produce goods and services to justify its price. The problems we experienced in 2008, and may experience in the not-to-distant future, suggest that we may be reaching this limit.

This entry was posted in Financial Implications and tagged , by Gail Tverberg. Bookmark the permalink.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to financial problems for oil producers and for oil exporting countries. We are really dealing with a physics problem that affects many parts of the economy at once, including wages and the financial system. I try to look at the overall problem.

24 thoughts on “Will 2011 be a rerun of 2008? (Longer version)

  1. I guess demand destruction and thus vulnerabilty to the wider economy will vary by area and level of dependency on road fuel, and whether any sharp price increase can be offset by tax or duty reduction.

    Here in the UK, many of us drive 60-70 mpg diesel cars, or sensible small cars. Being densely populated, we have relatively short distances to drive, often with some alternatives in a (fairly) good public transport network. This is cancelled out by a very high fuel tax rate, set at about 75% of the pump price, though recently stated UK Government policy/aspiration is that offsets will be made to counter sudden underlying price rises. Our current forecourt price is around £1.25 a litre, which I guess would be getting on for $10 a gallon. But we get by.

    Notably, all the mitigating factors counteracting our high fuel costs are absent from US arrangements. Not many in the UK appreciate that, and some here get very irate when they see some hick dude from the ‘burbs on TV complaining about $3 ‘gas’….

    100 miles to a European is a long distance, 100 years to an American is a long time…!

  2. There is a psychological component to rising fuel costs. A degree of anxiety will set in when gasoline breaches $3.30 because people remember how quickly it rose to $4. We are within a dime or so of $3 now and the price of gasoline rises each spring to the summer peak. Wages are stagnant, but essential goods prices are rising no matter what the CPI says. Consumer spending accounts for 70% of the US economy and a likely curtailing of spending may occur as fuel costs rise.

    The average life span of an automobile is 12 years and many Americans now finance their cars for 5 or 6 years and are indebted to their automobile. They can not simply go purchase a more fuel efficient one if they still owe years on their loan. After 2008, people have flocked back to large trucks and SUVs. Even many automobiles have dismal fuel economy such as Dodge’s Charger, Challenger and Magnum.
    When the cost of fuel rises to the point of pain, Americans must make a hard choice of discarding a vehicle of poor fuel economy and poor resale value or continue to pay high fuel prices. According to the Federal Reserve, the average auto loan payment is $540. With a gas spike above $4, trading in an SUV under a loan for a compact car could theorically give the consumer an $700 car note for a Hyundai Elantra. Between high gas prices and high auto loan costs, the family budget tanks and so does the economy.

    • I live in rural northern California. We’ve been around $3 for regular for a long time. It is currently $3.30. FWIW, diesel was $3.42 when I was in town today. I know the owner of the station. He gets a FAX that sets his price. He owns his station outright rather then being a corporately owned station.

      Todd

      • So when south Alabama breaches the $3.30 a gallon mark, you’ll be paying $3.80.
        Also remember wages in Alabama are less than California so an increase in energy cost to your level is significant.

  3. Hi Kenneth

    Did you see what I just reported on your “high” gas prices? (we call it petrol or diesel over here, which handily also avoids occasional confusion with natural gas in energy discussions). Anyroadup, I remember our ancient sunlight set us back 66p a gallon back in ’99… We had fuel protests the following year which shut the country down inside a week. Never mind subtle slow moving economic impact…

    M. Moutarde

    • Yes.
      $3 gasoline seems cheap by European standards, but many Americans drive vehicles that get 20 MPG or less on the highway ( even less in the city) plus they drive further distances. Public transportation is not practical for most of America. I visited New York City a year ago and loved its subway system, but in the greater Mobile, Alabama area- it is slow, inefficient and stigmatized. Americans want to go when they want, where they want. They eat in their car, whizing thru drive thru’s and have 6 cupholders for slurping soda on the road.
      It will take a crisis to change them.
      By the way, I drive a Toyota Corolla and get 40MPG on the highway and 30 in the city.

      • “but many Americans drive vehicles that get 20 MPG or less on the highway ( even less in the city) plus they drive further distances. ”

        At a certain price-point, one begins to count every MPG. It sure swayed my last car purchase. Other American drivers briefly began doing so in 2008. They’ll be doing so again come summer, perhaps just before high oil prices lead to the “second dip” in this recession.

        At $3 it seems that the car dealerships start touting MPG ratings. At $4 we saw some non-linear behavior among motorists (gas theft, “drill baby drill” thinking, etc.).

        Here Europe is far ahead of us Yanks, in more than fuel efficiency. At least with cars there is choice. For working vehicles, no dice. In the South, where I live, the right to a full-sized truck appears God-given, and the MPG ratings of those have plummeted since the mid-90s. And yep, I got me a “beater” F-150 for farm work 🙂 Meanwhile, manufacturers of the sensible and durable small diesel trucks common in the rest of the world claim there’s “no US market” for them, apparently to get buyers into the full-sized beasts on the lots with all the extras and costing more than $35K.

        It will be interesting and unpleasant when gas crosses the $4 mark again, as I suspect it will by summer. Once the realization sets in that we’ve crossed some Rubicon in oil production…well, the Brits on this list can certainly once again expect to become “very irate when they see some hick dude from the ‘burbs on TV complaining about $3 ‘gas’.”

        At $5 or $6 per gallon, you may be thankful for the UK’s independent nuclear deterrent as President Palin gets ready to annex some oilfields.

  4. Kenneth,

    Yup, I get 70 mpg+ in a fiendishly fast Skoda Octavia diesel, which will be familiar to you dudes in its VW Golf / Jetta or Audi form. Now, if I was truly green, I could have opted for the 80mpg eco version.

    And yes, I drove from DFW to PHX in a Dodge ‘mini’ van earlier this year. 23 mpg(!) and seriously wondering whether I’d make it to the next fuel stop. But Sonic’s mocha coffee / ice creams and burgers were sooo good… In fact, even better as I drove through the depleting Midland / Odessa oil patch, knowing how lucky I was to be enjoying the ancient sunlight inheritance party.

    Sorry to kinda hijack the thread Gail, but I did point out how cheap and fantastic fuel and everything that results from it actually was to my working class all-American fellow traveller (with one L) . He agreed…

  5. I think there will be little or no growth in the global economy in 2011. Hence, my SWAG is that oil prices will remain around $90 per barrel as production remains roughly the same as in 2010. IMHO, the conventional wisdom about a 2% or 3% rate of real economic growth in the global economy is too high; I expect only a 0% to 1% rate of real global GDP. I expect Chinese growth to decline sharply, and U.S. growth to gradually fizzle out as the year goes on. Also, I expect a sharp decline in global stock markets, partly caused by an increase in long-term interest rates.

    Because of the Fisher effect, central banks cannot hold long-term interest rates down for very long while they engage in aggressive quantitative easing (“printing” money) to finance ever larger government deficits. Thus, as expectations of stagflation increase, I think long-term interest rates will rise to take account of this change in expectations.

  6. Predicting the economy is pretty popular, and almost always the results are whatever will make the predictor money. So hedge funds and investment banks will always be bullish, to attract money to manage.

    The rest of us with no axe to grind can look at what’s what and ignore models that have no oil price input in them (most sell side models do not include oil impact).

    First, the tax deal is not stimulative because it’s not a cut. It maintains; it does not cut. It merely prevented government policy from becoming short term contractive, though maybe the 2% SS tax reduction (about $17 per average monthly paycheck) will buy an extra movie ticket.

    So with that a flatline, we look for pluses. Bernanke’s monetary stimulus of $600B is one such, though with low bank lending, it is money to nowhere. We have the Tea Party bomb throwers arriving, and bombs they will throw. I expect them to demand $100-150Billion in cuts in return for a debt ceiling jack up, and that is most decidedly NOT stimulative. That will appear immediately as a GDP drag.

    Then we have about $200 Billion in individual state budget devastation due in 2011, and one has to presume the Bernanke will try to buy municipals as QE 3.0 in order to lessen the state government firings that will inevitably result from $200 billion in slash. If he does not, and he may not, that is going to be a sledgehammer to GDP.

    And so, oil. If GDP gets smashed by these effects, plus a Spain swap triggering default, then sports fans, oil price will be DOWN.

    • The question in my mind is whether oil price goes up for quite a bit of 2011 and then down, or down fairly soon (without having a chance to go up very much). A big piece of the economic gap to date has been hidden by governments (federal, state, and local) that have spent more than they have taken in. But it is hard to keep this spending up, because the shortfall becomes more and more obvious. Eventually bondholders demand higher interest rates, and representatives in congress refuse to fund spending far in excess of tax receipts.

      It seems like eventually something will bring the world back to steep recession–higher interest rates because bondholders demand them, or cut back in government spending, or impacts of fall in property prices that have not yet been fully recognized by lenders. And then oil prices will fall, and oil use will fall some more.

      • Hi Gail,

        whether oil price goes up for quite a bit of 2011 and then down, or down fairly soon

        The recent IEA report seemed to imply that prices in the $80 to $100 range (if I recall correctly) would allow non-conventional oil (tar sands, etc) to be competitive. All environmental issues aside, they suggest that there is a huge supply of this stuff.

        Is it possible that we will see a long period of $80-100 oil prices that allow US gasoline pump prices to stay in the $3-3.50 range? This price would probably not push the economy into another tailspin.

        I really hate this scenario; but is it possible?

        • Whether or not there is a huge supply of non-conventional oil, it won’t ramp up quickly, even with oil in the $80 to $100 price range. Maybe if oil were in the $250 to $300 price range it would ramp up quickly, but non-conventional takes too much capital and too much time, and there is not enough profit falling through to the bottom line to do this investment without doing a lot of borrowing, and that limits the speed at which the ramp up takes place.

          I think it is more a question of whether demand can stay low enough for the price to stay in the $80 to $100 range. I could see a fairly widespread recession causing this. It is hard to imagine a recession only in, say, Europe, being the cause, and the US still doing well. But maybe this is possible, if US and European policies are very different, and the US somehow manages to borrow and stimulate itself to growth. It still seems very unlikely–interest rates would rise, and the US would have problems too.

  7. >>
    Eventually bondholders demand higher interest rates, and representatives in congress refuse to fund spending far in excess of tax receipts.
    >>

    No. That is a common sense perspective and it is borne of yesteryear.

    History has no relevance to this present world. Bondholders never demand higher rates. Bond *buyers* may, but bond holders are locked in where they bought. It’s the bond buyers who are the issue, and in this present history-irrelevant world, his name is Ben Bernanke. He will do anything to keep the balls in the air. He’ll buy any bond that must be bought to address his 2nd mandate of keeping a lid on unemployment. Any government debt, meaning not any maturity or any type of federal government debt, but rather ANY GOVERNMENT’s debt . . . he will buy if he thinks he should.

    That means California. Illinois. Maybe even Spain. There are no restrictions on him. He’ll do what he must to prevent killing, because it is presumed that is what riots will eventually generate.

    That’s why there can be no defaults. And as long as there is not growth, it’s hard to raise the prices of things no one wants — so there’s no inflation. He can quantitatively ease forever while this remains so.

    Only oil can’t be printed. In the end, that will be the end.

  8. 2011?

    Oil or economy, which is trigger?
    The Bush Admin. knew full well oil was an impending issue for US economy, hegemony, world status. This was pointed out in the writing of the Neocons from Pearl to Cheney prior to their election. It was the focus of their efforts to keep the oil can going down the street. Their solution was to plop our military flat in the middle of 75% of all oil reserves and hope the oil would keep going, driving the world system.

    It was just one option and not totally wrong, I suppose. It may have worked to a limited degree. 2.5MBPD today from Iraq about what it was before, and we are firmly planted in the area of interest. They played their cards there.

    What they didn’t seem to realize was the weakness of the economic system. They had been led to believe that it was intact and not threatened. They were naive to put it flatly. The system was systemically corrupt, dysfunctional, inoperable, too complex, being looted by various Ponzi schemes and unsustainable but they had been told by Greenspan that all was fine according to his models.

    I believe they were caught totally off guard when it went to hell. Now, I know there are some, Jeff Rubin, that still are holding that oil was the kicker but it appears it was the economic system itself that failed for any number of reasons.

    What I am getting at is that in looking at 2011, I am beginning to think oil will still not be the trigger and may hold below $100, but rather the economic system that has still not, in any way, corrected itself. There are a multitude of unresolved issues out there that I believe will still show themselves this year, European sovereign debt, US state debt, housing and commercial deflation, costly wars, unemployment, unmanageable US debt, bond defaults, the list goes on.

    You may think that Ben can pull off these QEs and states can be bailed out to limp the wounded bird along, but I am getting the feeling we are making the same mistake the Bush Admin. made.

    As you say, oil is always there and if economy doesn’t set the trigger, oil sure as hell will. I just don’t think they can keep this economic act together. Watch the Tea Bag crowd. I get the strange feeling they may be willing to trip the system and take the hit now rather than running down the road. Just a thought.

  9. The Tea Party people are bomb throwers, and bombs they will throw. The left wing in the Senate will filibuster any number greater than 100-150Billion in cuts as the price of debt ceiling. That would erase easily the 2% Social Security holiday.

    It’s the states and their $200 billion in cuts that Bernanke can fund. So +600 in QE2 from Bernanke and -100B from the Tea Party. Bernanke wins.

    Unless oil returns to $150. That’s the alpha asset of civilization. Bernanke is powerless before it.

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