Peace at the pumps won't last long

[Stuart Mackey]

link to NZ Herald

Some of this relates to New Zealand, dear reader, not the US of A.

Brian Fallow: Peace at the pumps won't last long
5:00AM Thursday July 31, 2008
By Brian Fallow


International oil prices have fallen more than 10 per cent over the past month, bringing some blessed relief at the pumps for hard-pressed consumers.

But to break out in a full-throated rendition of the Hallelujah Chorus would be premature.

The fall so far has only taken oil prices back to where they were in May.

They are still around 240 per cent higher than they were four years ago.

Retail petrol prices have not increased quite so much, some 75 per cent over the same period. The increase is smaller partly because the tax take per litre has not risen as much as the crude oil price and because the exchange rate has taken some of the sting out of higher US dollar prices.

The IMF estimates that the US dollar's depreciation since 2002 explains US$25 a barrel or about a quarter of the rise in the oil price since then.

But with the New Zealand economy almost certainly in recession and the Reserve Bank in easing mode, the NZ dollar is now 9 per cent off its peak early this year. The depreciation has further to run and will at least partially offset any further declines in the world price of crude oil.


What has driven oil prices so high so fast is strong growth in demand from developing countries, led by China, with which the supply side of the industry has struggled to keep pace.

As spare capacity has been compressed, markets have been more easily spooked by news, like sabre-rattling by and at Iran, which threatens a supply disruption.

The IMF reckons 95 per cent of the growth in demand for oil since 2003 has come from developing economies, led by China and India.

The International Energy Agency (IEA) forecasts the developing world's oil consumption will equal that of developed countries by 2015.

BP attributes just over half of the growth in oil demand last year to China alone. It now has around 160 million vehicles on its roads and petrol which costs about half what it does here.

But it is hardly fair to point the finger at China or blame any developing country for developing. If China's rate of vehicle ownership was similar to ours, it would have something approaching a billion on its roads.

The problem is really the sluggish supply side response of the industry to soaring oil prices.

It does have its work cut out for it, though. The amount of new oil supply the world needs each year is enormous.

The IEA estimates world demand for oil will increase by 7.2 million barrels per day (bpd) over the next five years, an annual increase of 1.4 million bpd. That is about 10 times what New Zealand consumes.

But that is on top of the need to find new supplies to offset declining production from existing fields. The IEA estimates over 3.5 billion bpd would be needed just to hold global production steady.

So altogether the industry will need to find five million bpd of new supply every year.

To calibrate the scale, that is about what Japan consumes. It is about two-thirds of what China consumes. And its about half of what Saudi Arabia produces.

That is the requirement for new oil supplies every year.

The sluggish supply response to higher oil prices is not for want of investment.

The IMF says between 2003 and 2006, investment by the 53 largest national and international oil companies increased by two-thirds, to over US$240 billion ($326 billion).

But the increase was almost entirely eaten up by higher prices, reflecting a global scarcity of oil rigs and the like and skilled personnel too. In real terms investment spending barely increased.

It is instructive to look at where the industry is going in search of new supply: Central Asia, which is about as far from the open sea as you can get, deep waters off the coast of Brazil, West Africa and in the Gulf of Mexico and Siberia.

Canadian tar sands have become an important source of supply, despite the costs of mining the stuff, separating the tar from the sand and then hydrogenating it to form a synthetic crude which can be refined in the ordinary way.

The industry is even starting to lick its lips at the prospect of drilling in the Arctic.

All this suggests a steeply rising cost curve on the supply side, even as the main engine of demand growth - the economic progress of the developing world - shows no sign of slowing. While there might be plenty more fruit in the tree, we need a cherrypicker to get at it.

And the fruit is getting smaller. The average size of an oil field is declining, which means fewer barrels for exploration and development costs to be spread over.

The IMF's first deputy managing director John Lipsky said in May that average exploration and development costs per barrel had doubled from US$5 a barrel in 2000 to US$10 last year and for marginal fields these costs were now closer to US$20 a barrel.

The upshot of all this is that Opec's spare capacity as a percentage of world oil consumption - an indicator of the tightness of the market - over the past five years has been only about two-thirds of its normal level and heavily concentrated in one country, Saudi Arabia.

The resulting high prices appear to have worked better on the demand side.

BP reports declines in oil consumption last year across the developed world, by 3.5 per cent in Japan, 2.6 per cent in Europe and 0.1 per cent in the United States.

But with demand outside the OECD expected to grow by 1.4 million bpd or nearly 4 per cent this year and next year, the IEA still forecasts global oil demand to rise 1 per cent in 2008 and 2009.

Beyond that it expects demand growth to pick up again as the world economy recovers.

For oil-importing countries, an oil shock of the kind which has occurred over the past four years is wholly bad news. It drives up inflation and by crowding out spending on other things retards growth.

Inflation across the OECD has jumped to 4.4 per cent and the consensus forecast for growth among New Zealand's trading partners keeps getting revised down.

But the extra ingredient which produced the persistent stagflation of the early 1980s was a cost-plus mentality, resulting in a wage price spiral as everyone who could passed on their increased cost to their employers or their customers.

That was especially tough on those at the end of the line with no one to pass the buck to.

If this behaviour takes hold, so that inflation becomes self-perpetuating because everyone who can passes the buck, the only remedy central banks have is to confiscate bucks by tightening.

That is the biggest threat to the easing cycle the Reserve Bank has just embarked on.

Let's hope this fall in oil prices has come in time to avert it.

[SirNitram]

While there's been signifigant demand destruction, I imagine alot of this.. And further drops.. Will be because the world economy is in a world of shit right now. That isn't a good thing.

[Stuart Mackey]

While there's been signifigant demand destruction, I imagine alot of this.. And further drops.. Will be because the world economy is in a world of shit right now. That isn't a good thing.

As the OP says

Beyond that it expects demand growth to pick up again as the world economy recovers.

OECD that is.

Trend up, with spikes either way.

[CaptHawkeye]

I'm astounded at the number of people i've already met who think a 10 cent drop in oil prices means we'll be seeing $2.50 a gallon by December. Remember guys, America's education spends millions on its sports programs. Economics programs at schools are few and far between and often aren't mandatory.

[Viridian]

I'm astounded at the number of people i've already met who think a 10 cent drop in oil prices means we'll be seeing $2.50 a gallon by December. Remember guys, America's education spends millions on its sports programs. Economics programs at schools are few and far between and often aren't mandatory.

Dunno where you went to school, but at LSU the football program paid for all the other sports and bankrolled the school's academic scholarship programs (Regent's and Chancellor's scholars). And given Louisiana's history of corruption I find it hard to believe they are too exceptional...

[CaptHawkeye]

I'm astounded at the number of people i've already met who think a 10 cent drop in oil prices means we'll be seeing $2.50 a gallon by December. Remember guys, America's education spends millions on its sports programs. Economics programs at schools are few and far between and often aren't mandatory.

Dunno where you went to school, but at LSU the football program paid for all the other sports and bankrolled the school's academic scholarship programs (Regent's and Chancellor's scholars). And given Louisiana's history of corruption I find it hard to believe they are too exceptional...

Uh yeah. That's nice for them. Especially considering they're a college and colleges are a little more mature about the objectiveness usefulness of their sports programs. I'm talking about high school. Something like a 10 cent spike in either direction of an economic curve is pretty basic high school level stuff that most people clearly know all of jack shit about.

[Big Phil]

I'm astounded at the number of people i've already met who think a 10 cent drop in oil prices means we'll be seeing $2.50 a gallon by December. Remember guys, America's education spends millions on its sports programs. Economics programs at schools are few and far between and often aren't mandatory.

Dunno where you went to school, but at LSU the football program paid for all the other sports and bankrolled the school's academic scholarship programs (Regent's and Chancellor's scholars). And given Louisiana's history of corruption I find it hard to believe they are too exceptional...

Uh yeah. That's nice for them. Especially considering they're a college and colleges are a little more mature about the objectiveness usefulness of their sports programs. I'm talking about high school. Something like a 10 cent spike in either direction of an economic curve is pretty basic high school level stuff that most people clearly know all of jack shit about.

That's because economics isn't taught in most high schools.

[Stuart Mackey]

Dunno where you went to school, but at LSU the football program paid for all the other sports and bankrolled the school's academic scholarship programs (Regent's and Chancellor's scholars). And given Louisiana's history of corruption I find it hard to believe they are too exceptional...

Uh yeah. That's nice for them. Especially considering they're a college and colleges are a little more mature about the objectiveness usefulness of their sports programs. I'm talking about high school. Something like a 10 cent spike in either direction of an economic curve is pretty basic high school level stuff that most people clearly know all of jack shit about.

That's because economics isn't taught in most high schools.

Your shitting me?

[ArmorPierce]

I vaguely recall a brief overview of supply and demand but no most students don't take any economics class.

[Big Phil]

That's because economics isn't taught in most high schools.

Your shitting me?

No, I'm not. A couple of pretty basic topics don't seem to be present in most American high schools, or at least I never took them in high school and they weren't available to take:

Economics
Finance
Geography
Statistics

My sister-in-law just graduated high school - she's pretty damned smart, but I doubt if she could point out Mexico or Canada on a map, or balance a checkbook, or explain what inflation is. The classes just weren't available, or at least, weren't required. On the other hand, she could do a pretty thorough job of fingerprinting a prisoner or documenting evidence at a crime scene - her high school offered a class in Forensics.

[Questor]

That's because economics isn't taught in most high schools.

Your shitting me?

No, I'm not. A couple of pretty basic topics don't seem to be present in most American high schools, or at least I never took them in high school and they weren't available to take:

Economics
Finance
Geography
Statistics

Geography and Finance are not offered where I work, but a light version of Econ is required. Stats is an AP class taken by students who want to do more math, but are unwilling to take Pre-Cal.

Geography is, in theory, supposed to be included in the standard set of Social Sciences courses that every student must take, but they are neglected because it is supposed to be covered by the middle schools. This is a continuing problem for people like me, who changed districts between middle and high school.

Finance is a good class, and at least one high school in our district does offer it, but we don't.

[Duckie]

1 semester of Economics, like 1 Government/Civics class usually is required to be taken, but as a required class everyone would thus sleep through it and thus don't learn, presumably.

I wouldn't know, as back in High School I took AP so I actually had to pay attention.

[Stuart Mackey]

That's because economics isn't taught in most high schools.

Your shitting me?

No, I'm not. A couple of pretty basic topics don't seem to be present in most American high schools, or at least I never took them in high school and they weren't available to take:

Economics
Finance
Geography
Statistics

My sister-in-law just graduated high school - she's pretty damned smart, but I doubt if she could point out Mexico or Canada on a map, or balance a checkbook, or explain what inflation is. The classes just weren't available, or at least, weren't required. On the other hand, she could do a pretty thorough job of fingerprinting a prisoner or documenting evidence at a crime scene - her high school offered a class in Forensics.

We covered the basics in 3rd and 4th form high school, or whatever they call it now, and including a quick trot through basic geology and biology!. Forensics? says a lot about society...*mutter*, Economics tended to be popular as an option as did the sciences..hell even our 'options' tended to be good practical stuff, although we had some fun stuff like history and classics.

[dragon]

When I was in HS they offered all those classes as electives, which is stupid.

[PeZook]

Geography isn't mandatory in American high schools? What? How can this be?

I can understand economics or statistics (though I think they should be mandatory), but geography? Please. It's essential to have at least a passing knowledge about the basics of geography if you want to function as anything but a mindless worker-drone. How can this not be mandatory?

[Fingolfin_Noldor]

Geography isn't mandatory in American high schools? What? How can this be?

I can understand economics or statistics (though I think they should be mandatory), but geography? Please. It's essential to have at least a passing knowledge about the basics of geography if you want to function as anything but a mindless worker-drone. How can this not be mandatory?

It certainly explains why they keep mistaking Singapore for some Chinese province.

[Gerald Tarrant]

Geography isn't mandatory in American high schools? What? How can this be?

I can understand economics or statistics (though I think they should be mandatory), but geography? Please. It's essential to have at least a passing knowledge about the basics of geography if you want to function as anything but a mindless worker-drone. How can this not be mandatory?

It might not be this way anymore, but in my school district in Utah the core curriculum required everyone to take a world studies course in 9th grade. When I did it that course included a term of geography, including memorization and regurgitation of countries and capitals.

[Glocksman]

Back in the early 1980's my high school's required classes WRT geography/history/economics consisted of four semesters of 'American Studies'.

At the risk of sounding arrogant, I managed to get a 'B' average during those two years despite being a lazy fuck who didn't do the homework simply because I scored over 100% on the finals (extra credit counted for 20% of the tests) for each class.

Also, two of the classes were taught by the football coach and I had the distinct feeling that I knew more about the subjects being taught than he did.

[Glocksman]

Added:

I had the 'World History' classes in 9th grade as well.
Though by the time the year was over, we'd barely made it to the medieval period.

That's because the teacher was passionate about the subject and wasn't merely teaching 'by the book' in order to pass an arbitrary test and instead was actually going in depth WRT the subject matter.

[ArmorPierce]

Geography isn't mandatory in American high schools? What? How can this be?

I can understand economics or statistics (though I think they should be mandatory), but geography? Please. It's essential to have at least a passing knowledge about the basics of geography if you want to function as anything but a mindless worker-drone. How can this not be mandatory?

.
geogrpahy is mandatory most places, usually falls under global studies

[Ma Deuce]

No "peace at the pumps" here in Ontario, since the recent drop in oil has dragged the loonie to below $0.94 USD down from very close to par. Because Ontario buys a lot of it's refined fuel from the US, this means we've been seeing only a small difference in gas prices.

[CaptainZoidberg]

geogrpahy is mandatory most places, usually falls under global studies

I was taught geography through World History classes in the 11th grade, and Spanish classes in the 9th and 10th grades.

But there isn't a geography HSA, so I can imagine that some schools in lower income areas might leave it out.

[Rogue 9]

A semester of economics and a semester of civics and government are required in order to graduate in Indiana. They're usually taken in the final year of high school, or they were at my school.