Overnight, world oil prices have tumbled further – Brent crude is down to $US 46 a barrel, $101 less than the July 7 peak of $US 147 a barrel.
That unsustainable Peak Oil was a bubble driven by speculators bailing out of the financial markets, but like the global housing bubble that burst last year, so too has the oil bubble.
July’s Peak Oil amounted to the Third Oil Shock, which brings back to mind the lessons from the first two.
For decades until the end of 1973, world oil supplies were controlled by the fabled Seven Sisters – the big oil companies — which fixed the price of oil at a constant $US 4 a barrel.
Then, on October 6 1973, Yom Kippur, the holiest day in the Jewish calendar, Israel’s Arab neighbours launched a massive, unprovoked attack on the tiny Jewish state which Israel was barely able to fight off. In the aftermath, the collection of oil-producing states known as the Organisation of Petroleum Exporting Countries threw off the shackles of the Seven Sisters, and, led by Saudi Arabia, reduced oil production in response to US support for Israel and tripled the price of oil to $US 12 a barrel, creating a wave of “stagflation” throughout the industrialised world.
This became known as the First Oil Shock.
The Second Oil Shock was sparked by the ousting of the pro-US Shah of Iran and the return to Iran on February 1 1979 of the religious figure Ayatollah Ruhollah Khomeini and the creation there of an Islamic republic. OPEC-member Iran was and is one of the world’s major oil producers. The revolution disrupted oil supplies and the price of oil tripled again, to $US 36 a barrel. New Zealand introduced “carless days” and other measures to cope, eventually launching the costly Think Big schemes of the early 1980s, which included a synthetic petrol plant in Taranaki to produce petrol from Maui gas by converting the gas first to methanol then petrol.
Almost all the predictions at the time were that oil would continue to increase steadily in price. Think Big was based on those predictions. But there was a dissenting voice, that of the noted American economist Milton Friedman. “Beware the tyranny of the status quo,” he roared. Oil was just a commodity. Its price would fall back to $US 12 as sure as the sun would rise in the east.
And it did. OPEC’s ability to manipulate prices was quickly lost as new oilfields began flowing, ironically made economic by the higher prices. By the mid-1980s oil was indeed back to its pre-1979 levels and Think Big became a white elephant that saddled New Zealand taxpayers with debts that took more than a decade to repay. The $2 billion synthetic petrol plant was hugely uneconomic from the day it opened and eventually the government paid Fletcher Challenge $178 million to take it off our hands. Fletchers quickly closed the petrol converter and ran the plant profitably by producing only methanol.
The first and second oil shocks seemed to have been forgotten when speculators pushed oil futures higher and higher last year and up to July 7 of this year. The ecstatic doom-mongers were gleefully chanting “Peak Oil, we’re all off to hell on a bicycle” and there was serious talk of oil hitting $US 200 by the end of the year.
Yes, some of the price shock was due to increasing demand from China and India but there was and is no shortage of oil. As sure as the sun sets in the west, if the price of a commodity goes beyond the economic value set by the laws of supply and demand, demand will drop and the price will fall. And that is what has happened since July 7, helped along by the still-collapsing financial markets that are now sending the entire world into recession, reducing the demand for oil further even as the price drops back in search of a level that will bring more buyers to the market.
How low will oil prices fall? Who knows? But few people on July 7 were predicting they would ever go below $US 100 a barrel again. I am delighted to recall that, on June 7, when when I was describing the price spike as the Third Oil Shock, I was also predicting prices would inevitably fall.
The benefit of the big and sudden collapse of oil prices is to remove the inflation that was largely caused by the sharp rise in oil prices in the first place, putting more money in people’s pockets to spend or reduce their credit card debts, thus, hopefully, helping to make this world recession much shorter than it would otherwise be.
But it is not all good news. Oil prices at today’s levels will not pay for the development of marginal oil fields, the exploration for new ones in difficult places, or the alternatives to oil that will eventually be needed and which will replace oil long before the wells run out. That means oil prices will again rise, as they must, to pay for these things. But not before Christmas. Please.
13 Comments
November 21, 2008 at 9:53 am
It is estimated that oil at around US $70-80/bbl is where alternatives (Ethanol/Biodiesel) become competitive, given the still strong desire to reduce Carbon emissions, I would see this price as a likely near-term average.
What will be more interesting thou is the impact this recession will have on Co2 emissions. I don’t how many times we were told by the outgoing government that the reason NZ’s emission were higher than expected was that growth was stronger. While the drought in early 2008 would have not helped our profile, the closing of a few 1000 toy factories in China, along with the shuttering of a few car plants around the world, should start to dent the current upward trend.
November 21, 2008 at 10:36 am
Just one thing – You don’t know many Arabs do you Poneke? If you did you would spare us the tired pro-Zionist line.
So, “…Israel’s Arab neighbours launched a massive, unprovoked attack on the tiny Jewish state …” And I am sure you would describe the six day war as a brilliant pre-emptive attack? It all depends on where you take the start date of the war to be, don’t you think?
The racist and imperialist narrative of Israel as a plucky little western democracy in the heart of Arab darkness is long past its use-by date for a generation who see little more than a religious military state barely distinguishable from its enemies, whose slow genocide of the Palestinian people shows they have learnt nothing from the holocaust the led to the state of Israel being established in the first place.
November 21, 2008 at 10:53 am
The economic situation of the last few months reminds of the wisdom of Rudyard Kipling…
If you can meet with Triumph and Disaster
And treat those two impostors just the same.
November 21, 2008 at 11:11 am
The price of oil will eventually settle atthe maringinal cost of the next barrel of oil. I recall the great southern oil basin is viable at around $40 barrel, I also believe the Brazilian off-shore fields will be economic at the same price or slightly less. So a medium term future after the current volatility settles could be at or under $40. Which suggests that bio-oil is a bad bet unless prices are required to include carbon taxes. Negatives of bio-fuel probably outweigh the vlaue of the taxes (loss of food supplies), but that would be good for NZ as farming here would benefit and Sthn oil basin could be developed.
Well done to Poneke for being will to make a prediction at a time of considerable peak oil hysteria.
November 21, 2008 at 12:35 pm
Congratulations, a very good post on a topic that far too many people cannot seem to understand.
It will be interesting to see what happens to Canada’s oil sands, as they are only economic at above $60/barrel.
I believe that the Greens lost many votes because they were still talking about peak oil in their closing, even as prices were dropping rapidly.
November 21, 2008 at 1:53 pm
Negatives of bio-fuel probably outweigh the vlaue of the taxes (loss of food supplies),
That depends which biofuels though.
November 21, 2008 at 5:26 pm
Demand destruction in the us US, Mad Max scenario has been postponed due to unforeseen circumstances.
Travel on all roads and streets changed by -4.4% (-10.7 billion vehicle miles) for September 2008 as compared with September 2007. Travel for the month is estimated to be 232.8 billion vehicle miles.
http://calculatedrisk.blogspot.com/2008/11/dot-us-vehicle-miles-off-sharply-in.html
November 21, 2008 at 10:04 pm
Poneke’s trip down memory lane outlining, concisely, the last 35 years of major historic reasons for the rise and fall of oil prices, neatly puts events into perspective. Surprisingly, after having outlined the historic facts, one paragraph in particular has had a narcotic upshot from one of those expected to be the equivalent of a Tag team activist member of Anthropogenic Global Warming. Having the temerity to dump onto Poneke in no uncertain terms our tagger then proceeds to rewrite Middle East history from under the stupor of one who has being snorting on the dregs of historic falsehoods.
November 21, 2008 at 10:26 pm
Would I be correct in saying that the oil prices never returned to $12/barrel, for any real length of time, but instead fluctuated above this, occassionally touching on this lower price? The effect is that the running average price (over some “window” of time) is higher. I believe running averages are a reflection of cost to consumers than “spot” lowest prices. I think this fluctuation in prices needs to be added to your final remarks (which I suspect will prove correct), as the variability in price pushes the average price up quite a bit.
For what it worth, I recommend to people to view graphs of the oil prices over at least the last 50 years, ideally with world events overlaid. With all respect for poneke’s writing, I think this is one case where well prepared graphs do a better job of conveying the story.
November 22, 2008 at 7:25 am
US production peaked about 30 years after oil discoveries peaked, here’s a graph of global oil discoveries:
http://anz.theoildrum.com/files/growing_gap_old_fields2.jpg
Here’s a prediction from me; the global economy will soon recover if oil gets and stays below $40, but the recovery will not last as it will push oil demand up against a production ceiling causing another price spike.
November 22, 2008 at 11:08 pm
One thing that perhaps needs to be factored in is the extent that the current low oil prices are a reflection of the current poor world economy (i.e. lower demand for oil due to the economy slowing). In that sense the low oil prices may not be such a good thing in the bigger scheme of things if they are a reflection of poor demand for bad reasons, rather than higher production or other “good” reasons, and would then be expected to rise when the economy improves–? (Taking nothing away from how it might help the consumer in the short term or help bring the global economy around.)
But I’m only bumbling along speculating…
November 24, 2008 at 10:58 am
A great post Poneke putting it all in perspective.
I too would quibble with the line “unprovoked attack on the tiny Jewish state”, but without the “imperialist and racist” mumbo jumbo.
In 1973 Israel wasn’t so tiny any more as it had seized the Sinai, West Bank, and Golan Heights in its attack on its neighbours in 1967. That followed the 1956 war in which Israel conspired with Britain and France to snatch control of the Suez Canal.
November 24, 2008 at 11:20 am
I’m one of those ‘peak oilers’ that thought the price of oil wouldn’t drop below US$100 again, and I must admit I was pretty surprised when it did. Well, we can’t be right all the time eh….?!
Having said that, the fact that it reached as high as US$147 was pretty clear proof that demand had strongly exceeded supply, which has been largely stagnant for about 4 years now. For it to fall so fast indicates that speculators believe that demand will drop greatly, leaving excess supply. Hmmm, is it good that buyers think that the world economy is going to be in such poor shape that we won’t need so much oil…..?
But even as demand is falling, so too is supply. The International Energy Agency’s latest World Outlook Report (link below) states that decline rates from existing fields is around 6.7% a year. Add that to demand growth (which might still rise), and oil producers have to increase production by around 8% a year. The IEA picks that the world will need to invest $26 trillion dollars between 2007 and 2030, to allow supply to meet demand. That’s over a trillion dollars a year, at a time when finance is evaporating like meths in the desert. Where’s the money going to come from? And if demand (and the price) stays low, then it’s only going to prevent further necessary investment or even basic maintenance. Expect an even faster decline rate.
So, don’t celebrate too soon that the Third Oil Shock is over. While demand is falling, it’s likely to be because we’re entering a major recession (possibly a depression). If it starts to rise, it’ll run smack bang into falling supply. And even if demand doesn’t rise, then it might just run into falling supply anyway.
The Third Oil Shock hasn’t ended. It’s just on holiday for the moment. The bugger is still out there.
http://www.iea.org/Textbase/npsum/WEO2008SUM.pdf