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By Robert Rapier on Feb 26, 2011 with 19 responses

Oil Back at $100

I am between flights and have been traveling for a few days, but wanted to get off a quickie on current oil prices.

In hindsight, perhaps I was not aggressive enough with my predictions for 2011. My predictions covered two themes: Next generation biofuel producers whose business models would begin to collide with reality, and oil prices that would head back over $100 per barrel. Less than two months into 2011, there has been big news on both fronts. We have already spent a few weeks discussing the Range Fuels debacle, and now oil prices have once again breached $100. In fact, many markers such as Brent crude have been above $100 for several weeks, and they recently approached $120 per barrel. Here in the U.S. we tend to pay closer attention to West Texas Intermediate (WTI), and now it too has crossed back over the $100 threshold.

What does this all mean, and should you be worried? For one, it means higher fuel prices and strained budgets. The average person is going to spend more of their income on fuel, and/or they will have to slash their discretionary driving. Incidentally, ethanol prices aren’t immune; they tend to track gasoline prices and are also sharply higher.

It also reiterates that global economies remain at the mercy of unstable regions of the world, and implies that there is very little spare capacity out there (although Saudi is reportedly putting more oil into the market to compensate for potential supply disruptions from Libya). I think we all recognize that our level of oil imports keeps us in a precarious position, but we just don’t have the collective will to say “I am prepared to sacrifice in order to remove that threat.” After all, we could eliminate oil imports, but we would all have to get by with less oil. That’s the only way to address oil imports in the near term.

If oil remains at current prices, it is likely that the world will be right back into recession. The Wall Street Journal weighed in on this scenario:

Rising Oil Prices Threaten Recovery

The biggest risk to the economy from climbing energy prices stems from U.S. consumers, says James Hamilton, an economist at the University of California-San Diego. Collectively, they use about 140 billion gallons of gasoline a year, he notes, so the roughly 30-cents-a-gallon increase in pump prices over the past three months adds up. “That’s a significant drain on consumer budgets that could put a drag on the recovery,” he says.

To reiterate, this is a scenario I call The Long Recession. Oil prices are historically high even though the economy is weak, because there isn’t a lot of spare capacity in the system. A strengthening economy puts upward pressure on oil prices, which puts the brakes on recovery. Ultimately, it becomes very difficult for the economy to gain much momentum when there is very little spare oil production capacity in the system.

If prices remain at these levels, one of the first industries to get hit hard will be the airline industry. When oil prices surged in 2008, we saw a number of airlines declare bankruptcy; an extensive period of high oil prices will severely strain the airline industry. Industries that are dependent on trucking will suffer. Food inflation is likely to surge, and this will be worsened by high corn prices. In short, because so many sectors of the economy are dependent upon oil, high oil prices will put the squeeze on the economy and the longer this situation persists the more likely we will slide back into recession.

Now imagine that the situation in the Middle East gets worse. If the demonstrations spread to Saudi Arabia, we could see $200 oil overnight. That price level is probably not sustainable though, as that would certainly push us back into recession very quickly.

But even if the situation in Libya is resolved soon and tensions across the Middle East ease, isn’t it unsettling to know just how vulnerable we are? As an individual, you can take reasonable steps to limit your own fuel consumption and ease the strain on our personal budget. But as a country we need to take this issue much more seriously and recognize the threat as entirely unacceptable. Then we need to get serious about fixing the problem.

  1. By Kit P on February 26, 2011 at 11:37 am

    “isn’t it unsettling to know just how vulnerable we are?”

     

    No and No! The US is the third largest oil producing country in the world. It is not unsettling and we are not vulnerable. Some of us were raised by people who survived the depression and WWII. It is always good to know that we can survive and kick ass when we need to.

     

    I was a dinner with a dozen co-workers. I mentioned to a young person that the napkin could be folded and used again joking that I saw my grandmother iron napkins and we would use them again. The old guy sitting next to me joked that some could not get past the depression.

     

    If you commute long distances in a SUV and live beyond your means, you could be ‘vulnerable’ to higher energy prices.

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  2. By rrapier on February 26, 2011 at 12:47 pm

    Kit P said:

    “isn’t it unsettling to know just how vulnerable we are?”

     

    No and No! The US is the third largest oil producing country in the world. It is not unsettling and we are not vulnerable.


     

    I am curious as to whether you ever put any thought into your posts, or you just post the first random thoughts that pop into your head. Whether we are the third largest or the largest has no bearing on the issue; the problem is that we use a lot more than we produce. If not for that fact, then the money that went toward higher oil prices would stay in the country; some would win and some would lose.

    However, the truth of the matter is that increases in oil prices cause a massive exodus of cash out of the country. In this case, those who lose in oil importing countries are not balanced by those who win.

    Further, it doesn’t matter if you drive a gas guzzler; almost everyone will feel some impact on personal budgets because oil permeates almost every aspect of our society. How do you think the groceries get to the store? Something tells me that higher oil prices impact upon food costs. In fact, the ethanol industry has pointed fingers at that many times as the primary cause behind food inflation. Surely you believe them?

    It is well documented that rapid oil price increases have resulted in recessions. If you believe that threats to our economy due to events halfway around the world doesn’t put us in a vulnerable position, then we can agree to disagree. You can have your own private reality and I will share the one that the rest of the world lives in.

    RR

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  3. By russ-finley on February 26, 2011 at 3:44 pm

    Boeing just won a $35 billion dollar military contract. I don’t see how the commercial airline industry can continue to grow if liquid fuel costs continue rising. An airliner is essentially a flying fuel tank. High fuel costs translate into high ticket prices. Biofuels will never be cheap, electrification is not an option.

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  4. By Benny BND Cole on February 26, 2011 at 8:02 pm

    Excellent commentary by RR.

    Why we leave ourselves so vulnerable to thug states, year after year–while spending literally trillions of dollars on long-term Asian wars–is a question with only stupid answers.

    There is quite of a bit of excess global productive capacity out there, roughly 6 mbd, and I suspect oil demand has been flat for three or four years now. In June the next annual figs will come out from BP. At $100 a barrel, oil demand will go flat. So the situation is probably not too dire.

    The other good news is that at $100 a barrel, almost any oil play makes money and a lot of it. I don’t know if biofuels become competitive at $100 a barrel, although palm oil does.

    The other good news is that technology not only exists, but is being commercially introduced (such as the Volt, the Leaf, and even the Lincoln MKX hybrid that gets 40 mpg) that radically curtails gasoline demand. At $100 a barrel, we have probably seen Peak Demand forever for conventional crude oil.

    That said, given the kookiness of oil states–who trusts Libya, Venezuela, Russia, Saudi Arabia et al?–it makes sense to promote domestic sources of liquid fuel and conservation.

    I’ll say it again, with all the impact of a spitwad against a battleship: We need gasoline taxes. And ethanol is just another farm subsidy program in drag.

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  5. By Wendell Mercantile on February 26, 2011 at 9:08 pm

    In hindsight, perhaps I was not aggressive enough with my predictions for 2011.

    RR~

    Don’t be so hard on yourself — not even the CIA predicted what was going to happen in Tunisia, Egypt, and Libya, and may continue sweeping through the Arab states of the Middle East.

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  6. By eugene on February 26, 2011 at 11:32 pm

    I’ve just started looking at this site. Kit P is a waste of time and simply starts a senseless conversation. As far as the “six million barrels of excess capacity”. That figure is, most certainly, debatable. First of all it comes from the Saudis who, consistently, release very questionable data. Secondly, it is, probably, heavy, sour oil that is marginally marketable and then only to refineries that are able to refine it.

    Oil isn’t simply oil. There are wide variations in quality, types, marketability, whether refineries can handle it and a long list of other issues. In addition, the net is full of statistics, quotes, statements, etc that are clearly misrepresentations to folks who are knowledgable.

    Another part of the equation is the rapidly changing international market place as China circles the globe buying parts of fields, making agreements to circumvent the dollar, the Saudis begin moves towards finished product production and a range of other moves that will/are impacting the global market place. The next years will be most interesting.

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  7. By OD on February 28, 2011 at 11:08 am

    Robert, surely you are kidding. How can we be plunged into a new recession, when we never left the 07/08 recession?!

    In all seriousness, I say bring on the $5 gas. Yes, it’s going to be painful for a long long time, but it seems like nothing else will change our behavior! I could not believe the amount of whining about high speed rail, after Obama mentioned it during the SOTU… “doesn’t he know we are a car ONLY country”… “we are not europe!!” Yes, let’s not be at all like Europe, because if we were, we could be 80+% energy independent and possibly be on our way to a real recovery. Yes, we definitely DO NOT WANT THAT!

    I agree about taxes Benny, but it seems like our window of forcing conservation via taxes is closing rapidly. Now we will be faced with conservation forced via geopolitical restraints which, IMO, will be much worse. At least if we had forced this issue via taxes the $ would have stayed in the country. Oh well, hindsight is 50/50 I guess.

    I do have to wonder how things will shake out in Europe. Yes they are currently using 1/2 the oil per capita versus the US, but they have already made the ‘easy’ cuts, which to me would imply any more cuts in consumption are going to be cutting away at the muscle and not just fat. On the other hand, the US doesn’t appear to even be on a diet yet, leaving much fat left to be trimmed. Interesting times!

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  8. By rrapier on February 28, 2011 at 11:44 am

    OD said:

    Robert, surely you are kidding. How can we be plunged into a new recession, when we never left the 07/08 recession?!


     

    I agree that in principle economic conditions haven’t improved much, but the official indicators for recessions says that we have come out. But I take those with a grain of salt; the economy is still very frail as far as I am concerned. The unemployment rate is still at around 10%, double the rate of five years ago.

    RR

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  9. By Optimist on February 28, 2011 at 4:55 pm

    RR, I agree with your comments on conservation and energy independence. But I don’t see oil prices causing a recession by themselves. Current fiscal policy? Now that’s a suspect worth investigating. High oil prices might wake us up to the fact that the emperor has no clothes on, but the emperor will be wearing just as much as before…

    Let’s look at the numbers. I’ve seen one analysis that claims that $220/bbl means gas @ $7.16/gal. Sounds astronomical, right?

    Only NOT so much. It adds ~$5,000 to the average annual transportation budget of $9,000. Can be done. More importantly, it will be. And of course, that neglects the fact that a lot of driving will suddenly be cancelled, eating away at that $5,000 figure.

    As for the impact of $7/gal on the cost of a chart full of groceries: we’ll see. I suspect transportation makes up a smaller portion of the cost than you expect.

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  10. By Wyoming on February 28, 2011 at 9:18 pm

    RR (OT) question. I have a good friend who owns a trucking company. He told me that up in the Pacific NW they are adding bio-diesel to the petroleum based diesel that he puts in his trucks. He thought it was at the 10-15% ratio. When his trucks are running on the mixture he gets only 90% of the fuel mileage that he gets when he fills up in other parts of the country where the fuel is not mixed. What gives? I thought that the kind of bio-diesel (not made from vegetable oils) used for non-agriculture purposes was essentially identical to regular diesel. Does it have a lower BTU content similar to the situation with ethanol used in gasoline? txs

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  11. By rrapier on February 28, 2011 at 9:51 pm

    Wyoming said:

    RR (OT) question. I have a good friend who owns a trucking company. He told me that up in the Pacific NW they are adding bio-diesel to the petroleum based diesel that he puts in his trucks. He thought it was at the 10-15% ratio. When his trucks are running on the mixture he gets only 90% of the fuel mileage that he gets when he fills up in other parts of the country where the fuel is not mixed. What gives? I thought that the kind of bio-diesel (not made from vegetable oils) used for non-agriculture purposes was essentially identical to regular diesel. Does it have a lower BTU content similar to the situation with ethanol used in gasoline? txs


     

    Biodiesel does in fact have lower energy content. Green diesel from hydrocracked oils or from Fischer Tropsch has almost the same energy content, though.

    RR

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  12. By Kit P on February 28, 2011 at 10:04 pm

    Wyoming it is a little know fact that gravity is different in the PNW. I always get much better mileage in Oregon than Wyoming. It might be the speed limit is 10 mph higher in Wyoming but I can find answer for anything with anecdotal evidence.

     

    For example, one poster from the oil and gas industry is very fond of FT and very negative on biofuels.

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  13. By zach on March 1, 2011 at 1:47 am

    RR, I’ve been reading the blog for about a year and want to thank you for the time, energy, and frankness you put into it. Do what you need to do to keep the posts and questions of a high caliber (myself included). I’d hate for the blog to degenerate into the equivalent of my favorite economics blog comment section (calculatedrisk)… just hundreds of useless comments.

    A couple of comments – to Benny – I’ve recently been looking into sensitivity of CapEx in the Exploration and Production industry. I originally set out to look at when certain oil plays become economical. What was shocking, even though you hear of it, was finding some of the public cost inflation data out there on what happened to costs in ’02-08. Lots of $50/bbl oil turned into $90/oil when oil doubled. So I’m not planning on oil sands to keep oil below $100 if we really had to start going after them.

    As for US policy – I’ve thought for a long time how if we had the political will and forsight we’d not only implement a tax on oil, but we would preferentially tax oil pumped from the US at a higher (not lower) rate and use proceeds to subsidize building up our own reserve production capacity. Production capacity that we’d keep shuttered except for times like this. I don’t know why you want to be dependent on an unstable region of the world for your lifeblood… and I don’t know why you want to run out of oil before the Saudis. We make sure we can oversupply the market in food, but not in oil. The ability to supply an extra 1-2 mbpd gives you so much leverage when push comes to shove. Crazy.

    And oil prices – I’ll take oil over $250/bbl and under $50 in the next 5 years. Inelastic supply and demand will make a wild ride.  Both the Malthusians and Cornucopians get to be right if they just market time well enough.

    RR – I’ve been wondering when CNG and nat gas would come into play in the US. Just how large a gap would need to develop and for how long before CNG and domestic FT (GTL) got a fresh look. Any thoughts?

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  14. By Anonymous One on March 1, 2011 at 2:56 am

    http://en.wikipedia.org/wiki/E…..of_biofuel
    Diesel 40.3 MJ/L
    Biodiesel 33.3-35.7 MJ/L

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  15. By Benny BND Cole on March 1, 2011 at 4:08 pm

    For the record, global Peak Demand for crude was in 2007, with global demand falling in 2008, then more in 2009. 2010 figures not yet out from BP.

    Oil demand has been falling or flat in Europe for nearly 40 years, and US demand is about the same as it was in 1973.

    If I told you that the demand for a good in the USA was the same now as in 1973, you would call that a weakling trade.

    And these figures largely reflect an era of cheap oil.

    If oil stays near $100 a barrel (I don’t think it can sustain that price), look for radical reductions in demand–which will lead to an inevitable glut and bust. Sure, oil can spike at any time, and the spike may last a year. The ramifications of a spike are felt for years afterward in diminished demand.

    I have suggested there may be anothere spie left in oil–but each spike is another nail in the oil coffin. The business model of scaring your customers with price spikes and cutoffs is not one taught at Harcard.

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  16. By Optimist on March 1, 2011 at 8:02 pm

    The business model of scaring your customers with price spikes and cutoffs is not one taught at Harcard.

    You’re assuming OPEC is purposely letting oil jump. Why on earth would they do that? Are you suggesting OPEC is behind the events in Egypt and Libya?

    OPEC likes to pretend they are in control, like many prostitutians. Like with the prostitutians, real events tend to call their bluff.

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  17. By OD on March 2, 2011 at 12:10 pm

    Benny, I don’t believe a peak in global demand is enough, and I question if that is even true sans recession. We need demand to be declining, not just on a plateau & there are no signs of that happening. I’m afraid that it’s going to take the world many high oil spikes, followed be recessions/depressions, before we wake up.

    We missed the boat for a smooth transition, imo. Not necessarily because of the amount of time required for such a transition, but more so because of economic reasons. We could have done this during the last 2 decades when the economy was relatively stable(compared to today) and developed economies still had very low debt levels. Now we will likely be dealing with peak credit/debt along with peak oil. The economic impacts must not be left out of the equation.

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  18. By Benny BND Cole on March 2, 2011 at 1:39 pm

    OD-
    Yes, we missed the boat; on the other hand, God takes care of fools, drunks and the United States.

    There is lots of proven technology out there to sub for oil. Even stodgy ol’ GM has brought on the Volt, which 10 years ago would have been hailed as a miracle car. Now, people yawn and nitpick. That is how far we have come.

    10 years from now? Only gets better.

    If oil is sustained at $100 for several years, I thik you will even see diesel from lignite, gasoline from natural gas, and real biofuels.

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  19. By Peter Haken on March 2, 2011 at 4:52 pm

    All the conflict going on in the Middle East is going to drive the prices higher!

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