Has there been a structural shift in market fundamentals that points to a substantially higher and sustainable price for the oil market? Does the substantially higher price include a $100 per barrel oil? If so, when and how will it affect the economy? If prices go that high, should we open the Strategic Petroleum Reserve to bring the price back down? At what price points do different alternative fuels become viably profitable?
When Adam E. Sieminski, CFA, Chief Energy Economist, Deutsche Bank AG, was asked what affect a $100 per barrel of oil would have on the economy he replied, “The old rule of thumb that economists used was that every $10 increase in the oil price (from about $40) would reduce GDP by about a quarter of a percent. The impact was expected to come from the hit on consumer spending from higher energy and the impact on inflation…So far, the economic impact of last year’s $59 a barrel oil appears to be fairly muted. US and global GDP appears to be very resilient.
The latest thinking is that oil is still only 3% of global GDP… and that it would have to be 6% to get the same sort of effects as we had in the early 1980s. My guess is that much of the reaction in the economy depends on how you get to $80 or $100. If it is a gradual rise driven by strong demand and time required to get more supply- I think the impact is still relatively benign. If it comes as a sudden shock (a surprise confrontation with Iran over the nuclear sanction dispute, for example) I think it might hurt consumer sentiment- and then have a quicker and stronger impact on the economy.”
According to Marilyn Radler, Senior Editor, Economics, Oil & Gas Journal, most oil analysts are in agreement that the geopolitical risks are currently built into the price of oil.
Some of the geopolitical risks are:
1) unrest in Nigeria (supply disruptions by rebel groups have typically been sporadic, but the current uprising there, by a group called MEND, is better organized).
2) Plus there is the Iranian nuclear issue, Russian uncertainty (government shut off gas supplies to the neighbor in January), and Venezuela (Chavez). All of these are generally accepted factors that can upset the oil market.
3) Also, there is “China”. Includes demand growth in China, India, Thailand, etc.
4) Non-OPEC supply growth is limited. Increases in oil production in the former Soviet Union, Africa, and South America in the short-term will be offset by declines in North America, Asia, and the North Sea.
These geopolitical factors are holding oil prices at their current rate of $55-65/bbl.
In December 2005 Radler wrote an article stating that “an analysis released by the Cato Institute concludes that the United States does not need the Strategic Petroleum Reserve (SPR).” The article goes on to say that the SPR, the largest government-owned stockpile of petroleum in the world, has a capacity of 727 million barrels of oil.
Radler’s article says, “The Cato paper says that the operation of the SPR has become politically controversial in recent years, with the central question being whether the stockpile should be used only during a national emergency or whether it should be used occasionally as a means to suppress high oil and gasoline prices. The SPR has been tapped only three times. In each instance, the release was too small and too late to produce significant benefits, Cato says, with the exception of this year’s release related to Hurricane Katrina.”
Cato figures that the minimum real cost of the SPR has been $41- 51 billion. If so, then the SPR has cost US taxpayers $64.64-79.58/bbl. Radler’s article gives three faulty assumptions:
Cato finds three common problems in most cost-benefit analyses of the SPR. First is an excessive fear of supply interruption.
Most analysts have expected that supply disruptions would be more frequent and more severe than has actually been the case. Secondly, politicians are unlikely to order inventory releases as quickly or as robustly as economists would recommend. If the SPR is not used robustly and immediately at the onset of disruption, then Cato contends that it is of limited value.
And the third problem is that few studies consider the possibility that private oil inventories-estimated at three times the size of public stocks-will release significant oil volumes to the market in response to a disruption.
Cato concludes that if the SPR were shut down, the US could avoid paying for it during good times and simply pay market prices during shocks. Instead, we pay both the costs of the SPR and market prices during shocks.
Getting off the dependence of foreign oil
The United States consumes more oil than any other country in the world, consuming 140.4 billion gallons of gas for vehicles alone in 2005, or 3.3 billion barrels of gas per year. According to the U.S. Department of Energy (DOE), the U.S. imports 58 percent of its oil and is predicted to be importing 60 percent by the year 2025. In President Bushs State of the Union speech on January 31, 2006, President Bush said, “Breakthroughs on this and other new technologies will help us reach another great goal: to replace more than 75 percent of our oil imports from the Middle East by 2025.” How much oil would that be and how could we substitute it?
First, many people don’t realize that there is a difference between OPEC and the Middle East when it comes to oil. OPEC is made up of some African, South American, and Middle Eastern countries. The largest importer to the US of OPEC members in Venezuela. The largest importer to the US from the Middle East countries is Saudi Arabia.
Secondly, we are not going to stop using 75 percent less oil. If we are going to replace 75 percent of our oil imports from the Middle East by 2025, where, or which country, are we going to get that energy from?
According to Radler, the worldwide production of oil is 85 million barrels per day, while worldwide demand for oil is 83 million barrels per day. The US demand for oil is 20.77 million barrels per day. The US demand for motor gasoline in 2005 averaged 9.125 million barrels per day or 3.3 billion barrels per year. Radler believes that Bush was talking about today’s level, not 75 percent of the 2025s level. 75 percent of Middle East oil is about 1.7 million barrels a day. Radler says it is a shell game.
“There will be more arbitrage on the sea between tankers. If the United States is to decrease its supply of oil they will just buy it from some other country.”
What President Bush should have called for was a 1.7 million barrel a day reduction in imported hydrocarbons.
What happens as the price per barrel increases?
Jack Jacometti, Shells Vice President of gas-to-liquids (GTL) development in London stated in a telephone interview that, “GTL is already a viable option. Biomass-to-liquid will be a viable option at around $80 per barrel.”
GTL is the optimization of fossil fuels into liquid diesel petrol. takes remote natural gaseous fields and, through the Fischer-Tropsch (FT) synthesis, and turns them into liquid petrol that can fuel diesel engines. GTL, coal-to-liquid (CTL), and Synfuel all end in the same result: fossil fuels that are turned into diesel petrol or FTdiesel.
Biomass-to-liquid (BTL) is a more expensive chemistry that doesn’t involve fossil fuels. Instead, cellulose would be used to create cellulose ethanol which can be used as vehicle fuel or a blend in fossil fuels. A by-product of cellulose ethanol is electricity which would be used to run the producing plants for cellulose ethanol or BTL.