Monday 7 February 2011

Oil at $100: Murky

One of my predictions for 2011 has oil above $100 by the end of the year and staying there forever:
... It will cross the 100 line earlier than that, but there is scope for some dithering on either side initially.

Brent hit the magic number a few days ago, then promptly dipped back below. This is in contrast to 2008 when it powered through, and famously peaked at $147 before plummeting.

What does $100 mean this time around ? Firstly we need to note that the Brent-WTI basis differential has mushroomed, from irrelevantly small to a highly significant $10 or more - for background go to Alphaville where they speak of little else (who she? - Ed). Significant ? I have known US oil companies to hedge their North Sea production with WTI contracts, on the grounds that they are active in that market and the correlation is - or was - 99%. Not now. Something is amiss - these markets should arb pretty well. The reasons lie somewhere in the arcane delivery logistics that bedevil both blends: some blame Brent, others WTI. Whatever the 'true cause', and notwithstanding Brent sets the price for more than twice as much oil worldwide as does WTI, we can't say that oil has unequivocally broken through the $100 just yet.

The second point relates to a question I was asked by one of our commenters a while back: when will we know we are seeing something significant ? I suggested that to cancel out the effect of the declining US$, we should watch for a sustained rise in oil denominated in Aussie dollars, i.e. a commodity-based currency.

Look at the graph above. If we go with WTI rather than Brent, oil in AUD remains more or less range-bound. So by this criterion, no significant breakout just yet.

But when it does, strange things may happen. A while back I did some work with a huge buyer of oil - both as fuel and petrochem feedstock - and observed that in risk-management terms they had a tidy and seemingly stable business model, being able to pass through essentially all their oil-related costs to customers. I asked how robust this would be against oil prices in 3 figures, and they said they had tried modelling it, but couldn't. $147 lasted such a short time, it didn't really test anything to breaking-point. So far as they are concerned, above $100 on a sustained basis, all bets are off.

It's significant all right. And coming soon, to an economy near you ...



Old BE said...

Are you saying that you disagree with Mervyn when he says that inflation will peak at 5%?

Nick Drew said...

well it can't help BE, but not necessarily

oil could trash the recovery instead!

or maybe both !!

actually as we both agree, the ideal situation is for oil to get it on as soon as possible, & put paid to the more ridiculous 'green' schemes (= almost everything except good old energy conservation / efficiency measures) before we have spent too much more on them

I see the Nats are promoting the 'stabilizer' today in Parliament: bet Osborne is pleased to have a low-risk airing of this daft idea

Tim Worstall said...

The explanation of the WTI disconnect is here:

Logistical problem, no more.

Nick Drew said...

Thanks, Tim - it had to be logistics, as I said - & triggered by your professorial link I have checked the Gulf (of Mexico) grades and they have been tracking Brent almost perfectly

so Brent's the daddy !

(until they fix Cushing)

Budgie said...

"oil could trash the recovery instead!"

What recovery? I am not being facetious; if GDP grew in the UK by about 1.5% last year and inflation (RPI) was 4.5%, then in real terms GDP shrank by 3%.

Timbo614 said...


Quite! and IF "recovery" is 1.5% it is going to take the whole of this parliament to get back to where we were in 2007/8 before the 6.5%?? total dip!!

Deduct 15-20% inflation in the same period! We are going backwards!

@generally :)
I commented on another blog: use a pocket calculator to work out the following:

Fact 1:
According to current forecasts (don't have a source sorry - there are a few) oil production has peaked and is now starting to decline at 2% COMPOUNDED annually.

Fact 2: we need growth of 4% COMPOUNDED annually to get out of the s**t.

Starting at 100 base for facts 1 and 2 deduct and add to each figure as appropriate, how far apart are these 2 figures in 10, 20 & 30 years time?

Fact 3: Growth needs oil...

Result = deep S**T!

I agree with much said on this site except your criticism of "green schemes".

Green Schemes of one type or another will have to be implemented, energy conservation and efficiency is great but it is only the low hanging fruit. The cost for "green schemes" will eventually not matter... Hopefully new technology will make it all better and cheaper, but they WILL come it's written in the numbers, even using those extremely simplistic ones above.

Anonymous said...

But surely you are assuming that oil supplies are limited? My understanding is that the additional supplies coming on stream will depress the price to the extent that it stays stable. I am also told that Brazil rivals Saudi. And the supply from Canada, including shale oil, is also pretty substantial - peak oil is not quite as imminent as the doomsayers will have us think.

Timbo614 said...


It's cheap oil at a good energy-expended to energy-extracted balance, oil that is viable, that is what I am talking about.

Oil is finite - fact (1 Planet = 1 Planet's worth of oil)

Viable oil even more so.

Old BE said...

I always assumed that GDP figures were inflation-adjusted.

Nick Drew said...

the stone age didn't end because of a shortage of stone, comme on dit

we will reach peak price long before the oil "runs out" = maximum the world is willing / able to pay before substitutes kick in

starting with GAS of which there is far more than there is of oil, & not even remotely peaking yet

I am against green schemes that attract daft subsidies (like PV in northern climes, FFS) whilst all the time protesting that they are 'nearly economic'

when oil doubles they will either be economic with no subsidy, or of no worth whatsoever

look at how the nukes were saying - just give us € 50 CO2 price and that's all we need

a few months later it was - oh, it needs to be € 80, plus a few more sweeteners besides

the subsidy-wallahs have got Huhne's number just as they had Miliband's, aye, and Cameron's

I never thought I'd hear myself saying this but the only hope is Osborne !


Timbo614 said...


You've taken me the wrong way, I shouldn't have used "Green". I don't support "Green" with regard to saving the planet or keeping it cool, or warm (I'm not actually convinced either way by Co2 etc) - I won't be here to feel it in a 100 years! And I'm pretty sure Earth will still be here bobbing around the Sun as it has for a while now.

I'm talking about being retired and trying to buy fuel, heat, of some sort and food at 200-300-400% of what it costs now! And these prices seem not to far away :(

So to me... at my age and with my financial resources actually investing in something that provides heat and power for free (sans the original investment) is actually starting to look quite attractive, especially when your best earning years are probably behind you because you can't keep up with those type of price hikes in retirement. If it happens to look "green" well so be it, but that is not my main consideration. The price of the Oil as you say is going nowhere but up and with it food, plastics etc, etc. We can't (yet) grow food with gas, but hell, we are already growing food to feed cars instead of people!

Like you I am a technologist. The current crop of windmills and PV may as well be made of stone when iron and bronze were unknown. BUT lets be fair - how much has the oil-gas technology really improved since it's invention - we push it down a pipe in various situations and sizes and set fire to it at the end! Not really sophisticated is it?

I sometimes feel that the Chinese are thinking like me, they are building coal fired power - but it occurs to me that they are using it to hedge their bets by using the (dirty & expensive) power to build solar and wind (they are building with a fury)- not as effective, yet, but the more they build the better they will get at it, and they can switch to it eventually and have their essential industries powered by the sun and wind - for free. Think on it - the Chinese are all about the long term.

You say wait for the iron/bronze age - technology and the all-new sparkling urguantuamitatisation engine will save us - yes it will I agree, but WHEN? 10 years, 20 years? To damn late for me and possibly for our precious, nay necessary 4% growth!

with respect of course, excuse mistakes- blame it on the brandy :)

Nick Drew said...

hey Timbo, no problem with a bit of cut'n'thrust - I'd been on the sauce too

(I don't much like the idea of retirement into a world of soaring food & fuel prices either, believe me)

to continue the rant (aimed squarely at politicians, not your goodself), the Huhne mantra is: higher electricity prices now and for many years to come, to pay for currently VERY uneconomic kit; because "when we have decarbonised" (which personally I may not live to see) it will be cheaper than if we hadn't.

This is the merest b*ll*cks, in so many ways, & here is not the place

there is a vastly superior strategy: (a) let other subsidize these technologies until they are economic (b) adopt them if/when they have reached that happy position (c) in the meantime, go flat out for efficiency measures (self-financing) and use gas to replace the already-doomed old coal plants and nukes - which, incidentally, will yield a strong contribution to CO2 reduction

because gas prices ain't going the way of oil prices (see this blog and elsewhere passim)

(BTW we can & do make food out of gas, it is the primary feedstock for ammonia)

Timbo614 said...


The Huhne price hikes will come, whether engineered to save Co2 or by the energy industry to line pockets. Every increase though underlines my point. Wholesale prices are low for gas - but retail prices are not! Huhne's report (or one by his minions) forecasts 20-25% increases in prices over the 20 years - who is he trying to kid! It went up by 7-9% just this year already.

Investing now and negating all these increases seems a sensible plan I've calculated in my situation a return on investment (Given annual 4-5% increases in energy prices) of around 8-10% averaged over 15 years. Where else could I get that rate on my money? (and unless I move) no-one can take it away, no market crashes to worry about no inflation nibbling, no persistent 1% interest on cash. Huhne is promising me the increases - so making the alternative energy investment near certain to pay off.

Admitted in the UK it is rather ineffective in the worst of the winter months especially if they are like this year - continuous cloud cover for weeks on end! My PV test rig (oh yes I have been running a test rig for about 18 months now) has been next door to useless - but the backup system proved rather good - Re-charging using over-night cheap-rate - the day rate for electricity increased by 8% but the night rate by only 1% :)

It's not quite capitalism, or is it? Huhne is playing straight into my hand by providing near certainty in the future I am using capital to offset future costs?

Tim Worstall said...

"I always assumed that GDP figures were inflation-adjusted."

They are. 4.5% inflation plus 1.5% GDP growth means nominal GDP growth of 6% and 1.5% real GDP growth.

Of course, we then get into hte howling fight about which inflation measure to use, whether we're calculating it properly etc but no, current 1.5% growth does not mean a shrinking GDP with inflation at 4,5%.

Nick Drew said...

Timbo - the backup system proved rather good ... ?

Tim - thanks

monoi said...

Whatever happens to be true with regards to oil production (by the way, there are some very good prospects for oil created by bacteries in large amount), it is stupid to spend more now (windmills/solar) for something that you can get cheaper.

It is the "what you see" versus "what you do not see". Google Bastiat, it was true 150 years ago, still is now.

Timbo614 said...


:)) - one is not trying to live "Off-grid" that would be daft in suburban Surrey.

The test system is a 110 Amp/hr battery with 60 Watts of PV - so was never designed to or likely to last the winter (cost less than £200). Anyway what I did not say is that it's also like a hobby, I enjoy designing and fiddling with it :)

None of that allows you a winning point - as we agreed, this stuff is the stone age of this technology... but it will come into it's own.

Nick Drew said...

monoi - stupid to spend more now for something that you can get cheaper

agreed - particularly since we don't build the expensive stuff ourselves!

Budgie said...

Blue Eyes and Tim Worstall: "'I always assumed that GDP figures were inflation-adjusted.' They are."

I am corrected. However I cannot find a bald statement to that effect; and is it CPI or RPI or another bigger basket (a steam turbine in a basket?!??!)?

Old BE said...

Budgie, I think the ONS calculate their own inflation rate called the GDP Deflator. Some regard this as a better measure than the consumer prices indices.