Markets cheer 15 % decline of oil prices - after a rise of 434 %

Monday, May 02, 2005

Wall Street took a deep breather on Friday as the price for a barrel of crude oil got slam-dunked to a level below 50 dollars. The decline of oil prices, which ominously started right at the close of London's International Petroleum Exchange and was therefore manufactured in the last 30 minutes of trading, propelled the Dow Jones Industrials Average to a 1.2 percent higher close at 10,192 points, thereby reducing the past month's loss to roughly 3 percent. Never mind the cheer of share traders, the sharp 15 percent decline of crude oil prices from their historic high above 58 dollars will soon be seen as a technical correction in oil's 7-year bull market that saw the price rising a full 434 percent from its 1998 average price of 10.87 dollars in nominal terms and that will continue. The rapid expansion of the far eastern economies will scatter hopes that oil prices will return to lower levels on a durable basis. And let's also talk about the huge political risks US oil imports face after a look on future global consumption patterns.
While the US has been having a share of roughly 30 percent of global oil consumption in the recent past, this is about to change. Automakers are going to invest another 15 billion dollars into China's plants until 2008. Despite a slowdown in sales in 2004 on the back of curbs Beijing implemented, China's domestic car market is expected to grow 10 percent to 5.64 million vehicles this year, supported by fierce price wars that pushed most of the foreign producers into the red already. Remember when you got your first car and the joyrides you took, no matter what the gas price was. A Chinese car buyer will not act differently.
In the USA, the transportation sector accounted for two thirds of petrol use in 2003 while the industrial sector had a share of 24 percent. The remainder goes into residential use (heating oil) and electricity generation. Natural gas will not be able to get a sizable share of the transportation sector as this means vehicle engines will have to be adapted for Liquefied Natural Gas (LNG) at a cost starting at 3000 dollars per car. Cash strapped US individuals, already living on borrowed money, will be reluctant to shell out this investment sum unless gas prices see another very sharp rise into the 4 dollar region.
Don't forget India
The world is predominantly concerned with booming China, overlooking the other huge car market: India. Growth rates there are even more staggering. In 2004 passenger cars witnessed 34% growth in sales, helped by strong 78% growth in exports. Commercial vehicle volumes exceeded growth rates of 32 percent in all sectors. India's middle class consists now of about 300 million people, far exceeding the number of potential car buyers in China.
This translates into steadily rising oil consumption forecasts. The latest report on the oil market by the IEA forecasts a rise in global oil demand to 86.1 million barrels per day in the 4th quarter of 2005 from an average of 82.5 million barrels per day in 2004. Higher growth is only restrained by the current record prices for gasoline and diesel fuel. OPEC barely manages to keep up with demand, reporting today that production will be geared up by another 2 million barrels per day. That still leaves a gap of another 1.6 million barrels, which is most likely to result in rising prices again, based on the classical economic theories of supply and demand.
A look into future refining capacity, currently at a level of 82 million barrels per day, gives a reliable idea where oil demand will shift to. According to the Energy Information Administration (EIA), refining capacity in the Asia/Pacific region is expected to surpass capacities in the USA. To meet projected demand, worldwide refining capacity is expected to rise by 60 percent to 131 million barrels per day in 2025. Gas pump prices will be lightly cushioned by technological advances in new refineries which will allow savings on refinery costs in the total cost of bringing a gallon of gas to the driver.
Political risks
The achilles heel for oil prices grows even larger on perceived political risks. The top 6 suppliers of US crude oil are Saudi Arabia, Mexico, Canada, Venezuela, Nigeria and Iraq, according to 2003 figures of the EIA. Of these only the Saudis and Canada can be expected to remain reliable suppliers in the longer term outlook. Mexico might be forced to reduce deliveries because of its own rising domestic oil needs. Venezuela's president Hugo Chavez has already threatened to stop exports to the US, should there be an assassination attempt aimed at him. He is also currently negotiating higher oil exports to China once a pipeline has been built to a pacific hub in Colombia which would reduce transport costs by half and thereby giving him a huge competitive advantage in comparison to current condidtions.
Iraqi oil at 403 dollars a barrel
For the stability of oil exports from Iraq, where US ally Chalabi was appointed oil minister, turn to other news sources like Al-Jazeera that are very busy reporting on the continuously rising attacks on Iraqi oil installations by domestic guerrilla fighters. The EIA figures state daily deliveries of 481,000 barrels oil from Iraq, worth 24 million dollars at the current price. Add in the daily cost of the war in Iraq of 170 million dollars per day and the effective cost of a barrel of the black gold rises to a staggering 403 dollars. Even in the not very likely event that Iraqi oil exports rise again to their pre-war level of 2 million barrels anytime soon, oil from this region will still cost around 100 dollars a barrel including occupation costs.
Still better than an oil market with the Euro as its main currency
In the long term these huge costs might still be cheaper to the US than the most feared shift of all: Oil being priced in Euros instead of US greenbacks. Iraq was invaded for exactly this reason: Saddam Hussein had started inofficial negotiations about such a move which would be highly uncomfortable, if not ruinous for the US. So far the still biggest economy of the world has a superior advantage to all other nations. It indebts itself in its own currency only. As the dollar is backed by nothing this means that all it takes to get more oil and other goods from its trading partners is simply printing more greenbacks. I have discussed the problem of the US currency in this post and this one and this one.
Looking at the current oil price levels in a longterm perspective one conclusion arises: The real currency of this globe is oil. This is not going to change soon, but some hope is being discussed in this former post.
UPDATE: Some oil numbers from "Stumbling and Mumbling"


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