Oil eases after Greenspan speech on energy - warning on housing bubble

Friday, May 20, 2005

Crude oil prices eased below 47 dollars and the Dow managed to lock in the biggest weekly gain (3.3 percent) since six months after Federal Reserve chairman Alan Greenspan said that private crude oil inventories rose to the highest level since 3 years. In his speech on energy issues given before the Economic Club of New York Greenspan said the fact that higher oil prices have modestly slowed the growth of oil demand had resulted in this build-up of inventories which he expects to continue until demand rises again. Greenspan's energy bets for the future seem to lie with natural gas and a change of consumer's preferences towards lighter or hybrid vehicles. Greenspan warned that geopolitical uncertainties could materially affect oil prices in the future. The status of world refining capacity is also a cause for concern, he said. This was discussed in this post.
Note: the total energy use of hydrogen powered cars is even less efficient than conventional combustion engine powered cars as hydrogen has to be produced as well through other forms of energy.
A compilation of the most important paragraphs of Greenspan's speech
World markets for oil and natural gas have been subject to a degree of strain over the past year not experienced for a generation. Increased demand and lagging additions to productive capacity have combined to eliminate a significant amount of the slack in energy markets that was essential in containing energy prices between 1985 and 2000.
Reflecting a low short-term elasticity of demand, higher prices in recent months have slowed the growth of oil demand, but only modestly. That slowdown, coupled with expanded production also induced by the price firmness, required markets to absorb an unexpected pickup in the pace of inventory accumulation. The initial response was a marked drop in spot prices for light, sweet crude oil. But that drop left forward prices sufficiently above spot prices to create an above-normal rate of return for oil bought for inventory and hedged, even after storage and interest costs are accounted for.
As I indicated in early April, this emerging condition could encourage the buildup of enough of an inventory buffer to damp the price frenzy. Indeed, since early April, private crude oil inventories in the United States have been accumulated at a seasonally adjusted rate of around 250,000 barrels a day, rising as of last week to the highest seasonally adjusted level in three years. A somewhat lesser, but still important, accumulation of crude oil is evident in other major countries. Inventory accumulation is likely to continue unless demand rises, output declines, or we run out of storage capacity.
Altering the magnitude and manner of U.S. energy consumption will significantly affect the path of the U.S. economy over the long term. For years, long-term prospects for oil and gas prices appeared benign. When choosing capital projects, businesses in the past could mostly look through short-run fluctuations in oil and natural gas prices, with an anticipation that moderate prices would prevail over the longer haul. The recent shift in expectations, however, has been substantial enough and persistent enough to direct business-investment decisions in favor of energy-cost reduction.
Of critical importance will be the extent to which the more than 200 million light vehicles on U.S. highways, which consume 11 percent of total world oil production, become more fuel efficient as vehicle buyers choose the lower fuel costs of lighter or hybrid vehicles.
We can expect similar increases in oil and energy efficiency in the rapidly growing economies of East Asia as they respond to the same set of market incentives. But at present, China consumes roughly twice as much oil per dollar of GDP as the United States, and if, as projected, its share of world oil consumption continues to increase, the average improvements in world oil-intensity will be less pronounced than the improvements in individual countries viewed separately would suggest.
Aside from uncertain demand, the resolution of current major geopolitical uncertainties will materially affect oil prices in the years ahead. The effect on oil prices, in turn, will significantly influence the levels of investment over the next decade in crude oil productive capacity and, only slightly less importantly, investment in refining facilities.
In the more distant future, perhaps a generation or more, lies the potential to develop productive capacity from natural gas hydrates. Located in marine sediments and the Arctic, these ice-like structures store immense quantities of methane. Although the size of these potential resources is not well measured, mean estimates from the U.S. Geological Survey indicate that the United States alone may possess 200 quadrillion cubic feet of natural gas in the form of hydrates. To put this figure in perspective, the world's proved reserves of natural gas are on the order of 6 quadrillion cubic feet.
To be sure, energy issues present policymakers and citizens with difficult tradeoffs to consider and decisions to make outside the market process. The concentration of oil reserves in politically volatile areas of the world is an ongoing concern. But that concern and others, one hopes, will be addressed in a manner that, to the greatest extent possible, does not distort or stifle the meaningful functioning of our markets. We must remember that the same price signals that are so critical for balancing energy supply and demand in the short run also signal profit opportunities for long-term supply expansion. Moreover, they stimulate the research and development that will unlock new approaches to energy production and use that we can now only barely envision.

UPDATE: CalculatedRisk highlighted the Q&A session after Greenspan's speech where the Fed head said he sees quite a lot of local bubbles in the housing market. William Polley adds his comments about Greenspan's remarks about the want/need for a Yuan revaluation and links to this Reuters dispatch. According to it "Greenspan poured cold water on the idea that a revaluation will shrink a record bilateral deficit with China that hit $162 billion last year. It will mean that suppliers will turn to other countries like Malaysia or Thailand for cheap textiles and other goods that China now supplies. 'So essentially what we will find is we are importing from a different area but we'll be importing the same goods,' Greenspan said."


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