- Without rereading, I’m not sure but believe that JH is relying on official data which, to my understanding, depends on such measures as implied demand, so also official or ‘visible inventories’ that may not be so accurate as imagined. Not yet clear in my mind but am thinking the obscure nature of OTC markets and non-reported inventories are part of the picture.

Aside from that, and even though he admits the tenuous quality, I’ve a sense the paper is another example of a dominant theory finding that which it has presupossed.

- Anon 11:34, Isn’t it correct that ‘the London oil market’ is the ICE, which acquired the IPE in 2001 and is a global electronic trading platform advantaged, perhaps, by its slightly earlier launch partners as well as JCS’s foresight?

- Yves, I don’t believe there is a ’smoking gun’ but a process which has been compounding since, if I can rely on Citi’s Alan Heap, at least early 2004 when reallocating activities of long only funds had become noticeable.

While long, you might be interested in Frank Veneroso’s 17 April, 2007, World Bank presentation:

Reserve Management
The Commodity Bubble, The Metals Manipulation, The Contagion Risk To Gold And The Threat Of The Great Hedge Fund Unwind To Spread Product
http://www.venerosoassociates.net/

Can you elaborate? Thanks. That would explain what the oil execs are saying, but I haven’t seen anyone produce the smoking gun.

I don’t buy your assertion that the earthquake in China will lead to more diesel use on anything more than a short-term basis, as in during the rescue phase.

Michael Pettis:

Sichuan is 4% of GDP, main impact will be to increase ag costs since it is a pig producing area

China is believed to be about to relax price controls on oil due to earthquake. Now would be a good time to ask for sacrifices. That will lower demand once it works through.

Fuel is being diverted to the rescue area but supplies are being cut back to other areas (Hunan, Hubei, Guangdong)

http://piaohaoreport.sampasite.com/china-financial-markets/blog/The-effect-of-the-earthquake-is.htm

http://piaohaoreport.sampasite.com/china-financial-markets/blog/d/2008-05-21.htm

Bloomberg:

Seven major expressways damaged and tunnels and bridges on five national highways were destroyed. Rescue workers having trouble getting into area. That implies once the rescue push is past, less rather than more car/truck activity in the area.

Government agencies asked to cut spending to fund rescue effort. China is trying not to have undue fiscal stimulus.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aG2Qc7bYPJts&refer=home

http://www.bloomberg.com/apps/news?pid=20601116&sid=a.oIHsVJfLaE&refer=africa

In general:

10 million people who had a reasonable life are now living in tents or worse. I doubt their diesel use is up. Once the rescue push is past, the ongoing demand from the area will be lower (people who have lost everything they have aren’t going to be using as much fuel as before).

They also stated that the refineries were not producing gasoline at peak because the market was well supplied.

At the same time we have Calpers, the British Postal Pension fund, and a host of huge pension funds, SWF, hedge funds, mercantilist national dollar piggy banks, insurance companies, and our own Fed funded investment banks putting money to work in the commodity markets.

Traders would like us to believe in peak oil, declining resources, and other diversionary rhetoric. They ain’t making any more land (to iteratate their siren call during the housing bubble).

Which is the most logical scenario ? That demand suddenly exceeded supply, even though demand has dropped significantly ? Or that the highly leveraged, unregulated futures whorehouse is driving the price into a bubble in front of a wave of speculative cash ?

Hamilton has never met a price action that he hasn’t attributed to “free competitive market” pricing. He has yet to recognize a bubble/swindle while it was occurring or to acknowledge the numerous market swindles that have been exposed over the years. I think he was espousing a cometitive market scenario during the 2004 natural gas swindle.

There was an excellent write up on the Bakken Shale on Oil Drum with some graphs that illustrated your point.

http://www.theoildrum.com/node/3868

Another example is the Barnett Shale. Production peaked in Aug ‘07 at 84.7 BCF and by March ‘08 had fallen to 62.7 BCF, a whopping 26% decline in six months.

Drilling these sorry reservoirs has historically been a promoter’s dream and an investor’s nightmare. However, with the huge increases in the price of gas, the investors might get bailed out this time.

Hamilton gives a ballpark figure of 4% for the decline rate of existing production. I think that’s significantly too low. Schlumberger’s Gould puts the figure closer to 8% based on work with their clients. Total’s de Margerie put it at 6-7% over the past two years. Even CERA, which has a history of consistently overstating production, puts it at 4.5%. And none of these estimates take into account the extra energy being spent on production. In other words, the energy return on energy invested is dropping as well, because it is taking so many more rigs to get what production we’re getting.

Also, the most important thing about the decline rate is that it is steadily increasing. That’s because newer projects, once they hit decline, tend to have a far sharper decline rate than the old-time projects did. Some of the old Permian Basin fields are still declining at only a very slow rate, while newer fields, such as the North Sea, have been subject to much better technology right from the start. When one of these newer projects goes into decline, production tends to fall off a cliff. Also, when a project is extremely expensive to produce, optimal return on investment is often obtained by going for the kill–producing as fast as possible, even if that means you end up leaving some oil behind that you might have gotten if you could have afforded to pump more slowly.

I’d say there is no way at this point that we’re going to see 6.9 mb/d of new production coming online in 2008. We’ll be lucky to see 4 mb/d, and since at least half of that will come online in the second half of the year, we’ll see even less available in actual 2008 supply. In other words, the 2 mb/d that come online in the first half of 2008 will mean roughly 1.5 mb/d of actual 2008 supply, but the 2 mb/d that come on in the second half of 2008 will bring only 1 mb/d of actual 2008 supply overall, for something like 2.5 mb/d actually added to overall 2008 supply. If you add in some production that was just coming up to speed at the end of 2007, my own estimate is that we’ll see about 3 to 3.5 mb/d of new production in overall 2008 supply.

All of this changes the supply picture enormously. We’re losing somewhere between 4 and 7.5 mb/d, give or take, and we’re adding only 3 to 3.5 mb/d.

If worldwide demand were absolutely flat in 2008 (and it’s not–it’s still rising) and product prices tracked oil prices closely (they don’t, but they’re getting closer) this would mean prices would go up roughly 15% to 68%. A 1% rise in worldwide demand would raise prices another 15%. This means we could expect a price rise of roughly 30% to 80ish%, just to account for the decline rate and rising demand in China, India, and the oil-exporting countries.

But wait, there’s more! Now you have to factor in the worldwide shortage of diesel, which is getting worse, not better (partly because of China’s earthquake emergency and natural gas shortages in the Middle East). And the diesel shortage isn’t easy to change quickly. It’s virtually impossible to get more diesel out of a barrel of oil than we’re currently getting, and changing away from diesel to a product that’s in less demand (like gasoline, or even solar power) is not fast or easy. It means changing how electric power is being produced and goods are being transported, and it means changing the existing car fleet. All of this will take time.

I don’t agree that the real price of oil follows a random walk without drift, but that’s an argument between economists and traders that will probably never be resolved.

I think it’s especially helpful that Hamilton points out how it may be rational for producers to pump less in some circumstances. I have posted this myself at nakedcapitalism, but I never provided a specific example, and Hamilton’s Kuwait example is a good one.

Anonymous 9:05 am, I wish you good luck with your investments.

Moe Gamble

I want to thank you for hosting, and others such as Moe Gamble and Juan for their frequent additions, to this conversation about oil prices.

I have oil and gas investments, and am thinking about making more, and have found the discussion here on Naked Capitalism to be about as dispasionate and free of cant as any around, whether in the conventional media or the internet.