The reverse oil shock

It’s temporary – but it’s a reverse oil shock. Peakists (analysts based on the peak oil model) were surprised with the swing – some of them continue completely bullish until the downtrend was sound evidence. From near $145 ($143.95, July 3) a barrel (Brent Spot price) just six months ago to less than $40 – the barrel got crazy.

What went wrong in the peakist mind? I myself must confess my resistance for a shift in the mindset – for a while. But, be sure, the «structural» problems remain, so the peak oil will return and you’ll pay for this dramatic reverse trend. May be only in 2010 or later, when the current recession will be over, forecasts Rembrandt Koppelaar, a 23 year-old Dutch energy specialist, the editor of The Oil Drum.

The incredible Mark Twain said once: «The art of prophecy is difficult, especially about the future.» So, check always the hard facts and be sensible to the trends that already move under your feet, even if the others do not “see” them, as the late Peter Drucker wrote.

In last November OPEC met in Egypt and in December 17 will meet again in Algeria. The different approaches regarding this reverse oil shock will be discussed by the members of the oil cartel. In November, in Cairo, the political divisions inside the cartel closed the meeting without any decision regarding further cuts.

INTERVIEW by Jorge Nascimento Rodrigues, November 2008

Rembrandt: « I don’t think the prices can go further down then 40 dollars per barrel, as this is the level at which many oil fields currently in production will drop below a point of profitability.»

Q: How far will go this dramatic slump in oil prices?

A: I don’t think it can go further down then 40 dollars per barrel, as this is the level at which many oil fields currently in production will drop below a point of profitability (these oil fields will then get shut down and prices will have to go up because of a massive decrease in supply). In addition the average OPEC budget for 2008 (and 2009) is based upon 55-60 dollars per barrel. Such low prices will give a HUGE incentive to OPEC to cut supplies drastically.

Q: Can we expect less than 40 dollars a barrel before the end of the year, or the price will go up again due to the holiday season?

A: I still think that prices will rebound due to the decision by OPEC to decrease supply by 1.5 million b/d, like I wrote previously. I have been wrong so far, but there will be a rebound eventually. This is going to happen as soon as consumption/shipping increases. Worldwide shipping is now down 20% year on year. The Baltic Dry Index (measures demand for shipping capacity versus the supply of dry bulk carriers) is at an all time low at the moment (reflecting the huge decline in shipping). This can be checked here. The index appears to have bottomed out for now (after a decline of 93%). The question is when consumption again will increase as demand picks up slightly. This could be soon (within weeks), but also within months. It depends on how bad it is going to get with the financial players (when is the deleveraging done of bad credit/financial unwinding). My guess is that shipping demand will pick up again in December due to holiday season, and that we will not end the year with 40-50 dollars per barrel but around 60-70 dollars per barrel.

Rembrandt: « Oil prices of 25-30 dollars per barrel are out of the question. A realistic ‘bottom’ oil prices for 2009 when OPEC supply cuts work their way through the market is 50-60 dollars per barrel. Prices will likely be higher than that in 2009. »

Q: If the recession and depression goes in the OECD countries for 1 year or more, and if the growth in the big emergent countries goes below 4-5% per year, can we expect oil prices in the range of 25-30 dollars?

A: No, this will not happen because that would make many oil fields currently in production unprofitable. A recession does not lead to a severe enough drop in demand to undercut the supply cuts that will happen at an oil price of 25-30 dollars. In addition it will cause supply cutting behavior in OPEC countries as well to balance their state budgets. Oil prices of 25-30 dollars per barrel are out of the question. A realistic ‘bottom’ oil prices for 2009 when OPEC supply cuts work their way through the market is 50-60 dollars per barrel. Prices will likely be higher than that in 2009.

Q: The majority of the peakists failed to understand the economic climate radical change in July-August and continue to insist unwisely in the escalade of the oil price. What went wrong with the peakist mind?

A: A lot of the peakists indeed are still making bullish statements on the oil price. I was one of them two months ago, but reality makes one more humble over time. I think that in the long run (2010 and beyond) oil prices will escalate again if we go out of recession, but for now we are going to continue to see prices between 40 and 80 dollars per barrel for a while (until end 2009). That is what I expect.

Koppelaar: «If oil prices drop below 40 dollars per barrel, the oil sector will partially collapse and nearly all of the oil export countries will have a severe problem due to a lack of cash available to invest for the state.»

Q: You mean we will see a new escalation of prices only after the end of recession?

A: Only if the recession ends and the world economy grow by several percent a year will oil prices increase again beyond 100 dollars per barrel. I think the earliest that this will happen is 2010.

Q: With oil prices in the range of 30-40 dollars, parts of the world oil sector would collapse and turmoil in export countries would grow?

A: If oil prices drop below 40 dollars per barrel, the oil sector will partially collapse and nearly all of the oil export countries will have a severe problem due to a lack of cash available to invest for the state. The OPEC countries as well as Russia, Azerbaijan, Kazakhstan will politically prevent such a thing from happening at ALL COSTS. Because the alternative for those countries is economic breakdown in the short run (1-2 years) and social breakdown in the long run (3+ years) as a consequence.

Q: What’s your comment about the recent meeting of OPEC in Cairo in November?

A: As OPEC has postponed to make further cuts we can expect oil prices to remain between 45 and 55 dollars per barrel. Perhaps we will even hit 40 dollars per barrel. Oil usage is declining fast at the moment as we are diving into a year of economic recession on a global scale. An event that has not occurred since world war II. The loss of economic activity is causing a decline in demand of all most 1 million barrels per day in the current quarter versus a year earlier. And oil demand is not going to pick up soon even with declining gasoline prices in the United States due to the world economic situation. The current cut of 1.5 million b/d will thus likely have no effect whatsoever to halt the price decline.  If OPEC wants to bring the price to a higher level, they need to make at least a second cut of significance above 1 million barrels per day.

© Jorge Nascimento Rodrigues and Rembrandt Koppelaar.

6 Responses to “The reverse oil shock”

  1. The ‘peakists’ were not aware of Nassim Taleb‘s ‘The Black Swan‘ – “history does not crawl, it jumps”!
    To which I add: Conservative forecasts never happen, the avalanche effect is always at hand.

  2. […] Os preços do petróleo parecem estar loucos. Em cinco meses, o barril de Brent (crude de referência na Europa) caiu de perto dos 145 dólares para menos de 50. O processo inverso levara ano e meio – desde Janeiro do ano passado até ao pico histórico de 3 de Julho deste ano (143,95 dólares em Londres). Assistimos, num curto período, a um verdadeiro “choque petrolífero ao contrário”, como sublinha o analista holandês Rembrandt Koppelaar, editor do The Oil Drum, e um dos especialistas europeus do modelo designado por ‘pico do petróleo’. Koppelaar deu uma entrevista a Janelanaweb que pode ser lida na íntegra aqui. […]

  3. Very usefull post.
    Thanks.
    P.S. I like your writing style.

  4. First of all congratulation for such a great site. I learned a lot reading article here today. I will make sure i visit this site once a day so i can learn more.

  5. sooooooo this whole post is BS because oil is at 38 dollars a barell today…

  6. Sam, as you see the WTI closed the year (2008) near $45, and the Brent also above $40. Daily and intra-week volatility, “wild oscilations” sometimes, as Ugo Bardi told janelanaweb.com are the pattern.

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