Modern Commodities Markets are Badly Distorted

Adapted from an earlier posting on Al Fin


Dian Chu suggests that under the modern regime of commodities pricing, very few people know what the true market price of oil -- and other commodities treated as "asset classes" -- is.

The only real market principles are based upon who is using the product, i.e., who needs the commodity to actually take or provide physical delivery. I know what a novel idea, actually using futures contracts the way they were originally intended. But this is something that modern societies must enforce through necessary market reforms. You would find out real quick what the true market price is for many of these necessary commodities by making players take or provide physical delivery. _EconMatters

You might look at modern oil markets as hundred billion dollar casinos, where everybody's a winner -- as long as they control the spin of the wheel.

Prices are not determined by the fundamentals in a manipulated market they are determined by oil being an “Asset Class” which is code word or a euphemism for giant Casino in New York instead of Vegas.

...The price of oil, and as such gas is determined not by supply and demand factors, but by whether Goldman Sachs (NYSE: GS) or Morgan Stanley (NYSE: MS) or J.P. Morgan (NYSE: JPM) puts $400 million on Black or Red, the literal Oil Roulette game of the big banks... If Goldman Sachs puts $400 million on Black prices go up, if they put $400 million on Red prices go down, as simple as that, this is actually how the price of oil is determined, nothing more and nothing less. _Dian Chu

In a simpler world of fewer trades, where commodities futures can be monitored closely by a conscientious overseer, manipulating the market would be more difficult. But in the modern, ultra-high volume speed-of-light trading by the giant banks with minimal oversight, the smart money bets on the smart manipulators.

...lets just abolish the SEC and the CFTC, as they are completely useless. Furthermore, since all markets are ripe with manipulation, essentially the wild-west; why not reduce government costs by cutting funds to these two agencies entirely. They serve no real purpose when markets are corrupted everyday with Fake Orders, Dark Trading Pools, High Frequency Trading Algos, and the like except to further government costs & bureaucracy while strictly providing the illusion of fair markets. These organizations are a complete joke, and have been for decades!

... _Dian Chu

If you combine Dian Chu's reasoning above with Andrew McKillop's thinking featured in this Al Fin Energy article, you may begin to see a pattern developing.

Even in an era of relative oil oversupply, markets can be tweaked so as to bring oil prices further upward -- until it is time to let them drop again.

It is difficult to deny that global oil markets have become the equivalent of casinos, with all the big players standing around the wheel, placing bets and exerting small bits of control over the ball, here and there, now and again, over and over again.

As for US government oversight, fuggidduhbowdit! The Chicago outfit only wants to make sure that it gets its piece of the action.

More from Dian Chu here:

Physical-delivery-needed-in-agriculture & Energy Markets

But don't hold your breath waiting for any meaningful reforms that might make these markets more transparent and less manipulable. The big players will always give themselves the upper hand if at all possible.

There are many indicators suggesting that big governments and large intergovernmental agencies are happiest when managing a world where information and data transparency is limited to persons or entities on the top, politically and economically.

This has generally been the case in Asia and Europe (and for the UN, World Bank, and IMF), and is becoming increasingly the case in the US under the Obama administration, also known as the Goldman Sachs administration.

Global Oil Oversupply vs. Global Oil Markets

Oil prices have been relatively stuck recently, with no apparent rational relation between the real world and oil prices.

Andrew McKillop takes a look at why oil prices appear to be in a non-responsive limbo over the past few weeks:

Following the 12 December OPEC meeting it took around 15 days, stretched by the holiday season, for the message to sink into the minds of traders: by 1 January 2013 prices were at $111.11 per barrel for Brent and over $91 for WTI. The unreal logic is that OPEC is by its own admission pumping more oil than the world needs - so prices must rise!

The logic is in fact double-stage: if oil prices are pushed up and stay high, OPEC will maintain output, and in a certain hard-to-specify period inventories will grow enough to make the already plain fact of oversupply even plainer. At that unspecified time interval forward from now, prices will fall.Talk about what constitutes the "reasonable price" for oil is rigorously and always talk only: at OPEC meetings no figures are ever mentioned. The trader and analyst community supplies the numbers - but these range from below $50 a barrel to around $120 a barrel.

The net result is directionless markets tagging along behind the incoming news on growth (and recession) outlooks, currency trends, CPI and purchasing manager forecasts, non-oil energy news, and of course the always intriguing subject of Arab Spring, Syrian civil war, al Qaeda in the Middle East and in Sahel Africa, and other material from the Indiana Jones collection.

We therefore have an interesting entry scene to year 2013 oil trading, with current supply/demand most surely and certainly out of balance, with too much supply. To be sure, the Mid East geopolitical scene can unwind at any time, and winter cold can storm across the northern hemisphere - both of which can bolster prices. By late January however, we could expect the accumulated set of problems for overpriced oil to start taking their toll. _Andrew McKillop

Markets can be much like herds of cattle or sheep. Made up of hundreds or thousands of relatively dim-witted beasts, they can usually be easily herded and arbitrarily kept in artificial "holding areas" for varying lengths of time.

But when the "stampede" signal hits the herd, the herders and herd owners had best be prepared to cash in quickly, before the losses start to pile up.

Another piece by Andrew McKillop, looking at the larger stage of global Ponzi Scheme economies

If McKillop and all the others are right -- those who point out the insubstantiality of modern economic foundations -- the underpinnings of the global economy are far less substantial than we are being told by "our betters" in government, the media, academia, and the punditry. What that means for intermediate and long term oil prices, will be left as an exercise for the reader.

Sell at $115 bbl; Produce at $15 bbl; Profit of $100 bbl

...certain oil fields in places like Iraq and Saudi are still pulling oil up at a cost of about $10 per barrel.

This $100 oil malarkey is a function of an explicit cartel (OPEC), dangerously unregulated commodity oil trading in global investment banks and the background noise of those who think oil will soon be extinct. _IrishExaminer

Oil production costs vary wildly from one region of the world to another -- even from one adjacent oil field to another adjacent oil field. Profits for some producers are much higher than for others. Let's look at some comparisons of production costs:

The first table comes from the USEIA.
EIA:

Costs for Producing Crude Oil and Natural Gas, 2007–2009
2009 Dollars per Barrel of Oil Equivalent¹

	Lifting Costs	Finding Costs	Total Upstream Costs
United States – Average	$12.18	$21.58	$33.76
On-shore	$12.73	$18.65	$31.38
Off-shore	$10.09	$41.51	$51.60
All Other Countries –Average	$9.95	$15.13	$25.08
Canada	$12.69	$12.07	$24.76
Africa	$10.31	$35.01	$45.32
Middle East	$9.89	$6.99	$16.88
Central & South America	$6.21	$20.43	$26.64

¹5,618 cubic feet of natural gas equivalent to one barrel.

Source: Tables 10, 11 and 12, Performance Profiles of Major Energy Producers, 2009.

Last reviewed: November 1, 2012

The next table comes from the IEA:

Oilfields                   Estimated Production
 /source                        Costs ($ 2008)
 Mideast/N.Africa oilfields         6 -  28
 Other conventional oilfields       6 -  39
 CO2 enhanced oil recovery         30 -  80
 Deep/ultra-deep-water oilfields   32 -  65
 Enhanced oil recovery             32 -  82
 Arctic oilfields                  32 - 100
 Heavy oil/bitumen                 32 -  68
 Oil shales                        52 - 113
 Gas to liquids                    38 - 113
 Coal to liquids                   60 - 113
 
 Source: International Energy Agency World Energy Outlook 2008
 

Bakken oil & gas producer GEOI:

Net Oil and Gas Production, Average Price and Average Production Cost

The net quantities of oil and gas produced and sold by us for each of the three fiscal years ended December 31, the average sales price per unit sold and the average production cost per unit are presented below.

		Year Ended December 31,
		2008			2007			2006
Oil Production (MBbls)			743			392			184
Gas Production (MMcf)			2,962			1,648			577
Total Production (MBOE)*			1,236			667			280
Average sales price (net of hedging):
Oil per Bbl		$	82.42		$	67.20		$	54.61
Gas per Mcf		$	8.12		$	6.19		$	6.83
BOE		$	68.96		$	54.74		$	49.92
Production cost per BOE**		$	27.46		$	23.67		$	20.37

*	Barrels of oil equivalent have been calculated on the basis of six thousand cubic feet (Mcf) of natural gas equal to one barrel of oil equivalent (1 BOE).

Notice that as the price of oil goes up, the cost of production per barrel also goes up -- due to automatically increased tax rates. Also notice that the cost of production given by GEOI is much lower than the $60 to $80 per barrel prodution cost usually quoted for tight oil.

This graphic is a big picture comparison of different regions and countries. Better technologies for tight oil, oil sands, and other unconventional oil production, are pushing production costs down -- while prices seem to be stuck on an undulating plateau.

Clearly the Persian Gulf countries are sitting in the best seats in terms of watching the oil money flow in. Russia is not doing too badly either -- if not for corruption in high places, stripping away oil profits for wasteful personal consumption by cronies.

The best North American oil producers are enjoying a profitable season, and are happy for it. Even if oil prices drop to $60 a barrel, many of the North American producers will be able to keep producing long enough to wait out the slump, and catch the ride back up.

Global Oil Production Booming; Demand is Softening

Oil prices have remained remarkably stable over the past few years, considering the impressive price boom and bust of 2007 - 2008 - 2009. Peak oil doomers have been particularly disappointed at the failure of their predictions of near-term global collapse -- made so gleefully in the heady days when it was still possible for a halfway intelligent person to believe that oil production had permanently peaked in 2005. But the real world still holds a lot of surprises for people who believe they understand its energy complement -- or even its climate, for that matter.

The reason for the oil price softness is slowly but surely being revealed. Oil and gas production is booming globally but particularly in the US to the point where just last month, the International Energy Agency projected that “extraordinary growth in oil and natural gas output in the United States will mean that … the United States becomes a net exporter of natural gas by 2020 and is almost self-sufficient in energy, in net terms, by 2035.”

According to the EIA, the average cost of production is lowest in the Middle East at around $US17 a barrel, with a global average around $US25 a barrel. This suggests the low will be a little above that, barring a demand free-fall. In the US, the cost of production is in the mid $US30 range, all of which suggests a level as low as $US40 is possible.

Add to that the tepid growth phase of the global economy and price trends should be down. _BusinessSpectator

There is a lot more oil to be discovered, particularly around the great underexplored areas of the planet. Even the Persian Gulf is underexplored compared to North America, by a factor of roughly 1,000.

“We see an easing of oil prices [in 2013] as demand remains weak,” explained Peter Kiernan, lead energy analyst for the Economist Intelligence Unit, adding that even fast-growing emerging markets and non-OECD nations will experience a poor economic performance next year.

...A “shale revolution” in the U.S. promises to change the market landscape. “U.S. production of shale gas has exploded with a nearly 50% annual increase between 2007 and 2011,” a report by the National Intelligence Council noted, while shale oil production, still in its infancy, could bring anywhere from 5 to 15 million barrels per day by 2020 at a break-even price as low as $44 to $68 per barrel. “By 2020, the U.S. could emerge as a major energy exporter,” the report added. _Oil 2013

This is bad news all around for aging peak oil doomers, who sit wanking in their circular echo chambers.

It is also bad news for many supporters of US President Obama. Obama has backed dozens of failed or failing big green energy startups at taxpayer expense, to please green political backers and to enrich the bank accounts of campaign bundlers and other crony supporters.

Obama favours intermittent unreliables, but it is the hydrocarbons and nuclear power -- both of which Obama dislikes -- that deliver reliable energy, power, and fuels. Obama was the accidental beneficiary of an unplanned US shale boom. But he is happy to take the credit for an economic boom that only happened because his EPA was too slow to kill it before it bloomed.

And now that the US oil & gas boom is proceeding ahead, despite Obama, the UK and the EU may be next. And don't forget China. If Australia can dump its foolish green "energy suicides", it might wish to join the global party.

If Oil Prices Drop Below $80 a Barrel . . . .

According to the consensus, only a collapse in demand for oil is capable of driving oil prices below critical levels. At that point, the expectation is that marginal producers would quite production, resulting in a drop in supplies, and a rapid rise in oil prices above the critical cutoff.

The European recession, the slowing growth in China, and the Fiscal Cliff in the United States could drive oil prices much lower.

Recent economic figures from China were mixed. Its Service PMI was above 50, but still dropped quite significantly over the last two months. Europe’s unemployment is rising as the economy slows again, and in the U.S., talk of the Fiscal Cliff is raising the level of uncertainty for markets. One might extrapolate from all of this to mean lower economic activity ahead. This would mean lower demand for energy.

What if Brent Crude Oil prices were to drop below $80? WTI Crude oil was $88.50. Brent Crude Oil was around $110 on December 4 2012. A drop in Brent prices would hurt profits for oil companies. _The Street

The short article above focuses on the effect of a price drop on small to medium-sized oil companies, and marginal producers. Certainly a number of them would be forced to halt production and new drilling if prices dropped below $80.

But quite a few producers of shale oil and oil sands would be able to ride out oil prices below $80 -- as long as prices dropped no lower than $60. A drop in prices would force even more of them to innovate more economical production methods.

But what about the effect of a serious oil price drop on Russia and a number of OPEC countries?

Many of these countries -- including Iran, Russia, and Venezuela -- have ambitious plans for regional domination through military power. To achieve these goals they will require high global oil prices. Other countries such as Saudi Arabia, Iraq, and other Gulf states, need high prices to pacify their restless populations -- and to fund global Islamic fundamentalist movements.

It is in these parts of the world -- where governments are dictatorships and free markets are not allowed to function -- where a sustained drop in oil prices would lead to serious unrest.

As mentioned above, the consensus hovers around the idea that only a drop in demand could possibly lead to a serious drop in oil prices. But if free market forces were unleashed across more of the world -- including the US, Europe, South America, MENA, Africa, and Australia -- significant new supplies would complicate the picture as well. It is only by bottling and confining markets and innovation that political entities artificially contain latent supplies. Thus the term, "political peak oil."

The Oil Curse: Over-dependence On Petroleum Revenues In a Volatile Age

In one sense, the price of oil has been very volatile -- boom & bust -- ever since the beginning of the oil age in the late 1800s. The price of oil in US dollars has been particularly volatile. But even when measured against the price of gold, the price of oil has seen some significant peaks and troughs over the years.

Severe oil price swings make it very difficult for countries that are overly dependent upon oil & gas revenues to balance their budgets. Countries such as the MENA oil states, Venezuela, Russia, etc. are finding themselves in a difficult pickle with regard to mounting obligations toward the future.

A new report suggests that Saudi Arabia will need an oil price of $320 a barrel by 2030 in order to balance its swelling government budget.

Russia's fiscal breakeven number varies between about $130 a barrel and $150 a barrel, depending upon who you are asking. Regardless of the exact figure, the number is likely to skyrocket in the future, and Russia is already having trouble making ends meet. What of the future?

Gustafson said that many in Russia's government realize that trouble lies ahead but that consensus is lacking on how to move forward. A reduction in oil revenues could devolve into a power struggle between interest groups over shrinking oil rents... A decline in oil revenues could usher in a major crisis, forcing cutbacks to major spending programs such as pensions and subsidies that underpin the stability of the Putin regime. In such a crisis the state would be forced to confront the difficult choice it has avoided for so long--whether or not to lessen the tax burden on the oil industry and enable it to invest in the next generation of fields and technology. _If Oil Declines, Russia Declines

Putin's agenda of bread and circuses will only suffice to cover up Russia's ruinous corruption and cronyocracy for so long, in the face of stable or falling oil prices.

The chart above reveals that the actual cost of production of oil for these countries is quite low -- in comparison with their fiscal breakeven oil price. The difficulty balancing their budgets in the light of their already huge production profits, points out the depth of oil dependency and corruption so prevalent in these countries.

In the meantime, US oil production continues to grow -- despite the Obama / Salazar agenda of energy over-regulation. The vast deposits of Canadian oil sands are also waiting to be developed, and shipped to market. A rapidly accelerating oil production from the huge Iraqi deposits of oil await a suitable environment of stability. And large oil & gas deposits in Iran, Africa, Central Asia, the Arctic, and offshore deposits around the world, await the proper geopolitical and global economic milieu for development.

Vast amounts of global energy await the proper conditions for development and distribution. Advanced nuclear energy from unranium and thorium, clean coal technologies of IGCC and liquefaction, efficient and scalable GTL technologies, development of vast deposits of bitumens in Canada, Venezuela, and elsewhere, huge deposits of kerogens, and huge quantities of gas hydrates.

Advanced nuclear energy could supply abundant energy for tens of thousands of years. But until such technologies are developed, fossil fuels can bridge the gap in time.

As for carbon hysteria and climate change? Only a clear and dispassionate knowledge of the global carbon cycle of the land and sea can eradicate those phantom fears. For humans to acquire clear knowledge and wisdom on that and many other crucial issues -- a better leadership and a more honest information media will be needed.

Global Oil: Supplies High, Demand Low

A global economic slowing from China to Europe to North America has put a damper on demand for oil -- just as global supplies are beginning to ramp up in reaction to high oil prices.

Oil prices have fallen approximately 13 percent this year. Oil futures, which haven't closed below $86 since mid-July, fell to a low of $84.86 a barrel last week. Weak outlooks recently provided major companies such as Caterpillar, DuPont, and 3M have raised concerns that the global economy is weakening, which could further reduce demand for oil. The Energy Information Administration earlier this month reported that oil production in the U.S. was at a 15 year high, despite lower demand. _News Yahoo

As long as the price of oil remains above $75 a barrel, the ramp up in production is likely to continue. That means that in the intermediate term, oil prices are likely to stay close to present levels.

"There is a correlation between the equity markets and the oil price," said CMC Markets analyst, Michael Hewson. "We've had various companies missing price forecasts and these concerns about the future outlook for earnings are keeping a lid on oil prices." _Five Star Equities

Of course, in the long term, supplies of unconventional hydrocarbons are likely to grow as improved technologies are perfected for producing clean gas to liquids (GTL), coal to liquids (CTL), bitumens to liquids (BitTL), kerogens to liquids (KTL), and gas hydrates to liquids.

Conventional oil & gas producers -- including those of OPEC and Russia -- will be hard put to compete with the rising unconventional producers, at least in the sense of being able to pacify their populations and to support their dictators in the manner to which they have become accustomed.

Fiscal Breakeven: Why War Is Inevitable

Many people are confused between the concept of oil production costs and the concept of fiscal breakeven, for countries that rely on oil production to finance their government budgets. The graphic below looks at fiscal breakeven for a number of oil states belonging to OPEC.

Real Clear Energy

This is how much each nation must charge for a barrel of oil to support its government budget. For Russia -- not a member of OPEC -- estimates for fiscal breakeven vary between $125 and $150 per barrel.

The price of oil is currently around $85 per barrel, which means that all the countries to the right of Saudi Arabia are losing ground. This is where Hulbert sees the a pending instability. He writes:

"A key outcome of the Arab uprisings has been a significant increase in the prices needed by the producers to manage their fiscal position. This is a serious indictment of the producers' failure to diversify their economies away from a dependence on oil revenues over the past 20 years.

“If the oil price goes much lower, three scenarios could ensue sequentially: a price war forcing prices even lower, a period of internal repression as revenues fail to buy compliance among populations, and internal unrest among producers, which could lead to supply disruptions followed by prices bouncing back." _RCE

Contrast fiscal breakeven levels as pictured above, with upstream production costs for various regions: Costs for Producing Crude Oil and Natural Gas, 2007–2009
2009 Dollars per Barrel of Oil Equivalent¹

	Lifting Costs	Finding Costs	Total Upstream Costs
United States – Average	$12.18	$21.58	$33.76
On-shore	$12.73	$18.65	$31.38
Off-shore	$10.09	$41.51	$51.60
All Other Countries – Average	$9.95	$15.13	$25.08
Canada	$12.69	$12.07	$24.76
Africa	$10.31	$35.01	$45.32
Middle East	$9.89	$6.99	$16.88
Central & South America	$6.21	$20.43	$26.64

_USEIA
Keep in mind that for the US, Canada, most of Europe, etc. the concept of fiscal breakeven does not apply, since these nations do not depend upon oil sales to finance their governments. The concept of upstream production costs, of course, still applies.

The reason that war is inevitable, is that nations such as Iran, Venezuela, and perhaps Russia, are losing money at current oil prices. And yet, oil production is set to increase from North America to Iraq to Brazil to the far East.

Russia is struggling to produce as much oil as it can, using an infrastructure that should have been replaced over 20 years ago. Red Queen Russia is faced with the need to lure more competent international oil companies into the country to upgrade badly deteriorated oil & gas infrastructure. But Russia has a bad reputation of stealing foreign investment outright -- without apology. Getting insurance to do business in Russia can be difficult, for that reason, and due to rampant organised crime, violence, and extortion.

Is there any wonder why Russia is egging on Iran to build nuclear weapons, or supporting Syria's bloody suppression of a popular uprising? Russia thrives on the geopolitical risk premium built into the price of oil -- between $15 and $30 per barrel in some markets. Russia seeks to push that risk premium even higher, to avoid being forced to curtail its ambitious military and nuclear upgrades.

The same dynamic is at work in the thinking of the dictatorships of Iran, Venezuela, and other oil tyrannies. These despots may understand that wars often grow out of control and consume those who sought to gain from them. But some of them may see no other way out of their fiscal trap.

For Europe, North America, Oceania, and East Asia, the lesson is clear: Develop your own energy resources. Conventional and unconventional oil & gas, coal, nuclear, bitumens, kerogens, gas hydrates, biomass, geothermal . . . . Everything must be on the table -- except for the intermittent unreliables which are more destructive than constructive.

It is time for the more advanced nations to decouple themselves from the incredibly unstable OPEC / Russian oil & gas producers -- as much as possible. That is the only way to prevent the inevitable war from spreading out of control.

Oil Prices: Stable or Falling? Plus Obama's Crony Energy Game

What will happen to oil prices over the next several years?

Kevin McElroy thinks oil prices may drop by 50% over the next few years.

The IEA expects oil prices to fall over the next 5 years as demand slumps and supplies grow

Andrew McKillop sees Brent prices dropping by 25% and WTI dropping by around 15%

Citi sees oil prices between $80 and $90 through 2020

No one actually knows where oil prices will be in 5 or 10 years. But as long as prices stay near or above $80, upstream producers will be making money.

Despite ongoing sanctions on Iran and continuing speculations of war in the Persian Gulf, oil prices have resisted the urge to spike. This price stability reflects increased supply from other sources, and must be a tremendous source of disappointment to oil traders and peak oilers alike.

Meanwhile, US President Barack Obama continues his policy agenda of energy starvation, continuing to support intermittent unreliable forms of energy, rather than more reliable and dependable forms. But he has a good reason for his approach -- Chicago style political quid pro quo!

Some 80% of companies receiving Department of Energy backing, according to the Hoover Institution's Peter Schweizer, are "run by or primarily owned by Obama financial backers." One, Mr. Al Gore, is worth an estimated $100 million, thanks to $2.5 billion in federal loans, grants and tax breaks, according to Friday's Washington Post.

What about the "green" jobs that were supposed to sprout? By Mr. Obama's own arithmetic, the $21 billion spent so far should have delivered 700,000 jobs. Actual count: 28,854, according to Friday's Bloomberg Businessweek. _WSJ

Obama is doubling down on stupid by pushing a trade war with China over solar panels!

As has been stated here before, when it comes to producing and installing green intermittent unreliables, whoever wins is the one who loses.

Advanced next-gens nuclear energy will be the future of large scale energy for at least a few thousand years, once the leadership of advanced nations wakes up to the obvious. That should take about 10 to 20 years.

In the meantime, we are going to need both conventional and unconvention oil & gas, as well as coal, kerogens, bitumens, gas hydrates, and advanced biomass and microbial fuels.

What we absolutely do not need to do is to waste resources on destructive green intermittent unreliables.

What's Next for Oil & Gas?

UK based think tank Chatham House has published a new report: What Next for the Oil and Gas Industry? The report predicts a continued lessening of demand for middle eastern oil on the part of both North America and Europe. The authors see significant changes coming in the global oil & gas industry and the geopolitics of the middle east, as a result.

‘Peak oil’ is proving a misleading idea. The foreseeable problem is not finite resources but the rate at hich these very large resources can be converted into reserves for potential production. Reserves of oil and gas have each more than doubled since 1980 – faster than the increase in production. Technologies are developing which are creating new reserves of ‘unconventional’ oil, as they already have for gas.

These technologies have more places to go, many of them outside the existing oil-exporting countries. These new areas are opening a field of growth for private-sector companies which was not foreseen a few years ago. The companies also still have opportunities for collaboration with state companies, in half of the world’s oil reserves, provided they meet each country’s terms and conditions and bring technology to complement the state company’s own resources. In some countries whose economies depend on oil exports, expansion of production is problematic, because their governments may choose to keep oil in the ground for future production, while gaining time to diversify their economies. Technology is the master key to both sets of opportunities.

With demand vulnerable to other industries, and supply growing from ‘unconventional’ sources and new areas, there is no long-term escalator for oil prices. There is no clear trend; all depends on investment by competitors for the transport market and on the creation of new reserves.

... _Chatham House Exec Summary PDF

This report focuses on several critical challenges facing the industry: The effect on the demand for oil of the substitution of oil-avoiding technologies (such as in energy efficient vehicles) and the use of alternative fuels;

1. The resulting split between growth and no-growth downstream markets and its consequences;
2. The changing role of OPEC;
3. The uncertainties facing gas producers in markets defined by government policies towards alternative fuels for power;
4. The perception that limits to the expansion of oil production have weakened;
5. The continuing role of national oil companies;
6. The financial challenge from investors in the private-sector companies;
7. The geopolitical connotations of the shift in oil trade to Asian developing countries

Each chapter sets out the current position, analyses changes in technology, policy and competition, and concludes with the implications for the oil and gas industry. _Chatham House report description

The authors of the Chatham House report see oil prices as staying in the $100 range or higher indefinitely.

Full Report PDF Download

Energy analyst Andrew McKillop thinks that oil prices are too high for the fundamentals, and expects oil prices to drop about 10% to 15% for WTI and 25% for Brent, from today's prices.

Declining oil consumption... is spreading like green algae on European beaches in several countries, linked to massive agrochemical and municipal waste runoff. Staying with Europe, 2012 is the sixth straight and consecutive year of falling oil consumption in Europe - not "declining growth of consumption". If the global economy uses less oil per unit output for slow-growing or no-growing output, only idiots and oil traders could imagine prices have to go higher. This the traders can do, be sure about it.

How long they do it is the open question. Oil is overpriced and needs at least another 15% cut in WTI prices and 25% off Brent. Knowing the oil trading community and its circus act, it will soon find the "killer numbers" enabling it to further talk down prices without losing face and having to be bashful. Opec and Nopec may help, or may not, that is their problem in a global economic context where overpriced oil is a real luxury we do not need. _Andrew McKillop

Both Chatham House and Andrew McKillop see continuing reductions in demand coming from Europe and North America. If one combines such a reduction with a lessening in demand from the BRICS countries that are currently experiencing economic slowdowns, one should see significant deviations from IEA and EIA demand projections -- on the low side.

Even with the ongoing devaluation of the US dollar by the Obama administration and the Federal Reserve, significant reductions in global demand should be reflected in significant reductions in price.

And while all of that is happening, a large number of oil & gas projects are scheduled to come online around 2020, which should add significantly to supplies. In addition, several gas to liquids (GTL), coal to liquids (CTL), and heavy oil / oil sands projects should also begin production over the next 10 years.

What the world is truly waiting for, in terms of high volume oil substitutes, is the opening of the flood gates that should accompany the commercial factory mass production of gas cooled nuclear reactors. The copious high temperature process heat from scalable gas cooled reactors will almost certainly be an important game changer in a larger scale development of petroleum substitutes from unconventional hydrocarbons.

Are Oil Prices on the Skids?

Slowing economic growth in Europe, the US, and China, are causing more people to understand the importance of the demand side in oil pricing.

Weak global growth is slamming oil prices, sending them nearly 10 percent lower in less than two weeks, with more declines likely.... "You're seeing it in the streets, in Greece and in Spain, and it's just a telling sign of how bad the economy is. If you see how the world is so interconnected, a slowdown in Europe is going to affect both China and the U.S., and those are the type of things that are affecting the price of oil." _Oil Prices Likely to Slide Further

There is a slow spread of global economic gloom sentiment which is slowly rising from the subconscious into the more conscious levels of the minds of analysts.

Many analysts -- who have been expecting rapid rises in oil prices exceeding the famous 2008 runup in oil prices -- still seem unaware of how strongly the 2007 - 2008 runup in oil prices was affected by a global economic bubble.

.... during the 2004-2007 global economy growth surge, it was still possible to have annual growth rates of world oil demand near 2 percent, another rearview mirror item in global energy history. Betting on if, rather than when world oil demand can again rise by even one half of that Belle Epoque rate, that is 1 percent or about 890 000 barrels per day in a 12-month period, is integrated in oil market trading as a background bet, still today.

Despite that, both the IEA and EIA, since 2008, have on multiple occasions been forced to backtrack on their growth forecasts, always trimming their estimates of global oil demand growth going forward. _MacKillop: Oil's New Floor Price: $75

At this time, there is no shortage of oil supplies. That is unlikely to change in the near to intermediate future, unless political tensions in the middle east flare up out of control.

It is within Russia's power to cause such a violent flare-up -- either overtly or covertly -- but at this time it does not seem to be in Russia's best interest. If the price of oil falls too low, however -- putting a severe strain on the corrupt Russian government's budget -- all bets may be off.

Useful Article on "The Pricing of Crude Oil"

The Reserve Bank of Australia provides a useful article on "The Pricing of Crude Oil," by Stephanie Dunn and James Holloway.

The article provides a basic introduction into how crude oil fits into the overall global commodities hierarchy, and into how crude oil prices are determined for the important benchmarks Brent and WTI. Intriguing hints as to how futures prices can sometimes affect spot prices in crude, are also provided. Worth a look:

Arguably no commodity is more important for the modern economy than oil. This is true in terms of both production and financial market activity. Yet its pricing is relatively complex. In part this reflects the fact that there are actually more than 300 types of crude oil, the characteristics of which can vary quite markedly. This article describes some of the key features of the oil market and then discusses the pricing of oil, highlighting the important role of the futures market. It also notes some related issues for the oil market.

Introduction

The crude oil market is significantly larger than that for any other commodity, both in terms of physical production and financial market activity (Table 1). The value of crude oil production is more than twice that of coal and natural gas, 10 times that of iron ore and almost 20 times that of copper. Crude oil is the most widely used source of fuel, supplying around one-third of the world's energy needs. It is also used to produce a variety of other products including plastics, synthetic fibres and bitumen. Accordingly, changes in the price of crude oil have far-reaching effects.

Table 1: Physical and Financial Market Size of Major Commodities
2011, US$ billion

	Physical market(a)		Financial market (exchange-traded)
	Annual production	Annual exports	Annual turnover	Open interest (b)
(a) RBA estimates based on volumes and indicative world prices (b) Open interest is the total dollar value of futures and options contracts outstanding that are held by market participants at the end of each month; averaged over the year (c) Physical market data are for 2011/12 US financial year (d) Includes exchange-traded swaps (e) Export data are for 2010 Sources: ABARES; Bloomberg; BP (2012); Bureau of Resource and Energy Economics; Commodity Futures Trading Commission; International Copper Study Group; RBA; United Nations Comtrade; United States Department of Agriculture
Oil	3,250	2,211	40,194	288
Natural gas	1,578	530	3,160	38
Coal	1,203	187	40	3
Iron ore	318	164	8(d)	1(d)
Rice(c)	285	22	58	1
Corn(c)	245	27	2,865	48
Wheat(c)	200	43	1,257	27
Copper	173	51(e)	13,726	93
Gold	139	156(e)	9,362	85
Soybeans(c)	119	45	6,540	70
Sugar(c)	93	32	3,614	28

The pricing mechanism underlying crude oil is, however, not as straightforward as it might appear. Almost all crude oil sold internationally is traded in the ‘over-the-counter’ (OTC) market, where the transaction details are not readily observable. Instead, private sector firms known as price reporting agencies (PRAs) play a central role in establishing and reporting the price of oil – the two most significant PRAs being Platts and Argus Media.

Much more at RBA

It is important to understand the ways in which oil prices reflect fundamentals of supply and demand -- and the ways in which oil prices can at times swing away from the basic fundamentals.

All mechanisms of pricing are subject to manipulation by persons of vested interest. While safeguards can certainly be built into systems to try to minimise such manipulation, even the safeguards on the safeguards are subject to manipulation and circumvention by sufficiently motivated and savvy groups and individuals.

Investors and interested observers must keep all of that in mind as they monitor the states of various markets.

Rapid Buildup in North American Oil Production Expected

Global capacity for production of liquid hydrocarbon fuels is immense -- far beyond what was imagined by Hubbert or any of his peak oil cohorts. To produce most of those hydrocarbons, humans will need to create improved technologies from scalable high temperature nuclear reactors to improved mining and drilling robots to improved exploration technologies.

But even with today's technologies, oil production could be rapidly geared up -- if the economic need and the political will were both present. Here is a look at what might happen in the near future with North American oil production (h/t Brian Wang):

Technological breakthroughs are freeing up oceans of black gold from plays in the United States and Canada. Couple that with rising production from Alberta’s oil sands and North American markets are flush in domestic oil, which is leading many giddy Americans to think they are on the cusp of achieving a treasured goal: energy independence. CIBC World Markets Inc. agrees with that view and says that North American oil production can grow by 800,000 to 900,000 barrels per day (bpd) annually through 2016. And the production growth will come from the onshore, offshore and the oil sands. _Alberta Oil Mag

Political will is every bit as important as technological advances. Policies of energy starvation under European, US, Australian, Japanese, and other governments tend to slow down energy exploration and production in those countries. Political corruption and policies of neglect of oil production technologies tends to slow down production in Russia, Venezuela, Iran, and many oil producing African nations.

The largest conventional oil deposits of the world lie under countries that restrict access by international oilcos -- which has the effect of artificially dampening oil production in those countries. In other areas, political and social turmoil lead to sabotage, kidnappings of oil personnel, hijacking of oil shipments, theft of oil, and several other ways in which oil delivery to international markets is artificially reduced and suppressed.

The effect of all of this suppression of production is additional elevation of oil prices, beyond other artifactual influences on oil prices.

These artificially high oil prices make it more economical for North American producers to expand production in unconventional and marginal oil fields. As long as oil prices stay high, expect to see a ramping up of unconventional oil & gas production in the more politically stable parts of the world.