Fabius Maximus teaches us. Thank You, Fabius.

Our brother Fabius, who evidently writes about oil was courteous enough to inform me that he has posted the following in his blog.  I thank him for his help in explaining this complex phenomenon.  So many have sought to help in similar ways.  I am especially grateful to the army of social scientists who "lent a hand" in so many ways.  pl

-----------------------------------------------------------

"Colonel Lang shows us why the 21st century might prove difficult - even painful - for America"

As the evidence grows that global oil production will peak in the next decade, many Americans grow increasingly frantic to deny this possibility.  Hence the campaign against speculators (an historically common response to changed conditions).  We see this even by intelligent and experienced people, showing how deeply rooted is our desire not to make the necessary (and probably painful) adaptations necessary.

An especially clear example of this appears in the posts about oil by W. Patrick Lang (Colonel, US Army, retired) at his blog, Sic Semper Tyrannis.  His observations about military and geopolitical affairs are IMO consistently interesting.  About oil, however, he confidently tells us of things outside his area of training and experience, about which many of the world’s top experts speak tentatively — as there are alternative explanations with strong supporting evidence.  As the IEA states in its ”Medium-term Oil Market Report“, 1 July 2008 (see the free slideshow here):

Like alchemists looking for a way to turn basic elements into gold, everyone wants a simplistic explanation for high prices … often it is a case of political expediency to find a scapegoat for higher prices rather than undertake serious analysis or perhaps confront difficult decisions.

These posts are worth reading, as I believe they illustrate many of the cognitive errors hindering America’s adaptation to the changes looming ahead in the 21st century.  To repeat, they are interesting because of the quality of their source (Colonel Lang).  They are another bit of evidence showing that America’s broken Observation-Orientation-Decision-Action loop is not just a function of the wrong President — or the wrong Party in office — or influential neo-cons.  Its causes perhaps lie within us, collectively.

These are all short posts, which I believe these excerpts adequately represent.  For discussion of these issues see the links in the text or those at the end of this post.  Note:  this site has no short-term forecasts of oil prices.  The experts have done poorly enough at it during the past few years; my amateur errors will contribute nothing to that debate.

“King Abdullah and the speculators“, 15 June 2008 — This illustrates over-simplification.  The Saudi Princes are playing a complex game, seeking to maximize their oil income without antagonizing their chief ally — or destabilizing their domestic political situation.  Lang notes their pleasant words and token gestures (tiny short-term production increases) which have proved effective in soothing Americans as oil prices have risen from $20/barrel to over $100 — a 5x increase in 8 years.  Given Lang’s background, we might expect a more subtle and broad analysis of the Saudi’s actions.

Sooo, the Saudi king is going to increase production at the margin on crude oil going into the spot market and this is expected to lower the market price on deliveries of crude to refiners. That, in turn, is expected to cause a failure in confidence in the whole nasty complex of capitalist hedge fund managers, index fund managers, bankers, advisers to same, and individual mega-investors. It is hoped/believed that this failure in confidence will cause the players to lose faith in their ability to pass the risk along to the greater fools waiting somewhere in speculator limbo. After that set of developments the price per barrel is supposed to fall, a lot. I believe this to be true. We will assemble here afterwords to gloat, or not.

“‘Speculators accused of dictating oil prices’“, 18 June 2008 — One distinguishing aspect of Lang’s posts about oil is the lack of reference (or even apparent awareness) of the vast expert literature about these issues (for a small sample see here).  Everyone gets to have an opinion, but he makes little effort to support it with evidence.  This is a common characteristic of blogs.

I offer the opinion that the “fundamentals” of supply, demand and all the other undergraduate economics concepts that we all remember from long ago do not adequately explain the pricing process that now prevails in the oil and financial markets.

“The Oil Meeting at Jeddah“, 21 June 2008 — Here we have “ignoring the big news”, one of the most powerful and frequent cognitive errors of American leaders.  Lang’s comments about the Saudi’s are hilarious, given their announcement in April (after hints over the past few years) that they will not be increasing oil production as expected over the next decade or so.  This initiates of “political peaking” of global oil production (see here for more evidence).  This has resulted in increasingly alarmed forecasts by the world’s major government energy agencies (e.g., the EIA and IEA).

We are about to enter a period in which a major lesson will be taught to the world regarding the fact that market prices are more a product of mass perception and a form of hysteria than they are of “hard data.”

Greed feeds greed.  Prices in oil have been rising because there was money to be made in the atmosphere of “casino” gambling fostered by the impatience of the young and ruthless adventurers who dominate the derivatives markets.

… The Saudis are going to lend a hand in that process this weekend.  The amount of the increase in their production is not significant as an incremental rise in the world’s oil supply.  Its significance lies in their stated intent to cripple the process of parasitic speculation in a vital commodity.

“The Oil Meeting at Jeddah -2“, 22 June 2008 — Good reporting.

“The oil bubble is leaking“, 19 July 2008 — Here we see the triumph of an amateur making a successful single short-term market forecast, made with 50-50 odds.  Investment professionals do this for a living, and the market teaches them to do so only with caution — and expectation of a low batting average.  His confidence that it is a long-term problem — not today’s — is extraordinary, given the fact that global oil production has been flat since early 2005 (which explains the rise in prices since then).

I told you so!  Ah, that’s not very mature.  Yes, but it feels sooo good.  Down how much last week?  What’s that again?  I couldn’t hear you…

It is true that there is a severe supply and demand problem in crude oil supply, but it is a long term problem.  As is often the case, the time-scape of this problem is one of the most important parts of it.  There clearly is not enough oil in the ground for humanity to continue using it in the ways that we have been doing.  Growing demand in newly industrialized places like China and India exacerbates that problem.  The solution to the supply problem in energy lies in new reliance on different ways to produce electricity.  Cheap electricity would enable short distance drivers to use electric cars and could eliminate the absurd reliance on fuel oil to heat buildings in the deep north.  That would produce a very different situation.  Al Gore is calling for windmills, etc., but the real solution (as he says) is nuclear power.  The Greenies will have to “suck it up” and accept the idea.  Hey, the French get most of their electricity from nuclear power.  The Francophobe crowd should take that as a challenge.

The short term problem is not the same.  This is and has been a bubble generated in the ways that have been discussed in previous articles.  Short term investment in the futures and spot markets have driven prices to levels unrelated to present supply and demand.  The markets have recently been a fantasy world without real limits for movement on the up side.

The bells are now tolling for that fantasy.  The smart people who stand to lose from this festival of childish greed have been kicking the psychological props out from under the process of finding bigger and bigger fools.

You don’t think so?  Good.  It will be amusing to see how much money is lost in your disillusionment.  Sometime in the next few months the price per barrel will fall below 100/barrel.  It will be interesting to see how far it falls below that level.

“More oil leaking from the barrel“, 22 July 2008 — The world is so simple when one has a master narrative explaining events — that rendering one superior to experts who see the world in terms of many complex dynamics!  This is one of the most common sources of error — often folly — on blogs.

The last month or so I have been watching the various TV financial market networks.  Marvelous!  These “analysts” by and large have no idea at all as to what really moves the various markets.  They just mouth the received wisdom and describe what happened as a forecast of what will happen.

“The oil “head game” is collapsing - for now“, 24 July 2008 — Peak Oil is described by experts as a process taking place over years — or decades.  Lang calls it off based on a few weeks decline in prices, what might be (who knows?) just a correction in the rise of prices extending back to 2001 (or 1998, depending on one’s perspective).

What happened to all the babble on the 24/7 news about the end of western civilization as we knew it?  What happened to the images of Ali Velshi (aka - “the bald headed prophet of doom”) trudging across the Alberta tar sands,  gloating over the pain?

“Kudlow - “Drill, drill, drill, so that the futures traders will flee“, 4 August 2008 — The confidence Lang’s exhibits in the first line below is classic Americana.  Such confidence has worked for us in the past when tempered with the knowledge and judgement.  Has our great successes in the 20th century resulted in us losing this precarious balance?  The next line exhibits the ancient but enduring dream of easily manipulating markets so that they better meet our needs — to the detriment of those on the other side, in this case oil producers.  Excerpt, quoting the economist Larry Kudlow:

He gets around enough in the right circles to know that short term traders in oil futures are the fire behind the crude prices we see now.

“… Ah,” he said (roughly). “Approval of drilling will frighten the futures traders out of the market and the price will go a long way down.” “They are already leaving the oil futures market” he went on. “This will push them out even faster.”

“The price per barrel - down, down, down.“, 15 August 2008 — Like most people not familiar with the operation of markets, Lang shows no awareness of the normal volatility of markets, nor the need to describe their direction on the basis of long-term trends — not short term movements.  Every professional working with markets — both as investors or commercials — often finds short-term movements to be incomprehensible.  Excerpt:

The TV business channel 24/7 crowd have more or less lapsed into sullen quietude over the continuing fall in the price of the oil commodity.  Why?  They can’t explain it in terms that they are willing to accept.  Some of the anchors are restive and asking embarrassing questions that are “slapped down” as quickly as they arise.

“How to burn the speculators” - Galbraith“, 20 August 2008 — In my opinion, nothing illustrates America’s dysfunctional thinking better than calls to tap the Strategic Petroleum Reserve (SPR) in hopes of a short-term decrease in oil prices.  Filled at vast expense when oil prices were far lower, it is our best protection against any one of the thousand events — natural or deliberate — that could interrupt the supply of the most vital input to the global economy.  As Chet Richards notes, the SPR is the closest thing America has to a national savings account.  Tapping it other than in an emergency is like eating one’s seed corn:  it feels good but has long-term costs.  Not only can the SPR be re-filled only slowly (to avoid pushing prices up), we might consider it too expensive to do so.  Many respected analysts forecast substantially higher prices in the next few years, as new sources continued be delayed and production declines from existing fields (e.g. Cantarell, North Sea) continue at horrific rates.  Excerpt, quoting from “How to Burn the Speculators”, James K. Galbraith, Mother Jones, September/October 2008:

Finally, the federal government should burn the oil speculators by selling up to 4 million barrels a day from the Strategic Petroleum Reserve. And as economist Tom Palley has pointed out, consumers can help too. An awful lot of gas is stored in cars. If people stop topping off and make do with half a tank, they’ll back up supply and lower demand. It’s a brilliant suggestion and definitely worth a try.

Advising us to fill to only half a tank is bizarre. Since auto manufacturers recommend keeping at least a quarter tank, this means lines at gas stations as people make frequent visits.  The effect will be to decrease gasoline demand while we draw down our inventory — and increase prices when we refill them.  The net effect is a period of increased volatility to the long, complex energy “pipeline.”  Meanwhile, the date of Peak Oil comes ever closer, while we play games that do nothing — absolutely nothing — to prepare for it.

The Hirsch “Mitigations” report — the closest thing America has to a sensible proposal for an energy policy — shows that it will take two decades to prepare/adapt to Peak Oil.  The clock is running.

Afterword

Lang’s posts are among the best – informative and well-written) on the Internet about geopolitics (defining the term broadly, as I do on this site).  As evidence, read some of these.

About the Presidential candidates

• “Biden is a fighter, and a screamer.“, 23 August 2008
• “Frank Rich on ‘Change’“, 24 August 2008

About Iraq

• “Will Maliki “torpedo” the peace?“, 22 August 2008
• “Can outsiders manage change in alien cultures?“, 17 July 2008

Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more information about Peak Oil

Here are some of my posts about Peak Oil.

1. When will global oil production peak? Here is the answer!, 1 November 2008
2. Links to articles and presentations of some A-team energy experts, 11 November 2008
3. The most dangerous form of Peak Oil, 8 April 2008
4. The three forms of Peak Oil (let’s hope for the benign form), 23 April 2008
5. The world changed last week, with no headlines to mark the news, 25 April 2008
6. Peak Oil Doomsters debunked, end of civilization called off, 8 May 2008
7. When the King of Saudi Arabia talks about oil, we should listen, 2 July 2008
8. The secret cause of high oil prices, 6 August 2008

Here is an archive of all my articles about Peak Oil.
Here are other resources to learn more about Peak Oil.

Comments

[Brian Hart]

1. I have not seen an empty gas pump or line of cars at a service station in the US for years - either at $40 per bbl or $130.

2. Price does impact consumption and the cars we buy very quickly whether in Hollywood or Darfur. Big oil may be in liquidation mode, but we still need to drive to work and our choices range from a hummer to a prius. Consumers react to price.

3. With 80 percent or so of the world's oil controlled by national governments, and given that many of them are not inclined to be kind and generous to the west - Russia, Venezuela, Iran, Iraq, Saudia Arabia, Indonesia... How can one not expect a correlation if not causation between political turmoil and pricing? Strait of Hormuz and other issues aside, there are simply huge inefficiencies created by chaos. Look at how inefficiently oil is produced and driven to market from Iraq and Iran not to mention Russia.

4. Would a more rational foreign policy combined with a determined long term effort at maximizing domestic energy resources - renewable or otherwise - not be a prudent national policy direction under any of a hundred scenarios?

When Paris Hilton's video spoof political ad makes more sense than McCain or Obama, you know we're in trouble.

[jon]

Col., you say that psychology is present in commodity and financial markets and responsible for price movement. That is undoubtedly true. Nothing that humans do is ever entirely removed from the effects and influence of psychology.

But the issue that you have posed and pursued, if I understand correctly, is that large and recent movements in the price of oil is largely the work of speculators, as opposed to other factors. This is where I must differ.

I am certain that speculation has been responsible for a portion of the recent runup in oil prices, but only a minority of that movement. Much more of the price movement can be attributed to supply and demand, political risk, weather, production, transport and refining factors. Market movements correlate closely to changes in these factors in the short term as conditions and risks change and are reassessed.

Financial and commodity markets are speculative, and at root games. Therefore they are inherently susceptible to being gamed. They can become more transparent, and manipulative effects lessened, but they will never be entirely rational or just.

Oil is now about six times more expensive than it was before the Iraq War, five years ago. In the past two months the price has dropped approximately one sixth or seventeen percent. These are substantial movements, and the daily and weekly changes have been more abrupt at times. If this is a bubble, it is a pale reflection of Tulip mania.

I think that there is a valuable discussion to be had about the relation of psychology and manipulation to other factors, and the weight, impact and importance of each. I will continue to maintain that one saber rattling speech by Dick Cheney, or Iranian missile launch does more to move the oil market than does financial manipulation. Of course, Cheney's behavior may be a calculated form of financial manipulation...

We should always be mindful of Zanzibar's pithy quote of Grahamr.

[Got A Watch]

Col. Lang was likely correct to some degree when he pointed the finger at speculators in the short-term.

"The CFTC...now reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX, a far bigger share than had previously been stated by the agency. That figure may rise in coming weeks as the CFTC checks the status of other big traders."

Washington Post

The rub lies in who is classed as a "speculator" or not, and why, by the CFTC. A highly clueless "regulator" to rely on, this is the agency that had no problem with Enron's actions in the electricity markets in California, to name one glaring example.

Some real economist Blogs who disagree with that WaPo story, in detail:

EconBrowser

Economists View

They are not so supportive of the "evil speculator" theory. Some great comments to those Blogs too.

Another factor not mentioned in the MSM is the collapse of 'SEM Group', a huge Tulsa, OK, energy trader (and 12th largest US private corporation), on July 17. This caused a vast amount of un-winding of futures and related contracts. Apparently they were hugely 'short' and sunk when the price did not fall...ironically, they likely would have been fine had the price collapsed a month earlier than it did. Some 'traders' who did not 'trade' very well, too many one-way bets, it seems.

We have to make a distinction between volatile short-term price actions, and long-term fundamentals. From my own lengthy readings at The Oil Drum and many other places, I see no major flaws in The Peak Oil theory as postulated. Their 'Export Land Model' is not comforting reading if you are in an oil-consuming nation.

[Got A Watch]

Sorry, forgot link to the 'SEM Group' story:

IHT

I too found Fabius' lengthy post rather thin on supporting facts to his arguments. And I tend to agree with him in general. It sounds good, but personal observation is not proof. More links to supporting facts/articles/analysis please.

Especially if you are going to criticize the Col., who usually has his ducks all in a row before he starts talking (my personal observation from reading this Blog). Or most of the commenter's here, who are top rank.

Col. Lang deserves credit for publishing such a critical work on his own Blog, something most Bloggers ego would not permit.

This Blog has one of the highest level and most informed discourses found anywhere on the net. The quality is consistently high. Keep on keeping on.

[Richard Whitman]

The whole idea of Peak Oil is a myth. There is no such thing. I have been involved in the oil industry for 49 years. When I started US oil was $3/bbl and production was limited by the Texas Railroad Commission by allowing wells to produce only 8 days per month. Foreign oil was $1.40/bbl but you needed import certificates from the US Govt to bring into the US. These certs led to much corruption in the 50s and 60s. As the price of oil rose during the last 50 years so did the amount available. In 1973 when oil went to $12/bbl the North Sea and Alaska became economically feasible to produce. When the price of oil went to $35/bbl, production offshore at water depths of 5000 ft became economic. Oil at $100/bbl make very deepwater wells profitable. At $125/bbl the North Pole is in play.The amount of oil available is price dependent with a lag of 5-10 years.NOC's can stand this lag. IOC's cannot. At some point the US has to create an NOC- The United States Oil Co. to compete on the world stage.

[Cieran]

David Habakkuk:

This is a very important question that you ask, because it touches on a number of the discussion threads we've seen here of late, including some related questions that Dr. Kiracofe has asked about refinery capacity:

If the long-term expectation is for prices to rise (both for oil and for gas), and if moreover an exporting country knows that its own reserves are liable to be exhausted quite rapidly -- may it not then be a rational strategy for such a country to pursue 'nationalist policies' and limit the amount of its dwindling resources it makes available to the market?

Again, pardon the length of this, and feel free to skip to the next comment!

The obvious answer to your question is "yes", but there is an assumption underlying that apparently rational strategy, namely that the nation's oil reserves will be worth more to their citizens in the future than they will be in the present.

And while phenomena such as peak oil would tend to support that strategy (as it will invariably tend to add value to remaining reserves), it may be that the assumption is entirely wrong, so that perhaps a new disruptive technology (e.g., hydrogen fuel cells) or perhaps a market-driven response (e.g., demand destruction caused by economic collapse) will drive down the long-term price of oil faster than peak oil drives it up, so that the net effect is that nations that hold onto their reserves may ultimately find that they bet wrong.

This is in fact closely akin to the situation that refiners find themselves in 24/7/365. Refinery infrastructure is extremely expensive (to build and to operate), and since oil comes in all kinds of shapes and sizes (more on that below), adding refinery infrastructure to handle new products or new supplies can turn out to be a poor bet if demand does not materialize for those products (or if current demand diminishes for whatever reason).

If crude prices stay high, people switch from gas-hogging SUV's to fuel-sipping hybrids, and so successful refining companies like Valero must constantly attempt to make accurate predictions about future demand, and then adjust production (including building new facilities) accordingly in the hope that short-term events don't negate their best long-term predictions. They have to constantly bet the farm on these predictions, so there's lots of inherent risk to the corporate bottom line.

And since most of these energy-supply companies are publicly held (Koch is the main exception I can think of), if the officers of the corporation determine that they can make a better return on investment via stock buybacks (as Exxon has done), or by shorting supplies to drive prices up enough so that aggregate profit increases even as output decreases (as BP has done), then the corporation must act in these manners, because the corporate management is responsible only to make the most money for the stockholders, not to create parts of a de facto national energy strategy!

And finally, the last point here about near-term fluctuations in oil prices is that crude oil prices are reported in dollars per barrel of a form of oil that is getting scarce remarkably quickly (i.e., light sweet crude, often sold out of Cushing, OK), with other forms of oil (i.e., heavier and sourer, or more sulphurous) sold at a discount measured relative to the light sweet crude case.

We tend to think of "oil" as a commodity like "pork bellies", but oil comes in a lot of forms, and only the light and sweet variety is best-suited for our current refining infrastructure (and really, no one demands oil -- we demand those products, like gasoline, that are derived from oil, so this refining aspect is a really important part of the oil-price puzzle).

Without sufficient well-situated refinery infrastructure to do extra work required before processing to make diesel or gasoline (e.g., removing the poisonous sulfur residues from non-sweet varieties), then these other, less expensive and increasingly more plentiful forms of oil are not of as much use as they might seem, and that's a part of why some experts claim that we're awash in oil, while others claim that we're not (with both sets being correct on some level).

And since the light-sweet stuff is getting rarer quite rapidly (by dint of diminishing supplies, but also because of the kind of insurgencies that Duncan Kinder has been writing about here lately), its price tends to swing more wildly than it ought to, since its supply is the tightest relative to refinery demand.

We could likely remove some of those oscillations in price by investing more in refinery infrastructure to process the more common sour and heavy oil supplies, but that takes some substantial investments by refining companies that may or may not pay off, in the exact same manner that it may or may not pay off for a nation to hoard its oil.

Hence the question applies not only to how a nation can best use its energy capital, but also how a key part of the oil products supply chain can best use its precious financial capital.

The whole thing is complicated enough to make my head spin, but each of the factors can be analyzed with some degree of independence, and then hopefully re-assembled into a coherent whole. That's where the multivariable differential calculus comes in very handy.

So you ask a darned good question! Sorry if I put you to sleep, tho...

[Ingolf]

Wonderful comments. I do so like this site. Paraphrasing what someone said recently, there often really is a cumulative refining process underway here at SSC, if you'll pardon the pun.

Before offering a few thoughts on speculation vs fundamentals prompted by some comments on the previous page, one quick aside. I do think the good Colonel is occasionally being slightly misrepresented. Unholy though his glee may have been at times(!), I certainly never took him to be suggesting that speculative activity was the primary driver in anything but the short term.

Now, to those few comments. Fnord, no argument that the financial system is in crisis. It's one that's been building for decades. Like you, I also have no doubt the recent moonshot in oil was born of some combination of shifting long term fundamentals and speculator/investor activity. As you say, uncertain financial and geopolitical times set against a growing backdrop of Peak Oil fears makes for fertile speculative soil. Indeed, although the odds that the top is in for a fair while are probably quite good, I certainly don't feel confident in ruling out a resumption of the blowoff.

Where I feel much less comfortable is with what seems to be a fairly common view that speculators (or for that matter the “oil interests”) comfortably run the game. Both were also around in late 2001 when oil languished under US$20, or early 2003 when it dipped to US$25. Or (rather more spectacularly) in the mid 80s when oil plunged from well over US$30 to US$10 in a little more than four months. Truth is I don't think anyone's in charge of the game, not even close. Even if you're big enough to push a market around, you're still faced with the challenge of getting out profitably. The bigger you are, the greater the chance you'll end up getting in your own way if you've misjudged your market, in addition to being set upon by other players who then smell the blood in the water. Look at Amaranth a few years ago. Really big money is harder to run than smaller sums.

What is qualitatively different this time around is the movement of long term, long only money into the commodity markets, both through ETFs and OTC instruments. The amount apparently passed the US$250 billion mark this year and there's every chance that estimate misses quite a lot. This is of course across all commodities but Verleger (thanks, Fabius) estimates the amount devoted to energy markets would probably have been close to US$100 billion at the peak. The impact of this investment money has, I'm sure, been even greater on some smaller commodity markets but this is almost certainly a big enough sum to have a substantial impact, even on a market as deep as crude.

While plenty of opportunistic or trend following speculative money would have piled into the game as the move became ever more pronounced, its influence on prices on the way up is (as always) going to be pretty much mirrored by its downside effect when speculators decide to (or are forced to) bail out. Exciting though their effect can be in the short to medium term, the net effect of traders, in the bigger picture, is effectively nil.

[R.W. Bloomer]

The object of speculation in petroleum futures is NOT control of petroleum or petroleum products, it is money. The volume of traded promises and their affect on money are the relevant facts. Riches gained this way are the ultimate proof to speculators that they are far more clever than those who believe the market had something to do with it.

[fnord]

Ingolf: Agreed to a certain extent on the point of wether anyone is in control. Much to the concern of our Norwegian finance department, none of our analysts were able to foresee this top.I am not a finance-expert by far, but I do know something of logistics. So against the argument of pure speculation being responsible, I am wondering if certain factors are left out of the equation in the real-cost side of the pricecalculation, though.

One would be the fact that there is a war on in two places, and so much of the resuply capacity of *carriers* etc. will be longterm hired by now and making milk runs for the gulf. Another factor I know no data on is the capacity of the shipping-lanes, in other words how much of the produce is in movement towards the free markets at any given time contra the volume available pre-Iraq.

Another factor is to what extent emerging economies without oil are building *their* oil reserves, so that the commodity goes into storage and is not in play on the market. A third would be about possible chokepoints in the processing-line, how much refinery capacity is bound up by long term contracts. A war sharpens the markets fiercly due to these factors, I would think? So I think these and propably many others may be some real structural factors in play, wich of course leads to a much leaner & meaner speculators market for the product that is freely available.

And I second that the US should have a staterun oilcompany, its magic ;-)

[Fabius Maximus]

Jonst: "What credential/s makes one an expert in market-related dynamics"?

I said expert, but rather than credentials I prefer to look at training (which need not be academic) and experience.

IMO the most relevant fields are trading, finance, and economics. Of course, not everyone in those fields works with markets -- and these are just the largest relevant fields, not an exclusive list. Nor does this cover fields unrelated to markets, but which provide a good foundation to understand them. For example, Wall Street hires experts in quantitative methods (e.g., mathematicians, physicists), and then trains them.

[Ingolf]

Fnord, I'm sure you're right that a multitude of structural factors are at work. Still, it's part of the market's business to adjust to shifts of this nature.

FWIW, although I think there are very good grounds for resource rich countries exacting rents (whether via royalties, taxes or partnership arrangements), I have mixed feelings about state run oil companies, even though Statoil has by all accounts done a very good job. In any case, I doubt the political culture in the US would allow anything similar to work. Or even to be established. It's much too partisan. (Given your little smiley, I suspect you may well share my view on this.)

By the way, I don't see the fact that no-one is in control as a bad thing.

[Fabius Maximus]

About supporting evidence

This was a survey article, not an discussion of a specific point. Spelling out the evidence for each section would have extended the post beyond its already long 2600 words, so I provided links.

My primary point was supported by the two studies referenced at the start (by one of the two major energy agencies in the world, plus a well-known expert), and the 10 links in the text. Most of the things mentioned were discussed at length in one or more the 30 articles about peak oil on the FM site, most of which focus on a specific question, supported by the 20 major studies whose links appear on the reference page. Links to both appear at the end of each post for those who would like more information.

I have found that no matter how extensively documented an article, I always hear the cry "not sufficently documented" -- usually without asking any specific questions that would demonstrate a real issue. Since only 3% of visitors click on even one link, I am sceptical that additional documentation would provide more value.

I will answer questions, preferably on the FM site -- but here if you prefer.

[Cieran]

Fabius Maximus:

I will answer questions, preferably on the FM site -- but here if you prefer.

Thanks for your offer. And let me congratulate you for your publicizing the Hirsch report, as it was buried for entirely too long, given its importance. I've long recommended it (including here at SST) as essential reading for informed commentary on this topic.

I have one question, implicit in my earlier post, namely "how does peak oil operate in fast time, i.e., over periods measured in days or weeks instead of years or decades?"

The only way I can see for physical extraction processes to operate in fast time is in response to transient hazards, e.g., the hurricanes approaching the Gulf Coast can cause near-term fluctuations in production for specific reservoirs, and in this case the effect on global supplies would be mediated by the cumulative production in other unaffected regions.

It's clear that peak oil operates on secular time scales (the various case studies in the Hirsch report document this very well), and it's highly likely that the rate at which peak oil causes crude prices to increase with time will itself increase with time, so that its effect on price-time curves is to induce positive first and second derivatives (i.e., upward trends that increase in magnitude with time).

I can even see how some singularities might occur in the price-time curve as oil supplies run out, but that's clearly not happening today.

So what kind of coupling mechanism do you see (besides the obvious one of market psychology, as Taleb has written so eloquently about in The Black Swan) that permits the secular physical response of peak oil to drive the near-term market oscillations that Colonel Lang (and his army of correspondents) has been discussing here?

Without such a coupling mechanism, some of your assertions about these SST posts risk becoming unsupportable, hence the question.

Thanks in advance for your consideration.

[David Habakkuk]

Cieran,

You certainly did not put me to sleep. There is a lot of food for thought here -- I had not followed this whole sequence of threads as closely as it merits, and need to do some boning up. It seems to me that we have been moving into a more 'mercantilist' world, that the Georgian war is likely to reinforce this, and that the dynamics of such a more 'mercantilist' world are very difficult to assess.

As to the strategic questions facing an energy exporting nation (particularly if it is largely dependent on such exports), as you say, the uncertainties surrounding technological change and demand destruction mean that estimates of the future value of resources are subject to quite extraordinary margins of error.

What I would add is that energy security considerations may in certain circumstances increase the incentives to hoard supply -- although technological change may reduce or eliminate dependence on oil and gas, if energy security is at issue it may be sensible to give the downside if it does not much greater weight than the upside if it does.

This may apply in Russia -- but I also think back to North Sea oil and gas has been handled.

We British are now getting vociferous about the possibilities of Russia using energy as a weapon. Such fears have clearly been exaggerated -- it really is absurd to treat Russian expectations that the Ukraine and Belarus should pay market for gas as an instance of political pressure. Moreover, both Russia and Europe have an enormous amount to lose by the disruption of historically rather stable energy trading relationships.

However, as we seem to be heading into some kind of new Cold War, the possibility of energy disruptions has to be given greater weight -- and the intensive exploitation of North Sea oil and gas does not perhaps look, in retrospect, very wise.

Your observations about the tensions between the maximisation of shareholder value and the requirements of a coherent national energy strategy fit very well with one of points that Jérôme Guillet has been hammering away at in his posts on the European Tribune site. Looking at the matter from the point of view of an investment banker financing alternative energy projects, he stresses that the much-touted energy liberalisation in Europe actually intensifies our dependence on Russian gas: because gas-fired plants, having lower initial costs, are much easier to finance.

My own views are in part a product of the reaction against 'statist' solutions in the economy which in Britain both produced and was produced by the Thatcher government, and has been carried forward by the Blairites. This was, initially at least, the product of bitter experience of the gap between hopes that the British state would act as a 'rational actor' in the economy, and how it actually behaved.

But if -- particularly given the vast margins of uncertainty about future energy prices -- the maximisation of shareholder value by energy companies is incompatible with the kind of investments necessary for the long term in the context of dwindling energy supplies, a larger role for the state becomes indispensable.

One is then left with two problems 1. overcoming ideological resistance based upon 'market fundamentalism', and 2. devising relationships between the private and public sectors which seek to make best use of the strengths and avoid the weaknesses of both -- while also seeking to avoid or mitigate some of the problems associated with close interdependence of public and private (such as corruption.)

[Fabius Maximus]

Cieran - That is a complex and difficult question, and illustrates my earlier point about the length of articles necessary to answer questions in this field. My newest post discusses a more simple peak oil question, takes 2300 words to do so (although a better writer could do it in less!), and relies on links for evidence (which I could increase 2x or 3x and still be insufficient).

Little research is being done about peak oil, so that many vital questions today can be answered only by guesses. Like yours about the nature of the peaking process, this should be the subject of a multi-disciplinary team doing extensive modeling.

Since there is no literature to lean upon, think of this as a crayon sketch.

Peak oil is a multi-year transition of energy sources. The connecting link between this long-term trend and short-term events (e.g., market prices) is information. Think of it in term of the late John Boyd’s (Colonel, USAF) OODA loop. We Observe changes, slowly Orient ourselves to changing circumstances, make Decisions, and then Act.

This process works slowly, as information drips out. Geological peaking of fields has usually been recognized only after the fact. (e.g., the US 48 states, UK North Sea). Political peaking, which it appears the King Abdullah announced in April, may be more slowly recognized.

The speed of this process is driven not just by flow of information, but by the crowd psychology by which insights and emotions spread. This is more granular, often with discontinuous changes.

There are other factors. To mention just two…

(1) The amount and quality of information flow. In energy, tiny and poor. Does anyone here know the source of the Saudi production numbers that you see in the media and reports? Of information about consumption and inventories of emerging nations?

(2) The size and skill of the relevant institutions. With respect to energy, we have only tiny funding to collect and analyze information. Hence our reliance on inspired guessing by experts. As David Halberstan said in The Best and the Brightest: the elephant was great and powerful, but preferred to be blind.

I apologize for the length of this comment (370 words). But there are few brief answers about these matters. {I have cross-posted this to the FM site, so please delete if it is too long.}

[Cieran]

Fabius M:

Thanks for your informative reply. I appreciate your thoughts here, e.g., how the quantity and quality of information contribute to the general question. I especially like the OODA interpretation -- I believe that approach, perhaps coupled with the viewpoint that the loops are being practiced by organisms that occasionally behave like lemmings, explains much.

As far as this:

this [peak oil] should be the subject of a multi-disciplinary team doing extensive modeling.

I'm a member of a similar team, actually. I've published in the open literature on poromechanics, and am currently working with a few national energy companies on more extensive modeling techniques for simulating mainstream and advanced recovery methods for oil and natural gas. The physical modeling will be combined with financial modeling to permit these firms to better manage their resources for their stockholders.

About twenty years ago, several teams of international researchers independently re-discovered some visionary and pioneering post-war work in reservoir mechanics that had been performed for Shell Oil by the brilliant physicist Maurice Biot. Biot's theories, when implemented in a more general framework amenable for high-speed computation, are now among the best ways to try to predict peak oil and related physical phenomena.

I was lucky enough to be a principal of one of the teams that rediscovered and successfully implemented Biot's work, and hence have enjoyed a front-row seat for the resulting exciting developments in poromechanics, petroleum engineering and in geology.

Hopefully, multidisciplinary efforts such as this can help pin down the details of peak oil, so we can better prepare for the inevitable transitions in energy resources.

Thanks for sharing your thoughts here, and for pointing out your new post on the subject.

[Fabius Maximus]

Cieran: I am glad to hear about your work.

I was thinking about a different level of analysis. We need data and tools for energy modeling like those used to manage the US economy - compared to which the resources allocated to this kind of energy research are tiny. These draw on vast time series of data, run through hundreds or thousands of equations. They are not perfect, but the economy might quickly crash if economists had to rely on the sketchy tools used by energy analysts.

Making the comparison worse, economists first developed the predecessors of these tools, the National Income Product Accounts (NIPA), in the 1930’s. Since then their worth has been well demonstrated, so the failure to apply these tools to energy research is especially odd (aka daft).

With these we could model different scenarios of oil supply, demand, and pricing -- running scenarios for different public policy mixes. This might work better than the inspired guessing that is the basis for today's energy policy.