May 2, 2012
March 22, 2012
June 17, 2011
Sounds as if Vermont Senator Bernie Sanders and Connecticut Senator Richard Blumenthal missed Energy Economics 101 in school. But that doesn't stop them from publicizing their utter ignorance (H/T Byron Hood) of basic energy economics:
Sen. Bernie Sanders, I-Vt. introduced legislation today that would require the Commodity Futures Trading Commission to impose strict regulations on oil speculators, who some blame for rising gasoline prices.
Sanders said if the agency failed to meet the two-week deadline outlined in his legislation, he would call for the resignation of commission chair Gary Gensler.
The legislation, if passed, would cap the amount of oil that speculators are allowed to buy and sell annually to 20 million barrels, increase the amount of money investors would have to back bets with from 6 to 12 percent and redefine investment banks as speculators rather than hedgers - investors who use the product they are buying for business.
The bill would limit speculators' influence over the energy futures market. [. . .]
"There is mounting evidence that the increased price of gasoline has nothing to do with supply and demand and everything to do with Wall Street speculators jacking up oil and gas prices in the energy futures market," Sanders said. [. . .]
Sen. Richard Blumenthal, D-Conn., a co-sponsor of the bill, said: "These price increases have been absolutely crushing. We need to attack these increasing prices that are the result of gaming and gambling. The CFTC should have acted five months ago." [. . .]
The instinct of most politicians and much of the mainstream media is to embrace simple "villain and victim" morality plays when attempting to explain price increases in markets or investment loss.
The more nuanced story about the financial decisions that underlie the market fluctuations doesn't garner enough votes or sell enough newspapers to generate much interest from the politicians or muckrakers.
That's why we are again enduring demagoguery regarding speculators. Thus, it's important that citizens who are not familiar with the function of speculation in markets take a moment to learn about its beneficial nature.
Or read University of Houston finance professor Craig Pirrong's fine overview of how speculation in oil and gas markets actually helps all of us in dealing with rising energy prices.
Or peruse this Matthew Lynn/Bloomberg piece on how bubbles in oil markets are a reason to celebrate.
In Texas, one has to look no farther than Southwest Airlines' success to understand the beneficial nature of speculation. Over most of the past decade, Southwest has taken advantage of futures markets to hedge its fuel costs (previous posts on Southwest's hedging program are here). That hedging program has been one of the major factors in allowing Southwest to become the most (and one of the only) profitable U.S. airlines.
So, what Sanders and Blumenthal are really trying to do is restrict the very markets that provided Southwest and many other businesses with the platform on which they hedged fuel-cost and other business risk. The wealth and lower prices that is generated from those hedges is not inconsequential.
Stay informed fellow citizens. Demagogues such as Sanders and Blumenthal can inflict real damage on all of us.
February 8, 2011
U.S. airlines have lost nearly $60 billion (2009 dollars) in domestic markets since deregulation, most of it in the last decade.
More than 30 years after domestic airline markets were deregulated, the dismal financial record is a puzzle that challenges the economics of deregulation. I examine some of the most common explanations among industry participants, analysts, and researchers -- including high taxes and fuel costs, weak demand, and competition from lower-cost airlines. Descriptive statistics suggest that high taxes have been at most a minor factor and fuel costs shocks played a role only in the last few years.
Major drivers seem to be the severe demand downturn after 9/11 -- demand remained much weaker in 2009 than it was in 2000 -- and the large cost differential between legacy airlines and the low-cost carriers, which has persisted even as their price differentials have greatly declined.
August 10, 2010
The Houston business community is in mourning this week over the sudden death this past Sunday of Matt Simmons, the 67 year-old investment banker, author and pundit whose views were a common topic on this blog over the years.
Matt founded Simmons & Company in Houston in the mid-1970's with his brother L.E. as one of the first investment banks focusing on the increasingly important oil field service sector of the oil and gas industry. Simmons & Company eventually expanded into other areas of the energy industry and, by the late 1990's, became one of the top energy mergers and acquisitions investment banks in the country.
Around 1983 or so, Matt's firm and my law firm were on two of the floors near the top of the 700 Louisiana building in downtown Houston, so we developed a cordial friendship over the years by taking innumerable elevator rides together. I've always been involved in a fair amount of oil and gas litigation, so Matt was always interested in that part of my practice. And during the depression in the energy industry in Texas during the 1980's, Matt was arguably the most insightful businessperson in Houston at the time on the direction of the industry and how it's recovery should be structured.
Matt was a joy to talk with -- witty, intelligent and interesting. That's one of the reasons why, over the past decade or so, he became a media favorite for providing his provocative opinions about the energy industry. Matt enjoyed his new role as one of the media's energy industry pundits, but that wasn't the best fit for the chairman of a company that was often advising companies that could be affected by his controversial opinions.
Matt retired from day-to-day management of his company in 2005 about the time his peak-oil treatise was published, but he continued on as executive chairman to help the company maintain client relationships. Matt and the company formally split ties earlier this year when he made his utterly unsurprising public comments in Fortune magazine about the probability of a British Petroleum bankruptcy.
Sadly, I didn't see Matt again after the split, so I was never able to ask him about it. But my sense is that it was probably not that big a deal for him. He was working hard on his Ocean Energy Institute and I really think that is where his heart was as he segued into elder statesman status in the energy industry.
So, the local energy industry has lost a big part of its personality with the death of Matt Simmons. Many folks in the industry did not agree with some of Matt's often controversial views, but that never stopped him from expressing those views and forcing energy businesspeople to think about the issues and formulate alternative viewpoints toward them. That is a resource that is vitally important to all industries, particularly one that is facing the current challenges of the U.S. energy industry.
Yes, Matt Simmons will be missed. Rest in peace, friend.
June 14, 2010
In this NY Times op-ed, Richard Thaler picks up on a theme that Ken Rogoff and James Hamilton raised last week – the similarity between the miscalculation of risks relating to the Gulf of Mexico oil spill and the Wall Street financial crisis:
AS the oil spill in the Gulf of Mexico follows on the heels of the financial crisis, we can discern a toxic recipe for catastrophe. The ingredients include risks that are erroneously thought to be vanishingly small, complex technology that isn’t fully grasped by either top management or regulators, and tricky relationships among companies that are not sure how much they can count on their partners.
For the financial crisis, it has become clear that many chief executives and corporate directors were not aware of the risks taken by their trading desks and partners. Recent accusations against Goldman Sachs suggest the potential for conflicts of interest among banks, investors, hedge funds and rating agencies. And it is clear that regulators like the Securities and Exchange Commission, an agency staffed primarily with lawyers, are not well positioned to monitor the arcane trading strategies that helped produce the crisis.
The story of the oil crisis is still being written, but it seems clear that BP underestimated the risk of an accident. Tony Hayward, its C.E.O., called this kind of event a “one-in-a-million chance.” And while there is no way to know for sure, of course, whether BP was just extraordinarily unlucky, there is much evidence that people in general are not good at estimating the true chances of rare events, especially when human error may be involved. [. . .]
How can government reduce the frequency and the severity of future catastrophes? Companies that have the potential to create significant harm must be required to pay for the costs they inflict, either before or after the fact. Economists agree on this general approach. The problem is in putting such a policy into effect.
Suppose we try to tax companies in advance for activities that have the potential to harm society. First, we have to have some basis for estimating the costs they may inflict. But before the recent disasters, companies in both the financial and oil drilling sectors would have claimed that the events we are now trying to clean up were, well, one-in-a-million risks, suggesting a very low tax.
Alternatively, an offending party could be made to pay after the fact, by holding it responsible for the costs it imposes. BP has volunteered that it will pay for all damages it considers “legitimate,” but we can expect a fight over how to define that word.
. . . Suppose a company worth only $1 billion was responsible for this accident. It would go bankrupt and we would be unable to collect. And if we aren’t careful, we will encourage companies that have enough money for collection to leave the drilling to those that don’t. [. . .]
We are left in a difficult place. Neither the private nor the public sector seems up to handling these kinds of problems. And we can’t simply wait for the next disaster, because, as people might say if they had to use G-rated language, stuff happens.
Professor Hamilton zeros in on the group dynamic that leads to the underestimation of risk:
I think part of the answer, for both toxic assets and toxic oil, has to do with a kind of groupthink that can take over among the smart folks who are supposed to be evaluating these risks.
It's so hard to be the one raising the possibility that real estate prices could decline nationally by 25% when it's never happened before and all the guys who say it won't are making money hand over fist.
And this interacts with the forces mentioned above. When the probability of spectacular failure appears remote, and moreover it hasn't happened yet, it's hard to set up incentives, whether you're talking about a corporation or a regulatory body, in which the person who makes sure that the risks stay contained is the person who gets rewarded. When everyone around you starts thinking that nothing can go wrong, it's hard for you not to do the same. It can become awfully lonely in those environments to try to be the voice of prudence.
Finally, Cato's Gerald O'Driscoll, Jr. notes the futility of reacting to the oil spill by implementing even more regulation:
What is the missed lesson from all this? When President George W. Bush had his Katrina moment, the federal government's bumbling response was blamed on him, on the Republicans, and on conservatives. Now it is President Obama's turn. His administration's faltering response to the disaster in the Gulf is attributed to his personal failings, staff ineptitude, communication failures, etc. And, of course, the two administrations have shared responsibility for the poor handling of the financial crisis.
A big-government conservative administration failed in crisis, as has a big-government liberal administration. The regulatory state did not prevent excessive risk taking whether in financial services, nor perhaps in offshore oil drilling. Government response to crises once they occur is slow and inept. All this is not because either Republicans or Democrats are in power, but because big government doesn't work. It can't deliver on its promises. Big government overpromises and underdelivers. In reaching to do more, big government accomplishes less. That is not an ideological statement, but an empirical observation.
In the case of financial services, virtually all the proposed regulatory reform offers more of the same. Additional regulations will be added to existing ones without addressing why existing ones failed to prevent the crisis. The same process will likely happen with respect to offshore drilling.
The oil spill has triggered an important debate about the value of off-shore drilling, and that debate might conclude that off-shore drilling generates more harm than benefit.
But despite the nightly photos and videos of the oil spill on television, it’s important to remember that drilling produces benefits in addition to its costs. Deep-sea drilling has been ongoing for decades with relatively few incidents that even come close to the current spill.
So, while this spill may reveal that deep-sea drilling is too risky, it’s also quite possible that this incident was simply the result of poor decision-making combined with bad luck, and that there is a nominal chance that it will reoccur.
And it is very difficult to regulate bad decision-making and bad luck.
Stuff happens, indeed.
June 28, 2008
June 18, 2008
As noted many times over the years on this blog (recently here and here), the instinct of most politicians and much of the mainstream media is to embrace simple "villain and victim" morality plays when attempting to explain investment loss. The more nuanced story about the financial decisions that underlie the failed investment strategy doesn't garner enough votes or sell enough newspapers to generate much interest from the pols or muckrakers. That's why we are currently enduring demagoguery regarding speculators and why it's so important that citizens who are not familiar with the function of speculation in markets take a moment to read Mark Perry's primer on the economics of future trading:
In fact, speculators don't determine market forces, they respond to market forces of supply and demand.
Therefore, speculators can't be blamed for high oil prices, because high oil prices are ultimately caused by factors beyond the control of any speculator: rising global demand in places like India and China, and global supply in places like Saudi Arabia, Nigeria and Venezuela. No individual speculator, or any group of speculators has an iota of influence over the demand for gas or oil in Brazil, nor do they have one iota of influence over the amount of oil in Canada or ANWR, or any control over OPEC quotas. Think about it - Exxon Mobil, one of the largest oil producers and private oil companies in the world, has NO control over the world spot price of oil, so how could a small group of speculators?
April 29, 2008
Peter Gordon observed the other day that "politicians are better at creating problems than addressing them. Schools, housing, health care, transportation and others suffer from too much political attention."
As a result of ethanol subsidies and mandates, the dollar value of what we ourselves throw away in order to produce fuel in this fashion could be 50% greater than the value of the fuel itself. In other words, we could have more food for the Haitians, more fuel for us, and still have something left over for your other favorite cause, if we were simply to use our existing resources more wisely.
We have adopted this policy not because we want to drive our cars, but because our elected officials perceive a greater reward from generating a windfall for American farmers.
But the food price increases are now biting ordinary Americans as well. That could make those political calculations change, and may present be an opportunity for a nimble politician to demonstrate a bit of real leadership. I notice, for example, that although Senator Barack Obama (D-IL) was among those who voted in favor of the monstrous 2005 Energy Bill that began these mandates, Hillary Clinton (D-NY) and John McCain (R-AZ) were among the 26 senators who bravely voted against it.
Wouldn't it be refreshing if one of them actually tried to make this a campaign issue?
Sigh. Read the entire post.
April 20, 2008
As oil futures hit $115 per barrel late this past week, The Economist ran this article on the questions surrounding the recent announcement regarding the discovery of Brazil's Carioca-Sugar Loaf Field, which could be one of the largest oil discoveries in history. Given the time, expense and risk involved in extracting the oil, the announcement of the discovery didn't affect oil markets much, but The Economist article nevertheless concludes as follows:
The discoveries do suggest that the gloomiest pundits are wrong to predict that the world will soon run out of oil. It is not that there are still lots of huge oil fields out there: the number of mammoth discoveries is declining, Tupi (and perhaps Carioca-Sugar Loaf and Jupiter) notwithstanding. But the new finds do illustrate how the technology with which oil firms hunt for, extract and process fossil fuels is constantly improving. Petrobras’s recent success is only possible thanks to recent advancements in seismic surveys, drilling, and offshore platforms. Other technological developments are allowing a greater proportion of the oil found around the world to be recovered and are even expanding the definition of oil, as firms conjure liquid fuel from the solid tar-sands of Canada, for example, or from coal and natural gas.
As noted recently here, the recent increases in oil prices are making alternative energy sources economically viable. Thus, take note of what former ExxonMobil CEO Lee Raymond noted years ago in response to a question on oil prices:
Interviewer: "Some people think prices will keep going up?"
Raymond: "Maybe. I'll bet they'll be lower at some point."
April 15, 2008
Don't tell Ray Kurzweil that we ought to be all gloomy about the prospects for mankind. This WaPo op-ed reflects that he is downright bullish:
MIT was so advanced in 1965 (the year I entered as a freshman) that it actually had a computer. Housed in its own building, it cost $11 million (in today's dollars) and was shared by all students and faculty. Four decades later, the computer in your cellphone is a million times smaller, a million times less expensive and a thousand times more powerful. That's a billion-fold increase in the amount of computation you can buy per dollar.
Yet as powerful as information technology is today, we will make another billion-fold increase in capability (for the same cost) over the next 25 years. That's because information technology builds on itself -- we are continually using the latest tools to create the next so they grow in capability at an exponential rate. This doesn't just mean snazzier cellphones. It means that change will rock every aspect of our world. The exponential growth in computing speed will unlock a solution to global warming, unmask the secret to longer life and solve myriad other worldly conundrums. [. . .]
Take energy. Today, 70 percent of it comes from fossil fuels, a 19th-century technology. But if we could capture just one ten-thousandth of the sunlight that falls on Earth, we could meet 100 percent of the world's energy needs using this renewable and environmentally friendly source. We can't do that now because solar panels rely on old technology, making them expensive, inefficient, heavy and hard to install. But a new generation of panels based on nanotechnology (which manipulates matter at the level of molecules) is starting to overcome these obstacles. The tipping point at which energy from solar panels will actually be less expensive than fossil fuels is only a few years away. The power we are generating from solar is doubling every two years; at that rate, it will be able to meet all our energy needs within 20 years.
I just thought I'd toss in that third paragraph for those in the oil and gas industry that believe that a period like the mid-to-late 1980's can't happen again. Meanwhile, light, sweet crude oil futures for May delivery settled yesterday at $111.76, a new record, on the New York Mercantile Exchange.
January 14, 2008
Amidst the demagoguery of a U.S. Presidential campaign, it's rare to find the mainstream media willing to run Robert Bryce's common sense on energy policy and oil prices. For example:
Myth 3: Energy independence will let America choke off the flow of money to nasty countries.
Fans of energy independence argue that if the United States stops buying foreign energy, it will deny funds to petro-states such as Iran, Saudi Arabia and Hugo Chavez's Venezuela. But the world marketplace doesn't work like that. Oil is a global commodity. Its price is set globally, not locally. Oil buyers are always seeking the lowest-cost supplier. So any Saudi crude being loaded at the Red Sea port of Yanbu that doesn't get purchased by a refinery in Corpus Christi or Houston will instead wind up in Singapore or Shanghai.
Refer to this article whenever you are listening to the candidates from either party start talking about energy policy. Come to think of it, while considering political choices, you should also keep handy this Bryan Caplan/WaPo op-ed entitled 5 Myths About Our Ballot-Box Behavior.
January 6, 2008
This Examiner.com article picks up on something that this previous post noted over a year ago -- the economic absurdity of Joe "Che" Kennedy's deal with Venezuelan strongman Hugo Chavez under which Kennedy's non-profit Citizens Oil Corp buys discounted oil from Venequela to provide low-income American customers with a 40 percent discount on a one-time delivery of up to 200 gallons of heating oil. Kennedy rationalizes this program despite the fact that the poorest of Citizen's customers are relatively wealthy in comparison to the 40% of Venezuelans who subsist on about $2 a day. The Examiner concludes its story with the following observation:
Curiously, despite his wealth, Kennedy receives a $400,000 annual salary [from Citizens, which is a non-profit]. Instead of embracing his uncle's [the late John F. Kennedy] courageous anti-communist legacy, he has become just another smarmy celebrity who yammers on about having compassion for the poor from the doorways of multimillion-dollar mansions and private jets, all the while accepting oil stolen by a dictator. Lenin had a name for Western liberals who did this kind of thing – "useful idiots."
December 21, 2007
First, several of the bloggers over at the Oil Drum have launched an intriguing new project -- a Wikipedia project in which they and a number of other contributors are accumulating data on all the major, new oil projects around the world and contributing the data to a single database that can be used to document historical trends and attempt to forecast future trends in oil production. The contributors are focusing on basic data for all of the major projects that would add new oil production capacity, including estimates of the peak flow when such information is available. My compliments to the creators of this excellent information resource.
Meanwhile, this John Cassidy column predicts that the price of oil has peaked for the time being and that prices will begin falling to the $50 a barrel range:
. . . the experts who are predicting the worst, based on geology and geopolitics, are missing the crucial role that economic incentives play in determining the price of crude. The tripling of oil prices since the summer of 2003 has unleashed forces that within the next two or three years will bring oil prices tumbling back down to below $50 a barrel. Looking even further ahead, prices could easily fall to $30 a barrel or even lower. So before you trade in your Cadillac Escalade for a Toyota Prius, think twice: $1.50-a-gallon gas might not be gone forever.
December 19, 2007
It has something to do with subsidies for ethanol.
November 15, 2007
The BBC's Evan Davis provides a short article on how to keep the recent spike in oil prices in perspective:
It's clear that $100 a barrel is very high. Although it's worth saying, it's still not a record.
1864 was in fact the most expensive year for oil. It was over $104 in today's money. Notwithstanding that record (and most of us in the media will ignore it when talking of record highs in the next few weeks - we'll be using the high of $104.7 reached in 1980 after the Iranian revolution) we can at least say an impending $100 barrel is getting historically significant.
And Davis provides the following observation about the market for oil that echos that of former Exxon chairman, Lee Raymond:
But the point of volatile market is that it swings both ways.
The longer we have higher oil prices, the more we can economise on oil - by switching to smaller cars for example. And the more oil that gets produced – a small excess of supply over demand - and the price can plummet.
The lesson of history, is that when oil prices soar up to record levels, they usually then fall back down.
And here's one final price of oil thought for the day, courtesy of Shai Agassi:
The cost of the average used car in Europe is now cheaper than the cost of gasoline to drive it for a year . . .
August 13, 2007
I don't know what's more troubling. The candidates' answers or the fact that those inane answers are formulated because they help get the candidates elected to office?
June 2, 2007
Democratic presidential hopeful John Edwards says a wave of mergers in the oil industry should be investigated by the Justice Department to see what impact they have had on soaring gasoline prices.
During a campaign stop in Silicon Valley Thursday, Edwards planned to berate the oil industry for "anticompetitive actions" and outline an energy plan he says would reduce oil imports "and get us on a path to be virtually petroleum-free within a generation."
"Vertically integrated companies like Exxon Mobil own every step of the production process -- from extraction to refining to sale at the pump, enabling them to foreclose competition," says an outline of Edward's energy plan.
Now, you can peruse the "Economics-Energy Prices" category archive of this blog and find many credible resources that utterly debunk Edwards' theory regarding the cause of rising gasoline prices. But Andrew Morriss, one of Larry Ribstein's colleagues at the University of Illinois College of Law, provides this handy SSRN paper in which he cogently explains that governmental interference with gasoline markets has a far larger impact on gasoline prices than anything Exxon Mobil does:
Rising gasoline prices have brought energy issues back to the forefront of public policy debates. Gasoline markets today are the result of almost a hundred years of conflicting regulatory policies, which have left them dangerously fragmented. In this article, I analyze that regulatory history, highlighting the unintended consequences of regulation that have pushed the United States into a series of loosely connected regional markets rather than a broad, deep national market. This fragmentation leaves the American economy is vulnerable to natural disasters, terrorist attacks, and foreign dictators in ways that it need not be. It also produces higher prices for consumers and reduced innovation by refiners.
TigerHawk understands, too.
May 20, 2007
George Will brilliantly explains the folly of governmental initiatives to control the price of gasoline and, in so doing, exposes the true price gougers:
[House Speaker Nancy] Pelosi announced herself "particularly concerned" that the highest price of gasoline recently was in her San Francisco district -- $3.49. So she endorses HR 1252 to protect consumers from "price gouging," defined, not altogether helpfully, by a blizzard of adjectives and adverbs. Gouging occurs when gasoline prices are "unconscionably" excessive, or sellers raise prices "unreasonably" by taking "unfair" advantage of "unusual" market conditions, or when the price charged represents a "gross" disparity from the price of crude oil, or when the amount charged "grossly" exceeds the price at which gasoline is obtainable in the same area. The bill does not explain how a gouger can gouge when his product is obtainable more cheaply nearby. Actually, Pelosi's constituents are being gouged by people like Pelosi -- by government. While oil companies make about 13 cents on a gallon of gasoline, the federal government makes 18.4 cents (the federal tax) and California's various governments make 40.2 cents (the nation's third-highest gasoline tax). Pelosi's San Francisco collects a local sales tax of 8.5 percent -- higher than the state's average for local sales taxes.
To understand how gasoline prices are set, read this.
April 3, 2007
Saudi oil production is now down more than 10% from its peak level in 2005; . . . this decline in production has followed an erratic pattern, beginning in October 2005 when oil was selling for $62 and continuing through July 2006 when oil briefly touched $75, making it difficult to see these cutbacks as an effort to stabilize oil prices; . . . the production decline coincided with a doubling in the number of oil rigs employed in Saudi Arabia since 2004 and tripling since 1999.
March 1, 2007
Vaclav Smil is a distinguished professor of economics at the University of Manitoba and, based on this TCS Daily op-ed, doesn't think much of Peak Oilers, including well-known Houston-based Peak Oil advocate, Matt Simmons:
Simmons claims that Saudis have falsified their oil reserve data so much that in reality they have only a fraction of the claimed oil left in the ground, and that their, and the world's, largest oilfield, al-Ghawar, has been so damaged by waterflooding (used for enhanced recovery of oil) that it faces imminent and massive extraction downturn. And yet Saudis will be investing nearly $50 billion between 2007 and 2011 to get this nonexistent oil to the global market. Perhaps they know something that Simmons is not aware of (these days it is, after all, de rigueur to say only bad things about Saudis).
Smil concludes by reminding us of something that is not well understood by the political forces that frequently attempt to heap even more taxes on the energy industry -- that is, that investing in oil and gas exploration is not necessarily the lucrative long-term investment that many believe:
Finally, a practical reminder: If there is an imminent peak of oil extraction, should not then the prospective shortage of that increasingly precious fuel result in relentlessly rising prices and should not buying a barrel of oil and holding onto it be an unbeatable investment? But a barrel of a high-quality crude, say West Texas intermediate, bought at $12.23/b in 1976 as a nest-egg for retirement and sold before the end of 2006 at $60/b would have earned (even when assuming no storage costs) about 1.2% a year, a return vastly inferior to almost any guaranteed investment certificate and truly a miserable gain when compared with virtually any balanced stock market fund. And a freedom-at-55 investor who bought that barrel at 30 years of age in 1980 and sold in 2005 would have realized a nearly forty per cent loss on his precious investment. Being a true believer in imminent peak oil may be fine as a provocative notion but not as a means of securing a comfortable retirement.
February 15, 2007
So, I think it's safe to say that, after this blog post, Cato's Jerry Taylor is not going to be asked to contribute a piece to the Wall Street Journal's ($) next special section on alternative energy:
One could spend a lifetime slamming dross in the news pages of the Wall Street Journal - particularly when it comes to energy. Only the driving need to be more productive with my time keeps me from doing so on a daily basis. But when something as bad as this insert comes along, something must be said.
Taylor is not impressed with Houston-based Peak Oil advocate, Matt Simmons, either:
Moving right along, page two features recommended readings from Matthew Simmons, the most prominent proponent of the idea that the world’s oil fields are about to run dry. This, to put it charitably, is a minority perspective among oil analysts. That the Journal turns to someone like Simmons - and only Simmons - to lay in print the groundwork for readers interested in knowing more about the oil industry speaks volumes. Much more intelligent conversations about oil with Daniel Yergin and Robert Mabro are briefly referenced as on-line supplements.
Then, Taylor takes off on the John Biers article about Houston's leadership in promoting alternative energy initiatives:
Reporter John Biers mails in a vacuous piece titled “Texas’ New Tea” about how Houston is poised to become the center of the renewable energy biz, transforming the former oil town into the international headquarters of Big Green, Inc.. While his article might as well have been written by the city’s Chamber of Commerce, it would be nice to provide some perspective. For example, how much capital is flowing in to Houston to underwrite renewable energy investments versus how much capital is glowing in to Houston to underwrite fossil energy investments? I can guarantee you that the dollars associated with the latter are light years beyond those associated with the former and that rising oil prices are doing far more for the city’s economic health than anything else. He might have also asked how much of that venture capital is being driven by government regulation and subsidies. The answer would be “all of it” - which speaks volumes about how precarious those investments might be.
Here is Taylor's entire piece. Enjoy.
January 29, 2007
While President Bush on one hand made a productive health care finance proposal in his State of Union Address last week, his big push for alternative fuel development was not as well-conceived. As this OpinionJounal op-ed notes, the development of ethanol as an alternative fuel source has been mostly a con job of epic proportions.
[F]ederal and state subsidies for ethanol ran to about $6 billion last year, equivalent to roughly half its wholesale market price. Ethanol gets a 51-cent a gallon domestic subsidy, and there's another 54-cent a gallon tariff applied at the border against imported ethanol. Without those subsidies, hardly anyone would make the stuff, much less buy it--despite recent high oil prices.
Jerry Taylor of the Cato Institute has done a ton of work exposing the ethanol boondoggle, and this recent post links several of his works. The ethanol con is a quintessential example of special interests manipulating market conditions and political rhetoric to capture a windfall that would not otherwise be available. It's also a reminder to all of us to grab our pocketbooks whenever we hear a government official touting the next big government program to develop something at a supposedly cheaper or more stable price than what the markets are providing.
January 18, 2007
Crude oil fell to $50 a barrel earlier this week, the lowest price since early 2005 and a continuation of a steady decline in price since the market hit $80 a barrel last year. Why those greedy oil companies would continue to allow crude oil prices to fall after last year's election (rather than simply before) has not yet been explained by the O'Reilly-type conspiracy theorists, but Clear Thinkers favorite James Hamilton analyzes the data and concludes that there has not been any dramatic shift in the underlying market forces that would explain the decline. Professor Hamilton believes that fundamentals generally drive the price of oil, so he notes the trendy belief that speculators in the oil markets drove last year's price hike:
What about attributing the run-up in oil prices almost to $80 a barrel, and now the latest drop back near $50, entirely to speculation, without any reference to fundamentals? The reason I’ve resisted that hypothesis is that it’s based on the premise that the folks who manage these funds are just throwing their money away.
Thus, Professor Hamilton observes:
Until U.S. and Chinese oil demand are kept in check, and until big production increases are forthcoming, it's hard for me to see how the price could continue to plunge.
My advice to would-be speculators remains that fundamentals are ultimately what must drive the market. Anyone who believes otherwise should not expect to hang onto their wealth for long.
Check out the entire post, as well as some of the insightful comments.
November 30, 2006
This OpinionJournal editorial reviews the rather odd arrangement under which Houston-based energy company Citgo -- which is controlled by the Socialist Venezuelan government of Hugo Chavez -- supplies home heating oil to former Democratic Congressman Joseph P. Kennedy, II's Citizens Energy Corporation at a 40% discount. The nonprofit Citizens passes the savings onto the poor and contends that it helps 400,000 homes in 16 states that would otherwise have trouble heating their homes.
The OpinionJournal piece scours Kennedy for playing nice with Chavez, but the article fails to mention the oddest aspect of this supposed charitable venture. The poorest of the U.S. citizens who will receive the discounted price on the home heating fuel that Citgo sells to Citizens are far wealthier than the poor people of Venezuela, four out of 10 of whom survive on $2 a day or less. How does it make sense for Chavez and Kennedy to sell oil at a 40% discount to people in the U.S. who are far richer than Chavez's constituents in Venezuela? Sort of sounds like taking from the poor to give to the not-as-poor to me.
By the way, as noted in this earlier post, don't worry too much about Chavez cutting off Venezuelan energy supplies to the U.S. We'll be just fine without them.
November 9, 2006
When you meet someone who doesn't quite get the correlation between high energy company profits and the capital-intensive nature of oil and gas production, pass along this NY Times article to them:
As oil consumption grows and access to most oil-rich regions becomes increasingly restricted, companies are venturing farther out to sea, drilling deeper than ever in their quest for energy. The next oil frontier — and the next great challenge for oil explorers — lies below 10,000 feet of water, through five miles of hard rock, thick salt and tightly packed sands.
“It’s not a place for the timid,” said Paul K. Siegele, the vice president for deepwater exploration at Chevron, which commissioned a survey by the Neptune. “It’s a place where a lot of people have lost their shirts.”
To picture the challenge, imagine flying above New York City at 30,000 feet and aiming a drill tip the size of a coffee can at the pitcher’s mound in Yankee Stadium. Then imagine doing it in the dark, at $100 million a go.
Even after hitting pay dirt, it will take another decade and billions of dollars to transform oil from these ultra-deep reserves into gasoline. Some of the technology to pump the sludge from these depths, at these pressures and temperatures, has not yet been developed; only about a dozen ships can drill wells that deep, and no one knows for sure how much oil is down there.
While most people regard affordable and abundant supplies as an essential element of the nation’s prosperity, few realize how complex and costly the quest has become, even in the nation’s own backyard. At the same time, some experts argue that the industry is nearing the limits of what it can do to maintain a growing supply of fossil fuels.
Amen. Read the entire article.
October 27, 2006
Clear Thinkers favorite James Hamilton is thinking about oil prices again, and that's always a good thing. This time, Professor Hamilton examines the impact that scarcity rents are having on oil prices as the markets increasingly adjust for the risk of resource exhaustion:
My own view is that, for most of the past century, Dave [Cohen']s inference is exactly correct -- the resource exhaustion was judged to be sufficiently far off as to be ignored. However, unlike those whom Dave terms the Cornucopians, I do not infer that the next decade will necessarily be like the previous century. Certainly declining production from U.S. oil reservoirs set in long ago. And if one asks, why are we counting on seemingly geopolitically unreliable sources such as Iraq, Nigeria, Angola, Venezuela, and Russia for future supplies, and transferring vast sums of wealth to countries that are covertly or openly hostile to our interests, the answer appears to me to be, because we have no choice. Resource scarcity in this sense has already been with us for some time, and sooner or later the geological realities that governed U.S. oil production are also going to rule the day for the rest of the world's oil producing countries. My expectation has accordingly been that, although scarcity rents for oil were irrelevant for most of my father's lifetime, they would start to become manifest some time within mine. And I have been very interested in the question of when.
Read the entire post, and then try to resist calling your commodities broker. ;^)
Posted by Tom at 4:47 AM
October 9, 2006
A couple of weeks ago, this post noted the news stories about some pundits were floating the theory that the recent slide in energy prices was a dark conspiracy of powerful political forces that were attempting to ensure the victory of the evil capitalist roaders in the upcoming mid-term elections. Bill O'Reilly was probably pleased with these reports.
Subsequently, a week or so ago, Clear Thinkers favorite James Hamilton shot down a similar report that Goldman Sachs was really behind the price decline.
But absurd conspiracy theories do not die easily in American society. Last Friday, this Washington Post article again channels the conspiracy theory, this time pointing toward a new bogeyman, Saudi Arabia:
According to this theory, the Saudi government is doing Bush a favor by trying to bring down prices before the election. The evidence? Some say the Saudi government has a long-standing relationship with the Bush family. They also cite the 2004 book by author and Washington Post assistant managing editor Bob Woodward, "Plan of Attack," which said that then-Saudi ambassador to the United States, Prince Bandar bin Sultan, promised to keep oil production high enough to moderate fuel prices and bolster the U.S. economy during the presidential election year.
Professor Hamilton dutifully tries to keep up with the latest conspiracy theories:
So let me see if I've got this straight-- the evidence is that (1) Bob Woodward says that somebody told him that the Saudis made a promise in 2004 and (2) the Saudis could have reduced production by even more than they already have, if they really wanted to keep prices from falling. As for (1), the Saudis have made plenty of promises -- publicly, for all the world to see-- that came to nothing. And as for (2), what sort of economic theory is this? That the Saudis have been decreasing production over the last year is indisputable. If an even bigger production cut than the Saudis have already made would have been necessary in order to keep prices from falling, doesn't that prove rather conclusively that the cause of the price drop must be something other than what the Saudis have done?
Meanwhile, following up on a thought from this earlier post, Don Boudreaux over at Cafe Hayek chimes in with the following letter to the editor that responds to an earlier letter by an advocate of the energy price conspiracy:
Alleging that today's falling gasoline prices result from a fiendish plot to keep the GOP in power, Kenneth Jones is certain that "gasoline prices will go right back up to $2.75-plus after the [November] election" (Letters, October 2).
If Mr. Jones is correct, he can make a financial killing. All he need do is to invest all of his assets going long in gasoline futures (which are today about 30 percent lower than they were in late July). Indeed, he ought even to cash out all the equity in his house, max out on his credit cards, and borrow heavily from his brother-in-law so that he can invest as much as possible in these futures.
He can then contribute his post-election financial bounty to the Democratic National Committee.
Donald J. Boudreaux
Keeping up with nutty conspiracy theories regarding fluctuation in energy prices is a full-time job.
September 25, 2006
Following on this earlier cue, NY Times business columnist Gretchen Morgenson contends in this column (Times Select, registration required) that Amaranth Advisors, LLP's loss of $6 billion or so last week on the natural gas trading market is conclusive proof that energy markets are in need of more government regulation:
Many of Amaranth’s monster trades in the natural gas markets were conducted on over-the-counter markets or with so-called voice brokers and so were not on regulators’ radar screens.
It is too soon to tell what role Amaranth’s gamble had on natural gas prices. But speculators played a significant role in the astonishing rise in energy prices in recent years.
Such is the conclusion of a compelling Congressional report produced in June by the Senate’s Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs. The 49-page report detailed the explosion in energy speculation on unregulated trading markets and recommended eliminating the so-called Enron loophole that put electronic energy trading off the regulatory reservation.
See how easy that was? Just associate "Enron" with a company that suddenly lost about 2/3rd's of its assets and, presto! -- you have the need for more government regulation of trading markets without any analysis whatsoever of whether such regulation would ultimately be more expensive than the cost of the allowing markets to allocate loss. Indeed, how one earth would it have helped had Amaranth made filings with the CFTC? Does anyone really think that such a requirement would have prompted Amaranth to modify its trading practices?
As noted earlier here and here, allowing investors to make bets in energy trading markets -- although not widely understood by the general public -- is tremendously beneficial in forecasting energy prices. Not only will greater regulation of those markets likely undermine those benefits, Morgenson's dubious assertion that speculation in energy markets has caused an increase in natural gas prices is based upon a Senate report that, as noted earlier here, is a sham that was essentially produced by the regulators to feather their nest.
Although I could go on and on about the irresponsible nature of Morgenson's analysis, but Larry Ribstein's weekly evisceration of Morgenson does it much better than I ever could:
As in any free market, the natural gas market aggregates many right and wrong trader bets into a collective judgment about reality that is usually more accurate than a single mind can come up with. This judgment assists society in allocating resources, thereby making us all better off. We may not like what the market is telling us – i.e., that prices are going up -- but that doesn't mean we should regulate it. If we're going to constrain the operation of these markets we ought to be very sure that this regulation helps them be more accurate.
Even if there is a case for regulation (which I doubt), nothing about the problems at Amaranth suggests that such regulation will get us more accurate energy prices. Amaranth made a bad bet and its rich investors suffered. Perhaps Amaranth misled its investors about its trading strategies. But as far as I've seen, there was no manipulation of energy markets.
That doesn't stop Morgenson from linking Amaranth, with absolutely no justification, to BP traders' manipulation of propane prices and, of course, to Enron. Morgenson ends her story by saying that "as last week's implosion of Amaranth shows, Enron's' troubling legacy lives on." Morgenson wants to talk about regulating markets, and Amaranth happens to be the most visible anecdote right now connected with those markets, and so she's damn well going to use it for her purposes, relevant or not.
This is irresponsible. The task of a financial columnist with millions of readers should be to enlighten readers, not mislead them with a magician's sleight of hand (Amaranth = BP/Enron). Sadly, we have come to expect this sort of thing from Morgenson. No doubt Morgenson's column will be fodder for equally disingenuous lawmakers who are working on regulating energy markets as we write, and she will play her part in the manufacture of misguided regulation. In the end, Morgenson will get the attention for her writing she craves, while doing more harm than any of the targets of her weekly indignation.
September 20, 2006
Oil prices kept falling yesterday as the October crude contract on the New York Mercantile Exchange dropped $2.14 to settle at $61.66 a barrel, which is the lowest price for a front-month crude contract in six months. A couple of weeks ago, Pejman Yousefzadeh wrote this TCS Daily op-ed in which he observed that, despite such declining prices, the Bill O'Reilly-type claims of manipulation of oil markets continue to persist.
As if on cue, this NewsBusters post reports on a recent installment of the CNN show, "The Situation Room," in which CNN reporter Bill Schneider speculated ominously that the current decrease in energy prices has been timed to help Republicans in the midterm elections:
"The drop in prices may last a couple of months, long enough to get through the November election. Could that be what the oil companies want?"
Schneider's observation was then "buttressed" with the insight of one Tyson Slocum, a "consumer advocate:"
"Eighty-one percent of their money goes to members of the Republican Party. I cannot say for sure whether or not they are influencing prices to assure that outcome, but it is, I think, more than just a coincidence that we're seeing an easing of prices at a time of running up to a very, very important election."
That's a helluva consumer advocate who argues that lower prices for consumers is a dark conspiracy of the Republican Party and big energy companies. Does that mean that the far lower energy prices that existed in the run-up to the 2000 election were the result of an equally dark conspiracy of the Democratic Party and big energy companies?
September 11, 2006
Oil prices continued a steady slide last week, ending the week at a five-month low as concerns about possible shortages that fueled this summer's rally ebbed. The October crude contract on the New York Mercantile Exchange settled at $66.25, the lowest level for a front-month contract since April 5. The contract has lost more than $11 in the past month. Previous posts on the energy markets are here.
Meanwhile, James Hamilton posted this typically astute analysis of the big discovery in the Gulf of Mexico last week and explains why it may not have as big an effect on energy markets as big discoveries of the past. Also, the Chronicle's David Kaplan provides this interesting article on Houston-based chemical engineer Henry Groppe, who has long been one of the most respected behind-the-scenes experts in the Houston business community for predicting energy prices. As noted in this Resource Investor piece from last year, the 80-year old Groppe is the forerunner of such younger experts as Matt Simmons, who have carved-out careers in advising businesses on risks relating to energy prices.
Finally, this recent Economist article reminds us the silliness of bashing big U.S. oil companies for supposedly controlling energy prices. Turns out that the thirteen largest oil companies in the world are all state-owned and control about 90 percent of the world's oil reserves. The biggest U.S. major -- Exxon Mobil -- is a measly 14th and controls only a fraction of the world's reserves.
Pass that information along to Bill O'Reilly if you have a chance.
September 5, 2006
Chevron Corp. and partners Devon Energy Corp. and Norway's Statoil ASA are expected to announce today (WSJ ($) article here and NYT article here) the first successful oil production from a deep-water region in the Gulf of Mexico called the Jack Field that could become the biggest domestic source of oil since the discovery of Alaska's North Slope over 30 years ago.
Meanwhile, the Wall Street Journal ($) is reporting that Paris-based Compagnie Generale de Geophysique has agreed to acquire Houston-based geophysical seismic company Veritas DGC Inc. for about $3.1 billion in cash and stock.
And Clear Thinkers favorite James Hamilton notes a drop in gasoline prices, which is good news. Or is it?
August 31, 2006
As noted in this earlier post, the recent run-up in energy prices and the lingering "contango" in the crude oil trading markets -- that is, futures contracts for a given product priced substantially higher than that same product for near-term delivery -- has prompted the usual conspiracy claims from demagogues who seek more power through damaging regulation of the beneficial trading markets. As if on cue, the U.S. Senate Permanent Subcommittee on Investigations recently issued a report asserting that traditional supply and demand conditions cannot adequately explain current high oil prices and contending that evil capitalist roaders in the trading markets are to blame for a substantial portion of the lingering high prices.
Thankfully, the blogosphere provides a counterbalance to such demagogic appeals. In this post, University of Houston business professor Craig Pirrong disassembles the Senate report, observing at the outset:
Where to begin? The report is a farrago of facts, factoids, and falsehoods stitched together to arrive at a conclusion that is miles beyond what the evidence actually supports. Moreover, although I concur that manipulation is a potential problem in energy markets–as it is in all commodity and even financial markets–the report does not even make the effort to show that current price levels are the effect of manipulation. Nonetheless, it sternly recommends a variety of new regulatory initiatives to combat manipulation, suggesting (by implication) that manipulation is the cause of high oil prices. This is a flagrant example of bait-and-switch of a variety that I imagine that the Subcommittee members would vigorously condemn if committed by your local used car salesman.
The report (and most of the other criticisms of speculation) fails on only two points: logic and evidence. Other than these shortcomings, it’s great.
Read the entire post.
August 18, 2006
Following on this post from earlier in the week on the benfits of speculation in the oil and gas commodities markets, Chronicle business columnist Loren Steffy pens this column (related podcast here) along the same lines that includes an interview with Craig Pirrong, the director of energy markets for the Global Energy Management Institute at the University of Houston's C.T. Bauer Business School. As Pirrong notes, the current criticism of speculators in the oil and gas markets is simply the latest salvo in a long and misguided American tradition of scapegoating speculators:
Investors [in oil and gas commodities markets] . . . make bets on what the price of oil will be. If they're right, they make money. If they're wrong, they lose.
That, Pirrong says, allows producers to share the risk that comes with volatile prices. Speculators, using derivatives and other financial tools, can offer producers more stable price contracts. The stability makes it easier for oil companies to invest in new production or new technology, he says.
"We'd be worse off if they hadn't come in," Pirrong says.
Historically, though, speculators have been blamed when markets have gone awry. When Congress attempted to regulate agriculture markets in the 1880s and 1890s, speculators were cited as a threat to price stability, Pirrong says. The same was true in the 1920s, when regulation was enacted amid slumping commodity prices that were again blamed on speculators.
"This is just the latest chapter in a very old story," Pirrong says.
August 16, 2006
According to this report, Illinois senator Barack Obama warned citizens at his 50th Town Hall meeting about gas guzzling vehicles and proclaimed that such vehicles are a big part of the blame for the world's higher temperatures. In urging citizens to switch to higher mileage hybrids, Obama observed that "it would save more energy, do more for the environment and create better world security than all the drilling we could do in Alaska."
After the meeting, Obama proceeded to leave in his SUV, a GMC Envoy.
But it's not finished. When Obama's staff saw the news report, they sent the following email to the station that published the report:
A story your station ran seems to imply that my boss Senator Obama was being hypocritical when he said Americans should drive more fuel-efficient vehicles though he was himself traveling in an SUV.
The SUV in question, though, is a Flexible Fuel Vehicle that can run on E85, which the Senator fills it with wherever its available (and in fact he's worked very hard to provide tax credits to increase availability and access to e85). I believe in light of these facts the story is misleading and warrants a correction.
Let's get this straight. Don't drive an energy guzzling SUV. But it's o.k. to do so if your SUV can guzzle primarily ethanol, for which the Senator promotes tax breaks because it is uneconomic to produce otherwise, partly because of the energy cost involved in such production.
Something tells me that Senator Obama and his staff should shut up on this particular issue. Hat tip to Steven Hayward.
August 14, 2006
This Norm Alstar/NY Sunday Times article notes a recent analyst report suggesting that a stampede of institutional investors, mainly pension funds, into the commodities futures markets is actually the chief cause of the rise in oil prices, which the report characterizes as “a bubble.” Maybe so, but as James Hamilton noted in regard to the contango situation in such markets awhile back, this is a good thing and not an ominous one as the Times article suggests.
If the speculators turn out to be right that prices will be higher in the future, then they will earn a profit and provide a benefit for consumers. By bidding up the price of oil today, oil inventories rise as owners save for the higher future price and consumers conserve so that more oil is available in case there is a shortfall in the future.
However, if the speculators bet wrong, then they will have bought high and sold low. That results in consumers paying more now for oil products than would be necessary if the future price of oil could be predicted with certainty. But consumers' increased payments for oil products will pale in comparison to the money that the speculators will lose on their bets of higher prices in the future. Consequently, the only reason to be worried about all this is if you are concerned about the speculators losing huge amounts of money when the bubble bursts.
In short, as former Exxon CEO Lee Raymond reminds us about oil prices when he was asked recently whether he thinks that they will continue to go up:
"Maybe. But I'll bet they'll be lower at some point."
August 4, 2006
This Bloomberg article is reporting that former Nymex president and former El Paso Merchant Energy trading chief J. Robert "Bo" Collins sent investors in his hedge fund MotherRock L.P. a letter yesterday informing them that MotherRock is shutting down after betting big and losing on trades in the volatile natural gas market during June and July.
Collins formed MotherRock in early 2005. At its peak, the fund managed about $430 million in assets and reported net gains of 20% for 2005. Although its energy fund was up slightly as of the end of May, that MotherRock fund lost $230 million as investors fled and the natural gas prices moved contrary to MotherRock's positions. After an unusally high draw in natural gas from storage last week and a a heat wave across much of the country, natural gas prices rose 17% during the week of July 24 and 14% this past Monday. Guess which way MotherRock was betting prices would go?
The Wall Street Journal's ($) Ann Davis reports from Houston on the funny money flowing into oil and gas investment opportunities, even those that do not own any oil and gas yet:
Barry Kostiner traded electricity and natural gas for eight years on Wall Street. Last fall, he reinvented himself -- as a Texas oilman.
With no assets beyond plans to buy oil and gas fields, he set up shop as Platinum Energy Resources Inc. He had never worked in the oil industry or managed a company. Yet he carried out an initial public offering of stock and within two months persuaded several New York hedge funds to buy a large chunk of the shares, raising $115 million in all. . .
Energy-related endeavors of all kinds are a magnet for cash these days, thanks to the gravity-defying rise of oil prices and the recent boom in investment pools that cater to deep-pocketed institutions and the wealthy. Some energy investments, to be sure, are relatively low-risk and involve industry veterans. But private-equity firms, hedge funds and other professional speculators are also pouring billions into unconventional loans, management teams with limited track records and IPOs on lightly regulated stock markets.[. . .]
The fevered pitch reminds some of the Silicon Valley boom a few years back. "Energy's about as hot right now as tech was in 2000," says Ben Dell, an energy analyst with Sanford C. Bernstein & Co. [. . .]
One popular trend: management teams with virtually no assets other than big and costly ideas.[. . .]
Exotic new loan markets are another energy investment trend. Some energy companies that don't yet have positive cash flow are borrowing from hedge funds or others at double-digit interest rates. The loans are sometimes called "second-lien" loans because in the event of trouble the hedge funds have to line up behind more-traditional lenders that have first rights to any collateral.
I began practicing business law during the late 1970's-early 80's boom in the oil and gas business, and cut my teeth in insolvency and reorganization law while unraveling and putting oil and gas deals back together again during the prolonged bust that followed that boom. Although this boom is different in material respects from that earlier run-up in the oil and gas business, that prior experience compels me to listen more to the following advice of former Exxon CEO Lee Raymond from an earlier WSJ interview than the sharpies quoted in the latest WSJ article:
Q: What do you think of [the current boom in the oil and gas business]?
A: I can never remember an industry consolidating at high prices. But I can remember an industry consolidating at low prices.
Q: Some people think prices will keep going up.?
A: Maybe. I'll bet they'll be lower at some point.
Let me go back to the last time we went through something like this, which started when the shah of Iran was around. [The shah went into exile in 1979.]
A lot of people don't remember, but we went through a period of relatively high oil prices, which by today's standard would be very high oil prices, that lasted for almost five years. It was at that time that we got into our first stock-buyback program.
As today, we had very strong cash flows. There were a lot of people that were talking about buying other companies. Although we didn't say it directly at that time, we had a view that the price structure could not last -- that it was fundamentally unstable, and that it was just a matter of time. And so we concluded that the cheapest oil we could buy was our own. But because of the stock-buyback program, we were roundly criticized on Wall Street. There were no opportunities. We were liquidating the company. All that kind of stuff.
But the facts are that, behind the scenes -- we were not going to say it publicly, obviously -- we just felt that the price structure couldn't persist. And, come along December of 1985, it just collapsed. Went from $28 to $10 in two weeks. So when people ask today, what are you going to do with the money, my answer is: We're not going to do anything stupid. We're going to manage it like we've managed everything else.
Q: What is Exxon planning to do with all its cash?
A: First of all, we'll sort through it. And secondly, why in the world would we ever tell anybody in advance what we were going to do with it anyway?
July 10, 2006
This Bhushan Bahree-Russell Gold/WSJ ($) article reports on Chevron Corp's pilot project in Saudi Arabia in which it is using its steam injection technique to to loosen up sludge-like heavy-oil reserves in Wafra, the huge field in the so-called neutral zone between Saudi Arabia and Kuwait.
Heavy oil is costlier to produce than light oils, typically contains more contaminants such as metals and sulfur, and is priced lower than light oil to boot. But because of the decreasing supply of easily-produceable light oil, a growing number of refineries around the world are acquiring the special equipment necessary to turn heavy oil into petroleum-based products such as gasoline, jet fuel and heating oil. Inasmuch as most heavy-oil fields in Saudi Arabia are not included in the country's current estimate of 260 billion barrels of recoverable reserves, a successful steam injection initiative in such heavy-oil fields would potentially add billions of barrels to Saudi reserves
Meanwhile, Clear Thinkers favorite James Hamilton explores the effect that a recent reduction in Saudi oil production may be having on speculation over oil prices. Interestingly, the drop in Saudi production has occurred at the same time as the Saudis are aggressively increasing their drilling efforts.
June 30, 2006
Bill O'Reilly contends that it's all just an energy company conspiracy, but this week's price hike for gasoline and crude oil is actually showing just how sensitive U.S. energy markets have become to disruptions that just a few years ago would have barely registered a blip in those markets.
Gasoline and crude-oil and prices surged after the June 20 spill of 47,000 barrels of oil waste snarled the Calcasieu Ship Channel, a major Louisiana waterway that connects the Port of Lake Charles to the Gulf of Mexico. The stoppage stranded oil barges and tugs that are delivering crude oil to three refineries that together refine about 775,000 barrels of crude oil a day into fuels such as gasoline. The Coast Guard reported yesterday that it might open the channel to limited traffic by this weekend.
Primarily as a result, gasoline futures on the New York Mercantile Exchange have risen by almost 15% over the past week to yesterday's close of $2.29 a gallon, the highest level since the aftermath of last summer's Gulf Coast hurricanes. Meanwhile, August crude-oil futures rose over $1.30 to $73.52 a barrel, which is about $3 higher since the spill and an 11% increase for the current quarter. The spill is merely the latest in a series of supply disruptions over the past year that have increased average U.S. gasoline prices by almost 25% and crude-oil prices by 15% since the beginning of the 2005 hurricane season.
Not only are the US gasoline and crude oil markets tightening because of increased global crude-oil demand and flat production levels, US refineries are already operating at almost 95% of capacity, which is making the US more dependent on gasoline imports. Accordingly, expect short-term gasoline prices to go even higher during this hurricane season and the peak summer vacation season while longer term prices also will likely trend upward because of the limited refinery capacity. Inasmuch as the US currently uses just over 9 million barrels of gasoline a day and US refineries can produce about 8.5 million barrels a day, the balance of the US daily usage is imported and will grow if US demand for gasoline increases.
Just a few years ago, an incident such as the Calcasieu spill would have barely caused a ripple in the gasoline or oil markets that had bountiful supplies and untapped refining capacity. But no more. With little spare global capacity in crude oil and even less untapped refining capacity, any blip on the global oil production or refining radar screen is likely to generate quick price hikes in those markets. Remember that the next time you hear O'Reilly railing against energy companies or US politicians dithering about how to limit energy company profits rather than on how to encourage those companies to increase production of oil and gasoline.
June 5, 2006
Well, after a hurricane season last year when prices skyrocketed to above $15 per British thermal unit and stored supplies were slashed as multiple storms played havoc with Gulf of Mexico production and storage facilities, U.S. supplies of natural gas are now so plentiful that the natural gas industry is running out of places to store it. Thus, despite the prospect of another active hurricane season, natural gas prices are down over 40% this year to $6.62 per BTU and likely will move even lower.
Rather than governmental intervention, the primary reason for the declining prices is the weather. As a result of a relatively mild winter, lower-than-expected demand for heating resulted in more plentiful supplies of natural gas this spring. Accordingly, over half of the estimated four trillion cubic feet of U.S. underground natural gas-storage capacity is already being used, which means that those facilities could be at near full capacity even before the first hurricane hits the U.S. mainland later this summer.
Meanwhile, Bill O'Reilly and attorneys general from several Midwestern states -- who last year condemned the big oil and gas companies and gas traders for manipulating prices and pushing up home-heating bills for all U.S. citizens -- have not yet explained how, with all their market power, those avaricious companies and traders could not prevent the current collapse of natural gas prices.
May 19, 2006
Amidst the concern over relatively elevated crude oil prices, natural gas prices continued their slump yesterday after governmental data showed volumes in gas storage rose more than expected last week. The news pushed futures contracts for June delivery down to $5.997 per million British thermal units on the New York Mercantile Exchange, the first time that the price for such contracts had dipped under $6 per BTU since February, 2005. Gas futures are now down 47% for the year and 65% below their December high, which was a Nymex record.
The Energy Information Administration reported yesterday that total gas in underground storage rose by 91 billion cubic feet, which is almost eight billion cubic feet more than previous estimates. Volumes in storage as of May 12 totaled 2.08 trillion cubic feet, the highest ever for this time of year. Some analysts are speculating that the U.S. could actually run out of storage space if the current trends continue.
Still no word from Bill O'Reilly on how the big oil and gas companies allowed such a situation to occur.
May 8, 2006
This post from a couple of weeks ago noted the rise of crude oil prices to over $70 per barrel, and this subsequent post examined the unusually long contango period that has existed in the oil trading markets during the current run-up in crude oil prices.
Well, crude oil prices have now fallen below $70 per barrel again. Thus, Clear Thinkers favorite James Hamilton is wondering whether oil prices have peaked for the time being. One interesting observation in the post is about the impact of $3 a gallon gasoline prices:
These data seem to suggest that the April gasoline price increases may have been sufficient to reverse the usual tendency for the U.S. public to use more gasoline each year than the previous year. Certainly that's what we observed last fall when gas prices were around their current values, and I see no reason not to expect to see the same thing to be repeated now.
April 27, 2006
This post from last week noted the seeming contradiction between rising oil prices at a time of rising inventories and the current longstanding "contango" in the oil trading market -- i.e., futures contracts for a given product are priced substantially higher than that same product for near-term delivery.
In this post, Clear Thinkers favorite James Hamilton takes a stab at explaining the situation, and casts doubt on the conventional wisdom that speculation is a separate force from supply and demand in affecting the price of oil. In so doing, Professor Hamilton makes the following common-sense observation, which you will never hear from politicians and a mainstream media that prefer to characterize business interests that make money speculating on oil prices as greedy capitalists:
[I]f these speculators turn out to be right [that prices will be higher in the future] and earn themselves a tidy profit, they will have done us all a favor. By bidding up the price of oil today and filling the storage facilities to the brim, they will have caused consumers to conserve today in order to have more oil available in the event that we do run into a big shortfall in production before September. On the other hand, if the speculators turn out to be wrong, they bought high and sold low. That would be destabilizing, forcing us all through some current pain, which, if we somehow could predict the future with certainty, will turn out to have been unnecessary. Our only consolation would be that the speculators will undoubtedly feel our pain, and then some, as their multibillion dollar bets flew into the wastebasket.
So, the only reason I see to be concerned about the contribution of speculation is if you think that the speculators are in danger of making huge losses. But if that's your concern, I have a simple cure -- just put yourself on the selling side of some of those futures contracts -- let their pain be your personal gain.
April 18, 2006
Crude oil closed above $70 a barrel yesterday for the first time despite the fact that U.S. oil inventories are at their highest levels in nearly eight years. Thus, this current price spike appears to be a reflection of a new phenomenon -- investment in oil futures driving higher prices rather than the typical principles of supply-and-demand.
The U.S. is the world's largest oil market, generating almost a quarter of world demand of about 85 million barrels a day. U.S. benchmark oil for May delivery settled at a record of $70.40 a barrel yesterday on the New York Mercantile Exchange, up $1.08 a barrel. Although oil prices are up almost 15% for the year, the inflation-adjusted record price for oil remains the April 1980 price, which equates to $97.21 in 2006 dollars. Yesterday's price came after the U.S. Energy Department reported last week that commercial crude-oil inventories had risen to 346 million barrels, the highest level since May 29, 1998. At that time, the crude-oil market was about to crash and, by the end of 1998, prices fell below $11 a barrel from an average of over $18 in late 1997.
The seeming contradiction of rising prices and inventories probably is best explained by concern over supply constraints in Iraq and Nigeria and the steadily increasing demand in large countries such as China and India. As a result, investors are flocking to oil markets where it is currently estimated that investment managers are holding between $100 to $125 billion in commodities investments, which compares to less than $10 billion in such investments back in 2000. That level of investment indicates that the market is betting that demand for oil will continue to rise under tightening supplies.
For over a year now, the three-year bull market in oil has resulted in what energy traders call "contango" -- i.e., futures contracts for a given product are priced substantially higher than that same product for near-term delivery. As a result, it pays to buy and hold oil now to sell it later at the higher price. "Backwardation" is the opposite of contango and occurs when near-term prices are higher than long-term contracts. That market condition would prompt buyers to dump inventories, which would in turn dampen prices considerably.
March 27, 2006
This NY Times article reports on the successful lobbying effort by the oil and gas industry in the mid-1990's during a time of low energy prices to persuade Congress to create incentives for energy companies to explore for oil and gas in the Gulf of Mexico.
Congress passes legislation to create the incentives, but the legislators don't bother to read the legislation carefully.
During the current period of relatively high energy prices, the oil and gas companies take advantage of the legislation to make a lot more money through paying reduced royalties to the government than they would otherwise have made without the legislation.
Journalists point this out to legislators.
February 21, 2006
As oil prices reversed a downward trend and rose over the weekend on the news of more Nigerian political problems (James Hamilton explains why this is important), the roller coaster of emotions that is the natural gas market continued unabated.
Just over two months after prices hit an all-time high amid fears of shortages this winter, the natural gas market is flush with a record amount of gas and, as a result, natural gas prices are in full retreat. A U.S. government report last week reflected that natural gas supplies in underground storage facilities are almost 45% above what is normal for this time of year and now speculation is increasing that a record amount of gas will be left over from winter as the weather warms in the midwest and northeast U.S. this spring. As a result, prices for natural gas settled last Friday at $7.182 a million British thermal units, which compares with the $15.378 per million British thermal units closing price on December 13th. The drop in prices is allowing industrial buyers of gas to enter the long side of the market and hedge their risk of higher prices in the future.
No word yet from Bill O'Reilly on how the big oil and gas companies allowed such a situation to occur.
February 16, 2006
Crude-oil futures dropped $2 on the New York Mercantile Exchange yesterday, falling to the lowest level in two months. Benchmark light, sweet crude-oil futures for March fell $1.92 to settle at $57.65 a barrel, which is the lowest front-month settlement since Dec. 19th. That makes four straight days of losses amounting to almost $5 a barrel. Meanwhile, government data reflects that U.S. petroleum inventories are above the higher end of the average range for this time of year, and oil stockpiles are now at their highest level since late June, 2005.
No word yet from Bill O'Reilly on how the big oil companies, with all their market power, could not prevent this large decline in crude oil prices.
January 24, 2006
Always a source of common sense, the W$J's George Melloan passes along this timely column today in which he patiently explains that demagogic calls for more control of energy markets is precisely the opposite approach that legislators need to be taking in response to rising energy prices. In so doing, he passes along this pearl of simple wisdom, which the confused Bill O'Reilly could really use:
But it's also deplorably true that when constituents complain about soaring prices of natural gas and gasoline, [politicians seeking more regulation] have a ready scapegoat, "the giant oil companies." Anyone still buying that line should ask himself why the "giant oil companies," with all their market power, somehow couldn't prevent crude oil from collapsing to $10 a barrel a few years ago.
January 20, 2006
While the price for natural gas has receded quickly from the post-hurricane highs of last summer, oil prices have been a different story.
Crude-oil future contracts on the New York Mercantile Exchange climbed about a dollar yesterday, settling at a four-month high of almost $67 a barrel. Benchmark light, sweet crude-oil futures for February rose $1.10 to settle at $66.83 a barrel, which was the highest closing price since mid-September. Although inventory data indicates that U.S. crude and product stocks are at above-average levels, market jitters remain over the possibility that international oil supplies could be disrupted further as a result of political problems in both Iran and Nigeria.
Clear Thinkers favorite James Hamilton is thinking about what the rise in oil prices indicates, and he continues to believe that the current oil price rise is demand-driven, unlike the speculative bubbles of past spikes.
January 6, 2006
Wasn't it just a few weeks ago that we were enduring demagogues' calls for governmental intervention in regard to increasing oil and gas prices?
Well, continuing a trend noted in this post from a week ago, the natural-gas contract for February delivery on the New York Mercantile Exchange settled at $9.499 per million British thermal units during intraday trading on the New York Mercantile Exchange, the first time that such contacts have settled below $10 since Hurricane Katrina wreaked havoc on Gulf Coast production facilities last summer. This represents almost a 40% decline from the Dec. 13 record. The market was undercut yesterday by an Energy Information Agency report that natural-gas volumes in U.S. storage actually rose last week, which is unprecedented during the last week of December.
Meanwhile, Clear Thinkers favorite James Hamilton is wondering whether the U.S. economy has faded the 2005 oil price shock and notes that there are some reasons to worry about energy prices in 2006.
December 28, 2005
Remember this post just two weeks ago about natural gas futures contracts settling at an all-time high price over $15 per million British thermal units?
Well, markets have a funny way of reacting to such pinnacles, and the market for natural gas futures has been in a free-fall almost ever since that earlier post. Yesterday, natural-gas futures for January contracts dropped 10% and pushed prices below $11 for the first time on the New York Mercantile Exchange since mid-September before settling at $11.022 per million British thermal units. Prices for January contracts have fallen 23% since Dec. 21 as thin trading and forecasts for mild weather are powerful forces driving the price of contracts downward. Some traders are now predicting that gas-futures prices will fall below $10 after the New Year if above-normal temperatures persist.
Clear Thinkers favorite Holman Jenkins's W$J/Business World column today provides a wonderful analysis of how domestic political demagoguery over Big Oil profits works to enhance fascist control of oil and gas supplies internationally. In so doing, Jenkins tosses the following delicious salvo at David Boies' latest Big Oil lawsuit:
Consider the perfected idiocy of Sen. Maria Cantwell of Washington, who bought her Senate seat with a now-diminished dotcom fortune and has reason to worry about whether voters will find her worth re-electing. This undoubtedly explains her sudden and shrill emergence as the most unhinged of oil-industry bashers.
Last week she was quick to confuse the filing of a lawsuit with proof of guilt, denouncing BP and Exxon because they were named in an antitrust complaint by the deservedly obscure Alaska Gasline Port Authority. Ms. Cantwell was likely impressed by the name of David Boies, celebrity lawyer, as counsel for the plaintiffs. In fact, the AGPA consists of three Alaska municipalities whose plan for a gas liquefaction facility in the port of Valdez was recently rejected by the state as lacking any means of financing.
The group has decided to blame its troubles on BP and Exxon for allegedly sitting on undeveloped natural gas reserves in Alaska in order to drive up prices in the U.S. domestic market. This overlooks the fact that the two companies supply just 12% of the natural gas in the lower 48, so any such manipulation would benefit mostly their competitors.
In reality, the AGPA nakedly exists to divert Alaska's untapped gas wealth into a local construction boondoggle, lacking any economic rationale. Indeed, the mere act of liquefying Alaskan gas and loading it aboard a ship would put the state in competition on absurdly unfavorable terms with far cheaper suppliers of liquefied natural gas in Qatar, Indonesia, Australia, Russia and elsewhere.
In contrast, a pipeline to the Midwest would deliver the gas, without the expense of liquefaction and refrigeration, directly to a large, landlocked market where supply is short and getting shorter. That's why Exxon, BP and a third leaseholder, Conoco, prefer this approach and are prepared to finance it, joined by Alaska's sane governor, Frank Murkowski.
This should be a no-brainer, but the little Putins of the Alaska Gasline Port Authority, cheered on by the silly Ms. Cantwell and the cynical Mr. Boies, are determined to politicize what should be a straightforward economic decision. This is not just bad economics for Alaska. It's an example of increasingly nonsensical policymaking by energy-consuming nations, promoted in the U.S. by kneejerk oil industry critics on Capitol Hill.
Read the entire piece.
December 20, 2005
For many years, the State of Alaska has been trying to persuade Exxon Mobil Corp. and BP PLC to invest with the state in a natural gas pipeline that would be built from the North Slope Oil Field to Valdez in the southern part of the state, where the companies' natural gas would be liquefied and loaded onto tankers. But BP and Exxon Mobil prefer an alternative, longer pipeline over which they would own a larger share that would run through Canada to the Midwest. According to the companies, such a pipeline would deliver the natural gas directly to markets and be less risky than the state's proposal. As a result of the disagreement between the state and the companies, there is currently little natural-gas production generated from the North Slope even though U.S. natural-gas prices are soaring.
So, what's Alaska to do? Compromise and cut a deal with the owners of the natural gas? No way, not when the state can hire David Boies to come up with an implausible lawsuit against the companies (W$J article here) that plays on the public's resentment of greedy capitalists.
Let's see if we have Alaska's lawsuit right. Exxon Mobil and BP, which generate less than 10% of the U.S. natural gas production, are refusing to enter into the pipeline deal that the state favors (and which might make the companies more money now, but maybe not) because the price of natural gas in the future will probably be higher than it is now. Thus, the companies prefer to "warehouse" their gas for the time being so that they can make more money in the future than they would make now.
That's a lawsuit? Sounds as if Exxon Mobil and BP are making either a good or bad business decision to me (too early to say how it will turn out), but that should not be the basis of a lawsuit. Unless, that is, the purpose of the lawsuit is to punish those companies for having the right to make that decision in the first place.
December 16, 2005
Well, there has been almost a week's worth of bets on the proposed ConocoPhillips - Burlington Resources merger, and those bets have been decidedly against ConocoPhillips.
Since Monday, ConocoPhillips shares have been hammered, closing yesterday at $58.77, which is down almost 7% since the proposed merger was announced. Moreover, Houston-based investment bank Sanders Morris Harris and A. G. Edwards both downgraded ConocoPhillips stock to a "hold" from their pre-merger announcement "buy" recommendation. As noted in this earlier post, the ConocoPhillips play for Burlington runs contrary to traditional big energy company policy toward such mergers during times of high energy prices.
Responding to this market skepticism, ConocoPhillips chairman and CEO James Mulva conceded yesterday in public comments that the company is paying "a full price" for Burlington, but that "access to quality long-term resources has become much more difficult and expensive. We are in an extremely competitive environment and a portfolio of assets of Burlington's quality cannot be replicated." Mr. Mulva also noted that ConocoPhillips is analyzing whether to use hedges to "either lock in prices or mitigate the potential downside of a reduction in gas prices." Finally, Mr. Mulva predicted excess cash flow would allow ConocoPhillips to reduce the relatively high debt-to-capital ratio that it is taking on to make the deal to between 18% to 23% by the end of 2006.
Picking up on this early betting trend, Chronicle business columnist Loren Steffy notes in this column that Mr. Mulva has not been a good horse to bet against over the past several years. As Mr. Steffy notes, Mulva has been an ambitious risk taker who stands out among generally conservative big-oil chief executives. Since becoming chief executive at Phillips in 1999, Mulva has engineered a series of deals of a total value close to $30 billion. Among those deals are the 2001 acquisition of refiner Tosco Corp. for $7.5 billion, the $17 billion merger of Conoco and Phillips in 2002, and the September 2004 purchase of a minority stake in Russian oil giant OAO Lukoil, which gave ConocoPhillips a local partner in the competition to tap Russia's enormous untapped reserves. Although Mulva has financed such acquisitions primarily through debt, that financing technique has turned out to be a good bet as surging profits based on higher energy prices have helped drive ConocoPhillips' debt-to-capitalization ratio down to around 20% while the company's liquidity has increased to a robust $2.8 billion.
So, I share Mr. Steffy's caution about betting against ConocoPhillips in regard to the acquisition of Burlington Resources. Mulva has stood out among the major energy companies in redeploying his company's profits aggressively, and that strategy has transformed ConocoPhillips from a couple of sleepy mid-tier companies into what could be the second largest publicly-owned oil and gas company in the U.S. That track record indicates that he has a good chance of pulling off his biggest bet yet.
December 14, 2005
On the heels of this post from last week and ConocoPhillips' big bet on natural gas earlier this week, natural gas futures jumped to another all-time high yesterday for a front-month contract and settled above $15 per million British thermal units for the first time. January futures on the New York Mercantile Exchange rose as high as $15.78 and settled at $15.378 per million British thermal units, which is an increase of about 38 cents from its previous settlement high.
Inasmuch as natural gas production in the Gulf of Mexico has still not recovered fully from the damage caused by multiple hurricanes earlier this year, natural gas supplies remain constricted. As a result, price is volatile on virtually any indication of increased demand, and the recent cold weather in the Upper Midwest and Northeast -- the two main areas of hearing fuel demand -- is seen as the primary cause of the increasing price of natural gas over the past week's trading sessions. Following an unusually warm November in those regions, December has been bitterly cold as weather futures are betting that it will be at least 20% colder than normal in New York City and Chicago through the Christmas holiday.
Just the thought of that type of weather may force me to hit some golf balls at the driving range this afternoon in Houston's beautiful late fall weather. ;^)
December 9, 2005
It was the coldest day of this winter season in Houston and much of rest of the U.S. yesterday, and the cold blast was met with a new record price for natural gas -- January natural-gas futures hit an all-time high of $15.10 a million British thermal units on the New York Mercantile Exchange and then settled at a record high of $14.994 a million British thermal units.
Although damage to production facilities from the hurricanes earlier this year reduced available supplies of natural gas, the impetus for the current spike is cold weather. Although November was a relatively warm month, December is shaping up to be bitterly cold as weather futures on the Chicago Mercantile Exchange predict that December will be almost 25% colder than normal in Chicago and New York. What is even more remarkable is that the spike in natural gas prices isn't bigger news than it is. Until the prior spike hike after hurricanes earlier this year, gas futures had rarely risen above the $10 a million BTU level and industry players thought a price of $15 was analogous to $100-a-barrel oil prices. Interesting how perceptions quickly change as people adjust to changing market conditions.
November 30, 2005
This earlier post noted that even the Washington Post editors now understand the folly of Congress considering a windfall profits tax against oil companies as a result of the price spikes that resulted from temporary supply disruptions. The last time that Congress imposed such a tax (late in the Carter Administration), domestic oil production actually decreased by about 5%, which resulted in higher gas prices, and U.S. reliance on foreign oil inceased by about 10%.
Reflecting that markets tend to take care of supply problems if Congress just stays out of the way, this Wall Street Journal ($)/Russell Gold article (free version here) notes that the recent surge in natural gas prices has prompted major exploration companies to make huge investments in recovery of natural gas from unconventional fields located in the contintental United States. The unconventional gas fields contain natural gas that is locked in giant swaths of coal, sandstone or shale from which extraction is expensive and difficult. However, the increase in natural gas prices, coupled with new technologies that crack open these rocks and extract large quantities of gas, is touching off an exploration boom in such fields throughout the Rocky Mountains and in Texas.
Meanwhile, not to be outdone by the fruits of such boring capitalism, the world's favorite socialist of the moment -- Venezuela's Hugo Chavez -- has hooked up with the Kennedy Family and other northeastern U.S. anti-capitalists to supply some oil to U.S. consumers in the northeast at 40% below current market prices. This Opinion Journal piece scours the political motives of Chavez's "charity," but there is an even simpler problem with this dubious arrangement -- it does not make any sense for Chavez to sell oil at a 40% discount to people in the U.S. who are far richer than his constituents in Venezuela. Not exactly what I would call looking out for the interests of the little guy.
November 21, 2005
This earlier post noted the extensive damage that Hurricane Katrina caused to the MARS floating production platform in the Gulf of Mexico, which generates about 220,000 barrels of oil and 220 million cubic feet of natural gas daily when operational. Following up on that story, this Tom Fowler/Chronicle article reports on the delicate repair operation that will be taking place this week on the MARS platform. Essentially, the process involves removing a damaged rig from the platform, but the damaged rig is so ensnared with other equipment on the platform that removing it could cause even more damage to the equipment on the platform. Another story on the repair operation from the Baton Rouge Advocate is here. It's this type of cost of doing business in the oil and gas industry that tends to get overlooked amidst the bright lights that shine on this grandstanding.
November 12, 2005
A couple of days ago, this NY Times editorial dusted off about every archaic economic theory of the Carter Administration to promote a windfall profits tax on energy companies. So, I was thinking about doing an Econ 101 post pointing out how the Times' position would actually make things much worse than they already are, which is really not all that bad (have you noticed what's been happening to the price of oil and natural gas over the past week or so?).
Then, somewhat surprisingly to me, I came across this Washington Post editorial that does the job for me.
I don't know about you, but I find it quite refreshing that the Washington Post editorial page has come to understand that the market is much more effective than government in dealing with energy supply reductions.
October 28, 2005
Almost on cue with the latest round of energy company earnings announcements, our political leaders in Washington -- both Democrats and Republicans -- signaled their intent to attempt to demonize the energy industry for political gain and, in so doing, make it more difficult for markets to respond to the current limited supplies of oil, natural gas, and refined products.
This really is utterly amazing. Sen. Bill Frist (R., Tenn.), the Senate majority leader, asked the chairmen of three Senate committees to investigate high energy prices and declared that he might support a federal anti-price gouging law.
Meanwhile, Energy Secretary Samuel W. Bodman advised a Senate committee that the Bush administration is considering taking steps to create a stockpile of refined products like gasoline, diesel and jet fuel that would require the industry to set aside stocks of a variety of fuels that could be tapped in future crises. In other words, Secretary Bodman is showing government's usual tendency to make matters worse and more expensive by buying limited supplies of oil products at their currently high price. And this policy is supposed to be a stabilizing force in the energy market?
Mr. Bodman did recommend that the energy industry increase its spending on refining to ease the capacity crunch that has contributed to the recent increase in prices for refined products. However, at almost the same time, Senate Democrats on the Senate Environment and Public Works Committee engineered a deadlock on that committee over a Republican proposal to streamline federal and state permit procedures for companies that want to build refineries or expand plants.
Finally, despite the cyclical nature of the energy business and the need for reinvestment of energy company profits into drilling and exploration for new supplies of energy, politicians are already talking about instituting a windfall profits tax on the industry to make such investment even more expensive and difficult.
Hopefully, our pocketbooks can survive all this nonsense.
October 5, 2005
Following on this thread of posts over the past month, natural gas for November delivery rose 20.7 cents to a record $14.224 per million British thermal units on the New York Mercantile Exchange Tuesday afternoon after Interior Secretary Gale Norton warned it would probably take months before repairs to oil and gas production facilities in the Gulf of Mexico region would return production from that key region to normal. The Minerals Management Service reported that Gulf oil and gas production remains severely restricted, with 90% of the oil and over 70% of natural gas still off-line now a week and a half after Hurricane Rita came ashore.
The gas market was already stretched thin by heavy demand from power generators over the summer, but the double whammy of damage to production facilities from Hurricanes Katrina and Rita over the past month have jolted the natural gas market. As a result, futures contracts on the Nymex have nearly doubled since late July. The one good piece of news from the oil and gas markets was that crude oil, gasoline and heating-oil futures continue to weaken in the face of high pump prices and resultant diminished U.S. gasoline consumption in recent weeks. Oil futures fell for the third straight session on the Nymex as November light, sweet crude-oil futures slid $1.57 to $63.90 a barrel, the lowest price since mid-September.
September 30, 2005
Following on this post from yesterday, the markets continued to react to more information that indicates that damage to Gulf of Mexico offshore production and drilling facilities from the recent hurricanes is going to reduce production and exploration from that key region for an extended period of time.
That information, combined with the slow process of restarting Gulf Coast refineries, is generating one of the more unusual political ironies that America has seen in some time. As a result of the restricted energy supplies from the Gulf region, the outspokenly pro-exploration and production Bush Administration is sounding eerily like the Carter Administration from the late 1970's, promising a national energy-conservation campaign to give Americans tips on saving energy during the winter heating season.
Actually, markets are still trying to adjust to the news of the restricted supplies. Gasoline and heating-oil futures settled lower on the New York Mercantile Exchange yesterday, but front-month crude oil contracts posted a 44 cent rise to $66.79 a barrel -- its highest level in over a week -- although forward month oil contracts were lower. After increasing almost 8% during Wednesday trading, October gasoline settled down about 4% to $2.2516 a gallon and October heating oil fell 1.64 cents to $2.1247 a gallon. November natural-gas futures continued their relentless increast as they rose 9.6 cents to $14.196 per million British thermal units.
The double whammy of Hurricanes Katrina and Rita has not only damaged the Gulf's production and drilling infrastructure, it has damaged the important service industry that provides key logistics support for the offshore exploration and production industry. Helicopters at this point are in such demand that they are nearly impossible to find and many Louisiana dock facilities that used to launch supply boats to the Gulf have been destroyed. Service companies are even having a difficult time finding enough employees to meet the demand for assessment and repair service. This lack fo workers, helicopters and equipment is hampering the damage assessment process with regard to offshore oil and natural-gas facilities, most of which remains shut down nearly a week after Hurricane Rita came ashore last Saturday morning. The Gulf of Mexico accounts for roughly one-quarter of U.S. oil and natural-gas production.
Even when existing production is restarted, the hurricanes have damaged so many drilling rigs that efforts to increase Gulf production of oil and natural gas will likely be severely hampered. Current assessments are that the two hurricanes either sank or seriously damaged 13 drilling rigs, which is 12% of the Gulf rig fleet. As a result, that will make drilling more expensive, adding yet another element to the upward pressure on energy prices.
Finally, although Houston area refineries are firing up operations, the seven refineries in the hard-hit Port Arthur and Lake Charles areas will probably take longer than initially thought because of problems in getting reliable power to those facilities. About 20% of U.S. refining capacity was shut down for at least some period of time by the hurricanes.
September 29, 2005
Following on this post from yesterday, Chevron Corp.'s announcement that its Typhoon tension leg platform was severed from its moorings by Hurricane Rita and is floating upside down in the Gulf of Mexico dovetailed with the news that natural-gas futures on the New York Mercantile Exchange skyrocketed 10% to almost $14 per million British thermal units, which is its highest closing on record.
Natural-gas futures on the Nymex for delivery in October rose $1.251 to $13.907 per million BTUs. The expiration of the October contract at the same time that the delivery point for Nymex futures, Louisiana's Henry Hub, which has been closed down for the past week, added to the uncertainty and volatility in the market.
As a result, the Natural Gas Supply Association -- an association that represents producers and marketers -- issued this alert (pdf) that colder weather in the East combined with hurricane-related supply disruptions along the Gulf Coast will likely translate into substantially higher natural-gas prices across the U.S. this winter. The damage from the two major hurricanes in the Gulf over the past month have delayed or halted production of about 5% of the annual U.S. production of natural gas from the Gulf of Mexico, and that reduction in domestic natural gas production cannot be readily replaced with imports.
As for the Typhoon platform, it is floating upside down after the deep-water facility took a direct hit from Rita. Although Chevron has not announced whether the massive platform can be salvaged, my sense is that it's probably a total loss because its engines, pumps and living quarters are probably unsalvageable. The Typhoon is located in 2,000 feet of water in the Green Canyon area approximately 165 miles south-southwest of New Orleans.
September 28, 2005
This Financial Times article reports that preliminary assessments of the damage that Hurricane Rita caused to offshore oil and gas drilling and production facilities reflect that the damage is greater any other storm in history.
Rita's path -- which was west of the path of Hurricane Katrina last month -- tore through an area of the Gulf of Mexico that contained a large amount of exploratory rig activity. Given the apparent damage to the rigs, the biggest impact from the storm may be that it will exacerbate an already tight market for rigs in the region. As a sign of just how precious rigs are becoming to the market, The Woodlands=-based Anadarko Petroleum Corp., one of the biggest U.S. independent exploration and production companies, raised eyebrows in the energy industry earlier this week by committing to a rig six years in advance.
Oh, how times have changed in the exploration and production business.
September 25, 2005
First, the Houston community responded to the worst natural disaster in America in decades by taking in tens of thousands of evacuees (posts here, here and here) from New Orleans and the central Gulf Coast who had almost everything but their lives. Then, as that relief effort was winding down, Houston confronted Hurricane Rita, a category 5 storm bearing down for a direct hit on the city. Implementation of the city's evacuation plan led to an estimated 2.7 million Houston area residents hitting the road, resulting in unprecedented traffic gridlock and gasoline shortages throughout the region. After Rita veered off to the east to make landfall on the Texas-Louisiana border, Houston is now dealing with the not insubstantial problem of how to have 2.7 million people return to their homes in the region without experiencing the same type of gridlock and shortages that occurred when they left.
Despite all that, the initial signs are that the feared economic repurcussions of damage from Hurricane Rita will not be all that bad. Damage to the vital concentration of oil refineries along the Texas coast appears to be relatively light, and U.S. Coast Guard aerial reconnaissance of the Ports of Houston, Galveston and Port Arthur and their related shipping lanes showed few problems as a result of the hurricane. The biggest problem at the Port of Houston is that the winds out of the north as the storm pushed onshore pushed water out of the Houston Ship Channel and Galveston Bay so that those relatively shallow waterways do not have enough water to accomodate deep sea vessels at this point. However, the water levels should should return to normal levels by Monday or Tuesday, so no substantial disruption in Port operations are expected.
Inasmuch as prices for gasoline and diesel fuel would rise if Houston-area refineries and ports are slow to resume operations, the light damage reports were good news for markets that are still recoiling from the economic impact from the damage to the New Orleans area from Hurricane Katrina.
However, even without extensive damage to refineries and Gulf oil and gas production facilities, the energy industry's pre-Rita shutdown will at least stretch gasoline supplies for the next several weeks. Sixteen refineries were shut down in anticipation of Rita, and that accounts for almost 25% of U.S. refining capacity. That's nearly twice as much of the U.S. capacity that was shutdown prior to Hurricane Katrina, and only about half of that capacity affected by Katrina has come back on line. It normally takes between a week and two weeks for a shutdown refinery to resume normal operations.
Nevertheless, good news emanated on Saturday from the Houston area refineries. Exxon Mobil Corp.'s Baytown plant, which is located between Port Arthur and Houston and is the nation's largest, announced that it planned to restart a number of units beginning today. Terminals and pipelines have already reopened, and the 557,000 barrel-a-day refinery is already delivering gasoline out of storage. Similarly, Royal Dutch Shell PLC announced Saturday that its 340,000 barrel-a-day Deer Park refinery near Houston was not damaged and that both its North Houston and Pasadena distribution terminals are fully operational. BP PLC's huge Texas City refinery is thought to be in the process of restarting, while the smaller Marathon Oil Co. and Valero Energy Corp. refineries in Texas City were also moving towards restarts after reporting no serious damage.
The initial damage reports are worse from the refining area near the Texas-Louisiana border where Rita made landfall. The Port Arthur-Beaumont area has four refineries and Lake Charles, La. just across the border has three plants. Although damage assessments are still ongoing at those plants, the restarting of those plants will take longer both because of probable greater damage than to the Houston area plants and the lack of power, which will probably not be remedied until later in this week.
As a result of the foreoing, crude oil futures fell sharply in unusual Sunday trading as it appeared that oil rig and refinery damage from Hurricane Rita was less than originally feared. Oil prices had climbed steadily last week as Rita churned through the Gulf of Mexico as a category 5 and then 4 hurricane, but fell Friday as the storm weakened before its early Saturday morning landfall just south of Sabine Pass, La. A barrel of light sweet crude for November delivery was down $1.40 at $62.80 on the New York Mercantile Exchange, and unleaded gasoline fell 10.46 cents to $1.98 per gallon. Sunday trading via the Nymex electronic Access system and on London's International Petroleum Exchange was arranged late last week in an effort to mitigate energy market volatility resulting from Hurricane Rita. However, the lack of damage to the facilities appears to have deflated interest in early trading. On London's IPE, Brent crude futures fell $2.59 to $62.01 in light trading.
September 24, 2005
Following up on this post from earlier this week, Entergy Corporation's New Orleans subsidiary filed a chapter 11 case on Friday in New Orleans (that filing location will certainly cut down on the number of lawyers attending the first round of hearings). Neither the Entergy parent company nor any of its other subsidiaries were included in the bankruptcy filing, which is important because about 250,000 of Entergy's Gulf Coast unit's 1.3 million Texas customers are currently without power as a result of Hurricane Rita. The difference between those two units is that those 250,000 customers without power are still Entergy customers. In stark contrast, Entergy's New Orleans unit has lost a staggering 130,000 customers as a result of Hurricane Katrina, and its unclear how many of those customers will even return to the New Orleans region.
The filing occurred after Entergy concluded that the estimated $750 million to $1.3 billion cost of rebuilding the unit's electric system from Hurricane Katrina-related damage far exceeds what the utility's customers can afford to pay. Immediately upon filing, Entergy's parent corporation requested bankruptcy court authority to advance the New Orleans unit $150 million to head off an emergency liquidity crisis and to provide funds to continue the rebuilding effort. Even that emergency financing was dependent on the parent company obtaining emergency concessions from its lenders to avoid a cross-default on its $2 billion emergency line of credit. Although the New Orleans unit's reorganization plan is in the infancy stages, Entergy is attempting to arrange a plan that is based on insurance proceeds, federal support and a limited rate increase to cover rebuilding costs.
September 22, 2005
With the eastern shift of the projected path of Hurricane Rita directly into the part of the Houston metro area that contains a huge number of some of the nation's largest oil refineries and petrochemical facilities, Rita's economic ripples have now turned into waves with the distinct possibility that they could turn into an economic tsunami.
It now appears almost certain that Rita will substantially disrupt operations at a significant number of the oil refineries that transform crude oil into gasoline, diesel and other products. The only question is how long those facilities will be down and how much gasoline prices will increase as a result of the shutdown. At least eight refineries in the Houston area will shut down soon as they began scaling back operations yesterday. Inasmuch as four refineries in Louisiana and Mississippi have been closed as a result of damage from Hurricane Katrina last month, almost 20% of U.S. refining capacity will shutdown with the closing of the Houston area facilities, which will only reduce already tight inventories of gasoline that have pushed prices to record levels. To make matters worse, the new projected path of the hurricane would also cause probable extensive damage to offshore oil and natural gas platforms and pipelines that were west of the ones that were damaged in Katrina's path. I think it's safe to say now that the U.S. energy industry has never had to deal with anything on the magnitude of the 2005 hurricane season.
To put this in perspective, the main worries that energy markets are dealing with are the supply of gasoline for the next few days and the amount of natural gas that will be available for the winter months when that fuel is used to heat homes across the entire United States. About 25% of U.S. oil and natural gas production comes from the Gulf of Mexico region and the entire Gulf Coast region contains a third of U.S. refining capacity. So, higher gasoline prices are a certainty and winter heating bills will also increase substantially. According to the U.S. Minerals Management Service, almost three days of natural gas production have already been lost during this hurricane season and that amount is clearly increasing because about half of the Gulf natural gas production remains shut-in. This is an even bigger problem than a reduction in oil production because the nation's capability to import natural gas is much more limited than oil.
Reflecting these concerns, the near-month futures price of natural gas was up 1% to $12.59 per million British thermal units yesterday in trading on the Nymex, which means that the price is up over 54% since the beginning of August. November light, sweet crude futures settled up 60 cents on the New York Mercantile Exchange at $66.80 a barrel after hitting a high of $68.27. October Nymex gasoline futures settled up 7.65 cents at over $2 per gallon. However, prices rose sharply in overnight electronic trading after the Wednesday Nymex session ended with crude futures up 65 cents at $67.45 a barrel and gasoline up 4.19 cents at $2.095 per gallon.
Finally, in addition to the impact on the Houston area refineries, Hurricane Rita also poses a major threat for the chemical and petrochemical plants that exist along side the refineries in the Houston area and along the Texas coast. More than 160 plants from Port Arthur to Freeport are in the potential path of the hurricane. That region generates 50% of U.S. chemical-production capacity, and most of those chemical plants were in the process of shutting down yesterday in preparation for the hurricane.
Accordingly, less than a month after Houston showed just how important it is to our nation when it opened its arms to tens of thousands of evacuees from New Orleans and the central Gulf Coast region, Hurricane Rita is about ready to show the nation just how important Houston is to the nation's economic health. It could be one very tough lesson.
Update: James Hamilton provides his usual measured analysis of the probable economic impact of Rita.
September 21, 2005
Crude-oil prices surged on Monday as it became clear that Tropical Storm Rita would threaten the Gulf Coast, then prices fell on Tuesday morning when the National Hurricane Center forecast a more southerly path for Rita that might spare the Houston area, and then yesterday afternoon and overnight, prices rose again as the storm evolved into a major hurricane.
Such are the vagaries of predicting hurricane tracks and commodity markets.
Oil prices settled Tuesday afternoon more than $1 a barrel lower than Monday's closing price as early Tuesday projections had Rita coming in closer to Freeport so that the brunt of the storm would miss the Houston area refineries. Those initial reports triggered a drop of more than $2 a barrel in oil prices, but those prices recovered quickly during the day as Rita strengthened into a major hurricane and evacuations from offshore rigs picked up. At the New York Mercantile Exchange, the October crude contract ended $1.16 lower from its Monday high at $66.23. October gasoline closed at $1.9766 a gallon, down 6.61 cents for the day and October heating oil, up more than 20 cents Monday, ended at $2.0113, down 2.71 cents.
Refineries that are located on the southeast side of the Houston metro area in or near the cities of Pasadena, LaPorte, Texas City, and on east toward Beaumont and Port Arthur generate about 13% of total U.S. refining capacity. Although Hurricane Rita could cause even more damage to the offshore drilling and production infrastructure in the Gulf of Mexico that was already extensively damaged by Hurricane Katrina, the trading markets' even more critical concern at this point is that Rita will hammer Houston's refineries, which would have a huge effect on U.S. refinery capacity.
James Hamilton made a good point awhile back that underscores the importance of Houston's refineries. Older refineries cannot process heavy, sulfur-rich "sour" crude oils (Mexico's Maya grade crude is an example of a common sour crude) and even newer refineries cannot process such sour crudes as efficiently as light, "sweet" crude oil. Consequently, if Houston's modern refinery facilities are shut down by the storm, then demand for light, sweet crude will rise and push its price even higher relative to lower-grade crudes. Inasmuch as about 75% of the crude oil that OPEC countries produced last year was sour, OPEC's promise to increase output has had little effect on trading markets that are more concerned about refinining capacity. Although OPEC has incrementally increased its production of sweet crude since 2000, world production of sweet crude has declined steadily since that time.
Finally, the Chronicle's Tom Fowler has this informative article today about the Houston area's refineries and the potential market impact of damage to those facilities.
September 20, 2005
Whoa, Nellie! Oil prices surged yesterday in anticipation of Hurricane Rita plowing through the Gulf of Mexico as OPEC ministers meeting in Vienna conceded they have no real means to cool red-hot petroleum markets that have become roiled by successive hurricanes in the extensive Gulf of Mexico production region.
The price of U.S. benchmark crude-oil futures for October delivery shot up $4.39 a barrel on the New York Mercantile Exchange and settled at $67.39. That was the highest one-day rise in nominal terms since Nymex began trading oil futures in 1983. Moreover, the storm's approach is slowing down efforts to fix Gulf production infrastructure that was damaged by Hurricane Katrina. The U.S. Mineral Management Service reported yesterday that 44% of the daily output of oil and natural gas remained off-line from the earlier storm.
Folks, hang on to your hat because it's going to be one wild ride this week in the oil and gas markets.
September 15, 2005
A funny thing happened in response to the recent run-up in gasoline prices resulting from Hurricane Katrina -- demand for gasoline dropped dramatically.
August 5, 2005
Exxon Mobil -- the world's largest company in terms of market capitalization -- announced yesterday that chairman and CEO Lee R. Raymond, who is 66, would retire at the end of the year after 12 years on the job. As is typical of ExxonMobil's conservative management style, the company also announced that Mr. Raymond will be repaced by native Texan, Rex W. Tillerson, who is 53 and, as ExxonMobil's president, has been a longtime company insider being groomed to replace Mr. Raymond. Here is the company's press release on the change, and here is an earlier post about an interesting interview with Mr. Raymond.
Mr. Tillerson -- who is from Wichita Falls and is a University of Texas at Austin alum with a degree in civil engineering -- has the quintessential tough act to follow. Mr. Raymond managed ExxonMobil into a more successful company in almost every respect, including the successful 1999 merger with rival Mobil Corp. Probably the biggest problem that Mr. Tillerson will face is the sheer size of the type of exploration projects in which ExxonMobil invests. Over the past decade or so, the cost of those projects -- often hundreds of millions -- has grown quickly as producers seek to tap formerly uneconomic reserves. As the increased price of oil justifies even larger investment, the price of those projects will likely grow into the several billions over the next decade. Laying off a large part of projects that size to hedge risk is no easy task.
August 4, 2005
Clear Thinkers favorite James D. Hamilton and Robert K. Kaufmann, professor in the Center for Energy & Environmental Studies at Boston University, are the participants this week in the Wall Street Journal's excellent Econoblog series (it's free!). The topic is the notion of "peak oil" and exploring the economic ramifications of a drop in oil production, and the discussion between these two experts is insightful and informative.
By the way, both men share a disdain for the recently-passed Energy Bill, to which Mr. Kaufman comments:
Policy is needed to help the entrepreneurial spirit anticipate the peak, but we don't need the type embodied in the current energy bill. No serious person can believe that it will help. The current bill demonstrates that Republicans and Democrats have the same view of policy, they just give tax dollars to different groups.
Sound policy should establish an economic environment that increases the economic returns and reduces the risk to long-term research and development on alternative energies. Specifically, policy should impose a large energy tax that is phased in over a long period, perhaps 20 years. Furthermore, increases in the energy tax should be "offset" by reducing other taxes, such as payroll or corporate taxes. Economic studies show that such an approach can generate a "win-win" solution -- reduce energy use (and the environmental damages not paid by users), stimulate research and development on alternative energies, and speed economic growth. Phasing in an energy tax would send a signal to entrepreneurs that there will be a market for alternative energies. The tax does not pick technologies -- that will be left to the market, which is smarter than any Democrat, Republican, or even myself!
And Mr. Hamilton makes the following sharp observation regarding efficient allocation of resources:
It is precisely because I agree with Robert about the importance of this transition [from peak oil] that I think it's critical that we put all our resources to their best use. And I honestly believe that the best way to ensure that happens is to count primarily on the same system that has generated the fantastic improvements in global living standards over the last few centuries, namely, individuals choosing to direct the resources they personally control to those activities that yield the highest personal reward. Yes, the risks are great here, but so are the private rewards to those who best figure out how to navigate our way through them.
In so saying, let me be clear that I distance myself from those who might say that there is nothing to worry about and markets will solve everything. I think there is plenty to worry about, and markets may or may not solve the problems. But what I am saying is that I see private incentives as our best hope. Notwithstanding, I enthusiastically endorse the kinds of active government assistance for those incentives that we've been discussing.
July 31, 2005
Daniel Yergin -- energy economist and author of the 1992 Pulitzer Prize winner, The Prize: The Epic Quest for Oil, Money, and Power -- writes this sensible Washington Post op-ed in which he reminds us that the current relatively high prices of energy do not mean that the end of the oil age is right around the corner:
Prices around $60 a barrel, driven by high demand growth, are fueling the fear of imminent shortage -- that the world is going to begin running out of oil in five or 10 years. This shortage, it is argued, will be amplified by the substantial and growing demand from two giants: China and India.
Yet this fear is not borne out by the fundamentals of supply. Our new, field-by-field analysis of production capacity, . . . is quite at odds with the current view and leads to a strikingly different conclusion: There will be a large, unprecedented buildup of oil supply in the next few years. Between 2004 and 2010, capacity to produce oil (not actual production) could grow by 16 million barrels a day -- from 85 million barrels per day to 101 million barrels a day -- a 20 percent increase. Such growth over the next few years would relieve the current pressure on supply and demand.
Read the entire op-ed, and then recall Exxon/Mobil CEO Lee Raymond's observation during a Wall Street Journal interview earlier this year regarding Chevron's bet of continued high energy prices that underlies the high price it is paying for Unocal:
WSJ: What do you think of ChevronTexaco's decision to acquire Unocal?
Mr. Raymond: I can never remember an industry consolidating at high prices. But I can remember an industry consolidating at low prices.
WSJ: Some people think prices will keep going up.
Mr. Raymond: Maybe. I'll bet they'll be lower at some point.
July 20, 2005
Chevron Corp. has increased its acquisition offer for Unocal to about $63 a share and Unocal's board is supporting that offer over the competing bid of the China National Offshore Oil Corp. Here are the previous posts on the bidding for Unocal.
Inasmuch as Chevron's initial offer was valued yesterday at about $60.51 a share, Chevron increased its offer before a Unocal board meeting yesterday by about $2.50 a share in cash, bringing its total offer for Unocal to about $17.5 billion. Chevron increased the cash portion of the bid to 40% from 25% and raised the per-share value of the cash to $69 from $65, besting Cnooc's offer of $67 a share. The ratio of Chevron stock to Unocal stock in the bid has not changed. Chevron can afford to toss in the extra cash into the bid as it currently has about $11 billion in cash reserves and is adding to that amount by about $1 billion a quarter as a result of high energy prices.
Meanwhile, Cnooc's board has already authorized an increased offer by as much as two dollars a share, but it remains unclear whether Cnooc will make that play. Given the Unocal board's endorsement of the modified Chevron bid, and the political and regulatory obstacles confronting its bid, Cnooc may elect to fold at this point.
Interestingly, investors did not react all that well when Chevron announced that it had won the bidding for Unocal in April as the price of Chevron's stock declined out of out of concern that Chevron was buying at a peak price was ignoring financial returns in favor of increasing oil and gas reserves. However, since that time, energy prices have continued to climb and there is now greater market consensus that such prices are likely to be sustained over the long term.
July 18, 2005
Even before he started his smart blog recently, Professor James D. Hamilton of the University of California at San Diego was one of my favorite experts on the economics of energy prices (previous posts here).
In this post, Professor Hamilton reviews several interesting tidbits of information that affect oil prices, which declined 5% last week. Of particular note -- the futures market currently allows for a purchase of oil for delivery in December, 2011 for under $55 a barrel.
July 17, 2005
Awhile back, this post made the point that, rather than focusing on CNOOC's bid to overpay for a second tier U.S. oil & gas company such as Unocal, the real issue that needs to be addressed is that American society is currently impoverishing future generations of Americans by accumulating more debt.
Picking up on that issue, James D. Hamilton provides this insightful analysis that explains why the issue is not the amount of debt that foreigners hold, but the low U.S. saving rate. As noted earlier, the effect of Unocal's bid on Chevron and Unocal is a much narrower issue.
The late Corbin Robertson, Sr. was a bright business mind when he came to Texas as a young man from Minnesota in the 1940's. After marrying Wilhelmina Cullen -- the daughter of famous Houston wildcatter Hugh Roy Cullen -- Mr. Robertson ultimately became the brains behind the investment of the Cullen Family oil and gas fortune, a role that Richard Rainwater successfully emulated decades later for Ft. Worth's Bass Family. Houston benefitted greatly from Mr. Robertson's business acumen as both the Cullen and Robertson families became among Houston's greatest philanthropists, contributing huge amounts to institutions such as the University of Houston and the Texas Medical Center.
Mr. Robertson's son -- longtime Houston businessman Corby Robertson, Jr. -- has continued his legacy of astute business acumen and philanthropy. After starring as an outside linebacker for the University of Texas football teams of the late 1960's, Mr. Robertson returned to Houston and worked his way into assuming leadership from his father of the Robertson Family's closely-owned oil and gas business, Quintana Petroleum Corporation. However, over the years, Mr. Robertson has branched his family's fortune into the ownership of a non-sexy but more plentiful (and potentially more lucrative) alternative energy resource -- coal.
As this Chronicle article reports (here is an earlier Forbes article), Mr. Robertson's Natural Resource Partners, a Houston-based master limited partnership -- has a market capitalization of $1.6 billion and, since going public on the New York Stock Exchange in 2002, the value of the partnership's units have more than tripled to a recent price of $63. Quarterly distributions have also increased 62 percent since the partnership went public.
By the way, one item the Chronicle article missed is that, among his many civic duties, Mr. Robertson is currently the chairman of the board of Baylor College of Medicine, where he has led Baylor's board during its historic split last year with its longtime primary teaching hospital in the Texas Medical Center, Methodist Hospital. Nevertheless, the Chronicle article is a good overview of the business background of Houston's First Family of energy and highlights the business talent that has helped make Houston the energy capitol of the United States.
July 12, 2005
In this WSJ ($) op-ed, Chevron Corporation CEO David O'Reilly makes the case to Unocal Corp. shareholders for choosing Chevron's lower bid for the company over the China National Offshore Oil Corp.'s higher bid (here are the previous posts on the Chevron and CNOOC battle over Unocal).
Mr. O'Reilly does a reasonably good job in making his case. His main point is that Chevron's bid is a sure thing that is much further along in the approval process than the CNOOC bid. In short, he advises Unocal shareholders to take the slightly smaller Chevron bird in the hand rather than the bigger CNOOC one in the bush.
But in making his case, Mr. O'Reilly veers off course with his second argument:
The second critical issue is in the arena of public policy. For the U.S. government, the proposal by Cnooc presents fundamental questions about fair trade that have profound implications for all U.S. businesses. Contrary to claims by Cnooc, the company's offer is simply not a commercial transaction. The company is 70% owned by the Chinese government and is relying on large subsidies in the form of government loans at below-market rates to finance its $18.5 billion offer. A conservative analysis shows that the value of these subsidies is at least $2.6 billion or $10 per Unocal share. These terms are simply not available to commercial companies operating in the open market. If Cnooc were to finance its offer on truly commercial terms available to most non-government owned corporations, as Chevron is, it simply couldn't make a competitive bid.
Stated another way, Mr. O'Reilly reasons that Unocal shareholders should reject the higher CNOOC bid because CNOOC's bank (i.e., the Chinese government) is willing to loan the company too much money.
My sense is that this argument might work on U.S. Congressmen, many of whom tend to gravitate toward dubious mercantilist policies. However, arguing to Unocal shareholders that they should reject the CNOOC bid because CNOOC's bank is willing to loan CNOOC so much money that the company can overpay the Unocal shareholders strikes me as a reason for Unocal shareholders to embrace the CNOOC bid, not reject it.
July 7, 2005
Prior posts here and here have highlighted the work of University of California at San Diego profeesor James D. Hamilton, who is one of the country's foremost experts on the economics of energy prices.
In this recent post, Professor Hamilton analyzes the chances of whether the price of oil will hit $100 a barrel in the near future. Using the options market as a guide, Professor Hamilton estimates that there is about a 7 percent chance that the price will rise to that level by June 2006. On the other hand, there is about a 15 percent chance that the price will tumble below $40 a barrel by that same date. Which reminds me of the following exchange, noted in this earlier post, between a Wall Street Journal interviewer and Exxon Mobil CEO Lee Raymond on the rising price of oil:
WSJ Interviewer: Some people think prices will keep going up.
Mr. Raymond: Maybe. I'll bet they'll be lower at some point.
July 6, 2005
This earlier post addressed the folly of developing a mercantilist governmental policy in response to the China National Offshore Oil Corp.'s hostile takeover bid for Unocal, which had previously accepted Chevron Corporation's friendly bid for the company. In this OpinionJournal op-ed, CNOOC, Ltd. chairman and CEO Fu Chengyu takes up that line of thinking in arguing that CNOOC's bid is actually good for American business interests and poses no threat to those those interests or American security.
In the meantime, in this post, Brad Stetser, senior economist for the boutique firm Roubini Global Economics, has been thinking about the CNOOC bid in the context of the amount of foreign assets that the Chinese accumulate each month by exporting more than they import. Mr. Stetser estimates that the value of those assets is around $20 billion, which is more than the $18.5 billion that CNOOC is bidding for Unocal. Thus, Mr. Stetser notes that it's a tad absurd to worry too much about the Chinese buying one second tier oil & gas company when the real issue is that China has become the largest creditor of an increasingly leveraged U.S. economy. Stated simply, it doesn't make sense to object when Communists want to buy U.S. companies, but sell away when the same Commies offer to buy U.S. debt.
Mr. Stetser estimates that China holds $700-750 billion in foreign reserves, and that about 66-80% of that amount is in U.S. dollars. Moreover, Mr. Stetser projects that China will add at least $250 billion to its foreign reserves over each of the next two years. Thus, it is only natural that China would want to diversify its reserves by investing in companies such as Unocal and Maytag rather than just holding Treasurys. Inasmuch as such investments are harder to unload than Treasurys, such investments are good from the standpoint that it is less prone to economic upheavals that could negatively impact the U.S. economy.
Nevertheless, the level of Chinese reserve accumulation and intervention in the global exchange markets is unprecedented, and Mr. Stetser notes that China's economic policies are challenging the norms that govern international economic relationships. CNOOC's bid for Unocal is important because it calls attention to the larger issue of how the U.S. has leveraged future earning flows and now must begin servicing that indebtedness. Thus, rather than focusing on CNOOC's bid to overpay for a second tier U.S. oil & gas company, the real issue that needs to be addressed in Washington is whether it's in the U.S. national and economic interests to continue being a massive debtor to China. Washington Post columnist Robert Samuelson echos these thoughts in this timely op-ed from today's edition.
July 2, 2005
One of the enduring myths of this era of criminalizing business practices is that Enron's energy trading policies were one of the primary causes of California's power crisis during the early part of this decade.
Well, with Enron gone, that myth is not going to hold up this time around if what James D. Hamilton predicts comes to pass:
California may again offer the nation a useful illustration this summer of how not to deal with an energy crisis.
California Energy Blog last month passed along the warning from the Federal Energy Regulatory Commission that the southern half of our state is in "the worst electricity supply situation in the entire country." I'm not worried about it, though, because I know that the California Energy Commission has been working for five years to come up with a plan.
And here it is, in all its glory: the fifth annual installment of the flex your power now! campaign. In the Commission's own words, here's how it works:Pitch in this summer, California. When you hear the "Flex Your Power NOW!" alert, immediately conserve energy. Learn more about what to do when you hear the alert.
But the really cool thing is the "Conserve-O-Meter". Go ahead, I'll wait here while you check it out.
And thus we continue in the great tradition of California regulators, who seek with great diligence, earnestness and, dare I say, ingenuity, to try to balance supply and demand every day by telling each one of us exactly what we need to do. As long as we all maintain the proper spirit and check up on the Conserve-O-Meter as the day progresses, I'm certain that all Californians can be counted on to do the right thing, ensuring the equality of supply and demand as a result of conscientious attention to civic duty.
June 28, 2005
Sebastian Mallaby joined the Washington Post editorial page in 1999 after 13 years with The Economist magazine, and is the author of The World's Banker: A Story of Failed States, Financial Crises, and the Wealth and Poverty of Nations (Penguin Press 2004).
In this fine piece regarding the China National Offshore Oil Corp.'s hostile takeover bid for Unocal (previous posts here and here), Mr. Mallaby points out that it's usually a bad idea to prevent a foreign company from overpaying for an American company:
Does it matter if China owns U.S. companies? Japan went on a corporate spending spree in the 1980s, and the chief victims were not Americans, as the protectionists predicted, but the Japanese themselves. The Japanese paid inflated prices for Hollywood studios and landmark New York buildings. The exiting American owners made off with a nice profit. The Japanese got burned.
The Unocal bid has triggered the same muddled complaining that attended those Japanese takeovers. The protectionists say the Chinese want to pay for Unocal with cheap loans from their taxpayers, just as Japanese corporations were once denounced for accessing cheap capital from servile banks. But this means that China's taxpayers are offering sure profits to Unocal's shareholders. Admittedly, it also means that Chevron's shareholders stand to forgo a business opportunity, but then that opportunity may not have paid off. From the view of U.S. economic interests, this is a net plus.
Q: What do you think of ChevronTexaco's decision to acquire Unocal?
Mr. Raymond: I can never remember an industry consolidating at high prices. But I can remember an industry consolidating at low prices.
Q: Some people think prices will keep going up.
Mr. Raymond: Maybe. I'll bet they'll be lower at some point.
If a store is selling quality products at low prices, why would anyone want to shut it down?
By the way, courtesy of John Wagner, Mark Palmer -- who was Enron's head public relations spokesperson as the company slid toward bankruptcy -- is CNOOC's public relations point person in its bid for Unocal.
June 23, 2005
Cnooc Ltd., China's third-largest oil company and it's major explorer of offshore oil and gas, yesterday made an unsolicited $18.5 billion cash bid for El Segundo, CA.-based Unocal Corp. The bid is attempting to scuttle the earlier $16.5 billion bid that San Ramone, CA.-based Chevron Corp. made for Unocal in April.
If successful, Cnooc's bid would be the largest foreign acquisition ever attempted by a Chinese company and would be the first time that a Chinese and U.S. company have competed in a takeover battle. Cnooc had been considering making a bid for Unocal in April, but backed off at the last minute.
Inasmuch as a good case can be made that Chevron's bid was over-priced, Cnooc's offer for Unocal reflects that China's government (about a 70% owner of Cnooc) will pay a high price to gain direct control over more energy assets to fuel its booming economy. Nearly half of Unocal's reserves -- the oil and natural gas equivalent of about 1.75 billion barrels -- consists of natural gas in Asia. Cnooc is offering $67 a share for Unocal, and would have to pay Chevron a $500 million breakup fee and assume Unocal's $1.6 billion in debt.
Although Cnooc's bid will undoubtedly raise political concerns in Washington, prominent U.S. executives advised political interests to remain calm. The Wall Street Journal reported that Exxon Mobil Corp. Chief Executive Lee Raymond said it would be a "big mistake" for the U.S. government to block Cnnoc's bid. "You have to have free trade. If you start to put inefficiencies in the system, all of us eventually pay for that."
June 20, 2005
Oil prices surged almost 10% last week and are widely expected to top $60 a barrel this week. The recent price gains show a sharp turn in the short term market since only a month ago, when reports of steady growth in U.S. oil inventories drove oil down to $46.20 a barrel on May 20.
Meanwhile, even as short term oil prices escalated, the price of the December 2011 oil futures contracts fell, which increased what is referred to as the "backwardation" of oil prices -- i.e., when futures prices are below current spot prices.
The mainstream media always seems to struggle with the economic implications of volatility in oil prices, so cruise over to this Econbrowser post, in which University of California at San Diego economics professor James D. Hamilton -- an insightful specialist in oil price fluctuations -- analyzes the current situation. This earlier post notes Mr. Hamilton's views on why the current run-up in oil prices is unlike those that occurred during the 1970's and early 80's.
Finally, here is an excellent Forbes Magazine graph that shows the real and nominal price of oil over the past century and a half.
May 15, 2005
T. Boone Pickens started Mesa Petroleum Company in 1956 with a $2,500 investment and built it into the largest independent oil and gas company in America. Then, during the 1980's, Mr. Pickens became well-known in business circles (Fortune magazine called him the "most hated man in America") for leading a series of hostile takeover attempts that earned him a reputation as a corporate raider and greenmailer. Although Mr. Pickens' ideas about corporate restructuring and the tactics he used for achieving them were controversial in those days, many of those ideas are common practice in the business world today, even among hedge funds.
This article reports on recent remarks of the 77 year old Mr. Pickens in which he provides an interesting overview of current oil demand and production statistics:
Let me tell you some facts the way I see it. Global oil (production) is 84 million barrels (a day). I don't believe you can get it any more than 84 million barrels. I don't care what (Saudi Crown Prince) Abdullah, (Russian Premier Vladimir) Putin or anybody else says about oil reserves or production. I think they are on decline in the biggest oil fields in the world today and I know what's it like once you turn the corner and start declining, it's a tread mill that you just can't keep up with.
So, when you start adding the reserves in these countries, you're not even replacing what you're taking out.
Let me take you to another situation quickly. 84 million barrels a day times 365 days is 30 billion barrels of oil a year that we're depleting. All of the world's (oil) industry doesn't even come close to replacing 30 billion barrels of oil. We don't spend enough money to even give ourselves a chance to replace 30 billion barrels. It may be because the prospects are not there. I rather imagine that's what the answer is to that.
So, if you accept that 84 million barrels a day is all the world can (produce), and then look at refining capacity, I think it's just a coincidence that refining capacity... world capacity... is 84 million barrels a day. So, we're in balance: 84, 84.
Now you see the projections for the fourth quarter of '05, I mean like tomorrow; it is 86 to 87 million barrels of oil a day required. China (and) India (are) growing fast. Our economy is going down a little bit, but it doesn't seem to be shutting off demand for gasoline, oil, natural gas, whatever. But around the world... just assume that the (U.S.) economy is slowing, but China is still ramped up; it is still 86, 87 million for the fourth quarter.
Now we've got some pretty good inventory, those will be... I think.. they'll be gone in the third quarter. I can't wait to see how this is all going to play out.
After his remarks, Mr. Pickens was asked if he agrees with Houston-based investment banker Matt Simmons that Saudi Arabia's oil fields may be on the verge of decline. Mr. Pickens replied that he agreed with Mr. Simmons.
As the article on Mr. Pickens' remarks notes, if he and Mr. Simmons are correct that Saudi promises to raise production over the next decade cannot be fulfilled, then Saudi Arabia's role as a swing producer and oil price stabilizer will be a thing of the past. That would probably lead to more volatility in energy prices as the world economy begins to adjust to more expensive fossil fuels. Thus, the coming year could be a very interesting one in the oil and gas business.
May 9, 2005
ChevronTexaco Corp. announced today that it is dropping the venerable "Texaco" part of its corporate name and shortening its name to Chevron Corp., which was the name of the company before before the company merged with Texaco three and a half years ago. Don't worry, though. That bright Texaco star will still grace the local gas station as Chevron plans on continuing to use the Texaco brand to market gasoline.
Chevron has been in the news recently with its proposed acquisition of Unocal Corp for about $17 billion, which is subject to shareholder and regulatory approval. Chevron's stock will continue to trade on the New York Stock Exchange under the "CVX" ticker symbol that was adopted after the Texaco takeover.
April 25, 2005
San Antonio-based Valero Energy Corporation announced early today that it would acquire refiner Premcor Inc. for $6.9 billion in cash and stock plus the assumption of about $1.8 billion of debt, which will the San Antonio company the largest refiner of crude oil in North America.
The deal -- which is subject to regulatory approval in the already heavily consolidated refining industry -- would give Valero total refining capacity of 3.3 million barrels a day, making Valero's refining capacity more than that of Exxon Mobil Corp. in North America. The deal gives Premcor shareholders an initial premium of about 20% based on the recent 30-day trading range of Premcor's stock price.
Valero has been on an refinery acquisition initiative for almost a decade. Beginning in 1997 when it owned only one refinery, Valero has made seven acquisitions and, if the Premcor deal is approved, will have 19 refineries. Valero already became the largest independent refiner in North America in 2001 when it bought Ultramar Diamond Shamrock Corp. for $4.03 billion plus the assumption of $2.1 billion in debt, and the 5,000 retail gasoline outlets involved in that acquisition gave Valero a large retail presence. The Premcor purchase would give Valero four additional U.S. refineries and bring its annual revenue to about $70 billion.
The deal highlights a startling turnaround that has occurred in the refining industry over the past several years. Since the big shakeout in the oil and gas industry that occurred in the mid-1980's, the refining industry struggled for over a decade. Investment in new refineries slowed to a trickle for a combination of reasons, including overcapacity, inadequate return on investment, oppressive environmental regulations and local political opposition to new and more efficient facilities. As a result, most people do not realize that the last new plant to be built in the U.S. was in 1976, that the number of refineries in the U.S. has declined to 150 at present from 325 in 1981, or that refining capacity for crude oil has declined from about 18.5 million barrels a day to about 17 million barrels per day over the past five years.
Accordingly, while worldwide demand for gasoline has been rising dramatically over the past several years and refiners have struggled to keep pace with increasing demand, the refiners' limited capacity and low inventories have resulted in substantially improved margins, which is the difference between the price that the refiners' receive for their product and the price that they pay for crude oil.
Thus, when you hear complaints about high gasoline prices, recognize that the relatively high price of oil is only one component of the problem. Lack of refining capacity is at least as big a reason for the problem, and making it difficult to construct new refineries only ensures continued high gasoline prices.
April 20, 2005
This New York Times article -- entitled The Troubled Oil Company -- reviews the Venezuelan dictator Hugo Chavez's mismanagement of Houston-based oil company Citgo, which is owned by Petroleos de Venezuela, the Venezuelan national oil company. Over the past two years, virtually every high-ranking Citgo executive has resigned, including the refining chief, the chief financial officer, the head auditor, and the marketing director. Here is a previous post on Mr. Chavez's mismanagement of Citgo.
Although the Times article about Citgo and Mr. Chavez is interesting, it's always funny how the Times analyzes a government's mismanagement of a big oil business. As late as 1999, Venezuela was the U.S.'s largest foreign supplier of oil, but then Mr. Chavez took over, began establishing close friendships with anti-business types such as Fidel Castro, and generally started mismanaging the Venezuelan economy. By 2003, Mr. Chavez had cut its exports to the U.S. by 22% and was threatening to cut off oil exports to the U.S. entirely if the U.S. government doesn't stop meddling in Venezuelan affairs.
Now, if the foregoing were occurring in Saudi Arabia, then the Times would be handling it as a major foreign policy story of impending doom. However, when a crackpot socialist and Castro admirer mismanages oil exports, the Times treats it as a typical business story.
Which is exactly the way the story should be handled. Mr. Chavez's management of the Venezuelan economy has been horrific, albeit aided by high oil prices. But U.S. oil imports as a percentage of GDP are relatively small, about $132 billion in 2004 compared with a about a $11 trillion GDP. That's about 1%, folks. Thus, if Mr. Chavez chooses to sell us less oil, hopefully the U.S. government shrugs, we replace Venezuelan oil with oil from the numerous other markets, market prices adjust, and we get on with getting to work.
Besides, if the U.S. government is going to take a hard line with an oil exporter, don't you think that the government should take that stance with the country from which we import the most oil? Oh, and what country is that?
Hat tip to Bryan Caplan for info on the Venezuelan oil imports.
April 11, 2005
This Angry Bear post provides a good overview of the probable impact of current oil prices on the American economy, which segues nicely to this recent Wall Street Journal ($) interview with ExxonMobil CEO Lee Raymond, in which he observes the following:
WSJ: What do you think of ChevronTexaco's decision to acquire Unocal?
Mr. Raymond: I can never remember an industry consolidating at high prices. But I can remember an industry consolidating at low prices.
WSJ: Some people think prices will keep going up.
Mr. Raymond: Maybe. I'll bet they'll be lower at some point.
Let me go back to the last time we went through something like this, which started when the shah of Iran was around. [The shah went into exile in 1979.]
A lot of people don't remember, but we went through a period of relatively high oil prices, which by today's standard would be very high oil prices, that lasted for almost five years. It was at that time that we got into our first stock-buyback program.
As today, we had very strong cash flows. There were a lot of people that were talking about buying other companies. Although we didn't say it directly at that time, we had a view that the price structure could not last -- that it was fundamentally unstable, and that it was just a matter of time. And so we concluded that the cheapest oil we could buy was our own. But because of the stock-buyback program, we were roundly criticized on Wall Street. There were no opportunities. We were liquidating the company. All that kind of stuff.
But the facts are that, behind the scenes -- we were not going to say it publicly, obviously -- we just felt that the price structure couldn't persist. And, come along December of 1985, it just collapsed. Went from $28 to $10 in two weeks. So when people ask today, what are you going to do with the money, my answer is: We're not going to do anything stupid. We're going to manage it like we've managed everything else.
WSJ: What is Exxon planning to do with all its cash?
Mr. Raymond: First of all, we'll sort through it. And secondly, why in the world would we ever tell anybody in advance what we were going to do with it anyway?
The fluctuation of oil prices is a common topic on this blog, and prior posts on the topic can be reviewed here.
April 5, 2005
San Ramone, California-based ChevronTexaco Corp. won the bidding yesterday for its California-based rival Unocal Corp. yesterday in a cash-and-stock package valued at $16.8 billion. The deal is the largest oil-sector deal since 2001 when the acquirer was created under Chevron's merger with Texaco.
ChevronTexaco is paying a premium price for Unocal as U.S. oil companies face heightened competition for scarce oil-and-gas reserves, many of which are locked up in regions where the companies are not welcome. The theory behind the deal is that it turns the merged company into the second-largest holder of oil-and-gas reserves in Southeast Asia behind Petrochina Co. and also strengthens ChevronTexaco's presence in the Caspian Sea region.
However, today's high oil prices can turn such deals upside down in a hurry. Although the price allows companies such as ChevronTexaco to have the strong balance sheet necessary for such acquisitions, should oil prices retreat from current levels in the next two to three years, the risk of write-downs in goodwill is high. ChevronTexaco hedged that risk somewhat by financing the deal mostly with its own stock -- ChevronTexaco will pay $4.4 billion in cash and the balance in stock, and will assume $1.6 billion in Unocal debt.
Moreover, the deal reflects the increasing price that oil companies will pay for reserves. ChevronTexaco was able to replace only about 20% of the oil and gas that it produced in 2004, even though it generated in excess of $13 billion in profits and ended the year with over $9 billion in cash. The merged company will have daily production of over 3 million barrels of oil equivalents and increases ChevronTexaco's reserves by about 15%.
The deal values Unocal at $62.07 a share, which is a 3.6% discount based on Unocal's closing price of $64.35 on Friday. Widespread market anticipation that Unocal would be acquired has increased its share price nearly 50% since the beginning of the year. News of the deal actually sent both Unocal and ChevronTexaco stock down yesterday on the New York Stock Exchange, Unocal to $59.60 and ChevronTexaco to $56.98.
April 2, 2005
Oil prices climbed to record highs Friday on mounting concern about limited supplies.
Crude futures for May delivery on the New York Mercantile Exchange settled up $1.87 at $57.27 a barrel. That price is a new record closing price, beating the old record of $56.72 a barrel of a couple of weeks ago. Adjusted for inflation, Friday's closing price close is the highest since Oct. 11, 1990 when Nymex crude closed at $40.42, which is equal to $58.18 in today's dollars. Nymex crude would still need to reach $90 a barrel to beat the inflation-adjusted high price that was established in 1980.
This Forbes graph provides an instructive overview of oil prices over the past 150 years. The last 30 years of oil price fluctuations has been quite a ride.
March 20, 2005
Though some grades of crude have recently set record price highs on New York and London futures markets, the Forbes graph shows that, when adjusted for inflation, the price of oil is still only 60% as expensive as it was in 1980.
March 19, 2005
Houston-based Continental Airlines reiterated this earlier warning by announcing in this Form 8K filing that it is forecasting continued "significant" losses for 2005, but projecting cash flows and reserves are sufficient to carry it through the year so long as employee unions approve management's proposed spending reductions. The company said in this latest filing that it expects ratification of the new labor contracts by the end of March.
Continental's update followed similarly downbeat forecasts issued in recent days by other legacy airlines. Continental expects cash expenditures during the quarter of $200 million, which would allow it to come out of the first quarter with decent unrestricted cash and short-term investments balance of $1.3 billion to $1.4 billion.
Continental also said in the filing that it does not currently have any fuel hedges in place, which is a move that has protected Southwest Airlines from escalating oil prices.
March 15, 2005
Traditionally, the NY Times views high energy prices as a failure of the government to regulate the oil barons properly. Thus, when the Times starts talking about a possible bubble in energy prices, take note.
March 5, 2005
This NY Times article reports on the concern in Houston business circles about Houston-based Citgo Petroleum Corp.'s status as the political football of choice for Hugo Chávez's Venezuelan government, which has controlled Citgo since government-owned Petróleos de Venezuela acquired a controlling interest in the company in 1990.
Basically, Mr. Chávez and his government have promoted popular sentiment in Venezuela against Citgo's links to the United States while, at the same time, taking actions that indicate that the government is going to exercise greater control over the company. Citgo brands its name to over 14,000 independently owned gas stations in the U.S. and generates about 15 percent of the U.S. oil refining output.
About a month ago, Chávez fired Citgo's chief executive Luis Marín and replaced him with Felix Rodríguez, who is a senior executive at Petróleos de Venezuela and a political hack for Mr. Chávez. Then, last week, Petróleos de Venezuela purged the entire Citgo board of directors and replaced them with another group of Mr. Chávez's political supporters.
Although the Times article tends to view the Venezuelan government's control of Citgo as perilous to the U.S. energy market, I'm not buying it. Frankly, it is far more likely that Mr. Chávez and his government will make bad decisions regarding Citgo, which will present opportunities for its competitors.
February 4, 2005
Royal Dutch/Shell Group announced another sharp cut in its energy reserve estimate yesterday even as high energy prices allowed the company to generate a fourth-quarter profit of $4.48 billion. Here is a series of posts over the past year on the reserve estimate mess and related problems that Shell has been confronting.
Shell's announcement highlighted a problem that is facing most of the major exploration and production companies -- i.e., the struggle to find new reserves to replace the oil and gas that the companies are currently producing.
Shell's problems in that area are are worst than most. Yesterday, the company reduced reserves by an additional 1.4 billion barrels of oil equivalent, the fifth such cut over the past year.
This brings the cumulative reserves reduction to about one-third of total company reserves since Shell first disclosed early last year that it had drastically overstated its reserves numbers. Moreover, Shell has not filed its required 2004 year-end reserves numbers with the U.S. Securities and Exchange Commission, so even further reductions are possible. Shell expects the five-year earnings impact of these cuts to total about $700 million, which is about 1% of the company's profit over that period.
Despite that relatively small impact on profits, it is Shell's dismal performance over the past year in replacing energy reserves that is placing the company in a precarious position within the industry. Reserves are the estimated bank of energy reserves that an oil and gas company has in the ground and energy companies typically attempt to replace at least 100% of the reserves they pump annually in order to provide markets with the confidence of future growth potential.
Shell is not even close to that standard. The company announced that it expected its 2004 reserve replacement ratio to be somewhere between 45% to 55%. Moreover, if one includes the effect of divestments and technical adjustments related to year-end oil pricing, the replacement rate plunges to a horrifying 15% to 25%.
Although not as drastic a problem as Shell's, the entire oil and gas industry is having a difficult time replacing its energy reserves. Last week, Houston-based ConocoPhillips announced that it replaced just 60% to 65% of its reserves in 2004 and ChevronTexaco Corp. announced that its replacement rate will also be disappointing.
January 27, 2005
One of the most interesting (and misunderstood) aspects of the energy business is the economics of extracting oil and gas. Those economics not only have much to do with the price that we end up paying for energy, but also the success or failure of investing in a particular exploration project.
In this instructive Wall Street Journal ($) op-ed, Peter Huber and former Reagan administration staffer Mark Mills -- who are authors of the new book, The Bottomless Well: The Twilight of Fuel, the Virtue of Waste, and Why We Will Never Run Out of Energy (Basic 2005) -- make an interesting point about why energy prices tend to gyrate from time to time:
Oil prices gyrate and occasionally spike -- both up and down -- not because oil is scarce, but because it's so abundant in places where good government is scarce. Investing $5 billion dollars over five years to build a new tar-sand refinery in Alberta is indeed risky when a second cousin of Osama bin Laden can knock $20 off the price of oil with an idle wave of his hand on any given day in Riyadh.
By simply opening up its spigots for a few years, Saudi Arabia could, in short order, force a complete write-off of the huge capital investments in Athabasca and Orinoco. Investing billions in tar-sand refineries is risky not because getting oil out of Alberta is especially difficult or expensive, but because getting oil out of Arabia is so easy and cheap.
Moreover, the authors point out that new technology is having a dynamic impact on the cost of extracting oil and gas:
The cost of oil comes down to the cost of finding, and then lifting or extracting. . . But these costs have been falling, not rising, because imaging technology that lets geologists peer through miles of water and rock improves faster than supplies recede. Many lower-grade deposits require no new looking at all.
To pick just one example among many, finding costs are essentially zero for the 3.5 trillion barrels of oil that soak the clay in the Orinoco basin in Venezuela, and the Athabasca tar sands in Alberta, Canada. Yes, that's trillion -- over a century's worth of global supply, at the current 30-billion-barrel-a-year rate of consumption.
January 11, 2005
This previous post from last summer told the story about a bizarre Federal Trade Commission investigation that had been launched into the planned closing of an unprofitable Royal Dutch/Shell Group refinery in California.
Shell had been unable for years to find a sucker, er, I mean, a buyer for the Bakersfield facility. Shell had lost more than $50 million over the past three years on the refinery and was facing between $30 million and $50 million in turnaround and environmental costs on the old facility. However, given that the closure would crimp gasoline supplies further in California -- where supplies are already tight and prices the highest in the nation -- both the federal government and the California state government pressured Shell to find a buyer rather than close the facility. Not surprisingly, buyers were not exactly lining up to bid on an obsolescent refinery, so last month the federal government agreed to let Shell exceed pollution standards in operating the facility in return for Shell keeping it open for another three months to find a buyer.
Well, Shell announced yesterday that it had finally found a buyer for the facility -- Flying J Inc., a closely held Utah-based oil company that specializes in distributing diesal fuel to truckers. The purchase price was not announced publicly, but is estimated to be around $130 million by sources close to the deal.
So, let's take stock here. Shell lost $50-$75 million to sell an asset for $130 million -- not bad, but not the type of risk that Shell normally indulges to make a return on its investments. Rather than adopting policies necessary to induce major companies such as Shell to invest the capital necessary to build new refineries that would address the tight supplies in the Western part of the United States, the federal government and State of California took legal actions and then even compromised their sacrosanct environmental standards to prod Shell to sell an obsolescent facility to a tire kicker. Flying J is a good little company who will continue to operate the refinery, but it does not have the capital necessary to turnaround the declining production at the facility or build new refineries that are really needed to increase gasoline supplies. In the meantime, average gasoline prices in California have risen almost 27 cents a gallon to $1.93 from last year when the feds and the State of California started strong-arming Shell over its plans to sell the refinery.
My sense is that the postscript on this story is that the federal government and State of California's actions in this matter have, in the long run, made California's chronic gasoline supply problems worse. So it usually goes with governmental intervention into problems that markets should be resolving.
November 29, 2004
This earlier post reported on an interview of Matt Simmons, the Houston-based investment banker who is an expert on forecasting oil supplies. Following that interview, this Barron's interview of Mr. Simmons warns that the Saudi oil supplies are not what they appear to be and that, because the Saudi oil industry is state-run, there is no independent auditor of national reserves who can verify just how large -- or small -- the Saudis' reserves are. As Mr. Simmons notes, that makes a big difference for the following reasons:
With global demand for oil on the rise, and prices hovering near $50 a barrel, the Saudis' production profile is more than academic. The No. 1 oil producer, Saudi Arabia pumps 13% of the world's oil and boasts 23% of its oil reserves. Moreover, the Saudis alone claim to have excess production capacity and the ability to increase output if demand continues to rise.
If the Saudis' numbers are correct, the kingdom could continue to produce at current levels of about 10 billion barrels a day for the next 50 years, or more. That would give the industrial world time to develop alternative energy sources and prepare for a graceful transition.
If Simmons is right, however, the world could face a dangerous imbalance between rising oil demand and diminishing supply, perhaps within the next 10 years. Oil prices could soar, economies could suffer, and oil-dependent nations, such as the U.S., China and Japan, would be forced to scramble for additional energy sources.
Matt Simmons' opinions are not to be taken lightly. Read the entire article.
October 21, 2004
Vaclav Smil is Distinguished Professor of Geography at the University of Manitoba, Canada, and is the author of many books on energy and the environment. In this Tech Central Station op-ed, he reminds us of something that the mainstream media generally fails to report regarding the recent run up in the price of oil:
The years of the highest oil prices were 1980 and 1981 (thanks to Ayatollah Khomeini and fall of the Pahlavi dynasty in Iran) when the Arabian Light/Dubai crude traded at nearly $36/bbl and when the West Texas Intermediate went for almost $38. In 2004 monies this is, rounded for easy memorization, between $ 70-75. The peak of the last few days -- $ 55/bbl -- is obviously well above what will be the annual mean for the year 2004 and it is no more than 73-78% of the record averages. But this is a wholly inadequate adjustment. Between 1980 and 2003 the amount of oil that the US economy used to generate an average dollar of its GDP fell by 43% as its oil intensity declined somewhat faster than the overall relative energy use.
And so in order to get an approximate but realistic comparison of how much today's prices impact an average manufacturer or average household purchases, we should multiply the current high price of $55/bbl by 0.57 to get an effective comparable price of around $30, or no more than 40% of the average record price we paid in 1980. Moreover, between 1980 and 2003 average hourly earnings in services, where most new jobs were created, rose by about 30% and so another adjustment taking into account this higher earning power reduces the comparable price to just over $20. Other, more sophisticated adjustments, are possible but this one is easy to execute and easy to remember: the effective -- that is inflation-, oil/$GDP- and earning power-adjusted -- cost of oil at $(2004)53-55 is no more than about 30% of the average record price we paid in 1980 and 1981. That is why recent "record" oil prices have not had any substantial effect on the way this continent uses, and wastes, the most convenient of all fossil fuels.
October 2, 2004
Houston-based ConocoPhillips announced earlier this week a $2.36 billion "strategic alliance" with Moscow-based OAO Lukoil under which Conoco will buy a 7.6% stake in the Russian oil company and get a share in joint projects. The deal provides Conoco access to Russia's enormous but largely undeveloped oil and natural-gas reserves and opens a possible avenue for it to become the first Western petroleum producer to return to Iraq.
For energy producers looking to increase reserves, Russia represents one of the few places in the world where large reserves are available to private investors.The agreement will contribute to Conoco's proved reserves and production, which are closely watched market measures of an oil and gas company's prospects.
The move catapults Conoco ahead of most of the other major oil companies, which have have been largely unsuccessful in seeking a Russian partner. The deal also reflects the strong interest in Russia from foreign investors despite increasing concern over a recent Kremlin clampdown on political life and control over the energy industry. To ensure Conoco's minority stake is protected, Lukoil agreed to give the company one seat on the 11-member board and change its corporate charter to require unanimous board approval of top corporate decisions.
Conoco plans to raise its stake to 10% by year end and to 20% within two to three years, which would cost about $3 billion at current prices. As Conoco's stake rises, it would gain another board seat. This corporate governance arrangement addresses a problem that has tubed earlier Western investments in Russian oil and gas companies. For example, BP PLC sold its 7% ownership in Lukoil in 2001 because the stake was too small to have an effective voice in company decisions.
Although Lukoil was overshadowed in recent years by faster-growing Russian competitors such as Yukos, Lukoil is run by Russian oil and gas veterans, and its management maintains extraordinarily close ties with the Kremlin. That political stroke has come in handy lately since Yukos and its founder Mikhail Khodorkovsky ran into trouble with the Kremlin and Russian President Vladimir Putin last year, as related in these earlier posts. Those troubles scuttled Yukos' negotiations with Exxon Mobil Corp. over a large investment in the Russian company.
The deal also gives Conoco an interest in Iraq's vast oil fields. A part of the deal gives Conoco a 17.5% interest in a 1997 contract granted to a Lukoil-led group to develop Iraq's West Qurna oil field, which is a major prospect with estimated reserves of 15 billion barrels. Although the contract was canceled just before the U.S.-led invasion in March 2003, all such Saddam Hussein-era contracts are currently being reviewed by Iraqi oil and gas officials.
Meanwhile, the stampede to gain a foothold in the Russian oil and gas market continued on other fronts this week as Royal Dutch/Shell Group executives met with Russian oil and gas officials in The Hague. Shell has recently expressed interest in a joint venture with OAO Gazprom, the big Russian natural-gas company. Those discussions have become more serious since Gazprom's announced merger with Russian oil company OAO Rosneft, which will transform the company into a huge state-controlled oil and gas company.
Stephen Kotkin, a Princeton history professor who specializes in the business politics of Russia, analogizes doing business in Russia right now to a rugby scrum with market reformers, hard-line security advisers and members of Mr. Putin's inner circle all wrestling for the upper hand in policy making. If market reforms are allowed to gain traction, then the rule of law will become established and likely supersede Russia's notorious security apparatus. However, I remain skeptical that such reforms will take place so long as Mr. Putin remains in power.
September 7, 2004
Matthew Simmons is the chief executive officer of Simmons & Co. International, which is a Houston-based investment bank that specializes in investment in oilfield service and related companies. Mr. Simmons is one of Houston's most knowledgeable experts on the oil and gas industry, and in this Chronicle interview, challenges the conventional wisdom that the recent spike in oil and gas prices is temporary:
Q: What do the fundamentals [of oil production and consumption] look like? Are supply and demand out of whack?
A: The fundamentals, to me, look scarier than hell. Demand ... is having the smell of a runaway train, downhill on a one-way track. The consensus forecast for 2004 fourth-quarter demand is 83.6 million barrels a day, an increase of over 2 million from where we are this summer. And if you look at the consensus for the fourth quarter of 2005, demand is 85.6 million barrels a day, another 2 million increase from the fourth quarter.
Q: What about supplies?
A: There are very few companies that are showing any ability to grow their global oil supplies by more than 1 or 2 percent a year. If you take all the announced projects of any significance, and if they all come on and peak in the first year, they account for ? at best ? 6 to 8 million a day of fresh supply by 2009. And we just talked about needing 4 of that over the next 14 months.
The missing piece of data in this tight equation is the rate of decline of the existing base. Over 70 percent of the current output is coming from fields that were discovered, at their most recent, 30 years ago. If the global decline rate is only 3 percent per annum, then we lose 11 million barrels by 2009 and add 6 to 8. I don't see how we balance this market, unless we have a stunning depression.
And Mr. Simmons has always been skeptical about Saudi Arabia's claims that it owns a quarter of the world's reserves and can simply increase production to meet rising world demand:
Q: Most analysts accept Saudi Arabia's claims that it holds about a quarter of the world's oil reserves. You have challenged the Saudis over their reserve estimates?
A: The grim fact about Saudi Arabia today is that, at the Saudis' own admission, the Ghawar Field, the king of all kings, is still producing about 5 million of their 8 to 9 million barrels a day of oil. That's all you need to know to be scared.
Here is a more extensive interview with Mr. Simmons. These are well-supported views of a formidable expert in the oil and gas industry. Take note.
Meanwhile, this Wall Street Journal ($) article reports that the prominent energy-stock analysts John S. Herold Inc. has issued a report contending that Exxon Mobil is overvalued when compared with a group of smaller energy companies that collectively mirrors the capitalization of the energy giant. The Herold report lumped the group of smaller energy companies into a single theoretical stock called "Synthetic Exxon Mobil," or "SXOM." Designed to resemble Exxon Mobil both in market capitalization and operational scope, SXOM includes six companies that, during the past three years, would have have generated a 31% return on investment. In comparison, an investment in Exxon Mobil would have yielded just 12%. The report tends to support the notion that the recent spike in energy prices is making the less-expensive stocks of more-aggressive energy companies look better than the more established giants.
August 20, 2004
This Wall Street Journal ($) article provides a timely overview of the economic and political forces that have caused the increased energy prices over the past two years and how this price hike differs from previous ones:
As oil prices near $50 a barrel, a fundamental difference between this oil crunch and prior ones is becoming clear: This one is less acute, but it may prove to be more chronic.
So far, the current oil-price surge still trails the big blows of the past. In inflation-adjusted dollars, oil peaked in 1981 at $73 a barrel, 55% above where it's trading now. Back then, moreover, the oil crisis sparked a full-blown recession. Today, despite some signs of a slowing, the economy continues to grow -- and, with it, oil demand.
However, it's that knotty problem of growth that continues to push prices upward:
It's precisely the steadily rising demand, however, that is worrying the market. Unlike in the 1970s, the problem this time isn't primarily a supply shock in which the world's biggest oil spigots have been shut off. It's that, even though they're wide open, the world is consuming pretty much everything that comes out of the ground. The resulting fear is that isolated supply disruptions -- a change in government in Venezuela, say, or a terrorist attack in the Middle East -- could push prices even higher.
And although U.S. energy prices remain relatively high, there are contrarians as to the current prices:
Still, [U.S.] commercial inventories of crude oil are 5% above last year's level, and gasoline stocks are up 4.5%.
Some observers see the U.S. inventory levels as evidence that there's plenty of oil to meet growing demand and that today's oil price is largely the result of excessive speculation. Trading volume has soared in recent months as hedge funds and other fast-moving traders have headed into the oil markets. "I don't think the fundamentals support prices anywhere close to this level," says Kyle Cooper, an oil analyst at Citigroup in Houston. He believes prices should be closer to $30.
But futures markets are still betting on continued high prices:
The market isn't betting on a quick fix. In a big change from past experience, this time it isn't just the price of today's oil that's surging. Futures contracts through May 2006 delivery are above $40. The contracted price of oil to be delivered six years down the road is also rising. After years in which they hovered between $20 and $25, these so-called six-year futures now are trading around $35.
And although the market takes time to adjust to higher energy prices, it does eventually work, as reflected in its reaction to the energy price hike of the 1970's:
Improving energy efficiency takes a long time. But it can be done, says a longtime advocate, Amory Lovins, chief executive of the Colorado-based Rocky Mountain Institute. He says that between 1977 and 1985, real GDP in the U.S. grew by 27% while oil use fell by 17%.
By his calculation, if the U.S. kept reducing oil use at that pace, every year and a half the U.S. would decrease its daily oil consumption by some 2.5 million barrels, about the amount it currently imports from the Gulf. "It's a measure of how much we did the last time we paid attention," Mr. Lovins says.
Also, for more analysis on how this energy price hike relative to past ones, review this earlier post on the work of James D. Hamilton, an economics professor from San Diego who specializes in analysis of energy markets.
July 14, 2004
This NY Times article reports that the recent uptick in oil and gas prices has not translated into an economic boom for the local Houston economy. The article does a reasonably good job of explaining that Houston's economy is less dependent on the oil and gas industry that in prior eras, and thus less prone to the boom and bust cycles that resulted from past run-ups in energy prices. Accordingly, while Houston's economy used to be largely countercyclical to the national economy (i.e., Houston would do well during times of high energy prices that would drive the national economy down), Houston's more diversified economy now tends to be more in step with the national economy.
Curiously, the Times reporter neglected to interview the foremost authority on the Houston economy, Dr. Barton Smith, University of Houston professor of economics and director of the UH Institute for Regional Forecasting. Twice a year or so, Dr. Smith gives an oral presentation over lunch to Houston businesspeople regarding the state of the Houston economy and his predictions for the economy's future. These meetings provide valuable nuts and bolts information and analysis regarding Houston's economy, and are extremely popular among Houston businesspeople. Not mentioned in the Times article is that Dr. Smith's model of the Houston economy currently predicts an annualized rate of job growth of 2.6 % that, if sustained for the next six months, would translate into about 50,000 jobs. That would be the best job growth rate in Houston since 2000.
July 8, 2004
In what can only be described as bizarre governmental intervention, this Wall Street Journal ($) article describes a politically-motivated Federal Trade Commission investigation that has been launched into the planned closing of an unprofitable Royal Dutch/Shell Group refinery in California and the FTC's reinstatement of an antitrust complaint against Unocal Corp.
Shell announced plans last year to close its Bakersfield, California refinery Oct. 1 because a nearby oil field will run out of crude in coming decades and because the refinery is too expensive to repair and profitably operate. Given that relatively few refineries in the United States produce the type of environmentally-favored gasoline that California requires, the closure will likely crimp gasoline supply further in the West, where supplies are already tight and prices the highest in the nation. The small refinery handles 70,000 barrels of oil a day, providing 20,000 barrels of gasoline that amounts to 2 percent of California's needs. It provides a larger percentage of diesel fuel, 15,000 barrels a day, which is the equivalent of 6 percent.
Shell lost more than $50 million over the past three years on the Bakersfield refinery and is facing between $30 million and $50 million in turnaround and environmental costs on the facility, which is old (the original portion of the facility was built in 1932).
So, let's see here. Rather than encouraging companies to invest and build new refineries that would address the economic problem of tight supplies in the Western part of the United States, our federal government is taking expensive legal actions against one of the relatively few companies in the refining business to minimize its losses in the business. My sense is that forcing companies to operate refineries at a loss is not a sound policy for addressing the problem of tight gasoline supplies in the West.
Separately, the FTC overruled an administrative-law judge and reinstated an antitrust complaint against Unocal for pursuing patents for a special low-emissions gasoline at the same time that the company was helping California regulators mandate that gasoline as a state standard. The complaint originally was filed in March 2003, but was overruled by the judge in November.
June 4, 2004
James D. Hamilton is an economics professor at Cal-San Diego who specializes in the economics of energy. In this excellent piece, Professor Sullivan summarizes the recent spike in energy prices and compares it to similar spikes of the past. The entire short piece is worth reading, and here is a tidbit to pique your interest:
The current behavior of oil prices is unlike the spike that preceded earlier recessions in two key respects. First, oil prices have gone up not because of a shortfall of supply but rather because of an increase in demand. The world is producing 3 million more barrels of oil each day relative to last year, nearly a 4% increase. But demand is up even more dramatically. . .
This is quite a different situation from other historical oil shocks that were caused by military conflicts that physically disrupted the production or delivery of petroleum, forcing consumers and firms to make less use of this vital input. The current situation is simply that we have to share the increased supply with other consuming nations. There should be no quarrel with the proposition that a booming world economy overall is good economic news, not bad.
The second way that the current oil price spike differs from those that preceded earlier U.S. recessions is that a good part of the recent increase is merely a correction to an earlier dramatic drop in oil prices. The current oil price of $41 a barrel is 45% higher than the $28 price we saw last September. However, it is important to remember that before those September lows, oil had been selling for $36 back in February of 2003, so that the current price is only 15% above what we saw just a little over a year ago. There were similar corrections (an oil price spike following an earlier downturn) in 1987 and 1994 with no apparently adverse economic effects.
For more a detailed analysis of price spikes in energy markets, review Professor Hamilton's paper "What is an Oil Shock" that he published originally in 1999 and updated in 2001.
Hat tip to Professor Sauer for the link to Professor Hamilton's work.
June 2, 2004
This Wall Street Journal ($) Holman Jenkins, Jr. piece lays the wood to John Kerry's "energy independence" blather that he has been using recently in various campaign speeches and working papers. The entire column is a brilliant expose of the demagogury that commonly revolves around the issue of energy policy and the alleged need for "energy independence" from Mideast, and here are a few choice tidbits:
[Kerry] puts himself in excellent company here, since the same shibboleth has been paid lip service by every president since Nixon. It's also a favorite of prominent newspaper columnists who, throwing up their hands about the Middle East and finding Americans more tractable targets for castigation, cite the urgent need for a "Manhattan Project on energy." The idea never fails to elicit applause from audiences of ordinary voters and focus groups too, in about the same way that Mom, apple pie and stopping foreigners from "stealing our jobs" are reliable applause lines.
That is to say, as a goal, energy independence is neither desirable nor practical and, were it otherwise, would still not solve any real problem. But it provides a useful service as a vehicle of escapism and an emblem of personal virtue.
In fact, Mr. Jenkins postulates that Kerry's plan to reduce dependence on Mideast oil would likely have unexpected consequences:
Oil is oil: We'd still be bound by prices in the international marketplace with all their unsettling volatility. Mr. Kerry proposes nothing more than a symbolic slap at the Arabs, his target accounting for less than 10% of total consumption. In fact, were his plan to have any effect at all, the U.S. would likely become more dependent on imports as high-cost U.S. producers were squeezed out; and more dependent on Mideast oil, as high-cost foreign producers were squeezed out.
Then Mr. Jenkins deals with several of the unspoken assumptions that underlie the escapist fallacy of energy dependence on Mideast oil:
We'd be able to wash our hands of military and security entanglements in the Mideast. No, we wouldn't. Oil would remain a commodity in global markets, so we'd still be exposed to the international price of oil, including all gyrations caused by Mideast politics. Even in the improbable and bizarre circumstance that the U.S. swore off oil consumption altogether, we'd still have to live in this world. Notice that we invest heavily in the security of Japan, South Korea, Israel and Western Europe, though none has oil.
Our dependence makes us beholden to Arab oil states. This is similar to the argument put to President Truman by the State Department when it vehemently opposed his recognition of Israel. Yet it's hard to imagine how we could make ourselves more irritating to Arab states than by supporting Israel, which we've done for 50 years. Somehow we still manage to keep buying all the oil we want.
We'd be freer to press for democracy and human rights in the Mideast. Huh? The U.S. is going to engage in campaigns of destabilization against unattractive regimes in which we no longer have an interest? On the contrary, their co-optation by petrodollars and consequent integration in the world economy is the main inducement to the Arab oil states to eschew antisocial behavior.
The Saudis spend our oil money on religious schools preaching hate against the West. The Saudis would continue to receive billions for their oil even if the U.S. weren't buying. In any case, their support for radical Islamists has nothing to do with oil and everything to do with the Saudi regime's domestic insecurities. We can't fix this problem with energy policy; let's hope we're not so feckless as to evade the real fight against terrorism in favor of a fantasy that all will be well if Congress is allowed to spend billions on a pork-barrel scheme to wean industrial society off hydrocarbons.
Mr. Jenkins concludes by noting that the problem of high energy prices is a different problem than reliance on Mideast oil:
None of the above means we don't have a real, workaday concern for "energy security -- more accurately stated as a concern about price, price, price, and even more importantly, volatility of price.
But this problem is steadily fixing itself as oil consumption becomes a smaller part of total consumption, leaving the economy better able to withstand price gyrations. Per unit of economic output, we burn 55% fewer petroleum Btus than we did 30 years ago. As is the case with most historical dilemmas, we will overcome our reliance on Mideast oil by surviving long enough for history to give the U.S. new and different problems.
As readers of this blog have heard before, your demagouge antenna should go up every time you hear a politician advocate a policy that means that we should pay more for a product such as oil.
May 25, 2004
Blogging time is restricted for a couple of days, but Arnold Kling's TCS piece on the Strategic Petroleum Reserve is quite good, as is his blog's follow up piece. Arnold sums up his theory regarding the SPR as follows:
It should be the responsibility of the private sector, not the government, to obtain insurance against oil market disruptions. The SPR has introduced government into the oil market as a destabilizing speculator.
Arnold also provides an excellent explanation of the concept of backwardation in regard to the price of oil.
May 24, 2004
Following on this Professor Ribstein post and this reply post here over the weekend regarding most airlines' failure to hedge fuel costs, this NY Times article reports that the hedging of fuel costs also varies widely in other fuel intensive businesses. One reason is that the practice is risky:
In a vexing illustration of the risks associated with hedging, though, not every company has been so fortunate.
For instance, the PanOcean Energy Corporation, which produces oil in West Africa, lost $1.4 million in the most recent quarter by essentially agreeing to sell oil for about $30 a barrel when the price of oil climbed much higher - just below $40 a barrel last Friday. PanOcean made the bet as part of a loan agreement with its bank.
"It's a crap-shoot, isn't it?" said David Lyons, chief executive of PanOcean, no stranger to risk after developing a natural gas field in Tanzania in East Africa to complement operations in Gabon. "Personally I feel hedging activities are overdone, but it's something our financial agreements require us to do."
Many companies find it less risky (albeit more incompetent) simply to avoid hedging and pass along the increased fuel costs to their companies:
Many choose instead to raise costs for their customers, contributing to concerns about rising inflation.
One company opting for a fuel surcharge instead of hedges is Waste Management, the Houston-based garbage collection company with a fleet of 20,000 trucks around the nation. Heather Browne, a spokeswoman for Waste Management, said fuel costs still remain a relatively small amount of the company's revenue, about 3 percent of $11.5 billion.
Nevertheless, hedging fuel costs is increasingly important for fuel dependent companies that serve a limited geographical area:
For companies with a more limited geographic reach and more dependent on the fuels that are becoming a bonanza in the oil patch, hedging is increasingly considered a necessity. Southwest Airlines exemplifies this trend, with 80 percent of its fuel needs hedged for this year and 2005, and 30 percent for 2006 at prices below $30 a barrel.
Alaska Air, which operates Alaska Airlines and Horizon Air, is also among the few that hedged a large share of its fuel consumption, about 40 percent this year and next, at prices from $25 to $27 a barrel. But even that was not sufficient, the company acknowledges.
"We're not at the Southwest level," Bradley D. Tilden, Alaska's chief financial officer, said in an interview. With the company consuming about 400 million gallons of jet fuel a year, each penny increase in the price of the fuel costs the company $4 million a year, he said. Jet fuel prices have climbed to $1.17 a gallon from 76 cents a gallon this time last year.
Nevertheless, many major airlines remain slow to hedge:
Other airlines are struggling with the prospect of large losses after hedging fuel needs at relatively high prices, like Continental Airlines, which secured 80 percent of it fuel consumption at $40 a barrel this quarter and 45 percent at $36.40 a barrel for the third quarter.
Delta Air Lines and Northwest Airlines did not hedge at all this year and American Airlines, the nation's largest carrier and a unit of the AMR Corporation, hedged less than 10 percent of its fuel needs for the second half of the year, according to a report by Lehman Brothers. Prying information from companies that placed erroneous bets on the price of fuel is sometimes akin to pulling teeth.
Finally, the NY Times piece observes correctly that the risk of hedging is not a reason to avoid it:
"People get their feelings hurt when they hedge poorly," said J. C. Whorton, executive vice president of StratCom Advisors, a company that provides risk-management services. "But it's most often the case that those companies that fail to hedge at all have done a very poor job."
My prior post noted Warren Buffett's distaste for investment in the airline industry because of its traditional lack of profitability. Could it be that the airline industry is simply an example of Mr. Buffett's following observation about troubled businesses?:
"When a manager with a great reputation takes on a company with a poor one, it is the company's reputation that survives."
May 21, 2004
This NY Times article provides a good analysis of the the difficulty that Russia's largest oil and gas companies are having in translating their huge reserves into stature among the world's major oil and gas companies in the marketplace for investors. The article starts by noting the huge potential in the Russian oil and gas business:
By rights, Russia should have a world-class energy company. It has 6 percent of the world's oil reserves and pumps 10 percent of daily global production, rivaling Saudi Arabia. And its economy has rebounded as oil-consuming nations east and west turn increasingly to Russia for energy supplies.
However, that potential has not yet translated into success. The article uses the example of Lukoil, one of the two Russian majors:
But the very things that make Lukoil work in Russia are holding it back in the rest of the world, analysts and industry experts say: Lukoil remains a very Russian company, with all that has come to imply, from its complex structure and opaque finances to its inefficiency and dependence on the good will of the Kremlin.
In short, the lack of business management development under the old Soviet Union's economy continues to bedevil Lukoil in comparison to other major oil and gas companies:
Though publicly traded as a single entity, Lukoil is structured more like a decentralized web of fiefs, and some investors say it is often unclear how profits flow to the center of the group or whether its published accounts fully capture what is going on.
"Some of the units within Lukoil, like Permneft, are, in management terms, very autonomous," said Ian Hague, co-manager of Firebird, a hedge fund specializing in Russian investments. "The amount of oil they're producing, as compared to net income, seems to show that large sums - hundreds of millions of dollars - are going places not clear to investors."
"Investors don't like things that are difficult to explain," Mr. Hague said. "If Lukoil is running an expensive ship, meaning more of their money goes to administrative costs than others, investors view that as a problem."
Stocks of American majors like Exxon Mobil and ChevronTexaco are now trading at price-to-earnings multiples in the mid-teens, based on estimated earnings over the next year. But Lukoil's multiple is just 7.9, in the middle of the Russian oil pack.
Now a decade and a half after the fall of the Soviet Union, is it fair to ask whether Lukoil and Yukos (the other Russian oil and gas major) will be able to achieve stature equal to the world's oil and gas majors in the marketplace for investors without the importation of Western oil and gas management expertise?
May 20, 2004
Don't miss Arnold Kling's analysis over at EconLog regarding the phenomenom known as backwardation energy prices. Arnold explains backwardation by using the example of current and future prices of oil:
As of May 20th, the June 2004 futures contract for light crude oil was at $41.66, while the June 2005 futures contract was at $35.58. When futures prices are below spot prices, this is known as "backwardation." I believe that it represents a puzzle. Think of it this way. If you have oil, by holding onto it for a year, you are losing 15 percent. That seems kinda dumb.
Arnold goes on to explain that the various theories on why backwardation occurs all seem to be somewhat flawed, but then makes this observation and asks this very salient question:
Speculators buy low and sell high. The American and Saudi governments do the reverse. Which is the stabilizing force in the oil market?
May 19, 2004
This NY Times article reports on Houston-based Continental Airlines' plan to respond to the recent spike in fuel prices that are straining profits of all airlines. Fuel is the second-biggest expense for airlines, after labor costs, and typically totals about 10% of operating costs.
Continental raised fares across the board late yesterday and said it will have to consider furloughs and wage cuts if jet-fuel prices do not decline from their current record levels. Continental raised ticket prices $10 each way for flights of as much as 1,000 miles, and $20 each way for longer trips. However, under heavy pressure from discount airlines, major carriers such as Continental have seen previous attempts to boost ticket prices fail when competitors decline to match. Even if this current increase sticks, Continental said it would offset only 15% of its higher fuel tab.
At current prices for oil, Continental faces an additional $700 million in annual operating expense over what it originally had planned for 2004. As a result, Continental CEO Gordon Bethune said he expects Continental to suffer a significant loss for 2004.
During a political season, you will not hear much about the benefits of higher oil prices. But this Wall Street Journal's ($) Holman W. Jenkins, Jr. Business World column dissects the issue and concludes that increased oil prices are not all bad. First, Mr. Jenkins addresses the current price spike and the reasons behind it:
The futures market puts oil for delivery next summer at $35, well under today's $41. Seers are not hard pressed to explain why. On April 24, three small boats operated by suicide commandos hit Iraq's southern oil terminal and a few days later kamikaze gunmen shot up a Saudi petrochemical plant. Osama bin Laden has a plan: Get control of Saudi Arabia through subversion and put himself in charge of its oil, foundation of a new Islamic empire. That is, Saudi survival can't be taken for granted.
Traders say five to ten bucks of today's price is due to terrorism fears. Notice also that the biggest speculator out there is the U.S. government, which has been frantically topping off the Strategic Petroleum Reserve ever since November 2001, yelps from private energy buyers notwithstanding.
Then, Mr. Jenkins focuses on the real issue, which is not a shortage of oil:
Note that the issue is not whether the world is running out of oil. The debate concerns a theoretical milestone called Hubbert's peak, after which output from any given field slows and becomes more costly to produce long before the last drop is lifted. Half of Saudi Arabia's oil comes from the giant and venerable Ghawar field; much of the remainder comes from four other aging giants that may be at or near their Hubbert's peak. . .
How much oil is left is far less significant than how quickly and cheaply it can be extracted, especially from a relative handful of large, cheap-to-produce fields that have carried industrial man for a century. Some believe that getting much above today's 80 million barrels a day would be horrendously costly if not impossible. If they're correct, two billion Chinese and Indians, right now beginning to trade their bicycles for Toyotas, would be stuck trying to achieve modernity by outbidding the rest of us for a share of the world's current rate of oil production rather than benefiting from additional output.
All this has some petroleum engineers predicting resource wars, famine and pestilence, preventable only by a massive effort of central planning to shift the world to a less hydrocarbon-intensive lifestyle. If so, we might as well pass around the cyanide caplets right now. Such global planning is certainly beyond the wisdom and power of politicians to manage.
Which brings Mr. Jenkins to his central theme -- i.e., the benefits of higher oil prices:
Yet the unwillingness of doomsayers to credit price signals with eliciting changed consumption behavior, new technology, a thousand substitutions and other adaptive responses is more than a little peculiar here. Oil companies have held back from investing in deep-water searches, Canadian oil sands and Venezuelan bitumen for fear oil prices will plummet to $15. Shareholders have kept Big Oil on a short leash, tolerating only low-risk investment projects that will generate cash flow in a small number of years. Won't this change now if higher prices seem a permanent feature of the landscape?
Motorists might or might not be willing to swallow price hikes, but what about other industries that use petroleum as feedstock? They're price sensitive and would be expected to adapt in ways that aren't all easy to foresee from today's vantage.
Scare talk is a hardy perennial in the global petroleum business, a passport to fun and attention from the media. Industrial society is frequently painted as a fragile, vulnerable machine, yet all the evidence suggests the opposite: It's a machine that has grown more resilient and adaptable the more complex and interdependent the world becomes. In short, as long as the price mechanism is allowed to work, mankind seems likely to muddle through. Hallelujah, then, for higher oil prices.
On a related note, although not quite as insightful as Mr. Jenkins' piece, this NY Times editorial strikes the correct theme that short term spikes in energy prices is not a cause for overreaction.
May 18, 2004
Almost on cue, this NY Times article reports on Congressional Democrats calling for the Bush Administration to use the Strategic Oil Reserve to increase supplies of oil in the economy to ease the recent spike in energy prices. On a more thoughtful note, Arthur Kling over at EconLog points us to a Allan Sloan's better analysis in this Washington Post article:
[T]he $41.55 price for oil today is much higher than the $35.50 it costs for a barrel to be delivered next year. This disparity inspired Loews chief executive Jim Tisch, whose company has extensive energy holdings and plays financial markets like a violin, to propose a trade. Let's sell oil out of the reserve, he says -- not for money, but for oil to be delivered next year. We could get seven barrels next year for six today. We're now buying 160,000 barrels a day for the reserve, which has 660 million barrels. But by trading rather than buying, we'd save taxpayer dollars, reduce the demand that's driving up prices today, and spook the speculators. I love it.
Meanwhile, this WaPo article indicates that the amount of oil going into the reserve amounts to less than two-tenths of 1 percent of the world supply, which is too small to have any more than a two to five cent price per gallon effect if the government's current "buy" policy were changed.
May 13, 2004
In the wake of this news regarding oil prices, Morris A. Adelman is a professor emeritus of economics at Massachutsetts Institute of Techonology and long has been one of America's leading energy economists. In this article, Professor Adelman eviscerates the myth that humanity?s need for oil cannot be met and that a gap will soon emerge between demand and supply. The entire article is a must read during the current season of political demagoguery, and here are a few snippets to pique your interest:
There is not, and never has been, an oil crisis or gap. Oil reserves are not dwindling. The Middle East does not have and has never had any ?oil weapon.? How fast Russian oil output grows is of minor but real interest. How much goes to the United States or Europe or Japan ? or anywhere else, for that matter ? is of no interest because it has no effect on prices we pay nor on the security of supply.
The doomsday predictions have all proved false. In 2003, world oil production was 4,400 times greater than it was in Newberry?s day [Newberry, a geologist, predicted in 1875 that the world was running out of oil], but the price per unit was probably lower. Oil reserves and production even outside the Middle East are greater today than they were when Akins claimed the wolf was here. World output of oil is up a quarter since [Jimmy] Carter?s ?drying up? pronouncement, but Middle East exports peaked in 1976?77. Despite all those facts, the predictions of doom keep on coming.
If the cost of finding and developing new reserves were increasing, the value per barrel of already-developed reserves would rise with it. Over the period 1982?2002, we found no sign of that. Think of it this way: Anyone could make a bet on rising inground values ? borrow money to buy and hold a barrel of oil for later sale. With ultimate reserves decreasing every year, the value of oil still in the ground should grow yearly. The investor?s gain on holding the oil should be at least enough to offset the borrowing cost plus risk. In fact, we find that holding the oil would draw a negative return even before allowing for risk. To sum up: There is no indication that non-opec oil is getting more expensive to find and develop. Statements about nonopec nations? ?dwindling reserves? are meaningless or wrong.
U.S. oil policies are based on fantasies not facts: gaps, shortages, and surpluses. Those ideas are at the core of the Carter legislation, and of the current Energy Bill. The Carter White House also believed what the current Bush White House believes ? that, in the face of all evidence, they are getting binding assurance of supply by opec, or by Saudi Arabia. That myth is part of the larger myth that the world is running out of oil.
Professor Adelman's piece dovetails nicely with this Fred Singer article on the ill-conceived Nixon and Carter Administrations' energy-related policies that were implemented in response to perceived shortages of oil.
Hat tip to Professor Kling over a EconLog for the link to Professor Adelman's timely article.
April 10, 2004
As noted earlier here, Houston-based Reliant Resources and four individuals are facing a criminal prosecution in San Francisco in connection with the shutting down of California power plants in 2000 allegedly to increase the price of electricity in that state.
William Anderson over at the Mises Economic Blog has posted this cogent analysis that persuasively contends that the indictment makes no sense from an economic standpoint and can only be explained in political terms. The entire post is well worth reading, and here are a couple of Mr. Anderson's points:
The California electricity fiasco has been well-documented in the press, and on this page as well. Economists like George Reisman have destroyed the many myths that sprang up while the state was suffering through rolling blackouts and extremely high wholesale rates. However, as is usually the case when energy issues come to the fore, in the end the political classes always lay all the blame upon energy producers. (This is logical, as the only other alternative would be for politicians to blame themselves, which is an impossibility in this politicized age.)
* * *
[A]t the risk of being a voice in the wilderness, let me say that the only fraudulent thing here is the indictment itself. As one who has devoted much of his time to the study of federal crimes, I can say that once again we have a case in which government prosecutors have built a series of ?crimes? around an activity that was perfectly legal. Furthermore, the indictment not only alleges criminal behavior where there was none, but also goes one step further: it attempts to repeal the laws of economics. (In other words, if Ashcroft is correct here, then perhaps one can expect federal goon squads to conduct raids on economics professors whenever they attempt to explain laws of supply and demand.)
Mr. Anderson then addresses the fundamental economic illogic of the theory of the government's case:
There is another problem, one that the government has conveniently ignored. If a reduction in supply of a good, ceteris paribus, leads to price increases, then the addition of supply must lead to price decreases. In other words, if Reliant?s alleged actions first led to price increases, then when Reliant?s plants came back on line ? and other producers rushed into the market to take advantage of the price increases by providing more electricity ? the prices would then fall.
Unless there were government interference in the market for electricity, withholding electricity in order for a company to enjoy higher prices would be a self-defeating strategy. As noted previously, not only would the addition of later supplies drive down the price, the higher prices would entice companies selling electricity elsewhere to divert their supplies to California, thus placing more electricity for sale than had been their previously.
Second, since shutdowns and startups are costly activities, companies like Reliant that would use such strategies would likely be making themselves worse off in the long run. That is because the gains from higher prices would be short-lived at best, and when one factors in the startup and shutdown costs, then the company would ultimately earn a lower net income than it would have received had it kept the plant on line.
Now, I am not saying anything that would be particularly profound, at least to an economist or someone in the electricity business. Furthermore, the article does not say if the ?scheme? even worked. Yes, it does say that prices rose, but it does not say that later they came back down. In other words, if Reliant had the ?power? to ?manipulate? the market, as the DOJ indictment alleges, then why did electricity prices eventually fall, as was the case in California, and prices were falling even before the government stepped in with unwise price controls over the western power grids.
Mr. Anderson then sums up with laser-like precision:
The California electricity crisis provided the opportunities for people to learn about the dangers of price controls. Instead, we have learned yet another lesson about the political classes and how they will ?manipulate? the political ?markets? (if I may use such a term) to turn the truth on its head. Furthermore, this indictment sets a very bad precedent in the energy markets as a whole.
That is because the United States has not seen a new oil refinery built since the Gerald Ford Administration in the mid-1970s, and refineries are being pushed to the limits. That means that any time a refinery is temporarily shut down for explosions, accidents, or even simple maintenance, that the DOJ now is going to look to see if criminal indictments can be handed down against oil producers for ?withholding fuels.?
As the power of governments at all levels has grown exponentially in recent decades, so has the prison population of this country. That is no accident. Today, we see more and more the government using criminal charges as a way not only to punish supposed ?criminals,? but also to engage in political manipulation. The Reliant indictments simply are another cog in the giant wheel of federal injustice.
A suggestion for defense attorneys in the Reliant Resources case -- Mr. Anderson just might be a wonderful defense expert witness!
April 2, 2004
Economist and writer Edward Lotterman publishes this insightful op-ed in which he makes the case that OPEC's threats of curtailing oil production do not merit much hand-wringing. He points out the following:
Ignoring inflation, world crude prices and U.S. domestic gasoline prices are at or near record levels. Fuel prices are becoming an issue in the U.S. presidential campaign. Some forecasters worry higher energy prices will stunt U.S. economic growth. Others fear it will fuel inflation, leading the Fed to constrict the money supply earlier than it might otherwise.
Such concerns are understandable, and, to some immediate extent, justified. But much dramatic hand-ringing is highly overdone.
OPEC has great pricing power in the short run, particularly when world demand or political uncertainty are high. In the longer run however, it is a paper tiger. Over any time horizon longer than a couple of years, OPEC needs oil customers more than oil consumers need OPEC. We need to be sure that short-term pinches, such as the current one, do not seduce us into longer-term policies that will prove to be self-destructive.
After discussing the concept of elasticity of demand, Mr. Lotterman keys in on the key consideration regarding demand for oil:
[I]f demand is inelastic and you raise prices, you raise the total dollar value of your sales. If elastic, raising prices cuts such total revenue. The demand for oil is very inelastic in the short run, but much more elastic in the long run.
And then Mr. Lotterman concludes brilliantly:
OPEC economists are well aware of consumer behavior. They also know that they control less than half of global crude output and that every time they act to hold short-term prices above the mid-$20-per-barrel range, they lose market share to non-OPEC members and to natural gas ? and such losses often are permanent.
No one studies elasticities of demand for oil more than OPEC. Its leaders know that in the very short term ? i.e., a few weeks or months ? a 10 percent price hike may cut their sales only 1 percent or less. But in the long term, price hikes cut OPEC member nation revenues.
If OPEC had any real long-term pricing power, the value of member-nation oil reserves would grow. They have not. If Saudi Arabia, for example, has sold a billion barrels of its reserves to someone else in 1974 or 1981 and put that money into U.S. Treasury bonds, they would have much more money today than the value of the same billion barrels at 2004 prices.
Alarmists always retort, "Yes, but it is different now; this time they really have us over a barrel." They are mistaken. As technology matures and alternative sources of energy come into play, the importance of oil will fade.
A century from now, there will still be billions of barrels of crude lying unpumped beneath the sands of the Middle East just as there still are large quantities of copper in Montana and Arizona. Like such copper, the oil simply won't be worth pumping because no one will be willing to pay much for it.
Nor should we worry unduly about maintaining dutifully friendly regimes in the Middle East or even Venezuela.
Countries like Saudi Arabia, Iraq and Iran have little going for themselves beside oil. Cutting off shipments to punish the United States or other industrialized countries would damage their own interests much more than those of anyone else.
Oil is an extremely fungible product. What matters is global supply and global demand. Blocking flows between any two particular countries or sets of countries is meaningless except in the very short run. Don't lose any sleep over this issue.
Not only should we not lose any sleep over this issue, our demagogue antenna should spring to life immediately whenever we hear a politician attempt to make this an issue in this political season.
March 31, 2004
During the political season, my demagogue antenna becomes more sensitive, and John Kerry's recent public remarks blaming the Bush Administration for high gasoline prices rattled my antenna. Arthur Kling provides this timely post on the economics of oil and the poorly-named "Strategic" Oil Reserve. Pay special attention to Fred Singer's piece on the ill-advised policies implemented during the Nixon and Carter Administrations in response to perceived shortages of oil.
March 10, 2004
The price of West Texas crude oil has climbed $10 in the last six months to its current level of $36.28, its highest level since the eve of the Iraq war. Meanwhile, the economy is expanding at a 4.1 percent annual rate, weathering the rise in oil and gas costs without the inflation and economic stagnation that occurred in much of the national economy after energy price spikes in the late 1970's and early 1980's. This NY Times article addresses the reasons for this reversal in the normal countercyclical effect that high energy prices have on the rest of the national economy, and the point at which even higher energy prices would likely slow the economy's expansion.
March 2, 2004
Houston-based Continental Airlines -- one of the Houston area's largest employers -- announced today that the airline's stated financial goal for break-even results in 2004 is "at great risk" due to the high price of jet fuel and oil.
February 18, 2004
Houston based El Paso Corporation disclosed that it is reducing the value of its estimated proven reserve base of its oil and gas properties by 41%. Proven reserves represent what an oil and gas company can reasonably expect to produce based on economic conditions and technology. As a result, El Paso will record a one-time, non-cash charge against its fourth-quarter earnings of about $1 billion on a pretax basis, which, under federal securities rules, must be taken to reflect the decline in value of the proven reserve base on El Paso's books.
El Paso's move comes on the heels of Royal Dutch/Shell Group's announcement last month that it was reducing the value of its proven reserve base by 20 percent and El Paso's warning to investors earlier this month that it expected to make a material negative revision in its proven reserve estimates.
El Paso continues to struggle under a heavy debt load. It has also been liquidating a number of assets over the past year to raise cash and reduce debt.
Update: The Houston Business Journal this afternoon reports that El Paso's stock price was hammered today on the report of the reserve write down. The HBJ article includes analysis on El Paso from John Olson of the Sanders Morris Harris investment firm. Mr. Olson gained local fame when he was one of the only investment analysts who was bearish on the stock of Enron Corp. well before Enron melted down in late 2001.
February 12, 2004
Following up on this earlier post, the Houston Chronicle reports that Texas Republican congressman Joe Barton will replace retiring Louisiana Republican Billy Tauzin as chairman of the House Energy and Commerce Committee.
In other energy news, the Chronicle reports that, despite the current run-up in oil prices, many in the energy industry believe that the better long-term play is in natural gas.
February 10, 2004
The NY Times reports that OPEC made a surprise announcement earlier today that it was cutting its production quotas. The Houston Chronicle reports that Crude prices rose on the news. The Wall Street Journal's analysis of the action is here (subscription required).
By this action, OPEC is attempting to do its part to maintain oil prices at their highest level in two decades. My sense is that this move may benefit the OPEC members in the short term, but that long term prices will fall from increased exploration and production that will result.