Oil Prices: Volatility gone mad or markets working The prospects for oil prices

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Oil Prices Volatility gone mad or markets
working? The prospects for oil prices
Professor Paul Stevens Senior Research Fellow
(Energy) Chatham House Professor Emeritus,
University of Dundee Consulting Professor
Stanford Public Lecture University College
London School of Energy and Resources Adelaide
5th August 2009
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A brief history of oil prices
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Presentation outline

• Why do oil prices matter?
• What has been happening to oil prices and why?
• What are the short term prospects for oil prices?
• What are the medium term prospects for oil prices?

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Why do oil prices matter?

• Aorta
• Oil prices and global economic growth
• Impact on oil exporters and oil importers
• Impact on investment decisions

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What has been happening to oil prices and why?
Wet barrel versus paper markets role in price
making?
Wet barrel market Trading real barrels
Paper barrel markets Money managers
versus Speculators
Relationship between the two markets?
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What has been happening to oil prices and why?
Wet barrel versus paper markets role in price
making?
Wet barrel market Trading real barrels
Paper barrel markets Money managers
versus Speculators
Influences perceptions about surplus/shortage
Signals what prices might be
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The State of the Wet Barrel Market

• Up to 2007 there were signs of increasing
  tightness
• The result is spare capacity to produce crude is
  squeezed
• There is also a refining story but time
  precludes

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The State of the Paper Barrel Markets
Wet barrel market
Paper barrel markets
Influences perceptions about surplus/shortage
Signals what prices might be
Frequently there is a disconnect between the two
markets Because the money managers do not
understand the oil industry. Some examples
Assassination of Benazir Bhutto 2008
- Taking by pirates of the Sirius
Star 2008 - Iranian
riots following the hijacked election 2009



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What happens when they realize they have got it
wrong?

• Rapid and dramatic adjustment
• Normally falling 10 but at the end of 2007 by
  20

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How to explain recent price movements Sept 2007
to July 2008 Money Managers poured funds into
the paper markets .

• Mistakenly believed in a shortage of wet barrels
• Nowhere else to invest Bonds bad, equities
  worse
• Geopolitics loomed
• Dollar exchange rates, Pavlovs dogs and
  bubbles

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What happens when they realize they have got it
wrong?

• Yet another rapid and dramatic adjustment
• Fell by 40 between early July mid August (WTI
  from 147 to 105)
• Then Lehman Brothers failed, attention focussed
  on impending recession and prices fell further
• What of the future?

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What are the short term prospects for oil prices?

• Demand is falling rapidly
• OPECs spare capacity is rising rapidly
• Can OPEC hold the line?

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Medium term prospects for oil prices? Demand

• Up to 2007 little sign of a recession which
  helps explain the lack of demand response to much
  higher prices
• But eventually the world economy will recover and
  oil demand growth will resume
• Probably faster than before because the oil
  burning appliance stock will be less efficient

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Medium term prospects for oil prices? Supply
Report available at http//www.chathamhouse.org.u
k/publications/papers

• The Hypothesis and Why it Matters

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Medium term prospects for oil prices? Supply

• Defining a supply crunch
• Excess capacity disappears because of inadequate
  investment
• Then an outage probably a geo-political event
• The result is a price spike

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Medium term prospects for oil prices? Supply

• The Investment Story
• International Oil Companies
• Value based management
• Oil price volatility and the credit crunch
• National Oil Companies
• Depletion policy

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The questions To produce now or later? Depletion
and choices
Government Choices
Access to acreage
Development policy

• Outcomes
• Rate of return? f (future oil rents)
• Rate of return? f (resource curse)
• Rate of return? f (role of oil funds)
• COMPARED TO WHAT?

Production policy
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The questions To produce now or later? Depletion
and choices
Government Choices
Access to acreage
Development policy

• Outcomes
• Rate of return? f (future oil rents)
• Rate of return? f (resource curse)
• Rate of return? f (role of oil funds)
• COMPARED TO WHAT?

Production policy
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Medium term prospects for oil prices?
Supply

• The Investment Story
• International Oil Companies
• Value based management
• Oil price volatility and the credit crunch
• National Oil Companies
• Depletion policy
• Resource nationalism
• Principal-Agent analysis

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Principal Agent Analysis

• Who is the agent and who is the principal?
• What is rent seeking?

Principal Controlling Ministry
Information Flows
Profit
Agent Management Of the NOC
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Principal Agent Analysis

• Why is the agent allowed to rent seek
• Key role of information asymmetries. Only the
  agent knows the true costs
• This may all be total rubbish BUT Finance
  Ministries stuffed full of young PhDs from
  Western Universities

Principal Controlling Ministry
????????? Information Flows ?????????
Profit
Agent Management Of the NOC
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The key issue is the timing of the supply crunch?

• Depth and length of the recession?
• Recession a double edged sword?
• Projects being delayed, postponed and cancelled
• Cost of projects has been falling
• Oil producers hungrier for revenue?
• Reversal of resource nationalism?

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THANK YOU FOR YOUR ATTENTION