The energy crisis: Background and outlook Short courses for Permanent Missions in Geneva Adapting to the new energy realities: trade and development perspectives 31 October 2008 - PowerPoint PPT Presentation

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The energy crisis: Background and outlook Short courses for Permanent Missions in Geneva Adapting to the new energy realities: trade and development perspectives 31 October 2008


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Title: The energy crisis: Background and outlook Short courses for Permanent Missions in Geneva Adapting to the new energy realities: trade and development perspectives 31 October 2008

The energy crisis Background and outlookShort
courses for Permanent Missions in GenevaAdapting
to the new energy realities trade and
development perspectives31 October 2008
  • Olle Östensson

  • A short history of the oil price boom
  • Why did oil prices rise and why did they rise by
    so much?
  • How high is high? The argument for continued
    (relatively) high oil prices

In the general commodity boom, energy prices
stood out
Oil prices increased most Crude oil prices 1960
to mid-2008, US/barrel
Source UNCTAD Commodity Price Bulletin
Price increases for coal and natural gas were
more modest
Reasons for the price increase
  • Demand
  • Two years 2003 and 2004 with above trend
  • Geographical differences
  • Expectations
  • Supply
  • Slow capacity expansion
  • Low spare capacity, concentrated in one place
  • Inventories
  • Supply-demand imbalances and price spikes in
    commodity markets
  • Other factors
  • US depreciation
  • Mismatch of refinery capacity
  • Speculation?

Global oil demand, change on previous year,
Forecast September 2008
Source International Energy Agency, Oil Market
Report, various issues
Shares of increase in global oil demand
Large share for China, Middle East and Other Asia
but also for North America
Source International Energy Agency, Oil Market
Developed countries still dominate total demand
Energy intensity, metric tons oil equivalent per
thousand US in nominal and PPP 2000 exchange
Source International Energy Agency
China was expected to follow the Korean path
Supply side factors Capacity developments
  • Slow capacity increase
  • Low oil prices in the 1990s reduced the incentive
    to add to capacity
  • There was no spare capacity among non-OPEC
  • OPEC spare capacity
  • In the 1990s, OPEC had cut back production
  • As late as 2001, OPEC spare capacity was 5.6
    million barrels/day
  • In June 2008, it was 1.5 million barrels/day
    (less than a weeks world consumption), all in
    Saudi Arabia

Supply side factors Production costs
  • Production costs rose rapidly after 2000, both
    reducing incentives to invest and creating
    expectations about future price increases
  • The peak oil theory made arguments based on
    rising costs of production more credible

Production costs, conventional oil
Source US Energy Information Administration
Supply side factors Inventories
  • The history of inventory changes is ambiguous
    total OECD stocks were actually higher than
    normal in the first half of 2007
  • OECD stocks fell in early 2008, particularly in
    Asia, creating an imbalance
  • Official stock build ups took place throughout
    the period of price increases and rumours of
    massive increases in Chinese stocks abounded
  • Very little information was available about
    stocks in producing countries
  • It is likely that a general atmosphere of
    uncertainty contributed to precautionary stocking

Reasons for price spikes in commodity markets
  • Very low short term price elasticity of demand
    because of lack of substitutes and because use
    cannot be postponed
  • Very low short term elasticity of supply because
    of fixed capacity and high capacity utilization
  • When prices are perceived to be rising, target
    inventory levels are raised because buyers want
    to avoid paying higher prices
  • If there is a perceived risk of shortage, target
    inventory levels are raised to avoid having to
    default on deliveries
  • Precautionary stocking is insensitive to price
    increases and will continue long after prices
    have exceeded reasonable levels

A source of uncertainty Estimates of non-OPEC
supply growth have been too optimistic in recent
Estimate 1 year ahead
Estimate end of current year
Sources December editions of IEAs Oil Market
Summary of factors
Sources WTI Reuters OECD Days Supply
International Energy Agency and U.S. Energy
Information Administration estimates World
Excess Production Capacity U.S. Energy
Information Administration estimates.
Other factors
  • US depreciation
  • Demand rose particularly fast in the
    transportation sector
  • Refineries produce products in fixed proportions,
    composition of crude oil is crucial
  • A shortage of light crude oil may have further
    fuelled the price increases

  • Financial speculation involves the buying,
    holding, selling and short-selling of stocks,
    bonds, commodities, currencies, collectibles,
    real estate, derivatives, or any valuable
    financial instrument to profit from fluctuations
    in its price as opposed to buying it for use or
    for income via methods such as dividends or
    interest. (Wikipedia)
  • Distinction between speculation and manipulation
    speculators benefit from market variations,
    market manipulators attempt to influence

Speculation?Argument 1 Direct influence of
futures markets
  • Low returns on stocks and other assets led hedge
    funds and other investors to invest in commodity
    markets, particularly oil
  • The volume of investment was very large and, it
    is argued, drove up prices

How do futures markets for commodities work?
  • Futures markets trade contracts for future
    delivery of a certain quantity of a commodity
  • The contracts are almost always cashed in and
    very seldom do buyers actually take delivery in
  • The attraction to investors or speculators
    compared to dealing in the physical commodity is
    (1) you avoid storage and handing costs and (2)
    you only have to pay a small part, usually 10 per
    cent, of the total price in advance therefore
    the potential for profits is very large

Who invested in oil futures and what was the
effect? (1)
  • Banks and others sold commodity index funds,
    that is, financial instruments that were intended
    to replicate the price movements of commodities
  • Oil is usually a large component in the indices,
    since it is an important commodity in world trade
  • Since the sellers of commodity indices wanted to
    avoid losses, they hedged by buying contracts on
    commodity exchanges that corresponded to the
    indices that they sold thus they would be able
    to pay off the investors this activity was
    responsible for the vast majority of futures
    market investment
  • The sellers rolled over their hedges, that is,
    they sold the contracts for cash before the due
    date and bought new ones for more distant dates
  • Accordingly, no oil ever changed hands and the
    price of physical oil was not affected
  • The process can be compared to betting on the
    outcome of a tennis tournament the bettors do
    not decide who wins the Wimbledon

Who invested in oil futures and what was the
effect? (2)
  • During most of the period of price increases, the
    oil futures markets were in backwardation, that
    is, the prompt price was higher than the future
  • The backwardation meant that the banks made a
    profit from their hedges
  • Other investors, who bought futures contracts
    directly, rather than as part of an index, also
    profited from the backwardation

Who invested in oil futures and what was the
effect? (3)
  • No correlation between the amount invested in
    futures contracts and the price level
  • Changes in positions did not precede price
    changes, but followed them (US Commodity Futures
    Trading Commission)
  • Backwardation is the classical indication of a
    physical shortage, speculators benefit from
    physical shortages

Who invested in oil futures and what was the
effect? (4)
Source CFTC Fact Sheet Speculative Trading in
Crude Oil Market, June 23, 2008
Speculation?Argument 2 Indirect influence of
futures markets
  • Herd behaviour
  • Holders of physical commodities observe that
    speculators are buying futures and conclude that
    prices are going to rise
  • They therefore hold onto their commodities or try
    to acquire more
  • The additional demand stimulates speculators to
    buy more futures and a price spiral results
  • Physical stocks are built up
  • The process continues as long as holders of
    physical commodities stand to gain from holding
    on to them, that is, as long as the market is in
    contango (future prices are higher than prompt
    prices), since otherwise they could earn more
    from selling
  • However, there was no sign of stock build up in
    fact, stocks declined in 2008 and the market was
    in backwardation
  • The hypothesis that herd behaviour contributed to
    the price rise in a situation of physical
    shortage is consistent with the inventory data,
    although the hypothesis can not be supported by
    any positive evidence (this would require
    knowledge of the motives guiding the behaviour of
    holders of physical oil)
  • However, changes in speculative positions
    followed price movements
  • Moreover, since prices of commodities that are
    not traded on futures exchanges rose at least as
    much as those of commodities traded on exchanges,
    the hypothesis assumes two causes for the same
    effect, depending on whether a commodity is
    traded on a futures exchange

The yield curve for crude oil- the market was
in backwardation except in early 2007
Where are oil prices going?
  • Demand
  • The rate of increase in oil demand has been
    modest compared to other commodities (only 2.2
    /year 2002-2007, the period of large price
    increases) and is unlikely to accelerate
  • Demand may be more sensitive to price increases
    than often thought
  • Developing Asia will account for most of the
    demand increase, but income elasticity is low
    (0.4 in China) and falling
  • The current oil price hike represents the
    strongest support programme that has ever existed
    to develop alternative energy sources and embark
    on a less carbon-emission-intensive economic
    development path
  • Governments may be prepared to commit to making
    high fossil energy prices permanent in order to
    stop climate change

Where are oil prices going? (contd)
  • Supply
  • Almost all energy production is extremely capital
    intensive and has low variable costs this means
    that prices can vary dramatically in the short
    term, but in the long term all costs have to be
  • Increasing cost of non-OPEC conventional oil low
    lifting costs, high finding and development costs
  • Non-conventional oil (heavy oil, bitumen, tar
    sands) has total costs of 70-90/bbl, high
    operating costs, environmental impacts are
    important and may constrain expansion
  • Non-oil alternatives (biofuels) have high costs
    although Brazilian ethanol from sugar cane has
    production costs of 25-30/bbl - and capacity is
    constrained by availability of land and water,
    trade barriers and standards
  • OPEC oil can not be taken for granted

(No Transcript)
US Energy Information Administration
International Energy Outlook 2008
  • Liquids production in reference case 112.5 Mb/day
    in 2030 (increase 1.2 /year)
  • 9.7 Mb/day are projected to come from
    non-conventional sources, accounting for a
    quarter of the production increase
  • OPECs share of production increases very
    slightly (from 41 to 42), the share of non-OPEC
    conventional oil falls

Prices are assumed to remain relatively high
EIA forecast, Mb/day
OPEC production
  • OPEC is an intergovernmental organization
    operating on the basis of consensus, decisions
    are usually the result of compromises
  • Several OPEC producers are experiencing cost
  • Only a few have large enough reserves to be able
    to increase production significantly in the long
    term (Iran, Iraq, Kuwait, Sadi Arabia)
  • Iran and Iraq have large populations and could
    use additional income but is such income better
    generated by increased market share or
    (continued) high prices?
  • Kuwait and Saudi Arabia have small populations
    and no need to increase their market share
  • Conclusion OPEC can not be counted on to
    automatically make up the shortfall in world
    production, that is, act as swing producers

Conclusion a realistic (?) assumption
  • The long term production cost of alternatives to
    conventional oil will set a floor for crude oil
    prices at US 60-80/bbl in todays dollars
  • The price can and will fall below this floor, but
    only for limited periods

  • Thank you!
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