Oil prices going down

[D. R. Pearson + 4]

Mr William Edwards' idea of oil prices going down to $20 for a few years is not logical due to the fact that world demand would not be meet if we had prices down to $20/bbl. The cost to produce oil is far higher than $20. Also when oil prices in the past were $20, in todays dollars that would amount to $38/bbl, thus the $20/bbl would actually be $10/bbl. 

Back in the 1970-80's when prices went down to $20/bbl there was substantial surplus conventional oil available to produce. Today that excess surplus does not exist, and if we do have a surplus it will be due to unconventional high cost to produce oil (i. e. Deep-water, oil sands,  and shale oil). We will not be seeing crude prices down to $20/bbl for 2 years, period. Regards.

 

[William Edwards + 708]

43 minutes ago, D. R. Pearson said:

Mr William Edwards' idea of oil prices going down to $20 for a few years is not logical due to the fact that world demand would not be meet if we had prices down to $20/bbl. The cost to produce oil is far higher than $20. Also when oil prices in the past were $20, in todays dollars that would amount to $38/bbl, thus the $20/bbl would actually be $10/bbl. 

Back in the 1970-80's when prices went down to $20/bbl there was substantial surplus conventional oil available to produce. Today that excess surplus does not exist, and if we do have a surplus it will be due to unconventional high cost to produce oil (i. e. Deep-water, oil sands,  and shale oil). We will not be seeing crude prices down to $20/bbl for 2 years, period. Regards.

 

May I kindly suggest that you re-visit your historical data, Mr. Pearson, then reassess your views. For example, in the late nineties the price of oil dropped below $11 in current dollars, about $20 in today's currency. Most of the world's production at that time had a cost greater than $11. Demand was met. Possibly not logical in your mind, but that is what actually happened. It has been said that markets can remains irrational longer than the participants can dig up funds to stay in the game. You might want to reassess your comfort from "logic".

Being the nice guy that I am, I am going to make the job easier for you. Here is a chart showing yearly average oil prices in 2016 dollars for the past 150 years.

Edited June 9, 2018 by William Edwards

[JunoTen + 118]

@William Edwards, what if the prices went down but it was because of demand declining due to a technological shift ? Do you think the producers would keep drilling or they would stop right away in that case ?

Edited June 9, 2018 by JunoTen

[William Edwards + 708]

6 minutes ago, JunoTen said:

@William Edwards, what if the prices went down but it was because of demand declining due to a technological shift ? Do you think the producers would keep drilling or they would stop right away in that case ?

Interesting question. However, I have trouble seeing the pricing mechanism connection that allows demand to set lower prices. As I see it, demand responds to prices, it has no mechanism to set prices. Directionally, lower prices should increase demand, not decrease it.

But proceeding to consider the question as to whether producers would stop drilling if prices fell, whatever the reason for the price drop, the answer is "Yes", but well after the over-expanded producing capacity had caused desperate producers to drop prices below the level that allows them to keep producing. You see, the price drives both consumption and production activities (but in opposite directions). And the resulting price moves, inspired by desperate buyers or sellers, will not be gentle and reasoned. Instead they will be comparable to jumping off of the bridge. Therefore, when the price destroys the business incentive to produce, the price drop will likely be severe, and production will decline fairly quickly and drilling will stop.

[Osama + 248]

@William Edwards Thank you very much for your kind words.... I am not sure why I didn't get any notification of the healthy discussion going in this thread. Apologies for the lack of response!

[Osama + 248]

On 6/5/2018 at 9:03 PM, William Edwards said:

Osama's reasoning is sound. I might suggest some additional guidance regarding the potential price range going forward. Since there is absolutely no correlation between price and demand, inventories, spare capacity, the weather, Trump's latest tweet or anything else, we conclude that the actual price level will be a random trading number. The only guidance that I can rely on is the historical record. Therefore I can easily see a price as low as $20 over the next few years, since that has been a historical comfort low.

@William Edwards There is one point however that keeps giving me afterthoughts. Given the extent of reform and change and the stakes that MbS' NPT or Saudi Vision 2030 involves.....do you think KSA will not interfere to keep prices falling that low ($20). There are two points here. One is, evidently, the IPO. For that they need a good oil price (but then what  is a good oil price? They--the Saudi's--have hinted towards it being $80) and the second is that they might have learned a lesson from 2014 when their strategy of not acting went awry. 

There is another factor that comes into play i.e. Trump. With news that Trump called Saudi authorities confirming that they'll support the markets before repudiating the Iran deal, formally JCPOA, and his tweet ("Looks like Saudi Arabia is at it again....") the influence seems quite blatant. 

 

What is your thoughts on it? I see Aramco's IPO as the single most dominating factor that will keep oil prices from falling. November's Vienna Agreement and the Saudi commitment in the following months can be seen in the same vein.

[Jan van Eck + 7,558]

18 hours ago, William Edwards said:

Interesting question. However, I have trouble seeing the pricing mechanism connection that allows demand to set lower prices. As I see it, demand responds to prices, it has no mechanism to set prices. Directionally, lower prices should increase demand, not decrease it.

But proceeding to consider the question as to whether producers would stop drilling if prices fell, whatever the reason for the price drop, the answer is "Yes", but well after the over-expanded producing capacity had caused desperate producers to drop prices below the level that allows them to keep producing. You see, the price drives both consumption and production activities (but in opposite directions). And the resulting price moves, inspired by desperate buyers or sellers, will not be gentle and reasoned. Instead they will be comparable to jumping off of the bridge. Therefore, when the price destroys the business incentive to produce, the price drop will likely be severe, and production will decline fairly quickly and drilling will stop.

To give examples of how stimulated production will collapse price, I invite readers to contemplate two recent sets of events. 

The first example is Western societies' desires to recycling of plastics.  Before mandatory recycling, there was a market for recycled plastics, typically priced out to the converter (the final customer of the waste stream) of perhaps as much as 45% of the price of virgin resin.  This pricing generated producers of sorted plastics waste streams who would take in mixed waste and hire people to go separate out the plastics containers, run them through a water cleaner, then into a granulator, and typically through an extruder and pelletizer to make a rather nice finished product, plastic pellets that can be mixed with virgin resins to be injection molded or cast into some new product offering. 

Now along come governments who mandate forced recycling, and waste haulers put out special collection bins for recycled products, including metals, cardboard, and plastics, and the stuff is sorted and offered to the waste recyclers.  Vast amounts of fresh waste bombard the industry, and the price paid by the recyclers drops to zero. 

The increase in material offered by producers, in this case waste haulers/sorters looking for a home for the mandatory recycled material, places competing producers against each other, to the point where there is so much material that the converters of the waste pay little to nothing.  Why?  Because if Hauler "A" wants $20/ton for his stuff, to cover his costs of $18/ton and make a few pennies,   and hauler "B" needs to get rid of the mounds accumulating in his sorting building (and remember that there is this avalanche of fresh material arriving in the garbage trucks every day), Hauler "B" will drop his price to  whatever it takes to move the material, and thus gain market share.  So he drops to $10/ton, and that puts Hauler "A" and those buddies in the industry in the position of having raw product overwhelm the sort building, so they drop to $5/ton, and soon you are at "free."  

And that is what happens when producers overload the system; the market cannot absorb what producers are offering, so producers compete against each other for market, collapsing the price. 

The second example is the shipping industry (let's take containerships for our example).  The volume of container trade keeps expanding, mostly because of increases of China shipments, which overwhelmingly go by sea container.  That motivates the shipping companies to add capacity.  That drives up the demand for newer and bigger containerships, which the shipping companies typically charter from firms that specialize in ordering and chartering out these ships.  

The charter guys then place newbuild orders, but they are not calculating their newbuilds in comparison to what other charter guys are ordering, with the result that the charter market gets flooded with tonnage capacity when all the newbuilds hit the water.  Now you have these ships (which might run say $150 million new and have a Note from some bank to finance it, thus hefty payments to make) pushing out to the shipping companies.  That gives the shipping companies the ability to pick up the capacity at progressively lower charter rates - and in recent times, down below the cost of ownership, simply because the costs of layup are higher than the low charter fare. These companies now bleed cash, and the bankers are unable to repossess the boat because there is no market for it.  Who is going to buy  that boat and clear the Note when you can go charter some distressed asset for peanuts?  Nobody.  And there is blood in the water.

Meanwhile the shipping companies have been chartering extra capacity, stimulated by the prospect of more China boxes coming from those manufacturers shipping product to the USA and Europe.  What happens?  Those big new ships (and some are up to 22,000 Containers in capacity!)  have to run "full" or the fuel bill will kill the company, so again the prices they charge ratchet downwards to steal loads from their competitors.  As prices collapse, companies start to run in the red, until finally some shipping companies spectacularly collapse into bankruptcy (and stranding containers around the globe, because the ports refuse to unload ships where they are not assured of getting paid, and the drayage companies refuse to take containers of those ships as there is no assurance the containers when emptied will be taken back by the bankrupt shipper, thus choking their yards without revenue).  Check out what happened when Hyundai went under in the months before Christmas last year, and retailers in the USA were stuck with air-freighting replacement merchandise to replace what was stranded at sea or in port, with ships getting seized by sheriffs in say Singapore stocked with transit cargo headed for Hamburg. (You know how fast the courts work, so if you get your stuff within a year you are doing great. Just lovely.)

In all these cases, it is the production of product, whether plastic scrap or empty containers or massive ships, that drives the market price. It is not "demand" that drives price; it is "production," however couched.  Over-production needs to seek out a home, and if you have to steal it from a higher-cost producer, so that is what you do, even if - as in the case of electricity produced in Ontario at night by wind turbines on ruinous and onerous tie-in contracts - you have to dispose of your production by paying someone to take it. Don't think that the oil markets are somehow exempt from this truth.

Edited June 10, 2018 by Jan van Eck
scrivener error

[William Edwards + 708]

1 hour ago, Jan van Eck said:

To give examples of how stimulated production will collapse price, I invite readers to contemplate two recent sets of events. 

The first example is Western societies' desires to recycling of plastics.  Before mandatory recycling, there was a market for recycled plastics, typically priced out to the converter (the final customer of the waste stream) of perhaps as much as 45% of the price of virgin resin.  This pricing generated producers of sorted plastics waste streams who would take in mixed waste and hire people to go separate out the plastics containers, run them through a water cleaner, then into a granulator, and typically through an extruder and pelletizer to make a rather nice finished product, plastic pellets that can be mixed with virgin resins to be injection molded or cast into some new product offering. 

Now along come governments who mandate forced recycling, and waste haulers put out special collection bins for recycled products, including metals, cardboard, and plastics, and the stuff is sorted and offered to the waste recyclers.  Vast amounts of fresh waste bombard the industry, and the price paid by the recyclers drops to zero. 

The increase in material offered by producers, in this case waste haulers/sorters looking for a home for the mandatory recycled material, places competing producers against each other, to the point where there is so much material that the converters of the waste pay little to nothing.  Why?  Because if Hauler "A" wants $20/ton for his stuff, to cover his costs of $18/ton and make a few pennies,   and hauler "B" needs to get rid of the mounds accumulating in his sorting building (and remember that there is this avalanche of fresh material arriving in the garbage trucks every day), Hauler "B" will drop his price to  whatever it takes to move the material, and thus gain market share.  So he drops to $10/ton, and that puts Hauler "A" and those buddies in the industry in the position of having raw product overwhelm the sort building, so they drop to $5/ton, and soon you are at "free."  

And that is what happens when producers overload the system; the market cannot absorb what producers are offering, so producers compete against each other for market, collapsing the price. 

The second example is the shipping industry (let's take containerships for our example).  The volume of container trade keeps expanding, mostly because of increases of China shipments, which overwhelmingly go by sea container.  That motivates the shipping companies to add capacity.  That drives up the demand for newer and bigger containerships, which the shipping companies typically charter from firms that specialize in ordering and chartering out these ships.  

The charter guys then place newbuild orders, but they are not calculating their newbuilds in comparison to what other charter guys are ordering, with the result that the charter market gets flooded with tonnage capacity when all the newbuilds hit the water.  Now you have these ships (which might run say $150 million new and have a Note from some bank to finance it, thus hefty payments to make) pushing out to the shipping companies.  That gives the shipping companies the ability to pick up the capacity at progressively lower charter rates - and in recent times, down below the cost of ownership, simply because the costs of layup are higher than the low charter fare. These companies now bleed cash, and the bankers are unable to repossess the boat because there is no market for it.  Who is going to buy  that boat and clear the Note when you can go charter some distressed asset for peanuts?  Nobody.  And there is blood in the water.

Meanwhile the shipping companies have been chartering extra capacity, stimulated by the prospect of more China boxes coming from those manufacturers shipping product to the USA and Europe.  What happens?  Those big new ships (and some are up to 22,000 Containers in capacity!)  have to run "full" or the fuel bill will kill the company, so again the prices they charge ratchet downwards to steal loads from their competitors.  As prices collapse, companies start to run in the red, until finally some shipping companies spectacularly collapse into bankruptcy (and stranding containers around the globe, because the ports refuse to unload ships where they are not assured of getting paid, and the drayage companies refuse to take containers of those ships as there is no assurance the containers when emptied will be taken back by the bankrupt chipper, thus choking their yards without revenue).  Check out what happened when Hyundai went under in the months before Christmas last year, and retainer in the USA were stuck with air-freighting replacement merchandise to replace what was stranded at sea or in port, with ships getting seized by sheriffs in say Singapore stocked with transit cargo headed for Hamburg. (You know how fast the courts work, so if you get your stuff within a year you are doing great. Just lovely.)

In all these cases, it is the production of product, whether plastic scrap or empty containers or massive ships, that drives the market price. It is not "demand" that drives price; it is "production," however couched.  Over-production needs to seek out a home, and if you have to steal it from a higher-cost producer, so that is what you do, even if - as in the case of electricity produced in Ontario at night by wind turbines on ruinous and onerous tie-in contracts - you have to dispose of your production by paying someone to take it. Don't think that the oil markets are somehow exempt from this truth.

You have done a fine job, Jan, of explaining the perpetual problem of too many suppliers facing what is essentially a fixed market. The producer that drops his price to try to gain market usually does not realize that the magnitude of price elasticity is expressed in fractions of a percent while price drops can be hefty percentages. In most cases it is impossible for the percentage of a demand increase to match the percentage of a price drop. Thus the price can drop to zero well before significant demand increases can occur. This leads to the conclusion reached by the management of Edwards Energy Consultants that "Strategic planning begins with a valid price forecast". And for that price forecast to truly have validity it must anticipate the results of collective industry action that can well overwhelm the necessary demand, with the resulting price disaster.

History has shown that the oil business is not immune from this general principle. Mike Shellman has often pointed out that the oversupply of crude oil, with its accompanying drop in price, is made possible by unwise leverage by producers. That unwise leverage is the result of there being no connection between the decision to borrow money and drill and the potential for price collapse if that activity is overdone.

Thanks for you help in trying to encourage thoughtful thinking and, hopefully, enhanced understanding.

[William Edwards + 708]

2 hours ago, Osama said:

@William Edwards There is one point however that keeps giving me afterthoughts. Given the extent of reform and change and the stakes that MbS' NPT or Saudi Vision 2030 involves.....do you think KSA will not interfere to keep prices falling that low ($20). There are two points here. One is, evidently, the IPO. For that they need a good oil price (but then what  is a good oil price? They--the Saudi's--have hinted towards it being $80) and the second is that they might have learned a lesson from 2014 when their strategy of not acting went awry. 

There is another factor that comes into play i.e. Trump. With news that Trump called Saudi authorities confirming that they'll support the markets before repudiating the Iran deal, formally JCPOA, and his tweet ("Looks like Saudi Arabia is at it again....") the influence seems quite blatant. 

 

What is your thoughts on it? I see Aramco's IPO as the single most dominating factor that will keep oil prices from falling. November's Vienna Agreement and the Saudi commitment in the following months can be seen in the same vein.

Thanks for your further question, Osama. I shall try to explain the apparent inconsistency between my price expectations and our guess of KSA's wishes.

The key fact to remember is that neither the Saudis, nor OPEC, nor the US Government, is able to translate their "wishes" into actual prices. Hope springs eternal, arrogance lends enthusiasm, but results do not concur. Why is that? Simply because the wishers and hopers do not posses the knowledge of the mechanism of price management that can translate their wishes into reality. And, compounding the disappointment from their lack of understanding on price management, their arrogance denies that they do not understand how to make prices behave as they wish. So the industry continues to expect prices to behave as the Saudis wish, but reality continues to prove that, as yet, Saudi management has not yet grasped an understanding of how prices are properly managed. So the price, with its volatility and surprises, continues to exhibit the volatility and surprises, in both directions, that futures speculators' actions dictate.

The Saudis may dearly wish for an $80 price floor, but their actions actually work against that result because they do not understand how to institute their desired floor price.

Regarding your last paragraph, "I see Aramco's IPO as the single most dominating factor that will keep oil prices from falling.", the reason that they will be disappointed is clearly described in Jan Van Ecks' comment on this subject an hour ago. Too much supply causes sellers to drop the price in the hope that they can regain markets, but the speed of the price drop is much greater than the speed of any resulting demand growth. The result: unreasonably low prices.

[Jan van Eck + 7,558]

4 minutes ago, William Edwards said:

Too much supply causes sellers to drop the price in the hope that they can regain markets, but the speed of the price drop is much greater than the speed of any resulting demand growth. The result: unreasonably low prices.

In the containership debacle of the last years, with vast supply of freight slots on massive ships all competing for a roughly fixed amount of container traffic, at one point the price of shipping a container on the "backhaul" from Northern Europe to China dropped to $200.  Remember that the containerships travel with full, or almost full, loads from China to both the USA and Europe, the big markets for Chinese manufactured goods.  But their containers have to go back to China for another load, and most of them are travelling empty.  That means that the shipping company is taking a big hit on the backhaul. 

Are there loads out there for the backhaul?  Sure.  And some can be stimulated by very low shipping prices.  At one point the price collapsed to 200 bucks.  Now think about this: a shipper could order a container dropped at his door, stuff the box with 80,000 lbs of freight, and send it all the way to China for two hundred bucks.  How is this even possible?  Well, from the point of view of that shipping company, their boat has to travel there anyway, and even if you take the local drayage off the tab  (figure $60), you are still left with $140 for the load.  And $140 is better than NO dollars.  So the shipping companies offer that deal.  And that is against a "usual" price of $2,100 for the same container and weight, absent the over-capacity. 

It gets expensive fast when you go buy yourselves some giant 22,000 TEU containerships for bragging rights, and then find you have added far more capacity than the market can absorb.  Now, how to pay the Note on those big boats?  

[Jan van Eck + 7,558]

19 hours ago, JunoTen said:

@William Edwards, what if the prices went down but it was because of demand declining due to a technological shift ? Do you think the producers would keep drilling or they would stop right away in that case ?

Technology shifts typically produce different results.  Take for example the interior of a subway car.  The builder can make that inside wall out of plastic formed sheet, or he can make it out of some new form of laminated molded wood, or he can make it out of a new grade of alloy aluminum that allows the sheet to be stamped and stretched without tearing.  If the plastic resin is expensive because the feedstock oil is expensive, then the wood laminate or the aluminum sheet becomes a substitute good, and takes away the market share.  The plastic fabricator sees his contracts run away, so he goes to the resin manufacturer and says,"Hey, guys, I need a better price."  So the resin guys go the feedstock refiners and say, "Hey, we need a better price."  Is the refinery guy going to shut down his refinery because he lost market for his plastic feedstock, due to substitute materials entering the marketplace?   Nope: he fights for market share by dropping his price (as do all the other guys in the chain). 

And that is how legacy products from legacy manufacturers respond to technological shift.  They go fight for market share, even if it collapses all the prices in doing so.  And you get the same situation with oil producers; even if you surmise that prices are going to drop for all your customers, you know that the other guys are going after your customers, so you drill and pump anyway even though the collective actions are totally ruinous. 

Who wins? The guy with the biggest starting pot wins, simply because he outlasts the pain. 

Edited June 10, 2018 by Jan van Eck
typing error

[Dan Warnick + 6,100]

Hello, Group.  I found the website and subsequently the discussions area a couple of weeks ago. Registered and joined today because of the quality and diversity of the participants and discussions.  You guys are great and the discussion is civil, even when it is difficult to be so.  I have already learned more about a commodity market that I have traded on and off for about 20 years.  I won't burden the group with much in the way of comments but hope you don't mind if I follow along and pickup some insights along the way.

Dan Warnick

Edited June 10, 2018 by Dan Warnick
Irrelevant detail

[William Edwards + 708]

6 minutes ago, Dan Warnick said:

Hello, Group.  I found the website and subsequently the discussions area a couple of weeks ago. Registered and joined today because of the quality and diversity of the participants and discussions.  You guys are great and the discussion is civil, even when it is difficult to be so.  I have already learned more about a commodity market that I have traded on and off for about 20 years.  I won't burden the group with much in the way of comments but hope you don't mind if I follow along and pickup some insights along the way.

Dan Warnick

Welcome, Dan. It is nice to have another intelligent participant.

[Bisoil 0]

[Tom Kirkman + 8,860]

11 hours ago, Jan van Eck said:

To give examples of how stimulated production will collapse price, I invite readers to contemplate two recent sets of events. 

The first example is Western societies' desires to recycling of plastics.  Before mandatory recycling, there was a market for recycled plastics, typically priced out to the converter (the final customer of the waste stream) of perhaps as much as 45% of the price of virgin resin.  This pricing generated producers of sorted plastics waste streams who would take in mixed waste and hire people to go separate out the plastics containers, run them through a water cleaner, then into a granulator, and typically through an extruder and pelletizer to make a rather nice finished product, plastic pellets that can be mixed with virgin resins to be injection molded or cast into some new product offering. 

Now along come governments who mandate forced recycling, and waste haulers put out special collection bins for recycled products, including metals, cardboard, and plastics, and the stuff is sorted and offered to the waste recyclers.  Vast amounts of fresh waste bombard the industry, and the price paid by the recyclers drops to zero. 

The increase in material offered by producers, in this case waste haulers/sorters looking for a home for the mandatory recycled material, places competing producers against each other, to the point where there is so much material that the converters of the waste pay little to nothing.  Why?  Because if Hauler "A" wants $20/ton for his stuff, to cover his costs of $18/ton and make a few pennies,   and hauler "B" needs to get rid of the mounds accumulating in his sorting building (and remember that there is this avalanche of fresh material arriving in the garbage trucks every day), Hauler "B" will drop his price to  whatever it takes to move the material, and thus gain market share.  So he drops to $10/ton, and that puts Hauler "A" and those buddies in the industry in the position of having raw product overwhelm the sort building, so they drop to $5/ton, and soon you are at "free."  

And that is what happens when producers overload the system; the market cannot absorb what producers are offering, so producers compete against each other for market, collapsing the price. 

The second example is the shipping industry (let's take containerships for our example).  The volume of container trade keeps expanding, mostly because of increases of China shipments, which overwhelmingly go by sea container.  That motivates the shipping companies to add capacity.  That drives up the demand for newer and bigger containerships, which the shipping companies typically charter from firms that specialize in ordering and chartering out these ships.  

The charter guys then place newbuild orders, but they are not calculating their newbuilds in comparison to what other charter guys are ordering, with the result that the charter market gets flooded with tonnage capacity when all the newbuilds hit the water.  Now you have these ships (which might run say $150 million new and have a Note from some bank to finance it, thus hefty payments to make) pushing out to the shipping companies.  That gives the shipping companies the ability to pick up the capacity at progressively lower charter rates - and in recent times, down below the cost of ownership, simply because the costs of layup are higher than the low charter fare. These companies now bleed cash, and the bankers are unable to repossess the boat because there is no market for it.  Who is going to buy  that boat and clear the Note when you can go charter some distressed asset for peanuts?  Nobody.  And there is blood in the water.

Meanwhile the shipping companies have been chartering extra capacity, stimulated by the prospect of more China boxes coming from those manufacturers shipping product to the USA and Europe.  What happens?  Those big new ships (and some are up to 22,000 Containers in capacity!)  have to run "full" or the fuel bill will kill the company, so again the prices they charge ratchet downwards to steal loads from their competitors.  As prices collapse, companies start to run in the red, until finally some shipping companies spectacularly collapse into bankruptcy (and stranding containers around the globe, because the ports refuse to unload ships where they are not assured of getting paid, and the drayage companies refuse to take containers of those ships as there is no assurance the containers when emptied will be taken back by the bankrupt shipper, thus choking their yards without revenue).  Check out what happened when Hyundai went under in the months before Christmas last year, and retailers in the USA were stuck with air-freighting replacement merchandise to replace what was stranded at sea or in port, with ships getting seized by sheriffs in say Singapore stocked with transit cargo headed for Hamburg. (You know how fast the courts work, so if you get your stuff within a year you are doing great. Just lovely.)

In all these cases, it is the production of product, whether plastic scrap or empty containers or massive ships, that drives the market price. It is not "demand" that drives price; it is "production," however couched.  Over-production needs to seek out a home, and if you have to steal it from a higher-cost producer, so that is what you do, even if - as in the case of electricity produced in Ontario at night by wind turbines on ruinous and onerous tie-in contracts - you have to dispose of your production by paying someone to take it. Don't think that the oil markets are somehow exempt from this truth.

^  Jan, that was a magnificent comment.

[Tom Kirkman + 8,860]

9 hours ago, William Edwards said:

Thanks for your further question, Osama. I shall try to explain the apparent inconsistency between my price expectations and our guess of KSA's wishes.

The key fact to remember is that neither the Saudis, nor OPEC, nor the US Government, is able to translate their "wishes" into actual prices. Hope springs eternal, arrogance lends enthusiasm, but results do not concur. Why is that? Simply because the wishers and hopers do not posses the knowledge of the mechanism of price management that can translate their wishes into reality. And, compounding the disappointment from their lack of understanding on price management, their arrogance denies that they do not understand how to make prices behave as they wish. So the industry continues to expect prices to behave as the Saudis wish, but reality continues to prove that, as yet, Saudi management has not yet grasped an understanding of how prices are properly managed. So the price, with its volatility and surprises, continues to exhibit the volatility and surprises, in both directions, that futures speculators' actions dictate.

The Saudis may dearly wish for an $80 price floor, but their actions actually work against that result because they do not understand how to institute their desired floor price.

Regarding your last paragraph, "I see Aramco's IPO as the single most dominating factor that will keep oil prices from falling.", the reason that they will be disappointed is clearly described in Jan Van Ecks' comment on this subject an hour ago. Too much supply causes sellers to drop the price in the hope that they can regain markets, but the speed of the price drop is much greater than the speed of any resulting demand growth. The result: unreasonably low prices.

And yet another great explanation, William.

This thread is great reading and food for thought.

[William Edwards + 708]

5 minutes ago, Tom Kirkman said:

And yet another great explanation, William.

This thread is great reading and food for thought.

Thanks, Tom.

[Tom Kirkman + 8,860]

6 hours ago, Dan Warnick said:

Hello, Group.  I found the website and subsequently the discussions area a couple of weeks ago. Registered and joined today because of the quality and diversity of the participants and discussions.  You guys are great and the discussion is civil, even when it is difficult to be so.  I have already learned more about a commodity market that I have traded on and off for about 20 years.  I won't burden the group with much in the way of comments but hope you don't mind if I follow along and pickup some insights along the way.

Dan Warnick

Welcome to the Oil Price forum, Dan.  Please feel free to ask questions and offer your views, as you see fit.

Some of the previous discussions have gotten a bit hot during the heat of the moment, but lately everyone seems to have settled into a more accomodating mode, using reason and logic to pick apart a variety of viewpoints, rather than emotions.

This thread has some pretty great commentaries by assorted members with a diversity of viewpoints.

No mean feat for a new forum that is only 3 months old.  Kudos to all the commenters for their level-headed and cerebral input.

[Osama + 248]

12 hours ago, William Edwards said:

Thanks for your further question, Osama. I shall try to explain the apparent inconsistency between my price expectations and our guess of KSA's wishes.

The key fact to remember is that neither the Saudis, nor OPEC, nor the US Government, is able to translate their "wishes" into actual prices. Hope springs eternal, arrogance lends enthusiasm, but results do not concur. Why is that? Simply because the wishers and hopers do not posses the knowledge of the mechanism of price management that can translate their wishes into reality. And, compounding the disappointment from their lack of understanding on price management, their arrogance denies that they do not understand how to make prices behave as they wish. So the industry continues to expect prices to behave as the Saudis wish, but reality continues to prove that, as yet, Saudi management has not yet grasped an understanding of how prices are properly managed. So the price, with its volatility and surprises, continues to exhibit the volatility and surprises, in both directions, that futures speculators' actions dictate.

The Saudis may dearly wish for an $80 price floor, but their actions actually work against that result because they do not understand how to institute their desired floor price.

Regarding your last paragraph, "I see Aramco's IPO as the single most dominating factor that will keep oil prices from falling.", the reason that they will be disappointed is clearly described in Jan Van Ecks' comment on this subject an hour ago. Too much supply causes sellers to drop the price in the hope that they can regain markets, but the speed of the price drop is much greater than the speed of any resulting demand growth. The result: unreasonably low prices.

Thank you for such a detailed response! Yes....I agree with price management.....and we can recall that this price management is one of the key features ever since D'Arcy bought that concession in Iran!

"Too much supply causes sellers to drop the price in the hope that they can regain markets, but the speed of the price drop is much greater than the speed of any resulting demand growth. The result: unreasonably low prices." ----- yes there are industry observers that now see oil falling to $50 in 3Q this very year. 

 

Interesting times ahead!

[Osama + 248]

14 hours ago, Jan van Eck said:

To give examples of how stimulated production will collapse price, I invite readers to contemplate two recent sets of events. 

The first example is Western societies' desires to recycling of plastics.  Before mandatory recycling, there was a market for recycled plastics, typically priced out to the converter (the final customer of the waste stream) of perhaps as much as 45% of the price of virgin resin.  This pricing generated producers of sorted plastics waste streams who would take in mixed waste and hire people to go separate out the plastics containers, run them through a water cleaner, then into a granulator, and typically through an extruder and pelletizer to make a rather nice finished product, plastic pellets that can be mixed with virgin resins to be injection molded or cast into some new product offering. 

Now along come governments who mandate forced recycling, and waste haulers put out special collection bins for recycled products, including metals, cardboard, and plastics, and the stuff is sorted and offered to the waste recyclers.  Vast amounts of fresh waste bombard the industry, and the price paid by the recyclers drops to zero. 

The increase in material offered by producers, in this case waste haulers/sorters looking for a home for the mandatory recycled material, places competing producers against each other, to the point where there is so much material that the converters of the waste pay little to nothing.  Why?  Because if Hauler "A" wants $20/ton for his stuff, to cover his costs of $18/ton and make a few pennies,   and hauler "B" needs to get rid of the mounds accumulating in his sorting building (and remember that there is this avalanche of fresh material arriving in the garbage trucks every day), Hauler "B" will drop his price to  whatever it takes to move the material, and thus gain market share.  So he drops to $10/ton, and that puts Hauler "A" and those buddies in the industry in the position of having raw product overwhelm the sort building, so they drop to $5/ton, and soon you are at "free."  

And that is what happens when producers overload the system; the market cannot absorb what producers are offering, so producers compete against each other for market, collapsing the price. 

The second example is the shipping industry (let's take containerships for our example).  The volume of container trade keeps expanding, mostly because of increases of China shipments, which overwhelmingly go by sea container.  That motivates the shipping companies to add capacity.  That drives up the demand for newer and bigger containerships, which the shipping companies typically charter from firms that specialize in ordering and chartering out these ships.  

The charter guys then place newbuild orders, but they are not calculating their newbuilds in comparison to what other charter guys are ordering, with the result that the charter market gets flooded with tonnage capacity when all the newbuilds hit the water.  Now you have these ships (which might run say $150 million new and have a Note from some bank to finance it, thus hefty payments to make) pushing out to the shipping companies.  That gives the shipping companies the ability to pick up the capacity at progressively lower charter rates - and in recent times, down below the cost of ownership, simply because the costs of layup are higher than the low charter fare. These companies now bleed cash, and the bankers are unable to repossess the boat because there is no market for it.  Who is going to buy  that boat and clear the Note when you can go charter some distressed asset for peanuts?  Nobody.  And there is blood in the water.

Meanwhile the shipping companies have been chartering extra capacity, stimulated by the prospect of more China boxes coming from those manufacturers shipping product to the USA and Europe.  What happens?  Those big new ships (and some are up to 22,000 Containers in capacity!)  have to run "full" or the fuel bill will kill the company, so again the prices they charge ratchet downwards to steal loads from their competitors.  As prices collapse, companies start to run in the red, until finally some shipping companies spectacularly collapse into bankruptcy (and stranding containers around the globe, because the ports refuse to unload ships where they are not assured of getting paid, and the drayage companies refuse to take containers of those ships as there is no assurance the containers when emptied will be taken back by the bankrupt shipper, thus choking their yards without revenue).  Check out what happened when Hyundai went under in the months before Christmas last year, and retailers in the USA were stuck with air-freighting replacement merchandise to replace what was stranded at sea or in port, with ships getting seized by sheriffs in say Singapore stocked with transit cargo headed for Hamburg. (You know how fast the courts work, so if you get your stuff within a year you are doing great. Just lovely.)

In all these cases, it is the production of product, whether plastic scrap or empty containers or massive ships, that drives the market price. It is not "demand" that drives price; it is "production," however couched.  Over-production needs to seek out a home, and if you have to steal it from a higher-cost producer, so that is what you do, even if - as in the case of electricity produced in Ontario at night by wind turbines on ruinous and onerous tie-in contracts - you have to dispose of your production by paying someone to take it. Don't think that the oil markets are somehow exempt from this truth.

The last paragraph says it all. Interesting views! I do agree with them..

What will you say to those who given the reduction in CAPEX in recent years (almost a trillion dollars) worry about a supply crunch in the near future. Just another reason to pump more I guess?

[William Edwards + 708]

33 minutes ago, Osama said:

Thank you for such a detailed response! Yes....I agree with price management.....and we can recall that this price management is one of the key features ever since D'Arcy bought that concession in Iran!

"Too much supply causes sellers to drop the price in the hope that they can regain markets, but the speed of the price drop is much greater than the speed of any resulting demand growth. The result: unreasonably low prices." ----- yes there are industry observers that now see oil falling to $50 in 3Q this very year. 

 

Interesting times ahead!

Interesting times, indeed!

[Jan van Eck + 7,558]

1 hour ago, Osama said:

The last paragraph says it all. Interesting views! I do agree with them..

What will you say to those who given the reduction in CAPEX in recent years (almost a trillion dollars) worry about a supply crunch in the near future. Just another reason to pump more I guess?

Ultimately, when the dust settles, I have no idea.  The reality of these markets is that they are driven by two factors:  greed and fear. 

I appreciate that you will find that unsatisfactory.  OK, so here are some theoretical thoughts. You assume that lack of capital investment in new fields will ultimately, at some future point, lead to reductions in offered product (crude oil).  But remember that most crude is not consumed "straight." There are exceptions:  crude from the Bakken in North Dakota is railed to Portland, Oregon, and the trans-Pacific ships can and sometimes do take the material straight from the railcar for use as bunker.  The Bakken crude has some diesel mixed in, used as a fracking fluid, and I suspect also contains volatiles as bubbles in the oil, such as butane and pentane.  That makes the crude capable of burn without further refining. 

The rest of the crude is being sold to refiners.  If production cannot fill orders, then prices will rise until some refiners drop out, because oil is a physical product and the refineries need physical product.  The refiners are creating finished product to be (eventually) sold at retail, so there will again not be enough production to supply orders, and the prices at retail rise until buyers either economize (i.e. driving slower, turning down the house thermostat) or drop out as buyers. Those buyers then look for substitute goods to replace their oil consumption habits. 

It is this threat of substitute goods that puts fear into the hearts of oil producing nations: the permanent loss of customers. When that happens, you will again see producers pumping loads that cannot find a home, and raids on competing producers by dropping the price.  As oil is inelastic, a price collapse is entirely predictable.  Let us look as some of these substitute goods. 

In Western markets, the first substitute good is insulation, also referenced as "weatherization."  When buyers are pushed to spend money on insulation, a permanent final customer home is lost, forever, to producers.  Insulation of an older home requires getting into the walls, and creating an air-lock at the entrance door.  Now, tearing out the sheetrock on the inside is a bear, lots of dust and disruption, so typically the outside wood clapboard covering is removed, a plastic wrap sheet is installed, and a layer of insulation board is attached. Then the siding is re-attached.  Now, this is an expensive project, and if the price of heating oil is low enough, nobody does this.  Jack up the price,and this is one result. 

The other result is that customers yank out the oil furnace and install a propane or natural-gas furnace, going to "substitute goods" for oil. 

The next area of substitute goods is with the automobile (and bus and truck).  Much has been written about electric drives, so I won't go there.  What you will see is an explosion of hybrid offerings, which effectively reduce the amount of distillate fuel needed to travel a specific distance. So, once that fleet hits, permanent customers are lost forever to the producers. 

Even more dangerous to the producers is the electric bicycle.  Consumers faced with high vehicle ownership costs, including insurance, maintenance, and fuel, will abandon those machines and buy a bicycle  (or its more expensive cousin, the electric motorcycle).  Electric bikes are in a rapid phase of evolution, and mass acceptance is out there simply because the barriers to entry to manufacture them are quite low.  Anybody can get into the business.  Caveat:  I own a production plant that makes a version that will run at 45 mph and with a range of 40 miles per charge, and has saddle-bags to carry your briefcase and groceries. The operating cost including finance is $15 a week.  As a substitute good, it permanently steals customers from the oil refiners and producers. And there are many entrants into the market, including bike-share companies, that make it cheaper and cheaper to get a substitute product. 

The further result of substitution of goods is the electric hoverboard (or rollerboard), which consists in essence of a plank onto which wheels are mounted, plus a collapsible pole and handlebars for control.  A small electric motor is fitted and a battery.   The urbanite can effortlessly roll along at a decent clip on his hoverboard, and when mounting a bus or at the office, fold down the handle and carry it as a satchel.  Your fuel use is down to zero. 

As substitute goods hit the market, oil becomes a good with limited homes.  And as these substitute goods, especially in personal transport, hit with a vengeance, there being low barriers to entry for manufacturers and low retail pricing which entices buyers of the machines, your distillate fuel consumption drops below what is being produced. And now the shoe is on the other foot, with oil loads chasing homes with closed doors.  So, again, blood is in the water and producers are fighting with each other to unload their production - and the price of oil drops like a stone. 

The point is that the overall demand for fuels, if unmet, will result in a stimulation of substitute goods, which will permanently take consumption off the table.  And this is the big fear of the producers.  Two things drive markets:  greed, and fear. 

[jaycee + 348]

I have been reading this chat room for a few weeks and this debate has prompted me to register to post. I see all the comparisons to plastic recycling and shipping etc being used to predict low oil prices however the industries choosen differ in one fundamental way from oil they do not have a cartel of most of the major supliers trying to keep prices up. Will OPEC and Russia continually produce oil at below production costs and do nothing? I don't think they will and as has happened this time rivalry will be put aside for mutual protection and they will agree production cuts to reduce any glut.

 

[William Edwards + 708]

6 hours ago, Jan van Eck said:

Ultimately, when the dust settles, I have no idea.  The reality of these markets is that they are driven by two factors:  greed and fear. 

I appreciate that you will find that unsatisfactory.  OK, so here are some theoretical thoughts. You assume that lack of capital investment in new fields will ultimately, at some future point, lead to reductions in offered product (crude oil).  But remember that most crude is not consumed "straight." There are exceptions:  crude from the Bakken in North Dakota is railed to Portland, Oregon, and the trans-Pacific ships can and sometimes do take the material straight from the railcar for use as bunker.  The Bakken crude has some diesel mixed in, used as a fracking fluid, and I suspect also contains volatiles as bubbles in the oil, such as butane and pentane.  That makes the crude capable of burn without further refining. 

The rest of the crude is being sold to refiners.  If production cannot fill orders, then prices will rise until some refiners drop out, because oil is a physical product and the refineries need physical product.  The refiners are creating finished product to be (eventually) sold at retail, so there will again not be enough production to supply orders, and the prices at retail rise until buyers either economize (i.e. driving slower, turning down the house thermostat) or drop out as buyers. Those buyers then look for substitute goods to replace their oil consumption habits. 

It is this threat of substitute goods that puts fear into the hearts of oil producing nations: the permanent loss of customers. When that happens, you will again see producers pumping loads that cannot find a home, and raids on competing producers by dropping the price.  As oil is inelastic, a price collapse is entirely predictable.  Let us look as some of these substitute goods. 

In Western markets, the first substitute good is insulation, also referenced as "weatherization."  When buyers are pushed to spend money on insulation, a permanent final customer home is lost, forever, to producers.  Insulation of an older home requires getting into the walls, and creating an air-lock at the entrance door.  Now, tearing out the sheetrock on the inside is a bear, lots of dust and disruption, so typically the outside wood clapboard covering is removed, a plastic wrap sheet is installed, and a layer of insulation board is attached. Then the siding is re-attached.  Now, this is an expensive project, and if the price of heating oil is low enough, nobody does this.  Jack up the price,and this is one result. 

The other result is that customers yank out the oil furnace and install a propane or natural-gas furnace, going to "substitute goods" for oil. 

The next area of substitute goods is with the automobile (and bus and truck).  Much has been written about electric drives, so I won't go there.  What you will see is an explosion of hybrid offerings, which effectively reduce the amount of distillate fuel needed to travel a specific distance. So, once that fleet hits, permanent customers are lost forever to the producers. 

Even more dangerous to the producers is the electric bicycle.  Consumers faced with high vehicle ownership costs, including insurance, maintenance, and fuel, will abandon those machines and buy a bicycle  (or its more expensive cousin, the electric motorcycle).  Electric bikes are in a rapid phase of evolution, and mass acceptance is out there simply because the barriers to entry to manufacture them are quite low.  Anybody can get into the business.  Caveat:  I own a production plant that makes a version that will run at 45 mph and with a range of 40 miles per charge, and has saddle-bags to carry your briefcase and groceries. The operating cost including finance is $15 a week.  As a substitute good, it permanently steals customers from the oil refiners and producers. And there are many entrants into the market, including bike-share companies, that make it cheaper and cheaper to get a substitute product. 

The further result of substitution of goods is the electric hoverboard (or rollerboard), which consists in essence of a plank onto which wheels are mounted, plus a collapsible pole and handlebars for control.  A small electric motor is fitted and a battery.   The urbanite can effortlessly roll along at a decent clip on his hoverboard, and when mounting a bus or at the office, fold down the handle and carry it as a satchel.  Your fuel use is down to zero. 

As substitute goods hit the market, oil becomes a good with limited homes.  And as these substitute goods, especially in personal transport, hit with a vengeance, there being low barriers to entry for manufacturers and low retail pricing which entices buyers of the machines, your distillate fuel consumption drops below what is being produced. And now the shoe is on the other foot, with oil loads chasing homes with closed doors.  So, again, blood is in the water and producers are fighting with each other to unload their production - and the price of oil drops like a stone. 

The point is that the overall demand for fuels, if unmet, will result in a stimulation of substitute goods, which will permanently take consumption off the table.  And this is the big fear of the producers.  Two things drive markets:  greed, and fear. 

Thanks for the additional perspective on substitute options.

Since you are obviously a much better typist and are infinitely more willing to give detailed explanations than I, could I make a request? Would you consider doing a piece in which you discuss the impact of timing, or lag time, on the change in both supply and demand which would result from a change in price? It would seem that most of the thinking considers an instantaneous response when, in fact, response time for high cost production may be decades to either turn on or turn off the resulting investment. A decision is made today, and the result appears in 2025. The response of demand to a price change is quicker, but still may be a year or two, and the impact is much smaller.  Would you consider thinking through and presenting this timing aspect?

Operating an industry with wildly fluctuating prices and long lag times is analogous to driving a car where both the accelerator and the brake have a five mile lag between activation and result. You would never be able to know when to hit the gas or the brake, and, further, you would never be able to look back and examine what you should have done. This explains the fundamental reason why most people get it wrong when they assess prices, supply and demand.

[William Edwards + 708]

58 minutes ago, jaycee said:

I have been reading this chat room for a few weeks and this debate has prompted me to register to post. I see all the comparisons to plastic recycling and shipping etc being used to predict low oil prices however the industries choosen differ in one fundamental way from oil they do not have a cartel of most of the major supliers trying to keep prices up. Will OPEC and Russia continually produce oil at below production costs and do nothing? I don't think they will and as has happened this time rivalry will be put aside for mutual protection and they will agree production cuts to reduce any glut.

 

"OPEC and Russia continually produce oil at below production costs"? "cartel"? Since my understanding is that neither of these statements are valid, could you please enlighten me by presenting the validation of your assertions? And regarding your use of the term "glut", could you please define this for us? History has shown that there has always been enough oil supply at the prevailing price. Obviously the supply capability was more than enough, and whether that capability exceeded consumption by one barrel or a million barrels was of little actual significance.

My guess is that when you provide your explanation it will be based upon the flawed presumption that, somehow, supply capability or demand magically set the price of oil, and on an instantaneous basis. If I have guessed wrong, please straighten me out.