Post on 30-Dec-2015
The energy crisis: Background and outlook
Short courses for Permanent Missions in GenevaAdapting to the new energy realities: trade and
development perspectives31 October 2008
Olle Östensson
Outline
• 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
Source: IMF, International Financial Statistics database.
Figure 1: All commodity and energy prices, 1993–2007(index numbers, 2000=100)
0
50
100
150
200
250
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Energy All commodities
Oil prices increased most: Crude oil prices 1960 to mid-2008,
US$/barrel
-
20
40
60
80
100
120
140
1Q1960
2Q1962
3Q1964
4Q1966
1Q1969
2Q1971
3Q1973
4Q1975
1Q1978
2Q1980
3Q1982
4Q1984
1Q1987
2Q1989
3Q1991
4Q1993
1Q1996
2Q1998
3Q2000
4Q2002
1Q2005
2Q2007
Nominal Real
Source: UNCTAD Commodity Price Bulletin
Price increases for coal and natural gas were more modest
Source: UNCTAD secretariat calculations based on IMF, International Financial Statistics database.
Coal price is for Australian coal. The real price is the nominal price deflated by the United States Consumer Price Index (CPI).
Figure 2: Coal prices, nominal and real, annual, 1970-2007 (Dollars per metric ton)
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20
40
60
80
100
120
140
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006
Nominal price Real price
Source: UNCTAD secretariat calculations based on BP (2008) and IMF, International Financial Statistics database.Gas price is natural gas European Union cif; the real price is the nominal price deflated by the United States Consumer Price Index (CPI).
Figure 3: Natural gas prices, nominal and real, annual, 1985-2007 (Dollars per million Btu)
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1
2
3
4
5
6
7
8
9
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
Nominal price Real price
Reasons for the price increase
• Demand– Two years – 2003 and 2004 – with above trend increases– Geographical differences– Expectations
• Supply– Slow capacity expansion– Low spare capacity, concentrated in one place– Inventories
• Supply-demand imbalances and price spikes in commodity markets
• Other factors– US$ depreciation– Mismatch of refinery capacity– Speculation?
Global oil demand, change on previous year, %
Source: International Energy Agency, Oil Market Report, various issues
-2
-1
0
1
2
3
4
5
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Forecast September 2008
Shares of increase in global oil demand 2001-2007, %
21%
2%
19%
26%
19%
13%North America
Europe
Other Asia
China
Middle East
Others
Source: International Energy Agency, Oil Market Report
Large share for China, Middle East and Other Asia – but also for North America
Developed countries still dominate total demand
29%
18%10%9%
11%
5%
8%4% 6%
North America
Europe
OECD Pacific
China
Other Asia
Former Soviet Union
Middle East
Africa
Latin America
Energy intensity, metric tons oil equivalent per thousand US$ in nominal and PPP 2000
exchange rates
OECD MiddleEast
Ex-USSR
China Asia Africa
US$ 2000 PPP
US$ 20000
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Source: International Energy Agency
China was expected to follow “the Korean path”
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100.0
200.0
300.0
400.0
500.0
600.0
700.0
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
China
India
Japan
Republic of Korea
USA
Russian Federation
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
producers
• 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 week’s 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 behaviour
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 years
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2003 2004 2005 2006 2007 2008
Mil
lio
n B
arre
ls P
er D
ay
?
Estimate 1 year ahead
Estimate end of current year
Sources: December editions of IEA’s Oil Market Report.
Summary of factors
0
30
60
90
120
150ja
nv
.94
jan
v.9
5
jan
v.9
6
jan
v.9
7
jan
v.9
8
jan
v.9
9
jan
v.0
0
jan
v.0
1
jan
v.0
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jan
v.0
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9
$200
8 D
oll
ars
Per
Bar
rel/
Day
s S
up
ply
0
2
4
6
8
10
Mil
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n B
arre
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ay
WTI Spot ($2008)
OECD Days Supply
World Excess Production Capacity (right axis)
Sources: WTI: Reuters; OECD Days Supply: International Energy Agency and U.S. Energy Information Administration estimates; World Excess Production Capacity: U.S. Energy Information Administration estimates.
Other factors
• US$ 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
Speculation?
• 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 variations
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 commodities
• 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 price
• 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? (cont’d)
• 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 covered
– 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 $25-30/bbl - and capacity is constrained by availability of land and water, trade barriers and standards
– OPEC oil can not be taken for granted
US Energy Information Administration:
International Energy Outlook 2008 • Liquids production in reference case 112.5 Mb/day in 2030 (increase 1.2
%/year)• 9.7 Mb/day are projected to come from non-conventional sources, accounting
for a quarter of the production increase• OPEC’s share of production increases very slightly (from 41 to 42%), the share
of non-OPEC conventional oil falls
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80
1984
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2028
Reference
Low Price
High Price
Prices are assumed to remain relatively high
EIA forecast, Mb/day
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120.019
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1994
1998
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Non-OPEC Conventional
Unconventional
OPEC Conventional
Total
OPEC production
• OPEC is an intergovernmental organization operating on the basis of consensus, decisions are usually the result of compromises
• Several OPEC producers are experiencing cost increases
• Only a few have large enough reserves to be able to increase production significantly in the long term (Iran, Iraq, Kuwait, Sadi Arabia)
• Iran and Iraq have large populations and could use additional income – but is such income better generated by increased market share or (continued) high prices?
• Kuwait and Saudi Arabia have small populations and no need to increase their market share
• Conclusion: OPEC can not be counted on to automatically make up the shortfall in world production, that is, act as swing producers
Conclusion: a realistic (?) assumption
• The long term production cost of alternatives to conventional oil will set a floor for crude oil prices at US$ 60-80/bbl in today’s dollars
• The price can and will fall below this floor, but only for limited periods
Thank you!