So spread the news to your flock, taking care to explain to them that if they are 'in' the oil market they should be on their toes at the conclusion of the present macroeconomic/financial-market malaise. If there will be a conclusion of course.

It seems you and Tam are on the same page with this article - minor miracles are indeed possible.

Education of the public and of governments is certainly a big problem, and the media could do a much better job than 60 Minutes did. Trouble is 60 Minutes is much more widely viewed than the intelligent posts you and Tam make to websites like this and others.

There is hope however since I believe the public is now sensitized to volatility in oil prices, and to the likelihood of future price spikes FOR WHATEVER REASON. Most average Joe's on the street hugely distrust oil companies, and deplore the apparent lack of action by governments to help get us off oil dependence. The intense world economic recession is now only partly to blame for the sudden decline in sales of new cars - it is being exacerbated by the public's fear of future oil prices, and the dilemma of deciding what to do about it for new vehicle purchases.

- Bob

This is a really well-written article. You did a great job in making the case for a supply-demand mismatch supporting higher oil prices.

My belief is that oil traders finally "got" the reality of peak oil in late 2007. This, along with the supply limits, caused them to spur the prices higher. What they didn't realize is that though supply might be limited (the peak oil supply month may very well be July, 2008) a slowing economy can reduce demand, which will bring prices down.

As you probably know, the oil drum folks look toward an undulating peak where oil demand rises as the economy recovers until it hits the production limit, causing the world economy to stall again. This will keep occurring until we use less oil in our economy commensurate with our GDP. So doing things that will displace future oil use is probably a good thing to do now, even though oil prices are not high at this point.

For what it's worth, I do think the populace realizes that oil prices will someday spring back to higher levels again. Three times fooled is enough.

As a requirement of bailing out the Amercian Big Three auto manufacturers, governments in both the US and Canada are insisting they table business plans based around much more fuel-efficient future products that consumers will buy. They effectively will be forced to do things that reduce our oil dependence for their own survival, which is perhaps one of the only good things resulting from the current economic recession.

Jim, thanks for the kind words. I agree we'll have an undulating peak, but it will be an undulating DECLINING peak, making it quite clear after the first iteration or two that we will never exceed the 2008 production figures.

If near panic can be sewn by speculators (aka “hedge” funds as well as unscrupulous market participants), then massive profits can be made. History has numerous examples of this sort of mischief.

I suspect hedge fund involvement in the oil run-up was much larger than in the past as a result of pretty much minimal regulation and oversight coupled with massive amounts of money held by the hedge funds.

The current commodities markets allow huge bets to be made with little or no collateral – derivatives are a real good example of betting. While some may argue that the “market” will ultimately prevail and punish the miscreants, the damage done to economies (industry, business and consumers) can be and has been staggering. This undue economic carnage needs to be avoided.

Reforms need to be implemented in commodities markets such that if you want to place a dollar bet, then you have to put down more like a dollar, as opposed to say 5 cents. Other reforms can also be implemented. For instance, in the corn markets, there is always the threat that you actually have to take delivery of the commodity.

I do very much agree with Tam that the underlying trends are dire, as his excellent article points out.

In order to avoid future massive economic dislocations, fundamentally more abundant “fuel” is needed within the transportation sector. That “fuel” is not necessarily limited to oil.

The joker in the pack is 'demand destruction', an expression I ignored until it came about with the macro/financial-market meltdown. I hope that somebody important is thinking about this.

A complex and often oversimplified subject indeed. If our mutual good friend Fred who has spent a lifetime studying this market doesn't know I am quite sure few others do.

But as you say the real problem is that sooner or later there will not be sufficient oil to go around therefore the call by the IEA for reducing carbon fuel use including oil makes some sense...although there is no pressing shortage of coal or methane gas as far as I know.

I added your quote from the IEA again....

The IEA report concludes: "Securing energy supplies and speeding up the transition to a low-carbon energy system both call for radical action by governments -- at national and local levels."

......because it sounded to me a like call to build lots of nuclear plants - a subject where I fear you and I will never agree.

But, Tam...miracles do happen so I always live in hope that you will someday realise that nuclear power is the only real long term sustainable emissions free energy source.

A good article Tam...one of your better ones.

Malcolm

Detroit deserves alot of blame for the mess it got itself into, but a significant share of that has to be shared by US consumers. Buying trends seem to be if you want mpg buy foreign, but if you want muscle, buy American. Ford makes a 60 mpg car, but cannot sell it here because it's a diesel.

To add to the complexity of oil pricing, if the US mandated PHEV/BEV/CAT vehicles only, dropping our oil consumption 4% a year for 10 years, the price of oil will drop or go flat. Which will make any such mandate difficult to hold to, as what one friend refers to as the "angry villagers" start getting fired up.

I will freely admit there could be unintended consequences of any restrictions of this sort.

But if it is, so what, since it is speculation in paper oil rather than physical oil. The lovely Paul Krugman made this point when he noted that the talk about speculation taking the oil price to 150 was horse raddish. There is of course a speculative component due to the influence of paper oil on expectations for physical oil, but that is probably not very much.

I'm doing a paper on this now, but with reference to the discussion on the 'Swans' paper, I will not have it peer reviewed. When I worked in Geneva I got into a conversation with a very well known economist from a well known university, and he said that he was peer reviewing by the dozen. However it was easy he said because the first thing he asked when reviewing a paper was "WHO IS THIS MAN, AND WHAT CAN HE DO FOR ME?". I'm talking here about economics and not real science, but even so..

I'd only add two things, the first of which I'm surprised Fred didn't mention, namely the role of the collapse of spare capacity, not just the stagnation of supply. WTRG has a nice chart on this that I have referenced periodically in my Energy Outlook blog. (See: http://www.wtrg.com/oil_graphs/excess.gif)

The other is that to whatever degree speculation did influence the NYMEX price, this would have been transmitted directly to the market for physical oil, since the majority of oil now trades at a negotiated differential above or below WTI, rather than a posted or negotiated absolute price. While I believe this explains less of the price movement than the fundamentals you described, it could certainly have added some froth to the market, amplifying the spike.

A few points: 1) Clearly, the runup and collapse of the dollar price of oil had elements of 'speculation'. i.e., what Fred calls the trading in paper oil. The real supply and demand did not change by that much in so short a time, though traders' expectations about future demand and supply certianly could and apparetnly did. 2) Clearly, too, as the comments above point out, the expansionary monetary policy and laissez faire financial regulation left a lot of hedge fund and other money sloshing around chasing peak oil rumors and the like. When that money evaporated in margin calls and covers, the boom not only stopped but busted. 3) Let's not forget the influence of the weakening dollar price of gold, (as per my 15Oct08 Energy Pulse piece): $100/barrel oil was consistent with $1000/oz gold. So here we go again - Toyota is canceling its new Prius plant because demand for hybrids has crashed with the price of oil and the economy/credit crunch. As the cartoon character Pogo famously misqouted Caesar's Gallic Wars: "We have met the enemy and he is us." Can't we take charge of our own energy destiny with a rational plan to become less oil dependent?

Maybe some of them will turn up here in the Kingdom of Sweden, where there is going to be a huge energy conference in March, organized by the government's energy organization. The ignoramus who arranged it thinks that wind can replace nuclear, and he hopes that he can obtain some international attention with this screwy message, which might lead to a nice high-salaried non-job later on. I just hope that he and his experts don't express themselves on oil.

I agree with Dan to watch the price of gold. When Nixon trashed Bretton Woods and allowed the price of gold to float, the Oil Embargo of '73 occurred not long after. Not just a coincidence.

http://www.cera.com/aspx/cda/public1/news/pressReleases/pressReleaseDetails.aspx?CID=8444

James Carson JBCarson@RisQuant.com

And as for that find off the Brazilian coast, too little and too late - given the amount of time that it will take to get large amounts of it to market.

As for the collapse in spare capacity, of course it has collapsed. Wouldn't it collapse if you were calling the shots for those other people? Why build out capacity in order to press down the price? There is an argument for doing it of course, which iturns on cooperation between oil exporting and oil importing countries, but when OPEC proposed that a couple of decades ago, Milton Friedman explained why it shouldn't be done. and as usual the fools listened to him.

Banks: Like I said, I am no oil guy. My field is power. However, I find Yergin/CERA much more compelling than you. Sorry. Incidentally, your argument makes sense if and only if producers actually controlled the oil market. Since the recent price record indicates otherwise....

I don't think CERA really has done that well, prediction-wise, since we've come to this time of peak oil. Even so, they also agree to an undulating peak, which is basically a PEAK. As in peak oil. CERA also forecast a much higher peak than what occurred in July, 2008, which may prove to be the actual peak.

CERA might believe the world economy crashed before that peak could be reached, but other might state the world economy crashed BECAUSE the peak was reached. Time will tell.

I think quibbling about what the post-peak decline looks like is a bit petty, though I'm more inclined to believe the oildrum folks, who predict steeper declines. (Mostly because that's what individual oil fields do, like Cantarell.)

I'd admit it's rather risky to question Daniel Yergin on matters of oil. But I've noticed that knowledgeable experts are usually right until they are not. Unfortunately, they rarely inform us when this transition has taken place.

As for this business of who controls the market, producers and consumers control the market. To say or think that speculators control the market is the kind of ignorance that is rapidly going out of style except for the hysterical bloggers that one can't help encountering these days.

About your field being power. Why don't you put some of your thoughts about electric deregulation into article form, and let us get a look at it. Then we'll know exactly what you are.

And finally, the IEA and EIA. You are definitely right about the IEA, but I'm inclined to give the EIA a pass. As for the statistics that you say they "regurgitate". I'd take a careful look at them if I were you. What they show is a decline or stagnation of output in some important producing regions, and given decline rates and the absence of spare capacity that is just the beginning. As a result, THE PEAK IS NO LONGER IMPORTANT. Who cares about the peak if the oil price goes to $150/b again?

As for IEA and conventional wisdom, I agree this has been their pattern previously. But they broke remarkably from that pattern with the 2008 WEO. I don't get the impression you've read this yet, from your comments. Read it. It's the first time they've done a field by field analysis. Ever. And it's the first time they've include climate change considerations. The 2008 WEO is a revoutionary document, calling for revolutionary ("radical") action by governments everywhere.

I'm surprised to hear about the IEA however. I had given them up as hopeless, but if you say that they are on the ball now, then that's great. Of course, being on the ball where I am concerned means agreeing with me about oil (and electric deregulation). Outside of those two items I'm always ready to learn something.

However, that nuttiness is useful to me, because I've got to give some lectures about the short-run situation with oil, and the nuttier the audience is the more I will shine. AND LET'S GET SOMETHING STRAIGHT: THAT NUTTINESS ABOUT SPECULATION DID NOT ORIGINATE WITH MICHAEL M. IT ORIGINATED WITH OPEC TO EXPLAIN AN OIL PRICE ESCALATION THAT CAME ABOUT BECAUSE THEY REDUCED OR KEPT STAGNANT THEIR OUTPUT. Wouldn't you have done the same thing if you were in their place?

What about that famous $25/b increase that took place in one day without - Mr M said - large changes in supply and demand. Well, if you have an icon like T. Boone saying that oil is going to go to $200/b, then those lovely guys and gals on Wall Street start shouting into their phones. But that's today. Tomorrow the demand countinues up - as demand was still doing and will continue to do - while supply stagnates, thus 'verifying' the rise. The bottom line for some people is the shouting into phones, but for me it's demand outrunning supply.

That's short term. Long term more oil is being consumed than is being found, deposits are depreciating (natural decline), OPEC is NOT going to invest in much more capacity because OPEC is smart, but even so more oil has to be consumed. Don't do the math. Close your eyes and think for a minute or two. Then you'll realize what is going to happen without having to talk about peaks and things.

I don't know that anyone has been 'right' in a long time.

Banks << About your field being power. Why don't you put some of your thoughts about electric deregulation into article form, and let us get a look at it. Then we'll know exactly what you are. >>

I likely will do so when I have some time. I do recall that we tangled about power deregulation two years ago. I will say that I believe, in contrast with yourself, that power deregulation has been successful in the markets that I work in, MISO, NYISO, ISONE & PJM. Further, ERCOT and CAISO are moving towards conformity with the eastern markets model because of their success.

Perfessor Banks: May I point out that the same arguments were made in the late 70s?

The situation is as follows. I haven't been wrong on oil for almost 30 years, although early in the 1980s I made a very bad mistake. BUT, the oil price did go where I said it would go, and it will return. However let's be clear about Mr Yergin. HIS MISTAKES have been very useful to certain persons.

On electric deregulation, this is a topic that interests me a great deal, but you are probably more up to date on this than I am, and so on second thought I dont think that I will tangle with you - unless of course I'm paid to do so.

I think a better terminology might be a “reasonably regulated” market place, with the interactions of the involved parties (private power companies, municipal power, government, industry, consumer, etc.) establishing what is “fair”. I sure as hell would not let a completely “free” and “deregulated” power market prevail, given the long history of abuse promulgated by weakly restrained financial interests. My thinking is based on the inherently monopolistic nature of electrical power – options are quite limited, thus inviting abuse.

Most traders would be thrilled with a 60-40 record on being right.

Keller << I'm not so sure I would characterize the various markets (MISO, PJM etc.) as “de-regulated”; the transactions are quite complex and hardly unfettered of rules imposed by the government attempting to artificially emulate a free market. >>

1> The term 'de-regulated' market does not mean, and never has meant, 'un-regulated'. 2> Even the grain markets have pervasive regulation wrt grading and many other rules. Some of those regulations are imposed by government (FDA, CFTC), some by the exchanges themselves (MGEX, CBOT, KCBOT). Often, the exchanges enforce government rules. Fyi, I worked in the Compliance Department at the MGEX for a time. 3> ISOs are not government agencies. They operate much more like an exchange. You may not see a distinction, whereas I do.

Keller << My thinking is based on the inherently monopolistic nature of electrical power – options are quite limited, thus inviting abuse. >>

The ISO operated markets are extraordinarily competitive. In fact, I would venture to say that they are far more competitive than markets that are widely acknowledged to be highly competitive, e.g. grain. Their 'inherently monopolistic nature' has been broken.

Hunt << as the CFTC report demonstrated, most traders were actually betting that prices would go down (shorts) during the big six month runup in early 2008, not the way they actually went: way up. >>

My recollection of the COT report differs. I recall that specs were net long in early 2008. I remember looking it up when the nonsense came through the media blaming the speculators for the price runup. Nevertheless, I agree with your conclusion that speculative pressures did not lead to the oil price spikes. Very few traders are outright long or short anyway. The vast majority are trading long versus short, trying to exploit relative price discrepancies.

For my part, the key to understanding the oil price run up lies in the changes in the intermonth spreads. Normally, the oil market is inverted. That is, the nearby price is usually higher than the deferred price. Economists typically bandy the term 'convenience yield' as the reason why this happens.

During the run up, however, the market changed to a contango profile. The deferred months' prices grew progressively higher, rising more rapidly. To me, that says that the market was anticipating a shortage in the future. The world economy was robust, especially in Asia. Demand for energy seemed to be growing rapidly. There is a natural limit to how steep the contango can be that is determined by the cost of storage and producer opportunities to defer production.

However, the rising cost of energy tipped the world into recession, which also toppled several vulnerable industries, including housing and banking in the US. That has brought the price of energy to its knees in short order. Recessionary demand destruction has led to lowered prices. I do notice, however, that the market remains contango. that is, deferred prices remain a substantial premium to the nearby.

About 'convenience yield'. It has the 'almost' the same importance for this topic as Einstein's mc(exp2) for relativity.

Alternatively, things can also get back to normal if we not longer believe peak oil is real, then we are honky dorry. That is, until we hit the production peak again.

I guess if the economy declines so badly that nominal production requirements are so far below peak production (July, 2008) that the peaking is a longer term concern, the markets might act quasi-normal as well.

I dunno dudes, we might be ~screwed.

That is not true. The August 2008 WTI contract traded up to $147 during the week of July 7th. The August contract would have been spot month that week. In any case, that WAS INDEED the real price regardless of whether or not it was a 'speculator's bet'.

Banks << About 'convenience yield'. It has the 'almost' the same importance for this topic as Einstein's mc(exp2) for relativity. >>

Isn't 'convenience yield' the label that economists use to explain the normally inverse energy forward curves? My reference to it was strictly limited to a brief explanation as to why energy markets are typically inverted. In any case, let's not argue about this (again) as I don't believe in 'convenience yield' anyway.

James Carson JBCarson@RisQuant.com

We talked about this before, there were other issues in place such as a physical limit to supply, similar to what happened in the silver market in the early 80's when the Hunts were attempting to corner it. West Texas Intermediate doesn't have that great a production quotient, and it is declining, so even though it is the "benchmark" there isn't a lot of it to go around. What is useful about WTI is it is such easy oil to refine (especially into gasoline) so all other oil is discounted relative to it, some exceedingly so.

The media is always wrong (I should just put a period here) - when they talk about this number being the "price" of oil. There are oils out of Venezuela for instance that sell at a 60% discount to WTI on a regular basis. During the price runup, Nymex itself got squeezed because just like with silver they sold more than they had to sell (they were counting on the contra contracts Carson talks about materializing, when they didn't, uh-oh). In the case of silver, Nymex was able to call foul and get their posterior covered, but in the case of oil, since it is so internationally traded, the ability of US regulators to pick on someone here was extremely limited. A certain Dutch trading firm comes to mind. Other major players in the game included the Chinese government trying to create their own strategic oil stockpile (at the worst possible time) and all the quant hedge fund traders swimming with new kinds of sharks in a bigger ocean than they expected. Finally of course what I'd said before about demand destruction due to the high costs of fuel came true with a vengeance. The only question today is how much destruction and for how long?

Looking to the future (a far more interesting state of mind than constant historianism) what does the current price portend? The majors are pulling back from investments left and right and marginal cost production is being pulled off-line or capped. Minors are facing credit defaults and are mulling over rotten offers from majors for assets at 10 cents to the dollar. An industry that barely recovered from the layoffs and restructurings of the 80's and 90's is getting ready to do it all over again. Petroleum engineers who used to graduate in the 10's of thousands now graduate in the hundreds, to poor prospects. Meantime, the world is consuming roughly 82 million bbls per day, down about 3 million bbls from its peak. The limits to supply have not changed, new elephant fields don't exist like before, but are replaced by high cost production such as Canadian oil sands. Even an elephant field takes ten years to bring to full production, the oil sands are double that, especially in out of the way places like Ft. McMurray.

So, we are facing a potential lost decade (ala the Japanese) wherein infrastructure in oil development/production is ignored, and as the economy falters to a recovery, the NEW oil prices will, without speculation - attain prices even the naive traders who lost their shirts this go-round could only dream about. The fuel that powers the world economy is oil, and no recovery can be complete without it. Unfortunately any recovery that occurs will only exacerbate the problems coming when the, ahem, oil hits the fan.

The transmission lines and generators are relatively limited in number (unlike say supplies of grain, which also can be stored).

Is the RTO somewhat of an artificial creation? Yes, in the sense that the underlying pricing mechanism is based on a complex nodal mathematical network designed to mimic constraints and demands within the electrical grid. Does a similar single entity and central model control, say grain markets (as in prices)? No.

Do we see some of the imaginative elements of commodities trading in the RTO system? Yes. I suspect it might be a good idea to get rid of that source of potential mischief, with the RTO’s completely avoiding any participation in the convoluted world of options trading.

Are the interests of the end users (business, industry and the consumer) the primary consideration for the RTO's? No, as the RTO's deal in the wholesale power market.

Do we see FERC (government regulatory agency) investigating the RTO's in response to allegations of a lack of independence? Yes. Are some changes being made by the RTO's as a result? Yes. Checks-and-balances at work.

Has the balance ever been overly tipped (gamed) in favor of the traders? Yes, on occasion. For example, some speculators drove up the cost of power in California several years ago. Did similar conditions exist with the oil price run up this summer? Probably not – likely was just the simple hysteria and emotions of your basic “bubble”, as opposed to covert manipulation of supply.

Given the vast amounts of money involved and constraints inherent to power generation and transmission, some level of government oversight is needed -- i.e. the market needs a reasonable level of regulation. Is the oil market the same as the power market? Not really, as there is no underlying centralized RTO (unless OPEC is like an “RTO”???) and central mathematical model setting prices.

Are the RTO's better for the end user? Tough call and open to diverging opinions in both directions. How about the generators? Seems to depend on if you’re an Independent Power Producer or regulated utility. Has the monopolistic nature of power been broken by the RTO's, as suggested by James. Based on the somewhat unhappy reactions of regulated utilities, I’d have to agree with James. Do we run the risk of the RTO’s becoming monopolistic in their own right? If completely unrestrained, yes.

Ultimately, I believe the end users are better served by ample and localized nearby generation, but that is a major brouhaha in itself. Would the end user be better off having nearby and plentiful supplies of energy (which includes oil) for transportation? I would vote yes on that.

Gee -- this is pretty far afield from Tams insightful article! Sorry about that.

Incidentally, I was thinking about the statement by your good self in which you say that the key to understanding the oil price is the change in inter-month (contract) spreads. THIS IS WRONG. Those changes are effects, rather than causes. The causes reduce to the physics of supply and demand. Of course I'm not going to make heavy weather of this in this forum, because until the oil price starts racing up I am going to give the unlearned some instruction in short-run phenomena, and heaven help those who think that they know enough to challenge convention.

I agree that the media is (nearly) always wrong. Especially watching CNBC, there seems to be two agendas underway. First, I suspect that the NYMEX floor traders have a running contest to see who can make the talking head make the dumbest comment. Second, I suspect that media commentary is used primarily to talk a large position that some trader with media connections wants to exit.

I beg to differ on your point about the price of oil. The spot month WTI futures price is widely used to price physical oil as well as other varieties of oil as a basis differential. Significant quantities of physical oil were transacted versus the $147 price during that week. The fact that the August contract went off the board and into delivery for $128 is irrelevant.

Finally, I fear that your prognostications are all too prescient.

Keller << The Regional Transmission Operators like PJM make a profit by managing the movement of power thru the grid. By definition, a single entity (a specific RTO) controls a large area. >>

Yes. The RTOs are designed to monopolize transmission and manage the market mechanisms.

Keller << Is the RTO somewhat of an artificial creation? Yes, in the sense that the underlying pricing mechanism is based on a complex nodal mathematical network designed to mimic constraints and demands within the electrical grid. Does a similar single entity and central model control, say grain markets (as in prices)? No. >>

Well.... Your point is well taken. However, you might be surprised to learn just how regulated the grain markets actually are.

Keller << Do we see some of the imaginative elements of commodities trading in the RTO system? Yes. I suspect it might be a good idea to get rid of that source of potential mischief, with the RTO’s completely avoiding any participation in the convoluted world of options trading. >>

The RTOs do not trade, they operate the markets. Further, the 'imaginative elements' and 'mischief' are essential elements of the price discovery process. Except for some noise about FTR options in PJM, the RTOs do not engage in options trading that I have ever heard of.

Keller << Are the interests of the end users (business, industry and the consumer) the primary consideration for the RTO's? No, as the RTO's deal in the wholesale power market. >>

I disagree. The very process of determining LMPs works aggressively to minimize overall system cost by selecting the set of generator offers that serves load subject to a set of constraints. If that doesn't serve the interests of end users, I don't know what could. Your point would be valid if and only if there were a complete disconnect between the wholesale and retail markets.

Keller << Do we see FERC (government regulatory agency) investigating the RTO's in response to allegations of a lack of independence? Yes. Are some changes being made by the RTO's as a result? Yes. Checks-and-balances at work.... Given the vast amounts of money involved and constraints inherent to power generation and transmission, some level of government oversight is needed -- i.e. the market needs a reasonable level of regulation. >>

Agreed. These are not markets that can be left alone. In fact, ALL markets require some level of regulation to ensure that abuses are minimized, that rules are followed. On balance, does power require more regulation than other markets? Definitely. Does that mean we should return to the old system? No.

<< Ultimately, I believe the end users are better served by ample and localized nearby generation >>

I would prefer to let the markets answer that question. They may well agree with you.

Banks << The next time you are close to an academic library, visit the finance section and see what the 'main men' have to say about that veery simple and almost trivial topic. >>

Yawn... I can read about it in my own library here in my office.

Banks << I was thinking about the statement by your good self in which you say that the key to understanding the oil price is the change in inter-month (contract) spreads. THIS IS WRONG. Those changes are effects, rather than causes. >>

Clearly, MY point was that the effect (oil moving from inverted to contango) pointed to the cause (a looming long term shortage of oil). We can infer the cause by examining the effect.

Banks << ... heaven help those who think that they know enough to challenge convention. >>

Then I am doomed.

James Carson JBCarson@RisQuant.com

Tell me, Mr Carson, what crime have I committed to deserve being punished with a looney-tune statement like that?

One of the principal reasons why oil is priced in this way is that the oil well owner in North Dakota might well have sold some or all of his production on the NYMEX futures market many months prior. The oil shipper might well have sold the oil on the futures market well before loading the tanker. The basis differential may or may not have been locked in at that time. That depends on the disposition/acquisition strategies. The traders often move from futures to physical by doing an 'exchange for physicals' or 'efp' trade.

Gould << Isn't the actual price of a futures contract the price when it "comes off the board and into delivery"? >>

Short answer, no. That price is irrelevant to everyone except those who actually were boneheaded enough to get into delivery. Yes, I have done that myself in wheat. What a nightmare.

Gould << What proportion of the consumer's 1,000 bbl / sec do you estimate might have traded above $128? >>

I am not that familiar with the marketing practices in the industry. In the grain industry, 1/3 to 2/3 of grain is sold on long term contracts with some futures component. I suspect that oil is higher than that. I base that on the CoT reports that normally show higher commercial (hedging) interest in oil than in grains. Here is a link. Btw, be sure you understand exactly which contract you are looking at.

http://www.cftc.gov/marketreports/commitmentsoftraders/index.htm

Grains are traded on the Chicago Board of Trade, Kansas City Board of Trade and Minneapolis Grain Exchange. Energy is reported through New York Mercantile Exchange. ICE does not report energy positions because their energy offerings are not regulated by the CFTC. [Yes, I agree that is a big problem.]

Gould << I'm obviously still learning oil trading issues. >>

We all have to start someplace. There are many great books out there. I suggest: Hull's Options, Futures and other Derivatives.

Reply to Banks

Banks << Carson, not being a trader means that I have no sympathy for the level of thrills that you imply. Apart from that however you are almost right about the time spread of oil prices - more right as a matter of fact than most. >>

Banks << Inferring a LONG-TERM shortage of oil because the price moved from inversion to contango. Tell me, Mr Carson, what crime have I committed to deserve being punished with a looney-tune statement like that? >>

So, which is it, perfessor? I am neither intimidated nor amused by your blustery bloviations. Rather, I found your bullying pathetic two years ago, and find it pathetic today. Hint: you don't get to call a position looney-tune until you have actually, you know.... REFUTED it.

I find your comments educating and interesting having experience working as a trader in a world commodity. But regardless of how the oil markets work with respect to futures and delivery prices, I think professor Banks' main point, as it has been in his of many recent posts, is that oil prices will go up again eventually. How prices undulate with regards to trading and the world economy won't matter in the long run because its overall production rate will surely decline - unless by some magic the conventional uses of oil disappear at a much faster rate. I doubt the latter will happen. The best we could hope for is that conventional uses of oil will decline with alternate energy sources replacing them fast enough to prevent a massive decline in the West’s standard of living.

As for professor Banks bullying people, he's not the only one writing on this website who routinely likes to discredit other authors with creative speech. But in spite of this he does have lots of economic wisdom to share with us, as does Tam Hunt.

We all have to start somewhere he says, and suggests the finance book by John Hull. I wonder if he knows what would happen if we were in a classroom discussing some item in that book. I've taught courses in derivatives in four universities, published a half dozen or more papers on the subject, and given papers on oil and copper derivatives at a dozen conferences or more. Here in Sweden I lectured on derivatives for almost 15 years as part of my course on international finance. A half dozen students have told me that I not only was the worst teacher they ever had, but I can't even speak English. About 500 told me that I was the best they ever had.

Let me make it clear however that I don't attach any great significance to any of this. I've taught at 14 universities, and been professor at 12, but the way things are shaping up it's going to be almost impossible to get a sensible answer about any subject in academic economics, and most subjects in finance, from students or teachers at any university on the face of this earth. James says that he finds my bullying pathetic. Better check with my students about this, because I tell them in the first five minutes of a course that if they don't shape up I'll fail them with a smile on my face. Of course, sometimes I had to be careful with this approach. For instance in Thailand last year, I waited until my second lecture, and to make sure they got the message I repeated it about twenty more times. I think I convinced them that I meant business.

Understanding the mechanics of how a commodity, any commodity is actually traded is a key element in understanding price behavior. For example, power prices appear to be chaotic until you delve into they mechanism by which those prices are determined. Then, they become understandable.

I do not disagree that oil prices will go back up again eventually. If nothing else, the forward curve says that much. My point was that I agree with the Yergin/CERA scenarios where 'unconventional oil' will supplant conventional oil. I don't know about 'undulating peaks'. My interpretation of that is that they expect these new resources to come into the market in such a way that they mitigate rising prices.

As for Professor Banks sharing of wisdom, he has yet to show me much. My experience with him is unfettered invective. If he is going to disagree, fine. However, I expect him to do it with a minimum of respect and to support his views with something like evidence or reasoning. I, myself, have no problem criticizing or challenging others' views. However, I will always do so with reason or evidence. Banks' behavior two years ago and today is ridiculous.

It is only gobbledygook because it is above your head and you can't admit that. Banks, your abuse is wearing very very thin.

My late electrical engineering professor supervisor who I did my Masters degree in engineering for, at McMaster University in Hamilton Ontario, was a lot like you. He was a very strict Scotsman who demanded students shape up or ship out. His toughness was disliked by many, but those who toughed it out were grateful to him in the end for pushing them to work hard.

A little more technical evidence that James is talking about would do a lot to back up your claims though, perhaps in another article someday, unless it takes a whole textbook to so.

There really isn't that much unconventional oil. Some tar sands in Canada and that Orinoco Belt stuff. Neither will EVER produce significant production in terms of barrels per year. Like they say, it's like having a million dollars in the bank, but you can only withdraw $10,000 per year. Are you rich? Kinda, but not really. (Note that unconventional gas IS a significant player, but there are lots of sources for that, plus the new techniques to release the tight formations is proving quite productive.)

Your comment about the Brazil find is also a bit disconcerting. That's a very deep site which has various layers of sand, salt, etc. to get through to get it. I dunno, dude.

This would all be well and good under more typical circumstances, but we have Cantarell crashing in a big way, and the Saudis just might be realizing there is only so much salt water they can pump before the whole exercise is futile (with respect to increasing production).

The more conventional 'elephant' field finds do not seem to be proving out. We are scrambling just to replace depletion, let alone increase production overall.

New resources will not 'mitigate rising prices' unless they are significant enough meet demand. 10 thirsty people scramble just as much for seven glasses of water as they do for six.

It would be great to see a credible dismissal of what the oildrum says about oil production, but for the last few years, they've been pretty good. Didn't exactly predict the economic turndown, but sure aren't surprised by it.

I think displacing oil demand has a better chance of succeeding versus getting unconventional oil to displace depletion of supply.

In the meantime I'm going to declare James the winner. I surrender, as I did two years ago. But I suggest that we talk about something else. Sweden may be going back to nuclear and a few lines on this subject by James or anyone else may be helpful. What about it James, Jim, Bob, Len, anybody.

And Bob, on your teacher and my humble self. One of my former students invited me to a party where there were a half dozen or so of my former students who were working for investment banks. One of them said that when they were applying for jobs they used the comments that I had written on their exams as a part of their reference. That was the good part. The bad part was that any of them could have bought and sold me a dozen times.

BTW, even really expensive nukes still make economic sense in the long run. Just build them where people are likely to be somewhat near for the next 60 years.

Another idea for Sweden:

1. Buy Iceland. 2. Further develop their domestic geothermal resources. 3. Add underwater HV electric link to Sweden. 4. Ta da!

(My poor knowledge of geography might make this solution a few hundred billion dollars more expensive than anticipated....)

The good news for that small, hurting, country is that they are powered primarily with renewable energy (about 90% electricity, which is already used to create hydrogen for buses, etc.). So their future is still pretty bright despite the latest snafu with their banking sector. This is a lesson for all of us and is a direct inspiration for our very vigorous efforts to wean our region of California from fossil fuels.

Jim, I also agree with you that unconventional oil is over-hyped. There's a crap load to be gotten (Orinoco, etc), but the question is flow rate: we simply can't bring unconventional oil online fast enough to make up for the rapid declines in conventional oil supplies, which appear to have already peaked globally. If the 6-8% decline figures cited by IEA are accurate, there is no chance in hell or heaven that unconventional oil will make up this difference.

Fred, I noted with interest Sweden's recent change to its nuclear policy. But note it was a very conditional revocation of the previous anti-nuke referendum: no subsidies will be provided to repower the existing reactors or to build new reactors. And as we can see from Finland's experience with Olkiluoto, prices for new nukes are exorbitant and construction delays are endemic. My prediction: no new nukes will be built in Sweden without significant subsidies. As Lovins has said: "You can de-fibrillate a corpse and it will jump but it won't come back to life." The US has massive subsidies lined up for the few few plants of the "nuclear renaissance," but it won't impact the long-term viability of nuclear power b/c it's simply far too expensive. There are far better options in the form of increased energy efficiency and renewables.

I have a suggestion. Why not finance new nuclear construction with private investors' money, at least in part. Sell shares to investors, and in return they are guaranteed a dividend for the life of the nuclear plants. This should be a sweet deal for rich investors with deep pockets because there's no such other guarenteed industrial stock investment around. That way rate payers or governments would be relieived of some of the construction costs.

Do you suppose SCE, SDG&E and Riverside had their eyes on the latest at:

http://www.eia.doe.gov/cneaf/electricity/epa/epat8p2.html

when they started de-fibrillating two corpses called SONGS 2 and SONGS 3? The SD U-T printed the latest story on the odyssey of four new steam generators for the units in the paper's 2/4/09 edition. The first reached site last week. Must be that a total operating cost (maintenance, fuel & operations) of a bit over $0.02/kW-hr (2007) has some sort of fascination for the de-fibrillators. What did you say the "levelized cost " of a kilowatt-hour of electric energy from Boulder and Grand Coulee Dams penciled out at, counting capital cost, of course? About a year ago, one of the folks at SONGS mentioned that they were coming in at about $0.048/kW-hr. Golly, when I look at the T&D charges on my bill, they're higher than that. Have you got some good calcs on what those T&D charges will be when all those renewable electrons hit the wires? Understand that even the good Dr. Chu has some reservations about that. Maybe you can talk him into doing some post-Nobel studies at RMI.

You are going to have to fill me in on the theory of "good" banks and "bad" banks. KPBS featured a gentleman named Anders Aslund who was credited with cleaning up a banking crisis in Sweden a few years back with this particular theory. Guess I've been so enamored with Greenspan, et. al., dealing with the LTCM fiasco that there was no awareness of a Swedish banking crisis. Interesting, was it not, that Sir Alan experienced LTCM and the "tech wreck" and did not protest with greater volume about truly Archimedean leverage? Perhaps instead of buying Iceland, Sweden could lend Mr. Aslund to them for a bit.

I remember him. When he was riding high in this country there was a question of his coming to my university, and so I took it upon myself to welcome him, employing my usual terminology. Following this some negotiations were necessary, in the course of which I promised that he could visit us without being told some things about life that he didn't want to hear.

And now he's back in action you say? Will miracles never cease. You know, in the case of Iceland, to get back on their feet all they need is another big aluminum plant, or maybe two. Remember that their population is only about 300,000-350,000 people.

About Swedish nuclear. Well, count on old Fred to clarify that issue for the unlearned. The basic issue you see is what will happen to this country without an adequate source of reliable and cheap energy. That's right, cheap - by which I mean that in a world where everything is relative, nuclear is the least expensive!

I am indeed an advocate other sources of generation besides nuclear, particularly distributed micro-generation. My ideal world would continue to have a conventional interconnected grid with large central generating stations plus widespread customer-owned micro-generators on rooftops. The ability of customers supplying their own needs at least half the time, and even selling excess power capacity back into the grid, should sooner or later make them economical. It's just a matter of time before these systems' costs come down to point the payback time is only several years. The big problem with rooftop systems is retrofit costs on existing homes and businesses. New construction installation is always going to be cheaper. Assisting the public with retrofit cost financing is precisely where governments have an opportunity to play a huge role in fostering it.

Also, I am actually a “reluctant” advocate of nuclear. It may very be expensive to build but the environmental footprint of nuclear is probably the smallest of any of the large central generating methods, and the environment is going to end up being the deciding factor in spite of those who despise environmentalists, because the environment is on every government and most citizens' radar screens these days. Nuclear fuel is also not likely to run out for centuries. Their high construction costs may end up being the price we are forced to pay, because replacing them with large wind and solar farms, or other fossil burning stations, will end up being limited with not enough capacity to feed total demand.

What is often not discussed too in these forums is the art of design cost reduction. In may cases of engineering design, pressures have always existed on designers like myself to lower costs when customers are unwilling to pay the initial product design's price. With more effort in R&D in nuclear plant design, I'll bet there are ways to lower costs not explored or developed yet. The problem is it takes investment in the R&D to do this, and it wont happen if nuclear plant commercialization is starved.

Far be it from me to assert that the Icelandic fishery could compete with a couple of new aluminum plants.

Since the "good" bank, "bad" bank gambit failed to gain traction, maybe a word or two from you on certain economics not working without massive government assistance will stimulate the contributing audience. After all, it is the era of packages designed for stimulation. Gee whiz, those danged, aforementioned dams were products of such assistance or, perhaps, the "stimulus packages" of our generation. Having put in some time at the Royal Blue Store warehouse at 22nd & Ogden, I can attest to the fact that the dams are doing better than the housing projects around the Institute you so fondly remember. Word has it the dams are still with us, the projects, at least the ones we knew, are not.

Google the Energy Commission's latest report on nuclear power in California and you'll find in reading through that report that nuclear power has been very expensive in California - Diablo Canyon cost ratepayers 10.0 c/kWh from 1986 to 2006, and there were significant other costs borne by shareholders instead of ratepayers. This is far more than natural gas, wind, geothermal or biomass, let alone energy efficiency.

Last, as you surely know, SCE is replacing SONG's steam generators, far sooner than anticipated, not the reactors. Ratepayers are one the hook for this upgrade, further increasing the levelized cost of power from these very expensive high-tech toys that are destined to go to the way of the dodo.

Central station solar power is fast becoming cost-competitive and solar thermal can be backed up such that it is a reliable peak power provider. Abengoa's Andasol plants are now online, with molten salt thermal storage that makes these power plants almost entirely dispatchable. Solar thermal is geographically limited, but by combining it with wind power, energy efficiency, geothermal, biomass, and utilizing existing natural gas and coal plants as we transition, we can technically become fossil fuel and nuclear free over the coming decades in North America.

The future you're describing, a blend of several baseload power sources, including demand responses viewed as such, is exactly what we're headed for in Ontario, and if I read president Obama correctly,iin the US too.

I'll bet the first long term goal will be fossil free, and if all these other sources combined can be implemented on a scale large enough to replace nuclear plants, and more critically at a lower overall cost, then I admit nuclear plants will go the way of the dodo birds as they reach their end of life. I suspect though that many don't know yet if this vision is achievable. Many will vigorously defend their views why it is, or why it is not. Fred is one I'm sure.

As an engineer with many years designing new products and being immersed in R&D, I will be the first to say that we should explore ALL options by putting money into several generation sources. This is because quite often you can only discover some things about a given design solution, and its costs, only after it is implemented in practice on a large scale. The proof is very often in the pudding as they say. Given our economic futures are so uncertain in the west today, no one can esily predict which solutions will be the most economical in the distant future. In that respect, I fully agree that as policymakers, it is a good idea to explore all alternatives.

My apologies. As Dad always said, "What you can't do with the head, you must make up for with the feet." Mortgages, did you say? Would those be like what Berkeley and several other more progressive CA entities are offering those who would install solar roofs? Or perhaps you mean the federal government's stimulating package that will take care of that pesky T&D renewable requires? Central solar, did you say? Does your favorite Commission have the figures for Kramer Junction over, say, 1986 through 2006? Uncooked, that is. Have to admit, though, you're making progress. NPPs have made it from corpses to very expensive high-tech toys. As for dodos, didn't they rely on their feet?

http://www.energycentral.com/global/news_text.cfm?id=11981091

CA's Renewable Energy Transmission Initiative has looked at this issue in great detail re renewables, finding that transmission costs are at times substantial, but often not, when all costs are combined to form levelized costs, that much more than natural gas. Also, the Phase 1B report calculated a huge potential for 20 MW solar facilities around the state to plug into the distribution lines at little additional cost - what they call "wholesale distributed generation."

The Phase 1B report is here:

http://www.energy.ca.gov/2008publications/RETI-1000-2008-003/RETI-1000-2008-003-F.PDF

Now that's what I call real home cookin'!

I find your post confusing. Are you saying that the overall levelized cost of renewables is not that much more than natural gas, or that the T&D is not that much more?

I glanced at that report. If you could reference which of the 379 pages of dense bureaucrateeze you mean.... The executive summary alone is fourteen pages!

Also, what exactly do you mean by renewables? The T&D costs of solar would actually be less than just about anything else because the energy is consumed practically in situ (depending on the technology) whereas wind requires enormous amounts of (mostly idle) wire to bring the energy to load centers.

James Carson, JBCarson@RisQuant.com

Whe I talk about levelized costs, I'm referring to an all-in cost that includes fuel costs, capital costs, T&D, amortization, O&M, etc. Large-scale solar still needs significant T&D, but you're right that small-scale solar does not. Small-scale solar is still, however, a lot more expensive than medium- or large-scale solar b/c of economies of scale.

If we choose 10 GW line capacity and $2000 / kw (550 GW) generation, it works out to 55 lines each 272 miles long. Still doesn't add.

Given that Eastern Interconnect exhibits a peak load of 625 GW ( http://www.nerc.com/docs/oc/opman/CPS2Bounds_2007.pdf ) then 20% (nameplate) of that would be 125 GW wind, requiring 13 lines each 1,154 miles long. THAT sounds fairly close, but are they saying that 125 GW of wind gen. would cost $1,100 billion? That's pricing wind generation at $8,900 / kw.

None of it makes any sense.

Eastern Interconnect - Joint Coordinated System Plan 2008 Overview

The 20% Wind Energy Scenario assumes that 229,000 MW of new wind capacity will be built by the year 2024, with 36,000 MW of new base load steam generation.

Appears the plan includes a backbone of 7 large HVDC lines running west to east, with a lot of infilling HVAC lines at each end of those. Very interesting is their conclusion that "Total Production Cost Savings (millions 2024 $) from Constrained Case (by adding 20% wind in a planned fashion) = $20,362 " Where the constrained case amounts to BAU with no aditional wind generation.

My own yellow pad scratching indicates otherwise. I find wind to be terrifically expensive even before T&D and storage are taken into account. Before T&D and storage and without subsidies or green credits, I see something like thirty year payback periods. This depends heavily on power price (driven by natural gas prices) and long term interest rate assumptions.

However, I find solar to be more economical than you indicate since T&D and storage are less relevant. Keep in mind that the sun is always shining during the peak hours of the year in summer peaking regions, while the wind is NOT blowing. Deferral is much less important for solar than wind. In addition, the market value of solar energy as a function of time of day is VERY relevant. Finally, there is a lot of flexibility to place utility scale solar on otherwise useless land as long as there is a transmission line nearby.

Len: I question your numbers on how much wind is necessary to meet a 20% mandate. The state mandates that I have reviewed are drafted as xx% of the megawatthours, not nameplate as percentage of peak capacity. The correct number would be [mandate x average 24x7 load / wind capacity factor. Given a 20% mandate, a 47% annual national load factor and 33% wind capacity factor we see here in the midwest, that would be: 20% x (625mw x 47%) / 33% = 178MW of wind capacity required.

You are right about the cost numbers on wind. They look wrong by about an order of magnitude.

Also, here's the latest report from Lawrence Berkeley Lab re the actual costs of wind power:

http://eetd.lbl.gov/ea/ems/reports/lbnl-275e.pdf

These costs are for generation only, so don't include T&D, but T&D typically adds no more than 20% to the total cost, depending on siting. As the LBNL report shows, wind power has been cheaper than wholesale power costs in every market in the US. And that's not even a fair comparison b/c wholesale power prices often reflect generators that have had their capital costs paid already. The better comparison is between the costs of new generation, which is what E3's analysis does.

Here's another LBNL report on the cost of transmission for wind power:

http://eetd.lbl.gov/ea/ems/reports/lbnl-1471e.pdf

Solar power is still quite expensive though there are some contracts signed between solar companies and CA utilities that claim they can beat natural gas gen costs. We'll see in a couple of years if this is just talk.

Another excellent article, that rather succinctly states what I said above about WTI and Brent and so on as price benchmarks. WTI, Brent as oil price benchmarks, caveat emptor