Adrift In A Sea Of Oil

Oil has been in the news to the point that it never leaves the news for more  than a few days.  Pundits and economists have now pronounced the slide in oil prices (barrels of crude oil) to have stabilized and are now on their way back up.  Of course if one remembers that almost all of the predictions by economists  about the various economies ever come true then one might do well to do the opposite of what they tell us.  Being an economist is far less reputable than being a psychic.  We appear to have more faith in things we cannot see versus things we cannot measure accurately.  For both professions it’s a crap shoot.

Ever since the days of oil in Pennsylvania and John D. Rockefeller, oil has never traded in a free market.  One way or another monopoly positions have been established.  Some might want to term much of the past ownership and control as an oligarchy, but the simply a technical way to say conspiracy to defraud.  The Texas Railroad Commission was given the task of controlling the oil production in Texas and similar state commissions were established in other states where oil was discovered through exploration.  In 1947 control was in the hands of the seven sisters (the international oil companies such as Royal Dutch Shell,  Anglo-Persian Oil Company (now BP), Standard Oil of California, Standard Oil of New Jersey (Esso), Standard Oil of New York (Exxon -Mobile), Texaco (Chevron), and Gulf Oil.  By 1949 Iran was petitioning other Arab states to form a new organization that would be called the Organization of Petroleum Exporting Countries (OPEC).  Eventually the official group would be formed in 1960 and governed by the seven sisters until the Yom Kippur War of 1973 when the Arabs took greater control due to the United States backing of Israel during that war.  Prices rose substantially due to that action.

Oil exploration was speeded up as money poured into the search for Oil Independence from the Arab producing states.  In the meantime more production came on line from Nigeria, Angola, South America, and Indonesia.  Inflation fed much of this capitalization since prices seemed likely to go up forever.  The term peak oil was coiled that signified that no more oil deposits would be found.  Unfortunately that would not be true due to the fact that the earth is always making new oil as part of its geological processes and that oil would be discovered in parts of the USSR (now Russia and the various independent countries that once comprised the USSR) as well as on the north shore of Alaska, Norway, Russia, and Canada.  We have found a great deal of oil at very deep levels below the ocean floor and can recover that oil, but at a steep price.  What has made so many of the discoveries possible it the amount of money that has entered into the financial arena as credit and becomes debt.

You may or may not remember back in 1986 when we had the first bit glut of world oil.  The North Sea oil fields were discovers and their production came online and there were further improvements in production in other parts of the world.  When oil prices started to fall, the Saudis demanded that every one cut production to keep the prices at the same levels prior to the glut.  No one did and then the Saudis reduced their oil output to only ten percent and nothing changed.  So the Saudis started pumping full out and the price of oil came crashing down.  The result was that in a less than a year the other producers decided to do as the Saudis asked and cut production.  One of the problems with this type of cooperation is that the players always cheat.  The volatility in the market is due to that little bit of cheating on quotas.  But 1990 we would start to see another steep rise in oil prices that would peak in 2007.  The volatility in the markets tend to be due to the problems of extensive use of credit.  The late 90s would see the rise of more oil exploration in terms of tas sands and oil shale, the latter using fracking for the recovery of oil and natural gas.  This is a more capital intensive method since mineral rights must be acquired in terms of the current inflated dollar.  However, this has produced a glut just as the Alaskan crude and the North Seas Oil did in the previous decades.

So what triggered the Saudis to once again start pumping full out?  Iran and Russia, with China being a side issue.  First, let us see who the new seven sisters are today.  Saudi Aramco (Saudi Arabia), China National Petroleum Company, Gazprom (Russian), National Iranian Oil Company, Petrobras (Brazil), PDVSA (Venezuela), and Petronas (Malaysia).  Primarily the problem began with the Russians who want to keep a Shia government in Syria when most inhabitants are Sunni, like the Saudis.  Second, the Russians were asked to cut production and Putin said no.  Unfortunately for Russia, their oil production needs a higher price per barrel to remain profitable.  You see, production costs are not all the same.  Most of the oil wells and facilities in the middle east were drilled quite some time ago and even the newer wells along with well maintenance is low cost.  The deep ocean wells are very costly to drill and production is not quite so easy as shallow gulf wells only a few miles from shore.  The oil shale wells can vary in cost per well and those that have already been dug will remain online.  The decline in the number of rigs is due to the cancellation of new wells that have not been started of completed.  Many but not all of these wells were dug or started with high measures of debt, especially since interest rates are so low and the need of cash for debt service low.  But most of these wells will depend on a minimum of $45 to $50 a barrel to break even and money more need $70 to $80 break even pricing.  The EIA oil supply summary is due out tomorrow and it won’t be pretty.  Expect the price of crude oil to drop like a rock again.  Those sources of oil that have come online in the last ten years will remain online because they have to and because they are making a profit however slim.  And now that Greece has Europe’s attention, oil may suffer a little more than usual.  Not because Europe produces oil (only in the North Sea, the arctic shelf off Norway has not come online and most likely won’t for a year or two due to the expense of drilling and production.  The current glut is not expected to disappear until July or August at the earliest.  Meanwhile we have yet to see what financial conditions develop in China, which has cut its oil imports by about 25%, Europe, whose aggregated economies are about to implode, and then our own oil consumption in this country as we enter into a depression.  No, boys and girls, pretty is not the outlook for oil.


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