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In reply to: Avenger on Saturday 07/06/08 05:38pm

Avenger, not sure that I can answer all your questions but I will have a go. I don't disagree with you about speculation. Just the effects of that speculation.

You have asked for examples of people queuing for fuel or examples of current fuel rationing. Well it hasn't got to that stage yet and I don't think the supply/demand equation is that tight that we are likely to see that anytime soon. Why wont we see queues or severe rationing?

I would suggest market forces will help see that it doesn't happen. Rationing etc. is a hallmark of communism/totalitarian states/lack of free market forces. I am thinking of the queues of Russians lining up for bread and images of shops with nothing in them. I am not suggesting that the free market is a perfect system. We have seen bubbles in tulips, real estate, technology etc. in the past and will almost certainly see more in the future. Commodities go in familiar boom /bust cycles as oversupply drops prices drastically and kills of greenfield investment leading to shortages 15 years down the track. We saw this recently in the price of zinc.

I would suggest that the market, though not always efficient, is the best model we have to work with and that giving total control to government has not proven very successful in the past.

You have said that you "don't dispute anything you guys keep telling me about demand and supply." So I presume that you do agree that the supply/demand situation is starting to look a little tight. If it wasn't that tight then the price would simply go back to $10 a barrel like it did during the glut times. So what the market is now telling us is that the rewards are now there for companies to get out there and find the stuff and take advantage of the good prices on offer. And we are/have been seeing this happen with record levels of oil and gas exploration in the last couple of years. The trouble is demand is so intense that we have not seen it tip into an oversupply/glut situation and prices have remained high.

What will the high prices achieve? Well, they will encourage companies to get out and find innovative solutions to the energy problem - wind, solar,wave,cng, electric, clean coal etc.

This would not happen if oil and gas were dirt cheap as the incentives would just not be there.

I would not disagree with you about there being a large element of speculation in the current oil price. However, rather than seeing this as a negative, I would argue that they are actually doing everyone a favour in helping solve the problem. Otherwise we could all just blindly carry on buying oil for $40 a barrel and then all of a sudden there is a shortage and we have the queues/rationing you mentioned. You asked what the connection was between the oil price and current Iran/Israel hostilities. I think a war in this region could have devastating effect on oil supply and the market has every reason to be alarmed by it. Once again the speculators have pushed the price up but here again I see this as being a positive. Maybe it will give the hawks reason to think and pause before they go off half cocked and potentially ruin their economies with $200 oil.

I do think governments need to provide more incentives for exploration though. I notice Martin Ferguson is on the right track here.

How did I go? cheers 2bs


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Just found this article over on the other channel. (Thanks to smiler).

What do others think. Looks to me like it was written by someone who has a good knowledge of economics but very little about the actual oil industry:i.e the lead times in getting projects up and running; the huge cost of offshore exploration; the difficulty of actually finding the stuff; the significant energy cost in extracting hydrocarbons out of tar sands and shale,etc,etc.

I have noticed quite a few similar articles recently. All seemingly written by students of economic history who use their knowledge of past bubbles and extrapolate this to the current oil supply situation. And you cant blame the average person from getting taken in by it. After all most bubbles do burst at some point. And if someone from the industry comes out and puts an opposing point of view across are suspected of bias.

My bet - we will never see sub $100 oil again. But you would expect someone with all their money tied up in oil and gas stocks to say that! cheers 2bs








Why oil prices will tank

Arguments that $4-a-gallon gas (or even higher) is here to stay are dead wrong. Housing's boom-and-bust cycle tells you why.

By Shawn Tully, editor at large




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NEW YORK (Fortune) -- High-flying tech stocks crashed. The roaring housing market crumbled. And oil, rest assured, will follow the same path down.

Not everyone agrees. In an echo of our most recent market frenzies, some experts pronounce that the "world has changed," and that the demand spikes, supply disruptions, and government bungling we face now will saddle us with a future of $4, $5 or even $10 a gallon gasoline.

But if you stick to basic economics, it's clear that the only question is when - not if - prices will succumb.

The oil bulls are correct in their explanations of why prices have jumped. It's indisputable that worldwide demand has surged, chiefly driven by strong growth in China, India and the Middle East. It's also true that most of the world's reserves are controlled by governments in places like Russia and Venezuela that mismanage production, thus curtailing supply growth.

But rather than forming a permanent new plateau for prices - as the bulls contend - those forces are causing a classically unstable market that's destined for a steep fall.

What do you think: Is $4-a-gallon case here to stay?

In a normal oil market, the cost of producing the last, most expensive barrel of oil

needed to satisfy worldwide demand sets the price for every barrel the world over. Other auction commodity markets work much the same way.

So even if Saudi Arabia produces at $4 a barrel, if the final, multi-millionth barrel required to heat houses and run cars costs $50, and is produced, for argument's sake, at a flagging field in West Texas, the world price is $50. That's what economists call the equilibrium price: It's where the price that customers are willing to pay meets the production cost, including a cushion, naturally, for profit or "the cost of capital."

But today, the sudden surge in demand and the production bottlenecks have thrown the market radically out of balance.

Almost exactly the same thing happened in the housing market. And both housing and oil supply react to a surge in demand with a long lag. In housing, the lag is caused by restrictive zoning and development laws, especially in coastal markets like California and Florida.

So when the economy roared back in 2002 and 2003, builders couldn't turn out homes fast enough for buyers armed with those cheap mortgages. As a result, prices spiked. They no longer bore any relation to the actual cost of buying and improving land, or constructing and marketing a new house (at some reasonable profit margin). Instead, frenzied buyers were setting the price.

Because builders were reaping huge windfall profits, they rushed to buy and develop land. And sure enough, those new houses were ready just as buyers were retreating to the sidelines because they could no longer afford to buy a home. That vast overhang of unsold homes is what's driving down prices today.

The story is much the same with oil, with a twist. A big swath of the market isn't really paying that $125 a barrel number you hear about seemingly every hour. In China, India and the Middle East, governments are heavily subsidizing oil for their consumers and corporations, leading to rampant over-consumption - and driving up prices even more.

But sooner or later the world won't keep paying those prices: Eventually, the price must fall back to the cost of that last barrel to clear the market.

So what does that barrel cost today? According to Stephen Brown, an economist at the Dallas Federal Reserve, that final barrel costs just $50 to produce. And when the price is $125, the incentive to pour out more oil, like homebuilders' incentive to build more two years ago, is irresistible.

It takes a while to develop new supplies of oil, but the signs of a surge are already in place. Shale oil costing around $70 a barrel is now being produced in the Dakotas. Tar sands are attracting investment in Canada, also at around $70. New technology could soon minimize the pollution caused by producing oil from our super-plentiful supplies of coal.

"History suggests that when there's this much money to be made, new supplies do get developed," says Brown.

That's just the supply side of the equation. Demand should start to decline as well, albeit gradually.

"Historically, the oil market has under-anticipated the amount of conservation brought on by high prices," says Brown. Sales of big cars are collapsing; Americans are cutting down on driving. The airlines are scaling back flights.

We've learned another important lesson from the housing market: The longer prices stay stratospheric, the worse the eventual crash - simply because the higher the prices and bigger the profit margins, the bigger the incentive to over-produce.

It's even possible that, a few years hence, we could see a sustained period of plentiful oil supplies and low prices, meaning $50 or below.

A similar scenario occurred following the price explosion in the 1970s and early 1980s. The price spike caused the world to cut back sharply on oil consumption. By the mid-80s, oil prices had fallen from almost $40 to around $15. They remained extremely low for two decades.

It's impossible to predict how the adjustment this time will take shape, just as it was in housing. There the surge in supply came in places the experts swore there was "no supply," and wouldn't be any. Builders found a way to extend vast tracts of homes into California's Inland Empire and Central Valley, and even build "in-fill" projects near the densely-populated coasts.

An earlier bubble is also instructive. In the early 1980s silver prices jumped from $10 to $50 on the theory that the world was facing a permanent shortage of silver. Suddenly ads appeared asking homeowners to bring their tea sets and jewelry to Holiday Inns for a big price. Silver supplies poured from seemingly nowhere, out of America's cupboards, of all places.

And so it will be with oil. We don't know where the new abundance will come from, from shale, or tar sands or coal or an OPEC desperate to regain market share. We just know that it will appear. With prices like these, it always does.

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In reply to: Twobees on Sunday 08/06/08 02:12am

yes and even less about game theory and access.


Oil project investment are typically in the hundreds of millions or even billions of $

(cf houses, the part-time house husband/wife can be a property developer)

So new supply are from companies typically of market cap $50M or more, not individuals with market cap of $5,000:)


If all oil companies in the $50M market cap or more range accepted the author's views as being correct, then who is going to invest in expensive, long-lead time development projects based on $50/bbl long-term oil price?......not many, perhaps only state-owned enterprises....and this leads to the lag in supply.


For inexpensive huge supply projects, it then becomes an economic "game" to who can build the most supply that costs $50/bbl first ---- because once you have already sunk your cost:

a) if price >$50/bbl you recover your sunk cost and overall cost of capital

b) if price <$50/bbl, your sunk cost is sunk already so your production decision is to increase production and will sell at any price just above marginal cost ----- this creates credible threat against new entrants, and very hard for competitor Board/bank to approve competitor's on-paper development projects once you have your new supply up and producing


the problem with oil, is that:

1. all the consented, inexpensive [incl. cost of "carbon capture"] huge supply projects have already been built, or are already in development...very tricky then for Board to approve $60/bbl projects because author below believes price could be <$60/bbl


2. there may be inexpensive ones left, but they are not consented or companies do not have access

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In reply to: Twobees on Sunday 08/06/08 02:12am


Hi 2b's.

Yes, an interesting article but I don't think the theory fits this particular situation. We're not going to see the equivalent of silver tea sets suddenly pop out of the woodwork! The equivalent in energy terms are expensive and largely still being evaluated/developed.

I've just finished reading " Twilight in the Desert ". I'm not selling my oil and gas shares!







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In reply to: Twobees on Sunday 08/06/08 03:12am

It is amazing that so many, especially educated people can not understand the concept of peak oil.......I beleive current prices are not so much a result of Peak oil but rather a result of Peak exports.......so while economists etc may look and expect production to keep rising slightly, it is not enough to stop the decline in exports.......


So yes, rising prices will curb demand...but can importing countrys voluntarily reduce consumption as fast as imports will fall........and to all those who state all the different alternatives available, I doubt they can be brought on fast enough to cover the shortfall between supply and demand let alone bring a significant cushion to the market in order to bring prices down... also many alternatives that are viable at a certain price see input costs rise as the oil price rises towards their targeted price.....thus they never really become economical....


Then there is aways opec to take a million barrels or so of the market if it looks like prices need to be held up.....


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In reply to: Twobees on Sunday 08/06/08 12:35am

Hi Twobees


Thank you and others for your response. I think your made a very intelligent and thought provocative posting and i respect what you have said.


Where we disagree is that I believe your conclusions are based on a classical market with lots of suppliers competing etc. It also assumes elasticity in demand and supply. I do not believe that demand is elastic at all, and hence all the price increases will do is push the world into recession. You believe in the efficient market theory. This in my view only works with non essentials. At a price of $2, what do you think will happen? The poores in our society will either have to give up other consumption to keep driving or not drive and/or not work. There are no options. And when prices of all other goods go up because of higher prices which will cause inflation/increase in interest rates etc, rational economist will still nod their heads and bow down to the efficient pricing mechanism.

I despair when people tell me we a rational market, when a single statement by an idiotic little politician who thinks that he has the God given right to tell other countries what to do, makes the market jump by 7% ! I am sure that panick buyers did not come out of the wood work. The price increase was instentaneous. So just how is the spot price set?






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In reply to: Avenger on Sunday 08/06/08 12:59pm


I agree that oil prices at the current levels are likely to push the world into recession. The problem is that not only is demand fairly inelastic, in fact it is increasing as countries which have been low per capita users acquire the habit. But the supply of oil is also inelastic and the result will be, as you suggest, that a lot of current consumers won't be able to afford to buy as much as they're used to.

I don't see any short term solution to this, certainly not one that politicians can do anything about.



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In reply to: macduffy on Sunday 08/06/08 02:46pm

md, I sometimes wonder if we not be surprised how much these increasing prices alter the way those in the west think about fuel usage. As avenger says, the poor will be obviously hit hard. But those in the middle socioeconomic groups may be forced to change tack, given their mortgage commitments etc. Obviously the rich wont give two hoots. I am thinking about the long lines of city traffic with one person in each car. It will get to the point where people will have to start car pooling and/or use more public transport. Or instead of long trips in the car on holidays, go on organized bus/train trips instead. We may see rapid conversion of fleet vehicles to CNG etc

My bet is though that this wont be enough to provide the amount of oversupply needed to bring the price down significantly. And as someone else has mentioned, as soon as the price drops people use likely to just using more again.

From an investing point of view the solution is obvious. Buy oil and gas stocks that either have good reserves or are producing/about to produce. Most other sectors are likely to get hit in the downturn. cheers 2bs

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In reply to: Twobees on Sunday 08/06/08 04:40pm


I agree with all that, 2b's.

As you point out, the only shortterm solution for many people will be to make lifestyle changes so that they use less oil. Unfortunately, that's unlikely to bring the supply/demand equation back into balance, given the rapid increase in demand from " emerging" countries.

I'm not selling any of my o&g shares, well maybe I might sell a few BPT to buy some AZA.





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In reply to: Commander C on Saturday 07/06/08 11:21am

why are prices high when there is no shortage" - this is how a ~free market price system works - price is high, so you don't get a shortage


nice logic, do you have a link to the transcript ?

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