As the evidence grows that global oil production will peak in the next decade, many Americans grow increasingly frantic to deny this possibility. Hence the campaign against speculators (an historically common response to changed conditions). We see this even by intelligent and experienced people, showing how deeply rooted is our desire not to make the necessary (and probably painful) adaptations necessary.
An especially clear example of this appears in the posts about oil by W. Patrick Lang (Colonel, US Army, retired) at his blog, Sic Semper Tyrannis. His observations about military and geopolitical affairs are IMO consistently interesting. About oil, however, he confidently tells us of things outside his area of training and experience, about which many of the world’s top experts speak tentatively — as there are alternative explanations with strong supporting evidence.
Start from a very simple fact. The price of crude oil in the summer of 2008 should be $70 per barrel, not $140. The rise from $70 to $140 has not been caused by a shortage. Instead it has resulted from bad policies, bad luck, and incredible inattention to market details by certain officials.
… In these circumstances, policymakers have very limited alternatives.
- They can relax environmental standards. There are supplies of higher sulfur diesel that would address Europe’s current needs.
- Governments can release strategic stocks. The U.S. and other IEA members hold significant sweet crude inventories. Release of these crudes (perhaps in a swap) would relieve pressure on prices while preserving environmental restrictions.
- The U.S. can suspend the renewable fuel mandate. This action would allow refiners to boost runs and produce more diesel fuel. Suspension of the renewable fuel act would also take pressure off food prices.
Regretfully, none of these actions will likely be taken. The failure of policymakers to diagnose the causes of the crude price increase properly makes the adoption of rational policy improbable. Prices will continue to rise.
Update: Verlerger has scathing comments about the Masters and White report attributing commodities price increase to speculators. See it here.
Like alchemists looking for a way to turn basic elements into gold, everyone wants a simplistic explanation for high prices … often it is a case of political expediency to find a scapegoat for higher prices rather than undertake serious analysis or perhaps confront difficult decisions.
Economist James Hamilton perfectly expresses my view about the causes of the 2008 increase in oil prices:
Is the price of oil today too high given the fundamentals? Could be. Is it too low? Could be. But one thing I’m sure that’s too high is the confidence on the part of those who insist they know the answer.
Langs’s posts (shown below) are worth reading, as I believe they illustrate many of the cognitive errors hindering America’s adaptation to the changes looming ahead in the 21st century. To repeat, they are interesting because of the quality of their source (Colonel Lang). They are another bit of evidence showing that America’s broken Observation-Orientation-Decision-Action loop is not just a function of the wrong President — or the wrong Party in office — or influential neo-cons. Its causes perhaps lie within us, collectively.
These are all short posts, which I believe these excerpts adequately represent. For discussion of these issues see the links in the text or those at the end of this post. Note: this site has no short-term forecasts of oil prices. The experts have done poorly enough at it during the past few years; my amateur errors will contribute nothing to that debate.
“King Abdullah and the speculators“, 15 June 2008 — This illustrates over-simplification. The Saudi Princes are playing a complex game, seeking to maximize their oil income without antagonizing their chief ally — or destabilizing their domestic political situation. Lang notes their pleasant words and token gestures (tiny short-term production increases) which have proved effective in soothing Americans as oil prices have risen from $20/barrel to over $100 — a 5x increase in 8 years. Given Lang’s background, we might expect a more subtle and broad analysis of the Saudi’s actions.
Sooo, the Saudi king is going to increase production at the margin on crude oil going into the spot market and this is expected to lower the market price on deliveries of crude to refiners. That, in turn, is expected to cause a failure in confidence in the whole nasty complex of capitalist hedge fund managers, index fund managers, bankers, advisers to same, and individual mega-investors. It is hoped/believed that this failure in confidence will cause the players to lose faith in their ability to pass the risk along to the greater fools waiting somewhere in speculator limbo. After that set of developments the price per barrel is supposed to fall, a lot. I believe this to be true. We will assemble here afterwords to gloat, or not.
“‘Speculators accused of dictating oil prices’“, 18 June 2008 — One distinguishing aspect of Lang’s posts about oil is the lack of reference (or even apparent awareness) of the vast expert literature about these issues (for a small sample see here). Everyone gets to have an opinion, but he makes little effort to support it with evidence. This is a common characteristic of blogs.
I offer the opinion that the “fundamentals” of supply, demand and all the other undergraduate economics concepts that we all remember from long ago do not adequately explain the pricing process that now prevails in the oil and financial markets.
“The Oil Meeting at Jeddah“, 21 June 2008 — Here we have “ignoring the big news”, one of the most powerful and frequent cognitive errors of American leaders. Lang’s comments about the Saudi’s are hilarious, given their announcement in April (after hints over the past few years) that they will not be increasing oil production as expected over the next decade or so. This initiates of “political peaking” of global oil production (see here for more evidence). This has resulted in increasingly alarmed forecasts by the world’s major government energy agencies (e.g., the EIA and IEA).
We are about to enter a period in which a major lesson will be taught to the world regarding the fact that market prices are more a product of mass perception and a form of hysteria than they are of “hard data.”
Greed feeds greed. Prices in oil have been rising because there was money to be made in the atmosphere of “casino” gambling fostered by the impatience of the young and ruthless adventurers who dominate the derivatives markets.
… The Saudis are going to lend a hand in that process this weekend. The amount of the increase in their production is not significant as an incremental rise in the world’s oil supply. Its significance lies in their stated intent to cripple the process of parasitic speculation in a vital commodity.
“The Oil Meeting at Jeddah -2“, 22 June 2008 — Good reporting.
“The oil bubble is leaking“, 19 July 2008 — Here we see the triumph of an amateur making a successful single short-term market forecast, made with 50-50 odds. Investment professionals do this for a living, and the market teaches them to do so only with caution — and expectation of a low batting average. His confidence that it is a long-term problem — not today’s — is extraordinary, given the fact that global oil production has been flat since early 2005 (which explains the rise in prices since then).
I told you so! Ah, that’s not very mature. Yes, but it feels sooo good. Down how much last week? What’s that again? I couldn’t hear you…
It is true that there is a severe supply and demand problem in crude oil supply, but it is a long term problem. As is often the case, the time-scape of this problem is one of the most important parts of it. There clearly is not enough oil in the ground for humanity to continue using it in the ways that we have been doing. Growing demand in newly industrialized places like China and India exacerbates that problem. The solution to the supply problem in energy lies in new reliance on different ways to produce electricity. Cheap electricity would enable short distance drivers to use electric cars and could eliminate the absurd reliance on fuel oil to heat buildings in the deep north. That would produce a very different situation. Al Gore is calling for windmills, etc., but the real solution (as he says) is nuclear power. The Greenies will have to “suck it up” and accept the idea. Hey, the French get most of their electricity from nuclear power. The Francophobe crowd should take that as a challenge.
The short term problem is not the same. This is and has been a bubble generated in the ways that have been discussed in previous articles. Short term investment in the futures and spot markets have driven prices to levels unrelated to present supply and demand. The markets have recently been a fantasy world without real limits for movement on the up side.
The bells are now tolling for that fantasy. The smart people who stand to lose from this festival of childish greed have been kicking the psychological props out from under the process of finding bigger and bigger fools.
You don’t think so? Good. It will be amusing to see how much money is lost in your disillusionment. Sometime in the next few months the price per barrel will fall below 100/barrel. It will be interesting to see how far it falls below that level.
“More oil leaking from the barrel“, 22 July 2008 — The world is so simple when one has a master narrative explaining events — that rendering one superior to experts who see the world in terms of many complex dynamics! This is one of the most common sources of error — often folly — on blogs.
The last month or so I have been watching the various TV financial market networks. Marvelous! These “analysts” by and large have no idea at all as to what really moves the various markets. They just mouth the received wisdom and describe what happened as a forecast of what will happen.
“The oil “head game” is collapsing – for now“, 24 July 2008 — Peak Oil is described by experts as a process taking place over years — or decades. Lang calls it off based on a few weeks decline in prices, what might be (who knows?) just a correction in the rise of prices extending back to 2001 (or 1998, depending on one’s perspective).
What happened to all the babble on the 24/7 news about the end of western civilization as we knew it? What happened to the images of Ali Velshi (aka – “the bald headed prophet of doom”) trudging across the Alberta tar sands, gloating over the pain?
“Kudlow – “Drill, drill, drill, so that the futures traders will flee“, 4 August 2008 — The confidence Lang’s exhibits in the first line below is classic Americana. Such confidence has worked for us in the past when tempered with the knowledge and judgement. Has our great successes in the 20th century resulted in us losing this precarious balance? The next line exhibits the ancient but enduring dream of easily manipulating markets so that they better meet our needs — to the detriment of those on the other side, in this case oil producers. Excerpt, quoting the economist Larry Kudlow:
He gets around enough in the right circles to know that short term traders in oil futures are the fire behind the crude prices we see now.
“… Ah,” he said (roughly). “Approval of drilling will frighten the futures traders out of the market and the price will go a long way down.” “They are already leaving the oil futures market” he went on. “This will push them out even faster.”
“The price per barrel – down, down, down.“, 15 August 2008 — Like most people not familiar with the operation of markets, Lang shows no awareness of the normal volatility of markets, nor the need to describe their direction on the basis of long-term trends — not short term movements. Every professional working with markets — both as investors or commercials — often finds short-term movements to be incomprehensible. Excerpt:
The TV business channel 24/7 crowd have more or less lapsed into sullen quietude over the continuing fall in the price of the oil commodity. Why? They can’t explain it in terms that they are willing to accept. Some of the anchors are restive and asking embarrassing questions that are “slapped down” as quickly as they arise.
“How to burn the speculators” – Galbraith“, 20 August 2008 — In my opinion, nothing illustrates America’s dysfunctional thinking better than calls to tap the Strategic Petroleum Reserve (SPR) in hopes of a short-term decrease in oil prices. Filled at vast expense when oil prices were far lower, it is our best protection against any one of the thousand events — natural or deliberate — that could interrupt the supply of the most vital input to the global economy. As Chet Richards notes, the SPR is the closest thing America has to a national savings account. Tapping it other than in an emergency is like eating one’s seed corn: it feels good but has long-term costs. Not only can the SPR be re-filled only slowly (to avoid pushing prices up), we might consider it too expensive to do so. Many respected analysts forecast substantially higher prices in the next few years, as new sources continued be delayed and production declines from existing fields (e.g. Cantarell, NorthSea) continue at horrific rates. Excerpt, quoting from “How to Burn the Speculators”, James K. Galbraith, Mother Jones, September/October 2008:
Finally, the federal government should burn the oil speculators by selling up to 4 million barrels a day from the Strategic Petroleum Reserve. And as economist Tom Palleyhas pointed out, consumers can help too. An awful lot of gas is stored in cars. If people stop topping off and make do withhalf a tank, they’ll back up supply and lower demand. It’s a brilliant suggestion and definitely worth a try.
Advising us to fill to only half a tank is bizarre. Since auto manufacturers recommend keeping at least a quarter tank, this means lines at gas stations as people make frequent visits. The effect will be to decrease gasoline demand while we draw down our inventory — and increase prices when we refill them. The net effect is a period of increased volatility to the long, complex energy “pipeline.” Meanwhile, the date of Peak Oil comes ever closer, while we play games that do nothing — absolutely nothing — to prepare for it.
The Hirsch “Mitigations” report — the closest thing America has to a sensible proposal for an energy policy — shows that it will take two decades to prepare/adapt to Peak Oil. The clock is running.
Lang’s posts are among the best — informative and well-written) on the Internet about geopolitics (defining the term broadly, as I do on this site). As evidence, read some of these.
About the Presidential candidates
- “Will Maliki “torpedo” the peace?“, 22 August 2008
- “Can outsiders manage change in alien cultures?“, 17 July 2008
Lang has written a pleasant note about this post: “Fabius Maximus teaches us. Thank You, Fabius.”
Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
For more information about Peak Oil
“Crude Awakening: Behind the Surge in Oil Prices“, Federal Reserve Bank of Dallas, May 2008 (3.2 meg PDF) — The best analysis I have seen of what is driving up oil prices.
Here are some of my posts about Peak Oil.
- When will global oil production peak? Here is the answer!, 1 November 2008
- Links to articles and presentations of some A-team energy experts, 11 November 2008
- The most dangerous form of Peak Oil, 8 April 2008
- The three forms of Peak Oil (let’s hope for the benign form), 23 April 2008
- The world changed last week, with no headlines to mark the news, 25 April 2008
- Peak Oil Doomsters debunked, end of civilization called off, 8 May 2008
- When the King of Saudi Arabia talks about oil, we should listen, 2 July 2008
- The secret cause of high oil prices, 6 August 2008
Here is an archive of all my articles about Peak Oil.
Here are other resources to learn more about Peak Oil.