Wednesday, September 19, 2007

Energy Prices Rise to New Record

First, let me say, mea culpa. With the price of oil now well above $80/bbl, my prediction in March that energy prices would stay within a range of $50-75 was clearly too optimistic. Even though I still believe in the general logic used then, the topic bears further discussion.

One obvious point is that the energy market is far too complex to use a single benchmark like $/bbl to represent the entire market. While prices for a barrel of oil are considerably higher than in March, gasoline in the USA is considerably cheaper. So is natural gas. Blame refining margins and captive markets. So, I'll need to figure a better way to characterize the energy markets.

Meanwhile, let's look at what has been happening in the market. On the conventional oil & gas supply side, the higher prices appear to be having little affect on supply. The number of working rigs is down, and there still is no evidence of an upsurge in discoveries or production. Perhaps this is not so surprising, since the latest spike is relatively recent and the timeframes for activities to increase production are long. On other fronts, supply does seem to be picking up. As many as 20 nuclear plant applications are expected to be filed within the next few months. Solar and wind power projects are proliferating. Oil sands production is accelerating. Ethanol production is accelerating. But, can these sources keep up with supply? Probably not in the short run, unless demand falls off.

Speaking of demand, it has softened somewhat, but continues upward. I see little change in consumer habits that would quickly decrease demand. I've been traveling lately and can vouch for the fact that hotels are full. I know of no one who has really cut back on their driving or turned down their thermostat. So, there seems to be no tidal wave of actions to immediately cut energy demand. It may take a recession to change this, and the fed seems determined to prevent that.

As for longer term actions, there at least seems to be talk of decisive action. A recent survey indicates that 57% of car buyers say they will consider a hybrid. GM has indicated that only their trucks and SUVs now need incentives to maintain sales. I know of several people who are looking at increased efficiency appliances and installing compact flourescents. Taken together, these seem to bode well for longer term decreases in energy demand. Once a vehicle or appliance is bought, it will decrease demand for 7-10 years.

And so, even though oil prices are above my predicted range, I continue to believe that energy supply/demand can be balanced at something close to current prices if oil decline is not too sharp. Current prices reflect the possibility of sharp, temporary drops based on hurricanes. Longer term, we are still waiting to see whether an oil peak has been reached and how sharp the decline will be. A shallow rate of decline can be managed. A sharper rate of decline could cause the crisis so often predicted by peak oilers. We shall see.