Crude Oil inventory increased another 2,091,000 barrels this week, to 339,899,000 barrels. Inventory is up 2,417,000 from 13 weeks ago and is up 19,527,000 barrels from a year ago.

We are at the 88th Percentile in barrels in storage, and we are at the 97th Percentile based on the 24.15 days of usage in storage. Distillate inventory dropped by 1,170,000 barrels, to 165,698,000, the 98th Percentile.

We are up 142,000 barrels from 13 weeks ago and up 40,725,000 barrels from last year. We currently have 46.30 days of usage in storage, the 96th Percentile.

Gas inventory increased 3,996,000 barrels to 214,081,000 barrels, the 81st Percentile. We are up 6,928,000 from 13 weeks ago and up 15,139,000 barrels from a year ago.

Days of usage are at 23.94, the 75th Percentile. The Crude Oil inventory will match last year’s level, in 8 weeks. Prices then were $46.47, about $30 less than currently.

In 13 weeks we will be comparing a Heating Oil price of 119.67 cpg compared to a current price of 196.22 cpg, and inventory will be 24 mm barrels higher. In 4 weeks Gas inventory will be 6 mm barrels above last year.

Price was then at 84.40 cpg, a 108 cpg lower than now. Prices are about to look very high on a year over year basis. The market is now at a large risk of a price break that may be very large.

If the demand is not improving, production is not dropping and demand is not improving. With these facts a major price problem can easily occur. If the inventory levels happen to increase and they are, and if demand cannot increase, and it is not, price ends up looking way too high.

Distillate demand must increase by 5%-10% and still going into winter we still have not seen a sharp demand increase. Production must drop sharply and that is not happening. These things change or we end up looking at a huge inventory, too much production and too little demand. Price will not go up based on these facts.

Refinery inputs fell to the 3rd Percentile with Distillate production is at the 55th Percentile with the HO Crack Spread at the 47th Percentile. Gas production is at the 82nd Percentile with the Gas Crack Spread at the 21st Percentile.

The HO Crack Spread remains high considering production levels. The production levels are not decreasing and the Crack Spreads will suffer if this continues. Over production with poor demand will almost always lead to price weakness.

Current demand should force production levels down 10% from current levels, so far that has not happened. Current production levels dictate demand increases of 10% or more in the products. If the production versus the demand remains here, then the price, and the processing margins, will not hold these levels.

There is the potential for extreme price pressure and for a potential price collapse. Something must change. Refiners must cut production.

Crude Oil imports this week are at the 7th Percentile, Distillate is at the 6th Percentile, Gas at the 79th Percentile and Jet Fuel at the 13th Percentile. Demand is simply not better than very poor.Import levels need to hold at these levels until we clear inventory.

Refiners are running at 79.66% this week compared to 84.34% last year. Still Crude Oil inventory does not seem to fall. Run rates must stay here or lower and imports must stay here or lower. Inventory, with current demand, shows only one conclusion; if we get higher imports, and become a dumping ground for product, price weakness will follow.

If we do not see this supply/demand imbalance end in the next few months, we will more than likely face a major price problem at some point. With too much inventory and too much production imports will trigger a problem unless they stay very low. If the imports do not stay depressed we will see inventory build and at a time when demand cannot take it. If this does happen, and we have a price collapse, we want to hedge 2-3 years into the future.

Distillate supplied this week is at the 14th Percentile with Gas at the 41st Percentile. Demand for Distillate remains continually poor at best. A year ago we were at the 38th Percentile. Demand for Distillate must improve. We are now in December and if we see an inventory build we have major problems and a price disaster.

Gas demand fell this week to the 41st Percentile compared to year when it was at the 40th Percentile with price 78 cpg lower. Price has maintained these levels only because of the extreme dollar weakness. If the $ was not so weak, prices would be at least lower by 1/3. If the US $ rallies begins to rally from here we will see a dramatic price break.
Prices are running sharply above a year ago with the market fundamentals about as bad as they could be. In a number of weeks, on a year over year basis, these prices are going to look very rich on a comparative basis. They will stick up like a sore thumb compared to a year ago.

Do not think that this is going to last forever, it will not. Something always comes along to tip over the apple cart

Crude Oil:
We closed down this week losing $0.67 to close at $76.05. We had a BUY SIGNAL and have partial hedges on at the 25% level. I remain negative but we follow the Indicators and they are still positive. The main reason for the strength is simply the US $ weakness. This week saw some $ strength as the credit problems of Dubai hit the markets very hard on Friday.

We have closed at the bottom of the weekly trading range 5 weeks in a row and this market appears set up for more weakness. If there is a $ strengthening about to take place this market should drop quickly and sharply to lower a price level. I expect a test of $67.50-$72.50 depending on any continued strength that we happen to see.

If though, the dollar weakens more from these levels, the market will probably not break a lot more. If the weakness is pronounced, we will probably test the swing highs at $81.50 and may advance up to the mid $80 range.

The HO Crack was up a little this week with the Gas Crack sharply lower as was the 3:2:1 Crack. This is not positive and if we see more weakness in the processing margins, Crude Oil will weaken. Overall the action just shows how inherently weak this market truly is.

We have had the announcement of three refiners shutting down operations and if we see the margins remain weak, and move down to lower levels more are sure to follow suit. Crude Oil will have a difficult time holding current price levels unless the Crack Spreads hold here or move higher.

The Crude Oil is now susceptible to price weakness if the Crack Spreads cannot hold. If the Crude Oil inventory grows, and demand drops, there is going to be a major price problem. The refiners are now right at breakeven and to hold these margins they must continue to hold down the run rate.

This will help Crude prices to remain stable and maybe get a rally going. If, the weakness in the Crack Spreads continues, we should expect more weakness in Crude Oil. If the 3:2:1 Crack Spread weakens sharply, Crude Oil could break then begin to have a very sharp break.

This will especially true for the back month Crack Spreads as they are trading at a very sharp premium to the nearby contracts in a number of cases. The huge Distillate Inventory, mixed in with horrible demand, does not lead one to suspect price will not eventually drop dramatically.

If we continue to have a mild winter, the Crack Spreads could enter into a meltdown stage and a price collapse. Do not doubt that under the right circumstances Crude Oil can collapse back down to the spring lows at $34, especially if there is a demand collapse.

If we have a normal to cold winter, which so far is not the case, with increasing demand, margins and price should be stable. The Vol Price Indicator is at the top of its range for the 12th week in a row, and this is bullish. The % Total Count is 79%, falling and this is bearish. The other two Indicators are at 81% and 79%, one rising and one stable and this is neutral to bearish.

Heating Oil:
We fell this week by 1.34 cpg and closed at 196.22 cpg. We have a Buy Signal, but we are using Crude Oil for hedging because the HO Crack Spread remains quite high. I expect to see weakness in this market versus both Gas and Crude Oil.

The facts are we have a very large inventory, that is not declining, and we have low demand. With those facts, I find it hard to expect a huge rally from here. Distillate production remains very high relative to demand. Demand, which is now much worse than just poor, must change or price will go down.

Inventory is 40 million barrels above last year with demand still poor at the 21st Percentile of the 10-year range. Production is at the 64th Percentile this week with Product Supplied is at the 21st Percentile. This could hardly be poorer at this time of year.

What it will take to rebalance the supply/demand equation? If something does not change price will suffer dramatically, unless the $ continues to drop. The fundamentals, which are worse than extremely negative, still has not caused price to fall because of the $ weakness.

If that weakness happens to turn into strength, we will see massive price weakness develop. The Crack Spread is still acting very negative for this time of year yet price has not fallen. If we now see a US $ rally we will see price problems quickly develop. We have too much inventory with too much production with too little demand.

These facts have been ignored, as the $ has been weakening, but the market stop ignoring them very quickly if the $ strengthens. When the $ changes direction is anyone’s guess, but when we see it we will see sharp weakness in the Oil complex and especially in Heating Oil.

Over the last 42 weeks, we have had no increases in product supplied on a year over year basis. Thus, it appears the only way to decrease inventory is to cut production. That is what we have seen over the last 7 weeks but inventory is only down 5 mm barrels from the all time high. Demand is depressed and until we see that change, the overall facts in this market will not change. By this coming spring, if we cannot get rid of some of this inventory, we have a major problem with storage.

If that happens we will see price decline no matter what the $ does. If that happens, expect to see a price collapse in Heating Oil and in the HO Crack Spread. If so, a drop of 75-100 cpg in Heating Oil and 20 cpg in the Crack Spread, or more, is likely. The market ran up from 115 cpg to 210 cpg, as inventory increased from 145 mm barrels to 171 mm barrels.

It is hardly unreasonable that we go back to where the up move began. If the demand function stays depressed the price drop could be long and deep. The Vol Price Indicator is at the top of its range for the 11th week in a row, this is bullish. The % Total Count is 79%, falling and this is bearish. The other two Indicators are at 78% and 76%, one rising and one stable and this is neutral to bullish.

Heating Oil Crack Spread:
We were up 0.26 cpg to close at 15.15 cpg this week. The rally seems now to have stalled. We closed on the high of the week and we must have some follow through this coming week. If we fail, and take out this weeks low, we should move down to under 10 cpg.

Inventory size and lack of demand is the story and it continues to pressure the market. Continued lack of demand will allow us to maintain close to record inventory levels for a long time and this will not help price. Eventually this will end badly for price if something does not change.

How we lower inventory without a demand increase is the question. If the inventory does not start to fall sharply soon we will have a storage problem by spring. If inventory does not fall to under 150 mm barrels by spring, we may see inventory build to 180+ million barrels by early next summer. That equals a major storage problem and a major price problem. A number of refiners will then be at the brink of collapse. This will be especially true if we have a major bear market on product prices.

As of now, the huge inventory and poor demand is a lid on price increases. The lows at the 15.00 cpg level are holding but I expect them to fail and we then should move to the 7.50-10.00 cpg area. Unless the can demand improve, the swing lows will more than likely be tested. If the low of 5.10 cpg is violated the break should carry us to the -2.00 to +2.00 cpg level. If we exceed, and hold, the 17.50 cpg level, which is highly doubtful, a run up into the 22.50-25.00 cpg level may happen.

Considering inventory levels and demand weakness the logical conclusion is that we will see more price weakness than strength. Distillate Inventory is at 98th Percentile, with Production at the 64th Percentile, Imports at the 37th Percentile with Product Supplied at the 21st Percentile. Those facts are simply terrible. If refiners do not scale back and inventory builds, as we enter winter, the Crack Spreads can collapse and dramatically.

If we do not soon see demand increase, with a production drop, the inventory will not be able to decline and the price will. Refining run rates must go down to the 75% level to help get rid of excess supply. The Vol Price Indicator rose to the top of its range this week and this is bullish. The % Total Count is 57%, stable and this is neutral to bullish. The other two Indicators are 54% and 54%, one rising and one stable and this is neutral to bearish.

Gasoline:
This week we broke 5.44 cpg to close at 192.62 cpg. If we cannot exceed the June high of 207.11 cpg we will see a large break eventually develop. Nine separate times we have tried to take out that high and if we ever manage to get the job done we should then go up sharply.

If we do not we will sell down sharply at some point. Inventory is now 9,609,000 barrels above last year and if it increases price will have a difficult time in achieving a major rally unless demand picks up. In five weeks year ago inventory comparison will be 208,103,000 when price was 84.40 cpg. If inventory remains unchanged from here, inventory will be 2.0 million barrels higher and price will be 112 cpg above last years price.

Then on a year over year basis, we are 112 cpg higher, with the same inventory and demand price will look very high. Then as we compare the facts, on a year over year basis, it will be tough to make a bull argument. The current fundamental facts are that inventory is up 4.84% from a year ago with production is up 2.52% and demand is up 2.77%.

The facts are neutral to friendly but no better. The question is what happens if inventory increases and demand does not increase. Indicators continue to be a mixed bag. If 207.11, is taken out price momentum should carry us to a sharply higher price level.

This, if it happens, more than likely will be caused by continued US $ weakness rather than fundamental data. There is no major fundamental reason for prices to go up now. This week Gas Inventory is at the 68th Percentile, Production is at the 93rd Percentile, Imports are at the 54th Percentile and Product Supplied is at the 57th Percentile. This is better than the Distillate market but is a poor set of relative facts overall to support current prices.

The key is if Gas demand falls from here, then we have a major problem, especially if inventory begins a sharp build up. If inventory goes to the 220-225+ million barrel range, price problems will probably happen and we could see price at 125 to 140 cpg and possibly down to 80 cpg depending on the US $. This is possible if demand drops and the $ strengthens. The Vol Price Indicator is at the top of its range for the 3rd week in a row, and this is bullish. The % Total Count is 46%, falling and this is bearish. The other two indicators are at 44% and 46%, both falling and this is bearish.

Gasoline Crack Spread:
The Gas Crack broke sharply this week falling 3.84 cpg to close at 11.55 cpg. Since the last week in July we have dropped 28.18 cpg or 71% from the high of 38.86 cpg. Inventory build and demand dropping as driving season ended initiated the break. We currently have a Sell Signal and the Indicators still point lower.

The problems in Gas are not as bad as in the Distillate market, but by next spring, they may end up being worse. This will be dependent on demand and inventory builds over the next 4 months. This time of year Gasoline inventory builds, and that is the last thing we need to see happen considering the huge distillate inventory we currently have.

If inventory builds above 220 mm barrels, we will see price problems. Inventory this last year held at a high level over the summer and fall because we had shrinking demand and no weather or refinery problems. This caused by the poor economic conditions we weathered, as the stock market tanked and unemployment rose to the highest levels in 26 years.

With inventory 34 million barrels above a year ago on 9/18, the lid on a major price advance was in place. The floor over the last 6 months though has been $ weakness and if that ends…! With those facts, the idea of a major lasting rally is tough to fathom.

The rallies we see should be short and the breaks should wipe out the gains twice as fast as they took place. A number of scenarios can cause a sharp price break. I do not see any realistic scenarios developing that will cause a sustained rally. There is no inventory shortage and there will not be with the present facts. Unless the demand improves, we will not have a lasting rally.

Last year saw inventory build over 19 weeks by 41,482,000 barrels. If that repeats this year, even to a much smaller degree, with current fundamentals, we will see a huge break in the Crack Spread. The Vol Price Indicator rose above the bottom of its range for the second time in a row this week and this is neutral to bearish. The % Total Count is 30%, rising and this is bullish. The other two indicators are at 22% and 22%, one stable and one rising and this is neutral to bullish.

3:2:1 Crack Spread:
The 3:2:1 Crack Spread fell 2.48 cpg this week closing at 12.75 cpg. I remain negative on this spread after the rally we have seen. The back months of the 3:2:1 are at a sharp premium to the nearby spreads with some at 20 cpg. Considering the current supply and demand scenario, they should be weak. The premium of the back month spreads, to the nearby spread, leaves room for a major break to develop if the fundamentals get worse than what we currently see. If demand does not improve these spreads could lose a lot of ground from here.

Distillate inventory, with poor demand, should prove too much in the weeks ahead. This will effectively limit upside advances until those facts change. The continued impetus, with a premium price structure, should be for more price weakness with an occasional rally.

If Gas inventory builds up expect price pressure to come into this market. The real question is, “What will make the spread move up from here?” With current inventory/demand what will drives product prices higher relative to Crude Oil? I cannot see anything that should cause the spread to move sharply higher and then maintain those higher levels.

Until we see inventory fall and the demand increase, price should remain relatively weak. We will see rallies, but the point is can they last? A decline to the record low, at 1.51 cpg, will happen if inventory does not drop. If we see demand fall this winter price will decline sharply and may carry us to a new record low. Something must change in the supply/demand balance or price is on its way to massive problem. The Gas Crack must not weaken, which it did this week, because there is no way the HO Crack will carry this spread.

I expect more price weakness with a possibility of record low prices at better than 50/50. The weakness may end up being especially powerful in the back months, which carry a sharp premium to the front months. The premiums will attract professional selling on every rally. With this supply/demand balance, we cannot hold the premium price structure in the back months. Either demand improves or production falls sharply.

If one of those things does not happen, inventory will build, and there is little chance for a major bull market run. I suspect the spread traders will sell this spread every time it rallies, just as they have been. If demand gets worse from here, we go lower. We must see refiners keep production down. If demand ultimately rules the market price, as of now, with this demand, price is in trouble. The Vol Price Indicator rose from the bottom of its range for the second week in a row, and this is bullish. The % Total Count Indicator is 35%, rising and this is bullish. The other two Indicators are at 28% and 28%, one rising and one falling, and this is neutral to bearish.
HO-Gas Spread:
The HO-Gas Spread gained 4.10 cpg this week, closing at 3.60 cpg. The spread looks tired, I expect to see price stall at 7.50 cpg, and if we get through -2.00 cpg, we should head sharply lower. We have huge inventory in Distillate to work through so even if we do see sharply colder temperatures supply may prove too much to overcome as far as price advances are concerned.

With the extremely poor Distillate demand that we see, and with over production, Heating Oil is going to have some extreme difficulty moving up versus the Gas. The HO Crack remains extremely high considering inventory level and demand that we are currently witnessing.

Gasoline would seem the more likely candidate to rally than Distillate. I expect this spread to return to sharp weakness, especially after the run up we had. Current price action looks like it is setting up a break. That could develop quickly if we do not see a reversal and rally from these levels. We traded up to 10 cpg and but it appears that we now have more bias developing to the downside.

The weakness seems to be setting in slowly and expect that will continue and intensify. The spread is in a weakening mode, and if there is no demand increase, for distillate, the next wave of weakness should be very sharp. We broke below the 0-cpg level and this sets us up for a decline to -20 to -30 cpg going into winter and then the spring.

The Vol Price Indicator remains at the bottom of its range for the 6th week in a row, and this is bearish. The % Total Count Indicator is 52%, falling, and this is bearish. The other two Indicators are now at 61% and 69%, both are falling and this too is bearish.

Dennis Mangan

November 29, 2009

We are at the 87th Percentile in barrels in storage, and we are at the 96th Percentile based on the 23.91 days of usage in storage. Distillate inventory increased by 349,000 barrels, to 167,725,000, the 99th Percentile. We are up 6,108,000 barrels from 13 weeks ago and up 39,374,000 barrels from last year.

We currently have 47.34 days of usage in storage, the 98th Percentile. Gas inventory increased 2,560,000 barrels to 210,837,000 barrels, the 70th Percentile.

We are up 1,083,000 from 13 weeks ago and up 12,742,000 barrels from a year ago. Days of usage are at 23.84, the 72nd Percentile. The Crude Oil inventory will match last year’s level, in 11 weeks. Prices then were $46.47, $31 less than current prices.

In 15 weeks we will be comparing a Heating Oil price of 119.67 cpg compared to the current price 200.35 cpg, and inventory will be 26 mm barrels higher. In 7 weeks Gas inventory will be about equal to last year. Price was 84.40 cpg, a 108 cpg lower than now.

In a few short weeks inventories will be about the same as last year, if they do not change, and price if it does not change, will be extremely over priced. The market is at extreme risk for a sharp break on a comparative basis. If demand does not improve sharply and if production does not drop we have a problem headed towards us on price.

If we have inventories increase, and there is no demand increase, price will look more than very high, on a year over year basis. Distillate demand must increase and that is not happening. Production must drop sharply and that too is not happening. Ultimately, if these two things do not change we end up looking at a huge inventory, too much production and little demand.

A price collapseRefinery inputs fell again and we are now sitting at the 3rd Percentile this week, Distillate production is at the 71st Percentile with the HO Crack Spread at the 48th Percentile.

Gas production is at the 75th Percentile and the Gas Crack Spread is at the 8th Percentile. The Ho Crack Spread remains high considering production levels but the Gas Crack has dropped dramatically.

Production has not fallen much so the Crack Spreads have fallen. Over production, low demand eventually leads to price problems. Current demand levels warrant lower than the current production levels. The production levels we have seen dictate a demand increase of 10% ore more and that is not here.

HO and Gas production must be decrease. If, production compared to demand for products, remains at these levels price and processing margins will not hold these levels. We will see pressure on price and the potential for a price collapse is increasing.

Concealed Clues

At the same time, another transformation was taking place.
The edges between the solid data and the gray zone gradually became sharper. Over the last few years, the agency’s estimates for peak oil production fell from 120 mpbd to 105 mbpd, but oddly, their forecast for the date of the peak remained stubbornly around 2030. Curves were gradually flattened, but reached the same point. Simple head-scratchers like that.
The language of the reports also grew in clarity and intensity, alarming critics. By last year, it had become downright shrill: “The world’s energy system is at a crossroads” . . . “global trends. . . are patently unsustainable”. . . “the era of cheap oil is over”. . . “Time is running out and the time to act is now.”
This year, they admitted what many of us had already figured out: Non-OPEC supply has basically peaked. Despite this, IEA still forecasts global oil supply will rise from 84.6 mbpd in 2008 to 105.2 mbpd in 2030.
They then devoted fully half the report to a “450 Scenario” in which a vigorous global investment in efficiency, renewables, carbon capture, and nuclear power averts global disaster by keeping atmospheric CO2 concentration below 450 ppm, with a price tag of $26.5 trillion (in 2008 dollars).
The good news now is the situation isn’t quite as dire as we thought it was last year. Their cost forecast has come down from $35 trillion, and they now think the world will only need to come up with 45 mbpd in additional crude capacity (another four Saudi Arabias) not 64 mbpd (another six).
Indeed, the divisions between reality and fantasy in this report grew sharper still. They worry at length about the effect of the global financial crisis on investment in new energy supply, yet still imagine the world will spend about $1.5 trillion a year on new supply infrastructure.
While envisioning a massive investment in efficiency and renewables in the 450 Scenario, they observed that low oil prices, receding investment in cleantech in 2009, and general economic malaise could mean slower growth rates for the solutions.
They forecast that OPEC alone would come up with 17.5 mbpd in new supply—85% of the global increase—but expect the Middle East to spend only $1.9 trillion out of a global total of $25.5 trillion.
In an extremely dubious scenario, they see global natural gas supply growing faster than demand, eventually resulting in a massive glut. At the same time, they published for the first time a detailed, field-by-field analysis of nearly 600 major gas fields, accounting for 55% of global production. It showed an average 5.3% post-peak decline rate for the world’s largest gas fields, and a global production-weighted decline rate of 7.5% for all post-peak fields—very similar to the decline rates they published (again, for the first time) last year on oil fields.
While noting that nearly all of the growth in global energy demand will come from the developing world, and that much of the investment capital needed to obtain their 450 Scenario will need to be invested there, they also expressed significant uncertainty about those prospects.
Most telling, however, were the comments made in the press conference at the report’s unveiling.
When a reporter asked why they’re still sending a signal that the world will come up with another four Saudi Arabias of supply in their Reference Scenario when no one believes that is possible, IEA chief economist Fatih Birol tipped his hand:
This is not the scenario we think is — first of all — likely; this is not the scenario that we want to happen. . . This is the scenario that, if it happens, we are going to have an accident in terms of climate, in terms of energy security, and other things, and it is the reason why we are pushing the 450. . . We push the 450 not only for the climate change reasons. . . it is also for the energy security reasons. And it is the reason why our ministers in October have endorsed our work in general. . . We think this [report] is a driver for [developing policy around climate change].
Essentially, he admitted that they deliberately tilted the report toward climate change with an expressly political purpose: to motivate capital and policy in the direction of a decarbonized energy supply. And they did that because it was politically expedient, with all eyes now on the upcoming Copenhagen summit on climate change.
Finally, the agency’s highly-nuanced, limp denial of the whistleblower allegations was well salted with impassioned pleas to reckon with their 450 Scenario, reiterating that “the era of cheap oil is over.” Birol even emphasized that the IEA had decided to make their data on oil depletion available on its web site for the world’s free and transparent examination—a clue that was not concealed, but painted in fluorescent orange.
The Climate Change Stalking Horse

I have considerable sympathy for the IEA. It’s not easy to follow your heart and tell the truth for the benefit of humanity while the boss man is glaring at you and pulling a finger across his throat. Of course their report is politically distorted.
Yet, as I highlighted the key points in the report’s executive summary and mentally ticked off the articles I’ve written on each one over the last few years, I realized how far the IEA has really come. They may have no choice but to walk a tightrope in an intense global spotlight, but they’re backing into the truth as quickly as they think they can. For that fact alone, despite its flaws, this report gets my thumbs-up.
Regarding the IEA’s Reference Scenario, my view remains basically unchanged from what I said this time last year: “Here’s my prediction: their 2010 report will state that the new peak is only 95 mbpd, at a cost of over $30 trillion. And by 2012, they’ll admit that the peak was in fact in June of this year, at 87 mbpd. By 2030, fully 20 years past the peak, world oil production will likely be under 70 mbpd.”
As for the 450 Scenario, I continue to believe that climate change is a backwards approach to the problem. I have seen no serious rebuttals to the studies by Kjell Aleklett and David Rutledge calling into question whether the world can even get to 450 ppm when peak oil, and then peak gas and peak coal, are properly considered. (Currently, no climate change scenarios have any cognizance of fossil fuel peaking whatsoever.)

In e-mail correspondence this week, Aleklett told me that he will soon have two new newspaper articles published in his native Sweden (which will be translated to English) that demonstrate on scientific bases that all of the IPCC scenarios are wrong.
But even that is not important.
Climate change is merely a stalking horse for the IEA. Whether we focus on energy or on climate, the ends are largely the same. And the IEA has astutely recognized that there’s a whole lot more public momentum and investment money to be focused on climate change than there is on dour old peak oil.
What the 2009 WEO Really Means

I could go on for pages and pages, as I have in the past, pointing out the discrepancies and critiquing the scenarios. But that’s not really what this report is about.
Never mind the outlandishly optimistic oil and gas production scenarios. We can throw out the 450 Scenario, as well. They’re wrong, and we all know it—wink wink, nudge nudge.
The IEA doesn’t believe either one of its scenarios any more than they believe humans roamed the earth with dinosaurs. Some stories are meant to be read as parables.
The internal message of the 2009 WEO is clear: The world is facing an energy crisis of epic proportions. The path we’re on is precarious and unsustainable. (The word “sustainable” occurs 18 times in the report, which I’m sure is a record, and Birol repeatedly emphasized the phrase “energy revolution” in his comments.) There is a way to avert disaster, but it’s going to require the world to commit an incredible amount of capital to the energy sector for many decades to come. And if we fail to rise to the challenge, we’ll be dead in the ever-rising water.
That, of course, is our entire raison d’être here. To motivate capital, rise to that challenge — and make some cheese in the process.
Until next time,

Chris

Let us know what you think!

Gail the Actuary on November 11, 2009 – 10:17am
Thanks, Sam! This is really a nice post. Explains a piece of the puzzle that all of us have been wondering about.

ROCKMAN on November 11, 2009 – 10:37am
Sam — I’m sure all appreciate your effort. Took some time no doubt. A question that perhaps you can only answer qualitatively: China has been acquiring rights (via contracts and direct ownership) of oil production around the globe for some time. The volume is difficult to estimate but the amount would seem to represent a reduction in the supply side of your model at least for the rest of the consumers out there. Of course, it also represents a volume that China wouldn’t have to acquire on the open market. Can you offer any hint to the potential magnitude of this situation with respect to your model?

Sam Foucher on November 11, 2009 – 11:27am
I was supposed to look at it in this post but that was way too long for a single post, part 2 will be posted tomorrow and will look at the Non-OECD demand. I think the Non-OECD is effectively outbidding oil through various mechanisms (not open market mechanisms).

Will Stewart on November 11, 2009 – 2:09pm
Great article, keep up the good work. Could I also request in the future that parameters in formulas have a little one liner explanation?

greenJamie on November 11, 2009 – 10:31am
Great post – it has clarified a few points I was wondering about.

“Some suggest that we are willing to and capable of moving away from oil” – I can see that those who are into wishful-thinking would like to interpret the recession induced reduction in demand as a signal we are safe from our dependence on oil. It is just that: wishful thinking.

westexas on November 11, 2009 – 10:44am
(Now everyone can see why Sam does the mathematical heavy lifting on our joint papers.)

It probably helps to show some specific examples, especially in regard to the export market. Saudi Arabia, at least based on annual data through 2008, is world’s largest net oil exporter; the US is the largest OECD net oil importer and China is the largest non-OECD net oil importer.

I think that the Saudis tried–as best they could–to restrain the price of oil from 2002-2008, and they significantly increased net exports from 2002-2005, but then from 2006-2008 their net exports fell below the 2005 rate, with 2008 (when oil prices averaged $100) actually falling below their 2004 net export rate (when oil prices averaged $42).

As one would expect, US consumption and net imports fell, in response to higher oil prices, but then we have China (their most recent data show monthly net imports of about 4.5 mbpd).

Saudi Net Oil Exports (EIA):
US Net Oil Imports:
Chinese Net Oil Imports:

Standard economic principles have demonstrated that price is a function of supply and demand. The same is true for the recent  oil prices fluctuations we have witnessed over the last few years,namely the equilibrium between supply and demand. However, the following conundrum has not been resolved: are oil prices high due to greater demand or too little supply? This ambiguity allows for vastly divergent interpretations of the same data and depending on the agenda you are trying to push, will easily support either.

Lately, the concept of “Peak demand” has been suggested in a multitude of recent articles that unfortunately do not qualify their analysis of the status quo. Some suggest that we are willing to and capable of moving away from oil. Are we?

A few years ago, some analysts lectured us about the effect of oil prices on the creation of new oil supply. Now that this argument has clearly failed, they have decided over night that we don’t need oil anymore. In this debate, it is important to distinguish between demand (what you want or need) and consumption (what you get based on your ability to buy). Following this logic, consumption is “satisfied demand”. Conversly, we can define the “unsatisfied demand” or “excess demand” that has been suppressed. Below the fold, I’ll show that the key driver behind the priceincrease since 2002 has been excess demand combined with unresponsive supply.

OECD Demand

In this analysis, I follow an approach similar to the one proposed by Ye et al. (pdf) using a model defining a desired inventory level. The consumption trend observed between 1990 and 2001, when the market was well supplied, can be easily and accurately modeled by a linear trend taking into account monthly fluctuations: The fit result is shown as the magenta line illustrated on Figure 1 below. The above model will

define normal demand levels assuming low oil prices. The OECD consumption has strongly reacted to higher oil prices and is now almost 10 mbpd the level expected by my nominal demand model.

Figure 2. Observed OECD consumption and nominal demand model (monthly, total petroleum products),

volumes in million barrels per day (mbpd). data from the EIA.

Looking at the residuals Ct-Dt, the fall in consumption from the desired level is even more telling:

Figure 3. Difference between the nominal demand models and the observed consumption (monthly, total  petroleum products), volumes in million barrels per day (mbpd). Data from the EIA.

I make the following assumptions:

1. because oil prices were so low during the 1992-2001 period (i.e. virtually no excess

demand), I will call “nominal demand model” the linear model defined above.

2. The difference between nominal demand and observed consumption is an estimate of the excess demand: EDt=Dt-Ct

Plotting the excess demand against oil prices clearly shows why prices rose until the financial collapse last year. Before 2002, prices and excess demand were contained within a tight cluster around 20$/barrel – evidence that the market was well supplied and at equilibrium. The red line shows that prices increased by $20 per 1 million barrels per day of excess demand between 2004 and 2008.

Figure 4. OECD Excess demand versus oil prices (WTI).

One could argue that the nominal demand model defined above is not stationary and has been affected by structural changes in demand. Unfortunately, the only way structural changes in demand could be estimated is if the oil prices of tomorrow would go back to $20 a barrel for a few years within a pro-growth and healthy business environment. Only then could a new nominal demand model be estimated; those conditions won’t be satisfied anytime soon. Peak demand would suggest that the demand model would change over time, but then the level of unsatisfied demand would go down, bringing down prices with it. Actually, the severe recession we are currently in since the fall of 2008 has destroyed demand as a result of high unemployment rates and reduced credit availability. Looking at the price model on Figure 3, a return to the $70-

80 range is equivalent of a demand destruction of around 3 mbpd for all of the OECD.

What about Spare Capacity?

Spare capacity, mainly provided by OPEC, is the amount of oil that can be made available within

30 days and sustained for at least 90 days (EIA definition).  Looking at the available spare capacity and the excess demand estimate, it is obvious that OPEC spare capacity has become deficient since 2002, and that the surge in excess demand coincides with the increase in oil pricesas shown on Figure 5.

Figure 5. Oil prices (right axis) and estimated excess demand along with EIA estimate for OPEC spare capacity

(left axis).

So What is Causing High Oil Prices?

As an interesting exercise, I looked at the causation between oil prices and demand/supply indicators. Causal search algorithms systematically investigate patterns of conditional dependence and apply the Causal Markov Condition to reconstruct the graph of the data generating process (A good overview is available here). I define the following quantities:

P: Monthly oil prices

S: Monthly oil supply

C: OPEC spare capacity (EIA)

D: Excess demand

I used the remarkable TETRAD IV software (family of software for causal modeling originating with Peter Spirtes, Clark Glymour, and Richard Scheines at CarnegieMellon University) available online. I split the dataset in two periods: 1998-2002 period when prices where relatively low and 2003-2008.

1998-2002 period:

Figure 6. Graphical causal model for the period 1998-2002

Spare capacity is dependent on prices and excess demand. Prices and excess demand are independent unconditionally; but are dependent conditional on spare capacity. In short, OPEC spare capacity was playing a buffer role in order to absorb excess demand.

2003-2008 period:

Figure 7. Graphical causal model for the period 2003-2008

Price is dependent on supply and excess demand. Supply and excess demand are independent unconditionally; but are dependent conditional on prices. Spare capacity is independent of all the other variables at 5% significance.

Conclusions

Lower consumption does not mean lower demand, nor does it mean the increase in alternate sources of energy. If it did, it would be akin to saying that an alcoholic is sober implies he has effectively dealt with his addiction. It may be that he is sober because he has simply exhausted all of his options for obtaining additional alcohol.  Also, I think it is important to differentiate between  the following two causes of demand destruction:

1. Recession induced demand destruction (e.g. business going bankrupt, rising unemployment,

etc.), or

2. Long-term structural changes in demand (e.g. increase in the average car mileage, increase efficiency, etc.)

In my opinion, the latter cause of demand destruction is the approach to take and can be implemented through adequate government policies  (e.g. higher CAFE standards). When people are unemployed, energy efficiency is the last of their concerns. If we do not proactively implement demand side policies and instead wait for high prices to take their toll, social unrest and  higher government deficits are likely to make things more challenging, or even completely unmanageable.

Anemic supply growth, only a preamble to peak supply, was enough to create our present troubles. Wait until supply growth is negative! We have enough data from the OECD to draw the following conclusions:

1. Sluggish supply growth is the main driver behind the 2002-2008 oil price increase. OPEC spare capacity has become irrelevant or at least unresponsive.

2. Nominal demand is between 3 and 5 million barrels per day above  production capacity.

3. Prices are increasing by $20 for every million barrels per day of excess demand.

4. OECD consumption is very elastic to oil prices.

5. Non recession induced peak demand  is not supported by the data.

6. The financial collapse and the current economic recession has at least reduced demand by 3 million barrels per day for the OECD.

In my next post, I will look at the non OECD demand.

]]> http://www.hedgeco.net/blogs/2009/11/11/samuel-foucher-logi-energy-peak-demand-or-peak-consumption-a-look-at-the-oecd-demand/feed/ 0 http://www.hedgeco.net/blogs/2009/11/04/nouriel-roubini-big-crash-coming/ http://www.hedgeco.net/blogs/2009/11/04/nouriel-roubini-big-crash-coming/#comments Wed, 04 Nov 2009 14:03:21 +0000 Larry Ortega http://www.hedgeco.net/blogs/?p=1328 logi Energy wants as many people as possible to read this article by Nouriel Roubina.

Dr. Nouriel Roubini, professor of economics and international business at the Stern School of Business at NYU and chairman of RGE Monitor, is perhaps best known for his prescient predictions of the financial market collapse in 2005.
Dr. Roubini will be the keynote speaker at IndexUniverse’s upcoming “Inside Commodities” conference on Nov. 4 at the New York Stock Exchange. We sat down with Dr. Roubini ahead of the conference to take his temperature on global markets, the role of oil (NYSEArca:USO – News) and gold (NYSEArca:GLD – News) and the impact of regulation.

Index Universe (IU.com): You’ve said that you’re worried we’re already sowing the seeds of the next crisis. Where do you see that most directly?

Dr. Nouriel Roubini (Roubini):Well in commodities, I look at oil prices. They fell from $145 last summer, came down to $30 earlier this year and now they’re back close to $80. But if I look at the fundamentals of demand and supply, demand is down to 2005 levels, supply and inventories are at all-time highs. In my view, the movement in oil prices is not fully justified by the fundamentals.

There are improving fundamentals. There is a global recovery. But that justifies oil going from $30 to maybe $50. I think the other $30 is all speculative demand feeding on it—speculators and herding behavior. Last year, when oil was at $145, that killed the global economy. I worry that oil is going to go up above $100 for reasons that have nothing to do with the fundamentals of supply and demand. Oil at $100 would have the same negative effects on the global economy as oil did at $145 last year.

Last year, when oil was at $145, the global economy was still growing. Right now it has collapsed, and is recovering. Oil pushing above $100 would have nasty, negative real trade effects and real disposable-income effects on all importing countries:U.S., Europe, Japan, China, India; all the countries that were hit by the oil shock last year. So that’s an element that is in my view totally speculative, and dangerous to the global economy.

IU.com:Is that true elsewhere?

Roubini: I could make a similar argument for other commodity prices. In my view, rising commodity prices are not justified by the fundamentals.

There’s a huge bubble, because we have zero rates in the U.S., zero rates around the world and a huge carry trade. Everyone is borrowing at zero interest rates in dollars and getting a capital gain because the dollar is weakening, so they are borrowing at negative rates. And then they invest in risky assets:commodities, equities, credit. We’re creating a bigger bubble than before.

It’s going to go crashing down, in an ugly way. That’s the basics of the argument.

IU.com:Is there a regulatory solution to the speculation issue? Is the CFTC tightening and enforcing position limits a step in the right direction?

Roubini: I think it’s an idea worth considering. I’m not usually in favor of position limits, but I think the swings in the value of oil have been extremely dangerous for the global economy. Oil at $145 was the reason—more than Lehman or anything else—that the global economy tipped into the worst recession in the last 60 years. After the collapse of the global economy, oil collapsed to $30. At $30, there can be investment in new capacity. But now it’s back at $80 and soon enough it’s going to be at $100.

If position limits are going to be effective—and I don’t know that—I would not be against them. Because these swings in value of oil, on the way up and on the way down, are extremely damaging to global economic activity. They are dangerous. They are not justified. And if they can be controlled, so be it.

IU.com:You recently co-authored a report in which you and your colleagues ranked the U.S. third in world financial markets, after London and Australia. Was regulation a big component of that?

Roubini: The U.S. might have been No. 3 overall, but it was ranked No. 38 out of 55 in financial stability, because we’ve had a disastrous banking and financial crisis. That was in part due to poor regulation and supervision of financial institutions. That’s one of many factors and reasons why the U.S. was ranked so low on that particular pillar. Certainly there has been a massive failure of regulation and supervision of the financial system. But the regulatory failure was more in the direction of unwillingness by regulators to apply regulations. The Fed had all the powers to regulate toxic underwriting of mortgages, but they believed in laissez faire markets, and they created a disaster.

IU.com:How does this get fixed?

Roubini: I don’t believe in market discipline. It doesn’t work. That was the ideology of the last 10 years; self-regulation means no regulation. Market discipline doesn’t exist with irrational exuberance and reliance on internal risk management models that don’t work. Nobody listens to risk managers, because it’s risk takers that make the profits. The reliance on ratings agencies that have their own conflicts of interest, the reliance on soft-touch regulation, the focus on principles instead of rules—that particular regulatory philosophy has been a disaster, and we’ve learned it the hard way. We have to go to simpler rules, tougher rules and more binding rules. That’s the right approach.

IU.com:You’ve been clear that you think most assets are currently overvalued. Do you think there are opportunities for investors in certain asset classes or certain geographies?

Roubini: Well, there is a wall of liquidity chasing assets. That liquidity can chase those assets higher for the time being until the huge carry trade—the asset bubble and the wall of liquidity—comes crashing down. You can still have all the risky assets going higher. Of course, the higher they go, the more they diverge from fundamentals, and the riskier the situation becomes. But eventually, if the recovery of the economy is going to be anemic, sub-par, below-trend and U-shaped, there is going to be a correction. And therefore my view is to stay away from risky assets. Stay in liquid assets. I don’t know when the correction is going to occur, it could be a while longer, but eventually it will be a pretty ugly correction, across many different asset classes.

IU.com:When you say “stay away from risky assets,” many people hear that and think, “Aha, gold!”

Roubini: I don’t believe in gold. Gold can go up for only two reasons. [One is] inflation, and we are in a world where there are massive amounts of deflation because of a glut of capacity, and demand is weak, and there’s slack in the labor markets with unemployment peeking above 10 percent in all the advanced economies. So there’s no inflation, and there’s not going to be for the time being.

The only other case in which gold can go higher with deflation is if you have Armageddon, if you have another depression. But we’ve avoided that tail risk as well. So all the gold bugs who say gold is going to go to $1,500, $2,000, they’re just speaking nonsense. Without inflation, or without a depression, there’s nowhere for gold to go. Yeah, it can go above $1,000, but it can’t move up 20-30 percent unless we end up in a world of inflation or another depression. I don’t see either of those being likely for the time being. Maybe three or four years from now, yes. But not anytime soon.

Crude Oil:
This week we finally saw weakness return and closed down $3.50 at $77.00. We had a BUY SIGNAL and we have put on partial hedges at around the 25% level. Considering the current Crack Spreads, the Crude Oil is where we want to hedge. The Indicators changed direction and triggered a Buy Signal, but this week we will not hedge more as they have went to neutral. Fundamentally, I am negative on the market, but I never let my bias about market fundamentals stop me from following the mathematics of the market. Too many times, I have seen the Indicators end up being right. Thus, to ignore them over fundamental facts is not wise. The market has changed to a bullish scenario. The main, and the only reason I can see, is the continued weakness in the US $. This week we saw the $ stabilize a bit, but we will see how long that lasts. One week does not make a trend. When the US $ strengthens the market should head lower. Then a break to the $67.50-$72.50 level is probable. If dollar weakness reasserts itself, we will see higher prices until the weakness reverses. This week HO prices rose and the HO Crack rallied a bit. The 3:2:1 Crack Spread is holding above the breakeven price for refineries. This will lend support to Crude Oil as long as we hold at this level or higher. Crude Oil is susceptible to price weakness if the Crack Spreads again begin to fail. The Heat Crack Spread lost 9.82 cpg or 38%, as the Gas Crack dropped 27.02 cpg or 68% and the 3:2:1 Crack dropped 60% of its value during that break. Thus, we may be low enough for now on the Crack Spreads. That though can change in a hurry if inventory and demand do not act better going forward. The refiners are a little better than breakeven as of now and that must remain stable. We have had a number of Refiners shut down operations and if the spreads do not stay at these levels or higher more will also shut down. If we see weakness in the Crack Spreads, that should signal weakness to come in the Crude Oil. If the 3:2:1 Crack Spread weakens Crude Oil could have a severe break. Distillate Inventory is huge and we still have very small amounts of demand. A mild winter could easily trigger the Crack Spreads to go into a collapse. Crude Oil prices can go back down to $34 if demand falls apart. With a colder than normal winter, and with increasing demand, the higher margins should stop that scenario from playing out. The Vol Price Indicator is at the top of its range for the 8th week in a row, this is bullish. The % Total Count is 79%, falling and this is bearish. The other two Indicators are at 77% and 76%, both rising and this is bullish.

Heating Oil:
We fell back this week losing 7.04 cpg to close at 200.52 cpg. Last week we generated a BUY SIGNAL but because of the HO Crack spread, we are using Crude Oil for the hedge. This week the weakness turned us to a neutral signal. I expect to see weakness return to this market. The huge inventory and low demand are simply the facts. Production remains high relative to the demand, which is worse than poor considering the time of year. Inventory is 41 million barrels above a year ago, with the demand still in the lower 20% of the 10-year range. This has been going on for the last 28 weeks in a row. Production finally fell back below the 50th Percentile, which is good but it must continue. The facts, and the price action, have not been agreeing lately. As always, there is no reason to try to argue with the price action. The fundamental facts appear, and are, very negative. That said the price still has been going up. The Crack Spread must hold these levels or we will eventually see price problems. We have too much inventory. We have too much production. We have too little demand for product. Yet, as of now, the market does not care. When it does is anyone’s guess, but it more than likely will at some point down the road. If the US $ begins to recover then we will see weakness. I cannot see how weakness will not return in the weeks ahead. Over the last 63 weeks, we have seen only 4 weeks of increases on a year over year basis in usage. It would appear that the only way to decrease the inventory is by a cut in production cut. If the demand cannot increase, along with production decreasing, we cannot clear the huge inventory as we go through the winter. Then we go into the March timeframe with very high or record inventory and then we have storage problems and that spells price declines. If, that is what eventually happens, I expect to see a price collapse in both Heating Oil and the HO Crack Spread. I would a drop of 50-75 cpg in Heating Oil, and 15-20 cpg in the Crack Spread. This market has run up to 210 cpg from 115 cpg while the inventory increased from 145 mm barrels to 171 mm barrels. Thus, we can fall right back to where it began once the market turns over. If demand stays depressed, price will have a hard time maintaining these levels, and the price break could be quick and large. The Vol Price Indicator is at the top of its range for the 7th week in a row, this is bullish. The % Total Count is 75%, stable and this is bearish. The other two Indicators are at 74% and 73%, one rising and one falling and this is bearish.

Heating Oil Crack Spread:
We closed up this week gaining 1.29 cpg and closing at 17.19 cpg. The market rally appeared to have stalled last but this week regained its footing. We will now see if we can rise to, and above, the 17.50 cpg level. The huge inventory build caused the price break. That with the worst product demand in 10 years triggered the downside action. Thus, inventory building, with a demand collapse, drove us to record supply levels. The lack of product demand might allow us to maintain close to record levels of inventory for an extended period. How will we ultimately work this inventory down is the key question. Will we get into a literal storage problem if we cannot? The inventory and the demand should limit a huge price advance. The low is 5.10 cpg made the week of 5/29. The two major lows were the week of 5/29 and the week of 9/11 at 8.10 cpg. I think that these lows are going to be tested. If we take out the low of 5.10 cpg, expect the break to carry us down to the -2.00 to 2.00 cpg level. If we exceed the 17.50 cpg level, expect the run to carry us up to the 22.50-25.00 cpg level. Considering inventory and demand, the logical conclusion appears to be price weakness. Considering the market action of the last few weeks that would have been wrong. I think we have had a rally that was caused by the market being oversold, not a shift in the underlying facts. Distillate Inventory is at 99th Percentile. Production is at the 39th Percentile, Imports at the 20th Percentile and Product supplied is at the 17th Percentile. These facts are simply terrible. Especially the Products supplied number. If the refiners do not scale back operations, and inventory builds going into the winter, the Crack Spreads will collapse. If we do not see demand increase, with a drop in production, inventory will not drop to a lower level. If that is what happens over the next 5 months we have a huge price problem. Refining run rates need to go down to the 75% level. For now, I think inventory, production and demand levels put a cap on a large sustained price move up. The Vol Price Indicator is at the bottom of its range for the 3rd week in a row, this is bearish. The % Total Count is 49%, falling and this is bearish. The other two Indicators are 55% and 57%, one falling and one stable and this is neutral to bearish.

Dr. Nouriel Roubini, professor of economics and international business at the Stern School of Business at NYU and chairman of RGE Monitor, is perhaps best known for his prescient predictions of the financial market collapse in 2005.
Dr. Roubini will be the keynote speaker at IndexUniverse’s upcoming “Inside Commodities” conference on Nov. 4 at the New York Stock Exchange. We sat down with Dr. Roubini ahead of the conference to take his temperature on global markets, the role of oil (NYSEArca:USO – News) and gold (NYSEArca:GLD – News) and the impact of regulation.

Index Universe (IU.com): You’ve said that you’re worried we’re already sowing the seeds of the next crisis. Where do you see that most directly?

Dr. Nouriel Roubini (Roubini):Well in commodities, I look at oil prices. They fell from $145 last summer, came down to $30 earlier this year and now they’re back close to $80. But if I look at the fundamentals of demand and supply, demand is down to 2005 levels, supply and inventories are at all-time highs. In my view, the movement in oil prices is not fully justified by the fundamentals.

There are improving fundamentals. There is a global recovery. But that justifies oil going from $30 to maybe $50. I think the other $30 is all speculative demand feeding on it—speculators and herding behavior. Last year, when oil was at $145, that killed the global economy. I worry that oil is going to go up above $100 for reasons that have nothing to do with the fundamentals of supply and demand. Oil at $100 would have the same negative effects on the global economy as oil did at $145 last year.

Last year, when oil was at $145, the global economy was still growing. Right now it has collapsed, and is recovering. Oil pushing above $100 would have nasty, negative real trade effects and real disposable-income effects on all importing countries:U.S., Europe, Japan, China, India; all the countries that were hit by the oil shock last year. So that’s an element that is in my view totally speculative, and dangerous to the global economy.

IU.com:Is that true elsewhere?

Roubini: I could make a similar argument for other commodity prices. In my view, rising commodity prices are not justified by the fundamentals.

There’s a huge bubble, because we have zero rates in the U.S., zero rates around the world and a huge carry trade. Everyone is borrowing at zero interest rates in dollars and getting a capital gain because the dollar is weakening, so they are borrowing at negative rates. And then they invest in risky assets:commodities, equities, credit. We’re creating a bigger bubble than before.

It’s going to go crashing down, in an ugly way. That’s the basics of the argument.

IU.com:Is there a regulatory solution to the speculation issue? Is the CFTC tightening and enforcing position limits a step in the right direction?

Roubini: I think it’s an idea worth considering. I’m not usually in favor of position limits, but I think the swings in the value of oil have been extremely dangerous for the global economy. Oil at $145 was the reason—more than Lehman or anything else—that the global economy tipped into the worst recession in the last 60 years. After the collapse of the global economy, oil collapsed to $30. At $30, there can be investment in new capacity. But now it’s back at $80 and soon enough it’s going to be at $100.

If position limits are going to be effective—and I don’t know that—I would not be against them. Because these swings in value of oil, on the way up and on the way down, are extremely damaging to global economic activity. They are dangerous. They are not justified. And if they can be controlled, so be it.

IU.com:You recently co-authored a report in which you and your colleagues ranked the U.S. third in world financial markets, after London and Australia. Was regulation a big component of that?

Roubini: The U.S. might have been No. 3 overall, but it was ranked No. 38 out of 55 in financial stability, because we’ve had a disastrous banking and financial crisis. That was in part due to poor regulation and supervision of financial institutions. That’s one of many factors and reasons why the U.S. was ranked so low on that particular pillar. Certainly there has been a massive failure of regulation and supervision of the financial system. But the regulatory failure was more in the direction of unwillingness by regulators to apply regulations. The Fed had all the powers to regulate toxic underwriting of mortgages, but they believed in laissez faire markets, and they created a disaster.

IU.com:How does this get fixed?

Roubini: I don’t believe in market discipline. It doesn’t work. That was the ideology of the last 10 years; self-regulation means no regulation. Market discipline doesn’t exist with irrational exuberance and reliance on internal risk management models that don’t work. Nobody listens to risk managers, because it’s risk takers that make the profits. The reliance on ratings agencies that have their own conflicts of interest, the reliance on soft-touch regulation, the focus on principles instead of rules—that particular regulatory philosophy has been a disaster, and we’ve learned it the hard way. We have to go to simpler rules, tougher rules and more binding rules. That’s the right approach.

IU.com:You’ve been clear that you think most assets are currently overvalued. Do you think there are opportunities for investors in certain asset classes or certain geographies?

Roubini: Well, there is a wall of liquidity chasing assets. That liquidity can chase those assets higher for the time being until the huge carry trade—the asset bubble and the wall of liquidity—comes crashing down. You can still have all the risky assets going higher. Of course, the higher they go, the more they diverge from fundamentals, and the riskier the situation becomes. But eventually, if the recovery of the economy is going to be anemic, sub-par, below-trend and U-shaped, there is going to be a correction. And therefore my view is to stay away from risky assets. Stay in liquid assets. I don’t know when the correction is going to occur, it could be a while longer, but eventually it will be a pretty ugly correction, across many different asset classes.

IU.com:When you say “stay away from risky assets,” many people hear that and think, “Aha, gold!”

Roubini: I don’t believe in gold. Gold can go up for only two reasons. [One is] inflation, and we are in a world where there are massive amounts of deflation because of a glut of capacity, and demand is weak, and there’s slack in the labor markets with unemployment peeking above 10 percent in all the advanced economies. So there’s no inflation, and there’s not going to be for the time being.

The only other case in which gold can go higher with deflation is if you have Armageddon, if you have another depression. But we’ve avoided that tail risk as well. So all the gold bugs who say gold is going to go to $1,500, $2,000, they’re just speaking nonsense. Without inflation, or without a depression, there’s nowhere for gold to go. Yeah, it can go above $1,000, but it can’t move up 20-30 percent unless we end up in a world of inflation or another depression. I don’t see either of those being likely for the time being. Maybe three or four years from now, yes. But not anytime soon.

After hitting the (so far) all time record monthly high of $134 in June, 2008, the monthly low spot US crude price was $39 in February, 2009.  In eight months,the price of oil has doubled.

October 28, Afternoon

One other point about oil prices around $78.  As noted, it is twice the  recent monthly low that we saw in February, but it is also higher than all average annual prices prior to 2008.

Note below, the production decline rates for the six examples of declining net oil exporting countries were all in the single digit range, and all but one were less than 5%/year.

October 29

(1)  Increasing production, and generally increasing net oil exports, e.g., Angola currently

(2)  Production peak and a near term net export decline rate (less than 5%/year), e.g., Saudi Arabia currently (2.7%/year).

(3)  Intermediate net export decline rate (5% to 10%/year), e.g., Argentina currently (8.6%/year).