Saturday, June 21, 2008

Reality meets Analysis, Part 3

In my recent post, I said very small changes in supply/demand cause large price changes in essential commodities, like oil. Here's some confirmation of that in a news story today:
"[U.S. Energy secretary] Bodman said that every 1 percent increase in the demand
for oil requires a 20 percent rise in price to balance the market. "
The figure I've bandied about blithely (but which was my gut sense of the magnitude) was a 5% change in supply or demand for oil could cause a 100% change in price. From my post ("Devils, Fools, and the Bogeyman":
A 5% drop in supply relative to demand can double the price if people *must*
have the commodity.
Bodman's figure is the same: 1% change in demand (or supply) giving a 20% change in price, is the same as 5% change in supply/demand that gives a 100% change in price. If we can accept a government official as an authority of anything, somebody owes me a beer. But who?

FYI, these figures suggest a 25% change in supply/demand accounts for the 5X increase in oil price since 1990, unadjusted for inflation. It would be interesting to plot the growth in regulations blocking oil exploration and development against a 25% increase in the demand/supply curve. I bet regulatory growth is much greater -- and technology is the reason that oil production has kept up as well as it has. But everything has to break when you push it hard enough.


US energy chief: Low oil production drives price
Published: June 21, 2008
Filed at 3:16 p.m. ET

JIDDAH, Saudi Arabia (AP) -- The U.S. energy secretary said Saturday that insufficient oil production, not financial speculation, was driving soaring crude prices.

Secretary Samuel Bodman's comments on the eve of an energy summit in the Saudi port city of Jiddah set the stage for a showdown between the U.S. and conference host Saudi Arabia, which has largely blamed speculation in the oil markets for record prices.

The U.S. and many other Western nations have put increasing pressure on Saudi Arabia, the world's top oil exporter, to increase production. Saudi officials have been hesitant to do so, arguing that soaring prices have not been caused by a shortage of supply.

Bodman disputed that assertion Saturday, saying oil production has not kept pace with growing demand, especially from developing countries like China and India.

''Market fundamentals show us that production has not kept pace with growing demand for oil, resulting in increasing prices and increasingly volatile prices,'' Bodman told reporters. ''There is no evidence that we can find that speculators are driving futures prices'' for oil.

He said commodities markets have experienced a huge influx of money from financial investors in recent years, but they have been following the market upward rather than driving the increase in the price of oil.

Saudi Arabia called the unusual meeting in Jiddah between oil producing and consuming nations as a way to show that it was not deaf to international cries that high oil prices have caused social and economic turmoil.

The Gulf nation has also become increasingly concerned that record oil prices could hinder growth in the U.S. and other major industrialized economies, potentially leading to a decline in oil demand and a sharp drop-off in prices.

While Saudi Arabia has been reluctant to drastically increase production, it has announced several small increases recently that it says were made to satisfy increased customer demand. The country has consistently said that it will produce enough oil to ensure the market is supplied.

The kingdom increased oil production by 300,000 barrels a day in May, and a Saudi official confirmed Saturday that the country would add another 200,000 barrels a day in July. The official spoke on condition of anonymity because of the sensitivity of the information.

Saudi Oil Minister Ali al-Naimi also confirmed the increase ahead of the conference. But neither announcement has done much to stem the run-up in the price of oil, which closed near $135 on Friday.

Saudi assistant oil minister, Prince Abdulaziz bin Salman, told a news conference Saturday that the delegates were ''congregating to achieve results'' and try to draw ''a collective way forward for how to attend to this situation.''

''This situation as we see it today as it exists needs everybody's attention simply because it no longer is a luxury to talk about it or ... to keep bouncing back and forth blame,'' he added.

The prince said that Saudi Arabia has been working with several international organizations to put together a background paper to focus Sunday's discussions and reiterated that the kingdom was ready to meet demand from its customers and foster stable prices.

He said it would be ''wrong'' to judge the success of the meeting by oil prices the day after it ends.

Many countries around the world have experienced social unrest by populations angry that rising fuel prices have driven significant increases in the cost of food and other basic goods.

Bodman said that every 1 percent increase in the demand for oil requires a 20 percent rise in price to balance the market. Demand in China, India and the Middle East has been soaring in recent years as the countries consume more energy to fuel economic growth.

Rising demand in the developing world has coincided with historically low levels of spare oil production capacity, which fell below two million barrels per day among OPEC countries in May for the first time since the third quarter of 2006, according to the International Energy Agency.

Bodman made clear that the responsibility for reducing oil prices did not simply fall on the shoulders of producing nations, saying consuming countries must increase energy efficiency and invest in the development of alternative fuels. But he saved his strongest words for oil producers like Saudi Arabia, who he said must step up long-term investment in production and spare capacity.

''The incentive (for investing) is simply reasonable prices so that we're not faced with having to drop everything and race to Jiddah for a meeting that was called on a week's notice,'' said Bodman.

Saudi Arabia is completing a $50 billion plan to increase capacity to 12.5 million barrels a day but has signaled it would not go beyond that.
CNBC said Saturday that Saudi Arabia's current capacity is 11.3 million barrels per day, quoting al-Naimi's adviser, Ibrahim al-Muhanna. Previous estimates by the International Energy Agency put current Saudi capacity at about 10.7 million barrels per day. The kingdom currently produces about 9.5 million barrels per day.
Associated Press Writer Donna Abu Nasr contributed to this report.

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