Oil Market: This is NOT a Repeat of 2007-2008, for Now

Oil Market: This is NOT a Repeat of 2007-2008, for Now

Anas Alhajji @anasalhajji

The increase in oil prices between 2003 and 2008, especially in 2007, was caused by several fundamental factors that are rarely repeated in history, if ever.

• The seeds for the sharp increase in oil prices in 2006-2008 were sown in the second half of 1990s when the Clinton Administration imposed sanctions or threatened to impose sanctions on several oil-producing countries, which prevented national and international oil companies from investing and expanding production capacity in these countries.

Then the Asian financial crisis, along with other factors, hit the oil demand hard in 1998-1999. Oil prices plummeted to $10/b.  Global E&P declined further.

As prices increased, American and European consultants convinced Saudi Arabia and other countries to halt the development of some major projects and NOT to invest in additional capacity because of the expected flood of oil from Central Asia, which NEVER happened!

• In 2000s, we had the September 11 Terrorist attack on the World Trade Center that led to a lower oil demand. Anticipation of US reaction slowed down E&P investment. Then the US invaded Iraq and wiped out Iraq’s oil production capacity.  Not long after that, China became a net importer of oil.  The writings were on the wall.  We were heading for an energy crisis.  I know, because I wrote an article then with my Colleague Jim Williams entitled “The Coming Energy Crisis”!

• Several other factors were brewing then: Private generation in China and several oil-producing countries demanded an ever-increasing amount of diesel that governments did not count for, and analysis did not see. Power burn in several oil-producing countries was increasing at the expense of crude oil exports when global demand increases in summer months.

• But the main reason why this time is not a repeat of 2007-2008: in OECD, China, and India, between 2005 and 2008, government spending, military spending, economic growth, incomes, and investments were all increasing when the US dollar, interest rates, and taxes were decreasing (Taxes applies to US only here). This mix happened only ONCE IN HISTORY: at that time and mitigated the impact of high oil prices.

Now we have an increase in the dollar and rising interest rates. The rise in income in India and China is way lower than in the past.  Just in case you are wondering about the impact of interest rates, the period before 2008 was the only period in history in which oil prices increased and interest rates decreased!

• Under massive political pressure, Saudi Arabia used its spare capacity in early 2008. They learned a lesson not to use the whole spare capacity again. The irony is, the shortage in 2007-2008 was in light sweet crude, heavy crude was abundant. Now we have exactly the opposite.

• Now we have shale. The short cycle investment is truly beneficial in case of shortages and crisis. By the time oil is pumped from a wellhead in the Middle East, shipped, and unloaded in the US, American shale produces can drill a well, produce the oil and send it to the same storage facility.  Some people might argue that it may not benefit us because of crude quality.  Well, in this case, let us talk about the crude quality crisis, which will affect differentials more than the overall international price levels, not the quantity of oil.

• Despite the fact that prices reached a record high of $147 in the US, gasoline and diesel prices in many countries were NOT at a record high, but they ARE NOW, simply because of the exchange rates, lifting subsidies, and increasing taxes. Any increase in prices above current levels means a decline in demand.

• Both IEA and OPEC expect global oil demand to DECREASE by about 1 mb/d in the first quarter of 2019 from the fourth quarter of 2018. If we lose a million from Iran, seasonal reduction in demand can take care of it in first quarter without any increase in production!  But demand data tells us a very important story: the decline from the fourth quarter to the first quarter of the new year is a function of price level. The decline is larger and steeper when prices are high.

• Now let us do the math, Iran’s oil exports will decline further, but the decline is going to be less than expected by most. One fact is clear, it will not go to zero.  So choose the decline number you like above current levels and let us do the math: Saudi Arabia and others will add 300kbd-450 KBD by November.  The US will release 30-60 mb from eth SPR, while we can withdraw 18 mb from commercial inventories per month for three months without causing inventories to go down to dangerous levels. Now we are in Q1 2019 and demand declines by 1 mb/d.  You do not like 1 mb/d that the IEA and OPEC is forecasting? Make it half: 500,000 b/d!  Do the calculations? What do you get?

You might agree with me, but say, what if we lose Venezuelan oil or Libyan oil at the same time?  My comments above are a reply to those who are talking about $100/b oil just because of the sanctions on Iran.