Sunday, February 01, 2009

Lightering our way to abundance

Lightering is the process of transferring oil cargo between vessels of largely different sizes and is undertaken as many port facilities cannot accept ocean-faring tankers of the size of oil transports.

An old Wall Street shibboleth says that nobody rings a bell at the top. To prove the point, even as oil and other commodities were making blistering new highs on a daily basis last year, few people saw the carnage that was to come in those markets as the year progressed.

But the same cannot always be said at the bottom of a market. Quite often, there are many bells ringing. It's just that by the time a bottom arrives investors are usually too exhausted, too nervous or too broke even to care. And, it's true that the price of any commodity or stock can trace out a bottom for a very long time, longer than most people have patience, especially if they've already been burned in a crash. And so, the bells can go on ringing for years until they just seem like background noise.

Still, I am willing to take a stab at what may turn out to be a fool's errand and suggest that crude oil prices have bottomed out. My signal? The image of oil supertankers cruising aimlessly for weeks near many of the world's ports waiting for someone to purchase their cargoes. And, when someone finally does, the supertanker is obliged to lighter oil onto another smaller ship because the buyer only wants a portion of what's in the hold. When all the supertankers are full, the next step will simply be to spill oil on the ground at the point of extraction. But since this is an unlikely outcome, I suspect that oil producers will scale back production because they have to. The transit system and the storage system are now overflowing.

Of course, demand for oil could drop even further if the world economy continues to shrink. But at some point there will be a bedrock level below which oil consumption cannot fall or the lights will go out on civilization itself.

There is, in fact, one other promising sign of a bottom, and that's the move by oil companies and Wall Street firms to secure tankers in which to store oil in order to play the contango in the oil market. By leasing a tanker and filling it with oil purchased at the current low price while simultaneously selling it on the futures market for delivery later this year at a significantly higher price, they can generate considerable profit--enough to pay for the costs of storage on the high seas and take home handsome paychecks to boot.

The smart money is saying that oil won't remain this cheap much longer or that the prices on long-dated futures contracts will collapse. Either way the oil companies and investment bankers make money. But, even though the bottom may be in, it could take a long time for oil prices to move considerably higher.

What is disturbing about the entire tableau is the false impression it leaves that oil is an abundant resource. People are led to believe that if we can hardly find storage for all of the oil, it must be available to us in such quantities that we have few worries for the foreseeable future. But nothing could be further from the truth.

Oil is a commodity that unlike coal or copper is difficult and expensive to store. It's a flammable liquid capable of exceptional environment damage that must be carefully sequestered in special tanks with berms around them to prevent the spread of a leak or of a fire; or, it must be put in hugely expensive double-hulled tankers. Although it can be transported by truck as can coal and copper, it is most often transported by pipeline since this is quite a bit cheaper. The upshot is that you can't store oil just anywhere, and the storage space that is available is quite limited compared to its production. U. S. inventories last week stood at just 23.6 days of supply. And, this is at a time when storage facilities are chock full of the stuff.

Our existing oil infrastructure is pulling petroleum out of the ground at a rate that is currently faster than we can use it. This makes for a temporary glut and in no way mitigates the long-term problems we face with declining petroleum supplies. But we are now treating oil, not as the world's key commodity, a commodity upon which our very way of life depends, but as a plaything for investors to game for temporary profits. It's all part of the mentality that resources are interchangeable, that all of them can be replaced with enough ingenuity and investment whenever we need to without disruption to our lives, and that we have no cause to worry about the colossal waste of finite oil resources that is being fostered by low oil prices.

In the face of the worst economic downturn since the 1930s, the current focus of policymakers is understandably to restart world economic growth. And, many experts have pointed out that low oil prices and low energy prices in general are a plus for this purpose. They give energy consumers the equivalent of a huge tax cut.

But as those in the oil industry already know, low prices will lead to a reduction of new supply in the future, a reduction that could cripple any attempts to restart economic growth. And, failure to provide adequate supplies of the world's most essential fuel will not only stifle growth, but also impede attempts to create the renewable energy economy that we will need as oil supplies decline due to geologic constraints. We need the energy from fossil fuels and especially from oil to help make the next energy transition. That calls for a massive change of direction for energy investment that simply cannot take place in an environment of low energy prices.

The implication is that we now need to put a floor under fossil fuel prices so as not to discourage the development of alternatives. That means new taxes, but ones that could be offset with reductions elsewhere. We need to discourage what we don't want, namely, wasteful use of fossil fuels, and thereby encourage what we do want, namely, carbon-free energy technology.

And, although you couldn't tell it by this week's reports from the high seas, there is no way we are going to lighter our way to abundance.


Anonymous said...

So because they are having dificulty selling the oil that means that the price must be bottoming? Dosn't that ussually mean the oposite? Although it will probably lead to decreassed production it will still take a while for that to catch up with the demand destruction from the economic collapse.

Kurt Cobb said...

Prices tend to lead rather than follow developments. In this case I'm suggesting that prices may have overshot on the downside. But I do also say that "even though the bottom may be in, it could take a long time for oil prices to move considerably higher." That's because, as Anonymous suggests, it will take time for the production system to adjust to the new lower demand.

The truth is that price movements in any market are not truly predictable. Sometimes our guesses are right and sometimes they are woefully off the mark.

My main point is that we shouldn't be celebrating low oil prices, but instead figuring out a way to make fossil fuels expensive enough to encourage conservation and the development on non-carbon-based energy.