Crude could Spike to $148 if Hormuz Blockaded

Global production has increased dramatically from the Recession low of 83.1 Mbd (Jan/2009), setting yet another monthly record (90.2-Mbd) in Dec/2011 and a new quarterly record of 89.5 Mbd (2011Q4).  The oil sector pace has shattered last year's annual record with a new mark of 87.4-Mbd and monthly production is poised to break the 95-Mbd threshold in 2015 & the 100-Mbd marker in 2028.  At this time, it appears the natural GEOLOGIC PEAK of 105-Mbd in 2030 is likely to be pre-empted by PEAK DEMAND of 100-Mbd in 2029 upon crude oil surpassing $213/barrel.

Not only was 2011 impressive for the scale of global production, but it stands as a hallmark year for Saudi Arabian extraction ... setting its own new monthly, quarterly & annual records.  In so doing, Saudi claims of its massive Surplus Capacity have been validated as bona fide ... stunning and shocking the purveyors of imminent Peak Oil (whom I fondly call McPeaksters) for the third time in five years (2006/2008/2011).  Geopolitical events in Libya & Iran have drawn the Kingdom back to its reluctant role as swing producer.  Yet again, traders were forced to acknowledge they were very wrong to adopt the McPeakster allegations of terminal decline.

Six of the seven major All Liquids streams are in growth mode.  Conventional Regular Oil (light sweet crude) peaked in 2005 and will plateau for twelve years.  Int'l Inventories are presently near their 5-yr avg and 5% of global capacity is presently idle, eagerly awaiting new Demand from non-OECD nations.  OECD consumption peaked in 2005.

Improving fundamentals, declining Windfall Profits and resolution of concern over Iran over the next several months should drive Crude Price down to $73 over the next 12 months and to $63 in 24 months.  Perceived cyclicality within the fundamentals leads me to expect the 2008 & 2011 spikes to be duplicated with future crests in 2016, 2020 & 2023.  Fear my Barrel Meter forecast of coming highs won't come to fruition may lead the more nervous and vulnerable OPEC members to again break quota discipline whilst publicly calling for intervention via production cuts at their scheduled June 2012 conference - and thereafter.

The inset further illustrates Crude Price took on its own variety of irrational exuberance within mere weeks after the ultimate $37/barrel correction trough in Jan/2009.  Only ten months later the detachment from FFV had attained a lofty inexplicable 36% premium - a level not seen since late 2002.  Producers were rewarded with obscene record reported earnings during this 4 quarter spree.  Price discovery was utterly non-existent.

Surprisingly, at the worst point of this episode only $5 of the $74 Crude Price was attributable to spec/hedging activity.  Currency Debasement added another $10.  This spike was heavily media driven (cable news induced fear-factor), as evidenced by a near-record $29/barrel assessed to Windfall Profits at that juncture.

One would have expected the juices to flow to new heights with the start of MENA geopolitical activity, especially considering faux rage in Barack H Obama's speeches.  But, the Barrel Meter reveals only $15 of the April 2011 price high ($113) is traceable to NATO strikes in Libya.  It is little known another $10 of the $39 price increase was attributable to USDollar Debasement related to his Deficit & National Debt woes.  From Inauguration Day to today, devaluation is responsible for an accumulated $15/barrel (36¢/gal pump) in Crude Prices.

It is very evident a sea change in pricing discovery is underway. In the six years from 2003 to 2008, Crude Price varied an avg 9& from oil's FFV. Since then, the variance has been 23%.

10-Yr Target ~ Ever-rising Extraction Costs and continued USDollar volatility surrounding uncertainty with respect to America's determination to finally addresses its Debt Wall could lead Crude Price to record highs in a fourth spike event ($138 record in 2020).  Assuming oil sector best practices results in the traditional pace of development of Reserves and maintenance of 5-Mbd avg Surplus Capacity, Crude Price is projected to settle back to a more reasonable 2022 target of $117/barrel.

2035 Target  (see chart below) ~ A fifth and final currency inspired spike event ($180 record) is forecast for 2023.  Permanent triple-digit Crude Prices after 2021 induce many forms of demand destruction leading to ultimate Peak Demand of 100-Mbd in 2029 upon surpassing $213/barrel.  Ever-rising costs for the marginal barrel are the main forcing.  Above-trend mini spikes will occur whenever Surplus Capacity falls below 4-Mbd.  Probable business cycle Recessions in 2017 & 2026 may give short respites but waning USA dominance over time will result in its downturns having decreasing adverse effects on global GDP.  The Barrel Meter projects rising Crude Price will be stymied by the Demand Destruction Barrier and will culminate in a record $363/barrel - the 2035 target.

Oil/GDP Ratios ~ The natural business-as-usual production scenario would have seen All Liquids form a GEOLOGIC PEAK of 105-Mbd in 2030.  But starting in 2004, the long-term trend for the growth rate of global Consumption began to wane.  Triple-digit crude costs are causing demand destruction. Consumers, commerce & institutions are substituting and conserving.  I have found this change has economic consequences that are predictable at four definitive petroleum/GDP ratios.  These invisible lines generally rise with time and GDP.  Three have global implications and one is unique to the USA.

 PEAK Demand Barrier ~ This first identifiable line is the Crude Price threshold which while surpassed blocks the setting of new global Consumption records.  It was recently triggered @ $90/barrel in early 2008 and again @ $99 in early 2011.  During three temporary incursions since 1980, global Demand was held at bay while Crude Price surged.  This petroleum/GDP ratio is represented by $103 today and was responsible for the absence of new monthly Consumption records since Dec/2010.  Admittedly there have been a series of Production records, but balance surpluses have resulted in stock builds.  Resolution of geopolitical factors and a subsequent receding of USA Contract Crude Price back below $103 should result in the resumption of new Demand records.

These PDB transgressions and temporary suspension of Demand records could occur in the future, particularly during the model's forecast spike.  But eventually, this line-in-the-sand will be encroached permanently.  The failure of Crude Price to retreat back below this delineation will mark All Liquids PEAK DEMAND.  Inventory builds will induce a coincident topping of global production:  PEAK OIL.  At this time, the Barrel Meter model projects this event will occur in 2029 upon Crude Price surpassing $213/barrel (see BM-2035 chart).  I discovered the PEAK Demand Barrier only recently and its first reference was in the Oct/2011 Peak Scenario-2500 update, whilst its first annotation within the Barrel Meter chart was in the Nov/2011 version.

  G-20 Recessions Threshold ~ TRENDLiners are quite familiar with this marker.  Annotations within the Barrel Meter chart since Jan/2010 have alerted the threshold past which higher petroleum prices would induce (or augment) a second round of economic Recessions among this global community of nations.  Record oil costs no doubt assisted in pushing weakened G-20 economies past their tipping points in 1980 as central banks waged a war on inflation via high interest rate monetary policy.  But 2008 marked the first time a significant round of G-20 Recession was induced by cumulative or "baked-in" high petroleum prices.

  Demand Destruction Barrier ~ When Crude Price spikes, certain vulnerable sectors of the global economy find it necessary exercise significant conservation measures such as scale backs, shuttering, switching to alternative energies or resorting to substitutions.  Barrel Meter analysis has identified two clear stages for this phenomenon known as demand destruction.

The Nov/2009 Barrel Meter chart was the first to identify discovery of the Demand Destruction Barrier - a definitive Petroleum/GDP ratio whereby Crude Price can no longer rise due to a virtual evaporation of bids.  There have been two episodes:  1980 & 2008.  The DDB halted the July 2008 price run @ $129/barrel (monthly avg - USA contract crude).  The DDB is currently $146 (note this ceiling wrt Iranian nuclear facility strike by Israel) and based on GDP projections would be instrumental in holding Crude Price to $372 in 2035.

  USA Light Vehicle Sales Barrier ~ The American economy is too diversified and per capita incomes too high to be adversely affected by the early stages of the aforementioned G-20 Recession Threshold.  That said, my Gas Pump model did detect way back in April 2010 a very similar phenomenon.  Chart annotations illustrate a Gasoline/GDP ratio at which the auto sector noticeably breaks down.  USA Light Vehicle Sales have collapsed four times upon breaching this threshold:  1980, 1990, 2007Q4 & March/2011.  The Barrier was $3.35/gal in December and the (blue) FRB chart below illustrates an auto sector resurgence has accompanied the Autumn downturn in pump prices.

The Great Recession saw volume collapse from a 16 million unit annual rate to 9 mu/yr.  Sales had rebounded to 13.2 mu/yr by Feb-2011, but dropped back to an 11.5 mu/yr pace in June as the auto sector again suffered pump price shock.  Now that gas is back to $3.33 and below the LVSB, it is probable sales will climb above the 14 mu/yr pace in January or February.

The Gas Pump chart also annotates a Demand Destruction Barrier marking the ceiling at which gasoline price spikes will reverse.  It was instrumental in blocking the July 2008 event @ $4.11/gallon and stands @ $4.37 today (again, note this if Israeli fighters take flight or Hormuz is blockaded).  The Barrel Meter had also been cautioning (since Nov/2009) of the LVSB, but with its tight proximity to the PEAK Demand Barrier, it was deleted due to the deemed greater importance of the latter to Peak Oil discussions.

The Trendlines Recession Indicator calculates cumulative high petroleum prices over past Quarters caused a 1.0% headwind against the USA GDP growth rate in December.  The previous high for this negative GDP forcing (set way back in Oct/2008) was just exceeded in October.  It will take the USA & other G-20 economies a couple of years to shake out the "baked-in" dampening effect.

Price Discovery ~ There are over three dozen grades of oil across the globe.  Long ago, most were sold on long-term contracts via fixed price lists.   Saudi Aramco maintains this method.  Today, oil is often sold at a discount/premium to several standard blends, facilitated by consulting assistance from Platts.  Unfortunately, a new crop of mostly neophyte buyers have been found to be quite vulnerable to media noise (fear factor).  This has led to an era of irrational exuberance with respect to Crude pricing over the last four years.

Failed Forecasts ~ The McPeakster blogosphere was burning up once again last Winter in anticipation of Steven Kopits (Douglas-Westwood) forecast of an American and worldwide economic Recessions upon Crude Price exceeding $86/barrel.  Kopits subscribes to the myth propagated by associate economist James Hamilton (Univ of California) that high oil prices were the main cause ten of the last eleven Recessions.

They both appear unaware correlation does not always imply causation.  To fully understand his present frame of mind, Kopits recently (2011/10/10) posted on Hamilton's blog:  "We will look back in maybe 10 to 15 years and see that we are/were in the midst of a second and Greater Depression."  Now just throw in David Rosenberg and I'm not sure if we have the three blind mice ... or three stooges.

Crude oil is a miniscule portion of the consumer price index in most nations and the breach of the $86/barrel threshold passed unceremoniously in Spring 2011.  The IMF has since reported Q2 GDP grew at a robust 3.7% pace.  As discussed above, the Barrel Meter model long ago addressed this forcing and found only when Crude Price breaches the definitive Petroleum/GDP ratio (represented currently by $121/barrel) would there be headwinds sufficient to result in a new round of oil cost induced G-20 Recessions.

As did Colin Campbell before him, Kopits appeared before the USA House of Representatives Energy Subcommittee (2011/2/18) to fear-monger the outcome of Crude Price surpassing his $86/barrel line-in-the-sand.  He could have avoided subsequent embarrassment of his impotent screaming and handwaving had he learned from many of the same analysis errors made three years prior by James Hamilton.

As a neophyte to the oil sector, Hamilton had adopted absurd assumptions relayed to him by the McPeakster fraternity with respect to alleged inadequate global surplus capacity, questionable annual new capacity build potential and over-the-top UDRO (underlying decline rate observed) assessments that were all terribly wrong.

If that wasn't enuf, James Hamilton's failure to recognize USDollar debasement as one of the largest forcings of price spikes spoke volumes to the ultimate demise of his prediction the rise in oil prices was linear.  In an Aug-2011 update to his own Peak Oil study, Chris Skrebowski has adopted the same linear price growth assumption and predicts Peak Demand will occur upon the Brent Crude Price exceeding $135/barrel in 2014.

McDoomers ~ There continues to be absolutely no merit to the cornucopia of pundit predictions (Feb/2011) for $200-$250 oil & $5-$7 gasoline by the Summer of 2011 disseminated by the lamestream media, McPeaksters & McDoomers.  We heard all the same rationalizations in the Summer of 2008 and our COPF chart (below) is testament to similarly hysterical musings.  Conversely, there was no hint of a MENA geopolitical event back in April-2010 when this year's spike episode with a founding on USDollar devaluation was initially foretold by TRENDLines!

Along with Extraction Costs and USDollar Debasement, crude price fundamentals include components for Inventory Draw & Surplus Capacity.  When OPEC tightens quota restrictions, this immediately puts pressure on global inventories and Price moves upward - about $2/barrel per 1-Mbd of reduced quota.  Unfortunately for OPEC, the Barrel Meter model has discovered that desired price increases are more than offset over extended time by the traders who rightly realize the collective action means the world now has (more) defined spare capacity and this factor becomes a negative forcing on gross crude price:  approx $4/barrel for each 1-mbd increase in apparent idle capacity.

In short, I argue that for every 1-Mbd of trimmed quota, Crude Price eventually declines $2/barrel.  OPEC cuts inadvertently create (additional) Surplus Capacity into a marketplace where many neophyte buyers had assumed there was none (due to McPeakster alarmism).

next "potential spike" past record $129/barrel:  Aug/2015

PEAK DEMAND:  2029 upon oil breaching $213/barrel

potential oil-induced G-20 Recessions:  2032 upon crude breaching $278/barrel

projected ultimate record high:  $363/barrel 2035

BACKGROUNDER excerpts  (2011/10/13) ~ Crude Price will permanently encroach the Light Vehicle Sales Collapse Threshold in 2028.  It is at this juncture policy makers and stakeholders must aim all their efforts to have infrastructure in place for the transition away from all-dominating gasoline/diesel transportation fleets.

Excepting the 2008 spike event, most  demand destruction on Crude Price's upward journey is quickly mopped up by eager emerging markets.  As Crude Price breaches the LVSCT ($192/barrel & $6.98/gal pump) for the final time, Peak Demand will prevail and stymie forever the increasing production of All Liquids.

Not accidently, my Peak Scenario-2500 oil depletion model currently projects maximum production will occur upon a Demand Peak of 100 Mbd in 2029 ... not the 2037 Geologic Peak of 110 Mbd based on the current trend of converting proved reserves to new capacity.

The benefit of a Demand-inspired scenario is its positive influence on maintaining global Surplus Capacity norms in Saudi Arabia, Russia, Brazil and elsewhere.  My analysis reveals approaching minimal spare capacity levels is the most critical forcing is raising Crude Prices today and over the next two decades.  Peak Oil will only be a problem if its unfolding results in drastic stock draws and waning idle capacity to the extent it causes price shocks.

BACKGROUNDER excerpts  (2011/8/13) ~ The $131/barrel monthly record was set in July 2008.  The current price run is actually the culmination of a secular trend commencing June-2004.  At that time the secular devaluation of the USDollar which had started Jan-2002 finally began to be factored in as a price component of Crude Price by frustrated stakeholders.  By July 2008, compensation for US$ Debasement comprised $31 of Crude Price (see table - above right).

The bursting of the USA's housing bubble led directly to the financial crisis by exposing the subprime mortgage fiasco.  The irony of the matter is that by March 2009 (just weeks after the Recession trough), the USDollar had regained virtually all its loss as the international investment community ironically sought safe haven in American treasury notes.  Upon inauguration of Barack Hussein Obama, US$ Debasement was in remission:  a mere $1 component of Crude Price.

In early 2009, Wall Street & the White House took glee in shining a light on Deficit & Sovereign Debt to GDP ratios of a plethora of jurisdictions.  The lamestream media were enablers in focusing on the ills of Iceland, Dubai, Ireland, Greece, Portugal, Hungary, Spain & Italy.  Inevitably when they ran out of nations, the same scrutiny was finally applied on the US Federal Gov't.  Just as savvy currency traders had lost faith in Congress ability to address its long-term Structural Deficits in 2002, now the international investment community is being clued in and taking stock of the USA's own fundamentals - and the secular decline of the USDollar has resumed...

As a component of Crude Price, USDollar Debasement was only $2/barrel in January 2009 after the USA's first celebrity President was inaugurated.  Growing unease with the socialist leanings of his Administration led to the Debasement factor running up as high as $12 over several quarters.  A pause occurred in the Summer of 2010 when it appeared the CBO had convinced the President & Congress to let the Bush-era Tax Cuts expire in December.  This sentiment was so entrenched that our own Barrel Meter extinguished its forecast of a $141 2011 spike in September 2010.  And the Debasement factor drifted back to $9.

Unfortunately, the mid-term Elections intervened and irresponsible electioneering reversed the momentum via promotion of an extension of the Bush-era Tax Cuts as a means to maintain fiscal stimulus in the face of a phantom double-dip.  The Trendlines Recession Indicator sported the earliest alerts of a potential downturn but had already dismissed a renewed contraction by its Sept/2010 outlook.  But, facts were not allowed to ruin strategic campaign rhetoric.  The Tea Party won big in November.

Regardless of a newly Republican-dominated House of Representatives, Congress severely disappointed the international investment community by its irresponsible disposition of the Bush-era Tax Cuts by extending them fully intact ... even for the top 1%.  The Obama Administration then added to the disgust with its own proposal of a $1.5 trillion Deficit 2011 Budget ...  and the Debasement factor rocketed to $24 by April.

There is an assumption in today's update of the Barrel Meter that the USDollar will continue to decline 'til the international investment community is satisfied a sea change in legislative attitude towards the structural deficit prevails.  The November 2012 Elections should present itself as that critical opportunity.

In a perfect storm of events Crude Price would have a tendency to rocket to $163 in September, but the model has high confidence a late Summer spike would be blocked by the same Demand Destruction Barrier (DDB) that firmly arrested the 2008 price run @ $131/barrel ($4.11/gal pump).  The negative effects of rising energy costs on the disposable income of consumers and the profits and viability of businesses and institutions eventually takes a toll against the economy.  The DDB represents a definitive Crude-Cost/GDP ratio ($138/bbl & $4.34/gal) where certain feedbacks come to fruition.  As happened in the Summer of 2008, Demand will be reversed as alternative energies, substitutes and conservation measures are pursued.

BACKGROUNDER excerpts  (2011/7/13) ~ The June short-term price outlook projected an imminent $136 spike.  Today that target is knocked down by $20 and Americans can give thanx to the Tea Party for this development.  Their stalwart position on forcing fellow Republicans to make expenditure cuts a condition to raising the Debt Ceiling has at least temporarily truncated the coming currency crisis.  The outcome of these negotiations will be clear by August 2nd and the magnitude of the eventual agreement with Obama will determine the course of the secular debasement of the USDollar ... and Crude Price.  In our analysis, oil will fall $4/barrel per each $1 trillion in spending cuts and/or new tax revenues within the Debt Limit disposition.  Unfortunately, stubborn positions taken by the Obama-Democrats at this juncture are signalling a lost opportunity to pare back the $23/barrel Debasement component.

The IEA marketplace injection of 60 million barrels over 90-days will be found to be grossly underwhelming when the bulk of withdrawals commence in early August.  My analysis suggests 120 mb/month is required to force a $10/barrel decline in Crude Price;  a 150 mb/month injection to move Price by $20/barrel.  Saudi Arabia has already boosted production by almost 1-mbd and as such TRENDLines projects the multi-month price run should terminate @ $116 in August and quickly dissipate.

Since Dec 2009, Trendlines Research had warned Crude Price was re-approaching a definitive Oil-Cost/GDP ratio which decimated Light Vehicle Sales in 1980, 1990 & 2007.  Upon surpassing $90/barrel in early February 2010, oil again breached this critical threshold and as seen in the (right pane) chart, the post-Recession rebound of New Car & Light Truck sales are in reversal from the 13.3 million unit pace.  New 2011 sales highs are improbable 'til Crude Price dips below $90 in Q4.

Barrel Meter analysis of the current nine-month $32 spike attributes $12 to USDollar Debasement, $6 due to lesser Surplus Capacity, $2 for higher Extraction costs & $1/barrel for tighter Inventories.  The balance is associated with non-fundamentals:  $3 for increased Speculation/Hedging activity & $8 to Windfall Profits that take advantage of subtle media-driven fear factors (of which $7 is MENA-geopolitics related).

BACKGROUNDER excerpts  (2011/6/9) ~ As such, our renewed forecast of a record Crude Price spike this month assumes the present pause will extinguish upon bond and currency vigilantes dismissing genuine intent by Congress & the President to resolve the Entitlement issues which are foundation to the Federal Govt's Structural Deficits and future Debt Wall.

This currency crisis will be opportune in inspiring a "Tea Party Intervention".  Their input conditions will result in successful disposition of the raising of the Federal Debt Ceiling by addressing the long standing Budget & Entitlement issues.  At this time it appears they will insist on demanding a dollar in future cuts for every dollar of increase to the Debt Limit.  If successful, the US$ will correct precipitously on this welcome news.  Unless the Debt Limit negotiations lead to an unexpected short-term agreement, Crude Price will fall to $63/barrel in 12 months.

BACKGROUNDER excerpts  (2011/4/9) ~ Logic was absent from the marketplace.  Price discovery was dysfunctional.  It appeared neophytes had taken control of buyer desks of the globe's stakeholders.  It was an era of irrational exuberance with respect to Crude pricing.

BACKGROUNDER excerpts  (2011/2/8) ~ This resumption of the US$'s secular decline (since 2002) is attributable to the failure of Congress to address its structural deficits as shown once again by the decision to extend all of the Bush tax cuts.  The pace of the Debasement may increase significantly in the coming weeks as international investors and sovereigns digest the ramifications of the "Moment of Truth Report" recommendations by the National Commission on Fiscal Responsibility & Reform being shunned by President Obama.