Can't outsmart world markets

April 2, 2012
Some 30 years after Edwin Drake drilled the first oil well in 1859, an official in the US Geological Service declared that all the available crude in the world had been found.

Some 30 years after Edwin Drake drilled the first oil well in 1859, an official in the US Geological Service declared that all the available crude in the world had been found. Politicians and government bureaucrats have been guessing wrong about energy ever since.

"Both traders and governments think that they are one step ahead of the other and often one step ahead of the market as well," analysts at Barclays Capital Commodities Research recently reported. "The problem is that the oil market has a mind of its own, and while the race to outsmart it will always continue, at times it is better to simply give into the market's will and roll with the tide."

Going with the market is not likely to happen in a US presidential election year, however. With average retail gasoline approaching $4/gal at US pumps, Olivier Jakob at Petromatrix in Zug, Switzerland, said, "The price of oil gains each week a greater place in the political debate." President Barack Obama has appropriated the longtime Republican mantra of "all of the above" in describing his policy for energy development. But opponents say his real policy remains "nothing from below" as he favors federal funding for high-cost, high-risk energy alternatives over proven fossil fuel resources.

SPR release 'likely'

The likelihood is "high" that President Obama will release crude from the US Strategic Petroleum Reserve to win favor from voters if oil prices remain high. "It would be just a matter of timing and what factor will trigger the release…further real supply disruptions or political motives," said James Zhang at Standard New York Securities Inc., the Standard Bank Group. Release of emergency oil reserves is not a sustainable solution to high oil prices, although it will inevitably lead to an immediate sharp price fall. "This is rather evident from the 'flash crash' in oil prices during early May last year and price actions following the reserve release in June," Zhang said.

Jakob said, "It is difficult at this stage to describe a major supply disruption that would legitimize such a release." Moreover, he said such a move would signal the administration "failed to get enough commitment from Saudi Arabia that it would proactively participate in calming markets on the road to the Iranian embargo. Yes, Saudi Arabia has claimed that it stands ready to act if needed, but action speaks louder than words."

For the past year, Barclays Capital analysts said, "The market appears to have systematically underestimated the strength in fundamentals; and each time it has come close to fully pricing-in physical strength, some key variable has changed, causing perceptions to swing back the other way." The latest twist started in the fourth quarter with the market focused on swift revival of Libyan production along with high Saudi output. But now "acute tightness in non-OPEC supply—with "unplanned and unseasonal outages" estimated at 1 million b/d—has offset supply gains elsewhere, they said. Later the focus shifted to "disbelief that global demand could remain fairly robust in the face of extremely weak US demand indications. Strong growth in Asian demand was "only perceived very belatedly, and even then that strength was attributed by some to stockpiling," they said. "Yet we find inventory builds so far this year have been within bounds to replenish the low stock levels of last year, while bulk of the strength in oil imports was attributable to actual underlying demand arising from a combination of structural changes (Japan), improving macroeconomic conditions (China and India), and weather (South Korea)."

The "mind games" the market is playing are far from over, said Barclays Capital analysts. Although Saudi production likely will continue increasing, they said, much of the additional production will be drained in rising domestic demand in the second and third quarters. "At the same time, spare capacity risks being run down to below 1 million b/d, setting prices on an upward and volatile trajectory," they said.

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About the Author

Sam Fletcher | Senior Writer

I'm third-generation blue-collar oil field worker, born in the great East Texas Field and completed high school in the Permian Basin of West Texas where I spent a couple of summers hustling jugs and loading shot holes on seismic crews. My family was oil field trash back when it was an insult instead of a brag on a bumper sticker. I enlisted in the US Army in 1961-1964 looking for a way out of a life of stoop-labor in the oil patch. I didn't succeed then, but a few years later when they passed a new GI Bill for Vietnam veterans, they backdated it to cover my period of enlistment and finally gave me the means to attend college. I'd wanted a career in journalism since my junior year in high school when I was editor of the school newspaper. I financed my college education with the GI bill, parttime work, and a few scholarships and earned a bachelor's degree and later a master's degree in mass communication at Texas Tech University. I worked some years on Texas daily newspapers and even taught journalism a couple of semesters at a junior college in San Antonio before joining the metropolitan Houston Post in 1973. In 1977 I became the energy reporter for the paper, primarily because I was the only writer who'd ever broke a sweat in sight of an oil rig. I covered the oil patch through its biggest boom in the 1970s, its worst depression in the 1980s, and its subsequent rise from the ashes as the industry reinvented itself yet again. When the Post folded in 1995, I made the switch to oil industry publications. At the start of the new century, I joined the Oil & Gas Journal, long the "Bible" of the oil industry. I've been writing about the oil and gas industry's successes and setbacks for a long time, and I've loved every minute of it.