Superspike Report
Deconstructed
By Adam Porter
04 April, 2005
Aljazeera
A widely
reported briefing by US investment house Goldman Sachs alerted markets
to the possibility of an oil price superspike - a spike as high as $105
per barrel. Yet the full report, paints a more complex and volatile
picture. Notably it pits gas-guzzling American consumers against the
geopolitical turmoil of oil-exporting nations.
One the one hand
it notes that "geopolitical turmoil in key oil exporting countries
coupled with populist rhetoric ... keep foreign oil companies from developing
host country resources in a timely manner ... that could otherwise meet
oil demand growth at lower prices."
These countries,
notably Russia, the Middle Eastern producer nations and Venezuela, all
come in for criticism. Goldman Sachs believes these nations in particular
have not invested in enough capacity to create a supply cushion.
It sees that lack
of investment as part of a 30-year cycle. Producer nations became reluctant
to invest in new production facilities after the recessions and price
collapses of the 1970s and 1980s.
On the other hand,
its condemnation of US consumers is equally unrestrained.
"Perhaps the
ultimate answer to how high oil prices need to go before demand destruction
occurs is derived from knowing when American consumers will stop buying
gas-guzzling sport utility vehicles (SUVs) and instead seek fuel efficient
alternatives. We estimate that US gasoline prices may need to exceed
$4 per gallon."
For ordinary consumers
around the world the phrase "demand destruction" is one repeated
often throughout the report. As Aljazeera.net has pointed out before,
in oil and energy terms this is shorthand for a major recession.
Goldman Sachs sees
the lack of investment, coupled with increasing demand, as a factor
that has caught out producers. But now producers, pleased with the high
prices of oil, may also be unwilling to let such amazing cash bonanzas
slip from their grasp.
It is particularly bleak over the prospect of Middle Eastern nations
adding to the supply chain.
"It is important
to remember that the Middle East has been one of the few areas in the
past 30 years to experience massive population growth - 2% to 3% per
annum.
"The combination
of rising populations, a lack of a diversified economic base, and the
existence of governments that are not representative of, or responsive
to, underlying populations all point to ongoing geopolitical turmoil
and an inability to meaningfully add to oil supply."
Even more straightforwardly
it says that, "persistent high prices are improving the financial
position of key oil-exporting countries and could serve to keep potential
revolution at bay. If future political crises are to be averted, we
believe it is critical that oil-exporting countries reinvest cash inflows
[to] allow the majority of their growing populations to have economic
hope."
On the now popular
subject of peak oil, Goldman Sachs takes the conventional view that
global production is not reaching any kind of plateau. However it does
give the subject some consideration.
"We are not
subscribers to the theory that global oil supply has hit some magical
inflection point that will result in permanent supply declines ... in
the near future ... it appears to us that there exists a large known
quantity of both conventional and unconventional oil resources to develop."
The company instead
again blames the lack of investment from Russia, the Middle East and
Venezuela. At the same time, in other areas of the report, it gives
passing credence to the theory. Rather than calling it any kind of peak,
it uses the phrase "geologic maturity".
With increased geologic
maturity come increased extraction costs. Rising labour costs and the
increased cost of commodities used in the extraction of oil, especially
steel, are also helping to drive the price higher.
"Rising ...
cost structures due to increased geologic maturity in many of the traditional
areas of oil supply as well as service and materials cost inflation
have driven an increase in ... prices," it says.
In other words,
old fields, unable to produce what they used to produce at the same
cost, are driving up prices. Paradoxically, these rising costs eventually
translate into increased profits for oil majors and exploration companies,
as well as producer countries.
Both Opec whose
"space capacity [is] essentially gone" and global refinery
capacity "now running full out" are also cited as reasons
for the conclusion of the report, a potential "superspike"
in pricing as high as $105pb. On the other hand "speculation"
and the "terror premium", as Aljazeera.net has already noted
in previous articles, are irrelevant in the current market.
Goldman Sachs sees
two sides to the superspike coin. The positive side is in oil stocks
and equities which they believe could "see as much as 80% total
return ... and believe investors should add to positions in the sector
on dips, at current levels, or even after a rally."
The negative side
is about the global economy. They reject the notion that current investment
can create a supply cushion, a significant gap between demand and supply.
Instead they see
recession as the way the market will deal with the problem.
"Until new
investments are made, we believe demand destruction will be needed to
recreate a spare capacity cushion in order to return to a period of
lower energy prices."
One question remains,
however. Will producer nations and oil multinationals be willing to
carry on investing in a collapsing market? Would they still be interested
in spending heavily on exploration and development to create the reports'
desire, a supply cushion? One that would inevitably end up earning the
same producers less profit? That is not a question this report could
answer, or ask.
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