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Continued Oil Price Pressures To Underpin Alternative Energy Investment

March 25, 2011

There is nothing like fundamentals to drive investment in an asset class.  For renewable energy, those fundamentals are underpinned by the case that conventional energy is expensive, the price volatile, and the supply often in a place you would rather it weren’t.

A few days ago Robert Gottliebsen wrote in the Business Spectator – an influential online business magazine in Australia – in an article entitled ‘The Oil Fire Won’t Last’ (free subscription required) that there would be no shortage of oil unless unrest spreads to other parts of the Middle East – and that upward price pressures were driven by speculation and would dissipate.

The oil price may not spike further in the immediate term.  In the February Oil Market Report the IEA notes:


Ceteris paribus, a cushion of stocks and spare capacity does provide some potential to constrain further price increases in 2011.

However, the evidence suggests that Gottliebsen gets it wrong: speculation is not the cause of price volatility and the signs for oil price softening are not good.  The IEA concludes that ‘the inescapable conclusion from our market balances is that the physical market has tightened significantly’ and that ‘remarkably strong oil demand (notably gasoil-diesel) ran well ahead of global supplies’.While global oil demand declined by 1.2 mb/d in 2009, in 2010 it increased by 2.8 mb/d and in 2011 demand is forecast to add a further 1.5 mb/d. 

Source: IEA (OMR Feb 2011)

The oil buffer has been significantly impacted by stock draw-downs and reduced Libyan production, thereby making price spikes and price volatility more likely should there be any additional scary moments.  Today at the Oil Drum, ‘Heading Out’ makes the case for the importance of the marginal impact even of removed Libyan production of circa 1.5 mb/d in face of mounting demand.

Perhaps Gottliebsens view is based on the view that Saudi Arabia – the worlds’ largest producer – can easily ramp up production to meet demand.   However, there has been much speculation as to whether Saudi Arabia can actually increase production on demand or, as Salman Shaikh writes at Foreign Policy, whether they would now be motivated to.  There is evidence that Saudi’s own rising consumption has actually eaten into it’s capacity to export.  Gregor has written about this extensively.

The oil price is high, and the price is volatile:


This volatility is largely driven by fundamentals – not by speculators.  The International Energy Agency (IEA) has looked extensively into this issue as reported in the March Oil Market Report (OMR – quotes below from non-pay summary).  The IEA concludes that the results of their analysis:

show that the price of crude oil fluctuated in a similar pattern to the seven non-exchange traded commodities throughout the decade. This suggests that speculation is not the only cause of volatility and that market fundamentals, notably strongly growing demand in emerging markets, are also at play.

Furthermore, their analysis continues:

For the past decade, many have tried to blame speculative oil traders for causing fluctuations in oil prices. As a result, policy-makers have responded to this point of view with a bevy of proposals that aim to control the activity of speculative traders. This recent IEA study casts doubt over both this pervasive view and the effectiveness of such policies.

Previous IEA analysis suggests that other factors, such as data transparency and market distortions within the physical market may be at least as important in causing oil price volatility.

(My italics)

That’s right: – the oil price data is not transparent.  What aspects specifically?   In addition to ‘data lags and gaps’, the real unaudited reserves, production capacity and capability of Saudi Aramco in whose trust we place our energy future.  When we think of physical market distortions, then concentration of supply, supply choke-points, and non-linear demand growth signals should spring to mind.

Indeed, also in Business Spectator, Stratfor suggests a signficant long-term addition to oil demand through a shift to oil rather than nuclear as an energy source in Japan.

Furthermore, we have written at this blog about the immediate and substantial addition to demand likely to come (on top of normal demand projections) from India and China now building a strategic reserve similar to those held by OECD nations.  Even when spread over the course of ten years, oil purchases by these two behemoths to build reserves constituting one year of consumption will further strain the ability to meet demand.

With unresponsive supply due to declining stocks among OECD producers; limited production increases possible in OPEC; and significant additions to demand emerging from rapidly growing BRICs and other emerging markets, it is inconceivable that the volatility and price increases of late will not persist for the foreseeable future (so long as the world economy avoids an OECD debt-driven cataclysm).

Source: EIA Washington

Energy price increases and volatility have a direct, tangible impact on Australia which have already been signalled through reducing disposable household income and contributing to core inflation (this will be the subject of a future post).

There can be no better incentive and motivation to invest in alternative energy sources (other than that pesky issue of the big blue ball we’re all living on overheating).  Indeed, we see that conventional energy prices do increasingly influence trade in alternative energy stocks.  Such investment is a hedge against geopolitical risk; enhances energy security; reduces downside energy price risk, and presents an opportunity to engage in significant new growth markets.

Good news for alternative energy proponents – but only of use for energy security and climate change purposes if some massive step-changes to our energy infrastructure and technologies can be achieved.  The message should not be muddied by placing false hope in declining oil price and oil price volatility in the future.

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