“Oil Shocks and OPEC”<br />by<br />Dr. James L. SmithMaguire Chair in Oil & Gas ManagementSouthern Methodist University<br />A Presentation to the Forum on“Energy Security: Global & US Fundamentals” Dallas Committee on Foreign RelationsJune 29, 2011<br />
Agenda<br />Energy shocks and price volatility: The 10x multiplier.<br />Interaction of supply & demand:Is the market “well supplied”?<br />OPEC: Is it still relevant?<br />Financial trading and speculators:The real culprits?<br />
Demand Shocks also Disrupt the Market<br />Chinese demand does not grow by 10% each year.<br />It grows by 2% or 17% per year (s = 5%)<br />Just like supply shocks, demand shocks also produce the 10-x multiplier:<br />2% demand shortfall = 20% oil price reduction<br />4% demand surge = 40% oil price escalation<br />
According to OPEC: Market is “Well Supplied” and Speculators are to Blame.<br />Source: J. L. Smith, J. of Econ. Perspectives, 2009 (updated)<br />
Oil Prices are High Because OPEC Capacity is Low<br />Since 2000 …<br />Demand increased by 52%<br />Non-OPEC Supply decreased by 13%<br />OPEC production capacity increased only by 8%<br />OPEC capacity is low because investment is low:<br />During 2007, the 5 “super-majors” (who own 3% of global reserves) invested $75 billion upstream.<br />During 2007, OPEC (who owns 60% of global reserves) invested only $40 billion upstream.<br />OPEC reckons the risk of expanding low-cost capacity within the cartel exceeds the potential harm from expanding high-cost capacity outside the cartel.<br />
Where do the Speculators Fit In?<br /> “It is still rather generally believed that futures markets are primarily speculative markets. They appear so on superficial observation, as the earth appears, from such observation, to be flat.” <br />-- Holbrook Working, Stanford University,1960<br />
Two Versions of the “Hedge Fund Hypothesis”<br /> 1. The Quantity Theory of Futures: The new money forced the oil price to rise of its own volition—independent of fundamental forces in the physical market.<br /> 2. Contagion: Trading by financial speculators altered the expectations of commercial traders, who were complicit in driving the oil price up.<br />Neither Version Seems True !!<br />
Physical Market Drives Futures, Not Vice Versa<br />
Summary and Conclusions<br />Price volatility is inherent, not contrived, and will not subside going forward.<br />Physical disruptions to supply and demand are predictably magnified (10x) by inelastic behavior. <br />OPEC is still relevant and effective at what it does:<br />OPEC not effective in deploying spare capacity to stabilize prices…<br />…but highly effective in suppressing investment and limiting development of new production capacity. <br />No credible evidence that financial trading impacts physical oil prices. Fundamentals drive the market.<br />
A particular slide catching your eye?
Clipping is a handy way to collect important slides you want to go back to later.