9th November 2007

The energy market is ‘testing’ the $100 per barrel price level for West Texas Intermediate – much as Goldman Sachs predicted. However the investment bank and securities firm did point out, when it made its prediction, that the price of oil would only spike to a price just north of $100 and then presumably fall back again. This leaves a mystery for the energy markets to ponder. Namely where will the price of a barrel of the black stuff settle – something that is of a key concern to any one developing technology for, or investing in, the alternative energy market.

At CarbonFree we place ourselves in the camp that admits it does not know where the oil price will end up or how continued irrational exuberance will impact on the alternative energy sector – as opposed to residing in the camp that pretends to know the answers to both of these questions. However after a lengthy session attempting to nail jelly to a tree there was a pile of old envelopes with the following notes scribbled on the back.

Speculation About Speculation.

Global GDP has been running at approximately 3% for the last seven years meaning that the world economy is now just over 22% larger than it was in 2000. In that time oil has risen from $30 per barrel to, at the time of writing, $98 per barrel. Over the same period the price of gold has risen from $280 per oz to $830 per oz. Both commodities have roughly tripled in price in seven years. Oil costs 60% more than it did a year ago while gold costs 72% more that it did last year. The recent jump in the price of these commodities seems to coincide with the collapse of the property market and could be due to the diversion of funds from property into commodities.

Commodity prices could also be driven by the need for some investors to make short-term gains to fill gaping holes in their balance sheets. If you ignore the recent jump in oil prices and assume that oil is really only worth $60 per barrel this still means it is on the market for 200% of what it was selling for in 2000 – 178 percentage points above compound global GPD growth for the same period.

China and India with their eye watering 10% annual growth rates - and their 0 – 60 mph from a standing start energy requirements - are sometimes sited as the reason for the mismatch between global GPD growth and oil consumption. However both of these countries have had their foot on the accelerator for almost a decade rather than just the last six months and, if anything, they have recently started to throttle back their overheated economies.

Disrupted And Inefficient Supply Chains

Here no one really knows the whole story – for an account of how economists and energy traders determine the volume of oil in the supply chain at any one time Simmons’ book ‘Twilight In The Desert’ makes interesting and entertaining reading. Perhaps someone is travelling around the world’s ports looking for ‘empty’ tankers that are laying suspiciously low in the water. However, even if they are, the fact that producer nations are shy about publishing production data makes estimates of the amount of oil sloshing around in the market, and the number of barrels sitting in small ports waiting for the price to peak, very much a known unknown.

Are We Running Out Of Oil?

Of course we are and at some point during this century there will be little oil of any consequence left. Most producers, other than those with access to shales and tar sands, have past peak oil. Having reached the peak have commodity traders, experiencing a serious bout of vertigo, embarked on a wave of panic buying? If this is the case then why are big oil companies seeing their share prices rise? If oil is about to run out any time soon these companies will have a lot of refining and distribution infrastructure with nothing to refine or distribute? Of course speculation and the need for quick returns could also be driving oil company shares to new heights.

Let’s Blame Granny

We are strong believers in demographics as a key driver for the global financial system – and also that the economies of industrial countries are being distorted by the expectations of baby boomers who are now approaching retirement age. As far back as the 1990s the money flowing into pension funds exceeded levels that investment managers could sensibly find a home for. A substantial amount of this money was launched into cyberspace – never to be seen again. However even the Dot Com crash did not diminish the tidal wave of pension contributions, which was eventually channelled into the property market – that place where central bankers hide inflation when they want to pretend it does not exist. Now with the property market on the slide fund managers need to find a new home for pension contributions – one that, in the light of the fact that the boomers will soon start to draw on funds, generates a decent return. So as the house market cools down the energy market is heating up.

Hardly Green With Envy

For us in the renewable energy sector the current turmoil in the oil market is viewed with a mixture of bemusement and pleasure. A bit like watching the house of an unpopular neighbour burning down. With oil at $100 per barrel most forms of alternative energy have little trouble finding backers – unlike in 2000 when oil was a mere $30 per barrel. However the fortunes of the fossil fuel and renewable energy sectors are inextricably linked and when the investment community decides to put the fire out in the oil market it will probably do it by hosing down the whole neighbourhood.

Stripping speculation out of the oil price could see the price of a barrel of oil following the price of a three-bedroom house into a black hole. It is difficult to sell a solar panel or a wind turbine to someone who has seen their heating oil bill halved – even more difficult if their house has been repossessed.