Black Gold No More:

We have been hearing a great deal about oil prices lately, most of it nonsense, having little to do with reality.

Since the discovery of oil at Spindletop at Beaumont Texas one hundred and fourteen years ago, there have been more times when there had been too much oil rather than too little. (The Standard Trust owned by  Rockefeller was forbidden from owning oil wells in the State of Texas) Indeed the Rockefeller fortune was made by solving the problem of too much oil rather than too little. Seems like not a whole lot has changed and history may well repeat.

The current pricing problem for oil has been caused by several  historic  factors. The breakup of the Seven Sister Oligopoly  and the policy of supplying oil by means of long-term fixed price contracts; the invention of the Spot Market; and most recently by the Federal Bank of New York and the flood of cheap money that allowed for  a binge of spending on uneconomic marginal production. (aka Oil Bubble)

Contrary to the in vogue thinking OPEC did not, and still does not play, a big part in oil pricing.

With the exception of the De-Beers  Diamond  Monopoly/Oligopoly, the Seven Sisters, formed by seven giant oil companies was, for many  years,  the most successful sub rosa trading organization in the World. ( Esso, Shell, Anglo-American Oil/ BP,Mobil, Chevron, Gulf & Texaco) It was the stability of oligopoly pricing, at a level no more than $3.50/ barrel, that allowed for the explosion of growth of the auto and aircraft Industries in the years following the end of the Second World War.

When the continuing Arab, Israeli conflicts led to the formation of OPEC the Sisters lost a lot of their pricing power and started to integrate.  The final end came with the introduction  of the Spot Market, a clever invention by a master trader, as a way of circumventing the attempted blockade of oil shipments by OPEC.

The Spot Market was good for the non-aligned countries but not so good for all the others because oil lost its’ status as Black Gold and became instead just another commodity.

Today it should be obvious, to all but conspiracy freaks, that COMEX futures drive the price for oil just as it does for nearly ever other commodity. The volatility of market prices is aided and abetted by a monetary component, that allows speculators to hedge currency transactions in addition to physical inventories of oil.

These two historical factors, along with the advance of the science of fracking  set the stage for the most recent blow out, that is bubble like  in nature. Throughout history we have witnessed many commodity bubbles ( the South Sea Bubble, the Tulip Bubble. the Housing Bubble  and now the Oil Bubble). Bubbles are  caused by excess liquidity that most times leads to  a gambling frenzy as the speculators rush in to bet on a sure thing.

Trouble with fracking is that it is not a sure thing, and the oil produced by enhanced methods maybe a lot more expensive than the marginal value. We have experience in this type risk taking with steam assisted forms of production from heavy oil deposits, Sometimes they work and sometimes they do not and almost invariably  the costs of production are far greater than anticipated.

A great deal of the present marginal production has come either from fracking or from other enhanced recovery operations that will likely be uneconomic at current levels of pricing.

If the past is any indication of the future we can expect the expensive oil to be shut in very quickly. (Oil companies are no different and cannot afford to lose money) Provided the relative value of the US currency remains the same (the Dollar is still rising against the other major currencies) oil prices should  stabilize as the bubble dissipates.

Beyond this point the future is murky.  My guess would be that the market will remain volatile because there is now no oligopoly to set prices.  World growth in oil consumption is unlikely allow for huge new high cost sources such as the Canadian Oil Sands and pipelines to everywhere, to come on stream for some years to come.

In the meantime get ready for Carbon pricing (new taxes on oil) as governments seek new sources of funds to pay for past excesses.

Stay tuned:



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