Futures Market Traders Bet On $200/Barrel Oil In 2008

In early 2002, George Bush requested that the DOE and EIA conduct a joint study to see what would happen if the world temporarily lost 4% of its oil production due to a terrorist attack. The result? They estimated that crude prices would spike to over $130 per barrel (at the time, crude was trading at ~$35/barrel on the NYMEX).

Even without a terrorist attack, we are running into a fundamental problem with oil production: big fields are rapidly maturing or even declining.

Many will say that current prices (nearly $100/barrel) will spark a new wave of oil exploration and new alternatives that will act to meet demand. Consider this though:

1. Conventional oil exists in a narrow "window" between 5,000 and 15,000 feet. Below 15,000 feet, pressure and temperature break oil down into methane. Conventional oil is also only trapped by salt domes. It isn't a mysterious art to find oil. We've had the seismic imaging capabilities for two decades. We've probably found all the super-giant fields.

2. All the new conventional oil will probably be in deep water (c.p. the Tupi field in Brazil) and will be difficult to produce. It would be a stretch to get more than 100,000 barrels/day from such a field. This leads me to my next point....

3. Peak oil has nothing to do with reserves and everything to do with production. Here's a good way of understanding it: Let's say I told you that you had $1,000,000,000 in a safe in your basement and that's all the cash you'd ever have. Would that be enough for you to live on? Most people would say "yes" but they'd be overlooking a critical point. They didn't ask how much cash they could withdraw every day. It doesn't matter if you have a billion dollars if you can only withdraw a dollar a day. This is the problem that faces the oil industry and the world economy. We might have billions upon billions of barrels of oil in reserves, but the rate at which we can extract that is falling dues to the laws of nature (see note below).

4. Unconventional oil resources face a problem that is similar to conventional oil: the reserves are high but production will ultimately be low. The University of Alberta was commissioned to study the use of nuclear power instead of natural gas for extracting heavy oil from tar sands. The result? To reach 1,000,000bpd four gigawatt nuclear reactors would have to be constructed at a cost of (more than) $20,000,000,000. The earliest such a reactor would be operational would be 2017. Just in time (sarcasim)

The best answer we have in the short term is conservation. We need massive carpooling programs and a fundamental redesign of vehicles NOW. Just simple stuff like engine downsizing and turbo compounding can double fuel economy. It's a start (cue BP logo and music)

Are they betting oil to go up, or the dollar to go down?

Technically these are options contracts, so that means people are 'more concerned about $200 oil, and are buying insurance against it.'

While I'm all for higher oil prices that drive alternative energy investment, this also has more mundane causes....(well not so mundane) like the subprime/recession stuff going on in the market that is currently raising volatility (perceived investor risk) on all asset classes.

I agree with GreenPlease - nice analogy. We're in an age of declines. Best get ready.

@Rolex Replica

Prices of any good go higher due to supply/demand considerations, right?

High prices will essentially force conservation (you said as much), but if such conservation is rapidly forced upon us it can cause serious economic distortions. People won't be able to afford to drive to work, the airline industry will become totally insolvent, and anything else that relies on petro chemicals will become prohibitively expensive. All of that is fine if it takes place over a decade, but if it happens over night you'll see anarchy.

@GreenPlease

Oil production hasn't peaked overnight, it HAS taken decades (was predicted in the '70's)
The problem is that investors care about profits THIS QUARTER,
Politicians only care about the NEXT ELECTION,
and people only care about their CURRENT BANK STATEMENT.

We are a society which finds it inconvenient to think about, or plan for, the inevitable

@GreenPlease

"To reach 1,000,000bpd four gigawatt nuclear reactors would have to be constructed at a cost of (more than) $20,000,000,000."

I read about that as well and there is another problem with nuclear. There is not near enough water in the region of the oil sands or vast areas around them. The little water that is there is already being used to get the oil out of sands and there is no water left for nuclear. Even if they could get 4 nuclear reactors worth of power to the region, there is not enough water to process the quantities that would be needed for the world. Canada already some of the largests man made lakes of the used toxic water from this process.

The shale oil areas in the US are almost worthless as the amount of energy needed to get the oil out is not worth it. Unless maybe people are willing to pay $500 a barrel for it.

Could you please provide a reference for your info about the 1,000,000 bpd. To my knowledge they're quickly approaching that production rate between all of the different operations. Syncrude alone is producing around 350,000 bpd without any nuclear reactors and I'm pretty sure Suncor is around the same size right now.

Thanks

I'm not arguing against conservation (duh), but has anyone actually READ the article this item references? The link's right there.

I think if you really read it, and not just skim it, you come away with a very different story. I'm just saying.

Honestly, sensationalizing the problems of a petroleum-based economy doesn't seem to be the best way to reach practical solutions.

But, I guess in an environment where people decry large oil company profits without ever asking about the size of the profit MARGIN, I should expect this lack of analysis.

"To reach 1,000,000bpd four gigawatt nuclear reactors would have to be constructed at a cost of (more than) $20,000,000,000."

at $100 per barrel, wouldn't that only take 20days to create a return on the investment? Of course, there is the 9 years to get them built part. Still, 9 years worth of r&d to get your return in the first 20 days of production is pretty damn good imo.

Legalize Hemp and it can be turned into Fuel

The glaring flaw in this article is that someone purchasing options to buy oil at $200 a barrel does not mean they expect oil to cost more than $200 a barrel. It means they expect the price of that contract to increase before it expires. The futures market is much more complicated than this article considers and the value of the options involves volatility -- not simply the price of the underlying commodity and the price of oil has been extremely volatile recently -- and will likely continue to be.

These purchases are more likely the result of someone taking an inexpensive and extremely speculative position in a contract rather than them hedging against skyrocketing oil prices.

Companies and individuals buy options for the same reasons they buy the underlying commodity or stock as an investment -- because they expect the price of that option to increase in value. The price of those options can increase significantly throughout the year due to volatility without the price of oil even coming close to $200.

Somedude,

Most of that $100 per barrel price point is the actual cost for extracting it in the first place. The more important thing is the profit margins, so it will take a lot longer than you think to recoup that investment.

When is all this speculation going to end ?
Who is being more abusive - OPEC , the Oil Companies,
the Car Industry or just stupid consumers out to buy the largest Tank Truck - old truck laden with expensive options - now marketed as a "S.U.V>"
Among the biggest gas guzzlers is government -laden with all the oil tax revenues
Get a Real Job

I agree, get oil to $200 or $300 in the next decade and technology will come in big time to save the day. The GM Volt will get 150 mpg. It comes out in 2010 or 2011.

@GreenPlease:

Technology will come and save the day.

I have said this for years and it is all happening now.

Hidden beneath the Rockies lies a big oil field! 2 trillion barrels
Let us say it is true. How come everyone is not running to exploit it, like they exploit any other economic and financial benefit?
The other aspect is how much energy, and at what cost – financial and ecological, is it going to take to heat the oil shale up and extract the oil.
I suggest conserving resources; we should use renewable energy, such as Solar and Wind energy etc. to heat up the shale.
Another issue is they are waiting for oil to reach $200 per barrel so the government can reduce the deficit and outstanding loans.
I hope that is the truth and that there are no hidden agendas.

Technological hurdles to extract oil from shale
"Despite all the attempts to develop a shale oil industry in the United States over the past 100 years, the fact remains that no proven method exists for efficiently moving the oil from the rock. There are a number of candidate processes possible, but none has demonstrated a practical capability to produce oil."
Experts with field experience who are bullish on the prospects for America's oil shale. But they recognize that, here and now, we are still not there yet technologically.
There are a number of problems yet to be solved before US oil shale can be recovered on any type of meaningful scale, let alone a mass scale. And getting the extraction technology right is only one monkey wrench in the works with US oil shale. There are others.
For example, there are questions of air quality regarding domestic oil shale operations. How badly would these operations pollute the air? Would the levels be acceptable? Shell isn't sure.
There are questions of water availability. During the extraction process, how much water would be required?
Experts are not sure. An early "guess" is two to three barrels of water per barrel of shale. This could be a conservative estimate. Either way, will the massive amounts of water necessary for heavy-duty shale extraction even be available in the first place, given that the Colorado River Basin is already running low?
You also need to account for the environmental and ecological damage and restoration to pre-drilling condition.
American technology and knowhow will find the answer – all you have to do is wave the dollar bill in front of corporate America and they will find the answer “by hook and by crook”. Then the executives, the shareholders and the politicians will laugh all the way to the bank.
Yehuda Draiman.

The price of the oil barrel is like the one of fuel, that varies every day. Futures reversed earlier losses that came on a dismal housing report and overnight declines in global stock markets.

Oil used to not affect the markets because it was never such a significant factor in people's spending. Now that we are spending (at $131 a barrel and 21M barrels a day) $2.75Bn a day on oil which, combined with refinery mark-ups and ancillary food and other inflation, comes to about $5Bn a day on essential consumables - it matters a lot!
Stay abreast @ http://www.getoilstock.com

I am Arjun Murty of Goldman Sachs. I am here to sincerely apologize for a typo in my memo. I meant $20 a barrell of oil by May 2009, not $200. Once again, I apologize for this inconvenience..it should be $20 a barrell, not $200 a barrell!