The nascent recovery in global economic activity could yet be derailed by rising oil prices, with Brent crude hitting $76 a barrel last week, its highest levels of the year to date.
In a blunt warning last week, Goldman Sachs called for a co-ordinated policy response to resolve the problems of commodity shortages, noting: “Although the financial crisis had been addressed, the commodity crisis has not.”
Francisco Blanch, commodity strategist at Bank of America Merrill Lynch, says that just as the rise in oil prices last year was an under-appreciated cause of the recession, this year’s collapse for crude prices has been an under-appreciated source of stimulus.
It would be nice if the Goldman Sachs-types would find a better term for shortages. It’s a bit misleading. The shortage is in the futures contracts for the underlying commodity, not the commodity itself. Infrastructure limitations define the quantity of a commodity to be delivered to a particular place at a particular time. When speculators (you can’t “invest” in a consumable and/or limited shelf-life product) surge into the market at a rate faster than the infrastructure can adjust then the price goes up exponentially.
It takes years to add new pipelines or capacity to Cushing, Oklahoma, the delivery point for NYMEX petroleum contracts. This limits the amount of contracts that can be sold at any particular time. If it were possible to create an infinite amount of contracts, to meet demand at any point in time then the price would never move. The reality is that someone has to deliver a barrel of oil for each contract sold. The supply of barrels is fixed for a particular period of time and therefore the number of contracts for its delivery is fixed. So, when the number of people wishing to buy a barrel of oil doubles overnight, it can’t be met with a doubling of supply–that is the number of contracts cannot be doubled.
Economics 101 speak: you do not have an upwardly sloping supply curve, it is vertical–at any point in time you have only one (aggregate) amount of supply for any price.
What the Goldman Sachs-types would have you believe by using the term commodity shortage is that we don’t have as much petroleum and petroleum products available in the marketplace as we did 19 years ago. But we do. So why is the price going up?
Valero and Marathon are both adding capacity and facilities to refine petrochemicals. The Marathon plant is scheduled to be producing by the end of this year. Why would these companies undertake major projects that will take years to recover the costs of construction if the raw materials were in short supply and the refinery would close before they earned a return on their investment? The people in the industry are not expecting a shortage, so why is Goldman Sachs?
At any rate, the next time you hear, “We would have made more gasoline, if we had more oil†will still be the first time you hear it.
And we would have more oil if the price goes up. The response to near $150/barrel oil last year was for much more accelerated drilling (so much accelerated that there was a shortage of rigs and casing).
At $30/barrel it simply isn’t profitable to drill for new oil, no matter where. At $79/barrel you are in the range where drilling can be profitable. At $150/barrel you can go after the really hard to get oil and still make a profit.