IEA: Oil supplies could fall well short  

The SMH reports that the IEA now thinks we'll struggle to ever produce more than 100 million barrels per day of oil. There have been rumours circulating about this for a while (poor Fatih and co have been harassed mercilessly by peak oilers for quite some time now), so I wasn't entirely surprised by it. The news is probably one factor behind the massive jumps in oil prices lately.

Global oil supplies could fall far short of need and expectations in the next 20 years, the International Energy Agency is concluding with a vast effort of detective work on production prospects, a newspaper report says.

The report appeared in the Wall Street Journal after a day of frantic trading on the world oil market which pushed the price up past record after record, briefly to touch $US135.04 a barrel.

The main point of the report was in line with remarks made by the chief economist at the IEA, Fatih Birol, to AFP at the end of February.

Birol argued that investment was flagging behind expected growth of demand and consuming countries had to take emergency action to increase energy efficiency and develop alternative energies.

The WSJ reported that a sweeping review of existing oil fields and investment in oil extraction was leading the IEA to conclude that the ageing of existing oil fields and inadequate investment meant that "future crude-oil supplies could be far tighter than previously thought".

The European edition of the newspaper said that for several years the IEA had calculated that supplies would increase steadily as demand rose, to exceed 116 million barrels per day by 2030 from about 87 million barrels per day now.

But it now estimated that "companies could struggle to break beyond 100 million barrels per day over the next two decades".

A large chunk of today's paper seemed to be devoted to one manifestation or another of rising oil prices, with headlines like Petrol pain ahead, Oil price fuels RBA woes and Qantas hikes fares again (and after today's 5% rise in the Tapis price this trend may continue for a while).

Pain at the petrol pump is about to get much worse. A day after petrol prices in some metropolitan service stations in Melbourne, Sydney and Adelaide surged to as much as 162.9 cents a litre, global oil prices have leapt to new highs.

And the pain looks like it's here to stay after crude oil pierced $US135 ($139.98) a barrel in Singapore this morning. Oil had surged nearly $US5 to just below $US134 a barrel in New York overnight after a US government report showed a surprise drop in crude stockpiles.

''The prices we're experiencing in pumps today reflect prices in crude 2-3 weeks ago,'' said Alan Cadd, managing director of price-tracking site Motormouth.com.au. ''The increase will flow through to higher prices in coming weeks.'' The shortfall reinvigorated fears of a supply crunch.

The SMH also reports that Farmers are being hit hard by soaring fuel prices - possibly reducing the amount of acreage that they are willing to plant.

The soaring price of diesel is driving down farmers' profits and forcing them to think twice about planting crops, despite attractive commodity prices. Diesel has hit $1.80 a litre and fuel-monitoring company Fueltrac has warned it could reach $2 by next year.

National Farmers' Federation economist Charlie McElhone said the price of fuel was "most definitely" a problem for farmers and was eroding margins. Fuel made up eight to nine per cent of farmers' costs, so higher prices meant farmers had to take fewer risks. "Farmers need to be a bit more cautious about the on-farm decisions they make because the costs are so much higher," Mr McElhone said. "It's really added to the risks of farmers."

He said higher world prices for key soft commodities, particularly grain, were tempting farmers to extend their operations. But this had to be balanced by higher prices for fuel, fertilisers, labour and servicing debt. Growing grain is particularly energy-intensive.

Somewhat bizarrely, there are rumours circulating in the local market that BHP may try to takeover an oil major after its bid for Rio Tinto has concluded.

An Australian broking house says mining giant BHP Billiton wants to takeover an oil major if its merger with rival Rio Tinto is successful. An Austock Securities report said one of the drivers behind the bid for Rio was for BHP " to be better positioned to grow significantly in the oil and gas sector". Austock said BHP may even redefine the sector.

On the energy policy front, while there isn't much to cheer about from the government or the opposition, Mr Nelson is certainly the worst of the two options available, with even chief bureaucrat Ken Henry criticising their policies - Henry slams Libs for truck tax block

AUSTRALIA'S most powerful bureaucrat, the Treasury Secretary, Ken Henry, has lambasted the embattled Opposition over its decision to block an increase in taxes on heavy vehicles. Coalition senators, who retain control of the Senate until July 1, have voted down legislation to increase the heavy-road-users charge from 19.63 cents to 21 cents a litre from the beginning of next year and increase it each year with inflation.

Economists say the tax level does not reflect the contribution of heavy vehicles to road damage, congestion and pollution, leading to under-investment in alternative transport such as rail. With the Opposition under fire for advocating a reduction in the petrol excise by five cents a litre, Dr Henry told economists in Sydney yesterday that increasing trucking charges was the easiest example of much-needed microeconomic reform.

Moving on, there are plenty of stories around claiming that oil prices are in a bubble like this one from The Times - "They're Wrong About China And Oil" (Energy Bulletin has some collections of bubble and non bubble articles).

Why, then, are commodity prices still rising? The first point to note is that many no longer are. Rice, wheat and pork are 20 to 30 per cent cheaper than they were two months ago, when financial pundits identified Asian and African food riots as the first symptoms of a commodity “super-cycle” that would drive prices much higher. And the price of industrial commodities such as lead, zinc and nickel, supposedly in short supply a year ago, has now dropped by 40 to 60 per cent. In fact, most major commodity indices would already be in a downtrend were it not for the dominance of oil.

But oil is the commodity that really matters and surely the latest jump in prices proves that demand really does exceed supply? Not at all. In the late stages of financial bubbles, it is quite normal for prices to become completely detached from economic fundamentals. House prices in Florida and Spain kept rising even after property developers built far more homes than they could possibly sell. The same thing happened in credit markets: mortgage securities kept rising even while banks created “special purpose vehicles” to acquire vast “inventories” of bonds for which there were no genuine buyers - and dozens of similar examples can be cited from the bubbles in internet stocks and Japan. Similarly, the International Gold Council reported this week that gold demand for commercial uses and investment fell 17 per cent in January, just as the gold price surged through $1,000 for the first time.

Now consider the situation today in oil markets: the Gulf, according to Mr Rothman, is crammed with supertankers chartered by oil-producing governments to hold the inventories of oil they are pumping but cannot sell. That physical oil is in excess supply at today's prices does not mean that producers are somehow cheating by storing their oil in tankers or keeping it in the ground. All it suggests is that there are few buyers for physical oil cargoes at today's prices, but there are plenty of buyers for pieces of paper linked to the price of oil next month and next year. This situation is exactly analogous to the bubble in credit markets a year ago, where nobody wanted to buy sub-prime mortgage bonds, but there was plenty of demand for “financial derivatives” that allowed investors to bet on the future value of these bonds.

In short, the standard economic assumption that supply and demand drive prices is only a starting point for understanding financial markets. In boom-bust cycles, the textbook theory is not just slightly inaccurate but totally wrong. This is the main argument made by George Soros in his fascinating book on the credit crunch, The New Paradigm for Financial Markets, launched at an LSE lecture last night. In this book Mr Soros explains how financial bubbles always start with some genuine economic transformation - the invention of the internet, the deregulation of credit or the rise of China as a commodity consumer.

He could have added the Netherlands' emergence as a financial centre triggering Tulipmania or Britain's global dominance as a naval power before the South Sea Bubble of 1720. The trouble is that these initial perceptions of a new paradigm tell us nothing about how far financial prices will adjust in response - will Chinese demand drive oil prices to $50 or $100 or $1,000?

Instead they can create a self-fulfilling momentum of rising prices and an inbuilt bias in the way that investors interpret the world. The resulting misconceptions drive market prices to a “far from equilibrium position” that bears almost no relation to the balance of underlying supply and demand.

The people who tell you that commodity prices today are driven by “economic fundamentals” are the same ones who said that house prices in Britain were rising because of land shortages. The amazing thing is that just months after losing hundreds of billions in the housing and mortgage bubbles, investors and governments around the world have reverted to the discredited fallacy that financial markets always reflect economic reality, instead of the boom-bust cycles and misconceptions that George Soros's book vividly describes.