October 14, 2009

Will oil prices stay high?

No, not in the long-term, due to lower price of substitutes for oil. As I have discussed on this blog, the fundamentals here are quite clear.

Substitutes are roughly in the same cost range as oil currently: PHEVs like the Volt1 become economic at about $3.35/gallon gasoline ($90 oil?). In the longer-term (the time it takes to ramp up PHEVs) this also puts a cap on prices.

In roughly 5 years economies of scale will reduce the cost of PHEVs to the range of $80 oil, and we'll see a race between oil depletion and EV growth.


1Pure EVs are cheaper, but much less convenient.

Are battery prices really this predictable?

The price-performance improvement of batteries has been very consistent for quite some time, and it's accelerating. Those improvements are based in new tech (lower cost materials in newer chemistries), larger formats (which eliminate the overhead of packaging and controls per cell), improved manufacturing, and economies of scale.

I've been using such batteries on laptops for a long time - they're not very long-lived.

You're using out-dated battery chemistry, with inadequate temperature and charge-discharge management. Look into the newer li-ion chemistries being used by A123systems and LG (and many others).

If I'm so confident on price of substitutes for oil, why don't I get rich in the futures market?

I am quite confident about the price of substitutes - I called the oil price peak last year (as you can also see in earlier entries here) as did Richard Rainwater looking at much the same data.

I'm not so confident about the time before another price peak ends - the next peak is likely to be longer and lower. Things depend as much on the willingness of oil exporters to recycle petrodollars, and the willingness of oil importers like China and India to subsidize their price controls, as they do on the speed with which substitutes replace oil.

If exporters get as smart as China and Japan, they'll finance exports just as long as exports exist: that could support much higher prices for quite a while, if the US was stupid enough to continue borrowing to support it's addiction to oil. OTOH, if China, India and other importers with price controls wise up and eliminate price controls & subsidies (or, even better, replace them with taxes and import controls), the price could drop sharply.

EV/PHEV substitution will happen incrementally. Lifestyle substitution, especially carpooling, could happen quickly with the proper "victory-garden" promotion (although it's hard to see that kind of realism in US politics at the moment).

What if world oil production declines more than a few percent per year? Wouldn't balancing supply and demand be very difficult without a worldwide economic depression?

Not because of a lack of BTU's. See http://energyfaq.blogspot.com/2008/09/can-everything-be-electrified.html . OTOH, the trade imbalances it would create would indeed be very difficult to manage. I haven't seen a good model for what might happen - I would guess we'd see economic stagnation for a good 10 years. Eventually I would hope to see an aggressive response in the US, which could dramatically reduce oil consumption quickly.

Emergency measures could easily reduce consumption by 25% in 6 months by conservation (just make all highway lanes HOV, strictly enforced), and drilling (in ANWR and off the coasts) and large-scale CTL could both be done in 3 years under truly emergency conditions.

We have more than enough energy to build new electric vehicles. For that matter, we can carpool and telecommute during the transition. We really can. I'm often baffled by the lack of awareness of the potential of carpooling: the US could cut it's oil consumption by 25% in 3 months, if it chose to. It would be inconvenient, and require an emergency to do, but everyone would still get to work.


Jonathan Callahan said...


I can see your logic about demand in the US decreasing because of price competitive alternatives. But I am concerned that the hundreds of millions of newly middle-class Chinese, Indians and Brazilians will begin increasing their demand for petroleum starting from a base of zero.

I also expect the $ price of oil to decline before the year is out. But I expect it to be due to a renewed economic downturn rather than a higher percentage of PHEV vehicles on the road.

Looking out a few years I think it is very difficult to make predictions of the $ price of oil because I expect the dollar to be quite volatile compared to other currencies and commodoties.

So I'm calling for a dip in $ denominated prices in the next six months followed by increasingly volatile prices after that.

Your thoughts?

-- Jon

Nick G said...


BRIC demand will certainly support oil prices, though they have the same substitutes available - the Chinese in particular are pushing CAFE-style efficiency, hybrids and EV's harder than the US. Of course, exchange rates will make reduce their effective oil pricing (except in China, where the exchange rate is pretty rigid - OTOH, gasoline prices are partially price controlled...).

Decreasing US demand will tend to put a ceiling on oil prices, until the US has mostly eliminated it's oil consumption (which will, of course, take a while).

Why do you see a renewed economic downturn? Rising oil prices will certainly put a damper on US growth. A $30 increase in oil prices is certainly possible, and that would send about $120B overseas. If US deficit borrowing doesn't rise by $120B to compensate, then you'll see an effect.

I expect the dollar to be quite volatile compared to other currencies and commodoties.

Do you expect more volatility than we've seen? Why?

As for oil price volatility: I just took another look, and was surprised to see that monthly WTI pricing was not as volatile as I would have expected. I suspect that OPEC will have some success in keeping a floor under prices. Could there be some surprises on the upside? It's possible, but I think traders will be wary about being caught again by a peak, so I think the rise will be fairly gradual. I also suspect that KSA will attempt to keep prices below $100, and I think they'll have some success - I'd be surprised if world demand rose all that quickly.