Fuel Conservation and Management Symposium Explaining the Rise and Fall in Oil Prices in 2008 September 22, 2008 1 Philip K. Verleger, Jr. PKVerleger LLC

Fuel Conservation and Management Symposium

Explaining the Rise andFall in Oil Prices in 2008

September 22, 2008

1

Philip K. Verleger, Jr.PKVerleger LLCHaskayne School of Business, Calgary, Alberta


Crude Oil: What the Hell is Happening?

Crude oil prices have doubled in one year. This is the largest increase in history. Yet.

There is no war.

There is no disruption in crude production.

The world’s refineries are working well.


WTI Prices, January 1997 to September 2008


Major Periods of Price Increases in the CRB Commodity Index, End-January 1970 to End-August 2008


WTI Forward Price Curve at the Peak of the Four Most Recent Price Cycles as Measured by the CRB Index


Possible Explanations

• Growth in Asian demand – particularly China

• Peak Oil – running out

• Inability of major oil companies to access oil in much of the world

• U.S. addition to oil

• Speculation


Real Explanations

• Environmental rules limiting sulfur in diesel fuel

• Limited supply of low-sulfur crude oil

• Disruption of production in Nigeria

• DOE decision to put sweet crude into the SPR

• Ethanol strategy


Impact on Diesel Fuel Supply of Oil MarketConditions and Events Occurring since August 2007

Incident

Incremental Addition toGlobal Diesel Demand

(Thousand Barrels per Day)Stringent Sulfur Content Rules for Diesel Fuel

Loss of Nigerian Production

U.S. DOE’s Hoarding (Taking Light Sweet Crude from the Market to Store in SPR)

Incremental Diesel Demand in Europe

Ethanol Mandates

The Euro’s Strength

Expansion of EU

Total

100

100

25

75

100

75

200

675


Distillate and Diesel Fuel Prices,1997 to 2008


Retail Gasoline and Diesel Prices inGermany and France, 2006 to 2008


U.S. Net Trade in Distillate Fuel Oil(Exports less Imports), 1995 to May 2008

Exports

Imports


Cumulative Distribution of Global Crude Production in 2006 as Reported by EIG


Relative Product Yields of Various Crudes

Product

Crude Yields (% of Product Produced from Crude)

ArabHeavy Brent

BonnyLight WTI

GasolineJet KeroseneULSDLow-Sulfur Diesel

36.8 6.7 3.0 6.7

46.7 8.019.810.0

44.9 7.829.610.0

48.1 8.120.910.0


Impact of Energy Policy Act of 2007 Biofuels Requirement on Adjusted U.S. Gasoline Demand


New York Harbor Gasoline/DistillatePrice Spread, 1986 to 2008


NY Harbor Spot Gasoline/Distillate Spread –2007, 2008, and Normal Range

Normal Range


“Extra” Margins Earned by Refiners –2006, 2007, and 2008


Imputed Refining Profits onLight Sweet Crude, 1997 to 2008


Use of U.S. Refining Capacity –2007, 2008, and Normal Range

Normal Range


Gasoil Spot Prices in Dollars vs.Brent Prices in Dollars


Policy Blunders Could Send Priceto $200 but for Recession

• This is not your father’s recession.– Consumer cutbacks in 1973-75 and 1980-81 led to lost U.S./EU output

and jobs.– Consumer cutbacks in 2008 will lead to lost Chinese jobs.– GDP growth will be strong but consumer expenditures will drop.

• Oil use will also drop as it did in prior recessions.– European consumers will lead the way.– U.S use will also decline.


Monthly U.S. Gasoline Consumption,January 1970 to February 2008

Iran Shock, Fuel Economy Standards


U.S. Gasoline Consumption Growth vs. Growth in Real GDP by Quarter from 1973 to 2008


Percentage of U.S. Personal Consumption Expenditures Allocated to Energy and Gasoline


Increased Supplies Will ArriveJust at the Wrong Time

• More light crude is on the way.

• Refineries are boosting diesel yield.

• New hydrocracking capacity will raise gasoil/diesel supply.

• Problems in Nigeria will be resolved at the wrong time.


Oil Prices Could Fall a Very Long Way

• OPEC successfully controlled markets from 1999 to 2005.– The instrument of control was heavy crude and gasoline supply.– Middle Eastern countries had leverage.

• Middle Eastern countries have little control over sweet crude production.

• Future price stability is in the hands of Nigeria.


Russia’s Invasion of GeorgiaCould Change Market Dynamics

• Russia is moving aggressively to prevent price collapses.– Bought Turkmenistan’s natural gas in December– Offered to buy Libya’s oil and gas in May– Invaded Georgia in August– Sent a group of 30 to OPEC’s September meeting

• Russia has a strong interest in high oil and natural gas prices. Putin said so himself in a 1999 thesis.

• However, Russia’s action may fail because it undermined Europe’s economy and the euro.

Documents

Fuel Conservation and Management Symposium Explaining the Rise and Fall in Oil Prices in 2008 September 22, 2008 1 Philip K. Verleger, Jr. PKVerleger LLC