It is time to stop quivering in our boots in pointless fear of the future and just roll up our sleeves and build it.
- Ray Pierrehumbert

Wednesday, May 21, 2008

Too too contango


The image is lifted from The Oil Drum and shows the progress of oil futures prices over the past couple of months. Normally, future prices are lower than present prices, because of discounting. Discounting amounts to an expectation that you can invest money somewhere else now and buy the commodity at a lower net price because of your profits. So when the curve goes the other way, it's unusual. According to the site (this is all news to me) this sort of reversal in futures is a prediction of a shortage and is called a "contango".

This week is apparently the first time ever that all future dates are in contango. There is an expectation of rising prices built into the market even with discounting.

Of course, there's some sort of tie-in between discounting and the growth imperative, so at some point the whole idea of futures pricing gets a little dicey if you enter a regime where what economists call "growth" is not the normal or long-term condition.

That's all interesting enough, if a little aside the point of the obsessions of this blog. But there's this comment from "westexas":

My 2¢ worth:

In my opinion, we are looking at an accelerating net oil export decline rate, combined with a requirement for an accelerating rate of increase in oil prices, in order to balance supply & demand, as forced energy conservation moves up the food chain.

Let's take all consumers in all oil importing countries and break them into five groups, and then rank them by income. So, at the bottom of the bottom quintile, we have a poor Third World consumer. At the top of the top quintile, we have Bill Gates. As we go up the income ladder, the cumulative purchasing power vastly increases, which as noted, IMO, suggests a requirement for an accelerating rate of increase in oil prices in order to balance supply & demand.

I think that these two factors will interact--and are interacting--to produce the following oil price trend: $50, $100, $200, $400, $800 . . .

Yeah. This is related to what I am saying about the effectiveness of prices in regulating behavior. We have a world where the distinction between the richest and the poorest is vast. The rich use the vast majority of the resources, and are very price insensitive compared to the poor.

I continue to search for something resembling a decent loaf of bread in Texas, the sort that any average boulangerie in Montreal will sell without a second thought (or a word spoken, but that's Montreal for you). I don't know what bread sells for in Montreal these days, but the closest equivalents (usually either too sour and pasty or too grainy and leaden, grumble) sell for almost $4.00 per loaf at Whole Foods or Central Market. (sigh)

Anyway, the cost of the wheat in that bread was what, like two cents. If it doubles to four cents it will not materially affect my decision whether to buy a loaf of somewhat disappointing bread or simply accept the wonderful tortillas on offer and eat tacos instead of sandwiches.

Enough whining. My nostalgia for a decent sandwich is something I can go on endlessly about, but somewhere in the world the difference between two cents and four is making a real impact on the budget of a desperately poor family. Their necessity is impacted long before my discretionary decision is influenced at all.

Similarly, people who can afford Hummers are not the people who care about $4 gas or even, in a lot of cases, $12 gas. I won't say they dominate fuel usage (there are freight trucks to consider) but they are a major player. High prices don't change their behavior much.

Families on a tight budget, meanwhile, often have long commutes and their lives are dramatically impacted by these changes.

Putting a price on carbon gives the most wasteful users a pass. When relatively few people were wealthy, when commodities were labor-limited rather than supply-limited, this sort of thing didn't matter. In the new order, newly-many wealthy people and still-many poor people are bidding on very different uses of the same resources (grain, fuel) that are changing from demand-limited to supply-limited.

I don't know if anyone saw this particular train wreck coming, but here it is. Commodities rule but prices aren't effective in reducing demand. This seems madly inflationary to me. It's also immensely destabilizing since it essentially makes the poor bear the burden of the adjustment, more or less on the grounds that if they wanted that flour badly enough they'd have been willing to bid a dollar on it.

10 comments:

Magnus said...

In sweden we pay +8$ right now... if my calculations is right...

Dennis said...

That's a way of seeing things that had never occurred to me before.

I think the next 'measure' along this chain of reasoning might then be 'flammability'. Flammability being a measure of social instability directly related to the difference in how well the rich are doing and how well the poor are doing in a society.

Someone once said that you'll never have a revolution as long as the common man has a full stomach. Someone else said that there are few people who are willing to just starve quietly. Or, said all at once, enough tension will finally generate a tear.

Anonymous said...

Michael, in your previous thread, you lamented you are becoming demoralized about blogging. You asked:

[I wish I had some better idea of what to do about it besides ranting.]

This new thread may be an opening for you and your University colleagues to pursue.

Relentless oil price increases and their effect on most every aspect of our lives are bleeding Americans of the bit of wealth we have. It cannot go on unabated without public anger spilling into resentment and diminishing sense of civility; including more theft and vandalism as some act out their frustrations or take what they cannot afford.

As I track US Congressional action on CO2 mitigation legislation, there is an open discussion about its cost to consumers but we all know what is coming at us; higher energy prices and increased cost of everything relating to energy consumption. Yes, the rich will accommodate those higher costs and the rest of us will be slowly driven mad as we fall farther behind in our monthly accounts.

Yesterday’s USA Today article about real US public indebtedness was a shocking revaluation of the true picture of America’s economic health; we are terminal victims of economic leukemia as the exponential growth of our debt (and personal debt as well) destroys our credit circulation system.

How will homeowners maxed out on credit afford to retrofit their homes, cars, lives to absorb the higher energy costs? How will States, cities upgrade and reduce the cost of mass-transit when their annual budgets are cut to reflect loss of revenues from foreclosed property and their higher energy bills?

Who will pay for 350 ppm by 2050?

That is a challenge the enviro seems unwilling to wrestle; in part, because groups like Environmental Defense tell us the cost will be cheap and lots of jobs coming our way. That is propaganda designed to keep the legislators from throwing chairs at us and running for the doors.

Finding creative capital-forming mechanisms to provide the trillions of dollars of infrastructure and retrofit investments is the first order of priority and must take shape before the CO2 laws take hold. By then, it will be too late to cut some slack for the energy consuming Americans and they will take their revenge at the polls by electing candidates who promise to overturn those laws and salvage what is left of the American lifestyle.

We enviros think everyone is on the same climate change bus but we are dead wrong. Price of energy will trump concern about climate change. Helping energy consumers find the cash to adjust will help reverse that certainty.

Shift your thread to focus on this and the world will come to your door.

John McCormick

Aaron said...

The entire American culture is predicated on very cheap oil. We use huge amounts of oil to grow food. Fourty percent of the energy cost to put california lettuce on a plate in New York is pumping water for irrigation. Then comes fertilizer and pesticides with the cultivation and transportation energy use at the bottom of the list.

Increases in the cost of oil will be accumulated in our food chain the same way that toxics are accumulated in natural food chains.

Increases in the price of meat will be a good excuse to eat more bread which is a good excuse to bake your own bread.

Julia Child got the physics wrong, and every writer of cookbooks since has coppied her mistake.

Bread dough has water in it. It is not necessary to spray water on the inside of the oven to produce steam. Use an electric oven with a good seal and a pizza stone. Make a large enough batch to make a full layer across the pizza stone. With the above in mind, look at the Joe Ortiz book; The Village Baker. You can put the Montreal Bakers to shame. (I have been told by a dozen Montreal residents that my baked goods were better than anything they could get at home.)

gravityloss said...

"prices aren't effective in reducing demand"

Well... in a sense, that is the crux. When you think about the rich.

Of course, what really happens is that high oil price makes synfuels from coal very profitable. (They are already quite profitable afaik.)

Just awaiting the first western nation to break the ice. US government or Germany announcing massive synfuel projects.

Wonder about those CO2 scenarios...

gravityloss said...

I also read about electric cars today. People here are organizing into a non-profit association to get the ball rolling and make them themselves, as you simply can't buy an electric vehicle over here.

It's going to cost more than a normal car to buy, but the usage cost will be much lower. Gasoline is about 1.5 euros per liter, or perhaps 8 dollars per gallon.

This oil futures price serves as an additional motivation, as does the resurgence of nuclear power in my country.

David B. Benson said...

mt -- The dollar has significantly depreciated. Maybe this is your 20 cnets worth. :-)

Seriously, farmers in the U.S. receive about 20% of the retail price of the bread, according to

http://www.farmpolicyfacts.org/ne_Farmers_Dont_GetMuch_Bread.cfm

Dano said...

Well, I agree to a point, but in Aurora, CO, there was a perfect opportunity to test this theory, with the 2002 drought and water rates.

Aurora found that restrictions and pricing both affected behavior. Restrictions the poor, pricing the rich. Don't have the paper now, at the GF's house.

So both th' regalayshun and pricing works for necessary goods, in this instance - an unprecedented amount of data and during a drought.

Best,

D

Michael Tobis said...

"Aurora found that restrictions and pricing both affected behavior. Restrictions the poor, pricing the rich."

Dano, I sure hope you got that backwards. Otherwise I am confused.

I agree that a mixed strategy is needed. I don't really know how to achieve that with a global problem.

Dano said...

Here's the relevant passages, Michael:

Kenney et al. 2008. Residential Water Demand Management: Lessons from Aurora, Colorado. ournal of the American Water Resources Association 44 (1) , 192–207 doi:10.1111/j.1752-1688.2007.00147.x

-----

The analysis by type of user confirms the hypothesis that price elasticities vary considerably among user groups (perhaps explaining some of the range in price elasticity estimates in previous studies), with high water users generally more responsive to price (elasticity of -0.75) than low water users (-0.34).

[Now, the question becomes, what about reactions during drought? This is where, Michael, your assumption expressed above comes in:]

The policy ramifications of this observation [ for any given customer, either price or restrictions (but not both) will be controlling, depending on which provides the lowest (i.e., first-encountered) threshold. Summing the price elasticity (-0.60) with the interactions term (+0.23) yields an effective price elasticity of demand during restrictions periods of -0.37. ] are particularly evident by looking at the results for each user group, which show the adjusted price elasticity during restrictions to range from -0.24 for high users to -0.46 for low users. Managers wishing to reign in the high users during drought, therefore, may be wise to focus on restrictions; whereas low water users are perhaps better targeted (if at all) with price modifications—although these users, by definition, have less opportunity to reduce consumption than others, and these price increases may therefore be more punitive than pragmatic.

[Which then leads to my area of interest for this topic and how we reduce water demand. In my little town on the Front Range, we controlled the high users (the rich) by pricing as a long term strategy, which is borne out by the paper's conclusion:]

In any case, it is important to appreciate that the theoretical savings from pricing policies and drought restrictions are not additive, the impact of each policy can vary significantly among user groups, and the choice of policy has ramifications that go beyond water savings to include issues of equity and revenue generation. Similarly, it is important to note that price elasticities among the three groups go in opposite directions depending on whether drought-inspired restrictions are in place, suggesting that the appropriate tool for drought management is not necessarily the appropriate tool for long-term (baseline) water conservation. Stated differently, if the goal of demand management is to control the high users, pricing policies may provide the best long-term option whereas restrictions may provide the most logical drought-coping strategy.

-----


Also, WSJ's got a good arty today on oil production woes:

Energy Watchdog Warns
Of Oil-Production Crunch
IEA Official Says Supplies
May Plateau Below
Expected Demand
By NEIL KING JR. and PETER FRITSCH
May 22, 2008; Page A1

The world's premier energy monitor is preparing a sharp downward revision of its oil-supply forecast, a shift that reflects deepening pessimism over whether oil companies can keep abreast of booming demand.

The Paris-based International Energy Agency is in the middle of its first attempt to comprehensively assess the condition of the world's top 400 oil fields. Its findings won't be released until November, but the bottom line is already clear: Future crude supplies could be far tighter than previously thought.

Best,

D