Countering Peak Oil

Energy Risk
Management Series
ERM02
What is Peak Oil ?

Peak Oil means

Reaching peak extraction limits
Often during peak demand
Causing peak demand supply gap
Resulting in peaking of prices
When do oil prices peak

When demand supply gap jumps

If supply becomes a constraint
If demand increases greatly
If prices are manipulated
Oil was a stable commodity for 20 yrs…

The producers cartel OPEC was under pressure from

the OECD Governments to stabilize oil prices
 … untill the ICE Trading cartel
took shape

The ICE Trading cartel was formed in the year

2000 by Europe’s Oil majors and global banks
namely BP, Shell, Total, Morgan Stanley, Goldman
Sachs, Deutsche Bank & Society General.
 They controlled Europe’s oil trade .

They controlled Europe’s supply chain, as well as the virtual

trading and swapping of oil contracts at ICE & NYMEX
electronic trading exchanges. Unlike OPEC, they are not a
limited membership official cartel and have several other
traders and hedge funds as associates.
 At the ICE future markets, oil prices became volatile.

It broke the OPEC price band of $22 to $ 28 in 2000 - 2005 and has
controlled oil price through its index indicator Brent Oil ever since.
 Formed on the concept of Enron’s deregulated energy
trading model, ICE added physical stocking to virtual trading.

The future markets at ICE Exchange thus had a unique effect on demand
supply trends, as stockpiling among OECD nations rose despite drop in
consumption.
 ICE created a modern electronic trading platform for oil
futures and chose Brent Oil (North Sea) as its lead index .

Brent Oil had incidentally reached peak oil conditions. The

strategic manipulation of supplies of Brent Oil , (North Sea) which
is less than 10 % world’s oil volume, but the lifeline of Europe,
was done by the ICE cartel both at the supply chain level, as well
as at the ICE exchange.
 The peaking of Brent Oil

After peaking between the year 2000- 2005 North Sea oil went into a
steady decline in production, due to higher exploration costs and lower
investment in new oil fields. As per a Financial Times report new oil
finds at North Sea accounted for 140 mbd in 2009 as against 600 mbd
in previous years
Since Brent had peaked, it was easy to control it by
supply chain investment
 However there was no such scare in other major sources of Oil chiefly
crude from OPEC , which scaled up production to meet demand .

OPEC crude accounted for 55% and Brent Oil less than 10% of the
market. Still it was the online trading of Brent Oil that set the prices.
The strategic control of the Brent oil supply chain and
betting on futures market pushed up the Brent prices.

Long term investors like pension funds were sold the concept
that reserves of Brent oil were depleting. The future contracts
of Brent Oil were both lucrative and safe from the investors point
of view, due to the falling reserves and the growing energy
needs of the world, and the rise of the index was the proof.
The success in pushing up oil prices
each year brought new investors.

Investment in commodity index funds by

institutional investors rose from $13
Billion in 2003 to $317 Billion in 2008
 Stock piling in super tankers

Besides the cartel leased out numerous oil tankers

on short time basis for additional storage, resulting
in a record 80 million barrels of oil being stockpiled
in oil tankers in ready to deliver condition at high seas.
 The contango trades

This also helped the cartel to soak up surplus stocks

and profit additionally from contango trades
buying spot and selling long, as the spot rates were
weak and the supertanker storage cost was nominal.
Tanker prices crash due to oil volatility

Oil tanker lease rates crashed to an unprecedented $ 1 per barrel

per month, due to demand volatility making it easy for contango
trades to profit on net –longs. In January the margin was as wide as
$8 per barrel on March futures and $ 21 on Sept futures , making it
extremely profitable to buy spot and hold oil in super-tankers.
 How oil contracts move

Oil contracts move through the shadow of middlemen mostly

based in Switzerland or other tax havens the biggest of them
being the Zug based commodity traders Glencore, Trafigura
Taurus Oil Transocean ( Gulf of Mexico disaster) , Masefield AG,
Xstrata etc. Some of them are suspects of the Iraq and West
African food for oil and embargo violation scams.

They buy crude from producers, sell it to refiners, buy back the
refined oil and charter tankers to ship it.
 Swapping at the London loophole

The Title to oil contracts , then may change hands 20 to 30 times

before the ship reaches port without physical transfer of goods. The
traders, the oil majors, Banks, hedge funds and the cartel members
swap the commodity in high speed round trip trading at the ICE
London commodity exchange, amongst themselves, driving the prices
up before it reaches the retail trade. Several Bills has been
spearheaded by Senator Levin ( currently heading the Goldman
investigation ) in the US Senate to limit speculation but with limited
effect .
 Shorting to create volatility

At times the prices are pushed down to ensure volatility, and the
cartel benefits on shorting as the commodity prices crash, against
market expectations. In all such cases the cartel’s production curve
drops instantly , in tandem with market demand, as if fore-warned
 Volatility lesser in OPEC production

In comparison the OPEC Oil Production, takes as lot of time to

adjust, as producers not having the inside information of how
markets will behave, react much late and more moderately.
 The London exchange has few curbs.

Being outside the US , there is little bar on speculative trading at the

ICE exchange in London. The regulator FSA is comfortably lax and has
been known to let off the cartel members like Morgan Stanley for
gross violations of speculation , punishing the trader broker instead.
Besides Mr. Sprecher who runs the exchange is an influential CFTC
member and Mr. Hatfield, a Director is a member of the current
Economic Policy Advisory Committee.
 Building the panic at Davos

The build up to panic started this year at Davos with BP Chief Tony
Hayward stating that a supply challenge of 100mbd oil demand was
around the corner, that would lead to a new oil peak. He was backed
by both Shell and Total Chiefs and Europe’s Press gave it the widest
coverage , blanking out the dissent of the largest producers of oil the
Saudi Aramco who shared the dais .
The Saudi’s refute peak oil theory

Saudi Aramco Chief Khalid Al Falih had promptly refuted Group

Europe’s claim, stating that the industry had adequate capacity
to meet any demand surge, and a third of his capacity was idle,
ready to add 4 mbd on demand . “We don't believe in peak oil”,
he said, criticizing the speculation on oil scarcity, and said that it
made investors shy away from investing in production .
 The stage was set for the spike

The unexpected face off at Davos, was followed by a series of

studies quickly taken up in the OECD by expert groups backing Group
Europe’s theory of demand shortage. The IEC soon followed with its
revised consumption projections of 86.6 mbd up by 1.7% from its
previous estimates. The stage was thus set for the cartel members
to hoard and punt.
 But two can play the game

•Risk Managing commodity prices is a real time game.

•It can be done by predictive analytics by matching counter moves.

•Since the market players and supply logistics are both known and
unknown, tracking of both is needed, along with other metrics.

•The most crucial is your development of your counterstrategy

that must be both dynamic and forceful.
 China makes the first move

With the the highest net - long positions in the futures market
being scaled since the early eighties, China quickly reacted to the
possibility of a price spike , taking advantage of being the first
mover in the market place.

Chinese imports of oil jumped by an unprecedented 28% to 33% in

January , February and March as it stockpiled hugely to avert a
possible supply shortage.,

It was both dynamic and forceful throwing estimates and forecasts

of Wall street analysts out of the window.
 China’s bold energy strategy.

This was in line with China’s well known policy of investing

aggressively in oil. Last few years China has even invested in several
smaller oil fields globally to ensure its energy security. It was also
reported that China struck a separate deal with the Saudi’s, who
assured increase in production to meet stable supply conditions in
Asia, ensuring China’s high growth without impediment.
 US joins the stockpile game

• In Cushing Oklahoma, where WTI is delivered into America's

pipeline system, there was a perceptible stock build up in March.

•This was due to US Energy Department’s decision to raise stock by

an additional 2 million tons creating record stockpiles of 356.2 MT,
a 7% rise in US inventory over the five year average stocks
 The advantage of stockpiling

By aggressive stockpiling , China was able to

achieve the duel objective of buying before
price peaks, and setting a higher demand
projection in IEA’s annual forecast, according to
which producers all over the world would plan
both their extraction as well as refinery
capacities.
How Brent oil moved
 Creating price inversions

One of the proven way to reduce volatility used by large

consumers is to stockpile before peak season. This helps it ease its
demand and buy spot during price troughs further releasing
pressure on demands. In an inverted market, current prices are
higher than future prices and thus the price of storage is negative.

This creates losses for the investors and speculators alike, but
brings back control to the real consumers and producers.

The effect of Chinese and US stockpiling caused price inversions

and caught the Big Bank analysts at Wall Street wrong footed.
Risk managing oil futures
Managing Risk through negotiations

China’s positive cash flow and large demand pattern has

helped it buy spot to create price inversions in the market.
If China ties up with other buyers and the large OPEC
producers it can stabilize the price of oil at below $70. This
will still generate profits of $15 to $20 billion for large
producers like Saudi Arabia but will hurt the speculators and
bring stability back to oil.
China’s growing energy needs is key

Apart from China’s positive cash flow and large demand

pattern , it’s growing energy needs is the key to the current
crisis. While speculators want to cash in on the demand surge,
it is aggressively tying up new sources, and the OPEC cartel will
want to enlist it as a stable and growth oriented customer.
Managing Risk through joint ventures

China signed a $ 20 billion oil for cash deal with Venezuela’s

state owned oil producer to form a joint venture to extract
crude oil from the Orinoco Belt block. This was an extension of
the ongoing $8 billion cash for oil program devised by it
 Managing Risk through financing

Last year China Development Bank signed a $ 15 billion financing

deal with Russian state oil firm Rosneft, and $10bn to pipeline firm
Transneft to develop a Siberian oil field and transport oil through
pipes to North China.
 Managing Risk through partnering

Last year China Development Bank and the state owned oil
company Sinopec tied up with Brazil’s Petrobras in a unique
$ 10 billion deal that will cover developing Brazilian oil
deposits, trade, engineering equipment and materials, that
demonstrated the flexibility that China devices for meeting
its energy needs.
 Stabilizing oil price

China’s positive cash flow and large demand pattern has helped it
buy spot to create price inversions in the market.

If China ties up with other buyers and strikes a deal with large
OPEC producers it can stabilize the price of oil at below $70. This
will still generate profits of $15 to $20 billion for large producers
like Saudi Arabia but will hurt the speculators and reduce volatility
of the markets . The Supply chain challenges and moves to overcome
speculative pressures independently shall be discussed subsequently.
 References and Sources

Ecology to Economics
Amazon Kindle Blog : Ecothrust
http://bit.ly/7XwAG or http://bit.ly/ecothrust
Article in Economic Times of 26th April
Oil: A tale of 2 cartels http://bit.ly/9meIGT
Technorati (RSS Feed)
http://technorati.com/people/Ecothrust/index.xml

Sources : Bloomberg, Business Week, The Economic times, OPEC,

The Oildrum , Telegraph U.K., Wikipedia, The Guardian, Financial
Times, Daily Bahrain and U.S. Senate Proceedings.
FOR ANY QUERIES MAIL TO ecothrust@gmail.com
 Risk Manage your life

Individual and Group Coaching

For Risk Management

and strategy planning
with complete client confidentiality
3 month course (12 sessions) starting June 2010
For 10 Students and 3 Groups
On First Come first serve basis
Rush MAIL TO ecothrust@gmail.com for details
Other Presentations by us
Climate Change Positive Solutions Series CE-01

http://www.slideshare.net/SandipSen/cop15bullshitting-15-years-on-
climate-change
http://tinyurl.com/luzxss

Climate Change Positive Solutions Series CE-01

http://bit.ly/4kzzIz

Climate Change Positive Solutions Series CE-82

http://bit.ly/XUrUd
Other presentations by us

Business Risk management Series

http://bit.ly/6Es2z6

Business Risk Case Studies Ba31

http://www.slideshare.net/SandipSen/business-risk-case-study-ba31
 Other Presentations by Us
Business Risk Case Studies Ba32
http://tinyurl.com/lnkv9h

Business Risk Case Study – Ba 33

http://www.slideshare.net/SandipSen/business-risk-case-study-ba33

What is Carbon ?
What is Carbon – ERM-01
http://bit.ly/bjDTl2
Energy Risk Management Series
Energy Risk Management Series
ERM 01
ERM 01
 COP 15 Failure Analysis
• PART 1 DISTRUST
http://bit.ly/5TNFhd

• PART 2 EQUITY
http://bit.ly/6dtoYm
•
• PART 3a TRANSPARENCY Base model
http://bit.ly/5oX8GL

• PART 3b TRANSPARENCY assessment

http://bit.ly/66UBTe