Oil, office buildings, forest products: explaining booms and busts
The Economist has a chart showing the wild swings in oil prices over the last thirty years:
Such swings are the rule, not the exception, in industries which are capital intensive, have high operating leverage, and in which capacity is added in big chunks. It is very expensive to build an office building, just like adding serious capacity in oil production and refining. Every real estate player waits until demand is incredibly strong before building a new office building, then they all do it at once. Then in a few years, often after the economy has cooled, all the new office buildings open at once. There is little demand for all the new space, so prices plummet, and all the rich real estate players from five years before declare bankruptcy.
Donald Trump is like the oil market on steroids. He manages to go boom and bust every couple of years, while the cycles in commodities like forest products, oil and gas, forest products, and aircraft are quite a bit longer. Hard to say when the current oil price squeeze will end, but we know this: end it will.
August 10th, 2005 at 11:59 am
$65.00 a barrel was reported gleefully by Maria at CNBC a little while
ago. They we all a bit down at CNBC this AM when the Dow was up
over $100, but their moods definitely improved as the gains evaporated
and bottles were probably popped with the DOW, Nasdq and S&P
closing at losses.
If it is good for the Dems who cares about America!
August 11th, 2005 at 6:07 am
I’ve emailed you on this before. This chart does not account for the severe decline in production of US oil since we hit Hubbert’s Peak in the 1970s. The WTI oil that is still used as a benchmark price is a very high grade of crude and only represents about 3% of the crude produced today. The average price of a barrel of crude is around $40 per barrel when you consider the whole basket of grades actually shipped. Yes, the price has risen rapidly from the low teens a few years ago, but its not as rapid as the chart implies.
In addition, demand gowth for energy products has risen thanks to economic growth in the East, and to a lesser extent in the West. Eventually, the entire world will hit Hubbert’s Peak and oil production will decline. Prices will have to continue to rise to accomodate this decline in daily production. Most estimates peg this eventuality about a decade away, but estimates can be wrong. The energy sectors has had trouble making new finds, and the new finds they make are smaller in quantity and more expensive to develop. Prices must be high to compensate producers for the MARGINAL barrel of production. It doesn’t matter if it still only costs $8/barrel to produce oil out of the Gawar (sp?) field in Saudi. It only matters what it costs to produce the next million barrels per day out of West Africa or wherever.
The largest oil field in the world was discovered in the 1950’s. Unless we hit some new big scores or new technology comes along (seismic, horizontal drilling, and pressure pumping in the 1990s) to make finding and development more productive, we have a problem.
(Hubbert’s Peak is roughly defined as the point at which half the world’s oil supply has been pumped. At that point, the rate of resource depletion = production declines.) Feel free to look up the book by Hubbert; it might change your views.