An even bigger risk for 2008

I'm amazed at the degree the discussion on the unfolding financial crisis misses a very basic, critical physical reality: that the world is hitting its physical limits to growth, most notably in crude oil production.

Take a look at these numbers from page 48 of the OECD IEA Nov. 13 monthly report at http://omrpublic.iea.org/currentissues/full.pdf

World oil total demand (actual and projected):
1Q06 2Q06 3Q06 4Q06 2006 = 85.5 83.5 84.3 85.7 84.7
1Q07 2Q07 3Q07 4Q07 2007 = 85.8 84.7 85.3 87.1 85.7
1Q08 2Q08 3Q08 4Q08 2008 = 88.2 86.5 87.2 88.9 87.7
World oil total supply (actual):
1Q06 2Q06 3Q06 4Q06 2006 = 85.4 84.9 85.5 85.3 85.3
1Q07 2Q07 3Q07 4Q07 2007 = 85.4 85.0 85.0

It's clear as water that, for the convergence of oil demand to supply in 2008 not to take place out of MUCH higher oil prices, oil production in 2008 must - contrary to its 2006 and 2007 behavior - experience a "surge". As Dirty Harry would say: Do you feel lucky?

In the previous post I mentioned that a further doubling of the oil price in 2008 (which comes right out of these projections) could be the final triggering factor of the collapse of the dollar value and its abandonment as the international trade and reserve currency (the Russians apparently aren't waiting for that). But then I learned from Matthew Simmons Oct 23 presentation at CalTech ( http://www.simmonsco-intl.com/files/CalTech.pdf ) that there is an independent and even bigger risk.

The analysis in my previous post had assumed that it was very unlikely that oil stocks would experience such big drawdowns during 2008 as to meet all of the IEA projected demand. Rather, the estimated price rise could be reasonably thought of as that needed for causing the amount of demand destruction that would allow stocks to remain at acceptable levels. But what if that were not the case? What if stocks were drained beyond critical levels? The following are bullets from pages 35 and 36 of the presentation:

***

Rapid rise in oil prices has yet to dent demand growth.

As supplies falter, demand drains key stocks.

When oil inventories reach minimum operating levels it is the equivalent of fuel tank reading empty.

If "min-op" inventories are breached, risk of shortages in some finished products is high.

Once shortages begin, likely reaction is for users to hoard.

Hoarding then creates a "run on the petroleum bank."

The problem then morphs into a nightmare.

***

Judging from 2007 events, this scenario doesn't seem too far-fetched. At end-of-August, start-of-September, US gasoline inventories in terms of days of supply were the LOWEST EVER recorded (the days of supply data goes back to March 1991), reaching just 20 days. This was even fewer days than seen following the hurricanes in 2005. In absolute terms, the Sep 7 value of 190.4 Mb was just slightly higher than the lowest number on record, which was on August 29, 1997 at 185.6 Mb.

So, ironically but logically, an easing of monetary policy aimed at preventing a run on financial banks will very likely enable a run on critical physical banks, with a much worse disruption in society. Of course, any particular country may bet on their being able to outbid others and thus avoid being the ones having the shortages. Again, do you feel lucky?

As I see it, the only way to prevent this IMMINENT collision is to enable a US-led OECD recession through a tight US monetary policy aimed (explicitely or implicitely) at preserving the dollar value for international transactions through checking its global supply growth.

This of course does NOT mean that a recession is the long-term solution to the energy problem. It just provides a window of opportunity for addressing the problem in a decisive yet orderly way.

Which should be the subject of the next post.