Daily Archives: April 26, 2012

The energy price version of “this time it’s different”

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Michael Giberson

David Wessel’s economics column at the Wall Street Journal takes a look at an IMF analysis of commodities prices since 1973. In the process, he makes an odd claim about energy prices.

CHART: Commodity prices since 1973 from the IMF World Economic Outlook

Commodity prices since 1973 from the IMF World Economic Outlook.

Wessel writes:

To help distinguish temporary trends from long-lasting ones, International Monetary Fund economists recently charted the inflation-adjusted prices of four baskets of commodities—energy, metals, food and agricultural raw materials (such as logs, cotton, rubber, wool and others) since the 1970s. For what it’s worth, the IMF’s bottom line: “The weak global economic outlook suggests that commodity prices are unlikely to increase at the pace of the last decade.”

But the IMF charts illuminate a bigger story.

• Something significant did happen in the 2000s: a sea change in what had been a downward drift in prices of commodities (other than energy) for decades. The consensus explanation: Demand from China, India and other emerging markets grew very rapidly as these big economies sprang to life….

• Energy prices are truly different. For one thing, they are much more volatile than other commodity prices for all sorts of reasons, including recurring geopolitical risks that oil supplies will be disrupted. For another, they are clearly rising—up 163% over the past four decades. The consensus explanation of energy’s exceptionalism: Rising oil prices depress economic growth and that depresses prices of other commodities.

• Metals prices have risen significantly in the past several years, as the IMF chart shows… Still, metals prices are roughly where they were in 1973, a clear contrast to the price of energy, which appears unlikely to ever be as cheap as it was then.

• Over the past several decades, the price of food is down substantially—despite the growth in the world’s population and the well-discussed change in the diets of the increasingly prosperous Chinese, and even after the uptick of the late 2000s. Food prices are roughly half what they were in 1973. Half. That long-lived trend is likely to continue.

Why should we believe “this time it’s different” about energy prices?

It seems an especially odd claim given the near two-decade period from about 1985-2003 during which energy prices were essentially the same as in 1973. That can’t happen again?

Maybe we’ve reached the global limits on energy-resource productive capability, but I doubt it. Instead I think we’ve seen significant growth in energy demand over the last decade or so, more or less exhausting any excess capacity (or, in economics jargon, the energy demand curve is now intersecting with a relatively inelastic portion of the energy supply curve). Energy supply has been increasing in response, but the effort is slow-moving, so we get higher and more volatile prices in the meantime.

My guess is that we will see inflation-adjusted oil prices back at 1973 levels within the next five years.

RELATED: The recent IMF World Economic Outlook analysis that inspired Wessel’s column.

Natural gas reserves may rapidly disappear (and later reappear)

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Michael Giberson

At Toronto’s The Globe and Mail, Nathan Vanderklippe reported, “Low natural gas price casts doubt on ‘proven’ reserves.”

He explains how rapidly falling natural gas prices can cause reserves to disappear. And, by the way, with higher prices reserves can just as quickly reappear. It isn’t magic. But the nature of oil and gas reserves is not well understood, often not even within the energy policy community, so it is worth looking at this relationship between prices and reserves.

Frequently in public policy discussions of oil and gas, reserve amounts get talked about as if they are estimates of all of the remaining oil and gas that will be developed. Reserves are actually just estimates of the currently discovered petroleum resource that is technically recoverable using current technology and anticipated to be profitable to develop at expected prices.

It is the last part of the description – “anticipated to be profitable to develop at expected prices” – that may be responsible for the disappearance of natural gas reserves this Spring. As Vanderklippe discusses, prices expected for this year and the next few were somewhat higher last year while reserve reports were being prepared (in the $3.50 to $4 range). Looking at the same set of resources at today’s much lower price (current futures prices for May are just over $2 an mmBTU) and a perhaps sizable fraction of reserves reported last year may no longer be profitable to develop. And if some of today’s reserves are no longer profitable to develop, the natural gas is no longer countable as a reserve. Experts quoted in the article suggest drops of from 20 percent to 40 percent of proved reserves due to lower prices.

But of course the natural gas resource doesn’t disappear when the reserve numbers fall, the gas just gets reclassified into a sub-commercial category, “contingent resources.” When prices rise again (or the cost of developing resources falls), the natural gas resource can just as suddenly reappear as a reserve.

One other reserve definition note: the reserve numbers most frequently mentioned in policy reports and news articles are “proved reserves.” As described in the Petroleum Resources Management System, the industry standard reserves definitions, proved reserves are a  fairly conservative estimate of the discovered resource anticipated to be profitable to develop at expected prices. Nine times out of ten you actually expect to produce more than the proved reserve estimate.

(Note that Vanderklippe’s article refers to Canadian reserve reporting practices, in the United States the Securities and Exchange Commission determines reserve reporting requirements which may vary from Canadian practice.)