Larry Kudlow Confident Oil Prices Headed Lower
CNBC Host Fails to Understand the "Rest of the Story."
Yesterday Larry Kudlow of CNBC and the National Review Online stated his case for lower oil prices. Unfortunately he is part of the problem as to why oil prices will go higher: his rhetoric silences the alarm bells and camouflages the red flags that should be evident to the public and our political leaders. Kudlows remarks are an example of groupthink in that he is going with consensus even though the consensus is wrong. He is ignoring the facts. His editorial is an example of how freedom of the press can actually harm our country. Whether Kudlow realizes it or not, he is giving a false sense of security to his readership and blurring reality by not telling the whole truth.
Below Kudlow and myself debate the energy issues.
Kudlow: "The Energy Department just announced that crude oil supplies rose 1.4 million barrels to 347.1 million for the week ended June 16. Analysts had been expecting a drawdown, so this news caught them by surprise. More, crude oil supplies in the U.S. are now at their highest levels since May 1998, when oil was trading around $15 a barrel. Add in the fact that Canadian oil inventories are fully stocked, and the more imminent reality is of a sizable oil-price decrease not a huge increase."
Dok: Petroleum inventories are at or near record highs due to expectations of higher prices in the future and nervousness about future supply disruptions. During the 1970s the oil industry also maintained oil inventories at higher than normal levels. Another reason why the oil industry inventories are so high is the razor thin spare capacity of oil production. Current oil production is operating at about 97% of capacity. There is no business in the world that can operate at sustained periods of capacity. Businesses must allow downtime for routine maintenance and other variables that would limit continuous production. So too the oil production industry must allow for such variables that would limit production such as hurricanes, terrorism, geopolitics, government policies, etc. Kudlow needs to understand that inventories are high because spare capacity is razor thin and we are near a breaking point that could send oil prices spiraling higher with the possibility of shortages and supply disruptions. This is why the oil industry maintains higher than normal inventories.
Kudlow: "Recently I interviewed four oil-tanker executives who control a combined 85 percent of the oil coming into the United States. They confirmed market rumors that the amount of oil being stored on large carriers on the high seas is abnormally high."
Dok: Spare Capacity is razor thin. The oil industry would prefer to store more petroleum than their storage facilities would allow. Therefore they are paying big bucks to store this petroleum on ships at sea. This is actually very bullish for rising oil prices.
Kudlow: "One of the CEOs even predicted the possibility of $40 to $50 oil in the next 6 to 12 months."
Dok: Notice the use of the word possibility.' Anything is possible. The odds of $40 to $50 oil in the next 6 to 12 months is probably about as likely as $1000 oil. It ain't gonna happen. My point is anybody can make a prediction or have an opinion. Notice the CEO wasn't named and didn't give a reason on his prediction.
Kudlow: "Chevron CEO David OReilly suggested that gasoline and energy demands have flattened in the U.S., and may be showing signs of decline."
Dok: I see gasoline demand flattening in the USA too year over year. Keep in mind that prices have been running 20% to 36% above last years gasoline prices. There has been no demand destruction. While it is true there are weeks where gasoline demand might be down a fraction of a percent, there are other weeks where demand is actually higher than year ago periods even in light of significantly higher prices. Gasoline demand is very inelastic.
Kudlow: "Prince Turki can threaten $200 oil all he wants, but we may instead be looking at a downward correction that will have oil prices dropping more than anyone imagines possible. Supplies are at their highest levels in eight years, while demand appears to be falling, or at least leveling off."
Dok: Hey Larry Kudlow does it bother you at all that spare capacity is razor thin? You keep going back to your argument about inventories being at historic highs. Do you not understand the meaning of 'spare capacity?' Demand is not falling off. U.S. demand for gasoline has flattened from last year no doubt. What is demand for gasoline in China and the rest of the world doing? No doubt it is growing.
Kudlow: "Should a significant price correction be in the offing, stock markets and the economy will cheer. The economic principles at work here are very simple: Markets work. Supply and demand works. Higher prices are gradually slowing consumption. "
Dok: Higher prices may be slowing consumption. However it should be underscored that higher prices are not causing demand destruction in the USA. This is incredible given the fact that gasoline prices are up 20-36% since last year. All signs indicate that demand for gasoline will be exploding in China and the rest of the developing world.
Kudlow: "There's even good news from Washington on the energy front. The House Resources Committee, chaired by California Republican Richard Pombo, has just delivered the Deep Ocean Energy Resources Act, which will give coastal states the authority to drill 100 miles or more offshore. This will allow for exploration and production in the deep seas and on the Outer Continental Shelf (OCS), where kajillions in oil-and-gas reserves are waiting to be siphoned. It also will provide the coastal states with significant oil and gas royalties. Democratic House Minority Leader Nancy Pelosi opposes this, but the bill has strong bipartisan support."
Dok: "This production will take time to develop. Deep ocean oil production will be more expensive. This underscores the fact that the cheap oil has already been produced or is being produced. Continued production is going to progressively get more difficult. Like the early whalers who eventually had to sail to the ends of the earth to harvest supplies of whale oil due to years of heavy consumption so is it also true today with our search for oil. It is becoming more difficult."
Kudlow: "Finally, the Nuclear Regulatory Commission has issued its first license for a major commercial nuclear facility in thirty years. Construction of the $1.5 billion National Enrichment Facility in New Mexico could begin in August, and according to Louisiana Energy Services CEO Jim Ferland, it could be ready to sell enriched uranium (for electricity) by early 2009. Senate Energy chair Pete Domenici calls this a à renaissance of nuclear energy in this country.""
Dok: "Increasing nuclear energy will have virtually no affect on reducing our demand for petroleum. This is because during the oil shocks of the 1970s we shifted our energy mix to replace oil fired power plants with coal and nuclear power. Today less than 3% of electricity is generated by oil. Reducing use of electricity in the 1970s certainly helped conserve oil. However this is not the case today. Unfortunately our automobiles are not nuclear powered."
Kudlow: "A combination of market forces and government deregulation could be setting us up for a big crack in energy prices, including gas at the pump. And it may happen sooner rather than later. Many years ago, during the 1970s oil crisis, Milton Friedman argued that free markets are more powerful than OPEC, and Ronald Reagan proved the point when prices plunged after he deregulated energy in the early 1980s. "
Dok: "Prices plunged in the 1980s because the shortages of the 1970s were caused by geopolitics. Spare capacity was significant during the mid 1980s and was testament to the fact that oil supplies were excessive. Demand for oil was also reduced as the USA adjusted the energy mix in favor of coal and nuclear power for electricity generation. Gasoline consumption was also reduced by lowering the speed limit to 55mph. Both Supply and demand forces no doubt caused prices to decline. Unfortunately the conditions fo the 1980s are completely different from the conditions today. Today spare capacity is razor thin. This can not be emphasized enough."
Kudlow: "Conventional forecasters understate the economic power of free markets, low marginal tax rates, and energy deregulation. As a supply-side contrarian, I'll take the other side of that trade. Indeed, as future events unfold, we may be headed for a much different energy and economic scenario."
Dok: "Unfortunately, low marginal tax rates and a strong economy contribute to high demand for petroleum. We need to kill demand because there is not enough supplies to go around. The only way to kill demand is for oil prices to rise. There is an amazing relationship between oil consumption and real GDP."
End Debate...
In conclusion, a growing economy will put additional pressure on already razor thin spare capacity as demand for oil increases. As oil demand increases prices will have to rise in order to kill the demand and to avert oil shortages worldwide. As prices rise so will inflation. The USA would certainly be at risk of going into recession as consumers have less disposable income to spend as a result of higher energy prices. An economic recession would reduce demand for oil short-term in the USA. The direction of prices would be determined by the consumption patterns of the rest of the world most notable China. As OPEC is losing control of oil prices by their limited ability to increase supplies, so too is the United States losing control of oil prices by limiting demand by virtue of our diminishing percentage of new incremental worldwide oil consumption. On page 111 of Peter Tertzakian's book, "A Thousand Barrels a Second," Figure 4.6 illustrates the sources of incremental world oil demand percent by region on a total 1.7 MMB/d 2005 over 2004. The United States consumed 11% of new demand. China consumed 23%. Certainly oil prices are headed higher and the USA will have very little control over the rising prices.
Bibliography:
Tertzakian, Peter. A Thousand Barrels a Second: The Comingoill Break Point andtheh Challenges Facing an Energy Dependent World. New York: McGraw-Hill, 2006.
CNBC Host Fails to Understand the "Rest of the Story."
Yesterday Larry Kudlow of CNBC and the National Review Online stated his case for lower oil prices. Unfortunately he is part of the problem as to why oil prices will go higher: his rhetoric silences the alarm bells and camouflages the red flags that should be evident to the public and our political leaders. Kudlows remarks are an example of groupthink in that he is going with consensus even though the consensus is wrong. He is ignoring the facts. His editorial is an example of how freedom of the press can actually harm our country. Whether Kudlow realizes it or not, he is giving a false sense of security to his readership and blurring reality by not telling the whole truth.
Below Kudlow and myself debate the energy issues.
Kudlow: "The Energy Department just announced that crude oil supplies rose 1.4 million barrels to 347.1 million for the week ended June 16. Analysts had been expecting a drawdown, so this news caught them by surprise. More, crude oil supplies in the U.S. are now at their highest levels since May 1998, when oil was trading around $15 a barrel. Add in the fact that Canadian oil inventories are fully stocked, and the more imminent reality is of a sizable oil-price decrease not a huge increase."
Dok: Petroleum inventories are at or near record highs due to expectations of higher prices in the future and nervousness about future supply disruptions. During the 1970s the oil industry also maintained oil inventories at higher than normal levels. Another reason why the oil industry inventories are so high is the razor thin spare capacity of oil production. Current oil production is operating at about 97% of capacity. There is no business in the world that can operate at sustained periods of capacity. Businesses must allow downtime for routine maintenance and other variables that would limit continuous production. So too the oil production industry must allow for such variables that would limit production such as hurricanes, terrorism, geopolitics, government policies, etc. Kudlow needs to understand that inventories are high because spare capacity is razor thin and we are near a breaking point that could send oil prices spiraling higher with the possibility of shortages and supply disruptions. This is why the oil industry maintains higher than normal inventories.
Kudlow: "Recently I interviewed four oil-tanker executives who control a combined 85 percent of the oil coming into the United States. They confirmed market rumors that the amount of oil being stored on large carriers on the high seas is abnormally high."
Dok: Spare Capacity is razor thin. The oil industry would prefer to store more petroleum than their storage facilities would allow. Therefore they are paying big bucks to store this petroleum on ships at sea. This is actually very bullish for rising oil prices.
Kudlow: "One of the CEOs even predicted the possibility of $40 to $50 oil in the next 6 to 12 months."
Dok: Notice the use of the word possibility.' Anything is possible. The odds of $40 to $50 oil in the next 6 to 12 months is probably about as likely as $1000 oil. It ain't gonna happen. My point is anybody can make a prediction or have an opinion. Notice the CEO wasn't named and didn't give a reason on his prediction.
Kudlow: "Chevron CEO David OReilly suggested that gasoline and energy demands have flattened in the U.S., and may be showing signs of decline."
Dok: I see gasoline demand flattening in the USA too year over year. Keep in mind that prices have been running 20% to 36% above last years gasoline prices. There has been no demand destruction. While it is true there are weeks where gasoline demand might be down a fraction of a percent, there are other weeks where demand is actually higher than year ago periods even in light of significantly higher prices. Gasoline demand is very inelastic.
Kudlow: "Prince Turki can threaten $200 oil all he wants, but we may instead be looking at a downward correction that will have oil prices dropping more than anyone imagines possible. Supplies are at their highest levels in eight years, while demand appears to be falling, or at least leveling off."
Dok: Hey Larry Kudlow does it bother you at all that spare capacity is razor thin? You keep going back to your argument about inventories being at historic highs. Do you not understand the meaning of 'spare capacity?' Demand is not falling off. U.S. demand for gasoline has flattened from last year no doubt. What is demand for gasoline in China and the rest of the world doing? No doubt it is growing.
Kudlow: "Should a significant price correction be in the offing, stock markets and the economy will cheer. The economic principles at work here are very simple: Markets work. Supply and demand works. Higher prices are gradually slowing consumption. "
Dok: Higher prices may be slowing consumption. However it should be underscored that higher prices are not causing demand destruction in the USA. This is incredible given the fact that gasoline prices are up 20-36% since last year. All signs indicate that demand for gasoline will be exploding in China and the rest of the developing world.
Kudlow: "There's even good news from Washington on the energy front. The House Resources Committee, chaired by California Republican Richard Pombo, has just delivered the Deep Ocean Energy Resources Act, which will give coastal states the authority to drill 100 miles or more offshore. This will allow for exploration and production in the deep seas and on the Outer Continental Shelf (OCS), where kajillions in oil-and-gas reserves are waiting to be siphoned. It also will provide the coastal states with significant oil and gas royalties. Democratic House Minority Leader Nancy Pelosi opposes this, but the bill has strong bipartisan support."
Dok: "This production will take time to develop. Deep ocean oil production will be more expensive. This underscores the fact that the cheap oil has already been produced or is being produced. Continued production is going to progressively get more difficult. Like the early whalers who eventually had to sail to the ends of the earth to harvest supplies of whale oil due to years of heavy consumption so is it also true today with our search for oil. It is becoming more difficult."
Kudlow: "Finally, the Nuclear Regulatory Commission has issued its first license for a major commercial nuclear facility in thirty years. Construction of the $1.5 billion National Enrichment Facility in New Mexico could begin in August, and according to Louisiana Energy Services CEO Jim Ferland, it could be ready to sell enriched uranium (for electricity) by early 2009. Senate Energy chair Pete Domenici calls this a à renaissance of nuclear energy in this country.""
Dok: "Increasing nuclear energy will have virtually no affect on reducing our demand for petroleum. This is because during the oil shocks of the 1970s we shifted our energy mix to replace oil fired power plants with coal and nuclear power. Today less than 3% of electricity is generated by oil. Reducing use of electricity in the 1970s certainly helped conserve oil. However this is not the case today. Unfortunately our automobiles are not nuclear powered."
Kudlow: "A combination of market forces and government deregulation could be setting us up for a big crack in energy prices, including gas at the pump. And it may happen sooner rather than later. Many years ago, during the 1970s oil crisis, Milton Friedman argued that free markets are more powerful than OPEC, and Ronald Reagan proved the point when prices plunged after he deregulated energy in the early 1980s. "
Dok: "Prices plunged in the 1980s because the shortages of the 1970s were caused by geopolitics. Spare capacity was significant during the mid 1980s and was testament to the fact that oil supplies were excessive. Demand for oil was also reduced as the USA adjusted the energy mix in favor of coal and nuclear power for electricity generation. Gasoline consumption was also reduced by lowering the speed limit to 55mph. Both Supply and demand forces no doubt caused prices to decline. Unfortunately the conditions fo the 1980s are completely different from the conditions today. Today spare capacity is razor thin. This can not be emphasized enough."
Kudlow: "Conventional forecasters understate the economic power of free markets, low marginal tax rates, and energy deregulation. As a supply-side contrarian, I'll take the other side of that trade. Indeed, as future events unfold, we may be headed for a much different energy and economic scenario."
Dok: "Unfortunately, low marginal tax rates and a strong economy contribute to high demand for petroleum. We need to kill demand because there is not enough supplies to go around. The only way to kill demand is for oil prices to rise. There is an amazing relationship between oil consumption and real GDP."
End Debate...
In conclusion, a growing economy will put additional pressure on already razor thin spare capacity as demand for oil increases. As oil demand increases prices will have to rise in order to kill the demand and to avert oil shortages worldwide. As prices rise so will inflation. The USA would certainly be at risk of going into recession as consumers have less disposable income to spend as a result of higher energy prices. An economic recession would reduce demand for oil short-term in the USA. The direction of prices would be determined by the consumption patterns of the rest of the world most notable China. As OPEC is losing control of oil prices by their limited ability to increase supplies, so too is the United States losing control of oil prices by limiting demand by virtue of our diminishing percentage of new incremental worldwide oil consumption. On page 111 of Peter Tertzakian's book, "A Thousand Barrels a Second," Figure 4.6 illustrates the sources of incremental world oil demand percent by region on a total 1.7 MMB/d 2005 over 2004. The United States consumed 11% of new demand. China consumed 23%. Certainly oil prices are headed higher and the USA will have very little control over the rising prices.
Bibliography:
Tertzakian, Peter. A Thousand Barrels a Second: The Comingoill Break Point andtheh Challenges Facing an Energy Dependent World. New York: McGraw-Hill, 2006.
posted by -Aztec- at 8:02 AM
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