Thursday, June 26, 2008

PostHeaderIcon More On Energy: Supply, Demand and the Not-so-free Market

Speculators in the market have, rightly, been targeted for thier use of the Enron-loophole to basically compete (unfairly) in a market that is mixed between highly-regulated (see integrated oil companies) and unregulated players (see commodity brokers).


This imbalance of power has led to the free flow of capital to a market from sources that a decade ago largely abandoned investment in oil companies -- in favor of the speculative bubble of the dotcom boom.


That lack of capital infusion -- and the capital-intensive nature of the oil & gas business -- led to the mega-mergers of 1999 - 2001.


Bear in mind that even with all that merger activity among the multi-nationals, their true competition is with national oil companies -- basically branches of their nation-state governments: Pemex (Mexico), Petrobras (Brazil), Pedevesas (Venezuala), Saudi Aramco (Saudi Arabia), Cinoco (China) ... you get the picture.


On the one end, you have national oil companies -- either in OPEC or non-aligned -- heavily subsidizing the production of oil and requiring gobs of money from traders to have access to that oil... On the other, using the profits to subsidize their governments (and line their pockets) and to artificially keep the price of of gasoline well below market rates.

This creates a fundamental imbalance on the old supply / demand curve -- and the supply curve for oil is highly inelastic now. We're well past the point were most of world oil supply can react quickly to price boosts -- especially since the capacity for adding production remains fairly static. It takes between 4 and 12 years to bring anything on production even with the most optimistic set of assumptions: ease of permitting, availability of equipment & crews, a discovery of commercially viable reserves, etc.

This is not the world we live in today.

So there you have it: a highly inelastic supply curve coupled with a demand curve that is artificially high for the world market price.

That's the world we live in.

That's the world we need to strategically plan for.

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