In the past five years, I have hardly met anyone who wasn’t convinced that energy prices could only increase. Most buyers of energy were strongly convinced that we had reached the point where demand growth is outstripping the growth of supply and discovered reserves. This point is called ‘Hubbert’s peak’ after the US geologist M. King Hubbert. The man successfully predicted the decline of US oil production since the 1970’s. He then went on to predict a similar future for the world’s oil production. He gathered an enthusiastic group of followers called the ‘peak oil theorists’ (www.peakoil.net). Mister Hubbert also predicted that live past the peak would be characterized by the high prices and increased volatility that we suffered in energy markets in 2005 – 2008. This made many people believe that peak oil theory is indeed correct. To them, the backdrop since July 2008 was due to the economic crisis. It wasn’t a fundamental reversal of the longer term rising trend. ‘In the long term, it can only rise’, is a phrase that I often heard in the past one and a half years.
The energy procurement strategy in line with such bullish sentiment is a strategy at securing long term energy prices. Many buyers have fixed prices for volumes up to three, four years into the future. Recently, I ran into one of the largest buyers of energy in Germany and observed that they were also following such a strategy of securing prices for the long term because of their fear that energy prices could only rise. This long term – rising trend conviction even made some buyers fix prices for large volumes when the oil price reached record highs of near 150 dollar per barrel in June 2008.
Meanwhile, what do we observe in the markets?
1. With Chinese oil demand growing at record levels, the Brent price broke above the 80 dollar level in the beginning of January. It’s still very early to call ‘bear’, but today the Brent traded below 73 dollar.
2. European gas prices in the spot market have traded below 15 dollar this winter, even while demand has reached record highs due to the cold weather.
3. With Chinese coal demand back on its previous growth path, the coal price dropped back below 100 dollar this week.
4. Power prices in most European markets are back below 50 euro per MWh, which is half the level of before the correction in 2008. With European power demand getting back to previous level, the power prices show no sign of rising.
Of course, it all depends on how you define ‘long term’, but anyway, today’s market is not resuming the bullish path of before the 2008 – 2009 correction. Moreover, there are some developments on the supply side that undermine the vision that from now on, demand growth will continue to outstrip supply:
1. Some expect Iraqi oil production to ‘plug the gap’ in the oil market in the coming years (see my previous blog entry).
2. The bull trend in coal prices was mainly due to logistical issues which have been solved. Coal seems to be abundantly available.
3. The US has expanded its natural gas reserves figure to 100 years of consumption due to developments regarding the production of shale gas.
And how certain is the continuation of demand growth? We shouldn’t forget that oil prices were already falling in July 2008, two months before the financial crises broke out. Oil prices started to fall because of the fact that consumers in the US were adapting their consumption behavior, e.g. by buying less fuel-thirsty cars. How durable will that trend be? The Brussels car show has ended this weekend. Salesman told journalists that they clearly saw a trend of buying cars with better fuel economies.
In ten years time, we will be able to assess whether we were indeed standing on the wrong side of Hubbert’s peak in 2010 or whether the prices of 2005 – 2008 were just a temporary bump. In the meantime, I strongly recommend buyers to forget that energy prices ‘can only grow’. Adapting a ‘it can fall as well as it can rise’ attitude to buying energy simply breeds much better results. More on that in a next entry.