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Fossil Fuels

Oil Prices Respond Quickly To Supply Changes

Originally published on The Lenz Blog.
By Karl-Friedrich Lenz

The Institutional Investor Group on Climate Change is an association of European investors representing  €13 trillion in assets.

It has just published a report titled “Investor Expectations of Oil and Gas Companies – Transition to a lower carbon future.

This document consist of a short introduction describing the economic and policy environment for oil and gas, with a view to climate change. That is followed by a set of questions for the boards of such companies.

I found one figure in the introduction very interesting. On page 5 they say that the 60% decline in price compared to 2014 oil prices was caused by a mismatch of supply and demand of only 2%.

Very small changes in supply have a very strong influence on oil prices.

That’s good news for the basic idea discussed here, Phaseout Profit Theory. That idea is: Oil companies should have an active interest in regulation limiting supply, since it increases their profits from selling oil and the valuation of their oil fields.

The above figure adds an important factor. It is not necessary to reduce supply by a large percentage to achieve big price increases. On the other hand, oil companies need to curb supply faster than demand is going down anyway (from electric vehicles, efficiency and the other factors discussed in the report). If supply overshoots demand by even a small percentage, that has devastating effects on price.

I hear that the US oil industry lost $67 billion last year.

It is obvious from basic market theory that reducing supply means higher prices. But this new information shows that on the oil market even a small reduction (say around 5% of present oil supply) has dramatic effects.

Reprinted with permission.

 
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