Three Factors Create Oil's "New Normal"

Three Factors Create Oil’s “New Normal”

by | published October 1st, 2012

As you read this, I am delivering a keynote address to the annual Shell Oil Global Technical Conference in San Antonio, Texas. The audience is comprised of field specialists from around the world.

Shell has asked me to update this esteemed audience on the current state of the market.

One thing I have learned from almost four decades of doing this is that oil and gas specialists know a great deal about what they do personally for a living. However, few specialists really understand enough about what the person to their right or left of them does.

The business breeds tunnel vision. And these days it has become a serious problem. That’s because what is already hitting the market will require more expansive and integrative understandings of what is taking place.

The Markets are Evolving

We are entering a period in the energy markets that I have begun calling the “New Normal.”

You see, a volatile, dynamically changing combination of factors now undermines the traditional way of viewing oil and gas markets.

And it is about to get a whole lot more unnerving for the average analyst still insistent on pushing square pegs into round holes.

Markets require that we be able to project where things will likely move at some point in the near future. After all, the inability to make such predications pretty well describes any investment strategy – be it for an international oil major or an individual retail investor.

Unfortunately, for the old school aficionado, we are rapidly moving into new territory. Here, market machinations are occurring that defy the “traditional” explanations.

You know what I mean by “traditional.” The talking heads on television try to explain the latest spurt or dive in oil prices by relying on the same trite and tired lineage of explanations. In just the last month, we’ve seen movements in energy prices justified solely on the following factors:

  • A supply glut in Cushing, Okla.;
  • Fluctuations in the euro-dollar exchange rate;
  • The European credit crunch;
  • The latest unemployment figures;
  • Inflation;
  • Manufacturing, housing, or production figures.

But it really doesn’t work this way anymore. While such factors are not completely irrelevant, they are also not calling the shots.

There are several factors contributing to this New Normal, but I will be restricting my comments in the speech this morning to three.

Now, I want to share the same three factors with you.

They are:

  1. The balance between conventional and unconventional production;
  2. Increased market volatility; and
  3. Global geopolitical matters.

So let’s get started.

Unconventional Production on the Rise

The rise of shale and tight gas and oil, coal bed methane, heavy oil, bitumen, and synthetic (upgraded) volume from oil sands has fundamentally changed the production landscape.

But it has also fundamentally altered the dynamics upon which pricing is determined.

Initially, most of us assumed that these unconventional sources would serve to restrain price, as more supply came online to meet rising global demand.

The reality, however, appears to be that this new largess is becoming more expensive to produce, transport, and process, while the distribution of the shale, sandstone, or in situ hydrocarbons are rendering basin projections less reliable.

There is more available, but the cost of production and the price commanded on the market are creating short-term aberrations with attendant risks and opportunities.

One thing it has done is temper the Peak Oil approach. It is certainly appropriate that I am going to make that observation before a Shell audience assembled in San Antonio. Over 50 years ago in an address here in this city of the Alamo, Shell scientist M.K. Hubbert kicked off the movement with one of the most famous presentations in the history of petroleum analysis.

Today, it is not availability, but where it is available and at what price that is making all the difference. The balance between conventional and unconventional, therefore, is making an impact but hardly all in the same direction.

Volatility with a Capital “V”

The second factor – volatility – is no stranger to regular readers of OEI.

This is not simply quick rises or falls in price, although these are the clearest impressions left. The Oil VIX is supposed to register volatility, and a “traditionally normal” market would expect that the OIL VIX would rise (as risk rises) in parallel with a fall in oil prices.

That often no longer happens.

The volatility now experienced is occurring within the average range of VIX figures. Stated simply, our new volatility is providing cycles occurring more rapidly than the session averages provided by the VIX. The traditional way of expressing what volatility means in the oil and gas markets no longer helps us in compensating for changes in investment patterns.

Such volatility also translates into how futures contracts on oil and gas determine current market prices. It used to be that, as we moved closer to the expiration of a futures contract – as the convergence between the paper barrel (the futures contract) and the wet barrel (the actual consignment of crude or natural gas) approaches, the two would merge into the same underlying price.

Often, that would make it necessary to buy on one side or the other to produce the desired equivalence. But such arbitrage was easily done, and the market was better off because of it.

Not anymore.

As I indicated in my last book (The Vega Factor: Oil Volatility and the Next Global Crisis), this is not usually a result of speculators or manipulations by companies, distributors, or mega investment funds.

Rather, the inability to connect the future contract with the actual price of the oil or gas results from problems within the trading system itself. This volatility has produced the rise of a whole new generation of derivatives, itself a clear sign that the market is not coping with rapid change.

Global Tensions Heat Up Oil Prices

Third is the geopolitical factor.

Now international events have always had an impact on oil prices. The current climate, on the other hand, has given the factor new urgency.

It is the reason I have been spending much time lately dealing with the Iranian crisis and the prospects of Iraqi production. Flash points in the region upon which the global market still depends for the brunt of its conventional oil are weighing heavily on our ability to estimate supply and price.

Most observers still regard these considerations as exceptions to some general textbook rule of market practice.

Sorry, this is not the case.

As I indicated last week when writing from my briefings in London, the closer one gets to the crisis centers, the more analysts recognize the longer-term implications of the geopolitical.

None of these new factors is going anywhere anytime soon. They are central parts of the New Normal.

Investors should become used to dealing with them.

Please Note: Kent cannot respond to your comments and questions directly. But he can address them in future alerts... so keep an eye on your inbox. If you have a question about your subscription, please email us directly at

  1. Dick Korn
    October 1st, 2012 at 11:59 | #1

    I think Kent needs to include in his equations the improvements in gasoline mpg that have lead to the decrease in usage in the US. This is a big item that is given very little shift.

  2. Lum Loy
    October 1st, 2012 at 13:49 | #2

    I can’t see why folks are focused on the unsustainable, which is finite & destructive. They could be focused on the sustainable which is virtually infinite & user friendly. It’s a failure to prioritize.

    October 1st, 2012 at 14:01 | #3


  4. eric taylor
    October 1st, 2012 at 15:41 | #4

    Yes, we are on target to knock out all of the Arabic oil contributions just from conservation alone; Under President Jimmy Carter, the last time we had a major fuel conservation reform indicates that the benefits will be spread over the nest 20 years, with little benefit concurrently to be met out, which is probably the reason President Obama received some bipartisan support! Let’s keep doing great things like the new MPG policy bill that should have every honest citizens support, with green laws moving our public electric utilities away from coal burn to natural gas.

  5. Richard Leeds
    October 1st, 2012 at 18:31 | #5

    Kent would probably tell you that the improvement in gasoline mpg is not significant since the U.S. produces only 10 million new cars a year in a total fleet of hundreds of millions of vehicles.

    Furthermore, the 1 million trucks, 4 wheel drives, heavy trucks sold each year are not seeing much change in fuel economy.

    Furthermore, fuel is being shipped out of the country and in the rest of the world the growth in vehicles is significant. The prediction over the next 20 years is for 500 million new cars and trucks will be added to the world fleet of vehicles. That is 500 million vehicles that never were previously fueling up. Think about 12 million new cars in China, 10 million in India and 1 million new trucks and buses each year that are added to the world fleets, not to mention the growth in the rest of the world: Africa, Asia, South America where economies are growing much more than they are in North America and Europe where there is stagnation.

    North America where you are concentrating on mpg and a drop in gasoline purchases represents 350 million people out of 7 billion people in the world, where economic growth rates now exceed the U.S., even if just from a lower base level.

    Energy demand is going to go up. Remember, 10% of all energy is consumed by planes. Take a look at the projections by Airbus and Boeing on the growth of the airline industry in terms of number of planes flying over the next two decades. China is 5 times the population of the U.S. with about the same size airplane fleet. How long do you think it is before the Chinese fleet increases by 100% to serve its growing population and economic wealth.

  6. enthusceptic
    October 2nd, 2012 at 08:11 | #6

    What then about North American – NA – nat. gas and exporting it from 2014 on? Vehicles in many countries are powered by ng because gasoline is too expensive.
    The search for shale gas rsources in Poland and other parts of Europe has disappointed. Can this mean that gas from NA can become viable sooner?

  7. enthusceptic
    October 2nd, 2012 at 08:28 | #7

    Mr Leeds, of course, is completely right. Fuel efficiency will continue to improve in all vehicles including airplanes. Especially this is important for airplanes since fuel is such a large part of their running costs. However, growth, also in air traffic, will by far surpass savings through improved fuel efficiency.

  8. enthusceptic
    October 2nd, 2012 at 09:08 | #8

    Let me just add to the above that newer airplanes are much more fuel efficient than older ones.

  9. enthusceptic
    October 3rd, 2012 at 09:29 | #9

    Yes, of course ng can replace coal, but for what? Certainly not electricity for water heaters and electrical heaters for houses, offices etc. A centralized system that pipes hot water to several buildings, both for heaters and hot water, is much better.

  10. Jan
    October 3rd, 2012 at 19:56 | #10

    Kent understands reality. Green energy isn’t viable and we should stop throwing money at it until there is a way to bring it online efficiently, and reasonably priced. The private sector, given the opportunity without regulations, will find a way. There is no reason not to continue to find as much oil as possible that’s what the system is set up for. The price of oil will always go up and down based on many factors such as Kent points out. Only the green lovers believe that this country can be run on alternative energy. Get real! Don’t try to stuff something up our rear-ends that exists only in you mind.

  11. Sumflow
    October 18th, 2012 at 08:51 | #11

    @Dick Korn It means nothing compared to the increased usage fron China.

  12. Sumflow
    December 7th, 2012 at 00:14 | #12


    A. We have to understand the big picture to be confident holding on to our investments long-term.

  13. Sumflow
    December 7th, 2012 at 00:15 | #13

    eric taylor :
    .. like the new MPG policy bill

    Dangerous SUV’s are a big part of the problem.

  14. Sumflow
    December 7th, 2012 at 00:20 | #14

    enthusceptic :
    .. of course ng can replace coal, but for what? Certainly not electricity for water heaters and electrical heaters for houses, offices etc.

    Electricity used for water heaters and electrical heaters can use natgas with out any problem. 25% of electricity now comes from natgas.

  15. Sumflow
    December 7th, 2012 at 00:22 | #15

    Jan :
    Green energy isn’t viable.

    Think for yourself!!

  1. No trackbacks yet.