Tag Archives: Colin Campbell

Chart of the Day, 3 Feb 2015: US Shale Oil and the Coming Production Cliff

The impact of shale oil, otherwise known as tight oil or light-tight oil (LTO), in the United States is indisputable. Aggregate production (conventional and non-conventional) is now almost level with its 1970 peak (click for larger image) with shale leading the oil rennaisance.

US Field Production of Crude Oil jpeg

The latest figures (which go up to November 2014) from the Energy Information Administration (EIA) released at the end of January are yet to show a slowdown in growth despite the oil price collapse illustrated below:

Crude Oil Spot Prices copy

Indeed, US production was 9 million barrels per day in November, a rise of 14.5% over the same period the previous year

How long will it take for production to adjust if crude stays around $50 per barrel? As I’ve mentioned before, shale is an industry with high upfront costs but relatively low operating and maintenance costs. The upfront costs are already ‘sunk’, so the ‘pump’ or ‘don’t pump’ break-even point is as low as $10-20 per barrel. Moreover, many producers hedge to varying degrees. To get a taste of this, here is part of a table on listed shale oil producers published at Seeking Alpha.

Oil hedges jpeg

Once these hedges roll off, profit margins will collapse. Meanwhile, the output of shale wells declines by around 60% in the first year; therefore, sustained production requires continuous new investment. And new investment requires a decent return on investment. Reuters has a good article by John Kemp on how this dynamic works.

Bloomberg New Energy Finance estimates that to sustain current levels of shale oil production would require a return on investment of 10%, but to increase production would need a 20% return (see their White Paper here). Using these rates, they then go on to look at what oil price is required for each region to get such returns (click for larger image).

Breakeven Points for US Shale Plays jpeg

Based on these calculations, the US oil industry will fall off a cliff should the oil price remain below $50 for more than a year.

Bottom line: shale oil has not killed peak oil, but cheap oil will kill shale. The only way this won’t happen is if the oil price moves back up again–which I forecast it will.

As Colin Campbell and Jean Laherrere said in a prophetic 1998 article in Scientific American, “The world is not running out of oil–at least not yet. What our society does face, and soon, is the end of abundant and cheap oil on which all industrial nations depend.” As I said yesterday for natural gas, to prove Campbell and Laherrere wrong we need to see low oil prices and rising production–not one without the other. It’s a simple test. Let’s see what happens.

Has Shale Killed Peak Oil?

Climate change has a certain unbearable logic. While temperature may oscillate around a trend, the trend remains. Moreover, to steepen or shallow the trend will take decades, or, indeed, centuries. Broadly, what you predict with climate change is mostly what you get.

Peak oil is a different beast. We are not sure when it will become a pressing problem, if indeed it ever will given the possibility that technology will allow us to transcend to a non-oil world.

Further, peak oil gives us a price―climate change doesn’t. As oil becomes harder (more costly) to extract, price rises. This then loops back to supply stimulation and demand destruction. Theoretically, as oil depletes, there will come a time when supply can’t respond (North Sea oil production, for example), at which point price will destroy demand, so pushing us back toward equilibrium. So what are we to make of this chart (click for larger image; source EIA here):

EIA Brent and WTI Oil Price jpeg

The sheer intensity of the drop suggests that it isn’t a function of demand. Unlike the fall in 2008, we aren’t witnessing a financial crash. The world economy may lack some puff, but it is still growing. So is this supply? And if so, it this the death of peak oil?

To answer this question, we first have to understand what we mean by peak oil. To do this, I prefer to go back and read what some key peak oil theorists have actually said. On this particular occasion, I don’t think it particularly useful to reread the dead M. King Hubbert, the father of peak oil theory, since he died long ago (1989 to be exact). Better to read the more eloquent advocates of what I call Peak Oil 2.0: Colin Campbell and Jean Laherrere.

Campbell and Laherrere wrote a seminal and prescient article for Scientific American in March 1998 titled “The End of Cheap Oil”. You can read it here. First off, focus on what they didn’t say: they didn’t say that oil was going to run out. Rather they said this:

The world is not running out of oil―at least not yet. What out society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.

They were also perfectly aware of unconventional oil.

…. economists like to point out that the world contains enormous caches of unconventional oil that can substitute for crude oil as a soon as the price rises high enough to make them profitable………Theoretically, these unconventional oil reserves could quench the world’s thirst for liquid fuels as conventional oil passes its prime.

But under their analysis, unconventional oil is too costly and too time consuming to ramp up quickly enough to compensate for conventional oil’s decline. As a result:

The world could thus see radical increases in oil prices. That alone might be sufficient to curb demand, flattening production for perhaps 10 years……But by 2010 or so, many Middle Eastern nations will themselves be past the midpoint. World production will then have to fall.

So we can extract three predictions. First, a steep rise in price will occur that is accompanied by a flatlining in production of conventional oil. Second, unconventional oil will be produced but not in sufficient quantities and at the right price to compensate for the collapse in conventional oil production growth. Third, eventually, and regardless of price, world oil production will fall.

In terms of calling the bottom of the market, Campbell and Laherrere were stunningly successful. The average oil price in 1998 for Brent crude was $12.8. Over the last four years, we have been averaging over $100 (click for larger image; source: here).

Crude Oil Price Change jpeg

These are nominal prices that don’t take account of inflation. Still, even if we adjust for inflation, the jump in oil prices has been impressive.  In 2013/14 dollars, the oil price in the late 1990s would have been around $25 to $30; so in real terms, we have seen a three- to four-fold increase. Apart from the two price spikes of the 1970s, the surge has been unprecedented.

Moreover, even if we take the current price of Brent oil after the slump of the last few months  ($72 as of writing), the appreciation is two- to three-fold.

Crude Oil Prices jpegAs for a flatlining in conventional oil, Campbell and Laherrere have been pretty good on that prediction too. Since 2005, we have been moving along a bumpy plateau (the blue section). Chart below is taken from Eaun Mearns blog here.

word total liquids production jpeg

Where Campbell and Laherrere have been wrong is with respect to unconventional oil. This category has been powering ahead, although not, until recently, at a sufficient pace to hold down price. Nonetheless, unconventional volumes have risen sufficiently to keep total aggregate liquids on the rise as well.

Global Liquids jpeg

So to recap, the peak oil camp has done pretty well on price and conventional oil volume, but not so well on unconventional oil production. However, we need to go back to Scientific American’s summary statement, the peak oil bottom line:

The world is not running out of oil―at least not yet. What out society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.

Using this statement as a yardstick, peak oil gets a straight “A”. Unconventional oil has been forthcoming but not at sufficient volumes and lower enough cost to push down the oil price back to the kind of levels seen in the 1990s. Indeed, up until a few months ago, unconventional was hardly moving the needle in terms of price.

But has everything now changed following the oil price plunge as much of the media would suggest? Note, what was so unusual about the recent period of high oil prices was that such prices were sustained over a prolonged period: 2011, average of $111 per barrel for Brent crude,  2012, $111; 2013, $109; 2014, likely to average around $100.

Oil has a notoriously inelastic supply and demand curves (they are steep on the chart), so you don’t need supply or demand to move much to get a major shift in price over the short term.But over the longer term, the supply curve is supposed to be more elastic. At the right price, technology and innovation should pour into the sector and push the supply curve to the right. This didn’t happen. Or rather it didn’t happen for a long time, but just possibly it is happening now.

Oil Supply and Demand jpeg

But we don’t really know if what we are seeing over the last couple of months is a short-term or long-term phenomenon. You can get to where we are now with the short-term curves alone. Push the demand a little bit to the left due to a slowing Chinese economy, and the supply a bit to the right due to oil from a few troubled regions coming back on stream and, hey presto, price plummets. But I repeat: peak oil is a story about long-term supply and demand, and long-term elasticities.

Over the short term, whether you pump oil depends on your marginal cost and the price per barrel. Whether you have invested $10 million, $100 million or $1 billion in a particular oil field makes no difference as  to whether you pump the oil or not—the investment is a sunk cost. The “pump or not to pump decision” has no relation to the investment in existing operating kit; you will produce if the cost of producing one barrel of oil (operation and maintenance) is below the price of a barrel of oil. Accordingly, when you see media reports that some shale oil fields are still profitable at $40 per barrel this has absolutely no relevance whatsoever to the veracity of the peak oil claim. The question to be asked is would you invest in new shale fields at $40, $50 or $60 per barrel?

Peak oil, in effect, says the long-term supply of oil is inelastic, not just the short term. Consequently, for new unconventional oil sources like shale to dispose of the peak oil thesis, they must come to market such that the return on investment including the maintenance and operating costs plus the opportunity cost of what your money could be earning elsewhere is considerably below the oil price level witnessed in recent years. Will shale win this argument? Possibly (although I think not).

The predictions made by Campbell and Laherrere have held up pretty well because the two said that the oil price would rise and then stay high for year after year—it did. For Campbell and Laherrere to be proved wrong, the oil price must fall and then stay low for year after year. Let’s see what happens in 2015.

Global Trends 2030: Futurology Fit for a President? (Part 2 Energy Constraints)

This is my second post on the  National Intelligence Council (NIC) briefing for the  U.S. president called “Global Trends“, a report that looks at potential risks to the United States 20 years ahead. The first post (here) dealt with climate change, but in this post I want to take a look at how the Intelligence Community views the potential threat of a future energy constraint on the U.S. and world economy.

The quick answer: not much of a threat at all.

In a likely tectonic shift, the United States could become energy-independent. The US has regained its position as the world’s largest natural gas producer and expanded the life of its reserves from 30 to 100 years due to hydraulic fracturing technology.
The one-hundred-years-of-gas refrain was also a feature of President Obama’s State of the Union address back in January 2012. I blogged about the authenticity of the claim then. Enough to say that both the President and the NIC appear to be confusing resources with reserves. The industry association Naturalgas.org has a good explanation of the difference here, including the following  component chart (click for larger image):
Total Oil & Gas Resource Base copy

Peak Oilers Now Welcome at the IMF

Taking a short interlude from my recent treatments of technology, I feel the need to do a quick post on Peak Oil’s continued transformation toward respectability. Some months ago, I highlighted the fact that the IMF had openly recognised the Peak Oil argument in even its most prestigious publication, the World Economic Outlook (see my post here). In particular, IMF staffers now appear to be thoroughly acquainted with the work of Steve Sorrell, who has provided us with some of the most in-depth reviews of the Peak Oil literature (see my post here).

Now, when I say ‘recognised’ that did not mean ‘accepted’. Rather, the IMF acknowledged in the World Economic Outlook that price alone had not brought forth sufficient supply or substitutability over a multi-year time frame, as had previously been predicted. Economists at the IMF, therefore, seem to have decided to widen their intellectual net to bring in some fresh ideas. Continue reading

Shale Gas (Part I): Energy Cornucopia's Great Fight Back?

The idea that resource constraints pose a limit to growth (one version of which is Peak Oil thoery) is subject to constant attack, with economists of a neo-classical persuassion frequently leading the charge. As such, those who believe in resource cornucopia, or at least that resources pose no impediment to economic growth, deserve a close reading since the victors of this debate will define how our world evolves over the next 50 years.

As I mentioned in my last past, it adds nothing to the debate when many mainstream economists begin their analysis by misconstruing the arguments of their opponents. Take a careful note of three things that modern Peak Oil theorists are not suggesting: they emphatically are not stating that 1) price doesn’t matter, 2) there are no more reserves to be found and 3) technological advances are irrelevant. If you don’t believe this statement, then I urge you to actually read the landmark article by Campbell and Laherrere in Scientific America (here) that brought the topic of Peak Oil back into the public domain. Or, at the very least, read the excellent summation of Peak Oil thought that ends their article:

The world is not running out of oil—at least not yet. What our society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.

Continue reading

The Chief Investment Officer of JP Morgan Comes Out of the Peak Oil Closet

At the heart of the cornucopian view of energy abundance lies the belief that technology will overcome any natural resource constraint. The poster child for this view of the world is Moore’s Law, whereby computing power follows the allegory of a grain of wheat on a chess board (so promising untold riches for us all).  Interestingly, Michael Cembalest the CIO of JP Morgan—surely the antithesis of The Archdruid—displayed a large dose of scepticism over this technological nirvana in a recent report that commenced by highlighting a few famous predictions of our energy future (in so doing, Cembalest makes the point that Moore’s Law is the technological exception—not the rule):  Continue reading

Of Straw Men and Peak Oil

Now here’s a task for you. Click on the link here to Economist’s View, probably the most widely visited economics blog and aggregator of all things economics-related on the web. Go to the Google Search function at the top and type in  ‘Peak Oil’ restricting the search to ‘This Site’. What do you get? The answer: very little (relatively speaking). Around 98o results, compared with a total of 9,500 for the word ‘Greece’.

Glance a couple of results down and you will see one headline titled “Peak Oil is Stupid”. If you follow the link, you will end up at a post by Tim Haab, blogger at Environmental Economics and an economics professor at Ohio State University. What does he have to say about Peak Oil:

Must be time to update my semi-regular ‘peak oil is stupid’ rant.  So here goes…

I don’t care when oil (OR COAL) peaks, I care when we run out, which we won’t because, as production declines, prices WILL rise. As prices rise, people WILL figure out alternatives. They might not be happy alternatives. They might not be as productive alternatives. They might not support the same lifestyle to which we are accustomed. But there WILL be alternatives, forced by higher prices–and no other mechanism is that powerful.

Well that has put the Peak Oilers in their place then! But just in case, let’s see what two of the most famous Peak Oil advocates, Colin Campbell and Jean H. Laherrere, had to say back in March 1998 when  they wrote a a high profile article (here) for Scientific American (when oil cost $12 a barrel):

The world is not running out of oil – at least not yet. What our society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.


From an economic perspective, when the world runs completely out of oil is thus not directly relevant: what matters is when production begins to taper off. Beyond that point, prices will rise unless demand declines commensurately.

Thus from a theoretical standpoint, there is in reality not much difference between Campbell and Laherrere, on the one hand, and Haab on the other.

And now a plea from me: could everyone please keep their straw men in the barn. If we only seek out the views  within the opposing camp of the extremists, or the outdated, it is relatively easy to knock down their arguments—but it doesn’t further the debate. Few Peak Oilers now say that one day there will be oil and the next it will be gone; most prescribe, like Campbell and Laherrere, to the idea of peak ‘cheap’ oil and the theory that an oil production growth constraint could increasingly impact on wider economic growth and human welfare.

More broadly, I mentioned in my last post that Peak Oil theory would need to overturn the neoclassical economics consensus. Actually, this claim needs refining somewhat, since I wasn’t referring to the theory of neoclassical economics but rather the empirical world view of most neoclassical economists. Mark that these are two very different concepts. Advocates of a biophysical economic view of the world do look at the world differently (look at the graphic below  from Question Everything). However, I would argue that the viewpoints are not contradictory; rather they are more like very different artistic interpretations of the same object: the earth system.

The critical point here is that biophysical approaches to economics warn of the tyranny of the second law of thermodynamics: energy and matter will tend to entropy (disorder). From a neoclassical perspective, this, translates into increased scarcity and an upwardly sloping supply curve that moves continually to the left. This contrasts starkly with the neoclassical cornucopian paradigm that as technology advances the supply curve moves inexorably to the right.

Put bluntly, the peak resource advocates see stuff getting progressively more scarce and thus more expensive; traditional neoclassical economists see stuff getting ever more accessible (through the magic of technology) and thus cheaper.

And so back to oil. A strong proponent of the magic of markets and technology over the years has been Daniel Yergin the cofounder of Cambridge Energy Research Associates and the author of a number of highly influential books on the oil industry, the most recent of which—”The Quest”—was a mainstay of my Christmas reading. If you don’t want to read the book, then I recommend an Op-Ed piece he wrote for the Wall Street Journal here.

The article, again, is built around a straw man, in this particular case the ideas of the earth scientist Marion King Hubbert, the father of Peak Oil:

Hubbert insisted that price didn’t matter. Economics—the forces of supply and demand—were, he maintained, irrelevant to the finite physical cache of oil in the earth. But why would price—with all the messages that it sends to people about allocating resources and developing new technologies—apply in so many other realms but not in oil and gas production? Activity goes up when prices go up; activity goes down when prices go down. Higher prices stimulate innovation and encourage people to figure out ingenious new ways to increase supply.

Hubbert is certainly a towering figure in the Peak Oil movement, and Campbell and Leherrere likely built on his intellectual foundations. But schools of thought (at least good ones) evolve, and it is no different with the advocates of peak oil. Thus, if one is to criticise Campbell, it cannot be because he ignores price (even though M. King Hubbert certainly held the market system in little esteem).

If one reads Daniel Yergin after reading the Campbell and Laherrere article, what jumps out at me is how little new is in “The Quest”, despite 12 years elapsing between the two publications. (Is that why Yergin had to reach back decades earlier for his straw man?) For example, Campbell and Laherrere recognised that technology is having an impact:

A second common rejoinder is that new technologies have steadily increased the fraction of oil that can be recovered from fields in a basin—the so-called recovery factor. In the 1960s oil companies assumed as a rule of thumb that only 30 percent of the oil in a field was typically recoverable; now they bank on an average of 40 or 50 percent. That progress will continue and will extend global reserves for many years to come, the argument runs.

They go on to argue, however, that such technological progress is already factored into oil company forecasts of reserves to a high degree. Moreover, their paper accepts the existence of large reserves of unconventional oil such as the Orinoco oil belt in Venezuela, and tar sands and shale in Canada. They also perceived the potential for natural gas liquids. They hardly come across as Luddite technophobes:
Theoretically, these unconventional oil reserves could quench the world’s thirst for  liquid fuels as conventional oil passes its prime. But the industry will be hard-pressed for the time and money needed to ramp up production of unconventional oil quickly enough.
If advanced methods of producing liquid fuels from natural gas can be made profitable and scaled up quickly, gas could become the next source of transportation fuel.
At this point, let me have a little rant of my own echoing that of of Professor Haab who kicked off this post. Peak Oil thought does not automatically contradict the underlying philosophy of market economics. Most of it can be encompassed in the idea that the oil supply curve is inelastic over the short term and will tend to move to the left over the long term as resources run dry, thus leading to permanently high prices.
Put differently, the argument is not one of whether supply and demand curves exist, but rather what shape they are and how they move through time.
Critically, the massive global oil market, consisting of numerous buyers and sellers and highly visible price, proves a wonderful free market test. So let us see what the oil price has done since Campbell and Laherrere wrote their paper back in March 1998 (chart is Brent oil):
The market speaks—and it is stunning reaffirmation of Campbell and Laharrere. Yergin’s book “The Quest” is a paean to technology: data processing on an unheard of scale, horizontal drilling, CAD/CAM oil field design, deep water drilling, new technology to extract oil from tar sands and shale—the list goes on. In other words, the modern world oil industry is a tribute to science, as well as man’s endeavour unleashed by free markets. Yet over that period the oil price has risen tenfold in nominal terms and over fivefold in real, inflation-adjusted terms. And here is the supply response (taken from the BP Statistical Review). Lacklustre at best.
In short, when the market price of an item rises, it should cause people to substitute away from the good and cause more investment in the production of the good: this is Economics 101. Taken together, the market should produce countervailing forces that ameliorate the rise. Over the last decade, this has not been happening. Mr Market has spoken, and it has been on the side of Peak Oil. It would be nice, therefore, if Economist’s View could give the issue a little more respect—despite the undoubted importance of Greece.