Tag Archives: Peak Oil

Chart of the Day, 11 February 2015: Is Supply What Done It to Oil (Says Goldman)

“Is supply what done it,” says Goldman Sachs (as reported by Bloomberg; click chart for larger image).

The big take-away: “[T]he decline in oil has been driven by an oversupplied global oil market,” wrote Goldman economist Sven Jari Stehn. As a result, “the new equilibrium price of oil will likely be much lower than over the past decade.”

Decomposition of Oil Price Demand jpeg

Looks authoritative? And, on top of the pretty chart, Bloomberg tells us that Goldman is using a “vector autoregression with sign restrictions”.

Yeah, right. Solid statistical (and thus econometric) forecasts need to be founded on known and stable relationships–we have neither (we rarely do in macro). Supposedly, Goldman knows that if demand is X (holding supply stable), price will likely be Y. Or, if supply is W (holding demand stable), price will likely be Z. And then a dynamic multi-factor model can be created to bring everything together.

But for oil, we neither have a good idea of what the underlying relationships look like nor, more importantly, do we understand how they evolve through time. As proof of my scepticism, recall that Goldman was predicting high oil prices just over a year ago (spot the oil forecast; source: Business Insider; click for larger image):

Goldman Sachs Macro Forecasts jpeg

Perhaps I am being too harsh. Goldman’s supply and demand decomposition does give us a cloudy window into past price movements, but it certainly won’t give us a reliable vision of the future. In reality, the prognostications of market strategists are a form of economic story telling. And the best story tellers get paid the most. In certain aspects, humanity has not come that far from 10,000 years ago.

Chart of the Day, 28 Jan 2015: Oil, Cornucopians, Peakists and Jeremy Grantham

The stunning collapse in oil and metal prices since last summer (see yesterday’s post) has brought the cornucopians and abundantites crawling out of the wood work. From an (otherwise very good) article in The Economist of 17th January titled “Let there be light”.

An increase in supply, a surprising resilience in production in troubled places such as Iraq and Libya, and the determination of Saudi Arabia and its Gulf allies not to sacrifice market share in the face of falling demand have led to a spectacular plunge in the oil price, which has fallen by half from its 2014 high. This has dealt a final blow to the notion of “peak oil”. There is no shortage of hydrocarbons in the Earth’s crust, and no sign that mankind is about to reach “peak technology” for extracting them.

Frankly, this is just sloppy thinking from The Economist: the second sentence, which talks of a “final blow” to the notion of peak oil, doesn’t follow on from the first.

In short, the paragraph muddles the short term and the long term. Why is a fall in oil prices barely six months’ old a “final blow” to the notion of peak oil? And while fracking shows we are far from “peak technology”, it says nothing about price. Can tight oil keep coming to market for years to come at current prices? I think not. For a longer treatment of oil supply versus oil demand, see my more detailed post titled “Has Shale Killed Peak Oil“.

One of the most vocal advocates of the ‘peakist’ or ‘depletist’ hypothesis is Jeremy Grantham, who has used The Quarterly Letter of GMO as a platform for his views. The chart below is taken from The Third Quarter 2014 letter (click for larger image):

U.S. Average Hourly Manufacturing Earnings:Oil Price per Barrel jpeg

Grantham points out that in 1940 one hour’s work for an American engaged in manufacturing could buy 20% 0f a barrel of oil. At the twin peaks of oil abundance–1972 and 1999–the same wage could buy over a barrel of oil. But those days, he argues, are long gone. According to Grantham, this has implications for not only oil markets but also for the energy underpinnings of global economic and productivity growth.

Yesterday, I also argued that the rapid slowing to the Chinese economy was the likely culprit behind the havoc in commodity markets rather than a breakthrough in one particular extraction technology. As evidence, I noted how iron ore and copper prices had collapsed along with the oil price, despite the fact that you can’t frack for copper and iron ore.

The critical question now is what will happen to supply in the face of sluggish demand. Tight oil production is dramatically different from traditional oil production due to the accelerated nature of the depreciation schedule. Fracked fields deplete quickly, so to maintain production you must continually invest. If you don’t, aggregate production falls fast–that is, within a year or two. So we won’t witness a decade long excess capacity work-out as you would have seen in previous oil price busts: supply should adjust to demand at breakneck speed this time around.

Consequently, while we are not at “peak technology” for oil extraction, we possibly are at “peak cheap technology”. If so, forget all talk of “final blows” to peak oil.

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.

Data Watch: US and Global Crude Oil Monthly Production April 2014 Releases

On April 30th, the U.S. government agency The Energy Information Administration (EIA) announced provisional U.S. crude oil production figures for February 2014. Key points:

  • February crude oil production was 224.9 million barrels, equivalent to 8.0 million barrels per day (bpd)
  • Change over February 2013 on a barrel-per-day basis: +12.8% y/y
  • February total crude oil plus natural gas liquids reached 300.0 million barrels, equivalent to 10.7 million bpd
  • Growth continues to remain in the double digits year-on-year.

As can be seen from the chart below (click for larger image, link to original data here), the fracking of tight oil formations in the U.S. has made a major impact on U.S. crude production over the last few years.

US Field Crude Oil Production April 2014 jpeg

Given crude oil is a globally traded commodity, U.S. production numbers need to be placed in the context of world supply and demand. The International Energy Agency (IEA), in its latest Oil Market Report (OMR) dated 11 April 2014, recorded global ‘all liquids’ (oil and condensate) production of 91.8 million bpd for March 2014. Year-on-year supply growth is averaging around 1 million bpd, or a little over 1%.

OPEC and Non-OPEC Oil Supply March 2014 jpeg

Mirroring supply, benchmark crude prices continue to bump along a plateau. Increased U.S. production is being offset by a reduction in OPEC output, particularly with respect to Libya and Iraq. As a result, both WTI and Brent have remained above $100 per barrel.

Crude Futures March 2014 jpeg

Full quarterly IEA world supply-and-demand figures, including 2013 provisional supply and demand numbers, together with 2014 forecasts, can be found here. Interestingly, 2013 supply is now given as averaging 91.6 million bpd, up only 0.6 million bpd from 2012. Successive articles in the media have pronounced peak oil dead due to the fracking of shale. This story is everywhere—except in the actual numbers, where almost no increase in supply can be seen.

Data Watch: US and Global Crude Oil Monthly Production February 2014 Releases

On February 27th, the U.S. government agency The Energy Information Administration (EIA) announced provisional U.S. crude oil production figures for December 2013. Key points:

  • December crude oil production was 243.8 million barrels, equivalent to 7.9 million barrels per day (bpd)
  • Change over December 2012 on a barrel-per-day basis: +11.1% y/y
  • December total crude oil plus natural gas liquids reached 324.8 million barrels, equivalent to 10.5 million bpd

The last three months have seen a sharp drop in production growth rates from the high teens to just over 10%. It is too early to tell if this is just a temporary blip or something more permanent.

As can be seen from the chart below (click for larger image, link to original data here), the fracking of tight oil formations in the U.S. has made a major impact on U.S. crude production over the last few years.

U.S. Field Production of Crude Oil Jan 14 jpeg

Given crude oil is a globally traded commodity, U.S. production numbers need to be placed in the context of world supply and demand. The International Energy Agency (IEA), in its latest Oil Market Report (OMR) dated 13 February 2014, recorded global ‘all liquids’ (oil and condensate) production of 92.1 million bpd for January 2014. Year-on-year supply growth is averaging around 1 million bpd, or a little over 1%.

OPEC and Non-OPEC Oil Supply Jan 14 jpeg

In this month’s OMR, the IEA emphasises that exuberant expectations with respect to the impact of U.S. production on world supply and demand have been disappointed. Outages in Libya, disappointing production in Iraq and higher-than-expected OECD demand have more than offset increased U.S. output (click for larger image).

Glut jpeg

As a result, benchmark crude prices continue along an elevated plateau.

Benchmark Crude Prices jpeg

Full quarterly IEA world supply-and-demand figures, including 2013 provisional supply and demand numbers, together with 2014 forecasts, can be found here.

Data Watch: US Natural Gas Monthly Production December 2012

The U.S. government agency The Energy Information Administration (EIA) issues data on U.S. natural gas production, including shale gas, on a monthly basis with a lag of roughly two months. The latest data release was made on February 28 and covers the period up until December 2012.

Data is reported in billion cubic feet (bcf). Key points:

  • December 2012 natural gas dry production: 2,041 bcf, +0.3% year-on-year
  • Average monthly production for the 12 months to December 2012: 2,004 bcf, +5.0% over the same period the previous year

Since the end of 2011, the rate of production increase has levelled off (click chart above for larger image).

US Dry Gas Production Dec 12 jpg

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Links for Week Ending 16th February

  • Professor Jim Hamilton is one of the few economists to give peak oil considerations a proper hearing. Moreover, as one of the world’s leading econometricians and author of the popular text book “Time Series Analysis” he cannot be accused of not knowing his numbers. This last week he has posted twice on oil (here and here) on his blog Econbrowser that he co-authors with Menzie Chin. Frequently, in any discussion of resource depletion, the standard economics response is that ‘price begets supply’. Hamilton points out that such logic only extends so far for an exhaustible resource
  • Dana Nuccitelli has a good post at Skeptical Science entitled “A Glimpse at Our Possible Future Climate, Best to Worst“. It delves into two of the major climate risk parameters: climate sensitivity and emission paths. Other major determinants of climate risk are changes in the carbon cycle, methane release and the extent of climate-related economic impacts themselves. And that is just the ‘known knowns’ and the ‘known unknowns’.
  • Veteran observer of the Chinese economy Michael Pettis has long argued that China’s supercharged growth rate is unsustainable. Here and here are recent restatements of his belief that we face a great re-balancing. This has major implications for both climate change-related CO2 emissions trajectories and resource depletion rates.
  • The Washington Post asks why monetary policy no longer works and economies fail to grow around the world. Personally, I think the answer is no longer solely to be found in the study of monetary and fiscal policy. Jeremy Grantham, the ever-thoughtful Chief Investment Strategist at GMO is squarely in my camp, with his firm predicating strategy on a U.S. long-term growth rate of 1.5%. Against this background his analogy is “of the Fed beating a donkey (the 1% growing economy) for not being a horse (Bernanke’s 3% growing economy)”. Read his last GMO letter on decelerating growth and the impact on investment here.
  • Grantham references an article by Chris Brightman of Research Affiliates which pegs long-term U.S. growth rates at 1% due to trends in population, employment and productivity. If true, and we then add in the impact of resource depletion and climate change over the next two decades (the pivot decades for me), we could easily be looking at a no-growth U.S. economy by 2030-2040.