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OPEC Wants Certainty

First OPEC wanted to be compensated if climate change legislation costs them revenue, and now this:

OPEC: give us certainty to invest

You only get a small preview of the following story, but I found the bit that is accessible to be pretty humorous:

OPEC’S producers need greater certainty over long-term oil demand if they are to justify upstream investments to bring new production capacity on stream, says the group’s secretary-general. In an interview with Petroleum Economist, Abdalla El-Badri reiterated Opec’s message that greater clarity about demand is necessary if the world expects Opec’s exporters to continue investing in new output capacity.

Uncertainty over demand yields a startling gap in the group’s 10-year outlook. Opec says demand for its crude in 2020 could reach 37m barrels a day (b/d) – up from 28.8m b/d now – or remain almost flat, reaching just 29m b/d.

It’s a dilemma, because the additional investment needed to meet the higher figure amounts to $250bn, says El-Badri. “We could use that money somewhere else; in our infrastructure or for the welfare of our people.

Sorry, but that’s just not the way the world works. All businesses would like some certainty about demand. If GM had some certainty about demand, they would never have had to declare bankruptcy. They could have just built the cars that would be demanded. But the best you can do is try to estimate where demand will end up, and make your decisions accordingly.

However, I will give some free advice. I don’t believe the world will be able to build out enough crude oil capacity to keep up with demand. (Even if demand remains flat, new capacity has to come online to compensate for depleting fields). I don’t believe biofuels can scale up enough to displace more than a small fraction of our oil consumption. I believe demand from China and India will continue to grow. I believe that oil production will soon peak (if it hasn’t already). And I believe that a lot of projects have already been delayed or canceled, increasing the likelihood of a return of supply/demand imbalances within a few years. If my musings are correct, upward pressure will continue to be the trend in oil prices, and countries that have export capacity will make a lot of money.

So nobody is going to give you certainty on demand (in fact, most people are likely to be appalled at the idea), but if it were me I would make the investments in capacity. Even though many countries will continue to attempt to migrate away from oil, demand for oil will remain strong for many years to come.

February 12, 2010 Posted by | crude oil, oil prices, oil production, OPEC | Comments Off on OPEC Wants Certainty

Top 10 Sources for U.S. Oil for 2009

It has been two years since I posted the Top 10 oil exporters to the U.S., so I thought I would update that list. In 2007, the U.S. imported just over 10 million barrels per day (bpd) of oil, with our top three suppliers being Canada (1.90 million bpd), Saudi Arabia (1.44 million bpd), and Mexico (1.41). Total oil imported into the U.S. in 2007 averaged 10.0 million bpd. OPEC countries supplied just over half of that – 5.3 million bpd. (All data sourced from the EIA).

Data for 2009 are available through October, so I tabulated the twelve-month period from November 2008 through October 2009. Total petroleum imports were down 7% from 2007 at 9.3 million bpd. Top U.S. suppliers for this time period were Canada (1.94 million bpd), Mexico (1.13 million bpd), and Saudi Arabia (1.09 million bpd).

Top 10 Sources for U.S. Crude Oil in 2009

1. Canada – 1.94 million bpd
2. Mexico – 1.13
3. Saudi Arabia – 1.09
4. Venezuela – 1.01
5. Nigeria – 0.74
6. Angola – 0.48
7. Iraq – 0.47
8. Brazil – 0.30
9. Algeria – 0.28
10. Colombia – 0.25

Observations

Canada remained the top supplier to the U.S., and their total exports to the U.S. actually increased slightly over 2007. Imports from Brazil and Columbia also increased.

OPEC supply was down to 4.6 million bpd, which is lower both in absolute terms and as a percentage of total imports (53.7% in 2007 versus 49.1% in 2009).

Dropping out of the Top 10 from 2007 were Ecuador and Kuwait. Taking their places were Brazil and Columbia.

Even though Mexico regained the 2nd spot from Saudi Arabia, total imports form Mexico fell by 20% over 2007.

The most unusual observation for me was that we actually imported a small amount of oil from China.

The overall theme seems to be that in general suppliers that are closer to the U.S. are gaining market share at the expense of those who have to ship their oil halfway around the world. However, there are a couple of important exceptions to that observation.

Equatorial Guinea did not make the list (15th place), but saw their exports to the U.S. increase by 67% over 2007. This trend could see them move into the Top 10 within a couple of years. Imports from Russia were up 98% over 2007, and they just missed the Top 10 (11th).

My expectation when I update this list again in 2012 is that either overall imports will be up, oil will be over $150/bbl, or both.

January 26, 2010 Posted by | EIA, investing, oil exports, oil production | Comments Off on Top 10 Sources for U.S. Oil for 2009

We’re Number One!

The U.S., that is, in total fossil fuel resources. At least those were the findings of the Congressional Research Service in a report they just released:

U.S. Fossil Fuel Resources: Terminology, Reporting, and Summary

The primary reason is our huge coal reserves. While we are 12th in oil reserves (Table 5 of the report), our coal reserves are by far the largest in the world. All together, the fossil fuel reserves (oil, natural gas, and coal) of the U.S. are reported at just under one trillion barrels of oil equivalent (BOE). The global total is reported at 5.6 trillion BOE.

While I think you have to take data from some of the listed countries with a grain of salt – especially when talking about categories like “undiscovered technically recoverable” oil and natural gas – it does point to the importance that coal will play when oil reserves start to seriously deplete. I have said this before, but when gasoline is $5/gallon, most objections to coal as a fuel will disappear. At that point I think you will start to see coal-to-liquids (CTL) plants moving forward.

Also from the report, at first glance this chart may seem ridiculous:

But I am also reminded of my amazement at a U.S. oil statistic I once came across. In 1982, U.S. reserves were 27.9 billion barrels. In 2005, U.S. reserves were 21.8 billion barrels. But over the course of that 24-year period we produced 57 billion barrels of oil and pulled our reserves down by only 6 billion barrels. So the graph above seems far-fetched, but so does the evolution of our reserves over past quarter century.

Of course it goes without saying that government policies will heavily influence which resources are developed, and over what time period. My guess is that over the next few years we will favor policies that are intended to wean us off of fossil fuels. While I applaud good intentions – and in fact my new job is all about moving developing fossil fuel replacements – I expect we are going to see more than a few unintended consequences. The one I am most concerned about is heavily disincentivizing domestic production, but not having an adequate answer for the domestic production shortfall. In this case, while more alternative energy may be the target, more oil imports may be the unintended consequence.

November 4, 2009 Posted by | coal, CTL, domestic production, oil production, oil reserves | 48 Comments

Book Review: Crude World

Crude World: The Violent Twilight of Oil by Peter Maass

Introduction

It succors and drowns human life. And for the last eight years, oil — and the people and places that make it — was my obsession. – Peter Maass

Today a new book by Peter Maass was released. The book is called Crude World: The Violent Twilight of Oil. Peter Maass is a name you may know from a 2005 article that he wrote for the New York Times called The Breaking Point. The story was a comprehensive look at where he thought oil production/prices were headed – and what the implications might be. Maass focused on Saudi Arabia in the article, and spent a lot of time covering Matt Simmons’ viewpoints. It was after reading this story that New York Times columnist John Tierney offered to bet Simmons on the future direction of oil prices. Thus arose the Simmons-Tierney bet.

I thought Maass’ 2005 article was well-researched, and it was a captivating read. So when Mr. Maass e-mailed and asked if I would like a copy of his new book, I thought it would probably be a book I would enjoy. I still have a stack of books that have been sent to me to review, but I jumped this one to the front of the queue. I hadn’t really intended to, as I am working on two other books right now*, and would normally finish those before starting another. But once I picked this book up and started thumbing through it, I couldn’t put it down.

The subtitle of the book is The Violent Twilight of Oil. The book talks about the twilight of oil, but as the chapter titles imply the focus is less on the twilight and more on the seedy side of the business. The book notes that there are some countries like Norway, Canada, United Arab Emirates, Kuwait and Brunei to which oil appears to have generally benefited the population as a whole. But then there are also many cases in which the discovery of oil seems to have brought many problems to the population. (The book suggests that countries with established democracies and strong self identities are less likely to suffer following the discovery of oil).

The Chapters

The chapters read like the Seven Deadly Sins: “Plunder”, “Rot”, “Fear”, “Greed”, and “Desire” are a few of the ‘sins’ covered in various chapters. Within each chapter, Maass then takes a look at an example that embodies that particular “sin.” That sort of style reminded me of a really good book I read a few years ago written by Matt Ridley. It was called Genome: The Autobiography of a Species in 23 Chapters. Each chapter of that book tells the tale of one gene from each chromosome. In Crude World, Peter Maass tells the story of oil one dysfunctional example at a time.

The book picked up where the New York Times story left off. In fact, Chapter 1 – Scarcity – was mostly about Saudi Arabia and incorporates much of that 2005 story. And if you liked his New York Times story, you will probably enjoy the book as the same style is evident. But I use the word “enjoy” loosely, as it is a sober read. You will find yourself shaking your head at some of the things that have been carried out as a result of the world’s desire for oil.

In Chapter 2 – Plunder – the book covers the case of Equatorial Guinea. The oil wealth was plundered, with the help of international oil companies, banks that looked the other way as government officials brought suitcases of money in for deposit, and governments eager for access to the resource. While he was investigating the oil story in Equatorial Guinea, Maass was accused of being a spy and kicked out of the country.

Chapter 3 – Rot – was all about Nigeria. I won’t tell you how that one turns out, but I am amazed at the (dangerous) lengths Maass went to for the story. Rot describes his journey deep into the Niger Delta in a leaky canoe, courtesy of one of the local warlords. It is well known in the oil industry that Nigeria is a dangerous place to operate. Oil companies generally pay very big premiums to get workers to agree to an assignment in Nigeria. Oil workers are kidnapped in Nigeria regularly (but rarely harmed) and held for ransom from the oil companies operating there. Warlords are constantly doing battle there, and Maass described his visit to one village that had been attacked. Shell also featured prominently in this chapter.

Chapter 4 – Contamination – tells the story of Ecuador, with special focus on the Chevron lawsuit. Maass notes the irony that California – one of the most environmentally conscious states – receives the largest portion of Ecuador’s exports.

The rest of the book’s ten chapters covers a litany of oil-induced miseries. Iraq, Russia, and Venezuela are all profiled. Former ExxonMobil CEO Lee Raymond is presented as the face of “Greed” (albeit it in the “Fear” chapter). There is an interesting explanation in “Greed” on why companies function as they do. Maass discusses a court case between Henry Ford and the Dodge brothers, in which the court ruled that a company’s mission “is organized and carried on primarily for the profit of its shareholders.” Thus, Maass argues that if Mr. Raymond had decided to run ExxonMobil in a more altruistic manner, the board would have removed him for not operating in the best interests of the shareholders.

The complaint that some will have about the book is that it isn’t balanced. There are a number of villains portrayed, but the oil companies really stand out. It seems that those who are telling the tales of misdeeds are generally trusted in the book, but those who are interviewed for balance are treated with suspicion. For instance, in the chapter on Nigeria, the author interviewed the director of Shell’s operations in Nigeria. The interview appears to proceed like a cross-examination. A Nigerian warlord’s words, on the other hand, seem to be taken mostly at face value.

But this is not intended to be a balanced book. It is a book designed to highlight the downside of our oil dependence. We can all think about ways in which oil has made our life better, but in the Western world we are generally spared from the nasty side of the business. In this book, Maass brings that message home loud and clear.

Conclusion

Crude World was released today, September 22, 2009. The general theme of the book is that the world’s dependence on oil has come at a very high price. This is not a book on peak oil, climate change, or renewable energy. It is not a technical book on the oil industry (for that see Morgan Downey’s Oil 101). The book covers the misery – the wars, the corruption, and the ruined lives – brought about primarily by greed from the lure of black gold. The book highlights the irony that oil could be used to improve the lives of a country’s citizens, but in far too many cases a country’s citizens end up being worse off after oil is discovered. The book was a fascinating read, and I couldn’t put it down once I started it. Now I can get back to my regularly scheduled reading.

Footnote

* The other books I am working on right now are Axis by Robert Charles Wilson and Outsourcing Energy Management by Steven Fawkes. The former is a science fiction book that I picked up because I really enjoyed Wilson’s previous book Spin. The latter has been a difficult read; I have been working on the book for six months. I met the author earlier in the year when he visited the Titan Wood plant in the Netherlands. We had quite a lot in common, and he sent me a copy of his book. But it is really a textbook, and so I have been reading it in small doses.

September 22, 2009 Posted by | book review, Matt Simmons, oil companies, oil consumption, oil exploration, oil production, peter maass | 55 Comments

Our Ironic Energy Policy

Energy policies in the U.S. often seek to punish our domestic oil and gas producers, while at the same time we work hard with foreign producers to ensure that the oil continues to flow. I noted in a recent essay:

It is ironic that Steven Chu doesn’t seem to feel the need to work with our domestic oil industry, but warns OPEC not to cut production, and then is pleased when they don’t. I believe the blind spot in the present administration over the need to support our domestic producers will simply mean that future energy secretaries are even more beholden to OPEC.

Now, over the weekend we have two bits of news that continue to show the irony of our energy policies:

Clinton on oil mission to Angola

LUANDA (AFP) – US Secretary of State Hillary Clinton shifted the focus of her Africa trip to business on Sunday, arriving in Angola to boost relations with the continent’s key oil producer.

The top US diplomat is on a one-day visit to the southern African nation, which vies with Nigeria as Africa’s biggest oil producer but where two-thirds of the population lives on less than two dollars a day.

Angola is now China’s largest supplier of crude oil, but it is also a key provider to the United States. Angola sold 19 billion dollars in exports to the US market last year, 90 percent of it oil.

I certainly understand the need to work with other countries to keep the supply chain open, but those policies don’t seem to extend to our own country. How about sending Clinton or Chu on a mission to ExxonMobil to figure out how to better work with domestic producers?

Then, we have the following two stories:

Other countries ink deals for oil drilling off the Florida Keys

While the debate about drilling off the coast of Florida continues in Washington and the state Legislature, several international companies are getting started on projects that could bring oil rigs within 60 miles of the Keys by year’s end.

Companies from nations like Norway, Spain, India, China, Russia and Brazil have signed exploration agreements with Cuba and the Bahamas that could mean drilling south of Key West this year, and 120 miles east of the Keys in the Cay Sal area of the Bahamas in fewer than two years.

“Wouldn’t it be ironic if the Russians could drill closer to our shores than American oil and gas companies? The losers would be the American consumers who are cut off from the trillions of dollars in government revenue and thousands of new jobs that could be created if more of America’s oil and natural gas resources could be developed,” Katie Matusic, media relations manager for the oil industry lobbying group American Petroleum Institute, wrote in an e-mail.

Russian oil rigs just 45 miles from Florida?

New York – Remember the Cuba Missile Crisis and the threat of Russian nukes 90 miles from Key West? Now, there is the possibility of Russian oil rigs even closer, drilling in Cuban waters off the Gulf of Mexico.

Last week, the Cuban government announced it had signed contracts with Russia, allowing Russia to hunt for oil and natural gas in the Gulf of Mexico, perhaps as close as 45 miles from US shores.

The US oil and gas industry is hoping the Cuban drilling causes the US to rethink its own policy in drilling in the eastern gulf of Mexico, an area the USGS estimates has 3.06 billion barrels of oil and over 11 trillion cubic feet of natural gas.

Last July former president Bush lifted the executive moratorium on drilling on the Outer Continental Shelf. The Congress, which usually renewed the moratorium each year, let it expire.

But, in February, Interior Secretary Ken Salazar, announced he was extending until Sept. 21 the period for public comment on a proposed five-year plan for drilling offshore.

Proponents of drilling maintain it would provide the Obama administration with a dramatic influx of $2.2 trillion in new revenue from royalties and taxes on profits. They estimate it would add 1 million new jobs as companies build new oil rigs and roughnecks get hired in Florida for the new rigs.

If you think we need to reduce our dependence on fossil fuels – and I do – then that’s one thing. Adopt policies that encourage this. But don’t adopt schizophrenic policies that result in us treating foreign producers better than we do our own domestic industry. The result could be that we will end up buying oil produced in the Gulf of Mexico from Russia, creating jobs for them and advancing their economy – at the expense of our own. And that is simply asinine.

August 9, 2009 Posted by | energy policy, Florida, Gulf of Mexico, oil companies, oil production, politics | 11 Comments

Anything But Oil

The 2009 EIA Energy Conference is history, and I will write a summary as soon as can. One of the things I commented on today is that I am concerned about the path we are headed down on our domestic oil and gas industry – and if things don’t go according to plan it will mean more dependence on OPEC. A great line by Paul Sankey today (he had many) was that the policy imperative seems to be “Anything but oil.”

I really do understand the desire to move away from oil. A portion of my career has been devoted to developing replacements for petroleum. But as I said today, I am also a realist. Let’s suppose for a second that the following happens. Policies are put into place that hasten the downfall of our domestic oil and gas industry. Marginal wells become uneconomic and are shut in. According to Morgan Downey in Oil 101 there are 500,000 producing oil wells in the U.S., 80% of which produce 10 bpd or less. Yet those 10 bpd wells account for 20% of U.S. production. What happens if we put these marginal producers out of business?

Some of you will say “That would be great. That’s what we need to combat climate change.” OK, I respect that opinion. However, there is now a shortfall in production to deal with. We either reduce demand or we have to find something renewable to fill the void. Right now, I don’t see anything that can fill even a 10% shortfall in U.S. production in the next few years. So that means either higher prices or some incentives (paid for by higher taxes) will be needed to reduce demand (and I don’t think that’s a bad thing) or we will become even more dependent upon OPEC – the outcome that I think is most likely in this scenario.

Robert Bryce* – author of Gusher of Lies which was the other book I mentioned today – just wrote a provocative essay that touches upon this theme of declaring war on our domestic oil and gas industry. He notes that while it is seemingly a great idea to have Treasury Secretaries from Wall Street, being from the energy industry almost immediately disqualifies a person from being energy secretary:

Let Exxon Run the Energy Dept.

This is stunning. At the same time that the Treasury Department has begun looking like a wholly owned subsidiary of Goldman Sachs and the other Wall Street mega-firms that are too big to fail, the top leadership at the Department of Energy remains a bastion of anything-but-Big Oil. “It’s the mythology of the Beltway,” one Houston energy analyst told me recently. “You are hopelessly compromised if you are anywhere close to the oil industry.”

Bryce runs through the history of our Energy Secretaries:

A Nobel Prize-winning physicist, Chu has experience in energy-related issues, including his job as director of the Lawrence Berkeley National Laboratory, but he’s never been in the energy business.

Jimmy Carter named James Schlesinger—an apparatchik with no history in the energy sector—as the nation’s first Energy secretary.

Ronald Reagan claimed he was going to dismantle the Department of Energy. His pick for Energy secretary was James B. Edwards, a man who understood drilling—he was a dentist.

Bill Clinton’s choices for the top Energy spot were: Hazel O’Leary, a lawyer; Federico Pena, another lawyer; and finally Bill Richardson, a politico and diplomat.

George W. Bush’s choices to head the Department of Energy included Spencer Abraham, a lawyer who’d just lost his seat in the U.S. Senate, and Samuel Bodman, an engineer whose professional career was in investments and chemical production.

I understand that there are many who still think if we can only run Exxon out of town, we will live happily ever after in a low-carbon, renewable world. I would just warn against the law of unintended consequences, as it is quite possible that Chu’s pleas to OPEC to keep production flowing will take on a more urgent tone if we pursue the extinction of our domestic oil and gas industry.

* Incidentally, if you guessed based on his views on energy, you would probably incorrectly guess Bryce’s political leanings. And if you want to be disabused of the notion that he is involved in the oil industry, read the book he wrote called Cronies: Oil, The Bushes, And The Rise Of Texas, America’s Superstate.

April 9, 2009 Posted by | EIA, Morgan Downey, oil production, Paul Sankey, Robert Bryce | 99 Comments

Anything But Oil

The 2009 EIA Energy Conference is history, and I will write a summary as soon as can. One of the things I commented on today is that I am concerned about the path we are headed down on our domestic oil and gas industry – and if things don’t go according to plan it will mean more dependence on OPEC. A great line by Paul Sankey today (he had many) was that the policy imperative seems to be “Anything but oil.”

I really do understand the desire to move away from oil. A portion of my career has been devoted to developing replacements for petroleum. But as I said today, I am also a realist. Let’s suppose for a second that the following happens. Policies are put into place that hasten the downfall of our domestic oil and gas industry. Marginal wells become uneconomic and are shut in. According to Morgan Downey in Oil 101 there are 500,000 producing oil wells in the U.S., 80% of which produce 10 bpd or less. Yet those 10 bpd wells account for 20% of U.S. production. What happens if we put these marginal producers out of business?

Some of you will say “That would be great. That’s what we need to combat climate change.” OK, I respect that opinion. However, there is now a shortfall in production to deal with. We either reduce demand or we have to find something renewable to fill the void. Right now, I don’t see anything that can fill even a 10% shortfall in U.S. production in the next few years. So that means either higher prices or some incentives (paid for by higher taxes) will be needed to reduce demand (and I don’t think that’s a bad thing) or we will become even more dependent upon OPEC – the outcome that I think is most likely in this scenario.

Robert Bryce* – author of Gusher of Lies which was the other book I mentioned today – just wrote a provocative essay that touches upon this theme of declaring war on our domestic oil and gas industry. He notes that while it is seemingly a great idea to have Treasury Secretaries from Wall Street, being from the energy industry almost immediately disqualifies a person from being energy secretary:

Let Exxon Run the Energy Dept.

This is stunning. At the same time that the Treasury Department has begun looking like a wholly owned subsidiary of Goldman Sachs and the other Wall Street mega-firms that are too big to fail, the top leadership at the Department of Energy remains a bastion of anything-but-Big Oil. “It’s the mythology of the Beltway,” one Houston energy analyst told me recently. “You are hopelessly compromised if you are anywhere close to the oil industry.”

Bryce runs through the history of our Energy Secretaries:

A Nobel Prize-winning physicist, Chu has experience in energy-related issues, including his job as director of the Lawrence Berkeley National Laboratory, but he’s never been in the energy business.

Jimmy Carter named James Schlesinger—an apparatchik with no history in the energy sector—as the nation’s first Energy secretary.

Ronald Reagan claimed he was going to dismantle the Department of Energy. His pick for Energy secretary was James B. Edwards, a man who understood drilling—he was a dentist.

Bill Clinton’s choices for the top Energy spot were: Hazel O’Leary, a lawyer; Federico Pena, another lawyer; and finally Bill Richardson, a politico and diplomat.

George W. Bush’s choices to head the Department of Energy included Spencer Abraham, a lawyer who’d just lost his seat in the U.S. Senate, and Samuel Bodman, an engineer whose professional career was in investments and chemical production.

I understand that there are many who still think if we can only run Exxon out of town, we will live happily ever after in a low-carbon, renewable world. I would just warn against the law of unintended consequences, as it is quite possible that Chu’s pleas to OPEC to keep production flowing will take on a more urgent tone if we pursue the extinction of our domestic oil and gas industry.

* Incidentally, if you guessed based on his views on energy, you would probably incorrectly guess Bryce’s political leanings. And if you want to be disabused of the notion that he is involved in the oil industry, read the book he wrote called Cronies: Oil, The Bushes, And The Rise Of Texas, America’s Superstate.

April 9, 2009 Posted by | EIA, Morgan Downey, oil production, Paul Sankey, Robert Bryce | 157 Comments

Another Helicopter Down in Scotland

It has been a very bad year so far for helicopters ferrying passengers to and from offshore oil platforms. Today comes word of another tragedy involving BP workers:

Sixteen people feared dead in North Sea helicopter crash

Sixteen people were feared to have been killed today when a helicopter crashed into the sea off north-east Scotland.

Police said eight bodies had been recovered from the North Sea while the remaining eight people who had been onboard were unaccounted for.

The aircraft was returning from an oil platform just before 2pm when it went down 35 miles off the Aberdeenshire coast, according to the coastguard. Police said the aircraft was believed to have been flying back to Aberdeen from BP’s Miller platform in the North Sea.

The picture in the video below (which discusses the crash) shows the helicopter platform in Aberdeen which was just next to my office and ferried workers back and forth to the platforms. (My house was 3 miles beyond those hills in the background).

The victims would have been at the end of an extended offshore rotation, looking forward to getting back home to friends and family. Last month off the coast of Canada another crash killed 17 workers. The month before, another one that went down in the North Sea had a happier ending with everyone surviving.

I previously documented the training all offshore workers in the North Sea have to go through in Surviving Survival Training.

April 1, 2009 Posted by | BP, helicopters, North Sea, oil production, survival training | 5 Comments

The Next Five Years

Peak Lite and the Current Oil Picture

A few years ago, after spending a lot of time thinking about peak oil, and then watching the price of oil break out of its historical trading range and head higher, the idea of Peak Lite came to me. Over time the price of oil had bounced between $10 and $30 a barrel, but about 5 years ago it broke from that pattern and started the steady climb that culminated in $147/bbl last summer. I had been having various debates about whether we were or weren’t at the global peak in oil production (I was taking the ‘not yet but soon’ position), but it started to become clear to me that we didn’t require a global peak before we started to feel the impact of peak oil.

I proposed the following to explain what I thought was happening. (Don’t get too fixated on the dates or prices as they are just there to illustrate the concept). Figure 1 shows the sort of price behavior if spare oil production capacity is constant. Of course spare production fluctuates up and down, as does price, but my thesis is that constant excess capacity should keep the price relatively stable – as long as the excess is large enough that several different producers have the ability to step up and fill shortfalls. This concept is illustrated by Figure 1, with a constant four million barrels per day (bpd) of excess capacity and an oil price of $25/bbl.

Figure 1. Simulated Oil Price Behavior at Constant Spare Capacity


Figure 2. Simulated Oil Price Behavior at Eroding Spare Capacity

Figure 2 illustrates the case in which demand growth is outstripping supply growth, leading to diminishing spare capacity. This is the mode that we have been in for the past few years. Spare capacity was eroded by several million barrels during the first half of this decade, and as a result the price of oil climbed higher, and became increasingly volatile. This was caused by a combination of stronger demand worldwide, and an oil industry that had not anticipated such strong demand growth. As a result, the global oil industry didn’t invest aggressively enough to meet demand, and while capacity did grow, it didn’t grow quickly enough to keep prices stable.


Figure 3. The Next Five Years?

Figure 3 illustrates a future in which world demand has collided with world supply, and then demand growth continues to stay ahead of supply growth. In the world of peak oil, this happens because supply is falling. In the peak lite world, it can occur even if supply is increasing. In the figure, I show an example of supply and demand colliding in 2010, then demand exceeding supply in future years. Of course demand as defined in Economics 101 won’t actually exceed supply, demand will just be destroyed by rising prices (as shown on the right axis) to keep it in equilibrium with supply. Figures 2 and 3 illustrate what Peak Lite is all about; that you don’t have to have falling supplies to start experiencing the effects of peak oil.

I created the original figures in mid-2007, and as we know by mid-2008 oil prices had risen much higher than the $95/bbl I illustrated on the figure. But circumstances have changed. As a result of climbing oil prices, new projects have begun to come online. Strong price signals from the previous five years had resulted in major investments into new oil production (but it takes a few years to bring new projects online); about 5 million bpd of new capacity was expected to come online in 2008 alone.

At the same time, oil prices climbed much too quickly for the economy to even begin to adjust, and this contributed to the overall economic collapse. The combination of high prices and the economic troubles have taken a bite out of demand (at least temporarily). So we essentially find ourselves back in the position of having perhaps three or four million barrels of excess capacity around the world, and oil prices back in the $40’s. Thus I think Figure 4 explains where we are now – and where I think we are headed.


Figure 4. When Do Prices Bounce Back?

In Figure 4, the year 2007 shows a world in which oil is at $80 and the demand has nearly caught up with supply. 2008 shows an example of no spare capacity, and the oil price sharply higher. Then 2009 shows the situation with reduced demand, some incremental capacity increase over 2008 (new projects scheduled to come online in 2009 will generally be too far along to cancel), and the corresponding price collapse arising from the largest spare capacity situation in several years.

So, where do we go from here? I think it depends on how quickly demand bounces back.

The Next Five Years

What might the next five years look like? Do we revert back to Figure 1, in which we see steady prices for years (except this time in the $40 region)? Or do we return to the eroding capacity case of Figures 2 and 3? I have reason to believe the latter is the case.

One reason for this is that the oil industry needs higher prices to warrant new projects. Sig Cornelius, the Chief Financial Officer of ConocoPhillips, recently stated that oil needs to average $52/bbl in order for the company to break even. The cost of finding and developing oil has gone up, and recently Eni CEO Paolo Scaroni said that oil prices would need to be $60 to keep up the needed investments. As a result of low oil prices, drilling rigs are being underutilized and projects are being canceled:

E&P Capital Expenditure Cutbacks

The International Energy Agency estimates that about $100 billion of worldwide oil production capacity expansion projects have been cancelled or postponed over the past half year. According to Barclays Capital, oil companies have cut worldwide exploration and production spending by 18 percent so far this year. Deutsche Bank estimates that U.S. energy exploration-and-production spending will drop $22.5 billion this year, a 40-percent, year-on-year decline.

Saudi Arabia has cancelled the development of several fields such as the Manifa and Dammam oil field, which would have added about 1 million barrels per day (MMBpd) of capacity. Refinery projects have also been delayed or cancelled while Saudi Aramco reviews cost estimates in the light of the significant weakening of oil prices. Saudi Aramco will consider re-issuing a tender for Manifa’s development at a later date, assuming bids from contractors reflect a reduction in raw materials to match lower oil prices.

Such cancellations come at a price, which the article summarizes:

New oil-and-gas projects usually take several years of development before starting commercial production. According to Cambridge Energy Research Associates, the scaleback in exploration and production could reduce future global oil supplies by up to 7.6 MMBpd in five years, or 9 percent of current production. If demand suddenly comes back as it did in 2003-2004, there could be a resulting shortfall of production and much higher energy prices. The International Energy Agency (IEA) also warns that the credit crisis and project cancellations will lead to no spare crude oil capacity by 2013.

The longer oil prices stay low, the worse the shortfall will be due to the project cancellations and increasing demand. Incidentally, these factors also explain a big part of why the oil industry is historically cyclical; in the good times producers spend money, and then when supply gets ahead of demand and the price falls, they slow down on investing. This eventually leads to tightness again, so the good times return. The steepness of the World Oil Price curve in Figure 4 could be much steeper if demand recovers sooner rather than later.

The prospect of sharply higher taxes on the oil industry is a second factor that threatens to slow the development of new oil projects. A recent study by the American Petroleum Institute concluded that this number is “at least” $400 billion over the next 10 years. That seemed quite high to me, so I wrote to the API for a breakdown. Jane van Ryan, Senior Manager of Communications at the API, responded:

The figure is, according to our tax experts, “at least $400 billion” and could be significantly higher.

Using EIA numbers, our tax analysts have examined the impact on the industry of the administration’s cap-and-trade proposal using five scenarios. The results indicate that about 60 percent of the administration’s proposal, which would raise $645.7 billion in “climate revenues,” would be funded by the oil and natural gas industry. This means the industry would pay about $400-450 billion. We have opted to use the lower figure.

The industry’s share of business-wide tax provisions as well as new taxes on the industry are estimated at $80-90 billion over ten years. Again, we have opted to use the lower figure. These tax provisions include the reinstatement of the Superfund Tax, the repeal of the LIFO provision, internal enforcement/reform deferral/related tax reform policies, an excise tax levy on federal offshore leases in the Gulf of Mexico, the repeal of the enhanced oil recovery credit, the repeal of the marginal well tax credit, the repeal of the expensing of intangible drilling costs, the repeal of the deduction for tertiary injectants, the repeal of the passive loss exception for working interests, the repeal of Sec. 199 for oil and natural companies, the increase of the G&G amortization period for independent producers to 7 years, and the repeal of the percentage depletion for oil and natural gas.

While I won’t get into all of the pros and cons of new taxes, higher taxes will provide a disincentive for projects which are projected to have a marginal financial return. If this further contributes to underinvestment, it will worsen the overall tightness in the oil markets, which will put more upward pressure on prices. Thus, high oil prices will likely again be a campaign issue in the 2012 presidential elections.

Conclusions

While the oil industry is historically cyclical, I believe we are approaching the point at which the industry will no longer be able to build out enough new projects to stay ahead of demand. This could manifest itself as peak oil, in which case the rate of depletion permanently overtakes the rate at which new production comes online. Or it could first manifest as peak lite, in which case new production still stays somewhat ahead of depletion, but can’t keep up with new demand. In either of these situations, I think the historical cyclicality of the oil industry will disappear. In early 2008 I thought we had reached that point, but it appears that we had at least one more cycle ahead.

While it is too early to tell with a high level of confidence just where we are on the depletion curve, the summer of 2008 provided of taste of life in an oil-constrained world. The current level of underinvestment and the prospect of higher taxes are setting up another situation in which spare capacity erodes, leading to higher oil prices and greater volatility. Add to this the prospect of a global oil production peak, and I have trouble seeing a case where oil prices will remain stable in the coming years.

As an investor, I use blue chip oil stocks as a defensive measure against much higher prices. I am not one who subscribes to the idea that oil companies are going to be put out of business by running out of oil, or by ethanol, algal biodiesel, or any other combination of alternative fuel technologies. In fact, I strongly believe that if an alternative technology begins to look attractive enough, oil companies have deep enough pockets to shift their business in that direction. But I think that’s unlikely to happen any time soon.

As a consumer, it would probably pay to evaluate just how much higher prices might impact your budget – and then take action. Can you sustain oil prices that return to $150/bbl or more? Even if you can, do you want that uncertainty hanging over your budget? If not, then it would be prudent to take steps to minimize the personal impact of high oil prices. Steps to consider include utilizing more fuel efficient transportation, public transportation, ride-sharing, and if possible locating closer to your place of employment.

Plan ahead and don’t get caught off-guard like so many did last summer. It is only a matter of time before history repeats itself. Here’s hoping our political leaders make policy decisions that won’t worsen the impact.

March 24, 2009 Posted by | oil prices, oil production, Peak Lite, Peak Oil | 54 Comments

The Next Five Years

Peak Lite and the Current Oil Picture

A few years ago, after spending a lot of time thinking about peak oil, and then watching the price of oil break out of its historical trading range and head higher, the idea of Peak Lite came to me. Over time the price of oil had bounced between $10 and $30 a barrel, but about 5 years ago it broke from that pattern and started the steady climb that culminated in $147/bbl last summer. I had been having various debates about whether we were or weren’t at the global peak in oil production (I was taking the ‘not yet but soon’ position), but it started to become clear to me that we didn’t require a global peak before we started to feel the impact of peak oil.

I proposed the following to explain what I thought was happening. (Don’t get too fixated on the dates or prices as they are just there to illustrate the concept). Figure 1 shows the sort of price behavior if spare oil production capacity is constant. Of course spare production fluctuates up and down, as does price, but my thesis is that constant excess capacity should keep the price relatively stable – as long as the excess is large enough that several different producers have the ability to step up and fill shortfalls. This concept is illustrated by Figure 1, with a constant four million barrels per day (bpd) of excess capacity and an oil price of $25/bbl.

Figure 1. Simulated Oil Price Behavior at Constant Spare Capacity


Figure 2. Simulated Oil Price Behavior at Eroding Spare Capacity

Figure 2 illustrates the case in which demand growth is outstripping supply growth, leading to diminishing spare capacity. This is the mode that we have been in for the past few years. Spare capacity was eroded by several million barrels during the first half of this decade, and as a result the price of oil climbed higher, and became increasingly volatile. This was caused by a combination of stronger demand worldwide, and an oil industry that had not anticipated such strong demand growth. As a result, the global oil industry didn’t invest aggressively enough to meet demand, and while capacity did grow, it didn’t grow quickly enough to keep prices stable.


Figure 3. The Next Five Years?

Figure 3 illustrates a future in which world demand has collided with world supply, and then demand growth continues to stay ahead of supply growth. In the world of peak oil, this happens because supply is falling. In the peak lite world, it can occur even if supply is increasing. In the figure, I show an example of supply and demand colliding in 2010, then demand exceeding supply in future years. Of course demand as defined in Economics 101 won’t actually exceed supply, demand will just be destroyed by rising prices (as shown on the right axis) to keep it in equilibrium with supply. Figures 2 and 3 illustrate what Peak Lite is all about; that you don’t have to have falling supplies to start experiencing the effects of peak oil.

I created the original figures in mid-2007, and as we know by mid-2008 oil prices had risen much higher than the $95/bbl I illustrated on the figure. But circumstances have changed. As a result of climbing oil prices, new projects have begun to come online. Strong price signals from the previous five years had resulted in major investments into new oil production (but it takes a few years to bring new projects online); about 5 million bpd of new capacity was expected to come online in 2008 alone.

At the same time, oil prices climbed much too quickly for the economy to even begin to adjust, and this contributed to the overall economic collapse. The combination of high prices and the economic troubles have taken a bite out of demand (at least temporarily). So we essentially find ourselves back in the position of having perhaps three or four million barrels of excess capacity around the world, and oil prices back in the $40’s. Thus I think Figure 4 explains where we are now – and where I think we are headed.


Figure 4. When Do Prices Bounce Back?

In Figure 4, the year 2007 shows a world in which oil is at $80 and the demand has nearly caught up with supply. 2008 shows an example of no spare capacity, and the oil price sharply higher. Then 2009 shows the situation with reduced demand, some incremental capacity increase over 2008 (new projects scheduled to come online in 2009 will generally be too far along to cancel), and the corresponding price collapse arising from the largest spare capacity situation in several years.

So, where do we go from here? I think it depends on how quickly demand bounces back.

The Next Five Years

What might the next five years look like? Do we revert back to Figure 1, in which we see steady prices for years (except this time in the $40 region)? Or do we return to the eroding capacity case of Figures 2 and 3? I have reason to believe the latter is the case.

One reason for this is that the oil industry needs higher prices to warrant new projects. Sig Cornelius, the Chief Financial Officer of ConocoPhillips, recently stated that oil needs to average $52/bbl in order for the company to break even. The cost of finding and developing oil has gone up, and recently Eni CEO Paolo Scaroni said that oil prices would need to be $60 to keep up the needed investments. As a result of low oil prices, drilling rigs are being underutilized and projects are being canceled:

E&P Capital Expenditure Cutbacks

The International Energy Agency estimates that about $100 billion of worldwide oil production capacity expansion projects have been cancelled or postponed over the past half year. According to Barclays Capital, oil companies have cut worldwide exploration and production spending by 18 percent so far this year. Deutsche Bank estimates that U.S. energy exploration-and-production spending will drop $22.5 billion this year, a 40-percent, year-on-year decline.

Saudi Arabia has cancelled the development of several fields such as the Manifa and Dammam oil field, which would have added about 1 million barrels per day (MMBpd) of capacity. Refinery projects have also been delayed or cancelled while Saudi Aramco reviews cost estimates in the light of the significant weakening of oil prices. Saudi Aramco will consider re-issuing a tender for Manifa’s development at a later date, assuming bids from contractors reflect a reduction in raw materials to match lower oil prices.

Such cancellations come at a price, which the article summarizes:

New oil-and-gas projects usually take several years of development before starting commercial production. According to Cambridge Energy Research Associates, the scaleback in exploration and production could reduce future global oil supplies by up to 7.6 MMBpd in five years, or 9 percent of current production. If demand suddenly comes back as it did in 2003-2004, there could be a resulting shortfall of production and much higher energy prices. The International Energy Agency (IEA) also warns that the credit crisis and project cancellations will lead to no spare crude oil capacity by 2013.

The longer oil prices stay low, the worse the shortfall will be due to the project cancellations and increasing demand. Incidentally, these factors also explain a big part of why the oil industry is historically cyclical; in the good times producers spend money, and then when supply gets ahead of demand and the price falls, they slow down on investing. This eventually leads to tightness again, so the good times return. The steepness of the World Oil Price curve in Figure 4 could be much steeper if demand recovers sooner rather than later.

The prospect of sharply higher taxes on the oil industry is a second factor that threatens to slow the development of new oil projects. A recent study by the American Petroleum Institute concluded that this number is “at least” $400 billion over the next 10 years. That seemed quite high to me, so I wrote to the API for a breakdown. Jane van Ryan, Senior Manager of Communications at the API, responded:

The figure is, according to our tax experts, “at least $400 billion” and could be significantly higher.

Using EIA numbers, our tax analysts have examined the impact on the industry of the administration’s cap-and-trade proposal using five scenarios. The results indicate that about 60 percent of the administration’s proposal, which would raise $645.7 billion in “climate revenues,” would be funded by the oil and natural gas industry. This means the industry would pay about $400-450 billion. We have opted to use the lower figure.

The industry’s share of business-wide tax provisions as well as new taxes on the industry are estimated at $80-90 billion over ten years. Again, we have opted to use the lower figure. These tax provisions include the reinstatement of the Superfund Tax, the repeal of the LIFO provision, internal enforcement/reform deferral/related tax reform policies, an excise tax levy on federal offshore leases in the Gulf of Mexico, the repeal of the enhanced oil recovery credit, the repeal of the marginal well tax credit, the repeal of the expensing of intangible drilling costs, the repeal of the deduction for tertiary injectants, the repeal of the passive loss exception for working interests, the repeal of Sec. 199 for oil and natural companies, the increase of the G&G amortization period for independent producers to 7 years, and the repeal of the percentage depletion for oil and natural gas.

While I won’t get into all of the pros and cons of new taxes, higher taxes will provide a disincentive for projects which are projected to have a marginal financial return. If this further contributes to underinvestment, it will worsen the overall tightness in the oil markets, which will put more upward pressure on prices. Thus, high oil prices will likely again be a campaign issue in the 2012 presidential elections.

Conclusions

While the oil industry is historically cyclical, I believe we are approaching the point at which the industry will no longer be able to build out enough new projects to stay ahead of demand. This could manifest itself as peak oil, in which case the rate of depletion permanently overtakes the rate at which new production comes online. Or it could first manifest as peak lite, in which case new production still stays somewhat ahead of depletion, but can’t keep up with new demand. In either of these situations, I think the historical cyclicality of the oil industry will disappear. In early 2008 I thought we had reached that point, but it appears that we had at least one more cycle ahead.

While it is too early to tell with a high level of confidence just where we are on the depletion curve, the summer of 2008 provided of taste of life in an oil-constrained world. The current level of underinvestment and the prospect of higher taxes are setting up another situation in which spare capacity erodes, leading to higher oil prices and greater volatility. Add to this the prospect of a global oil production peak, and I have trouble seeing a case where oil prices will remain stable in the coming years.

As an investor, I use blue chip oil stocks as a defensive measure against much higher prices. I am not one who subscribes to the idea that oil companies are going to be put out of business by running out of oil, or by ethanol, algal biodiesel, or any other combination of alternative fuel technologies. In fact, I strongly believe that if an alternative technology begins to look attractive enough, oil companies have deep enough pockets to shift their business in that direction. But I think that’s unlikely to happen any time soon.

As a consumer, it would probably pay to evaluate just how much higher prices might impact your budget – and then take action. Can you sustain oil prices that return to $150/bbl or more? Even if you can, do you want that uncertainty hanging over your budget? If not, then it would be prudent to take steps to minimize the personal impact of high oil prices. Steps to consider include utilizing more fuel efficient transportation, public transportation, ride-sharing, and if possible locating closer to your place of employment.

Plan ahead and don’t get caught off-guard like so many did last summer. It is only a matter of time before history repeats itself. Here’s hoping our political leaders make policy decisions that won’t worsen the impact.

March 24, 2009 Posted by | oil prices, oil production, Peak Lite, Peak Oil | 36 Comments