For Energy and Capital last week, I updated the peak oil debate, refreshed my outlook on oil supply and demand, and reviewed my predictive track record.
Peak Oil Update
World Will Soon Face an Oil Supply Crunch
By Chris Nelder
Friday, September 18th, 2009
Everyone who follows the peak oil story has by now seen some of the editorials that blanketed the press over the last few weeks, attempting to debunk it and disparage its adherents. I responded to the worst of them three weeks ago.
Michael Lynch fired back quickly, saying that my article “tops them all” and alleged that I had predicted $500 oil with a global depression.
I’m flattered, but as my longtime readers know, that was quite a mischaracterization.
Lynch was referring to my July 28, 2008 appearance on Yahoo! Finance’s Tech Ticker show with Aaron Task, wherein I explained the important concepts of the peak oil study, and some of the key data.
Here’s what I actually said (emphasis mine):
Task: “Where do you see oil prices in 10 years?”
Nelder: “That’s impossible to say. If demand holds up, which is going to be primarily due to continued growth in Asia and the Middle East, then the sky’s the limit–it could be $500 a barrel, for all I know. If we have a major episode of global depression that sets in and demand really–[Task: which may be a possibility]–it’s a likelihood!–then I think oil will come back down when that happens, but at what point does that happen? When oil’s $200, when oil’s $300 a barrel, and then it goes back to $250? You know–it’s going to be something like that.”
We all know what happened after that: Demand fell, a major episode of global depression did indeed set in, and oil did come back down.
Now I’ll admit that I was dead wrong about the floor for prices being around $120, nor did I know that when $147 a barrel had printed two weeks earlier, it would turn out to be the all-time price peak. Such are the perils of price forecasting, which I have tried to avoid ever since.
On the other hand, nobody expected crude prices to run the gamut from $147 to $33 and almost halfway back again over the course of a year. Thus did the market make fools of us all. I quite rightfully expected that prices would keep on going up, had oil demand continued to rise after last July in keeping with its long history. And nobody knew that $147 was the peak price until it had faded into the rear-view mirror.
In the same way, we can’t know for sure when the supply of “all liquids” has peaked until that date is also well behind us. Not coincidentally, the current record flow rate for all liquids production is a rounded 87 million barrels per day (mbpd), which occurred along with the price peak in July 2008. (“All liquids” includes conventional crude plus unconventional hydrocarbons such as natural gas liquids, “extra heavy” oil, synthetic oil made from tar sands, refinery gains, liquids produced from the conversion of coal and natural gas, and biofuels. Regular conventional crude production topped out in 2005 at just over 74 mbpd, and has remained at roughly that level ever since.)
Honest analysts know that one of the keys to oil pricing is the amount of spare production capacity, because oil is priced at the margins. When that spare capacity fell to around 1% of total supply last year, it created a tradeable opportunity that attracted speculators, driving prices still higher.
When global demand recovers, prices will spike again, because new drilling into progressively marginal fields will be unable to keep up with the decline of mature oil fields. This is one of the key concepts of the peak oil study.
We now know that the global economy’s maximum pain tolerance point is around $150 a barrel. However, it may not have to rise that high next time to destroy demand and cause prices to fall, because the global economy and the overall credit environment is now substantially weaker. At the same time, it’s not unthinkable that gasoline prices could again reach the $4 range, because refiners are operating now at substantially lower levels due to the compressed crack spread.
Therefore, oil prices will continue to have a volatile, stair-step pattern for a long time, as we keep bumping our heads against the supply ceiling.
So the next time you hear a peak oil denier who has spent the last several years blithely asserting that oil will soon be back to a nice comfy $30, or that technology is increasing reserves all the time without addressing the question of flow rates, ask yourself how credible he is.
Reviewing My Track Record
Now take a look at my track record. I have written an exhaustive book on peak oil (which geologist and peak oil expert Colin Campbell called “the best job I have seen in describing the Peak Oil issue in a sound and very understandable way”) and over 150 articles since 2003, in which I have explained the theory behind peak oil, showed the actual supply and demand data, put new discoveries into perspective, discussed the relationships between oil and the economy, and tried to peer into the future as accurately as possible.
So far, I have seen no serious factual rebuttals to my arguments. The counter-arguments, like the most recent ones from the peak oil deniers, are generally simple expressions of faith: Faith in technology, faith in the markets, faith in humanity. They aren’t supported by the data. Unfortunately, cars and power plants don’t run on faith. Faith can’t cook your food or keep your house at a reasonable temperature. And economies don’t keep growing without a continually increasing supply of cheap energy.
Other than that Tech Ticker appearance, my price guidance has actually been pretty good for the last three years. (Perhaps that’s why Lynch cited–and mischaracterized–that one call.) I knew when prices were too low, and put out contrarian bullish calls at almost exactly the right time for oil and natural gas. And when oil prices bounced back up to $60 in May, I said it would be prudent for investors sitting on double-digit gains to take some off the table. I also said that when prices neared $70, they would likely cool off. So far, so good. (Oil generally has been bouncing around the $70 level since May.)
The near-term future of oil prices is in some ways even murkier now, with upward pressure applied by a dollar that has been falling since March, and downward pressure applied by high inventories and falling crack spreads. My gut feeling is that they are currently in a kind of equilibrium, but it’s hard to support that quantitatively. For the last few months my guess has been that oil would be rangebound somewhere between $60 and $75, and I think that could remain the case for a while yet.
However, I also see an increasing risk that we could have an episode of dollar strength and a selloff in equities and commodities before the end of the year. That’s a discussion for another day, but at this point the downside risk for oil feels like it’s strengthening, and the rally in equities is starting to feel silly. A strong correction seems due (but try telling that to this ever-irrational market). I am still long commodity stocks because the getting has been very good, but my stops are tight and I’m prepared to get short at the first sign of trouble.
Again, contrast those calls with the repeated assertions of Lynch and Yergin that oil will soon return to a hallucinated “mean” in the $30-$40 range.
Warning Signs of Peak Oil Increasing
Putting the troublesome questions of price aside, though, let’s get back to the increasing indications that peak oil is indeed upon us.
For the last year, I have warned in this column that volatile oil prices and a weak credit environment were putting the hurts on investment in new oil production, leading to a lack of expected supply from new drilling in a few years. This week, French oil giant Total echoed that warning, saying that it had slashed 4 mbpd from its estimate for oil production in 2015 and that the world would face a supply crunch by the middle of the next decade.
I give Total credit for owning up to a future supply crunch where few of the other oil majors have, and agree with their assessment. The data suggest it’s now all but a foregone conclusion that the world’s oil supply will begin its inevitable decline around 2012. By 2015, the world will realize that the good ol’ days of cheap oil and continual economic growth aren’t ever coming back.
Ian Reid, a senior executive at the Australian investment bank Macquarie who had 16 years of experience in the oil industry, apparently agrees, telling Reuters this week: “This is our view – capacity has pretty much peaked in the sense that declines equal new resources.” He believes that the lack of investment this year, in addition to rising resource nationalism (e.g., Brazil) and the declining prospects for discovery will wipe out the current spare production capacity of 5.2 mbpd by 2012, causing global oil production capacity to fall from 89.6 mbpd this year to 87.3 mbpd by 2015, while demand rises to 90.9 mbpd.
If you’re now thinking that BP’s recent Tiber field discovery in deepwater Gulf of Mexico and the other “giant” finds of the last few years give the lie to peak oil, allow me to put them in perspective. As I wrote last week, the amount of actually recoverable oil from Tiber is probably under 1 billion barrels, and first oil from it might take as long as 10 years to come to market, at a development cost in the low billions of dollars. We have no way of knowing what the all-important flow rate might be at this point, but using other nearby fields as a benchmark, let’s assume it might achieve a maximum rate of 200,000 – 300,000 barrels per day in 10 to 15 years’ time. Meanwhile, the world stands to lose about 4 mbpd of supply capacity each year starting somewhere around 2012.
In other words, we would need to make a discovery like Tiber roughly once a month in order to significantly change the global supply curve, whereas we’re actually making such discoveries more like once a year. And then we would have to proceed to develop all of those finds quickly, regardless of cost or practicality, when the credit and willingness to do so is still clearly lacking.
Don’t be fooled. Peak oil is here, and the low prices of the last year are only setting us up for less supply just a few years down the road. Understanding the complex reality of global oil production is a recipe for investing success, but thinking that the next 20 years will be anything like the last 20 will lead to certain failure.
Play your cards accordingly.
Until next time,
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