Category 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, 8 February 2015: The Primordial Soup of US Renewables

If you like charts (as I do), and you are interested in all things energy and climate change, then the annual Bloomberg New Energy Finance‘s “Sustainable Energy in America Factbook” is an absolute treat. The 2015 edition came out last week.

While the United States does not have a Climate Change Act like the UK, it does have top-end academic research, government-backed blue sky thinking (via the Advanced Research Projects Agency for Energy), lots of entrepreneurial zeal, a deep well of venture capital funding and a multitude of innovative state-led renewable initiatives. Just as the primordial soup of complex molecules on early earth once gave rise to the chemical combinations that we call life, so we hope that the US renewable melting pot will also give birth to something transformational.

Of course, we are not there yet. And Voldemort is well represented in the US care of the anti-science Congress and a fossil fuel lobby that makes the tobacco giant lobbying of the 60s and 70s look like amateur time. But let’s stay upbeat. For a start, King Coal does appear to be in full retreat (click for larger image on all charts).

Electricity Generating Capacity by Fuel Type jpeg

Further, investment continues to pour into the renewable space at a rate 10 times higher than a decade ago:

Renewable Investment jpeg

With the exponential explosion in solar capacity particularly encouraging.

US Solar Roll Out jpeg

I could go on.

Nonetheless, for the US to lead the world into a post-carbon age before we are committed to extremely dangerous climate change still requires a step change upward in renewable investment. But the building blocks for a renewable revolution are there, they just need to be put in the right order.

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.

Chart of the Day, 2 Feb 2015: Still Talking about a Shale Gas Revolution?

The US government’s Energy Information Administration (EIA) has just come out with US natural gas production figures for November. But before we look at them, let’s glance at the long-term chart first (Source EIA here):

US Natural Gas Monthly Supply jpeg

Looks good if you are a fracking enthusiast, although the chart makes the shale gas surge seem like one continuous, seamless event. Scale up to the monthly chart and the situation looks a bit more nuanced:

US Dry Gas Production Nov 14 jpeg

For two years, 2012 and 2013, production almost flatlined, before jumping up again at the beginning of 2014. The latest numbers show dry gas production for November up 6.2% year on year, and the twelve month average rose 4.6%. What explains the two-year hiatus in the shale gas revolution? That’s easy: price (Source: Nasdaq).

Natural Gas Futures jpeg

The Holy Grail for shale gas enthusiasts is rising production and cheaper prices. In reality, however, what we have seen is rising production when prices are high, but stagnating production when prices fall. We haven’t really seen the same dynamic for tight oil in the US because we haven’t seen a prolonged period of falling prices–until now.

Meanwhile, the EIA’s latest Short-Term Energy Outlook (STEO) , released on 13th January, contains new forecasts that extend out through 2016 . The outlook is for a short plateau, then a renewed upward move:

STEO Jan 15 copyTo be honest, foresting oil and gas markets is a nightmare, the reason being that you are actually having to forecast two interlocking variables: price and production. Keeping that caveat in mind, here is the EIA’s price forecast:

Henry Hub Natural Gas Prices

The chart is a little difficult to read, but the EIA is looking at $3.44 per million Btu in 2015 and $3.86 in 2016. This compares with an average of $4.39 in 2014.

Putting price and production together paints a pretty optimistic picture from the EIA. Previously, the slump in prices in 2011 led to a plateauing of production in 2012. Further, a jump in prices in 2013 resulted in reinvigorated production growth in 2014. Of course, technology is changing, and this relationship may not hold. Indeed, that is what the EIA argues (from the 13th January STEO, click for larger image):

STEO Gas Production Commentary jpeg

There are a lot of moving parts to the story. I haven’t touched upon the implications for associated natural gas (gas produced as a byproduct of drilling for tight oil) stemming from the oil price slump. Nor have I dealt with the big spat between the journal Nature and the EIA over shale gas reserve calculations. More to come on both of these topics in future posts.

Overall, though, remember the “peak oil” theory is really one of peak cheap oil (see my posts here and here). and you can extend the same logic to gas. Consequently, the cornucopians have a golden opportunity to nail the peakists if they can show one thing: that the world can produce more oil and gas at the current low oil and gas prices. We have a testable hypothesis–let’s see what happens.

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.

Links for the Week Ending 16 July 2014

I haven’t posted for quite a while. Basically, family commitments have eaten into my blogging time, and this state of affairs will likely continue for an indefinite period longer. Nonetheless, I will try to get some posts out as we grind through the last few innings of what I would term the ‘Great Hiatus': a hiatus period—or pause— amid the longer term trend of rising global mean temperatures, higher oil prices, increasing resource constraints and greater global economic instability.

For example, with a 70-80% chance of an El Nino by year-end, temperature records have the potential to start falling again. Further, oil has built a solid base above $100 per barrel but appears poised to go higher in the next year or so as oil companies struggle to find new fields that can be developed at the right price.

At the same time, many of the financial fragilities in the system posed by ageing demographics, declining productivity and increasing resource constraints have to date been countered by the super easy monetary policy pursued worldwide. The aggressive, unprecedented and unorthodox monetarism  led by the Federal Reserve Board has been a policy triumph over the short term. Since the credit crunch of 2008/2009, the sky has not fallen down.

Yet the jury is still out as to whether the provision of free money can be maintained long enough to see a return to sustainable economic growth, or whether it will beget a new cycle of chronic instability through having fostered the extension of credit into intrinsically poor investments and a generalized asset price inflation that benefits few but the rich.

In the meantime, here are some links which I hope will flesh out some of the themes of this blog:

  • Occasionally, my left-learning friends berate me for reading the right-of-centre Daily Telegraph. I offer two defences: first, you need to read opinion with which you may instinctively disagree, but find of some merit with a bit of reflection. Second, a good newspaper has intellectual mavericks—and The Telegraph has many (probably more than The Guardian). Here is an article by Ambrose Evans-Pritchard portraying the fossil fuel industry as poor capitalists; in short, the oil majors have been investing ever more, to reap ever less; while renewables are slowing sloughing off their subsidies. Joseph Schumpeter would be proud of this epic creative destruction.
  • And despite all the new technology we are bringing to bear on oil extraction, when fields go into decline it is damn tough fighting the tide. North Sea oil was a much ignored saviour of the British economy in the 1980s, but is decline is inexorable and, according to the Office for Budget Responsibility (OBR), accelerating. The Financial Times has the story here (access to FT articles after free registration), but if you want to go to the primary OBR source you can find it here.
  • We are still seeing a lot of commentary over “Capital in the Twenty-First Century” by Thomas Piketty. Piketty argues that the relative reduction in inequality in advanced countries over the post-war period was something of an aberration. Accordingly to his analysis, without direct political intervention (or in the most extreme case revolution), capital will gradually accrue to a relative few. In short, when the return on capital is greater than the growth rate, it is the owners of capital who prosper most, not those in capital’s employ. For a fuller treatment, I recommend Cory Doctorow’s summary here,  and an interview by Maththew Yglesias of Vox  a while back with Piketty here.
  • You can also slice growing inequality in different ways. The Institute for Fiscal Studies (IFS) in the UK has just issued a report detailing how the real incomes of young people are falling much faster than those of any other age cohort (here). Meanwhile, I have often commented on how London has detached itself form the rest of the UK. In the US, Emily Badger of The Washington Post’s Wonk Blog charts a similar divergence between cities showing a virtuous cycle of education and growth and those showing a vicious cycle of poor education and decline (here)
  • Climate sceptics love to start any global mean temperature chart with a data point centred on 1997/98, which happens to coincide with the largest El Nino for a century. This monster El Nino ushered in the record breaking hot year of 1998 (slightly eclipsed in later years depending on which data set you look at, but still one of the hottest years on record: see NASA’s data set here). Global mean temperature is a construct of short-term weather volatility, long-term green-house gas induced temperature rise and the medium-term ENSO cycle. Eventually, CO2 will do its stuff and records will fall regardless of whether we have an El Nino. But for us to quickly retire all the talk of a hiatus in temperature rise will require a new and powerful El Nino. True, an El Nino appears on the cards by year-end, but quite how strong it will be is still clouded in uncertainty as this post at Skeptical Science explains here.
  • If you visit London, take time to visit some of the quirky, smaller museums. One of the most intriguing (and downright disturbing) is the Old Operating Theatre that used to be part of St Thomas Hospital just south of The Thames. This is no Disney Land reconstruction, but a perfectly preserved part of pre-antiseptic medical history.  Despite appearing to be a set from a particularly dark Harry Potter movie scene, the Old Operating Theatre shows how and where surgeons removed a damaged limb in around two minutes flat, with minimal anaesthetic. The museum demonstrates how far we have come health-wise in an historical blink of an eye (150 years or so). And for those who would welcome an economic collapse as a route toward a more authentic form of living, I direct you to a post at Club Orlov explaining a world of post-collapse, or village, medicine. Humanity is put right back on the St Thomas Hospital’s operating table. Pray for four strong men to hold you down—and a surgeon who has not only washed his hands, but is also quick with blade and saw.