America: You’ve got three more years to drive normally! – Part 2

Part 1 of this series stirred up a lot of interest with Rag Blog readers, and it was reposted by Resilience.org where it was also popular. I imagine the article’s somewhat alarming title struck a nerve, calling attention to the repressed fears that challenge our suburban, car-centric American culture. Fears that stem from our culture of denial in response to business as usual.

In Part 2 we will further explore the constraints on our energy resources and will look at the role of finance capital in perpetuating our denial; denial that inhibits energy reform until there is a full blown crisis.

A global glut of crude oil is the main driver behind the decline in gasoline prices. Relatively cheap oil has made it more profitable for refiners to produce gasoline and other fuels, and they have ramped up production to record levels. This boom in supplies has sent gasoline prices tumbling. Traders and other market observers expect the flow of both crude oil and gasoline to keep rising, likely exerting more downward pressure on prices.

Wait until they discover that the shale oil producers have never made a buck producing shale oil, only on the sale of leases and real estate to “greater fools” and creaming off the froth of the complex junk financing deals behind their exertions. Expect that mirage to dissipate in the next 24 months, perhaps sooner if the price of oil keeps sinking toward the sub $90-a-barrel level, where there’s no economically rational reason to bother drilling and fracking.

Let’s start with the common assertion that oil supplies are sufficiently abundant so that a peak in production is many years or decades away. Everyone agrees that planet Earth still holds plenty of petroleum or petroleum-like resources: that’s the kernel of truth at the heart of most attempted peak-oil debunkery. However, extracting and delivering those resources at an affordable price is becoming a bigger challenge year by year. For the oil industry, costs of production have rocketed; they’re currently soaring at a rate of about 10 percent annually. Producers need very high oil prices to justify going after the resources that remain—tight oil from source rocks, Arctic oil, ultra-deepwater oil, and bitumen. But oil prices have already risen to the point where many users of petroleum just can’t afford to pay more. The US economy has a habit of responding to oil price hikes by swooning into recession, and during the shift from $20 per barrel oil to $100 per barrel oil (which occurred between 2002 and 2011), the economies of most industrialized countries began to shudder and stall. What would be their response to a sustained oil price of $150 or $200? We may never know: it remains to be seen whether the world can afford to pay what will be required for oil producers to continue wresting liquid hydrocarbons from the ground at current rates.

Hughes explained that more than 80 percent of the nation’s shale oil comes from just two plays, the Bakken field in North Dakota and Montana and the Eagle Ford in Texas. He estimates that production in those regions will recede back to 2012 levels in 2019. Overall production across the nation’s shale oil fields will peak in 2017.

Husseini: My base oil price forecast in 2012 dollars still ranges between $105 and $120/barrel Brent with a volatility floor of $ 95/barrel and more probable upward spiking to $140/barrel within 2016/2017.

We see that the intersection point is somewhere in 2016. What is more important than the precise year in which the next oil crunch may happen is the widening gap in the 2nd half of this decade.

Conclusion: Whether the world wants to follow the New Policies Scenario of the IEA WEO 2013 is another question altogether. It seems governments are rather on a current policies track which increases oil demand and therefore pressure on oil prices.

The Medium Term Oil Market Report of the International Energy Agency (IEA, Paris), published in June 2014, contains a graph which implies that US crude production will start to peak in 2016. Few took notice although the world is continuously occupied with oil and energy related conflicts and wars in Ukraine, Libya and Iraq. So far, oil prices increased only shortly when fights flared up. Apparently oil markets are at ease while the US tight oil “revolution” is underway. But for how long?

The graph [Fig 1: US tight oil and crude oil in rest of world vs oil prices] shows that US tight (shale) oil sits on top of a bumpy crude production plateau in the rest of the world which clearly started in 2005 (average of 73.4 mb/d since Jan 2005). Despite increasing tight oil production oil prices did not go down but stayed at a level of around US$ 100 a barrel. We can safely say that without US tight oil – in May 2014 around 2.9 mb/d – the world would be in a deep oil crisis. People got accustomed to a higher oil consumption level which will be hard to come down from. Between 2005 and 2007, oil production declined by around 2 mb/d (supply shock) and oil prices doubled. That gives us an idea what will happen when tight oil starts to decline. So it is important to know when tight oil reaches its tipping point.

The two major forecasting agencies, Washington’s EIA and Paris’ IEA, are both more pessimistic than is generally known for they both foresee US shale oil production leveling off as soon as 2016. The reason for this is that drillers will simply run out of new places to drill and frack new wells. While new techniques of extracting more oil from a well are possible, there is need to look closely at the costs of these techniques vs. the potential payoff.

The shale oil situation in Texas is somewhat different than in North Dakota, for there you have much better weather and two separate shale oil deposits. The recent growth in Texas’s shale oil production has been much smoother than in storm-prone North Dakota and has been increasing at about 44,000 b/d each month. So far as can be seen from the outside of the industry, production in both states will continue to grow for at least another year or two — but then we will be at 2016.

The government has never gotten around to publishing the assumptions that go into the forecast that U.S. shale oil production will stop growing circa 2016. The biggest difference between EIA/IEA and independent analysts is the government forecasters do not see a precipitous drop in shale oil production following the peak. Instead they see a period of flat production followed by a gentle decline stretching well into the next decade. Such a gentle end to the shale oil “bubble” can only assuage fears of a calamity. This projection on a gentle end to U.S. shale oil is at variance with outside forecasters who note that shale oil wells are pretty well gone in three years and simply do not see where the oil to maintain production levels will be coming from for another 10 or 15 years after the peak…

Independent analyses of U.S. shale oil generally come to the same conclusion that production will peak in the 2016-2017 time frame, but as noted above see a much faster decline than does the government.

Oil companies have to make a big deal about shale plays because that is all that is left in the world. Let’s face it: these are truly awful reservoir rocks and that is why we waited until all more attractive opportunities were exhausted before developing them. It is completely unreasonable to expect better performance from bad reservoirs than from better reservoirs. The majors have shown that they cannot replace reserves. They talk about return on capital employed (ROCE) these days instead of reserve replacement and production growth because there is nothing to talk about there. Shale plays are part of the ROCE story–shale wells can be drilled and brought on production fairly quickly and this masks or smoothes out the non-productive capital languishing in big projects around the world like Kashagan and Gorgon, which are going sideways whilst eating up billions of dollars. None of this is meant to be negative. I’m all for shale plays but let’s be honest about things, after all! Production from shale is not a revolution; it’s a retirement party. [emphasis mine]

It seems that most oil companies are spending more than their revenues by increasing their debts. Countries can live for a long time with huge debt increase, not companies. They count on the stock market by delivering optimistic reports and keep drilling to avoid the production to decline. With shale oil or shale play, in contrary with conventional where wells are dry or producing, oil can be produced even for a while if not economical.

Such behavior explains why most peak forecasts are wrong. But the main question is about the slope of the decline after the peak. EIA forecast a LTO (light tight oil = shale oil) peak in 2017 it is not too far after my forecast, the big difference is the slow EIA LTO decline.

“We are swimming in crude, and they [the Saudis] know that better than anyone because they are the biggest exporter,” Mike Wittner, the head of oil market research at Societe Generale in New York, said by phone Sept. 9. “History shows that the Saudis will just do what’s necessary.” … Saudi Arabia made the biggest contribution to OPEC’s production cuts in 2008 and 2009 as demand contracted amid the financial crisis. The group took almost 5 million barrels of daily output off the market, reviving prices from about $30 at the end of 2008 to almost $80 a year later.

Both Saudi and Iran recently warned that declines in crude prices will be short lived. It is an ominous sign for motorists in the UK who were hoping that recent declines in the cost of a gallon of petrol would be sustained.

“Deepwater is providing lower returns and has shown no production growth while U.S. unconventionals have much higher returns (at least on paper), [and] enough scale of reserves to be of interest to the majors … so according to them, they will shift spending,” Wicklund noted.

…In other words, we are now in a world in which the biggest economy, Europe, is about to enter a triple-dip recession, and the third largest standalone economy, China, is undergoing an economic standstill, and all hopes and prayers are that China will join the ECB in activating monetary easing once again. But yes, the Fed will not only conclude QE but will supposedly begin rising rates in just over two quarters. Good luck with that.

Peak oil could be the catalyst for global collapse. Some see new fossil fuel sources like shale oil, tar sands and coal seam gas as saviours, but the issue is how fast these resources can be extracted, for how long, and at what cost. If they soak up too much capital to extract the fallout would be widespread.

I would argue that falling commodity prices are bad news. It likely means that the debt bubble which has been holding up the world economy for a very long time — since World War II, at least — is failing to expand sufficiently. If the debt bubble collapses, we will be in huge difficulty…

If we step back and acknowledge that the shale oil phenomenon will be over in a couple of years and that oil production is dropping in the rest of the world, then we have to expect that the remainder of the peak oil story will play out shortly. The impact of shrinking global oil production, which has been on hold for nearly a decade, will appear. Prices will go much higher, this time with lowered expectations that more oil will be produced as prices go higher. The great recession, which has never really gone away for most, will return with renewed vigor and all that it implies…

All this is telling us that the peak oil crisis we have been watching for the last ten years has not gone away, but is turning out to be a more prolonged event than previous believed. Many do not believe that peak oil is really happening as they read daily of surging oil production and falling oil prices. Rarely do they hear that another shoe has yet to drop and that much worse in terms of oil shortages, higher prices and interrupted economic growth is just ahead. We are sitting in the eye of the peak oil crisis and few recognize it. Five years from now, it should be apparent to all.

The Rag Blog