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Page added on June 18, 2016
Michael Lynch: Do Today’s Low Oil Prices Presage Another Spike?
Reduced capital investment and cancelled or postponed oil projects, combined with record-low drilling rig activity in the U.S. has many worried that renewed market tightness is inevitable, if not approaching. My favorite headline is “A 4.5-Million-Barrel Per Day Oil Shortage Looms” referring to insufficient production in 2035. Apparently, “looms” means different things to different people.
Many others have echoed this concern, including industry maven T. Boone Pickens, who in March 2015 predicted that a rebalanced market would see prices of $90-100 by late 2016. Others are not that bullish, but still expect increased prices within months.
This is actually a very old debate in the industry, with Paul Frankel, the British petroleum economist, arguing that the industry suffered through cycles of over- and underinvestment, while American petroleum economist M. A. Adelman noted that overinvestment was the norm and only various schemes such as the Achnacarry Agreement to restrict output and stabilize prices prevented market volatility. In the mid-1970s, most academic studies argued that prices would moderate after the 1973/74 increase, and it was only after the 1979 Iranian Revolution sent prices soaring again that many became convinced that prices would not be cyclical but rise inexorably.
The 1986 oil price collapse naturally made many think that lower oil supply and stronger demand would bring prices back up. Dan Yergin, the most prominent oil industry expert, put forward atypical view in 1985 (before prices declined) that “market realities will again give way to geological realities – the concentration of oil reserves in OPEC and in the Middle East. And that will eventually put the era of surplus behind us.”
But the more basic question remains: are prices too low to permit sufficient supply to be developed to meet demand and balance the market? This question has long bedeviled both the industry and energy economists, but some light can be shed on the subject.
First, the oil industry always thinks prices are too low, just as individuals always think their salaries are insufficient. Indeed, a quarter-century ago, at an International Association for Energy Economists conference in Bali, discussions of the tanker business, the LNG industry, and the upstream petroleum sector all centered on the price levels being insufficient to allow new investment. Penn State economist Richard Gordon, receiving the annual award for energy economics, felt compelled to point out that the one lesson we should have learned as energy economists is that markets always clear, and usually faster and at lower prices than we expect.
It is true that the industry has reduced spending and this will cause lower, (primarily non-OPEC), supply, but this is being replaced by oil from Saudi Arabia, Iraq and now Iran. If oil can be produced in the Iraqi desert for less than $10 a barrel, then multi-billion dollar deepwater fields might be unneeded. Those countries (and Mexico and Venezuela) have ample room to expand production, although there remains a variety of legal and political obstacles that create delays and impediments. However, this is roughly the same as in the late 1980s, when OPEC’s market share soared, but then plateaued despite “low” oil prices. (See figure.)
OPEC Market Share
Thinking of the non-OPEC industry, and especially shale oil in the U.S., how credible are comments about the difficulties of restarting production. As the Wall Street Journal reported: “But as oil prices show some signs of stabilizing, American producers and oilfield-services companies are warning that they may not be able to jump-start drilling. The reason: Many independent companies are too financially strapped, have let go too many workers, or have idled too much equipment to immediately ramp up again.”
Others argue that laid-off workers or idled equipment cannot be brought back into action quickly, but this seems at odds with reality. The graph below shows total drilling rigs active in the U.S. from 1991, and two things stand out: first, when prices were rising after 2002, the number of rigs drilling increased by 200/yr for five years (until the 2008 financial crisis). And this was above historical levels, although supposedly it takes years to bring newbuild rigs online.
Second, the recovery after the 2008 financial crisis was even more rapid. It took two and a half years to bring 1200 rigs back online, reaching the previous peak before falling natural gas prices reduced investment.
US Rigs Active
http://blogs-images.forbes.com/michaellynch/files/2016/06/total-rigs.png
Source: Baker-Hughes
Shale oil production is an even better example. The figure below shows that up until 2009, growth was negligible, with total production under 0.5 mb/d. By 2010/2011, annual growth was 0.5 mb/d, the type of increase one would expect from supergiant Middle Eastern fields. And this was as the industry was still feeling its way towards optimal engineering practices. Now, the geology is much better known, higher grade areas identified, and practices greatly improved, along with cyclically lower costs.
US Shale Oil Production (mbd)
http://blogs-images.forbes.com/michaellynch/files/2016/06/us-shale-prod.png
In all likelihood, stabilization of oil prices around $50 a barrel will allow shale oil production to resume growth, and any surge in prices should see a corresponding surge in drilling. In six months, a couple of hundred drilling rigs can be added to the fleet, and that should suffice to result in higher production. Never bet against the resilience of the industry, or its succumbing to another boom cycle.
25 Comments on "Michael Lynch: Do Today’s Low Oil Prices Presage Another Spike?"
onlooker on Sat, 18th Jun 2016 12:30 pm
The matters being discussed here are trivial what everyone should be focused on is determining what endeavors and uses this precious limited energy should be directed towards
Northwest Resident on Sat, 18th Jun 2016 1:13 pm
They can’t sell oil for a price that people and businesses can’t afford to pay. Therein lies the conundrum.
shortonoil on Sat, 18th Jun 2016 2:38 pm
” They can’t sell oil for a price that people and businesses can’t afford to pay. Therein lies the conundrum. “
Lynch, however, will never figure that out! He thinks oil is a magical substance along with Pixy Dust, and Unicorns. According to him if McDonald’s raised the price on a Big Mac to $250 they would make all kinds of money.
Our maximum affordability calculations put the maximum price of oil at:
2015 – $77.28
2016 – 65.94
2017 – 54.18
2018 – 41.16
2019 – 26.88
These are the levels at which enough demand destruction will occur to push the price back down.
Maybe all that Lynch needs is some new batteries for his calculator?
http://www.thehillsgroup.org/
Davy on Sat, 18th Jun 2016 3:05 pm
Wow, short, that time line is the equivalent of walking the plank. Man, the dead state is sneaking up on us!
penury on Sat, 18th Jun 2016 4:37 pm
Yes there will be another price spike and another drop when the economy tanks, followed by another spike and on and on, but keep track each spike will be lower than the previous and each drop will be lower than the previous. Its a long way down but the trip will be swift.
rockman on Sat, 18th Jun 2016 4:42 pm
“In all likelihood, stabilization of oil prices around $50 a barrel will allow shale oil production to resume growth, and any surge in prices should see a corresponding surge in drilling. In six months, a couple of hundred drilling rigs can be added to the fleet, and that should suffice to result in higher production.”
Dendends on what “resume growth” means: more shale wells at $50/bbl then In all likelihood, stabilization of oil prices around $50 a barrel will allow shale oil production to resume growth, and any surge in prices should see a corresponding surge in drilling. In six months, a couple of hundred drilling rigs can be added to the fleet, and that should suffice to result in higher production. Never bet against the resilience of the industry, or its succumbing to another at $30/bbl…reasonable. Or increasing shale production greater then the decline of existing wells…unreasonable IMHO.
And a rig count increasing to 600 to 700 will create a shale boom like the one we experienced when we had almost 3X that many rigs drilling…pure fantasy IMHO.
Northwest Resident on Sat, 18th Jun 2016 5:30 pm
“Man, the dead state is sneaking up on us!”
Think of it as countdown to apocalypse.
shortonoil on Sat, 18th Jun 2016 6:06 pm
“Think of it as countdown to apocalypse. “
If you plot the decay in the velocity of money since the late 1990’s, along with the decay in the energy delivered from a barrel of oil they are almost exactly the same!
Coincidence?? We don’t think so!
makati1 on Sat, 18th Jun 2016 6:33 pm
Economic growth was first built on coal. (Wood was a very limited energy source.)
Then oil became the energy of choice.
Natural gas found it’s niche as a way to sell something that was flared off in the beginning.
Nuclear butted in because it was promoted to build bombs.
Wind, solar, etc. are techie toys that get press as “alternatives” to cut planet destroying hydrocarbon use but are only extensions of oil.
Fusion is just a dream, always years and billion$ away. Never happen.
Muscle power is the energy of the future, if we have one.
onlooker on Sat, 18th Jun 2016 6:39 pm
“Coincidence?? We don’t think so!” And no coincidence that coinciding with these trends is cumulative debt and debt overload. Got reignite those dying embers don’t you
Don Stewart on Sat, 18th Jun 2016 8:46 pm
I have just started to read Nick Lane’s book The Vital Question: Energy, Evolution, and the Origins of Complex Life. Lane is a biochemist at University College London. Lane asks and proposes an answer to the question “For two and a half billion years, from the very origins of life, single-celled organisms, such as bacteria, evolved without changing their basic shape. Then, on just one occasion in four billion years, they made the jump to complexity. All complex life, from mushrooms to man, shares puzzling features such as sex, which are unknown in bacteria. How and why did this radical transformation happen? The answer, Lane argues, lies in energy: all life on Earth lives on a voltage with the strength of a lighting bolt.’
If you have some time, are willing to follow detailed explanatory trails, and are intrigued by the notion that it is energy which accounts for the complexity we experience in our own bodies and see around us in the natural world…and are willing to make some imaginative analogies to the new world which humans constructed on the backs of the fossil fuels, and speculate about how the demise of fossil fuels may impact us all, then I recommend the book.
Frank Wilczek, the Nobelist, contributes a blurb.
Don Stewart
JN2 on Sun, 19th Jun 2016 3:08 am
Thanks Don, Lane’s book looks fascinating!
Davy on Sun, 19th Jun 2016 5:48 am
This is an important component of peak oil dynamics because it points to further demand destruction deflation that points to lack of an oil price build. If the general economy is stagnating and worse contracting how are we going to see oil price growth? At least the healthy kind of sustained and modest growth that would stimulate the oil industry to preserve an all-important healthy supply base.
“Renormalization” Is Dead: The Market Is Pricing Just One Rate Hike Over Next 3 Years”
http://www.zerohedge.com/news/2016-06-18/renormalization-dead-market-pricing-just-one-rate-hike-over-next-3-years
“Several days ago, Jeff Gundlach said that the “rate hike cycle has left the building”. He was right: as of this moment, the Fed’s plans to “renormalize” are practically finished, with the market now pricing in just one rate hike over the next 3 years. And since it is virtually assured that a recession will take place some time in that period (the current growth cycle is already twice the duration of the average US expansion), the Fed’s next move is virtually assured to be a rate cut, not a hike. The only question is whether the Fed will ignore reality and hike anyway, unleashing the second coming of the Ghost of 1937, and with it a market crash.”
“Rates shock: market now pricing only one Fed hike over next 3 years. As bond yields in Europe and Japan hit new historical lows this week, the US 10y yield fell to a 4-year low, just 20bps above its 2012 historical lows.”
Davy on Sun, 19th Jun 2016 5:58 am
We are trapped economically from this point forward meaning oil is likewise trapped because oil and the economy cannot decouple only converge and reinforce.
“This Is What The Coming “Bond Shock” Will Look Like”
http://www.zerohedge.com/news/2016-06-18/what-coming-bond-shock-will-look
“As BofA adds “despite unprecedented central bank policies of QE, ZIRP & NIRP, 655 rate cuts since the Lehman bankruptcy, $12.3tn of central bank financial asset purchases, prospect of a “one & done” Fed, central banks have lost the “War against Deflation”. They have failed to stimulate animal spirits depressed by the 4D’s of excess Debt, financial Deleveraging, aging Demographics and technological Disruption.” This “central bank failure” helps explains the recent unprecedented scramble into bonds: a deflationary instrument… and trade.”
“In other words, while the Fed hates the constant buying of bonds as it reduces the funds available to purchase stocks, it will hate the sudden, dramatic repricing that would result from a bond liquidation also known as a bond shock, even more. Finally, for those eager to quantify the damage, Goldman already did the math two weeks ago: a 100 basis point blow out in yields would result in losses of up to $2.4 trillion. And that’s in the US alone. Add the rest of the world and one is looking at as much as $8 trillion in global MTM credit losses. We bring this up just in case there is still any confusion what the real reason behind Bullard’s unprecedented recanting on Friday was, and why the Fed has now given up on renormalizing interest rates, precisely as we previewed two weeks ago in “Why the Fed is trapped.”
tita on Sun, 19th Jun 2016 6:26 am
Yes, the 1998 price collapse had a huge impact on the global oil production in the 10 years following, and the price escalation due to insufficient investment. Today is more similar to this situation than the 1985 one.
The Iran filled the gap of the declining shale production, but is now at his pre-sanctions levels. There is other oil production stuck from geopolitical tensions (Nigeria, Lybia, Irak) that could fill future non-OPEC decline, but unlike 1985 there is not 5+ mbbl/d OPEC production deliberately kept away from markets.
Is there enough 50$ oil production to fullfill the 50$ oil demand? Nobody really can answer this question, and certainly not Michael Lynch. Wait a few years for the answer. IMHO, I think we will see another price escalation starting from 2017, but this is a wild guess.
rockman on Sun, 19th Jun 2016 8:00 am
tita – “Is there enough 50$ oil production to fullfill the 50$ oil demand?” Perhaps a better way to ask the same question: if there are too many potential buyers for all the $50/bbl oil available are there a significant number of buyers who can justify paying more then that? If yes then oil would be selling for more then $50/bbl.
That’s the nature of the supply/demand dynamic. But it’s not instantaneous. Feedback loops exist but they take time to balance. We may be at or close to that balance. But it will again become unstable if the global economy booms or contracts significantly and thus alters the demand side. The refiners can set the price they are willing to pay but can’t contrlol how much oil the producers bring to market.
Or it becomes unstable again if more oil is offered in the market place…or less. The producers can’t set the price…only how much they sell.
Just a long winded way of saying we no more have a glut today then we had an oil shortage when it was $100+/bbl. In both cases supply and demand were balanced. IOW today we have a huge glut of $100/bbl oil and a huge shortage of $20/bbl oil. But we do have just the right amount of $50/bbl oil. For the moment, anyway.
shortonoil on Sun, 19th Jun 2016 8:03 am
“Is there enough 50$ oil production to fullfill the 50$ oil demand? “
Oil must be able to power a quantity of economic activity that is at least equal to its price; if it didn’t the money would not exist to buy it. Or, in simpler terms, no one is going to spend $2 on oil to produce a $1’s worth of goods and services. Oil must be able to pay for itself, and that is a function of the energy it can provide.
The chart above informs us as to where that balance point is to be found over time. There will be enough $50 oil to fulfill a $50 demand for another year and a half. After that it will be $40, then $30, then ….
It is analogous to burning the house down one board at a time to stay warm in the winter.
http://www.thehillsgroup.org/depletion2_022.htm
Roger on Sun, 19th Jun 2016 3:17 pm
“Oil must be able to power a quantity of economic activity that is at least equal to its price”
Not exactly. Perhaps, “any purchase requires the purchaser to believe he’s obtaining a reasonable value in the transaction” is closer.
So, what’s a gallon of gas worth? Nothing, if you don’t own a car (or lawn mower, etc.). However, if you do, the amount of work done by that gallon is indispensable (try hiring your buddies to push your car 20 miles and see what they charge).
The price of oil will be set on the world market by supply and demand. Demand continues to grow by over 1 million barrels per day each year. Peak oil (barring a price above $150/bbl sustained for several years) is in the rear view mirror.
The price of oil has no where to go but up…and price shocks are just around the corner. Wish it weren’t so, but that’s the case.
I suggest covering your short.
Joe D on Sun, 19th Jun 2016 4:47 pm
Nope, wrong, not true: “So, what’s a gallon of gas worth? Nothing, if you don’t own a car (or lawn mower, etc.).”
Do you grow all of your food? Make your own clothes? Live off grid? Use only what you yourself have made? ETC?
Oil derivatives are in EVERYTHING!
Davy on Sun, 19th Jun 2016 6:30 pm
Price and value are two different things but related. Price discovery is not perfect. When price discovery is healthy and the underlying economy is sound price works marvelously. Value depends on the functional state of our economic and social system. Value must have congruity. Shocks do not have to mean high prices. Low prices that are part of shortages in a collapsing economy is a shock.
What is around the corner is destructive change and instability. This includes the economy, the climate, and our social fabric. One thing is certain we have left the old and we are stepping into a new reality regime. We cannot expect the old rules to govern this new regime. In fact the old rules are a hindrance to this new reality.
The ETP model forecasts a price trend based on the thermodynamics of depletion and the required energy for a functionally adequate EROEI for society if I am reading it right. The fundamental point to ETP is the cost of oil production and the resulting net energy to society. This price trend and oil resource lives within a global economy. Everything lives within a climate system. It is these interaction that will determine oil’s contribution to global society along with the thermodynamics of oil. It is a situation of multiple levels of abstraction that rain down on the local we all dwell in. This existential local has been delocalized so this leaves us at the mercy of these abstractions from without and resulting in locals lacking control.
Price is becoming increasingly irrelevant as we approach the dead state of oil and the bifurcation point of a collapsing economy. Price detaches from a functional significance as our system approaches a minimum economic operating level. This is because as this inflection point is approached dysfunction and abandonment occur. It is the boil and the turbulence of steam that lack definition and without definition there is a degree of chaos. These systematic incongruities are the marker for bifurcation and bifurcation is the condition of an unstable system seeking a stable state. Price is lost in instability. Deflation and inflation leading to a hyperinflation loss of confidence renders price irrelevant. We are approaching this state of affairs. It will be a crisis made up of multiple shocks. It will be a cascade of shocks in a collapse process. Price will be lost in this process.
Davy on Sun, 19th Jun 2016 8:34 pm
“Putin Said to Weigh $11 Billion Rosneft Sale to China and India”
http://www.bloomberg.com/news/articles/2016-06-19/putin-said-to-weigh-11-billion-rosneft-sale-to-china-and-india
Boat on Sun, 19th Jun 2016 9:09 pm
Davy,
This is a good time for these oil producing nations to be selling off their fields. In 15 years oil demand will have peaked and producers will be fighting over a shrinking market.
Roger on Sun, 19th Jun 2016 9:52 pm
Deflation and inflation leading to a hyperinflation loss of confidence renders price irrelevant. We are approaching this state of affairs. It will be a crisis made up of multiple shocks. It will be a cascade of shocks in a collapse process. Price will be lost in this process.
Sounds like the “Mad Max” movies…but, even in those, the boys wanted the gas to drive.
Don’t think it will get quite that bad on the oil front….but, the nukes are a real threat. One nut with a few nukes could light up the world.
Kenz300 on Wed, 22nd Jun 2016 10:07 am
Electric cars, trucks, bicycles and mass transit are the future…..fossil fuel ICE cars are the past…………..
Think teen agers vs your grand father…………………. cell phones vs land lines…….
NO EMISSIONS……..climate change is real………
Save money……no stopping at gas stations…..no oil changes……..less overall maintenance……
Boat on Fri, 20th Oct 2017 7:42 pm
Canada approves anti-Russian law sponsored by Russophobes
On October 19, the document was effected upon receiving a formal sanction from Queen Elizabeth II. Prior to that, the law was passed by the House of Commons, and on Tuesday – by the Senate.
Читайте больше на http://www.pravdareport.com/news/world/americas/19-10-2017/138983-canada_magnitsky-0/
Dam those Jews, they struck again.