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Page added on October 18, 2015
Goldilocks and the three prices of oil
We all know Goldilocks from the story of Goldilocks and the Three Bears in which the young maiden wanders into the home of the bears and samples some porridge that happens to be sitting on the dinner table. The first bowl is too hot, the second is too cold and the third is just right.
Like a corporate version of Goldilocks, the oil industry has been wandering into the world marketplace in recent years often finding an oil price that is either too high such as in 2008 and therefore puts the brakes on economic growth undermining demand and ultimately crashing the price as it did in 2009. Or it finds the price too low as it is today therefore making it impossible to earn profits necessary for exploiting the high-cost oil that remains to be extracted from the Earth’s crust. Oil that hovered around $100 per barrel from 2011 through much of 2014 seemed to be just right. But those prices are now long gone.
Violent swings in the price of oil in the last decade have made it difficult for the industry to plan long term to produce consistent supplies at moderate prices. This has important implications for future supplies which I will discuss later.
The great political power of the oil industry has led many to conclude erroneously that the industry must also somehow control the price of oil. If the industry has such power, it is doing a really lousy job of using it.
It is true that in times of robust demand, OPEC can maintain high prices by limiting oil production in member countries. But when demand softens, OPEC rarely exhibits the necessary discipline as a group to cut production. Typically, Saudi Arabia shoulders most of the burden of reduced production under such circumstances.
Which is why it was so shocking when, during this most recent swoon in the oil price, the desert kingdom responded with an emphatic “no.” No, Saudi Arabia will not curtail its production. And, since all the other OPEC members are unable to challenge Saudi Arabia’s power–which consists of the ability to add production to counter cuts by others–the price of oil has stayed low.
The stated reason for this move is that Saudi Arabia wants to undermine American tight oil production. And, low prices are doing just that. The U.S. oil rig count peaked in October last year at 1609. In the week just passed that number was 595.
The low-price strategy seems to be knocking the competition out of the game. And, it’s difficult to imagine investors in the future dumping great gobs of new money so freely into tight oil wells and the companies that drill them after having been thoroughly burned this time around. And, that’s probably true even if the price of oil recovers significantly. There will always be the fear that Saudi Arabia will flood the market with oil and crash the price. (This is not, in fact, what Saudi Arabia has done so far. In the most recent oil price rout, the Saudis simply refused to cut the kingdom’s then current production level–as it had regularly done in the past–even as demand softened and prices fell.)
Probably one of the best illustrations of the problematic future of oil supply is the recent abandonment of a multi-billion dollar arctic oil drilling project by Shell Oil Company, the American arm of the European-based Royal Dutch Shell PLC. Shell called its arctic discoveries “marginal” and indicated that it would cease drilling there for the “foreseeable future.”
This emphasizes that the remaining oil available for extraction is both difficult-to-get and high-cost. It turns out that the oil discovered by Shell’s arctic project comes in small packages instead of the giant reservoirs which have powered the oil industry and modern civilization up to now.
What this implies is that limitations on future supplies may result from the price of oil being too low. Contrary to the public perception that such limits would be accompanied by high prices, it is precisely high prices that make it possible to exploit the marginal deposits that are unprofitable today.
Writer Gail Tverberg has developed this thesis in detail on her blog Our Finite World, a thesis first advanced by energy analyst and consultant Steven Kopits. (A presentation by Kopits is available here.) Tverberg’s analysis is that high energy prices, particularly high oil prices, tend to suppress economic growth leading to recession and price declines. The lower incomes and lack of employment that accompany recessions make oil–despite its lower price–less affordable than is generally recognized. Lack of demand is partly the result of crimped living standards–which keep prices low, which, in turn, make it unprofitable to exploit high-cost oil.
Now, oil demand actually went up somewhat in the face of recent lower prices. But if Tverberg’s thesis is correct, then demand won’t hold up when the economy sinks into a recession or stalls close to zero growth. If the world economy shrinks or merely stalls, as it now appears to be doing, we may be in for a long stagnation for other reasons as the world works off debt built up previously in a long 30-year credit boom.
It seems only logical that if world oil production drops as a result of low demand and low prices, at some point shortages will appear and prices will rise even if the world economy remains in a slump. That may happen, but the big question will be this: Just how high can those prices rise before financially strapped consumers can’t afford to pay more?
If that price turns out to be somewhat less than $100 a barrel, very few deposits of unconventional oil such as arctic and deepwater oil, tight oil from deep shale deposits, and tar sands will be profitable to produce. And these unconventional sources have been virtually the only engines of oil production growth in recent years. The International Energy Agency, a consortium of 29 countries which tracks energy developments, is already on record saying that conventional oil production peaked in 2006.
With violent swings in oil prices continuing, it’s hard to imagine world markets delivering an oil price indefinitely above $100–which would encourage growth in unconventional oil production–but not above, say, $130, which could easily send the economy into recession and lower prices below the point of profitability for unconventional oil. It seems that either Tverberg’s stagnation scenario will limit production because of low prices or that a return to robust economic growth will be doomed to be short-lived because oil prices rise move above what the world economy can bear.
It’s always possible that some technological breakthrough will allow us to get out of this cycle. But we should not count on this soon. As I have pointed out, the most recently touted “new” technology, the technology that opened the deep shale deposits in the United States for oil drilling, has a 60-year history of development:
For those who point to hydraulic fracturing as a recent technological breakthrough, they need to do a little research. Hydraulic fracturing was first used in 1947. More than 30 years later in the early 1980s, building on government research, George Mitchell and his company Mitchell Energy and Development began pursuing natural gas in deep shale deposits. It took Mitchell 20 years of experimentation, government help and government incentives to perfect the type of hydraulic fracturing which is now used to release both natural gas and oil from deep shales. It took another 10 years for his methods to be widely deployed by the oil and gas industry.
For truly revolutionary technology to make an important contribution to the world’s oil supply over the next 20 years, that technology would have to be available today, but not yet widely deployed. The cycles of innovation in the oil industry do not move nearly as quickly as those in, say, the semiconductor industry. Major breakthroughs in oil extraction require long lead times, and there doesn’t seem to be anything but marginal improvements in some existing techniques in prospect for many years to come.
For now, we may be experiencing limits in oil production that are not absolute, but relative to what the world economy can afford. Of course, we could rework our infrastructure and daily practices to use less oil or even to begin to phase it out altogether. But, don’t look for that kind of dramatic move anytime soon, either.
17 Comments on "Goldilocks and the three prices of oil"
Plantagenet on Sun, 18th Oct 2015 12:21 pm
The idea that peak oil may result from an oil price that is too low is interesting, but ultimately false. We have low oil prices right now because we are in an oil glut. Thanks to KSA producing full out there is a supply overhang. But peak oil will inevitably produce oil shortages, and the oil glut will vanish.
When there are oil shortages the demand for oil will exceed the supply and the price of oil will go back up.
Cheers!
onlooker on Sun, 18th Oct 2015 1:06 pm
So then Plant you are willing to discount this dynamic of oil prices that peaked in 2008 along with other economic malaise bringing down consumer demand which in turn bought down prices of oil. Do you not think in general that this see-saw effect is logical, oil prices rise, demand lowers, stifling supply which in turn leads finally to lower price for oil that ignites some recuperation which starts the cycle again. Is that not logical?
paulo1 on Sun, 18th Oct 2015 1:09 pm
Excellent article. Plant, your hypothesis is the one generally accepted by economists, and hoped for by oil company execs. It is even mentioned in this article. However, it does not allow the compounding function of debt in the entire equation of energy supply. What is going to fuel the new wave of production when the price increases?(pun intended). Borrowed money at 0% invested on margin? Will credit ever again be available at such levels that brought us LTO? Is there a continual crop of people willing to risk their economic future when so many are going to go broke right soon?
I’ve got a few bucks stashed away and the last thing I would ever invest in would be future Shale prospects, or any other drilling scheme.
regards and cheers yourself….(by the way, just ate some smoked chum salmon and it was unbelieveably good!! Usually, the dogs get it….but this batch, mmmmmmm.)
GregT on Sun, 18th Oct 2015 2:05 pm
“The idea that peak oil may result from an oil price that is too low is interesting, but ultimately false.”
Absolutely. Oil prices are a result of peak oil, not the other way around. Money is a claim on future energy. Energy is not created out of money.
BobInget on Sun, 18th Oct 2015 2:06 pm
Memo, Plantagenet:
Dear Sir:
At the present time, there is no ‘oil glut’.
Yours, Bob Inget
Durwood M. Dugger on Sun, 18th Oct 2015 7:07 pm
Tverberg’s descriptions of the oil market are well thought out and at least partially correct. However, there is more complexity in today’s oil markets than she describes.
As both solar and wind and the electric car have started making significant impacts on fossil energy market volumes – albeit along way from replacing fossil them the “handwriting is on the wall” for fossil fuel producers.
Until very recently the excepted wisdom for oil producers has been to meter out production at the highest prices possible, because their resources are finite and they want to extend their sales at the highest values possible.
However, it is now clear that we will eventually (not tomorrow, but maybe in decade or two) stop our dependence on fossil fuels for most of our ground transportation needs. Now there is a horizon event in view where fossil fuel demand will be reduced drastically. So, why conserve national oil reserves? Rather it is better to sell them – while you still can. Clearly KSA does not see higher prices returning in the near term. Consequently, it is no wonder KSA refuses to cut production.
Add to that motivation (selling the resource while the market still exists) the ability to slow not only tight oil investment, but alternative energy development as well, even to stick their finger in Putin’s imperialistic eye in the middle east – and KSA is doing the logical thing for their strategic interests and needs.
I’m sure we’ll still see some swings in oil market prices, but as alternative energy sources take bigger and bigger bites of fossil fuel markets, it is going to be harder and harder to push those swings.
rockman on Sun, 18th Oct 2015 8:04 pm
Durwood – “As both solar and wind and the electric car have started making significant impacts…the “handwriting is on the wall” for fossil fuel producers.” What handwriting? Last time I saw the numbers the amount of Btu’s from fossil fuels had increased at a faster rate then those from solar and wind. You are certainly free to state the % increase in solar/wind but that doesn’t represent the situation in absolute volumes: the world is producing/burning more oil and NG then every before in history. And coal isn’t far behind.
Davy on Sun, 18th Oct 2015 8:34 pm
Durwood, you are missing the important picture of the current penetration of alternative energy along with electric transport. It is single digit and this is after years of effort during relatively advantageous economic times. Some of the best sweet spots have been taken by solar or wind farms. The grid had growing room for the variable output of these large alternative energy sites.
We are now in a declining economy with less support. Demand destruction has hit fossil fuels making them more price competitive. Some climate change efforts have achieved results but robust carbon controls seems unlikely. There is nothing impressive from alternative energy indication a dramatic breakout.
You talk about a few decades away like we generally hear with so many cornucopian sources. We don’t have a few decades. Alternative energy is not scaling with time frame nor capital investment.
This green fantasy only masks the pain and suffering ahead. There are changes that can be made now. We can mitigate and adapt somethings to lower suffering and early death. Unfortunately there is a great deal that can not be changed nor mitigated. We are going to have many die and much social complexity will be lost.
To paint an optimistic picture with all this ahead of us is a tragedy of a society without any kind of effective risk management. This will lead to huge suffering because food and fuel scarcity issues are not far off. Food and fuel represent the food chain for humans and that is at risk.
makati1 on Sun, 18th Oct 2015 8:35 pm
‘Renewables” is Disney’s newest Fantasy Land. So many people want to believe… “When I wish upon a star…”
“European Renewables Investment Heads Towards Zero”
“Southern Solar: Ministers accused of sabotage as another solar firm collapses”
“UK Energy Subsidy Cuts Claim First Victim”
“Germany Now Faced With Thousands Of Aging Wind Farms”
“How much mined material will we need to build a 100-per-cent renewable world?”
“Are Solar Power Towers Doomed in California?”
http://ricefarmer.blogspot.fr/
Renewables? LMAO
Durwood M. Dugger on Sun, 18th Oct 2015 10:02 pm
I’m very aware of the single digit inroads of alternative energy and have my own criticisms of the green euphoria and exaggerated economics and sustainability claims.
However, even single digit inroads are “significant” and technology is slowing improving both their efficiency and their economics. I do think there will be additional break-throughs in alternative energy – non-solar and non-wind (https://en.wikipedia.org/wiki/High_beta_fusion_reactor).
I also agree if these technological break-throughs do not occur in time – that wind and solar alone will never offset global energy demand – especially with still growing populations and their increasing energy demands. This doesn’t change my strategy perspectives on the long term energy producers like KSA and or the end of fossil fuels.
Ironically, few people get the fact that the petrochemical industry is economically dependent on the transportation fuel industry, its current economy of scale and its infrastructure to maintain current petro-chemical costs. The critical understanding being that global food production is 95% dependent of NPK which is 100% dependent on the petrochemical industry having stable costs.
I agree with Davy that failing to recognize critical food production linkages in advance of the decline of the oil industry is going to have tragic consequences. Worse the growing success of alternative energy only hastens these impacts as it shrinks the technological window for solutions. Again, we are talking decades. Thinking that 1st generation technology is the end of solar and wind – is naive. Clearly, KSA sees these threats, too.
Apneaman on Sun, 18th Oct 2015 10:36 pm
mak, just a heads up. You will do better by directly linking to each headline and not an aggregator site.
makati1 on Mon, 19th Oct 2015 2:23 am
Ap, true, but quantity proves my point as well as one ref. Not that anyone is going to go there and read them. I’ll consider your advice next time. ^_^
makati1 on Mon, 19th Oct 2015 2:29 am
Durwood, critical food production linkages is most prevalent in the West. For instance, the US has less than 5% of it’s population in farming. And most of that is corporate, big Ag, oil dependent food production and distribution. Should the system collapse or shrink in any considerable measure, the food problem in the Us would be worse than any in Africa, South America or Asia, where most food is still grown locally by a large percentage of the population.
Apneaman on Mon, 19th Oct 2015 3:29 am
“Not that anyone is going to go there” That’s it mak. We be lazy in 2015. It crazy but there it is. A certain percentage will click on a direct link though.
You Now Have a Shorter Attention Span Than a Goldfish
“No longer can we boast about 12 seconds of coherent thought
The average attention span for the notoriously ill-focused goldfish is nine seconds, but according to a new study from Microsoft Corp., people now generally lose concentration after eight seconds, highlighting the affects of an increasingly digitalized lifestyle on the brain.”
http://time.com/3858309/attention-spans-goldfish/
It’s just one small study, but I have seen it in myself to a lesser degree. Also, the part about multi tasking is bullshit. You may get two things done faster, but always at poorer quality. That’s what the research shows that I have read. Looks like we are going through a self inflicted cognitive devolution. How else would it be near the end?
Davy on Mon, 19th Oct 2015 6:55 am
Mak said “Should the system collapse or shrink in any considerable measure, the food problem in the Us would be worse than any in Africa, South America or Asia, where most food is still grown locally by a large percentage of the population.”
It will be disastrous for Asia you should have added Makster. Asia has 4.5Bil people that rely on imports to complete its food chain. You also did not mention that all those subsistence African, South American, and Asian farms do not produce much surplus if any. Most of these subsistence farms require food from other sources. Few subsistence farming operations cover all the various food groups. Many of these subsistence farms are part time farms with some of the farmers time spent working elsewhere.
You fail to mention that the US has a significant small farming class and hobby farmers. You didn’t mention how these third world countries have urban areas that are big importers. We are talking HUGE urban areas. You also missed your point with South American that mirrors the West with large corporate AG. Big AG is big in Asia and Africa also and growing. Your Chinese buddies are expanding in these areas.
The problem with these importing continents is they are growing population and consumption. Their subsistence class will be overwhelmed by people needing food if there is a food shortage. So Makster you can’t paint your typical agenda picture of winners and losers but in the case of food it flops. The reality of the food chain is simple and clear cut. It is carrying capacity and surplus or deficit.
makati1 on Mon, 19th Oct 2015 7:07 am
Ap, I think the human species is dying from electronitis. Too many hours staring at electrons flowing across mini screens inches from their face most of their waking hours. Especially the under 30 crowd. I’m always having to zig and zag to miss the young pedestrians here when I walk anywhere in the Makati area. They are all glued to those little toys and barely know what they are doing or where they are going.
I have hopes that the poorer, un-electron addicted classes will be able to take over when the internet dies. By then, the electronic toys will have all of the more affluent users brain dead. Glad we didn’t have them when I was young. TV in the evening was bad enough, even though it was one, one minute commercial every 15 minutes and the some of the shows were actually educational.
Durwood M. Dugger on Mon, 19th Oct 2015 9:53 am
Regarding to the dependence of 95% of global food production on NPK fertilizers and its dependence on petro-chemicals – which are dependent on oil industry economy of scales, there is one critical element phosphorus. Nothing lives without adequate phosphorous. We will never run out of phosphorus, but we will run out of bio-available phosphorous that plants use to grow.
Up until the 1800s and the industrial revolution (followed by the development of mechanized farming supported by NPK crop production levels) humans lived within the natural phosphorus cycle (the process by which mineral phosphates are converted into bio-available phosphate forms by bacteria and other organisms in the soil. It is a very slow process. (https://en.wikipedia.org/wiki/Phosphorus_cycle)
Exceeding this natural rate produces “depleted soils” which produce much lower yields of crops. NPK solved the depleted soil problem. Our population went from under 2 billion to 7.3 billion in less than two hundred years. (https://en.wikipedia.org/wiki/Human_overpopulation)
Today Asia is in the final stages of converting from manure fertilization to NPK fertilization. Once this is complete 99% of the world population will be NPK dependent, and more than two thirds of the global human population will be beyond the natural phosphorus cycle food production capability.
As it turns out like all other living things humans too are limited by their access to adequate phosphorus. Current technology and economics can only provide phosphate fertilizer through the chemical conversion of rock phosphates into bio-available forms of phosphorus. This is accomplished using large quantities of chemicals and energy from the petroleum and petrol-chemcial industry. However, the petro-chemical industry is less than 3% of the total petroleum industry. If we are able to get rid of transportation fuel industry (the bulk of the petroleum industry) there is no way that the petro-chemical industry can operate as stand-alone industry and produce its products under current economic expectations.
More than 80 years of research of how to convert our wastes (sewage) and other phosphorus rich organics into bio-available phosphorus fertilizers within the same economic paradigms as that produced by the petro-chemical/petroleum industry have failed. Even if it succeeds it would provide about 3% of our phosphate fertilizer needs. Unless we develop alternative energy sources that are much cheaper than even current petroleum and petro-chemical prices – there is zero chance that even the current human population is sustainable as finite petroleum resources decline, become scarcer and more expensive to exploit. Once food scarcity enters the process, then starvation will be the least of our worries as violent chaos will take the human population back to below 2 billion (if it stops there) where we can be sustained without petroleum. If you aren’t familiar critical resources and especially phosphates watch this slide show (http://www.slideshare.net/DevFutures/dana-cordell-phosphorus-scarcity)
and or this video. (https://www.youtube.com/watch?v=zieJqsmy43o)