[Graeme]

Peak Oil Revisited - Oil Limits Are Now Debt Limits

$this->bbcode_second_pass_quote('', 'T')otally unexpected change, at least unexpectedly fast change across the global energy supply-demand space is only now beginning to produce the right analysis. The above chart that ends in 2011 can be continued with another unexpected change - both curves have broken downward. What we have today is not a lack of liquid hydrocarbon resources, or other hydrocarbon fuels, or non-hydrocarbon energy, but the inability of the Old World OECD to compete in a global economy based on using all kinds and types of what will become cheaper energy, starting with cheap coal. This was, ironically, the basis of the Old World's economic takeoff and prosperity from the late 19th century.

The old paradigm was that cheaper energy in the shape of coal fuel anabled growth and led to higher standards of living. This paradigm was routed by the 1970s oil shocks and the ecology-environment and green energy movement, now morphed into the anti-Global Warming movement. The new paradigm is a future of declining oil and energy prices to levels too low for the 20 to 30 major oil exporting nations and major energy corporations, an economic and financial problem, just as too-high oil prices were an economic and financial problem for the more-than-160 oil importer nations. The old paradigm dating from the 1970s oil shocks had massive lingering impacts across the economy and economic policy space ever since, but however if oil and energy prices in general decline - and they will decline - the financial and debt connection will spell major crisis.


At its most brutally simple, any return to the Cheap Oil era or epoch of 1985-2000, when oil cost around $15 - $20 per barrel is now completely impossible without a corporate and country debt crisis. The reasons for this start bad, and quickly become worse.

Overpriced oil is now obligatory, to prop up damaged and weakened national finances, and to finance "secondary and tertiary" oil production, always higher cost than "conventional oil". The result is brutally simple - oil has to stay expensive, and has to price itself out of the energy mix, and is doing so, shown by world energy dependence on oil falling from about 53% of all energy in 1973, to about 32% in 2013. More than a half of all energy was oil, but today less than a third is oil. Two-thirds of world energy, today, is not oil energy.

Further contraction is inevitable. Only the rate of contraction is to discuss and analyze, and immediately throws us up against debt limits - for oil corporations and oil exporting countries, bent on producing and supplying more oil, and for the now fragile "bad banks" and financial entities of the world.



The new energy-economic and financial paradigm is simple. "Overshoot and collapse" is now programmed into world energy financing and energy economics, due to energy prices necessarily falling but being thought of as "impossible" for too long.

Other ramifications of this crisis are, for certain, less stark or more subtle but are very wide ranging. Entities as apparently immune as the IMF and global central banks are examples - dependent on or accustomed to "hot money" petrodollar and petroeuro flows. Even fiscal drag in the energy intensive Western economies is another example. Drugged on high energy like the corporate sector, governments have a touching but blind faith in high-price energy.

One example, already mentioned, is the near-total dependence of the Green paradigm and Climate consciousness on high oil and energy prices. Only partly known to or accepted by the persons and entities working this now-depleting lode of public sympathy and support, either a debt collapse or an oil price collapse will not only bring down investment and interest in all fossil fuels, but will accelerate the already existing decline of investment support and new capacity in renewable energy.

Quite simply we will need less energy - so why produce more?

[SeaGypsy]

A confused position, oil prices must come down because it is becoming a smaller part of the mix, can't come down due to producer nation interests and new field development costs being much higher than previous. Every time I see an article suggesting serious decline in oil prices any time soon, I wince at the ignorance. There has been a few percentage points fall in demand in developed countries. The demand in developing countries keeps going up and has a long way to go to get even a quarter of the per capita demand of the developed. To my view articles like this are either spin or just writers looking for something to write, regardless of the real worth of what is written.

[Graeme]

I found this difficult to follow too. My take is that he thinks that oil consumption is declining all over the world because of expensive oil. The outcome is a reduction in demand which lowers price consequently the investment on expensive oil cannot be paid back. Producers cannot break this cycle by drilling for more oil.

$this->bbcode_second_pass_quote('', 'D')ebt limits were also closely tied to oil supply limits. The crossover date for when this became a "were" problem is very easy to set. This was the period 2005-2008.

[Pops]

$this->bbcode_second_pass_quote('', 'T')he result is brutally simple - oil has to stay expensive, and has to price itself out of the energy mix, and is doing so, shown by world energy dependence on oil falling from about 53% of all energy in 1973, to about 32% in 2013. More than a half of all energy was oil, but today less than a third is oil. Two-thirds of world energy, today, is not oil energy.

[SeaGypsy]

His reasoning is partly unicorn, partly alternative fossil fuels, then demand destruction being an overwhelming global force. He is correct only on percentages of total energy in the mix. He is wrong in the second aspect. Almost everywhere in the world, people with a job can get a line of credit to purchase a motor scooter. Coastal areas rely on petrol driven engines for fishing fleets. As Pops has detailed in the Price of destruction thread, there is a huge demand for oil products globally and will continue to be for the foreseeable future. Very small, very economical vehicles are treasured possessions in the developing world. These places are a long way off demand destruction in their economic cycle. The price could about double overnight without causing major demand destruction where people jam onto 125cc scooters to get to work, where a 15 horse motor boat feeds a large family, where a 5 horse pump irrigates a family rice field.

[Graeme]

Thanks for your clarifications. Pops, your answer is what the oil industry wants - high-priced oil - so it can continue to drill and extract profits. McKillop is saying that in fact oil prices are declining because of demand destruction. What he doesn't say is that destruction hasn't gone far enough to make the industry unprofitable. Seagypsy says that the demand is still there even in third-world countries.

Pops, Thanks for referring me to McKillop's other posts because in this one, he says:

$this->bbcode_second_pass_quote('', 'A')nyone looking for respite on the oil price front will find nothing of solace in the latest edition of the IEA's World Energy Outlook. Its 2012 edition is a recap of extreme spending wishlists and want-its in global energy, at least the way the IEA sees world energy. Some estimates (including its own) for IEA must-spend action in world energy to 2035, to ensure "energy security and climate stability", are as high as $45 - $50 trillion. The likelihood of this actually happening, of this investment and development spending taking place, are at best minimal.

[SeaGypsy]

Pop's theorem is spot on in my view. Say demand destruction gets bad enough to collapse prices below break even for tight oil- what happens? Smaller companies exclusively or majorly tied to tight oil go belly up. The market domination of easy oil gains, their internal demands keep growing, meaning they must keep prices up and they have less to export anyhow. The price is held up perhaps just below tight oil viability, currently about mid $70's pbo. This cheaper pricing leads to even more growth in demand from developing countries, eventually leading prices back into tight oil territory. IMO there is no scope for oil to go significantly under this threshold for any significant amount of time, sans unicorn solutions. Eventually the easy oil runs out and we are back to tight and deep oil with nowhere else to go for the good stuff. If the whole world was already at parity consumption with the USA the demand destruction based theorem would be feasible. There is a long way to go before DD in the west meets DG in the east.

"there isn't enough money" What money? USD perhaps, Euro perhaps. There are other currencies and the first world centric view is not concurrent with reality in the sense of growth elswhere being very possible with these markets continuing to fade. The petrodollar is doomed. The petro Euro may be likewise. There is already an emerging contender, said to inevitably dominate the world this century.

[Graeme]

Even China doesn't have a budget THAT big for oil production.

[SeaGypsy]

Maybe, but lump China with the other 1.3 billion just south of it, Africa and South America. Lots of people in the process of willingly upgrading to micro transport; while the west whines about downgrading to what will eventually be the meeting point.

[Graeme]

They are all (including oil companies) better off investing in renewables. Fuel cost is zero.

[Shaved Monkey]

Unfortunately you make more money virtually giving away the razor just so you can sell them blades for the rest of their life,not the other way round.

[ROCKMAN]

There’s a somewhat odd relationship to oil company profits/cash flows that might sound contradictory: lower oil/NG prices develop much higher net cash flow for companies. To understand you have to separate production costs from development costs. Simply put oil prices could fall 50% and we would keep producing every bbl possible. In fact most companies would do whatever they could to increase production from EXISTING wells. At the same time they would slash their drilling budget.

Consider my little company: when NG prices were higher we spent our portion of $400 million in drilling. And then NG prices collapse and we haven’t spent a penny drilling for NG. If you separate our NG production from our oil operations we are making huge net income from our NG: all incoming and zero out going. Haven’t drilled one dry hole either. LOL. It’s all gravy. But not necessarily profit: thanks to low NG and a nasty cost overrun one of my wells will never recover 100% of the investment. But it still generates a nice income. And the nice net cash flow we’re getting from our NG is funding our oil exploration program.

And as everyone here understands it means we’re also not replacing those conventional NG reserves…just like almost every other company. NG is getting a bit of help from production associated with the oil unconventional plays. Except, of course, for all that NG being flared in N Dakota.

For existing oil wells there’s a manageable income to be made at prices as low as $20/bbl. Not a lot of income but “profit” none the less. So if oil were to take a price tumble like NG the net incomes of just about every company would be positive. My private company would just keep producing but also stop drilling for the most part. And so would every other company. Even pubcos would hit a brick wall that would destroy $trillions in market cap and credit lines as they were unable to replace declining booked proved reserves.

And that’s when you’ll see a feeding frenzy begin by the scavenger like ExxonMobil and other Big Oils with huge cash reserves. They would pick up oil reserves for a fraction of what it would cost them to do so with the drill bit. This how it always has worked in the past and will continue to do so in the future. When NG prices collapsed XOM acquired XTO at a bargain price. That one acquisition amounted to 80% of the increased book value of the reserves XOM produced that year. IOW they replaced almost all their produced reserves without drilling a single well that year. And China? They couldn’t spend money fast as possible buying up in ground reserves all around the world. Which is exactly what they did after oil crashed for a short time a few years go.

So the obvious: if there were a prolong decline in oil prices there would be a drop in drilling activity. That nice boost to US oil production from those unconventional reservoirs would disappear overnight. Those high decline rates and a falloff in drilling would guarantee it.

And obviously low oil/NG prices would knock the wind out of alternative energy development. But prices will eventually increase as less oil becomes available to the market even with a decline in demand. Of course, with lower oil prices there would be a surge in consumption/demand to some degree. And that would lead to higher prices and more drilling. Except now there won’t be 100’s of pubcos to toss $trillions at the unconventionals. Big Oil and the NOC’s would be the big game in town with their deep pockets but they are notorious for moving slow. It also wouldn’t be very advantageous for Big Oil to add reserves very quickly: their market cap would boom as oil prices increased for their proved reserves. Big Oil would see their reserves jump by billions of bbls of oil while the world would see a zero gain. And the NOC’s would see their incomes rise without drilling a single well. And a good bit more of global oil production would have been cornered by China at this point. And if their economy hadn’t crashed completely into the toilet they would have sufficient demand for all the oil they would control then.

If we do have a slump in oil prices the world should enjoy the moment because eventually those low prices may create an energy future much worse than they are facing today IMHO.

[Pops]

$this->bbcode_second_pass_quote('Graeme', 'T')hanks for your clarifications. Pops, your answer is what the oil industry wants - high-priced oil - so it can continue to drill and extract profits.

[ROCKMAN]

It might be difficult to accept but the oil patch would prefer lower but long term consistent oil prices over higher prices. The biggest risk factor is price instability. Two good examples: the boom of the late 70’s spurred by suddenly high oil and NG prices pushed companies to spend a huge amount of capex. At the height we had almost 3X as many rigs drilling as we have during this latest boom. And when oil prices collapsed 100’s of companies went out of business and $trillions in stock value were lost. And more recent: the zooming price of NG by early 2008 led to another massive boom in drilling. And when NG prices collapsed two of the largest US independents, Chesapeake and Devon, almost went under. Both are still suffering from the effect today. And countless other small companies did fail and again huge sums of cap ex were lost.

No way to prove it, of course, but if you gave the oil patch a guarantee of $65/bbl oil and $4.00/mcf NG fixed for the next 20 years they would pick that over whatever the future market dictated. Selling oil for $90/bbl is great when you used just $65/bbl to justify drilling. But spending capex based on an expected price of $100/bbl and eventually receiving a much lower price can kill a company. I personally know of more companies that went under than made a killing due to pricing instability. I also know of 2 geologists that committed suicide after oil prices crashed in the mid 80’s.

[sparky]

.
Thanks Rockman , as usual ,
the price boom ,crash , boom story is on going
best example is the 1973, 1980 oil price boom ........ severe recession ,
oil price crash ,( crude dipped below 15$ ) sacking of thousand of oil workers , virtual shut down of the exploration
the world economy took off on cheap oil , big bottleneck on production , anyone knowing which side of a derrick is up got a job
price shoot up ...... recession .

nobody had commented on the alternatives energy needing high prices to fly

As for hot money , there is something else going on , the currencies war , hardly anyone mention it
there is now a deliberate and sustained pumping of US dollar , Yen , Sterling and Euro by the reserves banks
this flooding of world markets is to devalue one currency against the competitors
everybody against the Yuan and each other ,
everyone buying everybody else government bonds to drive down their currency
the amounts are eye watering ,Japan is pumping trillions of yen with a national debt of 240 % of GDP !!!!
the rest are racing in the same direction .
Surprise surprise there is no inflation , rather there is deflation
all the money seems to disappear into the stock markets and the national debts
it certainly doesn't hit the street
this will make economists write hundreds of books to work out later what is happening now

[rockdoc123]

$this->bbcode_second_pass_quote('', 'N')o way to prove it, of course, but if you gave the oil patch a guarantee of $65/bbl oil and $4.00/mcf NG fixed for the next 20 years they would pick that over whatever the future market dictated. Selling oil for $90/bbl is great when you used just $65/bbl to justify drilling. But spending capex based on an expected price of $100/bbl and eventually receiving a much lower price can kill a company. I personally know of more companies that went under than made a killing due to pricing instability. I also know of 2 geologists that committed suicide after oil prices crashed in the mid 80’s.