Tuesday, February 16, 2010

Double, double, oil and trouble

(Photo: An explorer at work in Hoima, from
Epic quest for oil in Uganda, by Francis Mugerwa, no photo credit)

Let's face it, short term predictions about oil prices, supply, and demand are one of two things: simple because you presume a straight line, or bullshit either because something in the world changed that you didn't/couldn't account for or because the short term is too short to be useful. And long term, they're easy -- eventually prices get high and both supply and demand drop. Of course, exactly when "eventually" is does remain a question.

With the exception of the Saudis and a few dead-enders, everyone accepts that an extraction peak is coming. Whether that peak is recently past, coming soon, or a decade or two out is still a legitimate subject for debate (although that last is most unlikely, I think). Similarly, almost everyone expects a continuing worldwide increase in demand, especially from India and China.

But right now, we are riding a delicate balance between reduced demand (caused largely by the economic downturn) and at-best-stable supply. Prices are a far cry from the $147 we saw or the historical $20, but have been reasonably stable between $70 and $80 for some time. I've said before that I don't see long-term $40 oil again, and I don't see any reason to change that. Unless we make substantial changes, economic recovery will drive demand for oil, which will drive prices, which will reduce recovery, and the cycle will continue. Our ways out are limited: reduce demand (through conservation, efficiency, and alternatives) or discover a new way to increase supply (through exploration and improved extraction technology). The first is under our control, the second less so. Unfortunately, we seem determined to avoid conservation and alternatives on a large scale. If we fail to address the fundamentally unstable close match between oil supply and demand* we will continue to follow this sort of cycle.

* Economics says that supply and demand curves cross and that cross is a stable market price for a good. But classical economics doesn't say a lot about the dynamics of that process. We know it's not instantaneous. We also know that the assumptions behind classic supply/demand curves are not necessarily valid in the real world (the whole concept of peak oil denies the assumption that rising prices will continuously raise supply).

Signs of Declining Extraction Rates
ExxonMobil announced it will recover an additional 40 million barrels of oil at the Hawkins Field in northeast Texas, equal to the annual energy needs of more than one million Texas households.

The project will extend the life of the field, discovered by the oil giant in 1940, for an additional 25 years. Though a small part of ExxonMobil's reserves the extension of life for such a mature oil feed is at least some evidence that new technologies can help push back the reckoning of the world's "peak oil" moment.
This is a 70 year old field, so it's no surprise that extraction rates are low. What's interesting is that ExxonMobil is willing to spend a lot of money to extract another relatively paltry 40 million barrels (a bit over two months US demand) over 25 years when they could spend that money elsewhere.

Maybe there's no where else for them to spend it?
State oil giant Saudi Aramco plans to inject carbon dioxide into the world's biggest oilfield by 2010, a year ahead of previous plans, a government official said on Monday.

The giant field Ghawar pumped 5 million barrels per day (bpd) in 2008, more than half of top oil exporter Saudi Arabia's output. The kingdom announced plans last year for a pilot project to pump the climate-warming gas into the field to both improve production and reduce emissions.
The kingdom plans to inject 40 million standard cubic feet per day (cfd) of CO2 into the field, and has said this is part of the global push to trap emissions rather than because it needs to enhance oil recovery from the field.
Saudi Arabia is famous for being close-mouthed about their level of reserves, and is widely suspected (as are most OPEC members) of inflating their reserves, because OPEC allocates extraction quotas partly based upon reserves. Although Saudi Aramco claims that injecting CO2 is "part of the global push to trap emissions rather than ... to enhance oil recovery", there's no question that gas injection will increase extraction. Gas injection is considered a "secondary recovery" technology.

Sign of declining discovery
One tally pegged the Giraffe field -- anyone want to guess how they came up with that name? -- at some 400 million barrels. Heritage's CFO, however, suggested that the wider "Giraffe-Buffalo" field, which encompasses some 3,420 square miles, could contain several billion gallons of crude.

The find is the largest in Sub-Saharan Africa in at least the past 20 years. Previously, the largest onshore fields discovered in sub-Saharan Africa were at Rabi-Kounga in Gabon, where 900 million barrels were found in 1985, and at Kome in Chad, where 485 million barrels were found in 1977.
Four hundred million barrels of oil is about 22 months of US demand and less than 5 days of worldwide demand. The suggestion that the Giraffe-Buffalo field might contain several billion gallons has no real basis -- it's essentially a marketing claim and it does not suggest reserves (which depend upon recovery rate) but total oil in place.

Peaking? Duck!
Gabrielli states in his presentation that the world needs oil volumes the equivalent of one Saudi Arabia every two years to offset future world oil decline rates.
Gabrielli shows world oil capacity peaking in 2010 as shown in the translated version of his chart below. He shows historical world oil production to 2008. Next, he applies a decline rate of 5% per year to existing production represented by the lower light blue area. He then forecasts capacity additions from sanctioned projects estimated from Wood MacKenzie's Global Oil Supply Tool. These oil capacity additions are in four categories: OPEC new projects, OPEC expansion projects, non-OPEC new projects and non-OPEC expansion projects. In 2010 the biggest contributor is OPEC expansion projects which includes about 1.3 mbd from Khurais and 0.8 mbd from Khursaniyah. These additions include both crude oil and natural gas liquids and are sourced from Saudi Arabia's official statements which lack independent verification.
2009 was a banner year for oil discoveries, with a lot of headlines being generated by finds in Brazil and the deep waters of the Gulf of Mexico. In fact, we saw discoveries on the order of 10 billion barrels of reserves, the highest rate since 2000 when the giant Kashagan field in Kazakhstan was discovered. However, the world is consuming around 83 million barrels a day, which equates to 31 billion barrels a year. So even in this banner year, we are barely replacing one third of the oil we consume.
When you look back at the East Texas oil boom early last century, oil wells were being drilled a few hundred feet deep. In the deserts of Saudi Arabia and Iraq, giant oil fields are so close to the surface that you could practically stick a straw in the ground and strike oil. These big, easy finds were relatively inexpensive to develop.

But check out where we're looking now: The latest Gulf of Mexico discovery, Tiber, is a well drilled to a depth of 35,000 feet and lies beneath 4,000 feet of water. Think about that; the well is a mile deeper than Mount Everest is tall. It will likely take 7–10 years before this discovery produces anything. While this is a significant discovery, it certainly isn't cheap oil.
Let's put oil-field declines in context. World oil production is roughly 83 million barrels per day. Various estimates place the underlying global decline rate somewhere between 4% and 8% per year. That means that each year we have to add about five million barrels of new production to keep production flat. Step five years out, and we have to replace 25 mb/d of production, or about three times Saudi Arabia's current production. That's a lot of new wells that need to be started just to offset declines.

Plus, this does not account for any growth in oil consumption. Absent global recessions, underlying oil demand is increasing by about 1% per year. This means that five years out we'd need another 5 million barrels of oil per day just to keep the current equilibrium. Frankly, we're not certain that we'll be able to reach that level of production.
A top Saudi energy official expressed serious concern Monday that world oil demand could peak in the next decade and said his country was preparing for that eventuality by diversifying its economic base.
Al-Sabban said the potential that world oil demand had peaked, or would peak soon, was an "alarm that we need to take more seriously" as Saudi charts a course for greater economic diversification.

"We cannot stay put and say 'well, this is something that will happen anyway," al-Sabban said at the Jeddah Economic Forum. The "world cannot wait for us before we are forced to adapt to the reality of lower and lower oil revenues," he added later.

Some experts have argued that demand for oil, the chief export for Saudi Arabia and the vast majority of other Gulf Arab nations, has already peaked. Others say consumption will plateau soon, particularly in developed nations that are pushing for greater reliance on renewable energy sources.
Saudis say don't worry about peak oil (2010.01.28):
There is still plenty of oil in the ground and the world should put aside fears about "peak oil", the head of the Saudi state oil firm Saudi Aramco said on Thursday.
Of course, the Saudis could have no possible reason for encouraging the world to continue to guzzle oil like there's no tomorrow. In all seriousness, as noted above, the Saudis have incentive to inflate their reserves, and no incentive at all to encourage the world to switch from petroleum to alternative energy sources.

Let me begin with the narrative that all of my energy economics students must know perfectly after my second lecture. The Russian oil output is probably close to peaking, and in any event the director of one of the largest Russian firms says that his country will never produce more than 10 million barrels per day (= 10mb/d). This number may be slightly wrong, but it happens to be one-tenth of the amount (= 100 mb/d) that the present CEO of Total (the French oil major) says is the absolute maximum for world production. (Another Total executive recently suggested 95 mb/d).

If this is not sufficient, consider the following. The discovery of what we think of as conventional oil peaked in 1965. In the early 1980s the annual consumption of oil became larger than the annual discovery, and at the present time only about 1 barrel of (conventional or near-conventional) oil is discovered for every 3 consumed. According to a BP (BP) document, of 54 producing nations only 14 still show increasing production. 30 are past peak output, while output rates are declining in 10.

Non-OPEC countries produce 60% of world oil, and that output has peaked. It is also my opinion that while Russia may not join OPEC – or be allowed to join – it will go along with OPEC’s production agenda. OPEC is the arbiter of the world oil economy today and in the future, although that topic is too complex to be taken up in this note. Output in the U.S. peaked in 1970 at 9.5 mb/d, and production turned up when the giant Prudhoe field in Alaska came on line, but the previous peak was never attained. Instead the new peak was 7.5 mb/d. Today it is less than 6 mb/d, and steadily falling. North Sea oil (Norway + UK) peaked just before the end of the 20th century, and the super-giant Cantarell Field in Mexico – the third largest in the world – peaked slightly before that. Its decline is steeper than students of Mexican oil could possibly have expected.

Roughly two years ago the Saudi oil minister stated that his country would soon be producing 15 mb/d of oil in the not too distant future, and that output could be held for 50 years, but Saudi production has almost certainly peaked at less than 10 mb/d, despite what appears to be exceptional efforts to raise it to 10 mb/d after about 2005. Of course, as far as I am concerned, it does not make any difference what an oil minister or foreign oil expert says about Saudi intentions. Thirty years ago or so it was decided that (sustainable) Saudi production would never exceed 10 mb/d, although a surge output of 2 mb/d might be made available.
Whither Prices?
It has been 18 months since we all worried very much about high oil prices. Starting in July 2008 gasoline prices took an historic plunge dropping from a U.S. average high of $4.11 a gallon all the way down to $1.70 in January 2009.

In retrospect this price drop was a good thing for it did more to slow the downward spiraling recession than most people realized. In the last 12 months however, the situation has reversed and the average price for gasoline is pushing $2.80 a gallon. An increasing number of commentators are starting to talk of the return of $100 oil and $3+ gasoline.
There are numerous factors that will affect the balance of forces determining gasoline prices six months from now - the economic situation in the OECD nations, the pace of economic growth in China, India, and several other Asian countries, the stability of the U.S. dollar, the weather, stability of Iran, and perhaps even an OPEC decision to increase oil production if prices get too high.

While it is difficult to foresee clearly the interaction of all these factors, the conventional thinking is that U.S. and OECD oil consumption will remain flat, the Saudis will continue to withhold a couple of million barrels a day (b/d) from the markets, and China will continue to grow rapidly in 2010. Many believe the Chinese are coming up on a massive real estate bubble-burst one of these days, but this still seems to be a couple of years away and is unlikely to have much to do with gas prices next July.
Perhaps the most important of these are the announced plans of the U.S. Federal Reserve and Treasury to stop supporting the financial industry, the housing industry, low interest rates, and whatever else they are overtly or covertly subsidizing by the 1st of April. The idea would be to let the U.S. economy try to stand on its own feet prior to the November mid-term elections without the help of hundreds of billions in government subsidies. Whether this plan actually comes to pass is problematic, another couple of months worth of bad economic news may lead to a decision to continue the programs.

The greatest danger from hasty removal of government intervention is the likelihood that interest rates will increase substantially and that the U.S. dollar will fall thereby sending dollar-denominated oil prices higher no matter what happens to supply and demand.

At the minute, a substantial drop in oil prices in the next six months seems unlikely without a major untoward development. Shortages from insufficient global oil production are still a few years away, so for the time being the value of the dollar and the demand for oil will be the controlling factors. A Chinese economic meltdown still seems to be some years off. A better bet is the collapse of the U.S. equities markets which have been disconnected from reality for the past nine months.

We are already getting some numbers showing that the demand for gasoline in the U.S. is slowly dropping - this probably has something to do with the unemployment rate is which is realistically over 20 percent. As gasoline is so important to the average person in the U.S. reductions in automobile use will likely be slow and undertaken reluctantly. The inconveniences of less driving still outweigh the cost of gasoline for most.
Unless there is a major geopolitical upheaval in the next six months, oil prices are likely to creep up as they have been doing since last May. Gasoline prices will continue their tradition winter/spring climb likely passing the $3 per gallon mark which seems to be psychological point that impedes the sale of large cars.

How much further prices will go is impossible to responsibly forecast for there are simply too many unknowable variables involved.

The only thing we can be sure of is that this increase is going to damage, perhaps fatally, prospects for a U.S. economic recovery. With more and more money being sent away to pay for "essential" gasoline supplies, there is going to be less and less to pay for everything else.
...the key issue is not whether petrol and diesel prices should reflect today’s oil price of $75/barrel. It is that booming Asia will in a decade push oil to $200/barrel and maybe $300/barrel. India must prepare for a world of scarce, expensive oil instead of pretending that astronomical subsidies can ensure price stability.
In its latest economic brief on the oil market and budget developments, NBK noted that, crude oil prices fell sharply in the second half of January, moving closer towards the $70 per barrel (pb) level. After reaching the $80 pb mark on January 11th, the price of Kuwait Export Crude (KEC) fell by $9 to $71 pb by the 26th. Two factors seem to have been catalysts for the fall.

First, rising risk aversion across global markets saw a flight to the US dollar, which traditionally puts a damper on crude prices.

Secondly, the announcement of new measures to stem the growth of credit in China raised concerns of slower oil demand; China has accounted for 40% of the growth in global oil demand in recent years.

Yet despite the latest leg down, more bullish analysts still expect crude prices to remain range bound between $70-80 pb over coming weeks, before pushing higher as tighter crude market fundamentals (including rising demand and shrinking inventories) start to reassert themselves.

...This seems to reflect the view that current price levels – despite some volatility – are essentially well supported, backed by a recovering world economy and commitment from OPEC to keep prices in the $70-80 pb range.

...The Centre for Global Energy Studies (CGES) has revised up its forecast for incremental oil demand in 2010 for the second month in a row, this time to 1.2 million barrels per day (mbpd), at a 1.4% growth rate, from 1.0 mbpd a month earlier. This compares to its forecast of 0.7 mbpd in November. The centre expects year-on-year growth in demand in every quarter this year, although decelerating as the year unfolds as the base effect from weak growth in 2009 recedes. The International Energy Agency (IEA) has retained its bullish forecast for growth in oil demand of around 1.4 mbpd (1.7%). Both institutions (and others) expect practically all of this year’s growth to come from countries outside the OECD. The so-called BRIC countries – Brazil, Russia, India, and China – for example, could account for half of all the increase in global oil demand this year.