- Deciphering Current Natural Gas Market Data
- ConocoPhillips And Oil Industry Capital Spending In 2010
- Mexico Hits Service Sector With Doubts On Chicontepec
- Road Warrior Observations About Our Economy
- Peak Oil Will Influence The Shape Of Our Future World
Musings From the Oil Patch
October 13, 2009
Allen Brooks
Managing Director
Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies. The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks
In the last six weeks natural gas futures prices have jumped from a modern day low to nearly $5 per thousand cubic foot (Mcf) as commodity traders and investors started to cover their short positions in this fuel as the days moved closer to the beginning of the winter heating season. The jump in the gas price ends what has been an extended price slide that started back in summer of 2008 when prices were in excess of $13 per Mcf and early signs of the developing global recession emerged.
Exhibit 1. Natural Gas Prices Have Revived Somewhat
Source: EIA, PPHB
The traders and investors who have been covering their negative bets on natural gas prices have been motivated by signs the nascent U.S. economic recovery is gathering strength, especially among sectors such as automobiles and home construction that are large consumers of natural gas and its components as feedstocks for petrochemical materials. Additionally, there was the realization that the ratio of crude oil to natural gas prices, which at one point this summer stood at 27:1 (27.08) in contrast to the inherent energy-value ratio of 6:1, was way out of line historically and certainly unsustainable.
At the start of 2009, the oil-to-gas price ratio stood at slightly under 8:1 (7.94). It subsequently dropped in early January to the low so far for the year of 7:1 (6.79). Since that point the ratio has climbed steadily, reaching its peak on September 3rd. After falling to a recent low of 13.67, the ratio has bounced around due to volatility in both crude oil and natural gas prices, but it seems to be locked into a range of 14-15:1. The big question is with winter energy demand about to arrive will cold temperatures drive natural gas prices higher while at the same time crude oil prices remain stable, or possibly weaken further, given the continuing sluggish economic recovery?
Exhibit 2. Natural Gas Historically Cheap Even After Recovery
Source: EIA, PPHB
When we look at the ratio of crude oil to natural gas prices for the past 15 years, it is interesting to note how the ratio has become more volatile and higher in recent years following almost a dozen years of a relatively stable relationship fluctuating around a 7:1 ratio as shown by the red line from 1994 up until 2006 on the accompanying chart. The most recent years have demonstrated considerably greater price volatility between the two energy fuels. It appears the ratio averaged closer to 11:1 from 2006 through 2008. Volatility in the ratio has exploded in 2009. We have marked the low, high and current ratios with small red lines. It was this volatility and the extreme undervalued nature of natural gas that enticed more and more investors and traders into the commodity trade of the decade, which was to buy natural gas futures while at the same time selling crude oil futures. For significant parts of this year that trade didn’t work, but in recent weeks it has. Part of the success of the trade has been the calendar working against commodity traders who earlier in the year had sold natural gas futures with the expectation that gas prices would continue to fall. If they sold them early enough in the year, then they had profits locked in when natural gas prices started to climb. As time passes, bringing the start of the winter heating demand season closer, the impetus for higher natural gas prices strengthens. As a result, these commodity traders are now covering their short positions by buying near-month natural gas futures adding upward pressure to the gas price.
If one looks at the current prices for physical deliveries of natural gas, there is almost a $1 spread between them and the current November futures price. If we average all the physical gas price points as of October 8th, contained in the Enerfax Daily schedule, it comes to $3.98 per Mcf. This is when the November natural gas futures price traded for $4.96, or a spread of $0.98. This spread is truly reflective of the near-term oversupply situation for natural gas and the optimistic demand outlook associated with the futures price.
Exhibit 3. Physical Gas Prices Are Well Below Futures Prices
Source: Enerfax Daily
The nearly 100% increase in natural gas prices since the beginning of September seems counter-intuitive given the industry’s fundamentals. Natural gas storage facilities and pipelines are nearly all at full capacity forcing gas producers to involuntarily shut-in some of their current production. In other words, near-term industry fundamentals suggest the market should be experiencing weaker natural gas prices, which is consistent with the physical gas prices. On the other hand, the intermediate and longer term outlooks for natural gas demand point to higher prices in the future. The brighter over-the-horizon outlook reflects a universal belief that industrial demand for natural gas will recover with the economy and the recent growth in gas production volumes will slow and eventually reverse as the impact of the significant cutback in gas-focused drilling takes its toll on output.
Exhibit 4. Rigs Drilling For Gas Have Been Cut In Half
Source: Baker Hughes, PPHB
From the peak in natural gas drilling activity, the gas-oriented rig count has been cut by more than half. In recent weeks the number of rigs drilling for natural gas has begun to rise. It is this rig count increase in the face of an essentially stable natural gas production level that has investors, commodity traders and industry people puzzled. While a simple graph of onshore natural gas production is showing a decline since late last year, overall gas production has remained relatively flat for the past nine months as production from the Gulf of Mexico has risen to offset the decline in onshore gas production.
Exhibit 5. Natural Gas Production On Land Is Falling
Source: EIA, PPHB
After dropping due to Hurricane Ike last September, Gulf of Mexico natural gas production has recovered and is now above the declining trend line that extends back to the start of 2005. In fact, current gas production is back to where it was at the start of the summer of 2008. The recovery and subsequent production growth of offshore natural gas helps explain why total U.S gas production has remained healthy in the face of weak prices for most of this year.
Exhibit 6. GoM Gas Production Supporting Industry’s Growth
Source: EIA, PPHB
What continues to be absent from the dynamics of the natural gas market is a sustained pickup in industrial gas demand. Increased heating-related gas demand is inevitable as winter arrives. The issue will be the amount of heating demand increase if other economically-sensitive gas demand remains dormant. A recent forecast by Matt Rogers of Commodity Weather Group suggests that the U.S. Northeast may experience its coldest winter in a decade due to the development of a weak El Niño in the southern Pacific Ocean region. Mr. Rogers point is that 75% of the time a weak El Niño develops, colder than normal temperatures are felt in this region of the country. Of course, there is a 25% chance that it won’t develop.
When an El Niño develops, which it does periodically, the path of the upper atmosphere’s jet stream across North America is altered. Typically the alteration involves the jet stream dipping lower on the continent, i.e., shifting from Canada down into the United States, which allows Arctic cold weather to move further south than normally and into the Midwest and Northeast regions of the country. The challenge with predicting this jet stream shift is whether it becomes a more permanent shift during the winter months or only shifts occasionally.
Even the Farmers’ Almanac is calling for a colder winter than in recent years for at least two-thirds of the nation. Importantly, that means more periods of bitter cold weather for two of the major
Exhibit 7. Almanac Calls For Cold Winter
Source: Famers’ Almanac
populous regions of the U.S. That should boost natural gas demand. The one naysayer seems to be the Energy Information Administration (EIA) that is calling for heating bills this winter to be about 8% lower than last winter due to both milder temperatures and lower oil and gas prices. The EIA says it expects winter temperatures to average 1% warmer than last year – a sharp contrast to the independent weather forecasters. Maybe their forecast is tied to their view about the role of global warming. The real problem for the natural gas industry is that it really needs a recovery in industrial gas demand to help smooth out the industry’s supply/demand trends, and the latest government economic statistics suggest a mixed bag in that regard.
So far this year, natural gas prices have fallen from $6 per Mcf at the start to a recent low of $2.50 before rallying back to $5 in recent days. These prices are a far cry from the $13-$14 per Mcf prices achieved in the halcyon days of the summer of 2008. The extended price decline, while partially explained by the fall in industrial gas demand, has largely been attributed to continued over-production of natural gas from the industry’s highly successful gas-shale drilling efforts that are spreading across the country. The growth in the past several years of natural gas production associated with these successful gas-shale developments reversed an eroding production profile for the industry that had existed for decades. The questions facing the industry now are whether gas-shale production will eventually overwhelm traditional natural gas drilling and production efforts and whether it is possible that the U.S. becomes a net gas exporter at some date in the future.
To help arrest the growth in natural gas production and boost gas prices, producers have cut back their drilling activity by roughly 50% since last fall, but because gas-shale wells are so prolific compared to conventional gas wells, the drilling reduction appears to be having limited impact in slowing production growth. In the latest monthly data from the EIA’s industry survey, gas production does appear to be falling, at least on land. The challenge, however, is to try to decipher whether this production decline is real or involuntary.
Natural gas storage as of September 25th was at 3,589 billion cubic feet (Bcf) out of an estimated industry-wide capacity of 4,000 Bcf. The problem is that natural gas storage facilities are spread around the country in the eastern and western consuming regions and in the gas producing areas. Additionally, there are limitations on the amount of natural gas that can be transported via pipelines from the producing regions to the consuming markets. As a result of these infrastructure limitations, the overall storage capacity ratio may not accurately reflect the true impact that high storage volumes are having on gas production.
When we look only at industry-wide storage volumes plotted against total natural gas production, the surge in storage appears to be coinciding with a flattening, and now declining gas production.
Exhibit 8. Gas Storage Capacity Is Nearly Full
Source: EIA, PPHB
The level of gas storage volumes and the amount of injections shows even more clearly how the nearly full storage levels are impacting gas production. In the accompanying chart, we have plotted total gas storage against weekly gas injection volumes. As shown in the green circle, natural gas in storage at the end of the last heating season was higher than at the end of the prior two years, and considerably higher than the prior year. This meant that without an expansion of storage facilities there would be less room for new gas storage volumes this year. This problem is confirmed by the sharp fall-off in weekly gas injections following this season’s initial peak, which is measured by the line connecting peak injections for the past few years (black line). As total gas in storage has climbed to a record high, even after a roughly 100 Bcf of new storage capacity added, injection rates have fallen to low levels as there is little appetite or room for more gas. The chart suggests that some portion of the fall in current natural gas production has to be associated with involuntary production curtailments. The challenge is to determine how much of a fall-off is due to curtailments and how much is a fall in well productivity.
Exhibit 9. Storage And Injections Show Involuntary Shut-ins
Source: EIA, PPHB
To begin to look at this issue, we were provided some data reported to be monthly natural gas production for the state of Texas. At this point we cannot vouch for its correctness, but we plotted it against the initial daily production by month for the state coming from the EIA’s Form 914 survey of gas producers. Lastly, we went to the Texas Railroad Commission web site and took only the 2009 monthly natural gas production data currently available, converted it to daily production figures, and plotted that data. The point of the exercise is to show that all these Texas natural gas production data sources are consistent in their pattern – steadily down. The interesting thing is to look at the shapes of the curves for 2009. The production data provided to us shows flat production for several months and then a steep decline. The EIA’s data shows a decline but at a more modest pace for all of 2009. The Texas Railroad Commission data shows a steady decline, but at a much faster rate than the EIA data. Unfortunately, these curves don’t answer the question: Is the decline due to falling natural gas well productive capacity, or is it a function of low prices, or is it due to involuntary cutbacks due to rapidly filling storage capacity?
Since a lot of Texas natural gas tends to have higher finding and developing costs we suspect that some of the fall in gas production has been due to the weak gas prices. Producers must have been looking at their costs versus market prices and deciding to shut-in gas production. But some of the fall off in production has to be associated with older, less productive wells. Our guess is, however, that between these two explanations, the former is more important than the latter, but we cannot prove this conclusively.
Exhibit 10. Texas State Gas Production In A Steep Decline
Source: EIA, Art Berman, Texas Railroad Commission
So while we wrestle to understand the current falling gas production figures, we are drawn back to looking at what the industry is doing with its drilling effort. The sharp fall-off in gas-oriented drilling rigs will eventually take a toll on production, but for the time being one has to be concerned about the recent uptick in the gas-oriented rig count before we know why production has fallen.
Exhibit 11. Despite Rig Decline Gas Production Holding Up
Source: EIA, Baker Hughes, PPHB
At the same time, when we look at gas production compared to the number of rigs drilling horizontal wells, although we know not all rigs drilling horizontally are seeking natural gas, the strong upturn there could be a precursor of future gas supply challenges since the gas-shale wells, drilled horizontally, are so much more productive than conventionally drilled gas wells.
Exhibit 12. Are Horizontal Rigs The Gas Supply Nemesis?
Source: EIA, Baker Hughes, PPHB
The chart of gas production versus the total number of rigs drilling either directionally or horizontally shows a potentially less ominous supply challenge for the natural gas industry.
Exhibit 13. Non-vertical Rigs Are Helping To Boost Gas Supply
Source: EIA, Baker Hughes, PPHB
The recovery in natural gas prices back to the $5 per Mcf level is certainly a positive for the industry. The latest production figures suggest that gas supplies are shrinking, but the weekly gas injection figures continue to reflect the impact of nearly full storage capacity. We can safely assume that gas production volumes are being reduced due to involuntary well shut-ins. What we don’t know is whether the industry is Wiley Coyote having run of the mountain road and is now suspended in air waiting to fall. Is natural gas production about to drop like a rock? Or is it possible we just need to get rid of some of the gas storage volumes with cold weather allowing producers to ramp back up their shut-in wells? That last scenario will come with current or higher winter gas prices. The former scenario suggests a natural gas price that rockets straight up. Unfortunately an exploding gas price will bring with it the seeds of the next price collapse. We reiterate our view that without a healthy economy the natural gas market will struggle to regain solid economic footings.
Last week ConocoPhillips (COP-NYSE) announced a revision of its corporate strategy by selling disclosing plans to sell $10 billion in assets and reduce its capital spending for 2010. In an additional shift, the company increased its quarterly dividend by 6.4% to $0.50. The strategy revision seems to acknowledge the mistake of the company’s prior strategy of buying assets to expand the company’s critical mass and investors’ greater interest in current returns.
A major thrust of COP’s prior strategy was to build its North American E&P presence, which was largely accomplished by purchasing Burlington Resources in 2006 for $35 billion. COP also bought a 20% interest in Russia’s Lukoil oil company and it agreed to an $8 billion joint venture to produce and export liquefied natural gas (LNG) in Australia. According to Wall Street research, COP has reinvested almost 80% of its cash flow for the past five years, yet the mistiming of its acquisitions has contributed to the shares underperforming its primary competitors – ExxonMobil (XOM-NYSE) and Chevron (CVX-NYSE) – for the past two years.
By raising its dividend, COP has boosted its annualized yield slightly above that of Chevron and well above ExxonMobil’s return. After boosting its annualized dividend to $2.00 per share, the 3.9% dividend yield as of last Friday puts COP’s return approximately 0.2% above Chevron’s 3.7% yield ($2.72 annual dividend) and more than 60% above ExxonMobil’s current 2.4% yield ($1.68 annual dividend). The interesting question is whether COP is going to adopt a radically different approach to managing its affairs going forward. Will COP’s focus become more on how to generate greater and more consistent financial returns for shareholders over becoming a larger company and making larger corporate bets on future growth?
With that consideration in mind, we thought it interesting to note COP’s announcement about cutting its 2010 capital spending after having reduced its 2009 spending and laying off employees earlier this year. COP said it will spend $11 billion, down 12% from its 2009 spending target and fully 23% below what the company reinvested in 2008. It is interesting to note the historical trend in oil industry capital spending since 1970 and how spending has tracked crude oil
Exhibit 14. Conoco’s Stock Has Lagged It Prime Competitors
Source: BigCharts.com
prices over that time period. It is worth noting that whenever the industry enjoys a spike in crude oil prices such as happened in 1973, 1981, 1988-90, 1998-2000 and 2007-08, capital spending fell soon after. That reinforces the research that spikes in oil prices are generally associated with generating economic downturns.
Exhibit 15. Capital Spending Reflects Changes In Oil Prices
Source: Citibank, DeGoyler & MacNaughton, EIA, Barclays, Lehman, PPHB
COP’s spending cut in 2009 puts it in the industry pack. But the announcement of the 12% cut for 2010 puts it in a meaningfully large segment of the industry that responded to the recent spending survey question from Barclays. As shown in Barclays’s research report on its mid-year capital spending survey, the bulk of the global oil industry anticipates spending more money in 2010, with almost a third of respondents saying their spending will be up by 20% or more. Almost a quarter of the companies said they would hold spending flat. Yet 17% of the companies are suggesting they will be reducing their next year capital spending by 10% or more. On balance, it looks to us like the industry will be boosting spending in 2010, at least as of this mid-year point, by about 10%-15%. But as we all know, there is still a long time to go before companies really begin to nail down their spending plans for next year. How the global economic recovery progresses through the rest of this year will have a huge impact on that decision. If all the forecasts for continued economic recovery in 2010 prove accurate, then we are probably looking at an increase in oil industry spending. On the other hand, if the world experiences another dip in economic activity, obviously a minority view among economists at the present time, then look for lower or flat spending as the more likely scenario.
Exhibit 16. 2010 Industry Spending Looks To Be Higher
Source: Barclays
The COP announcement has broader oil industry significance because it highlights the growing struggle that major independent oil companies (IOCs) are having in growing their production due to limited access to attractive resource deposits around the globe. Additionally, the more attractive prospects are faced with rising costs and long development timeframes further adding to the financial challenges for boosting shareholder value. Therefore, COP’s decision to boost the annual dividend as a way of boosting shareholder return may become a more utilized approach to attracting and rewarding shareholder support for the largest of the IOCs. Watch whether COP once again becomes an industry leader with its new corporate strategy.
Late last week, Mexico’s National Hydrocarbons Commission (NHC), a new organization created as part of the overhaul of the country’s energy laws, issued an order to state-run oil company Petroleos Mexicanos (Pemex) to halt its exploration efforts in the Chicontepec field in central Mexico. Chicontepec was supposed to compensate for the declining production of Mexico’s major oil field, Cantarell, which has been supplying the country with the bulk of its oil for many years. In 2004, Cantarell produced over 2.1 million b/d of oil. Today it is producing only 600,000 b/d. There appear to be no other alternatives available to Pemex as 23 of its 32 largest fields are in decline. Without significant new discoveries, the world’s seventh-largest oil producer is forecasted to become a net oil importer by 2017, with significant implications for its neighbor and major customer, the United States.
Exhibit 17. Mexico’s Oil Production Down
Source: The Economist
The implications for the Mexican government from this fall in oil production are highlighted by the taxes and royalties Pemex generates. The oil income has accounted for almost 40% of the government’s revenues in recent years. That income stream is critically important since Mexico has one of the weakest tax regimes in Latin America, collecting just 11% of gross national product. If oil output drops below 2 million b/d, industry-watchers believe the Mexican government may be forced to either cut spending by 10% or raise taxes by a corresponding amount. Either action would threaten the country’s economic recovery with potentially negative repercussions for Latin America.
Exhibit 18. Chicontepec Was The Future For Pemex
Source: Rigzone
The NHC sets technical standards for the country’s crude oil and natural gas fields. It also establishes industry rules for the management of reserves and production practices. The findings of the NHC are only recommendations and not mandatory, however, given the recent radical overhaul of Pemex’s management, it will have a difficult time going against these recommendations when the company’s board of directors meets October 15th. Not long ago, Mexico’s president fired Pemex’s president and installed a new CEO, Juan Jose Suarez Coppel, who in turn has appointed several new senior operational officers.
Juan Carlos Zepeda, president of the NHC, said, “The project should be halted until Pemex has a proper development plan.” The Chicontepec field is an $11.1 billion project, but after having spent $3.4 billion, production still lags and drilling results are not matching lofty expectations. Wells are taking longer to drill and complete than targeted and the flows from the wells are below anticipated volumes. At the moment, the field is producing 29,000 b/d some 11,000 b/d below anticipated volumes. If the project is suspended, Pemex will have to deal with the eight significant contracts it has entered into in recent years involving $2 billion in expenditures. As these projects are now underway, it is possible Pemex may opt to undertake a project review encompassing the equipment, technology and techniques being utilized while allowing current work to continue so as not to set back even further the development of critically needed new production.
The dilemma of the poor results at Chicontepec point to the problem Pemex has in raising its technical competence. One solution would be to entice western oil companies into the country, but without access to the resources, the companies are reluctant to become merely technical service providers. Of particular attraction to western oil companies is the country’s potential oil reserves located in the deep waters of the Gulf of Mexico. Attracting the western oil companies will require a change in Mexico’s constitution that reserves all the nation’s oil and gas resources for the people. Absent that move, which might happen if economic problems worsen, Pemex will need to rapidly upgrade its work force or rely even more on the western oilfield service industry.
Our last drive home from Rhode Island this year turned into one of the worst trips of all time. The problem was the weather. We encountered rain, at some times heavy, initially from Rhode Island to the New York/Pennsylvania state line and then all the way from Knoxville, Tennessee, to Lafayette, Louisiana. The rain spanned the three days of our travel. Fortunately, the traffic – both truck and vehicle – was not very heavy. We wondered whether the lighter than expected road traffic was due to our traveling on Saturday afternoon, Sunday and Monday, but upon reflection we figure trucks are moving across the country every day. The lighter than expected traffic was coupled with less than crowded restaurants and hotels. Are these signs the economy is not improving despite various government statistics suggesting otherwise?
If we base our conclusion about the health of the economy on what we experienced in Rhode Island, then there is little doubt but that business and social conditions are worsening due to rising unemployment. The real estate market in Rhode Island has improved slightly since the beginning of the year, which is not surprising since the world appeared to be ending then, but since late spring there are few signs of increased momentum. More homes are going up for sale, especially in the South County region that tends to be heavily tourist and vacation home influenced. The Rhode Island economy continues to struggle with a weak job market that is now being hit by rising government layoffs including educators and health workers. The poor summer weather further contributed to the weak employment picture as many seasonal employer cut positions. For many of the unemployed, they have exhausted their benefits, which have contributed to a rising home foreclosure rate.
Some of our observations about the Rhode Island economy are based on dealings with people who worked for us last year on our house remodeling project. Our builder and his son, who owned the company that undertook the renovation, have had only one or two small jobs since last fall. They closed their company and the father has re-incorporated it as a sole proprietorship. He told me he had a deposit check in his pocket to return on a project being cancelled because the homeowner, a state worker, became concerned he would be laid off by the state.
The builder’s son has had very little work, and has resorted to collecting scrap metal and other waste products that he can sell to recyclers. His wife still has her part-time job, but they have lost their house to foreclosure and are moving into a very old home being given to him by his father-in-law. Our builder, who currently owes us money from liens on our remodeling job from bills he failed to pay and whose house we have a lien on, has had his home posted for foreclosure. He told me that he has renegotiated a payment arrangement with the bank as he has a cash-flow problem and is not upside down with his mortgage, so he will not lose the house. Two of the subcontractors working on our home last year have shrunk their businesses to just themselves and one or two employees rather than three or four multiple employee crews. Work is tough and they go all over the state (the size of Harris County) for work.
Some people might say that Rhode Island is a special case economically, but I would contend it has been, and remains, a precursor of our national economic problems. Based on that view, and I would certainly love to be proved wrong, this economy still has a lot of problems because of the unemployment situation that doesn’t appear to be improving. We understand that unemployment is a lagging economic indicator, but until we have a healthy and vibrant private sector, employment will show little improvement. Until Washington and the current administration understands that many of the big social issues it wants to address will actually increase taxes and living costs for low income families and small businesses, there will be more pain ahead. The uncertainty of taxes and economic restructuring further retards the pace of the recovery. Light truck traffic is a reflection of this economic malaise, which doesn’t auger well for increased energy demand.
Two new reports have come out arguing that the globe is staring at a peak in crude oil production followed by declines that will challenge our economies. Interestingly, the reports were issued on almost the same date last week. One report was prepared by a team of eight academics and technical people under the auspices of the UK Energy Research Centre’s (UKERC) Technology and Policy Assessment function following an 18-month study. The other report was issued by Deutsche Bank and was titled “The Peak Oil Market.” Neither report offers positive news for the global economy.
The UKERC report was a detailed examination of all the data and research into the topic of peak oil. The report addresses the question: What evidence is there to support the proposition that the global supply of ‘conventional oil’ will be constrained by physical depletion before 2030? In its examination of the data, the researchers only looked at conventional oil, which was defined as crude oil, condensate and natural gas liquids (NGLs). It excluded any fuel derived from oil sands, oil shale, coal, natural gas or biomass. Of course many of these fuel sources are what the International Energy Agency (IEA) is counting on in its assessment of the possibility for peak oil for the world.
The UKERC researchers concluded, in contrast to the UK government’s official position that peak oil will not occur before 2030, that the peak in conventional oil production will “likely” come before 2030 and there is ”significant risk” it will come before 2020. The UK government position relies on the IEA’s report. But as the UKERC researchers point out, fully two-thirds of the world’s current oil production, or 60 million barrels per day (b/d) must be replaced by 2030 as a result of depletion before there is any consideration for future oil demand growth. Relying on unconventional oil sources will prove inadequate according to the report as the most optimistic forecast for oil produced from tar sands made by IHS CERA says that production will peak at 6.3 million b/d by 2035. This peak would represent slightly over 10% of the amount of today’s oil production anticipated to be lost to depletion.
The Deutsche Bank study concludes that the impact of peak oil will be to drive oil prices to $175 a barrel by 2016. But that price will be the final nail in the oil demand coffin and will cause oil prices to crash back down to $70 a barrel by 2030. According to the bank, the world is about to experience a second significant peak, something the U.S. has already begun to feel – a peak in oil demand. As the bank puts it, “We believe Obama’s environmental agenda, the bankruptcy of the US auto industry, the war in Iraq, and global oil supply challenges have dovetailed to spell the end of the oil era.”
The underlying force that will bring the end of the oil era is the embrace of electrical propulsion. The bank expects the electric car to become truly a “disruptive technology” that will send gasoline into an “inexorable and accelerating decline.” By 2020, the bank expects electric and hybrid electric vehicles will represent 25% of new car sales in the U.S. and China. The bank stated, “We expect [electric propulsion] will reverse the dynamics of world oil demand and spell the end of the oil age.” Just as the rise of the digital camera made film irrelevant, they believe the rise of electrically-powered vehicles will make oil and gasoline irrelevant.
We find it interesting that these reports come out just after we finished reading two books dealing with our world after peak oil and the resulting high gasoline pump prices. One of the books we read was $20 Per Gallon: How the Inevitable Rise in the Price of Gasoline Will Change Our Lives for the Better by Christopher Steiner, a writer for Forbes magazine. The other book, by former CIBC economist Jeff Rubin, was Why Your World Is About To Get A Whole Lot Smaller: Oil and the End of Globalization. (We must acknowledge that Mr. Rubin was a co-worker during our tenure at CIBC. We often needed to consider Mr. Rubin’s work as we were researching and recommending oil service stocks to investors, however we always were impressed by the depth of his work and his reasoned positions.)
Both books deal with the changes the world and society, especially Americans, will face when oil supplies shrink and petroleum prices either skyrocket or the products are restricted to their highest economic-valued use. Neither author gets into forecasting when the peak in oil production will occur, but they acknowledge that it will happen and sooner than many people assume. Mr. Rubin approaches the topic from the viewpoint of an economist who has suddenly discovered that one of his (and our) profession’s key working assumptions – there is no barrier to future supply meeting demand growth – is no longer true. That revelation means that other factors – primarily price – come into the equation as the rationing mechanism. But when there is little ability to produce oil to meet existing demand, let alone potential demand growth, something has to give because price alone cannot handle the transition. In Mr. Rubin’s view it is the life-style of developed economies that will have to change, and change radically.
Mr. Steiner, who took time off from his reporter’s job, to research and write his book, comes to the same conclusion as Mr. Rubin, but his book is much more a story of how America will change as people can no longer afford to operate their automobiles. Mr. Steiner’s book is an easier read, but for someone who has spent essentially his entire life in and around the energy business, we felt he glosses over key points and fails to develop others that would have benefitted from deeper research. Mr. Rubin’s book is more substantial in its presentation of the case for a shrinking world as a result of peak oil, since travel and commuting will become prohibitive. He also sees our diets changing as many of the foods we enjoy today arrive at our dinner tables after extensive voyages fueled by cheap energy. As one would expect, Mr. Rubin’s book reflects much deeper and critical research.
We are currently reading another interesting book dealing with the global economy and cheap oil that combined to revolutionize the world’s transportation business and altered the history of our economic development. The book is called The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger by Marc Levinson. This book is essentially a history of the evolution of the mundane shipping container (just a large metal box) that brings us exotic foods and inexpensive consumer products from around the world. Much like the books, Cod: A Biography of the Fish That Changed the World and Salt: A World History, both by Mark Kurlansky that document the world-altering impact of simple things like a fish and grains of a chemical product, the shipping container is a remarkably simple device that also changed the course of the world’s economy. If oil is no longer available, or cheap, will developed economies be capable of getting cheap foodstuffs and industrial and consumer products that have contributed so much to their economic development and high living standards? The answer from Messrs. Rubin and Steiner is: No!
The two authors have the same theme – how Americans will have to give up traveling, abandon eating foods that come from great distances away and find new ways to work. These books, listed on the non-fiction book lists, amaze me because they truly are fictional works. Admittedly they are based on reasonable premises, but they are largely speculation about how the world of the future will unfold.
These books remind us of the various writings that emerged in the mid 1970s after the explosion in global oil prices following the OPEC embargo of countries supporting Israel in the Arab-Israeli war. At that time we had cars that average less than 10 miles per gallon, homes with little or no insulation and a life-style that ignored the cost of energy. In the past 30 years we have made huge strides in improving our energy efficiency, although there is certainly room for much greater improvement. The primary benefit from reading these books is to see how the authors perceive our society and economy will evolve. There are certainly lessons to be learned and steps individuals can take even now to reduce their dependency on energy, and its impact on family budgets. We caution readers that they should never underestimate the ingenuity and inventiveness of the human mind. That makes us more optimistic that either of the two authors about the future, but we respect their efforts at trying to alert us to possibly the most radical upcoming change to our lives.
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Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.
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