Other Thoughts on Oil Prices and "Speculation"

As a followup to my point on oil prices, here are a selection of posts on oil prices and speculation that have caught my eye of late:

McQ writes about the charge of "inactive" oil leases, which Democrats attempted to use as an excuse for not opening up new lease areas for drilling

Tyler Cowen has a big roundup on the topic, with many links, and Alex Tabarrok has a follow-up.  Cowen discusses rising oil prices in the context of Julian Simon here.

Michael Giberson also addresses speculation, while observing that non-industrial buyers have not increased their position in the futures market as oil prices have risen

Finally, via Scrappleface:

When the U.S. Supreme Court reconvenes on the first Monday in
October, the nine Justices may consider whether the Constitutional
preamble clause "secure the Blessings of Liberty to ourselves and our Posterity" guarantees an individual right to drill for oil.

Now that the court, in a 5-4 ruling on the Heller case, has upheld
the Second Amendment right of "the people," not just state-run
militias, to keep and bear arms, some scholars say the court may be
willing to go the next logical step and recognize the peoples' right to
acquire their own fuel.

  • http://www.tinyvital.com/blog John Moore

    Well, that is certainly confusing! I wish I knew more of the economics discussed in some of the links. Since I don't, I'll naively ask the assembled commentertude...

    How do expectations influence the spot market? It would seem that if expectations were for prices to increase or stay up, the seller would demand more and supply/demand would not strictly set the price... put another way, expectations of increase might cause the supply side to "reduce" its contribution in the sense of holding out for higher prices, while the demand side "increases" its `contribution by being willing to pay those prices. Does this make sense?

    Another question: does the spot market price really mean only that oil for which futures contracts are not in existence? If so, it could represent a significantly smaller part of the overall oil economy. How much oil purchases are hedged (i.e. through futures contracts) vs how much are on the spot?

  • Yoshidad

    This discussion still omits any of the peak oil stuff. Here's an interesting antidote for that from an energy journalist/financial analyst's newsletter at http://www.energyandcapital.com/newsletter.php?date=2008-07-09:

    Peak Oil Confusion - A Game Whose Time Is Up
    By Chris Nelder | Wednesday, July 9th, 2008

    Pain at the pump is finally putting energy on the front burner in this election season, but media coverage of the issue has been fraught with misinformation.

    I hate to say it, but I am beginning to think some of the confusion is intentional. From the news that Cheney's office has interfered with reporting on climate change science (what a shocker!), to the assertions of some pundits that there are 12 trillion barrels of oil yet to recover out there, to assertions by politicians that we can drill our way to energy independence, it's tough for the average person to get a real grip on the issues.

    Confusion breeds apathy, and that's not something we can afford anymore. I believe that the impending energy crisis is too urgent to allow misinformation about peak oil to go unanswered.

    So I am attempting to set the record straight.

    For this week's Energy and Capital column, I am publishing a formal rebuttal to a May editorial on peak oil in Investor's Business Daily, which got the facts about peak oil-as I understand them-badly wrong.

    It refers to a companion piece which has just been published, a "Peak Oil Media Guide" that I developed for the Association for the Study of Peak Oil - USA.

    I hope my readers will find these two pieces helpful in separating fact from fiction about peak oil.

    Until next time,

    Chris

    To the editors of Investor's Business Daily:

    I feel compelled to respond to your editorial of May 28, 2008, entitled "Peak Oil: An Idea Whose Time Is Up." For a respected financial publication such as yours, I found your coverage reprehensible and rife with errors. I have to wonder if it was deliberately designed to confuse the public, or if the authors were merely deeply misinformed.

    Our nation urgently needs to get up to speed on the realities of energy before we can have any sort of intelligent conversation about reforming energy policy. Articles such as yours do the public a grave disservice.

    First, peak oil is a study, not a "theory." That is why the name of the world's top authority on peak oil is the Association for the Study of Peak Oil (ASPO), not the Association for the Theory of Peak Oil. The peak oil study is simply a scientific analysis and modeling of available data. More data might correct existing models, but there is no theory to prove or disprove. Likewise, politics plays no role in the scientific assessment of the ASPO's respected petroleum geologists.

    Second, peak oil is not about "running out of crude," it's about the rate of oil production. You are correct "that one day the crude supply will effectively dry up," but that day, perhaps 100 years in the future, is not what the study of peak oil is about.

    I will refer to the "Peak Oil Media Guide" as I address your remaining statements.

    To begin with item 1, "It's not the size of the tank which matters, but the size of the tap."

    Talking only about the number of barrels of oil that might exist somewhere, without also talking about the rate at which that oil can be produced, and when, is utterly meaningless.

    You stated:

    U.S. production is trending down again, but it's not because there's no oil. It's due to shortsighted policies that prevent the industry from drilling for the almost 100 billion barrels of crude known to be under Alaska's Arctic National Wildlife Refuge and beneath the oceans just off of America's coasts. It's because politics and political correctness block the development of Big Sky state oil shale fields, where as much as 2 trillion barrels of crude, by some estimates, sit idle.

    Here's the reality.

    Right now, the world is producing between 86 and 87 million barrels per day (mbpd) of oil, just 2 mbpd more than it did in 2005. The world has reached a bumpy production plateau, and will likely continue on it for another three to six years before beginning the terminal decline of global oil production.

    Your numbers on oil are also questionable:

    But the impact of those nations on crude prices in recent months is suspect. Global oil consumption grew 2% in the first quarter of this year over the first quarter of 2007, while production increased 2.5% over the same period. On a daily basis, roughly 85 million barrels of oil are consumed across the world, almost exactly matching the amount produced each day.

    You don't state your sources, but according to the IEA Oil Market Report of May 13, the most recent publicly available global data I am aware of, the numbers are quite different:

    * Global oil consumption grew 0.81%, not 2%, from 85.9 mbpd in Q1 2007 to 86.6 mbpd in Q1 2008.
    * Global oil supply in the grew 1.81%, from 85.6 in Q1 2007 to 87.2 mbpd in Q2 2008. However, April supply fell 0.4 mbpd to 86.8 mbpd, due to declining output from OPEC and the FSU, plus North Sea outages.
    * Average demand in 2008 is projected to be 1.2% higher than 2007.
    * According to this data, supply is a scant 0.6 mbpd higher than demand.

    If you will refer to "Figure 3 - US Oil Production 1900-2005," which shows the historical peaking of U.S. oil production, perhaps you can explain why you would dismiss the U.S. peak with a comment like "Yes, domestic output has peaked. But it peaked at a level 13% above what Hubbert predicted. And the peak wasn't followed by a falling-off-the-table decline. Output rose after a temporary slide."

    Yes it did...and then resumed its downward course on a relentless, 38-year history of decline, as the chart clearly shows. Who are you trying to fool?

    As for the fact that U.S. production peaked 13% above Hubbert's prediction, I say, "close enough." Hubbert also found that if the recoverable amount of oil in the U.S. were increased by one-third, it would only delay the Lower 48 production peak by five years. A similar calculation for world production would produce similar results. Again, when it comes to the question of peaking, flow rates are far more important than reserves.

    The decline of U.S. oil production was not the result of politics, nor can any political decisions now significantly alter its future course. It is simply the nature of petroleum extraction that it ramps up to a peak and then declines, in a rough bell-curve shape. This observation has been made in thousands of oil fields (and oil producing nations) worldwide, which is why Hubbert's model continues to be respected.

    If you will refer to item 2, "We are now at, or ‘close enough' to the peak," you will note that global oil production has plateaued. It may continue to rise at a negligible rate for the next couple of years, but no major increases are possible.

    You seem to be among those who are laboring under the mistaken belief that the U.S. can somehow drill its way out of dependency on foreign oil, and that increased domestic production could the relieve today's "high" prices.

    Nothing could be further from the truth.

    In fact, the U.S. uses about 20 mbpd of petroleum, and produces about 7 of that. The other two-thirds is imported because there is no possible way that we could produce another 13 mbpd domestically, even if we drilled every single place that might have oil.

    Regarding the potential of oil shale, please refer to item 4, "Oil shale: the fuel of the future...and it always will be." After four decades of fully authorized, commercial, even subsidized attempts to develop oil shale into a usable fuel, no one has ever been able to make it economically feasible. Part of the reason for that is that it's not even really oil-it's kerogen, an immature precursor to oil, and it takes an enormous amount of energy to turn it into something usable.

    It remains to be seen if the energy returned on the energy invested (EROEI) for oil shale is high enough to even make its production worthwhile. Even if it does prove to be viable, it is unlikely to ever produce more than a modest flow (though perhaps a very long-lived one) of extremely expensive, synthetic oil. It is not some quickly available "two trillion barrels" of "crude," as you asserted, and it will require an enormous amount of energy, probably from coal, to produce.

    As for the oil reserves of ANWR and the continental shelf, please refer to item 5, "ANWR and the continental shelf are no panacea." The flow rates from these resources cannot be known until they are produced, but we can make ballpark estimates.

    Preliminary estimates by the USGS indicate that ANWR would likely only produce around 750,000 barrels per day at peak. More importantly, it would take 10-20 years to achieve that peak production level.

    If all limits on domestic drilling were removed, including ANWR, it could only increase US oil production by a maximum of 2-3 mbpd. It would come online slowly, and given the loss in global oil production by the time it arrives, the additional production from these remaining domestic reserves will be underwhelming. Together, they could amount to perhaps 12-15% of our daily usage today, or about 3% of world production.

    However, if we are currently on the peak/plateau of global oil production, and production starts to fall within the next five years, then 10 years from now, at a reasonable average 2.0% rate of net depletion, world oil production will be down 11 mbpd-about 12%-from where it stands today. Therefore any additional domestic production could only offset perhaps one-quarter of the global production that will be lost!

    It should be obvious, after a close look at the data, that at the rate that the U.S. currently uses oil, the chance of producing all of our own needs domestically is zero.

    The potential impact of increased domestic drilling on oil prices is also minimal. Since oil is traded globally, and the U.S. imports about two-thirds of the oil it consumes, the price of the oil we produce will always maintain parity with global prices. With the global supply and demand balance as tight as it is for oil, natural gas, and coal, increased production in the U.S. would make a negligible difference in U.S. gasoline prices.

    The U.S. Department of Energy estimates that drilling in ANWR would only reduce the price of gasoline by less than four pennies per gallon-20 years from now!

    The slight declines in petroleum consumption over the past year in the U.S. and Europe have been more than offset by the increasing consumption of countries in Asia, South America, Russia, and the Middle East. Net global consumption is expected to increase another 1 mbpd this year.

    Indeed, we should recognize, as the Saudis have, that the oil we still have will only become more valuable as time goes on, and it makes sense to save some for future generations. Oil is incredibly useful and energy dense, and we use it altogether too profligately today. Burning every last bit of what remains as quickly as we can makes no sense at all. I further submit that it is irresponsible and immoral to attempt it.

    One of the most glaring errors in your analysis was in misunderstanding depletion. I refer your attention to item 7, "Depletion is relentless."

    The concept is simple: Oil production first must make up for the depletion of mature fields before any net additional oil can be counted. It's like pouring water into a bucket with a hole in it. The background global decline rate is generally accepted to be 4.5 - 5%.

    Anyone familiar with a balance sheet should understand this concept, but you missed it when you said:

    Production over the next two quarters is projected to continue rising (3.3% and 4.1%, according to estimates from Citigroup), while demand is expected to grow at a slower 1.6% pace over the next six months.

    A net global production increase of 3-4% has not occurred in several decades, nor is it conceivably possible in the future, let alone the next six months, given what we know about the projects that are under way.

    Clearly, you confused "production" with net production. The world's net production over the next six months would be lucky to manage a 0.6% increase, after accounting for the background decline rate.

    You point out: "World output is expected to rise from 85 million barrels a day today to 110 million barrels by 2015, according to the International Energy Agency," but your information is out of date.

    Surely you are aware of the Wall Street Journal's article, "Energy Watchdog Warns of Oil-Production Crunch," published on May 23, 2008, about a week before yours? It previewed the IEA's upcoming report in November, which will announce the results of their first detailed study of the depletion rates of the world's top 400 oil fields. That study has prompted them to reduce their estimate to 100 mbpd by 2015.

    I should also point out that the IEA has lagged well behind other knowledgeable analysts who have consistently demonstrated why the IEA's past projections could not be obtained, and who are now of the opinion that global oil production is unlikely to ever exceed 90 mbpd.

    I must emphasize that no political considerations, or faith-based economics, are needed to understand the available data and the models. The mathematics are quite clear.

    Finally, I must address your quote from Peter Jackson of CERA, who said, "The 'peak oil' argument is based on faulty analysis which could, if accepted, distort critical policy and investment decisions and cloud the debate over the energy future."

    I respond that CERA's projections of future oil production have been far off the mark for about the last five years straight. If anyone's analysis is faulty, it is theirs. The ASPO's has come much closer to reality. ASPO-USA has directly challenged CERA to back their projections with real money; so far, they have declined to respond.

    CERA is correct, however, that faulty analysis could "distort critical policy and investment decisions and cloud the debate over the energy future." I beg you to consult more reliable authorities than CERA for that very reason. They have a lovely story to tell; unfortunately, it's wrong.

    I hope you will explore the information I have provided here, and avoid making such fundamental errors in your future coverage of the oil markets, and of the study of peak oil.

    Sincerely,

    Chris Nelder
    Energy Journalist