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time, the oil market was at its worst state, pessimism was ruling everything. And
when the analysts predicted prices to fall to $20 a barrel and below, what they did
was fueling the pessimism and pressuring oil prices to fall. Unfortunately, they
succeeded in dragging oil prices down only because they played with the right
emotion in the right direction at the right time.
But that is not the case now with their current pessimistic forecast. They are playing
with the wrong emotion in the wrong direction at the wrong time. Right now, the oil
market cycle emotion is optimism and events that have taken place in the oil market
during the last few weeks support this fact. For instance, despite the failure of Doha's
meeting, and the fact that Iran is ramping up its oil output, oil prices were able to
sustain their gains and continued increasing. In fact, just a few days after the failure
of Doha's meeting, oil prices continued their gains, breaking out of a trading band.
This shows the high level of optimism the oil market is in right now which some
analysts underestimate its ability to drive prices up.
It should be clear by now that the direction of the oil market at this moment is
different from that predicted by Morgan Stanley's analysts and other investment
banks which suggest that oil prices would fall again in the coming months. Judging
by the improvement in oil market fundamentals and the current high level of
optimism in the market, oil prices will continue its rally and it could reach to $50 a
barrel in the coming weeks.
It is expected that oil prices will remain in a range between $40 to $60 per barrel till
the end of 2016. Oil traders at this moment are very optimistic and they are looking
for a hope in anything whether it is the weakening U.S. dollar or the declining U.S.
crude oil output and rig count. Hope and optimism is required to get the market out of
this period and sustain oil prices at the current level or a little bit higher till market
fundamentals improvement intensifies. Once the oil market fundamentals play its
role completely, it will take charge of balancing the market and driving oil prices.
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Returning To Market
Balance: How High
Must Prices Be To Save
The Oil Industry?
Written by Art Berman from The Petroleum Truth Report
The global oil market is returning to balance based on the latest data from the EIA.
That should mean higher oil prices but how high must prices be to save the industry?
Data suggests that oil producers need prices in the $70-80 range to survive. That is
unlikely in the next year or so. Without more timely price relief, the future looks grim
for an industry on life support.
EIA Revises Consumption Upward
Major EIA revisions to world oil consumption* data provide a new perspective on oilmarket balance.
The world was over-supplied by only 570 kbpd of liquids in April compared to EIA's
earlier estimate for March of 1,450 kbpd; that March estimate has now been revised
downward to 970 kbpd (Figure 1). February's over-supply has been revised
downward from 1,180 to 240 kbpd.
These revisions indicate that oil markets are much closer to balance than previously
thought.
Figure 1. EIA world liquids market balance (supply minus consumption). Source: EIA
and Labyrinth Consulting Services, Inc.
EIA adjusted world consumption growth for 2016 upward to 1.4 mmbpd. Its estimate
for 2017 is now a very strong 1.54 mmbpd (Figure 2).
Figure 2. EIA annual consumption growth and forecast. Source: EIA and Labyrinth
Consulting Services, Inc.
IEA's demand growth estimate for 2015 is 1.8 mmbpd but the agency maintains
its 1.2 mmbpd estimate for 2016 based on concerns about global economic growth.It
is easy to be skeptical about these new revelations but reports by both groups have
been pointing toward improving market balance for some time.
Oil Prices and Market Balance
Oil markets are never in balance. Producers always misjudge demand and either
over-shoot or under-shoot with supply. Balance is simply a zero-crossing from one
state of disequilibrium to the next, from surplus to deficit and back again.
Since 2003, the oil market has only been within 0.25 mmbpd of balance 16% of the
time. The average price (2016 dollars) for that near-market balance rate was $82 per
barrel (Figure 3).
Figure 5. Brent oil price histogram at plus-or-minus 0.25 million barrels per day of
world liquids production. Source: EIA & Labyrinth Consulting Services, Inc.
In other words, market balance merely reflects whatever price the market deems
necessary to maintain supply at the time. There is no clear causal relationship
between market balance and specific higher or lower oil prices. Balance merely
represents the midpoint between prices on either side of the disequilibrium states
that it demarcates.
Our recent memory is of $90-100 per barrel prices so we think that was normal.
When those prices prevailed in 2007-2008 and in 2010-2014, the disequilibrium state
of the market was largely deficit. Moving toward market balance and being on the
deficit side of market balance are hardly the same thing.
The Price Producers Need
Lower-cost oil producers of the world (Kuwait through Deepwater in Figure 6) need
$50-80 per barrel and an average price of $65 per barrel to break even. Probably
$70-80 is a minimum price range for near-term survival of more efficient producers
allowing that some will still lose money at those prices.
Figure 6. Projected 2016 break-even oil prices for OPEC and unconventional plays.
Source: IMF, Rystad Energy, Suncor, Cenovus, COS & Labyrinth Consulting
Services, Inc.
Existing Canadian oil sands projects, and Bakken and Eagle Ford Shale core areas
are among the very lowest-cost major plays in the world. For all of the OPEC rhetoric
about the high cost of unconventional oil, few OPEC countries are competitive with
unconventional plays when OPEC fiscal budgetary costs are included.
Figure 7. First quarter 2016 and full-year 2015 tight oil E&P company capital
expenditure-to-cash flow ratios. Source: Google Finance and Labyrinth Consulting
Services, Inc.
On average in 2016, companies spent $1.90 more in capex than they earned while
in 2015, they spent $0.60 more than they earned. The percent of negative cash flow
has increased more than three-fold so far in 2016 compared with 2015.
The good news is that about half of the companies (Apache, EOG, Laredo,
Continental, Statoil, and Diamondback) only increased negative cash flow slightly
despite falling revenues. The bad news is that the rest (Marathon, Whiting, Pioneer,
Murphy, ConocoPhillips and Newfield) did not.
The debt side of first quarter earnings is far more disturbing. The average debt-tocash flow ratio for tight oil companies increased more than 3-fold to 10, up from 3 in
2015 (Figure 8).
Figure 8. First quarter 2016 and full-year 2015 tight oil company debt-to-cash flow
ratios. Cash flow was annualized based on first quarter data. Source: Google
Finance and Labyrinth Consulting Services, Inc.
Debt-to-cash flow is a critical determinant of risk from a bank's perspective because
it measures how many years it would take to pay off debt if 100% of cash from
operations were used for this purpose. This means that it would take these
companies an average of 10 years to pay down their total debt using all cash from
operating activities.
The energy industry average from 1992-2012 was 1.53 and 2.0 was a standard
threshold for banks to call loans based on debt-covenant agreements. That threshold
increased in recent years to about 4 but 10 years to pay off debt is clearly beyond
reasonable bank exposure risk.
READ THE REST ON FORBES
and some other big producers producing oil from conventional reserves that take 5
years or more to develop. And North American energy independence just goes away
like it had never been something that had disturbed our peaceful minds.
I have already said in a post some years ago that easy oil is over and the shale
revolution has not changed anything in this opinion of mine. I had also said that
although the planet still sits on an awful lot of the black glibber, it's going to be much
harder to produce. Super-deep Sea, Arctic, Sour Oil, Tar sands and Super Heavy
crudes - shale would be in that group as well but this special kind is out for the sake
of the argument right now.
The problem is that as the world's energy needs are still massive and rising, we
would pump the existing conventional reserves at even higher rates meaning that we
will meet depletion of those easy fields much quicker which in turn forces us back
onto the hard to find/extract/produce/process oil patch.
This means rising prices which no doubt OPEC and its 'familiars' (that's a term I
borrowed from the Blade trilogy) will massively enjoy. At least in the short run as it
will patch over their current financial problems.
But the current oil producer's problems are not shale or new extraction techniques.
It's not even cheap oil and the oversupplied market. It's also not even faltering
markets as we start to find out the scale of the cumulative financial worldwide Ponzi
schemes and what their collapse is going to do to consumption of - anything.
Their problem is their impossibly swollen state administrations, their reckless
spending, their unreformed internal markets and their restive populations that have
been bought off with largesse from the rulers for far too long. Loads of cash have
stymied any hint of reform and reduced oil producing countries into fiefdoms of some
strongman with a big wallet. Those countries had more than a decade to fall behind
other nations in competitiveness, in entrepreneurialism and in social development.
Those others, the consumers of oil suffered high oil prices as they bought the stuff.
Oil producing nations competitiveness sucks, their nonoil products make anyone
yawn, their economies are in a 'petrodollar hooked' shambles and their populations
are coddled to the point where some real entrepreneurialism is always confounded
with someone spending big money on big offices with no real business behind.
If high oil prices come back because shale is beaten, those same countries, rulers
and societies have it easy to return to their bad old ways and they will further deepen
the trench they are already sitting in. Rulers will choose the easy way and keep
feeding the Crocodile that will eat them in the end and everyone will play along.
There will even be plenty of economists which will restart praising the superiority of
the petro-economy as opposed to the weaklings from the political west. Riches are
just falling into their laps without them even trying and we consumer economies have
to labor hard to get results. Clearly they are superior - we had that kind of hogwash
multiple times during the high price tide. Remember the hype around the BRICS?
Look again today.
But even worse for them the consumer side of the oil business will redouble its
efforts to find ways to wean themselves off oil as the cost (both financial and
environmental) will be considered crippling which will ring in the true end of the
petro-business-model as we know it in the longer run.
Shale has given the oil business a shot in the arm and a new lease of life as it made
oil affordable again and hence allows consuming nations to go easy on oil
alternatives. That's maybe not great news for the Greenies out there but it's the best
that could have happened to OPEC. They might not agree yet.
And as for economic (and other) reform in producing countries - trust me, you will
see the benefits of that too - in time. Rome was not built in one day and so will a new
energy world take time to build.
Your populations might not want to wait that long and they might even less be
inclined to shoulder the pain that comes with it. Remember that they are used to the
easy life the oil money has given them so far but this was a one-way road as has
become clear by now. Any further down that alley will just make the crocodile bigger
and it has already grown to monstrous proportions.
Starting to tackle your fundamental problems now is still much easier than doing so
later even if the current problems are already daunting. Imagine what it's going to be
like after some more years of oil money induced standstill. It might even blow some
countries up then.
Shale oil is therefore maybe even the savior of your social fabric, of your continued
existence as a country, of your way of life. As hard as it looks from the vantage point
of an OPEC country you should thank those pesky shale drillers as they might have
pulled you back from the abyss at the last moment.
Even the hardest-headed oil-aholics have come to understand by now that oils days
are numbered.
Shale has slowed the countdown down but nothing will stop it again.
Saudi Arabia is
planning for the postoil era, why not the
United States?
Written by Kurt Cobb from Resource Insights
The world's largest exporter of crude oil, the Kingdom of Saudi Arabia,
recently announced a plan for its post-oil future. If a country almost synonymous with
the oil economy can see the need for such a plan, how can the rest of the world,
particularly the United States, the world's largest consumer of petroleum, not see the
necessity of such foresight?
The kingdom's plan includes sale of part of Saudi Aramco, the world largest oil
company and currently wholly-owned by the Saudi government. The company
controls all oil development in Saudi Arabia. That the Saudis want to sell part of the
most valuable company in the world means they have a different view about the
future of oil than those who will be buying. Commentators often report that markets
rise because investors are optimistic or fall because they are pessimistic. But this is
complete nonsense because for every buyer there is always a seller. Each side of a
trade believes in a different future for the investment being traded.
Certainly, there are many reasons for selling a minority stake in Saudi Aramco. But
one of them can't be that the rulers of the kingdom have an unalloyed bullishness
about Saudi capabilities and oil resources.
As recently as 2007 the U.S. Energy Information Administration (EIA) believed Saudi
Arabia would be supplying the world with 16.4 million barrels per day (mbpd) of oil by
2030. (And, that was down from 23.8 mbpd projected for 2025 in a 2003 report.) In
2008 theSaudi king appeared to embrace a policy of 12.5 mbpd and no more.
Since then long-term projections for Saudi production have come down with a range
of 10.2 mbpd to 15.5 mbpd for 2040 (in a 2013 EIA report) depending on which of
three scenarios you choose. No explicit range has been included in subsequent EIA
reports.
With the release of a new independent report on world oil reserves by a former BP
insider, a report that suggests that conventional reserves are half what is being
claimed, the issue of limits on oil production has resurfaced. (The report implies that
Saudi reserves have been inflated as well.)
By including Canadian tar sands and Venezuelan heavy oil, world oil reserves
increase back to about 75 percent of what is typically reported. But that number
makes no adjustment for the much greater difficulty and expense of getting these
unconventional resources out of the ground and then turning them into something we
call oil. The financial debacle taking place in the tar sands under the current lowprice regime is clear evidence that those resources cannot be sustained without high
prices.
The temporary glut we are experiencing now, however, does not disprove limits. It
only shows that we can still have market cycles in oil just as we did in 2008 when oil
fell from $147 per barrel to around $35 in six months. By 2011 oil was back above
$100, where it stayed with only brief forays under that price, until the end of 2014.
This period has so far given us the highest inflated-adjusted average daily prices for
oil ever.
For those who believe the United States does seem to have energy policies relevant
to a post-oil world, I would answer that this is not the result of some grand design,
but rather due to a hodge-podge of programs, many of which are conflicting. Even as
the U.S. tax code continues to provide substantial subsidies for oil and natural gas
production, it also provides substantial subsidies for renewable energy such as solar
and wind. But these renewables subsidies are really about producing electricity.
Subsidies for liquid fuels, the kind that replace fuels from oil, have been
reduced. The federal subsidy for ethanol ended in 2012. Subsidies for biodiesel and
other biofuels continue.
While ethanol was always really an energy carrier and not an energy source--it takes
about as much energy to produce corn ethanol as it yields--biodiesel is believed to
have a positive energy balance. Even so, converting the U.S. vehicle fleet to
biodiesel isn't in the cards, and doing so would require so much farmland to grow the
necessary oil crops that we might be able to drive, but probably not eat--an absurdity
of the first order.
Now granted, a post-oil society doesn't necessarily mean a no-oil society. Oil
supplies may decline gradually after a future peak in production. We won't, as the
critics say, 'run out.' That's just a canard meant to prevent people from
understanding the serious implications, not of running out, but of having less each
year.
There is the option of moving to electrified transportation which I support. But most
people think of this as a move toward electric cars. The entire car fleet in the United
States currently takes about 14 years to turn over. But, of course, we'd only get
replacement of all vehicles with electrics over this period if we started selling 100
percent electric-only vehicles now. Moreover, certain types of transport--emergency
services, farm equipment and rural transport--will likely require liquid fuels for a long
time to come.
Because we are only very gradually increasing the number of electric-only cars
available for purchase, it would likely take two to three decades for a complete
transition away from oil-fueled vehicles. It would be much wiser to electrify and vastly
expand public transportation, something that isn't on the policy radar in the United
States.
There are certainly local efforts to expand bicycle lanes and pedestrian areas to
reduce dependency on motorized transportation. But those efforts can hardly be
called coordinated and rapid.
If we had absolute clarity on future oil supplies, we'd know how quickly we must
make the transition away from oil. But we don't have anything approaching that.
Instead, we have competing estimates and timelines, and--here's the important part--
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this level of investment year after year especially during the regime of lower oil
prices?
Market Fundamentals
History has taught us that sustained higher oil prices negatively affect the demand,
but encourages supply side (assuming other factors remain constant). The most
important determinant of the level of exploration activity by international oil
companies (IOCs) is the current and most recent past oil prices. The initial response
of the industry to increase in oil prices may not immediately lead to an upsurge in
exploration activity, but possibly a reappraisal of discoveries made in mature regions
deemed uneconomic under lower price scenarios.
Therefore, exploration activities in new acreage especially high-risk-high-cost basins
are expected to increase after a year or two in response to higher oil prices
especially if IOC's strongly view that pattern of high oil price will continue in the
future. Higher oil prices improves profitability of oil and gas industry and therefore
they are willing to invest in high cost unexplored basins (new frontier - deep offshore)
in search of sizeable oil fields. In addition high oil prices also induces investments in
energy efficiency, conservation, backstop fuel supplies from unconventional crude oil
from tar/tight sands, oil shale, gas to liquid (GTL), coal to liquid (CTL)4, and other
renewable sources of energy - thus reducing the pressure on oil demand in the long
run. For example, recently, the sustained higher oil prices substantially encouraged
shale oil/gas development, particularly in the USA, which is complemented by
innovative technological advancements in horizontal drilling and hydraulic fracturing.
Likewise, the world has also witnessed rapid growth in renewable sources of energy;
however, it is not a threat to fossil fuels due to its marginal share in total energy mix.
Persistent higher oil prices also adversely affected the global economy - slowing
down oil demand. Therefore, eventually market fundamentals push the oil prices
downward. The recent memories of 2007/2008 and later during 2011-2014 a period
of higher oil prices followed by plunging oil prices during 2nd half of 2008 and
2014/2015 are still afresh.
In contrast to higher oil price regime, lower oil price environment reduces the oil and
gas industry profitability and therefore, they immediately take cost cutting measures
including cutting back exploration activities. Recently, we have witnessed that it is
difficult for most of the OPEC members to balance their budget given the low oil
prices, and are forced to deplete sovereign funds (or foreign exchange reserves).
That is, in the regime of softer oil price environment it will be even difficult for the
industry to sustain current level of oil production that requires continuous investment
encourage exploration activities, however, it is not like turning the switch on or off
rather it requires a number of years before the full impact is fully realized. In a similar
manner when oil prices plunge exploration activities did not die off instantaneously
due to contractual commitments, or in the middle of drilling, drilling rig is hired for a
number of year(s) etc. Therefore, the trends depict a lag before the impact of
increase/decrease in oil prices is fully realized. A similar trend could be witnessed
when relationship between oil prices and oil production are analyzed (Figures-3 & 4).
The response of oil production to changes in oil prices took longer adjustment times
than the drilling rig count.
In order to have a better understanding of the relationship between oil prices and rig
count and oil prices and oil production please see the Figures-5-8.
Figures-9 & 10 depicts the best fitted graph for both onshore and offshore based on
best estimated model. Onshore drilling is more responsive and requires less number
of months to increase/decrease in drilling activities in response to changes in oil
prices. Whilst offshore drilling activities is less sensitive, erratic and requires more
time to respond to changes in oil prices. Both the models fit quite well as more than
97% of the variation are explained by the given explanatory variables. The higher
sustained oil prices results in acceleration of exploration activities leading to more oil
and gas discoveries and enhanced production. Whilst lower oil prices over extended
period of time not only constrained industry profitability but also hampered the
required investment in exploration and development activities. What we have learned
from history is that neither higher nor lower oil prices are sustainable over an
extended period of time and world would continue to live in cyclical uncertain
environment. That is, lower oil prices over extended period of time will choke the
supply side but continue encouraging oil demand that in turn will gradually push the
oil prices - another episode of higher oil price will be followed. Though some
episodes are short lived while others could hold back for a number of months
depending on global economic situation and inventories level. The cyclical
movement in oil prices will ensure that neither high nor low oil prices will continue to
stay forever - giving a hope of oil and gas industry to continuously progress and also
allows to develop new-state-of-the-art-technology. It appears that such episodic oil
When oil was over $100 per barrel, human beings in many countries were
getting the benefit of most of that high oil price:
Some of the $100 per barrel goes as wages to the employees of the oil
company who extracted the oil.
Often, the oil company contracts with another company to do part of the oil
extraction. Part of the $100 per barrel is paid as wages to employees of the
subcontracting companies.
An oil company buys many goods, such as steel pipe, which are made by
others. Part of the $100 per barrel goes to employees of the companies
making the goods that the oil company buys.
An oil company pays taxes. These taxes are used to fund many programs,
including new roads, schools, and transfer payments to the elderly and
unemployed. Again, these funds go to actual people, as wages, or as transfer
payments to people who cannot work.
An oil company pays dividends to stockholders. Some of the stockholders are
individuals; others are pension funds, insurance companies, and other
companies. Pension funds use the dividends to make pension payments to
individuals. Insurance companies use the dividends to make insurance
premiums affordable. One way or another, these dividends act to create
benefits for individuals.
Interest payments on debt go to bondholders or to the bank making the loan.
Pension plans and insurance companies often own the bonds. These interest
payments go to pay pension payments of individuals or to help make
insurance premiums more affordable.
A company may have accumulated profits that are not paid out in dividends
and taxes. Typically, they are reinvested in the company, allowing more
people to have jobs. In some cases, the value of the stock may rise as well.
When the price falls from $100 per barrel to $50 per barrel, the incomes of
many people are adversely affected. This is a huge negative with respect to
world economic growth.
If the price of oil drops from $100 per barrel to $50 per barrel, this change adversely
affects the income of a large share of people who formerly benefited from the high
price. Thus, the drop in oil prices affects the incomes of many of the people listed in
the previous section.
Furthermore, this drop in income tends to radiate outward to the rest of the economy
because each worker who is laid off is forced to purchase fewer discretionary items.
These workers are also less able to take on new debt, such as to buy a new car or
energy products, and operate using energy products. Thus, energy consumption is
an important part of the economic growth pump. These capital goods are frequently
financed using debt, so debt is another important part of the economic growth pump.
Even apart from the debt necessary for financing capital goods, another way of
increasing demand is by adding more debt. If a company adds more debt, it can
often hire more workers and can add to its holdings of property. These also help
raise the output of the company. As long as the output that is added is sufficiently
productive that it can repay the added debt with interest, adding more debt tends to
enhance the workings of the economic growth pump.
The way governments have attempted to encourage the use of increased debt in
recent years is by decreasing interest rates. The reason this approach is used is
because with a lower interest rate, a broader range of investments can seem to be
profitable, after repaying debt with interest. Even very 'iffy' investments, such as
extraction of tight oil from the Bakken, can appear to be profitable.
The extent of the decrease in interest rates since 1981 has been amazingly large.
Figure 1. Ten year treasury interest rates, based on St. Louis Fed data.
Since 2008, additional steps have been taken to decrease interest rates even
further. One of these is the use of Quantitative Easing. Another is the recent use of
negative interest rates in Europe and Japan.
Falling demand would seem to suggest that the world's economic growth pump is no
longer working properly. This is happening, even with all of the post-1981
manipulations of interest rates to reduce the cost of borrowed capital, and thus
reduce the required threshold for profitability of new investments.
What could cause the economic growth pump to stop working?
One possibility is that accumulated debt reaches too high a level, based on historical
parameters. This seems to be happening now in many parts of the world.
Another thing that could go wrong is that the price of oil rises so high that capital
goods based on oil are no longer cost effective for leveraging human labor. If this
happens, manufacturing is likely to move to countries that use a cheaper mix of
fuels, typically including more coal. The shift of manufacturing to China seems to
reflect such a change.
A third thing that could go wrong is that pollution becomes too great a problem,
forcing a country to slow down economic growth. This seems to be at least part of
China's current problem.
If oil prices drop from $100 to $50 per barrel, this has an adverse impact on
debt levels.
With lower oil prices, workers are laid off, both from oil companies and from
companies that provide goods and services to oil companies. These workers, in turn,
are less able to take on new debt. In some cases, they may also default on their
debt.
Oil companies with reduced cash flow are also less able to repay their debt. In some
cases, companies may file for bankruptcy. The result is generally that existing debt is
'written down.' Even if an oil company does not file for bankruptcy, it is likely to have
difficulty adding new debt. The trend in the amount of debt outstanding is likely to
change fromincreasing to decreasing.
As the amount of debt shifts from increasing to decreasing, the economy tends to
shift from increasing to shrinking. Instead of adding more employees, companies
tend to reduce the number of employees. If many commodities are affected, the
impact can be very large.
We need oil prices to rise to $120 per barrel or more.
The current price of $50 per barrel is still way too low. A post I published in February
2014 was called Beginning of the End? Oil Companies Cut Back on Spending. In it, I
talked about an analysis by Steve Kopits of Douglas-Westwood. In this analysis,
Kopits points out that even at that time-which was before oil prices began dropping in
mid-2014-major oil companies were beginning to cut back on spending for new
production. Their cost of production was at that time typically at least $120 or $130
per barrel, if prices were to be high enough so that companies could fund new
development without adding huge amounts of new debt. Oil prices could perhaps be
lower if oil companies could fund their operations using large increases in debt.
Company management recognized that such a funding approach would not be
prudent-it could lead to unmanageable debt levels.
Today's cost of oil production is likely to be even higher than it was when Kopits'
analysis was performed in early 2014. If we expect oil production to continue to rise,
we probably need oil prices in the $120 to $150 per barrel range for several years.
Prices at such a level are likely to be way too high for consumers, because wages do
not rise at the same time as oil prices. Consumers find that they need to cut back on
discretionary expenditures. These spending cutbacks tend to lead to recession and
falling oil prices.
We can think of our economy as being like a big ball, which can be pumped up
to greater and greater size with either rising productivity or rising debt.
This process can continue to work, only as long as the debt added is sufficiently
productive that it is possible to repay the debt with interest. We seem to be reaching
the end of the line on this process. Returns keep falling lower and lower,
necessitating ever-lower interest rates.
To some extent, the pumping up of oil prices that occurs in this process represents a
lie, because the energy content of a barrel of oil remains unchanged, regardless of
price. In fact, the energy of coal and of natural gas per unit of production remains
unchanged as well. The value of energy products to society is determined by their
physical ability to leverage human labor-for example, how far diesel oil can move a
truck. This ability is unchanged, regardless of how expensive that oil is to produce.
This is why, at some point, we find that high-priced energy products simply don't
work in the economy. If we spend the huge amount of resources required for the
production of energy products, we don't have enough resources left over for the rest
of the economy to grow.
Low oil prices, plus low commodity prices of other kinds, seem to indicate that we
are reaching the end of the line in the 'pump up the economy with debt' approach.
We have been using this approach since 1981. At this point, we have no idea what
economy growth would look like, without the stimulus of falling interest rates.
The drop in oil prices and other commodity prices since mid-2014 seems to
represent a 'shrinking back' of our ability to use debt to raise prices to a level
sufficient to cover the cost of extraction, plus associated overhead costs, including
taxes. This drop in prices should be an alarm bell that something is seriously wrong.
Without continuously rising prices, to keep up with ever-rising extraction costs, fossil
fuel production will at some point come to a halt. Renewables will not work well
either, because prices will not be high enough for them to be competitive.
Of course, once the economy stops growing, the huge amount of debt we have
amassed becomes un-payable. The whole system we have built will begin to look
more and more like a Ponzi Scheme.
We are blind to the possibility that oil prices of $50 per barrel may indicate that
we are reaching 'the end of the line.'
The popular belief is that everything will work out fine. Oil prices will rise a bit, and
somehow the economy will get along with less fossil fuel. Somehow, we will make it
through this bottleneck.
If we would study history, we would discover that there have been many situations of
overshoot and collapse. In fact, those situations tend to look quite a bit like the
situation we are seeing today:
There is a popular belief that oil prices will rise, if there is a shortage of energy
products. In prior collapses, it is not at all clear that prices have risen. We know that
when ancient Babylon collapsed, demand for all products, even slaves, fell. If we are
reaching collapse now, we should not be surprised if the prices of commodities,
including oil, stay low. Alternatively, they might spike, but only brieflynot enough to
really fix our current situation.
Too many wrong theories
Part of our problem is too much confidence that the 'magic hand' of supply and
demand will fix the economy. We don't really understand how demand is tied into
affordability, and how affordability is tied into wages and debt. We don't realize that
the view that oil prices can rise endlessly is more or less equivalent to the view that
economic growth can continue indefinitely in a finite world.
Another part of our problem is failure to understand how the economic pump that
keeps the economy operating works. Once debt rises too high, or the cost of energy
extraction rises too high, we can no longer keep the system going. Price tends to fall
below the cost of energy extraction. The quantity of energy products consumed
cannot rise fast enough to keep the economic growth pump operating.
Clearly neoclassical economics doesn't properly model how the economy really
works. But the Energy Returned on Energy Invested (EROEI) theory of Biophysical
Economics does not model the current situation well, either. EROEI theory is
generally focused on the ratio of Energy Returned by some alternative energy device
to Fossil Fuel Energy Used by the same alternative energy device. This focus
misses several important points:
1. The quantity of energy consumed by the economy needs to keep rising, if
human productivity is to keep growing, and thus allow the economy to avoid
collapsing. EROEI calculations normally have little to say about the quantity of
energy products.
2. The quantity of debt required to produce a given amount of energy by an
alternative energy device is very important. The more debt that is added, the
worse the alternative energy device is for the economy.
3. In order for the economic growth pump to keep working, the return on human
labor needs to keep rising. This is equivalent to a need for the wages of nonelite workers to keep rising. This is a requirement relating to a different kind of
EROEIenergy return on human labor, leveraged with various types of
supplemental energy. Today's EROEI theorists tend to overlook this type of
EROEI.
EROEI theory is a simplification that misses several important parts of the story.
While a high fossil fuel EROEI is necessary for an alternative to substitute for fossil
fuels, it is not sufficient. Thus, EROEI analysis tends to produce 'false favorable'
results.
Lining up resources in order by their EROEIs seems to be a useful exercise, but, in
fact, the cut-off likely needs to be higher than most have supposed, in order to keep
total costs low enough so that the economy can really afford a given energy source.
In addition, resources that add heavily to debt requirements are probably unhelpful,
regardless of their calculated EROEIs.
Conclusion
We are certainly at a worrying point in history. Our networked economy is more
complex than most researchers have considered possible. We seem to be headed
for collapse because of low prices, rather than high. The base scenario of the 1972
book 'The Limits to Growth,' by Donella Meadows and others, seems to indicate that
the world will likely reach limits about the current decade.
The modeling done in 1972 laid out the basic situation, but could not be expected to
explain precisely how collapse would occur. Now that we are reaching the expected
timeframe, we can see more clearly what seems to be happening. We need to be
examining what is really happening, rather than tying ourselves to outdated ideas of
how the economic system works, and thus, what symptoms we should expect as we
approach limits. It may be that $50 per barrel oil is one of the signs that collapse is
not far away.
Weve got
it covered
Serving the E&P industry for over 25 years
From 2010 to 2015 7 to 8 billion a year was being committed to new projects.
Even in 2015 more than 4 billion worth of field development plans were approved.
But now, it is nothing, nada, zilch, not a single new FDP for the last six months.
So, which field is going to prove that the North Sea is not a wasteland.
Truth is I don't know, but I am guessing my audience does. So stick your neck out,
vote on the poll just here and let us know which project you think will get over the line
first. I'm bound to have missed the front runner, so if that is the case, email
me or tweet at me and I'll add in your favourite.