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FT: Oil industry sums do not add up


The most interesting message in this year’s World Energy Outlook from the International Energy Agency is also its most disturbing.

Over the past decade, the oil and gas industry’s upstream investments have registered an astronomical increase, but these ever higher levels of capital expenditure have yielded ever smaller increases in the global oil supply. Even these have only been made possible by record high oil prices. This should be a reality check for those now hyping a new age of global oil abundance.

According to the 2013 WEO, the total world oil supply in 2012 was 87.1m barrels a day, an increase of 11.9mbd over the 75.2mbd produced in 2000.

However, less than one-third of this increase was in the form of conventional crude oil, and more than two-thirds was therefore either what the IEA calls unconventional crude (light-tight oil, oil sands, and deep/ultra-deepwater oil) or natural-gas liquids (NGLs).

This distinction matters because unconventional crude has a higher cost than conventional crude, while NGLs have a lower energy density.

The IEA’s long-run cost curve has conventional crude in a range of $10-$70 a barrel, whereas for unconventional crude the ranges are higher: $50-$90 a barrel for oil sands, $50-$100 for light-tight oil, and $70-$90 for ultra-deep water. Meanwhile, in terms of energy content, a barrel of crude oil is worth 1.4 barrels of NGLs.

Threefold rise

The much higher cost of developing unconventional crude resources and the lower energy density of NGLs explain why, as these sources have increased their share of supply, the industry’s upstream capex has increased. But the sheer scale of the increase is staggering: upstream outlays have risen more than threefold in real terms over the past 12 years, reaching nearly $700bn in 2012 compared with only $250bn in 2000 (both figures in constant 2012 dollars).

Coinciding with the rise in US tight-oil production, most of this increase in upstream capex has occurred since 2005, as investments have effectively doubled from $350bn in that year to nearly $700bn in 2012 (again in 2012 dollars).

All of which means the 2013 WEO has the oil industry’s upstream capex rising by nearly 180 per cent since 2000, but the global oil supply (adjusted for energy content) by only 14 per cent. The most straightforward interpretation of this data is that the economics of oil have become completely dislocated from historic norms since 2000 (and especially since 2005), with the industry investing at exponentially higher rates for increasingly small incremental yields of energy.

The industry has been able and willing to finance such a dramatic increase in its capital investment since 2000 owing to the similarly dramatic increase in prices. BP data show that the average price of Brent crude in real terms increased from $38 a barrel in 2000 to $112 in 2012 (in constant 2011 dollars), which represents a 195 per cent increase, slightly greater in fact than the increase in industry capex over the same period.

However, looking only at the period since 2005, capital outlays have risen faster than prices (90 per cent and 75 per cent respectively), while in the past two years capex has risen by a further 20 per cent (the IEA estimates 2013 upstream capex at $710bn versus $590bn in 2011), while Brent prices have actually averaged about $5 a barrel less this year than in 2011.

Iran not a game changer

That prices have fallen slightly since 2011 while capex has risen by a further 20 per cent is a flashing light on the industry’s dashboard indicating that its upstream growth engine may finally be overheating.

Without a significant technological breakthrough reversing the geological forces that have driven the unprecedented increase in upstream investment over the past decade, prices will have to rise further in real terms from here or else capex – and with it future oil production – will fall.

It should also be emphasised that this vast increase in capex has occurred during a prolonged period of record-low interest rates. Once interest rates start rising again, this will put further pressure on the industry’s ability to make the massive capital outlays required to keep supply growing.

Of course, the diplomatic breakthrough achieved with Iran over the weekend could provide some much needed short-term relief to the market, as Iran’s exports could ultimately increase by up to 1.5m barrels a day if and when western sanctions were to be fully lifted. But this would not change the dynamics of the industry’s capex treadmill in any fundamental sense.

Even if global oil demand only grows at 1 per cent a cent a year, those extra barrels would be would be fully absorbed by the market within about 18 months. And that is probably how long it would take for Iran’s production and exports to return to pre-sanctions levels in any case.

Alternatively, if we take the IEA’s estimate that global production of conventional crude oil from all currently producing fields will decline by 41m barrels a day by 2035 (that is, by an average of 1.9m barrels a day per year), then Iran’s potential increase of 1.5m barrels a day would compensate for just 10 months of natural decline in global conventional-crude output.

In short, behind the hubbub of market hype about a new age of oil abundance, the toil for oil is in fact now more arduous and back-breaking than ever.

This should worry everybody, because with the evidence suggesting that consumers are reluctant to pay much above $110 a barrel, it is an open question what happens next to the industry’s investment plans and hence, over time, to the supply of oil.

Mark Lewis is an independent energy analyst and former head of energy research in commodities at Deutsche Bank; Daniel L Davis, a lieutenant colonel in the US Army, is co-author


8 Comments on "FT: Oil industry sums do not add up"

  1. paulo1 on Tue, 26th Nov 2013 3:12 pm 

    re: “This should worry everybody, because with the evidence suggesting that consumers are reluctant to pay much above $110 a barrel, it is an open question what happens next to the industry’s investment plans and hence, over time, to the supply of oil.”

    It sounds like if infrastructure is already in, the low return investments will be operating at marginal returns…and with this I am thinking of a large oil sands plant, refining, and delivery system. These are long term projects/facilities and the reserves are known, not guessed at or simply hoped for. I would not think the same applies to tight oil projects requiring ever increasing drilling/fracking. Easy enough to see what pipeline companies think by where they are proposing new lines and for what products. There is a massive and long term propaganda war to get bitumen to market by whatever means…and with Bakken declines rail and tankers seems to suffice. If the economy further tanks and crude prices fall a bit more, it seems reasonable enough to expect tight oil projects to come to an immediate and screeching halt accompanied by a rapid share price collapse as those in the know begin to short and sell.

    I just wonder what the news headlines will be, and how the general public will handle the news that energy will not be getting much cheaper anytime soon?

    These are interesting stairsteps down. It is a real corner we are now in, with almost no growth, higher energy prices, a degrading environment, and only funny money to use. My concern level has been increasing this fall, big time.


  2. rollin on Tue, 26th Nov 2013 3:44 pm 

    Very relevant article for FT, discussing the falling net energy from “oil” and it’s different types.

    Once the whole idea of decline sets in there will be a lot of scrabbling about to find and implement alternative energy sources as well as conservation and efficiency changes. Too bad we have wasted the prime time to make these changes, but they will still be good changes. Either that or we end up walking while only the rich get to ride around.

  3. shortonoil on Tue, 26th Nov 2013 5:16 pm 

    “but the global oil supply (adjusted for energy content) by only 14 per cent”

    I am wondering if these authors have looked at one of the pre-release copies of our study? To date we have sent about 100 of them out, mostly to individuals we have quoted. They seem to have a pretty good grasp of the significance of the energy difference between various hydrocarbons. But, the 14% number is a little high; it should be about 11%. Hydrocarbons below Heptane (C7H16) have lower Maximum Second Law Thermal Efficiencies, thus lower deliverable energy.

    Expect to see more articles like this one in the future.

  4. peakyeast on Tue, 26th Nov 2013 7:46 pm 

    “Once interest rates start rising again, this will put further pressure on the industry’s ability to make the massive capital outlays required to keep supply growing.”

    Interest rates wont rise until they have made supply rise significantly – or fusion power is on-line and globally available – or a similar game changer.

    Until then money will increasingly lose they value or increasingly be available to few.

  5. J-Gav on Tue, 26th Nov 2013 8:01 pm 

    “Toil for oil” is a succinct way of putting it.

    14%/11% … the difference isn’t that big Shorton but thanks for the info.

    Whichever figure is closest to reality, what I’m more concerned about is that a near-panic reaction to reality (which oil companies and governments are much more aware of than they let on) will bring about an Arctic/Siberian methane disaster.

  6. mike on Tue, 26th Nov 2013 11:46 pm 

    No shit FT, glad we have you experts around to tell us this so late in the day. GOOD JOB!

  7. BillT on Wed, 27th Nov 2013 12:42 am 

    Rollin, I doubt the rich will ride much longer than you or I. Think about the vast infrastructure that makes owning a car possible.

    Now think about how that could survive with say, 1 million cars vs 250 million.

    Now think about each step of the process. How many materials go into a modern car? Where do they come from? How do they get from scrap and ores to the finished product? And how do they fuel those vehicles if all of the gas stations are closed?

    And, last but not least. How safe would they be driving them in a country where most of the people are poor/desperate … and armed?

  8. shortonoil on Wed, 27th Nov 2013 4:57 pm 

    “14%/11% … the difference isn’t that big Shorton but thanks for the info.”

    That is equivalent of 2.25mb/d of light sweet. That is more energy than what is delivered to the end consumer by the combined shale oil, and Canadian tar sands industry. Crude without energy delivery capabilities is just black goo in a barrel!

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