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The Last Two Oil Crashes Show Peak Oil Is Real

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Summary

  • Recent oil crashes show you the hard floor for gauging value oil company equities.
  • Properly understood, the crashes lend an insight into the concept of Peak Oil.
  • All oil equity investors should understand the overarching upward trend on display here.

PLEASE NOTE: ALL prices used in this article are using current 2015 dollars, inflation adjusted using the US BLS inflation calculator

Generally, when I invest, I try to keep my thesis very simple. Find good companies, with good balance sheets and some kind of specific catalytic event on the horizon. But when one starts to concentrate their holdings in a sector, as I have recently in energy (see my recent articles on RMP Energy (OTCPK:OEXFF) and DeeThree Energy (OTCQX:DTHRF) , you need to also get a good handle on the particular tail or headwinds that are affecting it. Sometimes a sector like oil (NYSEARCA:USO) can be subjected to such forces, like the recent oil price crash, that almost no company specific data will matter.

One of the biggest arguments, normally used by proponents of owning oil stocks as core holdings, in the energy sector is “Peak Oil”. For the unfamiliar, it is a theory forwarded first by M. King Hubbert in the 1950’s regarding US oil production. Essentially, the theory stated that the US would reach a point where the oil reserves would become so depleted that it would be impossible to increase oil production further, or even maintain it at a given level, regardless of effort. This would inevitably lead to oil price rises of extreme magnitudes.

Since those early beginnings the details have been argued over in an ever evolving fashion. The argument has shifted with global events, technological developments, and grown to encompass nearly every basin in the world (even best selling books have been written about peak oil likeTwilight in the Desert: The Coming Saudi Oil Shock and the World Economy by Matt Simmons about a decade ago) consuming endless bytes of the Internet in every kind of investment forum and medium of exchange.

In general, I believe that the term “peak oil” is a highly flawed one. Some picture peak oil in a Mad Max fashion, with oil supplies running out like a science fiction disaster movie. Others simply dismiss peak oil as having failed to predict these so-called peaks repeatedly (the world is producing a record amount of oil right now so all previous absolute “Peak Oil” calls below these amounts are obviously wrong). But what people should be stating when they use these terms is a Peak Oil Price.

Using my own thinking and phrasing, I believe civilization has provably passed $25 Peak Oil. This means that if you set the oil price to $25 a barrel there is no method available to humanity to provide enough oil to meet demand over any period of time that’s really relevant. I also believe we are in the middle of proving that we have also passed $50 Peak Oil. My final conjecture here is that we will prove in the near term future to have reached $75 Peak Oil. I don’t believe we are quite at $100 Peak Oil.

Notice that in my formulation the term Peak Oil is always stated as a peak price. Oil is not consumed in a vacuum. The price effects the demand the world has for the product and simultaneously changes the ability of all sorts of entities (businesses and governments) to retrieve deposits of it. This is what I hope to prove in this article.

So what data could I bring to this crowded table?

Well we have one thing we now have that previous entrants into the Peak Oil melee didn’t, which is the recent price crash in oil. Peak oil is often falsely portrayed as a failed idea since it hasn’t resulted in a super squeeze to ultra high prices. These spike prices are viewed as the really critical element by energy investors since they are trying to find the best case. After all, who doesn’t want to own an oil producer if they can identify a spot in which oil prices will rise to some enormous number.

But that is the wrong way to go about it for your oil investments over the long haul. Because what $50 Peak Oil really provides is a floor. In a world where we have passed $25 Peak Oil, it should be impossible, without exogenous events of enormous magnitude (world war, etc), to press the price of the product below that price. If you could do so, you would immediately disprove the thesis. You would then know the floor provided by whichever peak oil price level you selected was wrong. The same idea seems to hold true for 50$ Peak Oil now.

To prove this “floor” we need to choose times of extreme stress in the oil markets, and look at those oil prices and see what the bottoms were. For these examples lets select WTI oil, whose weekly average prices are reported all the way back to 1986 by the EIA

Lets take the three big crashes in the oil markets. I will use a full year’s average to try to smooth out the various difficulties presented by weather, seasonal effects, or various one off events (outages, etc). The first crash I will use as a benchmark is The 1986 Oil Crash. The 1986 breakdown was a supply crash, caused by supply swamping demand. How big a disaster was it for the oil industry?

In 1986, the Saudis opened the spigot and sparked a four-month, 67 percent plunge that left oil just above $10 a barrel. The U.S. industry collapsed, triggering almost a quarter-century of production declines, and the Saudis regained their leading role in the world’s oil market. (link)

This was quite a crash obviously. Triggering a 25 year decline? Not going to find a lot worse than this. So in inflation adjusted dollars what was WTI oil at for the year of 1986? It sold for around $32 a barrel. Now lets note that at this time WTI crude was actually at a higher price vs Brent and other world prices. On a Brent basis crude would have been just around 25$ for the year. This will prove to be an important point in a short while.

The next crash we will use to benchmark was the 2008 Financial Crisis. On this website I should hope that this world crisis will need no introduction and little explanation. This crash in oil prices (and just about every other thing priced by human beings) was a demand crash. The financial disintegration across the world led to massive drops in demand, as jobs were lost across the world by the millions. So with this demand crash what was the average price of WTI crude in the year 2009? It sold in that year for a little over $60.

The last crash I will add is the current drop, starting sometime around October by my reckoning. I would find it hard to imagine any reader of this article is unfamiliar with the current situation in North America or the world regarding oil, at least in a headline sense. This seems to be a supply crash again, where North American led tight oil drillers have caused an increase in production that the world’s demand couldn’t handle at the $100 price level. Since then, prices have dropped down to a level that suppresses the production of oil and enhances demand.

In the first four months of 2015, the North American oil rig count has already dropped by more than 50% as compared to last year and the demand for oil has begun to increase according to EIA statistics. The current price of WTI oil has been just over $49 as an average for the year 2015. However let us note that WTI oil now sells for a large discount to world prices, and during the previous two crashes WTI sold for a premium.

Now we have three data points. Each one is a fairly long period of time, not just a single week. We know that the world in 1986 nearly ended for the oil industry, yet in current dollars WTI oil was unable to trade for a year below $30 a barrel. Then we had in 2008 and 2009 an economic crisis which was widely described as being the most dire financial disaster since WWII. In 2009 WTI oil still ended up trading well over the 1986 low. In fact it was nearly double that price. This shows just how hard it can be using almost any technique to push oil prices below a true peak number.

Now we have another supply led crunch. One that is widely described as the worst oil crash since 1986, a nearly 30 year time gap. We are attacking the oil price from the supply side instead of 2008’s demand side. Yet thus far, in 2015, oil is still trading more than 50% higher than the 1986 year average, inflation adjusted. In fact, WTI, when adjusted for its current discount to world prices, is trading close to its 2009 average price. Again, nearly double the price of the 1986 crash.

What does this all mean for investing? It means to me that $25 Peak Oil is behind us. You couldn’t really hit and maintain that number in the 1986 crash when many more virgin conventional reservoirs of oil were available. Despite the last three oil crises, not one of them could get WTI oil to $25 and keep it there. Now, using much more expensive oil resources (shale fracing, deep water drilling, arctic development, etc), it doesn’t seem like the last two disasters have been able to press WTI oil much below $50 for a material length of time. In this recent crash, the 50$ floor was able to be reached only with several years of hyper investment made possible by the twin forces of sustained high prices and access to ultra-cheap capital. Both of these forces are no longer present in the oil markets.

Therefore, I think using a $50 Peak Oil number is a very reasonable hard floor to use when stress testing your oil stocks. It means that when I am choosing a stock that produces oil, it can survive both from Supply and the Demand led crashes using the worst the world can throw at it.

Some will say this reasoning is simplistic. One could claim any number of variables in the future (technology, peace in the middle east, etc) could change all the points I am relying on here. But we have thrown everything at the oil complex between 2008 and now; both from the supply side and the demand sides. Breakdowns of the whole world economy. Wars. Sanctions. Natural disasters. Hugely stupid governmental polices. OPEC’s seeming fade to irrelevance. Biofuels. Periods of ultra-high prices. Technological progress. Electric cars. Etc. Yet, here we stand with these numbers staring us in the face.

In conclusion, I feel these prices points prove the reality of $50 Peak Oil (WTI). If WTI oil averages more than $50 in 2015 (which I strongly feel the data shows will happen), then it will confirm my thesis that no matter what happens in the world, human beings cannot seem to produce the amount of oil they require for less than that number. Therefore one will know what the hard floor for petroleum is provided by the hugely complex interplay of geology, politics, economics, and technology by simply measuring those effects on one easy to measure point of data, namely price. This version of peak oil also means I have a minimum to test my selections on. I can buy companies that can at least deal with that floor, then make large profits as the prices rise from that hard floor. All oil fields deplete and for the past twenty years the solution has universally been to add more expensive technological solutions, exploit smaller or more physically difficult deposits, or use more expensive alternatives. The oil market does not have the same options available to it like it did 1986. Large, cheap conventional oil deposits are no longer available in sufficient supply, which is likely what the oil price is telling us by having higher Peak Floors during crashes. Without the magic of sustained ultra high prices, the investment levels that made this run at the 50$ Peak Oil level will not exist going into the future. This means that the Peak Oil floor price should be creeping higher as a sector tailwind, giving a patient and selective investor a tremendous advantage for themselves.

seeking alpha



26 Comments on "The Last Two Oil Crashes Show Peak Oil Is Real"

  1. Plantagenet on Fri, 24th Apr 2015 6:30 pm 

    This gentleman doesn’t seem to understand the concept of INFLATION. You can’t compare a price in 1986 dollars to something priced in todays dollars without adjusting for inflation (i.e. loss of purchasing power in the dollar). So….taking into account inflation the 1986 dollar would be worth $2.16 today. Thus the oil price of ca. $50 in todays oil glut would cost less than $24 in 1986 dollars.

    This means the price of oil in the current oil glut has actually fallen LOWER then oil prices fell in 1986, i.e. Oil is waaaaaaaaay cheap now.

  2. BobInget on Fri, 24th Apr 2015 7:32 pm 

    Taking advantage of $24 today, oil requires a
    Deloran Time-Machine with an oversized fuel tank..

    When per oil barrel numbers are crunched for Saudi Arabia does one calculate so called
    ‘defense expenditures’ of 80 Billion per year.
    http://en.wikipedia.org/wiki/List_of_countries_by_military_expenditures

    As for that 10% of GDP you’ll notice only a non oil producing country, Israel, comes even close with 7% of GDP.

    The really great news for John Bolton types,
    All Muslim all the time KSA, partnered with Israel
    to take down Iran, (not in the top 15 arms buyers)

    If it’s true, Iran has the lowest cost oil, explains a great deal about why KSA wants to crush em.

  3. paulo1 on Fri, 24th Apr 2015 7:39 pm 

    Plant,

    You missed the sentence where he said he adjusted it for inflation in 2015 dollars.

    “PLEASE NOTE: ALL prices used in this article are using current 2015 dollars, inflation adjusted using the US BLS inflation calculator”

  4. apneaman on Fri, 24th Apr 2015 7:58 pm 

    Oil’s tipping point has passed
    The economic pain of a flattening supply will trump the environment as a reason to curb the use of fossil fuels, say
    James Murray and David King

    http://www.washington.edu/research/.SITEPARTS/.documents/.or/Nature_Comment_01_26_2012.pdf

  5. Nony on Fri, 24th Apr 2015 10:25 pm 

    And then there’s James Hamilton with his peaker-biased macro-weenie econ call of “hundred dollars to stay”. Dude needs to put down the time series and pick up the indifference curves. Moron.

  6. shallow sand on Fri, 24th Apr 2015 11:36 pm 

    Nony. Check out CLR investor presentation just released. They took on $440 million of additional debt from 12/31/14 to 2/17/15.

    I’d say they need $100 oil.

  7. rockman on Sat, 25th Apr 2015 3:47 am 

    The 1986 inflation adjusted value of oil was $31.10.

    http://inflationdata.com/inflation/inflation_rate/historical_oil_prices_table.asp

    So the oil price today is significantly higher then it was in 1986.

  8. marmico on Sat, 25th Apr 2015 6:36 am 

    So the oil price today is significantly higher then it was in 1986.

    So what? So is the (real) price of health care, college tuition and a laundry list of other goods and services.

  9. shallow sand on Sat, 25th Apr 2015 8:29 am 

    ROCKMAN. Although I agree each well is different, I am willing to bet the inflation adjusted average cost to find and produce a barrel of crude oil in the USA is higher now than in 1986.

    While we are on the topic, note my post above. In 1986 were independents still able to borrow large sums of $$ to keep drilling? It will be interesting to see if CLR has to borrow at that rate for all of 2015, or that borrowing was an extraordinary circumstance.

    I note Williston Light Sweet posted price as gotten a $4 bump up. That will help.

  10. Nony on Sat, 25th Apr 2015 8:56 am 

    Sand:

    So what? I could care less who needs 100/bbl. the equilibrium price will be where enough pain is caused to stop barrels from flowing with enough inducement to keep barrels flowing in a way that matches the willingness of consumers to buy more/less based on price being less/more.

    This is econ 101. Who gives a sh** if CLR has a problem. What matters is total supply and demand. And Hamilton HUGELY missed the key micro-economic insights. He way dismissed shale. At 100/bbl it goes gangbusters. Those wells are positive NPV at 100/bbl and we go back to super growth city. So the price dropped.

    Instead of hundred to stay, Hamilton should have said “hundred leaving forever”. He missed the boat hugely. He’s biased towards peaker views (read all the way back to his Ph.D. thesis to see that). And he doesn’t do micro-economic analysis (e.g. building up cost curves for suppliers).

  11. Nony on Sat, 25th Apr 2015 8:59 am 

    And the market came and CRUSHED his prediction. SMASHED it. And he lacks the stones to revisit his comment and examine how he screwed up. He’s a weasel along with lacking a micro mindset.

    Oh…and the cold, hard futures market is below 80 all the way out to 20 years or so. (probably less than inflation growth in price). We already got some recovery and will get a little more. Then equilibrium. Some jumps up and down. But the long term trend sure as SH** ain’t to 2014 real hundred dollar prices.

  12. Nony on Sat, 25th Apr 2015 9:12 am 

    Oh…and Rock, you STILL haven’t admitted that you misread monthly Marcellus change to be annual. Kind of hard to judge a play when you pull that sort of boner. Oh…and you had some tasty words for me on the RRC crude and condensate numbers, when you didn’t even know the basics of how those numbers have several month lag in final updates (a WELL documented phenomenon, even in peaker land). What a goober…can’t even admit you’re wrong. Have fun with the losers kissing your ass. I’d rather learn from real industry vets like Rockdoc.

  13. Nony on Sat, 25th Apr 2015 9:31 am 

    Natural gas kissing 2.50!!!!

    Oh Art Berman…how’s that “they need $8+” working out? You’ve been feeding that line since 2009 and we are at 2.50! And that’s not with a demand drop–volume is up 50%!

  14. shallow sand on Sat, 25th Apr 2015 9:49 am 

    Seem like in 2008-2009, price went from top of 140s down to low 30s then marched back up again, to crash to low 40s. I’m pretty sure the 6/14 futures price was not $105 in 2/09, just like the 2/15 futures were not trading at $45 in 6/14.

    Predicting prices is pretty tough in oil IMO.

    The people who like low gasoline prices, which I assume would be 99% of the USA populace, better hope the Middle East can keep cranking it out. I don’t see many other places in the world where $55 is profitable on a large scale.

    I’d say 906 oil rig drop in 6 months in USA is not meaningless. I’d say CLR borrowing $440 million in 48 days is not meaningless, unless they bought an asset as opposed to using the $ to keep operating.

    I have never seen companies not complete wells because the price is too low. Maybe USA is just to expensive and needs to rely on Middle East and Russia to supply cheap crude to be made into sub $2.50 gasoline for the long haul.

  15. Nony on Sat, 25th Apr 2015 1:46 pm 

    It’s a balancing act, SS. 100 was maintained for too long and the shale was too strong (at 100). We had a glut and a crash. Now prices will come up to something between 50 and 100. Maybe 65 long term? And there will be equilibrium. (Obviously with some random variation. But mostly around that level.)

  16. Nony on Sat, 25th Apr 2015 2:06 pm 

    SS:

    what CLR news are you referring to? I looked at Yahoo financial and they didn’t show any April filings. The 10k is from FEB. And it is a 200 page document.

    I applaud you for crunching numbers and being pretty fact-based (serious). But then, if you are so sure that CLR is overpriced (stock is at 55 today) why don’t you short it? [I do think you have to realize that people price a company like CLR with a bunch of non-producing acreage different from your stripper business. It was a growth play. And even know it has “option value” in the event that price recovers.]

  17. shallow sand on Sat, 25th Apr 2015 6:12 pm 

    N. look on their website at the April Investor Presentation. The debt for 2/17/15 on their loc is shown on it. The 10K is long, but you can find the outstanding debt as of year end on a schedule.

    Heck I hope they make it because that will mean long term higher price. I know you don’t want that and that’s ok. If I hadn’t invested in oil production I would likely want what you do.

  18. Nony on Sat, 25th Apr 2015 6:22 pm 

    Shallow:

    1. Come on. what page of the presentation do you want me to look at? Is the debt increase discussed or are you just comparing numbers from one source to another?

    2. It’s not nothing. But at the same time, it’s half a billion for a company that had 6 billion of debt.

    3. Also there debt to TEV is still very respectable. 6 bill of debt on 25 bil of TEV. That’s pretty low leverage.

    4. Somehow despite your concerns, the stock market doesn’t seem so worried.

    5. Was the debt increase, just exercising lines of credit or an increase overall?

    6. what were the terms of the new debt?

  19. shallow sand on Sun, 26th Apr 2015 2:57 am 

    Page 83 of 2014 10K. Credit facility balance $165 million as of 12/31/14.

    Page 20 of April investor presentation. Credit facility balance as of 2/17/15 $605 million.

    Its a debt increase, all long term bonds on 10K and April presentation the same.

    I say its overvalued at current prices because enterprise value is higher than Pv10 all categories using much higher oil and gas prices from last year.

    Market must be anticipating much higher oil, as 70% of mix is oil.

    I’m good with much higher oil, hope market is right and I am wrong.

  20. Amvet on Sun, 26th Apr 2015 5:35 am 

    Global peak oil production was prevented by changing the definition of oil. Naturally when NG liquids, refinery expansion, and liquids added during refining were included as “crude oil”, production increased.

  21. Nony on Sun, 26th Apr 2015 10:35 am 

    Shallow:

    The futures curve for both oil and natural gas is currently sloped for a moderate increase over next couple years. Presumably the market prices in that price (it is arbitrage-able if not).

    OK. I see what you mean about exercising part of the credit facility. Good find. I think you are more of a financial statement analyst than I am. Wonder what the comparison of cash balance would show.

    Still don’t think it is that big a signal, given the 20MMM+ scale of the company. I mean if they will have problems, they will have them (or not) regardless of this 0.5MMM debt.

    The PV-10 is not that far off the market cap. And is about 75% of the TEV. Yeah, price is down from 2014. But also, obviously, the market is valuing the entity for more than flowing barrels. [something different about them and you.] They have a lot of acre-age and have done downspacing tests also.

    I’m not saying to buy the stock or if it is overpriced. But I sure don’t see a danger of a BK. Look at the yearly interest payments on page 25. Is there any reason to think they could not hunker down and make those payments for many, many years.

  22. Nony on Sun, 26th Apr 2015 10:47 am 

    Amvet crude and condensate has gone up. Not just total liquids. We were about 73.75 MM bpd in 2005. Now we are at 78.5 MM bpd.

    And that increase has happened over a time that peakers predicted a few percent DECREASE per year.

    Peakers screwed up.

  23. Davy on Sun, 26th Apr 2015 11:54 am 

    NOo, patience grasshopper. It will come. Time is on our side. You corns must maintain an unsustainable meme.

  24. Nony on Sun, 26th Apr 2015 12:11 pm 

    NOOOOO! No doom. Boo.

    http://en.wikipedia.org/wiki/1999_(song)

  25. Apneaman on Sun, 26th Apr 2015 12:18 pm 

    Civilization Without Fossil Fuels

    http://hipcrime.blogspot.ca/2015/04/civilization-without-fossil-fuels.html

  26. Apneaman on Sun, 26th Apr 2015 12:29 pm 

    A Periodic Table Of Elements That The World Is Running Out Of

    This is one chemistry class the tech industry needs to get right.

    http://www.fastcoexist.com/3044467/a-periodic-table-of-elements-that-the-world-is-running-out-of

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