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Page added on May 10, 2018

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Oil Is Back

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In 45 years, the world has gone from energy shortage and fears of “Peak Oil” to an energy glut where it seems the world is drowning in oil and floating on a cloud of natural gas at the same time.

Yet that may not last. My models predict a long-term rise in energy demand and energy prices.

Of course, the same amount of energy has always been around. It’s just a question of technology, geopolitics and price as to whether the energy gets to where it’s needed when it’s needed.

Hydraulic fracturing, so-called “fracking,” is the biggest single factor in opening up oil supplies in the past 30 years. Oil that was always around but trapped in certain rock formations can now be released when those formations are subject to high pressure by pumping in water and sand composites.

Other innovations include horizontal as opposed to vertical drilling, so that one well can extract oil from a much larger area than before. Another rapidly growing aspect of the energy industry is the deployment of large liquefied natural gas (LNG) vessels than can move LNG across oceans instead of the gas being confined to continental areas.

Developing economies with large energy reserves such as Saudi Arabia and Russia are motivated to maintain output at high levels in order to finance ambitious internal development budgets, social spending or simple corruption. Russia and Saudi Arabia have been leaders in capping oil output lately.

But how long will that last with the U.S. picking up the slack, becoming a major energy export powerhouse? The race is on for global market share.

These technological and political drivers have caused much lower energy prices in recent years. Does this mean that energy companies are doomed to decades of low prices?

The answer may surprise you. I recently plugged into a private presentation by the top executives of a major energy company. Following is what they’re telling their investors behind closed doors:

With the energy business, it’s always best to take a long view, 20 years or more. That’s because the costs and scale of infrastructure are so large that overinvestment or underinvestment based on temporary trends can put a company out of business.

The bottom line is that based on the best information available now, executives forecast that the U.S. role as a major oil and gas exporter will not only persist, but expand greatly.

The constraint on short-term growth is not the energy or technology available but the infrastructure needed to move the oil and natural gas to the ports. These executives also take the view that the world will need every possible source of energy that can be developed to meet the increase in global demand projected for the next several decades. Here are the actual notes from the closed-door meeting:

Just a 1–2% change in the supply/demand equation for oil can move the price by $40 per barrel or more. Right now supply and demand are more balanced, restoring the price back to one where most can operate at a profit at this time. OPEC and Russia are helping keep global supply and demand fairly well in balance.

The CEO presented an analysis that projects demand for oil and gas to grow by 40% over the next 20 years despite an increase in renewable energy sources and even assuming conventional combustion engine cars obtain a fleet average of 50 mpg.

Electric cars are not expected to have a major impact in the next 20 years although they will grow substantially in number. Fossil fuels are expected to remain at around 80% of energy supply, as they are now, for most of this time period even as renewable sources do grow over time.

Global demand is expected to come from China, India, other parts of Asia and Africa during the next 20 years, while demand may actually drop in the U.S. and the EU. But those drops would be dwarfed by the increased demand from the other parts of the developing world.

The CEO expects the U.S. will become a substantial exporter of LNG eventually, once the infrastructure exists for that to happen.

A long-term imbalance creating a potential shortage of oil to meet daily demand is more likely than an oversupply in this view. It is also advisable to avoid shale plays, because they deplete so quickly. Companies should prefer long-lived reserves that others have abandoned.

As shown in the chart below, oil has staged a spectacular 25% rally from $60 per barrel in October 2017 to $70 per barrel today. The question is whether this rally represents supply shortages, robust demand by end-users or dollar debasement by inflation.

My models show that demand for energy from oil and natural gas will remain robust for decades to come.

LCOcl

With this long-term demand for energy as a backdrop, what are our predictive analytic models telling us about the prospects for the prices of energy and stocks of companies that support the energy sector in the months ahead?

Right now, my analysis agrees with the aforementioned CEO that demand for oil and gas combined will grow 40% over the next 20 years despite the increase in renewable energy sources, even assuming conventional combustion engine cars achieve a fleet average of 50 miles per gallon.

The demand for natural gas alone will increase 100% over the next 20 years.

These are the most conservative demand assumptions produced by our models and they assume a much higher shift to renewable energy and electric cars than standard models. In other words, these demand figures assume the electric car and solar revolutions will succeed and not fail. But we’re still going to use massive amounts of fossil fuels even with the success of renewables.

The world will need this energy not because of static demand in the U.S., Japan and Europe but because of exploding demand from China, Africa, South America and South Asia. Natural gas is expected to have the biggest increase in demand of any single source of energy during the next 20 years including wind, solar and electric vehicles.

If electric vehicles, solar and wind do not live up to their potentials, the demand for oil and natural gas will be even greater. In that situation, you could see an energy shortfall equivalent to 6 million barrels per day.

This shortfall could arise if electric vehicles fail to meet a target of 190 million vehicles by 2040 or if conventional internal-combustion engines fail to achieve the 50 mile per gallon fleet goal.

Apart from these natural and technical considerations, we cannot forget the role of geopolitics.

Venezuela is imploding and is coming close to the status of a failed state like Somalia or Yemen. If Venezuela collapses entirely, its energy output will come offline unless the U.S. intervenes militarily or unless China creates a cordoned-off energy mini-state on Venezuelan soil. Either scenario is certain to push up prices and restrict output under the best of circumstances.

Finally, we have learned through investment banking channels that China is tipping its hand with regard to the Saudi efforts to conduct a public offering of Aramco, the world’s largest oil company.

Aramco officials are balking at some of the disclosure and regulatory requirements that come with a public offering. They may pursue a private placement whereby China, or perhaps Russia, buys a direct stake. This gives Saudi Arabia the cash they need but still satisfies Aramco’s desire for nondisclosure.

China would not be pursuing this costly path if they did not see the same long-term supply shortages that my models predict.

I’ll be keeping a very close eye on this space in the days ahead.

Regards,

Jim Rickards
for The Daily Reckoning



17 Comments on "Oil Is Back"

  1. joe on Thu, 10th May 2018 10:01 am 

    Tight oil is not the solution, its a symptom of a wider problem. They need to replace the vast lakes of easy oil being sucked dry every year. They cant, cause it’s gone. Simple.

  2. Chico on Thu, 10th May 2018 10:41 am 

    After being in the industry for over 35 years, none of this shale production makes any sense!

    The squirrel cage continues that started in the Austin Chalk. Drill the next well to pay for the one you just D&C. If you don’t, you’ll go broke.

  3. rockman on Thu, 10th May 2018 11:33 am 

    Same problem again and again: at least since WWII there has never been a shortage of oil in the US. When oil hit $146/bbl there was no lack of oil…for any consumer with the funds to purchase what they required. IOW there was no “oil shortage” at that that that time. Likewise when oil recently hit $28/bbl there was no surplus: there were many millions who could still not afford to buy much refinery products from that such “cheap” oil.

    Oil shortage = insufficient amount of oil for purchase by those who could afford the price at that time.

    Oil surplus = No purcharers for all the oil for sale regardless of a low oil price that all potential buyers could afford.

    Some folks still try to use the price of oil to define shortages/surpluses. High oil prices represent strong competition among purchasers. Low oil prices represent strong competition among sellers. Recent high and low prices of oil are a function of price COMPETITION…not a function of surpluses and shotages.

    A simple comparison: is there a shortage or surplus of Ford four door pickup trucks today? Think about it for a minute. (A) They are much more expensive then they were 10 years ago and there are many Americans that would like to buy one but they can’t afford one…so a SHORTAGE? Or (B) Ford sells every F150 it produces today because it produces only as many as it anticipates selling. Otherwise it would have to reduce the asking price if it produced more. IOW it would have a SURPLUS of trucks and would have to reduce prices. Similar to what oil exporters had to do to sell their “inventory”.

    FYI: Both (A) and (B) conditions currently exists. Thus is there a shortage and surplus of those trucks occurring at the same time? Or is the production of those trucks dependent on prices competition? Just as price competition will determine the production of oil…for while yet.

  4. dave thompson on Thu, 10th May 2018 11:50 am 

    Rockman I can remember gas stations being out of gas in the 70’s. If there was no lack of oil where was the gas?

  5. rockman on Thu, 10th May 2018 11:52 am 

    Chico – Have you worked for publicly owned companies? I have off and on for 43 years and have sat in many upper management/board of director meetings where most of the focus was on increasing y-o-y booked reserves and not profitability. Most bonus plans I’ve seen were based on the amount those booked numbers increased and not on the accuracy of those numbers. This was a major factor why I chose to finish my career working for a private company whose sole focus was profitability.

    FYI – My first bonus came at Mobil Oil in 1976. It was based upon my group adding booked reserves on old producing fields. There was no peer review of our work: it was accepted blindly by management.

  6. pointer on Thu, 10th May 2018 12:00 pm 

    In other words, the planet is screwed.

  7. rockman on Thu, 10th May 2018 12:25 pm 

    Dave – There was no lack of oil. There was no lack of gasoline at the refineries. However there was a lack of gasoline at the service stations. And that was due to drivers transferring the inventory from the fuel depots to the tanks in their vehicles. And why? You tell everyone here: back in those times did you stop for fuel when your tank got down to 1/8…or less…like you normally did? Or did you start looking for a fill up when got down to ½ full…or more?

    I don’t have time now so I’ll let you research it. Warning: those facts are not easy to find. But after those long lines ended the govt came up with the accounting to show where those 100’s million gallons suddenly “disappeared”: into the millions of fuel tanks in American vehicles. Called panic buying. Same reason gas stations run out of as a hurricane approaches when an area. Not due to a lack of oil. Empty gas stations in Houston after Harvey was not due to a lack of oil nor a lack of gasoline at the terminals.

  8. dave thompson on Thu, 10th May 2018 12:38 pm 

    Rockman Yes I have heard all of that before so it was a loaded question. My point point being that a gas shortage is real if you have to live through it in a particular region. The other point is that we live in a world that has a just in time delivery system that can easily get thrown out of whack, by very real even if seemingly silly reasons.

  9. kanon on Thu, 10th May 2018 1:05 pm 

    Always good to get the inside scoop. Meanwhile, over at shalebubble.org they are projecting that the shale oil revolution will peter out over the next decade. Keep in mind that the shale miracle has yet to produce a profit, that banks and wall street want some returns, and the industry need to raise new debt, and you might see why this “inside information” is being revealed. If the currently prosperous and the expected new entrants to prosperity decide to use public transportation and bicycles, instead of cars and highways, then the projected demand growth would not occur. But there is likely some demand growth when the sea level rise displaced people move their belongings inland.

  10. Anonymous on Thu, 10th May 2018 1:36 pm 

    Permian grew faster than expected. We weren’t supposed to hit crude bottlenecks for severl months. But here we are. Too much oil with no way to get out. $15 Midland discount to Cushing. $20 to Brent. Them boys are drilling!

  11. Boat on Thu, 10th May 2018 5:23 pm 

    amouse

    An actual link.

    http://www.argusmedia.com/news/article/?id=1678193

  12. Chico on Fri, 11th May 2018 8:35 am 

    Why aren’t the Refinery’s retooling their systems to handle the lighter gravity shale oil if the shale oil has such high reserves?
    Maybe they don’t believe the hype?

  13. Duncan Idaho on Fri, 11th May 2018 9:00 am 

    Chico—
    Enough reality!

  14. rockman on Fri, 11th May 2018 10:06 am 

    Chico – “Why aren’t the Refinery’s retooling their systems to handle the lighter gravity shale oil if the shale oil has such high reserves?” A simple answer: because the refineries have no intention of refining pure condensate/light oil. As explained before they have refined only blended oil for decades. Typically with a gravity around 32 API. A huge amount of the global oil reserve base is heavy oil. Just look at the Alberta oil sands and the Venezuelan very heavy oil. Last year Venezuela had to import condensate/light oil half way around the world from north Africa to blend with its heavy oil. Without the condensate/light production to blend those heavy oils would have little value. Before the shale boom the US had to import a lot of condensate/light oil to blend with their heavy oil imports. The shale boom has eliminated most of those imports.

    If a refinery were to “retool” to handle only condensate/light oil from the shale plays it would lose access to the vast majority of the global oil reserve base…if not all of it. Refineries don’t buy/process condensate/light oil from the shale plays…they buy blended oil. They don’t buy heavy oil. There are huge operations that are a critical part of the oil production and refining dynamic that many are unware: the oil marketing companies like Vitol, one of the largest in the world. (https://www.vitol.com/). It sells more oil daily then almost every other oil producer in the world. And they sell oil to blending companies (or oil it blends) to the refineries. In 43 years the Rockman has not sold 1 bbl of oil to a refinery…always sold to a marketing company.

  15. rockman on Fri, 11th May 2018 10:08 am 

    Dave – “…a gas shortage is real if you have to live through it in a particular region.” Of course. But the focus was on the reason for those shortages. And it was not a shortage of oil.

  16. Anonymous on Fri, 11th May 2018 12:11 pm 

    Rock is right about now shortages (if price allowed to function). The gas lines in the 70s occurred because the government tried to keep gas prices artificially low (by law). This

    led to lines. Same as in a communist country. It is basic econ. There would be no lines if the prices were allowed to rise. Only reason for the lines was price control.

  17. MASTERMIND on Fri, 11th May 2018 12:24 pm 

    Just wait until the price hits 10 dollars a gallon in the near term…You will see the mother of all wall street crashes! And then its fight club after the economy collapse.

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