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Why crude prices must go up

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It may be difficult to look beyond the current pricing environment for crude oil, but the depletion of low-cost reserves and the increasing inability to find major new discoveries ensures a future of expensive oil.

While analyzing the short-term trajectory of oil prices is certainly important, it obscures the fact that over the long-term, oil exploration companies may struggle to bring new sources of supply online. The year 2014 may be the worst year in the last six decades in terms of new oil discoveries (based on preliminary data).

Worse still, last year marked the fourth year in a row in which new oil discoveries declined, the longest streak of decline since 1950. The industry did not log a single “giant” oil field. In other words, oil companies are finding it more and more difficult to make new oil discoveries as the easy stuff runs out and the harder-to-reach oil becomes tougher to develop.

The inability to make new discoveries is not due to a lack of effort. Total global investment in oil and gas exploration grew rapidly over the last 15 years. Capital expenditures increased by almost threefold to $700 billion between 2000 and 2013, while output only increased 17% (see IEA chart).

Despite record levels of spending, the largest oil companies are struggling to replace their depleted reserves. BP reported a reserve replacement ratio – the volume of new reserves added to a company’s portfolio relative to the amount extracted that year – of 62 percent. Chevron reported 89 percent and Shell posted just a 26 percent reserve replacement figure. ExxonMobil and ConocoPhillips fared better, each posting more than 100 percent.

Still, unless the oil majors significantly step up spending they will not only be unable to make new discoveries, but their production levels will start to fall (some of them area already seeing this begin to happen). The IEApredicts that the oil industry will need to spend $850 billion annually by the 2030s to increase production. An estimated $680 billion each year – or 80 percent of the total spending – will be necessary just to keep today’s production levels flat.

However, now that oil prices are so low, oil companies have no room to boost spending. All have plans to reduce expenditures in order to stem financial losses. But that only increases the chances of a supply crunch at some point in the future. Put another way, if the oil majors have been unable to make new oil discoveries in years when spending was on the rise, they almost certainly won’t be able to find new oil with exploration budgets slashed.

Long lead times on new oil projects mean that the dearth of discoveries in 2014 don’t have much of an effect on current oil prices, but could lead to a price spike in the 2020’s.

All of this comes despite the onslaught of shale production that U.S. companies have brought online in recent years. U.S. oil production may have increased by 60 to 70% since 2009, but the new shale output still only amounts to around 5% of global production.

Not only that, but shale production is much more expensive than conventional drilling. As conventional wells decline and are replaced by shale, the average cost per barrel of oil produced will continue to rise, pushing up prices.

Moreover, with rapid decline rates, the shale revolution is expected to fade away in the 2020’s, leaving the world ever more dependenton the Middle East for oil supplies. The problem with that scenario is that the Middle East will not be able to keep up. Middle Eastern countries “need to invest today, if not yesterday” in order to meet global demand a decade from now, the International Energy Agency’s Chief Economist Fatih Birol said on the release of a report in June 2014.

In fact, half of the additional supply needed from the Middle East will have to come from a single country: Iraq. Birol reiterated those comments on February 17 at a conference in Japan, only his warnings have grown more ominous as the security situation in Iraq has deteriorated markedly since last June. “The security problems caused by Daesh (IS) and others are creating a major challenge for the new investments in the Middle East and if those investments are not made today we will not see that badly needed production growth around the 2020s,” Birol said, according to Reuters.

If Iraq fails to deliver, the world could see oil prices surge at some point in the coming decade. Despite the urgency, “the appetite for investments in the Middle East is close to zero, mainly as a result of the unpredictability of the region,” he added.

resource investor

18 Comments on "Why crude prices must go up"

  1. dave thompson on Fri, 20th Feb 2015 9:01 am 

    The undulating plateau of oil glut security………..NOT!

  2. Plantagenet on Fri, 20th Feb 2015 11:23 am 

    The oil glut will end and oil prices will go back up.

  3. Davy on Fri, 20th Feb 2015 11:35 am 

    Planter, cat piss, there is no way to know what is going to happen anymore. We are in uncharted waters at night with no moon.

  4. Poordogabone on Fri, 20th Feb 2015 11:49 am 

    Oil will only go back up when the global economy picks up and that is no certainty.

  5. dave thompson on Fri, 20th Feb 2015 12:35 pm 

    1st quarter trends show an upward move for now. With the driving season around the corner and the refinery blend/maintenance looming. Yea, I say up she goes. How much? My guess is still + $25 by may.

  6. Perk Earl on Fri, 20th Feb 2015 12:40 pm 

    Right now most assert that oil can go back up to prices needed to discover and produce oil as needed.

    What I think will be a defining moment when it arrives, is the realization that affordability is limiting oil price, as Poordogabone suggests. The illusionary façade is ok now but when that moment comes there will need to be an international effort to subsidize oil exploration by way of loans, QE or taxpayer money. Whether or not that makes a difference or for how long will be the tale of the tape, but I’m sure it is coming.

  7. shortonoil on Fri, 20th Feb 2015 1:11 pm 

    The conclusions of this article would be correct if the implied assumptions that they started with were correct?

    the increasing inability to find major new discoveries ensures a future of expensive oil

    Here the author is “assuming” that the consumer will be able to pay for the higher production cost oil. He states it implicitly without one shred of evidence to support it. In effect he is saying that the price of petroleum can exceed the economic activity it can support. That is, it is possilbe to use $2 of oil to produce $1 of goods, and services. We don’t think that is likely to happen for very long!

    Petroleum has a value to the economy because it supplies energy to it. That energy has a value because it powers the production of other goods, and services. Because of depletion, the ability of oil to support that production has fallen to the point that higher cost production oils can no longer be justified. They just can not pay for themselves with the amount of other production they can power. Petroleum’s value to the economy is declining, as it does its price will decline with it.

    We have done the calculations, and came up with this graph; the maximum price that the economy can pay for oil:

    Production costs will continue to increase, and reserves will become more difficult to replace. At the same time, the value of a unit of oil to the economy will decline. The price has only one way to go as higher cost production is continually phased out of the market; down! Denying the ramifications of depletion is like denying the affects of gravity. It is like jumping off a tall building, and “assuming” that you are not going to hit the ground!

  8. Northwest Resident on Fri, 20th Feb 2015 1:30 pm 

    I wonder what portion of “the oil glut” is high quality conventional crude, and what portion is lower quality shale, tar sand and “other” liquids that have been classified as “oil”.

    In other words, we have all read the news describing how tankers and onshore storage facilities are being loaded up to store all the unsold oil (the glut). I wonder how much of that stored oil is from ME and other conventional wells, and how much is from other places (like North Dakota, for example).

    Does anybody know?

    I’m guessing that the majority of the “oil glut” is simply low quality unconventional fracked oil that costs too damn much for how much energy it can produce. Bad guess?

  9. GregT on Fri, 20th Feb 2015 1:37 pm 

    Oil today is selling at ~ twice the historical non-recessionary price. In the last 40 years, every time that oil has spiked above $40bbl, the economy has gone into recession. Given the fact that the average energy content of a barrel of oil has been decreasing over time, and more energy is required to produce less oil, why would anyone believe that ~$75bbl oil would not lead to further economic contraction?

  10. dave thompson on Fri, 20th Feb 2015 4:07 pm 

    Northwest, I like your guess. The stats on stripper well that account for about 20% of extraction are another example. These wells get 10 barrels or less per day and are subsidized with tax incentives. Making this oil a net energy loser.

  11. Energy Investor on Fri, 20th Feb 2015 5:38 pm 

    Short, I think the issue in this article is that oil is becoming more expensive to produce. Whether it can be sold at higher prices is another matter.

    Sooner or later a rational business model leads to folk who can only produce at a loss (at least in terms of direct costs), plugging their wells and thus production volumes will decline.

    And so we can expect a drawn out version of what happened to whale oil in the 19th Century in terms of price volatility, substitutes etc.

    Meantime, we can expect more alternatives being offered – though they too will be expensive in both EROEI and cost terms.

    Even so, I feel sure that GD1 will help your own price thesis as demand falters.

  12. rockman on Fri, 20th Feb 2015 9:36 pm 

    EI – Valid points but don’t confuse production costs with development cost: “…who can only produce at a loss (at least in terms of direct costs), plugging their wells and thus production volumes will decline.” It’s virtually impossible for oil prices to get low enough for any meaningful number of PRODUCING wells to be plugged. Total production decline will be a function of the depletion of existing wells and the gain of NEW wells drilled.

    And obviously that number of new wells will decrease with falling oil prices. Depletion might slow a very small amount as some operators reduce the rates of their existing wells but those will be the exceptions to the demand of maxing cash flow. But unless prices fall below $15/bbl or so for an extended time few producing wells will be prematurely plugged.

  13. Jimmy on Fri, 20th Feb 2015 11:44 pm 


    Consumers will no doubt direct all discretionary spending towards oil. Less money for IPhones and devices, less money for designer jeans, less money for everything. All consumption of consumer items will decrease in order to obtain energy.

  14. Perk Earl on Sat, 21st Feb 2015 7:45 pm 

    “Production costs will continue to increase, and reserves will become more difficult to replace. At the same time, the value of a unit of oil to the economy will decline. The price has only one way to go as higher cost production is continually phased out of the market; down!”

    It is interesting how the rising cost of production is conversely proportional to the declining value oil (due to depletion). We have two primary vectors headed in opposite directions. That can’t be good!

  15. Davy on Sat, 21st Feb 2015 8:30 pm 

    Perk, paradigm shifts work that way with epic inflections. What could be more epic than 7BIL oil dependent people riding a depletion curve down.

  16. keith on Sat, 21st Feb 2015 11:47 pm 

    People will no longer pay for expensive oil. It’s no longer a choice.

  17. Perk Earl on Sun, 22nd Feb 2015 1:04 am 

    “What could be more epic than 7BIL oil dependent people riding a depletion curve down?”

    Epic is the word, Davy. Still can’t quite wrap my head around what it will be like. Either it’s going to be a slow harsh grind down that curve or a sudden slam into a new reality. I’m still not sure which.

  18. Northwest Resident on Sun, 22nd Feb 2015 1:18 am 

    Perk, I’m guessing it will be a slow harsh grind down that curve TO a sudden slam into a new reality. We’re on the slow harsh grind down right now, if you ask me. The only preventing the sudden slam into a new reality is the frantic and desperate efforts of the global elite which we see as continued injects of debt/liquidity adding to the massive debt burden, the manipulation of the stock market that almost everybody has been pavlovian conditioned to believe is an accurate reflection of the economy, and I believe a constant coordinated efforts by central banks and the politicians they own to keep reality under wraps. But depletion marches on, not only for oil but for all resources, and we’re nearing the end of the extend and pretend phenomena. Or, so it seems to me.

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