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Peak Oil: Realities, Myths and Risk

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“We are not going to run out of oil any time in my lifetime or yours. The resource base is enormous and can support current and future demand” Exxon CEO.

At this point there are still people who defend the thesis that warns about the risk of declining oil reserves as a massive threat to the world. Each time oil prices rise $5/bbl we hear and read a lot from the peak oil community and the blame on the previous price rise focuses on hedge funds.
We can use many data, but I will try to be brief.
First, the reality of “Peak Oil”:
. Only 14 of the 54 countries that produce oil in the world have been able to maintain production since 2004. But most of those have done so due to geopolitical issues, OPEC quotas or conflicts, not because of geological issues. Also, 60% of world oil production declines from 1.5 to 2.5% annually, but global investments between $720 and $750 billion a year in oil and gas have also seen an unprecedented discovery and addition rate. Once investments increased between 2008 and 2011, unsurprisingly, reserve replacement dramatically improved. It’s a question of money and investment, and the industry had been investing below depreciation for too many years.

. Domestic consumption in producing countries increases by 8% average annually, so the net exportable capacity decreases, this is true, but at the same time demand in the OECD is also weakening due to efficiency (estimated by Nextera at 3.5% pa), alternative energy sources and technology. Read my other articles on Chinese demand (http://energyandmoney.blogspot.com/2011/06/china-slows-down-as-saudi-arabia.html).
. The countries that can still maintain or grow their production, Russia, Kuwait, Emirates and Saudi Arabia, have short-term capacity (4.5mmbpd) to mitigate the impact of problems in others, but unquestionably the price of oil reflects the risk premium that this situation creates. However, Brazil, expected to grow output by 8% pa from the current 2.3mmbpd by 2016, will mitigate that risk premium, and US shale oil could do it even more agressively, as it reaches 2.5mmbpd in 2016-17, as it is located in OECD countries.
. Extraction costs do not fall as expected, due to the geological complexity of extracting new and maintain current production. Between 2007 and 2009, with the oil services industry at 77% capacity and a global economic crisis, average costs fell less than 10%, and most IOCs and NOCs “break even” remains between $50 and $60/bbl.
Second, the myths of Peak Oil:

. “Peak Oil” theory focuses only on supply. The only thing that matters is whether demand is being attended adequately. And it is. Inventories at IEA are at six year highs in a year (2010) where the supply and demand balance tightened thanks to the economic recovery. And supply responded with an unprecedented increase in investments. This is the chain: demand drives everything. if demand is there, investments in oil will rise, unconventional and conventional resources, deepwater or onshore, will increase, and supply will respond. It is untrue that the time from reserves to production is an issue, because we have seen an acceleration not seen in years.

. Oil production will fall abruptly and unexpectedly. The fact is that the world could produce 90mmbpd today, if it wanted. It’s not a geological issue, as De Margeries (Total) or Tillerson (Exxon) say over and over, it’s just a geopolitical issue. Oil production stands capped by the Iran embargo, Iraq and OPEC quotas. Furthermore, non-conventional oil is rapidly taking over, and shale will be a significant game-changer, just as shale gas was. Yes, reserves decline, but reserve additions have made 2009-2010 reach +100% rrr and, even if we decide to question the OPEC data, global production has never been an issue. Supply continues to be more than adequate and demand has never been left unsatisfied.

Out of the “330 projects to change the world” report that Goldman Sachs analysed, I would highlight this part:

“The Top 330 Projects now represent 565 bn boe of oil and gas reserves and almost half the total planned capex for the Majors over the next four years and will deliver around 62 mnboe/d of production by 2020E (46% of current global oil and gas production) with nearly US$380 bn of expected capex. The average new project requires less than US$60/bbl to meet hurdle rates, while marginal projects require more than US$90/bbl”
There are more than 125 projects only in OPEC that will be adding between 3.8 to 6mmbpd to supply short term (*) that are just waiting to go on execution pipeline after receiving FID (final investment decision). The constraint is not projects, but project execution and human resources (engineers and capex) to develop them. 3 trillion barrels of conventional resources in the ground and 1 trillion of unconventional according to the US geological survey. That is more 4x more than what population has consumed in all the industrial era.

. Demand only goes up and up. Remember that IEA and EIA demand estimates are diplomatic. Based on GDP estimates of the countries themselves. Demand will adjust, and it’s already happening all over the OECD, due to efficiency and displacement (nat gas, alternatives). Additionally, the notion that Chinese demand will only rise over and over has to be taken carefully. Chinese demand is dictated by the government, up and down. Hong Kong already consumes more oil per capita than the EU. The major cities in China already consume 15-20 barrels per day per capita.
. It is a theory propagated by “speculators” to raise the price. I love this because it seems that nobody understands that financial actors are delighted to go short in an overpriced asset (see short positions in natural gas futures, CO2 or coal, for example). Moreover, according to the American regulator CFTC net long positions in oil today are at the same levels as in 2005.
. “Peak Oil” means that the price will go up forever. Not true. The asset price also depends on demand and the more it declines, the more volatile the price is. Today there are 87 million barrels a day of production only because there is demand and the price justifies the investment. When demand rises, production responds. But when demand drops, also does the price, which in turn erases marginal production (unconventional, tertiary recovery, etc..), so spare capacity is gone. In essence, demand dictates capex, which dictates spare capacity. About one drop of 1% of global GDP tends to cut between $8 and $10/bbl. But the volatility increases given the enormous variation between costs, days in transit and geopolitical risk, as generally more expensive oil is produced in lower-risk countries. The last barrel of oil will be worth zero.
. “Peak Oil” forgets technology improvements and unconventionals. Production from non-conventionals is expected to reach 2.5 mnbls/d only from Goldman Sachs’ modelled US unconventional liquids plays by 2015.

Decline rates have stabilized as well. While most peak oil defenders keep 5-6% as a decline rate average, it has fallen to 1.5-2% at the base thanks to enhanced recovery and advanced technology (horizontal drilling, deepwater).

. “Peak Oil” does not take into account the renewable and electric car. As an investor in alternative energy, I can say that the impact is minimal. First, because alternative energy will account, at best, 20% of the energy consumed in 2030. Second, since they too are relatively expensive, fossil fuels remain competitive. Do not forget that in constant dollars oil is trading at the equivalent today to $80/bbl of 2008, which remains very competitive, and easy to transport. However, natural gas for transport is already a viable option (10% of India’s fleet is in vehicles powered by nat gas liquids), and with oil trading at 6:1 to nat gas, which according to industry sources would still be 2:1 once all costs to vehicle are accounted. And there is abundant and OECD sourced natural gas for centuries.
Furthermore, IEA inventories all across the OECD in July are above the five-year average despite all the scaremongering about supply and Libya. If demand is there, and willing to pay for resources, supply will be there.

Finally, the biggest risk of “Peak Oil”
. Using “Peak Oil” to invest in the stock market. Decline of conventional sources and geopolitical risks, as discussed, generate more volatility and large supercycles, bull… and bear. This situation makes the average cost of capital of firms rise, margins contract, and it becomes more difficult to access to finance for large developments. Therefore, the stocks trade at lower-than-historic multiples. The old “long term” investment time frame is now one-two years maximum. That is why it is not advisable to use the futures curve as an equity price indicator, since it only takes into account income, and it is better to use the return on the average cost of capital and exploratory potential at $50-60/bbl.
Because the world is full of “corpses” of investors who bought blind at $140/bbl.

“There is no reason to consider there is a risk of sufficient supply,” “I don’t see major concerns as far as the production of oil and gas is concerned.”Middle East is “part of the world where we could be producing much more, but we cannot.” Christophe De Margerie, Total CEO.

(*) OPEC’s currently accounted 158 projects aim to add 21.3mmbpd by 2030.

Exxon CEO interview here
http://www.youtube.com/watch?v=QUjG3HRUYVo

Energy and Money



4 Comments on "Peak Oil: Realities, Myths and Risk"

  1. DIMEJI AKINKUGBE on Mon, 25th Jul 2011 12:37 pm 

    Hello Sir

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  2. M J Southwell on Mon, 25th Jul 2011 2:34 pm 

    Gosh. I feel so relieved. I can go and buy that ATV without fear of being stranded without petrol in the future.

  3. Globalthinker on Mon, 25th Jul 2011 6:05 pm 

    What a crap article. The countries that can still increase their extraction rate can only do so for a few years, they will inevitably go into production decline as well.

    Exxon is one of the companies that are still ignoring the reality of peak oil, and as such is a poor company to quote.

    Another oil company that do see and understand peak oil is Shell. http://www.energybulletin.net/node/39582

    But even they don’t know what will happen in the future. Thinking the road ahead will be nice and comfortable is rather naive.

  4. DC on Mon, 25th Jul 2011 7:26 pm 

    Since pretty much all these projects he refers to are almost ALL either in high-risk areas, and expensive to produce, and have long lead times etc or all of the above, what does he think the final product is going to cost. He doesnt say, and I dont know, but I probably take a guess-expensive.

    Expensive oil that no one can afford, is in some ways, almost as bad as haveing no oil at all right? I like to think of it this way, I cant afford a 5million dollar home, or a private jet. It hardly matters if there is a physical glut of private jets on the market or expensive homes, I wont be able to buy them, so for all intents, they dont exist for me. So it is for oil. If gas is so expensive that I cant justify buying it for trivial tasks, then Ill be biking everywhere(kinda what I do now). There may very well be ‘oil’ I could buy, but if I cant afford it, or can learn to get by without it for most things, then again, it effectively ceases to exsist. This is course, not what oil companies want people to do. The fact, oil companies need large masses of people to buy oil and set fire to it in the least efficent method our engineers and scientists can devise, and they have been. Regardless, the future will be one in which there will be lots of oil around……IF you can afford it. If you cant, then your plastic suburban craphole of a home wont be worth the salvage you can strip if for, much less the value of the mortgage.

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