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Why Oil Prices are Going Up, and Will Continue to Go Up

Why Oil Prices are Going Up, and Will Continue to Go Up thumbnail

Oil prices are going up as oil supply and demand are approaching a more balanced situation, writes geophysicist Jilles van den Beukel. And they will continue to go up as supply is expected to fall below demand in the 2018-2020 period. The key factor in supply reduction is that cost cutting is leading to higher decline rates of mature conventional fields. So far this decline has been compensated by new oil field developments, but the current severe investment cuts will gradually reduce the flow of “new oil” to a mere trickle by the early 2020’s. In the meantime demand is still growing, despite the expansion of renewables and higher efficiencies.

Oil prices have been going up over the last few months, from below $30 per barrel in February to the current levels of around $50. Many short term issues of a different nature play a role here, ranging from market psychology to supply interruptions such as those caused by the Alberta wildfires. But I would argue that in the background there is a persistent upward trend, caused by the simplest of explanations: supply and demand are getting more into balance again.

When predicting future oil supply and demand no individual can produce anything close to the comprehensive analyses of organizations like the IEA or the major consultancy firms. But one can try to highlight processes that give some insight into the way that supply is responding to changes in the oil price.

Increased field decline of conventional oil fields kicking in

Much of the publicity on the way that oil supply is responding to lower prices has focused on unconventional shale oil in the US. And indeed the rapid advance of US shale oil has been a key factor in the creation of ‘oversupply’. But actually the response of the more than 50 million barrels/day (mbpd) production from conventional (non-OPEC) fields plays a much bigger role. Small changes in the average decline rate of these fields result in large changes for oil supply in absolute numbers.

The figure below is taken from a recent study (June 2016) from Rystad Energy. It shows the average decline rate for mature non-OPEC oil fields. Up to 2015 these figures are actuals; for 2016 this is a prediction with limited uncertainty and for later years uncertainty increases.

Jilles oil price figure 1

Due to higher activity, the average decline rate in the 2010-2014 high oil price world was only about 3% (without any activity it would have been about 8-9%). Reduced activity in the subsequent low oil price environment resulted in higher decline rates of about 5-6%. In absolute terms: for 2016 this amounts to a supply decrease of 3.3 mbpd (on total global oil production of some 90 mbpd).

There are several important points to be noted about these decline rates. First of all, the fast response of field decline rates to price levels is due to the nature of the activities involved: workovers and infill drilling can be planned and executed in a relatively short time frame.

Secondly, the effects of this reduced infill drilling in conventional fields will be felt for years to come: a conventional well not drilled in 2015 is still likely to result in lower production in 2020 and beyond.

Thirdly, decline rates are much less of an issue for OPEC fields. Production in a country like Saudi Arabia is capped by political decisions or infrastructure capacity rather than geology (they have much higher reserves-to-production ratios).

So why do decline rates of conventional non-OPEC fields receive so little attention? I think it is because field decline has so far been masked by new fields coming on stream. For 2016, the added production from new fields amounted to about 3.0 mbpd, roughly compensating for the decline of existing fields. Many projects are still coming on line (especially in deepwater) that have been sanctioned in the 2010-2014 high oil price environment.

New oil compensating for field decline is not sustainable, however. Hardly any new major developments have been sanctioned in 2015 and the first half of 2016. Over the coming years new oil from projects currently being developed will gradually decrease from 3.0 mbpd in 2016 to a much lower level in the early 2020’s (exactly how low will depend on when the sanctioning of new developments will resume). For 2017, a similar level of field decline (compared to 2016) is already expected to outstrip new developments by about 1.2 mbpd.

Reduction in US shale oil production is kicking in, finally

At the same time, we are finally seeing a reduction in US shale oil production in response to the price decline, as can be seen in the figure below.

I have chosen to use data from a Seeking Alpha paper rather than the well known EIA figures that only give production up to the present day. Obviously the prediction beyond mid 2016 depends on future oil prices (the predicted further decline is in the middle of the range for a number of forecasts from different organizations).

Jilles oil price figure 2

The time it takes for US shale oil production to respond to the low oil price oil world is much longer than often assumed. It took close to a year before peak production was reached: it took close to another year before a steady reduction (per month) of up to 100,000 bpd was reached.

This shows that US shale oil cannot take on the role of short term swing producer (as Saudi Arabia used to do). It cannot do so timewise (it takes two years to fully respond) and it cannot do so volume-wise (changes in US shale oil production being too small compared to global supply). It does play an important role, as part of a complex global oil supply system.

A shake-out is taking place in the US shale oil sector with increased focus on the best plays and the best sweet spots within these plays. The Permian is emerging as the dominant play in shale oil, in the same way as the Marcellus has emerged as the dominant play in shale gas.

$50 per barrel is too low to be sustainable

The major international consultancy firms cover all parts of the energy business. Rystad Energy, a small independent Norwegian consultancy firm, primarily focuses on one part of the business only: maintaining a state of the art database of all oil fields (plus potential developments with timelines and oil prices needed for project sanction) on a global basis. This enables them to model future oil supply for different price scenarios. In this important niche they have become a world leader.

The figure below gives some of these scenarios. These integrated models combine shale oil production, conventional field decline and new conventional developments (as well as more secondary processes such as exploration, end of field life and project delays). The gradual decrease of global oil supply in a constant 50 dollar per barrel scenario is primarily due to the combination of the continuation of significant mature field decline and the gradual decrease of oil from new developments over the coming years.

Jilles oil price figure 3

Unless more dramatic cost reductions materialize, these models imply that a long term price of the order of $70-90 per barrel is needed to generate sufficient supply anywhere near expected demand. The reason is simple: it is at this price level that many projects, of a different nature (onshore, shallow offshore, deepwater and shale oil), become sufficiently profitable to go ahead. Lower prices will eventually result in undersupply; higher prices will eventually result in oversupply (regardless of oil demand continuing to increase at its current rate or reaching a plateau).

Oil demand: India taking over from China as a growth engine

In the meantime oil demand continues to stubbornly grow each year, at a rate of about 1.5 mbpd. So far any increase in efficiencies or renewables is more than offset by increasing demand in non-OECD countries. The populations of China and India (about 1.4 billion and 1.3 billion respectively) are so large that what happens in these countries simply matters most.

As the growth in Chinese oil demand abates it seems that India is taking over China’s role as the key country for oil demand growth in Asia. A recent study of the Oxford Institute for Energy Studies paints a breathtaking picture of a country where manufacturing and car ownership (and hence oil demand) are about to explode. Last year India’s oil demand grew by 0.3 billion barrels/year (compared to an average of about 0.1-0.15 billion barrels/year over the last decade). India is now in the position where China was about 15 years ago.

Even if India’s phase of rapid economic growth would be characterized by a greater focus on renewables this would be more of an issue for coal and gas than for oil.

Jilles oil price figure 4

One day the energy transition will take off in earnest and peak oil demand will be reached. But it will come at a slower rate than the response of oil supply to changes in oil price or changes in oil demand. The energy transition will lead to a reduction in volumes but not (necessarily) to a reduction in price. For an oil company volumes matter. But price matters much, much more.

energy post

61 Comments on "Why Oil Prices are Going Up, and Will Continue to Go Up"

  1. Don Stewart on Sat, 2nd Jul 2016 8:58 pm 

    I agree that under certain circumstances oil could be produced with energy from higher EROEI sources. An example would be cheap fusion, if it ever happens. Natural gas has been cheap the last few years, and can perhaps subsidize some oil production. HOWEVER, if you were advising a teenage child about the likely world they need to be preparing for, and oil was disappearing as a primary source of energy, then you probably would not spend much time talking about the specific ins and outs of the latest ROI calculations you did for a specific project. You would step back and take a broad view and give the best advice you could. You would not want to assume, for example, that zero cost debt would be available while they are trying to make a living….nor that the service companies will still be losing money. In short, you would probably take some look at whether oil can continue to be a primary source of energy under ‘normal’ business conditions. Alice Friedeman’s discussion with Kunstler covers the difficulty of finding a substitute for oil pretty well, I think.

    The point about the inefficiencies of getting to work is not to criticize anyone. I recently went back to my birthplace. When I was a child, we did not have a car. My father and grandfather walked to work. When my mother needed something from downtown, she pinned a list of what she needed to my collar, along with some money, and sent me to walk downtown to the store and get what she needed. Ice was delivered by horse-drawn wagon. We had chickens and vegetables growing in the back yard. That world has been destroyed. So getting to work is an energy sink for almost everyone. And the point is simply that getting to work is an example of a very inefficient use of oil. We were able to afford it (in the US) so long as the oil powered economy was producing a lot more GDP than we were spending to produce the oil (I like Hill’s graphs showing the relationship). But about 2000 things changed. We really needed to get far more efficient very fast. We did not…we resorted to adding more debt.

    So here we are in 2016 with lots of debt and an economic system which is using oil inefficiently. There are some clever, or lucky, people who figure out how to make money when life has dealt them lemons, but the average person is probably going to experience the average outcome. And EROEI is one indicator of what that average outcome is likely to be.

    Don Stewart

  2. yoshua on Sat, 2nd Jul 2016 10:07 pm 

    rockman – Said and said… official is official.

    Highlights of operations

    “Chevron is the only large international energy company to have a continuous upstream presence in the Kingdom of Saudi Arabia for more than seven decades. Through our subsidiary Saudi Arabian Chevron Inc., we are engaged in a wide range of petroleum-related interests in the kingdom, and we work closely with Saudi Aramco, the national oil company, as well as with various government partners in the region.

    We put special emphasis on projects that provide quality development opportunities, professional training and exposure to new technology.”

    Steamflooding in the middle east

    “Chevron uses thermal recovery technologies to extract heavy oil at the Wafra Field.

    Chevron conducts exploration and production in the onshore Partitioned Zone (PZ) on behalf of Saudi Arabia. The PZ lies between Saudi Arabia and Kuwait. Petroleum and mineral resources in the PZ are shared jointly by the governments of Saudi Arabia and Kuwait.

    Chevron Phillips Chemical Company LLC and its affiliates have interests in Saudi Chevron Phillips Company, Jubail Chevron Phillips Company, Saudi Polymers Company and Petrochemical Conversion Company. All four companies have facilities in Al-Jubail.

    Through our subsidiary Saudi Arabian Chevron Inc., Chevron has an agreement with Saudi Arabia to operate the kingdom’s 50 percent interest in the hydrocarbon resources of the onshore PZ. The agreement was extended and amended in 2009; it expires in 2039.

    In 2009, steam injection began at the Large-Scale Steamflood Pilot Project for the carbonate First Eocene reservoir at the Wafra Field. Steamflooding involves injecting steam into heavy oil reservoirs to heat the crude oil underground, which reduces its viscosity, enabling its extraction through wells. This project was preceded by steam stimulation of some wells, followed several years later by a small-scale test. The entire development project is designed to determine the technical and economic viability of thermal-recovery projects in the Eocene reservoirs of the Wafra Field.

    Beginning in May 2015, production in the PZ was halted as a result of continued difficulties in securing work and equipment permits. As of early 2016, production remained shut in. The exact timing of a production restart is uncertain and dependent on dispute resolution between Saudi Arabia and Kuwait. Once production resumes, additional development drilling, well workovers and numerous facility-enhancement programs are expected to partially offset field declines.

    The shut-in also affected plans for both the Wafra Steamflood Stage 1 Project, a full-field steamflood application in the Wafra Field First Eocene carbonate reservoir with a planned design capacity of 100,000 barrels of crude oil per day, and the Central Gas Utilization Project, a facility construction project intended to increase natural gas utilization while eliminating natural gas flaring at the Wafra Field. Both projects have been deferred pending dispute resolution between Saudi Arabia and Kuwait.

    A carbonate reservoir is an oil or gas trap formed in reefs, dolomite and certain types of limestone. Typically, carbonate reservoirs are highly fractured and not conducive to steamflooding on a large scale. However, the carbonate Eocene reservoirs at Wafra have properties that are promising for successful steamflooding.

    In 2015, the company made progress on a 3-D seismic survey covering the entire onshore Partitioned Zone. It is one of the largest land seismic programs ever undertaken, covering 1.1 million acres (4,600 sq km).

  3. yoshua on Sat, 2nd Jul 2016 10:30 pm 

    About Wafra – Officially there is a paper dispute.

    Unofficially the oil price is too low and the market too flooded to make the project economically viable ?

  4. rockman on Sun, 3rd Jul 2016 1:51 am 

    Don – Fortunately I have only 1 teenager to advise…my 16 yo daughter. LOL. And my advice to her learn all she can about putting a solar panel system together. I’m having her put a small one together this summer. More toy then practical but she has to start somewhere. As far as the rest of her future: keep it simple and chose a career as little dependent on fossil fuels as possible. And don’t assume the govt will be providing her much assistance in 30 or 40 years.

    The advice to all the other teenagers: get off your asses and learn as much about the system as fast as possible. There are decisions they’ll be making in the near future that if not made properly will lead to rather unhappy lives.

  5. rockman on Sun, 3rd Jul 2016 2:03 am 

    Juan – Here’s how wiki defines EOR:Enhanced oil recovery is the implementation of various techniques for increasing the amount of crude oil that can be extracted from an oil field. Enhanced oil recovery is also called improved oil recovery or tertiary recovery (as opposed to primary and secondary recovery).

    But definitions vary. But I’ll tell you more oil base been recovered injecting water (usually salt waster) then all EOR methods combined. Could be called pressure maintenance or a water flood. And sometimes some chemicals might be added but the vast majority case not. But I know of no one in the oil patch that would clarify it as EOR.

    But not a hard rule but in most cases EOR doesn’t increase production but lowers the decline rate. This allows a longer commercial field which, in turn, increases ultimate recovery.

  6. Don Stewart on Sun, 3rd Jul 2016 2:42 am 

    If you have the interest and about 5 minutes, check out this video on the ghost town of Three Sands, Oklahoma. Three Sands was a boom town in the oil fields just about 100 years ago. Three Sands helped make the fortunes of E.W. Marland and John D. Rockefeller. A number of people born in Three Sands have recently died, and the newspapers have printed their obituaries. So…unlike the claims in the Daily Oklahoman which start the video, there were families making a life and procreating and children going to school and now those children are passing from the scene.

    But there are a number of pictures showing some of the characteristics of the life that people in the oil field were living. By the way, the town moved as the sweet spot moved. So what you see are very simple houses and stores and schools and such which are as close to the action as practical. You don’t see anybody commuting many miles in a pick-up truck to work in the oil fields.

    I see this as graphical evidence of how our society has changed, in response to abundant oil, to become more and more dependent on the oil. Alice Friedeman’s story.

    Don Stewart

  7. Davy on Sun, 3rd Jul 2016 6:10 am 

    Sound wisdom Rock! I am teaching my twin boys slowly. They are still young but for example at the dinner table I tell them not to waste food because when they get older they are going to have less food. I save all my comments. The reason for this is I want my kids to know what I was doing during the prelude to collpase. I have already given my daughter, who is older, my comments. She asked for them so I gave them. She wants to work for NGO’s and help others. I have told her the world is going to become increasingly dangerous so think of doing this work in a place with some security. She mentioned kids at one time and I told her how awful life is going to get. I told her if you bring a life into this world realize its chances of making it are going down by the day.

    I am mainly concerned about teaching others now. This comes with age. I feel like a tribal elder. This is one of the main reasons I am here all the time. I want to teach others what I have learned and what I believe in. I want to learn from others in the areas of study we cover. I want to have my collpase radar on. This board is a good source for collpase prep. Our board discussions are not typical. Few of us here like the main stream narrative and those who do are vigorously debated.

    I am here for reasons of mental exercise. It takes mental energy to engage in the debates and the battles we have here. I feel mental exercise is as important as physical exercise. I physically exercise twice per week along with the activity farming involves. I also fast which is a way of practicing deprivations. Deprivation is both a physical and mental exercise.

    Knowledge and the pursuit of the truth is a higher level activity. I feel that is what we do here on this board. The truth has substance and purpose in a world where so much is fake and ephemeral. I search for truth because I enjoy it. It is addictive. It is rewarding for me personally. As I get older I feel my abilities both physical and mental diminishing. I want to delay the process of mental and physical death. I am not here for self-advancement. If that were the case I would not be on this site where so many disagree with me and despise me.

  8. brough on Mon, 4th Jul 2016 4:49 am 

    Many thanks on above suggestions for training of young people. It seems, I’m in charge of my 6 year oil grandson for the summer. Assembly of a solar panel kit is a great suggeston. His parents are going hate this

  9. MinorityOfOne on Mon, 4th Jul 2016 5:10 am 

    Apologies of this has been asked / explained before, but there are currently 58 comments but I can see only 8. Why is that?

  10. Davy on Mon, 4th Jul 2016 5:33 am 

    Minority, at the very bottom near the name box you can view previous comments by page. (< Previous 1 2)

  11. MinorityOfOne on Mon, 4th Jul 2016 5:48 am 

    You would think after reading articles for a year or two I would have noticed, but “Previous / Next” blends in very well. with the following text. Thanks.

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