Sunday, October 18, 2015

Goldilocks and the three prices of oil

We all know Goldilocks from the story of Goldilocks and the Three Bears in which the young maiden wanders into the home of the bears and samples some porridge that happens to be sitting on the dinner table. The first bowl is too hot, the second is too cold and the third is just right.

Like a corporate version of Goldilocks, the oil industry has been wandering into the world marketplace in recent years often finding an oil price that is either too high such as in 2008 and therefore puts the brakes on economic growth undermining demand and ultimately crashing the price as it did in 2009. Or it finds the price too low as it is today therefore making it impossible to earn profits necessary for exploiting the high-cost oil that remains to be extracted from the Earth's crust. Oil that hovered around $100 per barrel from 2011 through much of 2014 seemed to be just right. But those prices are now long gone.

Violent swings in the price of oil in the last decade have made it difficult for the industry to plan long term to produce consistent supplies at moderate prices. This has important implications for future supplies which I will discuss later.

The great political power of the oil industry has led many to conclude erroneously that the industry must also somehow control the price of oil. If the industry has such power, it is doing a really lousy job of using it.

It is true that in times of robust demand, OPEC can maintain high prices by limiting oil production in member countries. But when demand softens, OPEC rarely exhibits the necessary discipline as a group to cut production. Typically, Saudi Arabia shoulders most of the burden of reduced production under such circumstances.

Which is why it was so shocking when, during this most recent swoon in the oil price, the desert kingdom responded with an emphatic "no." No, Saudi Arabia will not curtail its production. And, since all the other OPEC members are unable to challenge Saudi Arabia's power--which consists of the ability to add production to counter cuts by others--the price of oil has stayed low.

The stated reason for this move is that Saudi Arabia wants to undermine American tight oil production. And, low prices are doing just that. The U.S. oil rig count peaked in October last year at 1609. In the week just passed that number was 595.

The low-price strategy seems to be knocking the competition out of the game. And, it's difficult to imagine investors in the future dumping great gobs of new money so freely into tight oil wells and the companies that drill them after having been thoroughly burned this time around. And, that's probably true even if the price of oil recovers significantly. There will always be the fear that Saudi Arabia will flood the market with oil and crash the price. (This is not, in fact, what Saudi Arabia has done so far. In the most recent oil price rout, the Saudis simply refused to cut the kingdom's then current production level--as it had regularly done in the past--even as demand softened and prices fell.)

Probably one of the best illustrations of the problematic future of oil supply is the recent abandonment of a multi-billion dollar arctic oil drilling project by Shell Oil Company, the American arm of the European-based Royal Dutch Shell PLC. Shell called its arctic discoveries "marginal" and indicated that it would cease drilling there for the "foreseeable future."

This emphasizes that the remaining oil available for extraction is both difficult-to-get and high-cost. It turns out that the oil discovered by Shell's arctic project comes in small packages instead of the giant reservoirs which have powered the oil industry and modern civilization up to now.

What this implies is that limitations on future supplies may result from the price of oil being too low. Contrary to the public perception that such limits would be accompanied by high prices, it is precisely high prices that make it possible to exploit the marginal deposits that are unprofitable today.

Analyst Gail Tverberg has elaborated this thesis in considerable detail on her blog Our Finite World starting as far back as 2007. Similar ideas have also been advanced by energy analyst and consultant Steven Kopits. (A 2014 presentation by Kopits is available here.) Tverberg's analysis is that high energy prices, particularly high oil prices, tend to suppress economic growth leading to recession and price declines. The lower incomes and lack of employment that accompany recessions make oil--despite its lower price--less affordable than is generally recognized. Lack of demand is partly the result of crimped living standards--which keep prices low, which, in turn, make it unprofitable to exploit high-cost oil.

Now, oil demand actually went up somewhat in the face of recent lower prices. But if Tverberg's thesis is correct, then demand won't hold up when the economy sinks into a recession or stalls close to zero growth. If the world economy shrinks or merely stalls, as it now appears to be doing, we may be in for a long stagnation for other reasons as the world works off debt built up previously in a long 30-year credit boom.

It seems only logical that if world oil production drops as a result of low demand and low prices, at some point shortages will appear and prices will rise even if the world economy remains in a slump. That may happen, but the big question will be this: Just how high can those prices rise before financially strapped consumers can't afford to pay more?

If that price turns out to be somewhat less than $100 a barrel, very few deposits of unconventional oil such as arctic and deepwater oil, tight oil from deep shale deposits, and tar sands will be profitable to produce. And these unconventional sources have been virtually the only engines of oil production growth in recent years. The International Energy Agency, a consortium of 29 countries which tracks energy developments, is already on record saying that conventional oil production peaked in 2006.

With violent swings in oil prices continuing, it's hard to imagine world markets delivering an oil price indefinitely above $100--which would encourage growth in unconventional oil production--but not above, say, $130, which could easily send the economy into recession and lower prices below the point of profitability for unconventional oil. It seems that either Tverberg's stagnation scenario will limit production because of low prices or that a return to robust economic growth will be doomed to be short-lived because oil prices rise above what the world economy can bear.

It's always possible that some technological breakthrough will allow us to get out of this cycle. But we should not count on this soon. As I have pointed out, the most recently touted "new" technology, the technology that opened the deep shale deposits in the United States for oil drilling, has a 60-year history of development:

For those who point to hydraulic fracturing as a recent technological breakthrough, they need to do a little research. Hydraulic fracturing was first used in 1947. More than 30 years later in the early 1980s, building on government research, George Mitchell and his company Mitchell Energy and Development began pursuing natural gas in deep shale deposits. It took Mitchell 20 years of experimentation, government help and government incentives to perfect the type of hydraulic fracturing which is now used to release both natural gas and oil from deep shales. It took another 10 years for his methods to be widely deployed by the oil and gas industry.

For truly revolutionary technology to make an important contribution to the world's oil supply over the next 20 years, that technology would have to be available today, but not yet widely deployed. The cycles of innovation in the oil industry do not move nearly as quickly as those in, say, the semiconductor industry. Major breakthroughs in oil extraction require long lead times, and there doesn't seem to be anything but marginal improvements in some existing techniques in prospect for many years to come.

For now, we may be experiencing limits in oil production that are not absolute, but relative to what the world economy can afford. Of course, we could rework our infrastructure and daily practices to use less oil or even to begin to phase it out altogether. But, don't look for that kind of dramatic move anytime soon, either.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now, The Oil Drum,, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at


Anonymous said...

So violent swings in oil price have resulted in higher global crude oil and lease condensate production in 2014 than at any point in time in human history, prices down 2/3's since 2008, and the US coming up with the two largest producing oil fields in the western hemisphere in just the past 5 years? I have to say, if this is the result on non planning and just the industry doing what needs done to provide the consumer with what they are demanding, then bring on less planning and more price volatility.

Kurt Cobb said...

Anonymous falls into the trap of looking only at the present moment and judging everything in the past and future by that moment rather than looking at the trend. The trend in U.S. production is decidedly down. World production slipped in July and so we'll have to see whether that turns into a trend.

The temporary euphoria over low prices is brought on in part by overproduction in the United States and in part by softening demand worldwide, itself a product of a slowing economy pressured by high oil prices. And, something I didn't mention in the piece is worth mentioning in this regard. Even at $100 a barrel, most independent tight oil drillers in the United States were experiencing negative free cash flow year after year. Only cheap finance (courtesy of the U.S. Federal Reserve's zero interest rate policy) and Wall Street hype made the overproduction possible. It certainly had nothing to do with actually making money. It's possible that even a return to $100 a barrel may not be enough to revive an industry that lost money consistently at that level. If it takes, say, $130 a barrel oil to make the tight oil drillers as a whole cash flow positive, then that might not be sustainable for the economy.

All of this is an argument for getting off oil (without even citing its climate effects) as an unreliable energy source. Gone are the days of rising production under practically all circumstances. We are now faced with frequent, large, short-duration fluctuations in price and supply, something the optimists were certain would never happen because technology would miraculously make all currently high-cost oil into low-cost oil. But that hasn't happened. And, there's no reason to believe it will happen anytime soon.

Anonymous is content today because the cost of the petroleum products he (or she) buys is down. But he (or she) must still have a job to pay for them unlike the thousands who are being laid off in America's oilfields so far and in America's manufacturing industries as the economy softens further. Affordability is a function of income and price, not just price.

OIL WATCH said...

Who benefits most from a low oil price buyer or seller?
During QE USA could print money to buy oil.
Since the end of QE the oil price has fallen to the benefit of USA
They buy 9MBD. At a saving of $60 a barrel that saves America $540 million a day
Graham Mewburn
Google +

Anonymous said...

Kurt: Regarding the history of fraking: "Fracturing oil or gas wells actually began in 1865 in Pennsylvania, where the practice of “shooting” wells began."

Anonymous said...

The trend in US production has been up for years, those years when some folks were proclaiming that oil production could only go down. The current trend of declining production has been going on for a few months, as opposed to the prior trend lasting years. And the current inflection point is all about price, and completely predictable as any economist might point out. The marginal barrel is now in the US because of the efforts of industry. When you control the marginal barrel, you control the price, until demand overruns your ability to provide that barrel and someone else dictates the marginal barrel price.

And with the estimates of this type of oil available now above 400 billion barrels worldwide, we aren't talking about an unreliable source, but perhaps one far MORE reliable than white elephant hunting of discretely reservoired traps. The risk of getting SOME amount of oil out of continuous sources? Near zero, and it is part of the USGS definition of these types of accumulations. It is nearly a perfect manufacturing model, as opposed to the heavy risks of first finding, and then developing economically, large complex projects, usually offshore. The new wells are cheap, onshore, and the entire economics revolves around nothing more than something Americans have been doing really well for centuries now…turn to the right, making hole, repeat ad infinitium.

I drive an EV, and currently don't give a crap what the cost of oil is, other than the knock on effects such industrial activity has on the economy as a whole.

Kurt Cobb said...

Let me take the comments above in order.

No doubt consumers of oil products are rejoicing at the lower price. But they won't appreciate the price spikes in the future that result from inadequate investment in new supply. The idea that oil will stay at this price in the long term is simply unrealistic.

As for fracturing starting in 1865, I suppose the techniques in the article could be described that way. But modern hydraulic fracturing, which is what I was referring to does, in fact, as noted in the article begin in the mid-1940s. However, you date it, well fracturing is certainly not a new phenomenon.

The third anonymous commenter tells us that the trend in U.S. oil production "has been up for years." What he leaves out, of course, is that it had previously been in almost continual decline from 1970 through 2008. The recent uptrend has been very short-lived.

He makes the claim that there are 400 billion barrels of so-called tight oil worldwide, but does not give us a source for this claim. Typically, these claims are for oil in place--for which recoveries might be 1 percent--or technically recoverable resources--for which recoveries might reach 5 or 10 percent. These numbers don't represent reserves which are strictly speaking known reservoirs containing oil available using existing technology at current prices.

Anonymous number 3 apparently didn't get the memo that the so-called manufacturing model has been completely discredited. The model claims that economical oil can be obtained by drilling anywhere in a deep shale formation. Reality has shown that drillers huddle together in the sweet spots of the formations and that only 10 to 15 percent of the formation typically falls into this category. In North Dakota, for instance, where the deep shale deposits are found in practically the entire state, drilling is concentrated in just four counties. If the manufacturing model were actually a reality, drillers would be dispersed throughout the entire state wherever the formation is, thus reducing competition for leases. But it turns out that shale formations are just like every other oil formation. There are sweet spots and there are spots that are not economical to drill.

The report "Drilling Deeper" by David Hughes details the actual drilling history in all the major shale formations based on industry data. All you have to do is to look at how concentrated the drilling is to realize that the manufacturing model was always a fantasy.

Beyond this, there is the now 96 percent downgrade by the U.S. Energy Information Administration of oil available from California's Monterey Shale, once believed to have 15 billion barrels of technically recoverable resources (the largest of any of the U.S. deposits) and now believed to have just 600 million barrels. Monterey was to be the mainstay of U.S. oil production in the decades to come. Now, not so much.

Anonymous claims tight oil wells are cheap and yet the costs can be up to $10 million a well. Less expensive than offshore wells, but also far less productive than offshore wells typically are. You get what you pay for.

Anonymous said...

Consumers have paid higher, and lower prices in this century. So there is no expectation of price stability. US oil production decline was reversed, and might have even peaked again, 40+ years after the initial Hubbert peak. Utilizing the fastest growth rates in the history of the country, according to the countries expert on such matters,Adam Sieminski. Those who were predicting only continued decline obviously have missed why peak oil ideas have failed in the past, and were certainly caught by surprise, perhaps because they had never taken Resource Economics 101 in school. 400 billion barrels should be known to anyone pretending to understand resources, it is the estimate from the EIA world shale study, contained here:

Again, if you want information, you ask the experts, as opposed to bloggers. Recovery factors are already accounted for within the studies referenced.

The manufacturing model of resource development has been ongoing since at least the Ohio shale play of the late 1800's in SE Ohio and west central WV. Again, one of those pieces of information that anyone interested in how successful this model of development has worked over more than a century. Perhaps you prefer the manufacturing model as applied to the development of the Big Sandy gas field, again in the devonian shale of Kentucky, during the late 1920's? Those involved or at least AWARE of the Eastern Gas Shales Project in the late 1970's and knew this gas was there before modern naysayers came along and attempted to pretend that the growth in natural gas production wasn't possible, Julian Darley jumps to mind. The result being the massive increase beyond all Hubbert estimates of what natural gas production should be right now, discrediting even the very idea of those fitting random declines to production data and mistaking it for a predictive model.

As far as David Hughes, you would do better referencing independent and objective analysts such as those at the EIA, with the modeling capabilities, experience and information to at least underestimate the shale revolution, while folks like David were implying it could never happen until..oops…it did. Ask him about the shale gas and shale oil volumes he included in the 2001 Canadian Potential Gas Committee study, and then compare those to what is going on in Canada, and ask why shale oil and gas has always been invisible to him, even as it expands to 50%+ of US natural gas production. Same with oil, just ask him, and compare THOSE volumes to reality.

Beyond this, the EIA explained why the Monterey was downgraded, I can provide chapter and page if you'd like, it involved, you know, geology and stuff. Something lacking in David's reports, but not the work done by WVU headed up by Doug Patchen. Now that was geologic work, including using the quantitative procedures of the USGS, rather than just grand proclamations by those who can't be bothered to do these kinds of quantitative assessments.

And when the Monterey went down, what happened to the rest of the countries shale estimates? Did the net number go down with the Monterey? Or up? Interesting that you won't discuss that, because it would negate the value of the Monterey going down, while the shale revolution was exploding the estimates all around the rest of the country. And the BEG has displayed costs for all the big shale gas plays during the 2014 URTeC conference, and there were I believe 4 of 5 analyzed easily below $10 million, some below $5 million. Why don't you talk about that, or, may you can't be bothered to get information from the experts?

Kurt Cobb said...

Anonymous tries to counter facts about oil production in the United States with claims, some very old indeed, about natural gas production in the United States and Canada. It's a response that is neither compelling nor on point since I'm not discussing natural gas production in North America in this piece. When the facts are not on your side, then resort to mere bluster and hope people won't notice.

With regard to the Monterey downgrade, Hughes predicted such a downgrade in his report "Drilling California" released in December 2013 and chock full of geological and production analysis. Six months later the U.S. Energy Information Administration downgraded the Monterey by 96 percent. That's a bull's-eye if there ever was one. On that day U.S. technically recoverable tight oil resources fell by more than 13 billion barrels.

We should take U.S. EIA's estimates with a grain of salt. The Monterey Shale was rated the largest of the U.S. tight oil deposits and in one day it went "poof." With regard to resources estimates for gas (and this goes to the reliability of the EIA's estimates), we've seen vast downgrades of U.S. natural gas considered available both by the EIA and the USGS with regard to the largest shale gas deposit, the Marcellus.

We should remember that these estimates are for what the EIA regards as "technically recoverable" and says nothing about whether they will be profitable to extract, an issue with particular importance today.

It doesn't help that the public and investors are being routinely misinformed by the oil industry about its actual reserves as reported by Bloomberg. Oil industry CEOs are announcing reserve numbers concerning tight oil that are 5 to 27 times what they report to the Securities and Exchange Commission.

As for Adam Sieminski, the EIA's administrator, it's important to know that he is an economist, not a geologist. And, Sieminski revealed his sympathies for the oil industry rather than his allegiance to objective analysis when he stated in a public briefing last year: "We want to be able to tell, in a sense, the industry story. This is a huge success story in many ways for the companies and the nation, and having that kind of lag in such a rapidly moving area just simply isn’t allowing that full story to be told."

The quote was included in a Hearst News Service story about the lag time for the reporting of domestic oil and natural gas production data to the EIA.

Anonymous said...

Avoided answering the question about the EIA explanation for the Monterey? Check. Avoided answering the question, how much of existing shale oil and gas production in Canada did David assess when he was in charge of doing just that, even after the USGS showed him how? Check. Avoid discussing the EIA underreporting the size of the shale revolution? Check. Not even understanding that the NEMS is EXACTLY an economics calculator, and explicitly converts TRR into producible and economic resource? Check. Repeats all standard talking points with zero recognition of prior booms and shale development? Check. The only thing I can assume Kurt is that your past arguing inside an echo chamber has not allowed you to actually understand the history of the industry, the development of shale resources spanning parts of 3 different centuries, or maybe this is just self preservation, to not land in laughingstock country? Nobody wants to be a part a chicken little exercise, at the exact instant the US is ramping into the fastest growth rates in oil production in the history of the country.

That Resource Econ 101 would have been way helpful, before this PR disaster. Just sayin..

Kurt Cobb said...

"Nobody wants to be a part [in] a chicken little exercise, at the exact instant the US in ramping into the fastest growth rates in oil production in the history of the country."

The EIA reports that U.S. production of crude oil including lease condensate peaked in the week ending June 5 at 9.61 million barrels per day. For the week ending October 9, the number is 9.096 million barrels per day, a drop of 500,000 barrels per day. If Anonymous considers this to be growth, then we are truly living different universes.

Anonymous said...
This comment has been removed by a blog administrator.
fpteditors said...

Thanks Kurt. Please keep up the great work. There is a way out, a growing movement for free public transport. When cars lose critical mass, the subsidies that keep them going will be seen as a burden.