When Will the Oil Price Pop?

Six month ago - when the world economy looked significantly rosier - I posted an analysis of projected supply and demand for oil going forward to 2015. The analysis was based on the assumption of continued demand growth, continuing decline of old oil fields and expected new production from announced oil megaprojects. I adjusted the magaprojects estimates for delays and I concluded that: “if these estimates are at all closely correlated with reality we should expect oil markets to be tighter than at present through 2012 followed by even more need for demand destruction from 2013 through 2015.”

I also offered an alternative scenario that included an unadjusted but smoothed curve of the Wikipedia expected annual megaproject supply which showed very substantial new projects coming on stream in 2008 and 2009. Based on this scenario for new oil supplies I concluded: “These “unadjusted” numbers show ample supply of oil through 2009 followed by shortfalls in 2010 and very important shortfalls starting in 2011 - possibly even catastrophic shortfalls in 2012 and thereafter if decline rates are more severe than 4.5%.”

I also showed an alternative model using an adjusted smoothed version of the megaprojects curve to account for likely delays in project startups, delays in reaching peak production, and the addition of new small projects in the out years. Based on such adjustments I concluded: “There will be unremitting stress in the oil price going forward and prices will escalate after 2010.”

In actual fact, the 2008 - 2009 economic debacle is expected to reduce global oil demand by millions of barrels per day (thus increasing global spare oil production capacity) and to simultaneously defer many megaprojects and smaller production plans further into the future. So it now seems appropriate to look at the changed landscape and prepare an updated estimate for oil supply, demand, and price through 2015.

The question posed in my earlier post (9/1/08) was “when will the price of oil pop to perhaps $300 - $500?” Now, as we live through a global depression, the question has become “when will the $35 - $50 oil price move through some “equilibrium” $70 - $90 price point and then pop back into the $100+ range, indicating a return of scarcity pricing?” To answer that question I’ve gone back to the original data and tried to update it to account for the depression-related impacts of the global demand downturn and delays in both new megaproject startups and in EOR (extraordinary oil recovery) work-over production.

Here is a new projection that aims at estimating spare global capacity going forward. Spare capacity in early 2008 was generally believed to be about 2 mb/d, virtually all of it in Saudi Arabia. Here’s my estimate now:

Please note all the numbers in the above chart are simply my own assumptions aimed at answering the question: “what happens if the global depression peaks in late 2009 with growth in economic activity and global oil demand starting to recover slowly in 2010 and growing more or less normally after that - all assuming oil decline rates grow slowly and that new production from megaprojects and work-over efforts comes in at a lower rates than had been projected before the cancellation of many such efforts due to the lower oil prices now in place?”

My assumptions reflect three hypotheses about oil supply/demand.

1. Oil demand will be some 2 mb/d lower in 2009 than 2008, reflecting my guess that current estimates of a 1.5 mb/d decline from the IEA will turn out to be too low. (Another analysis is here.) I estimate that oil demand will bottom out sometime in 2009/2010 and will grow from there.

2. Depletion of old fields will continue to increase steadily since it is a geological reality that is unaffected by above-ground considerations (other than by EOR projects that mitigate natural declines, about which I make no assumption).

3. New additional oil production from megaprojects and new EOR activity will be substantially weaker than had formerly been believed because so many projects have been put on hold due to lower prices. It will probably take 1 - 3 years of much healthier oil demand than is currently the case and much higher pricing to bring back those projects and there will be considerable time lags before they can come on stream.

One example of the deferral of new oil production projects is the Canadian oil sands. A study recently published in Oil and Gas Journal (3/2/09, pp. 20-23) indicates that instead of production growing from about 2 mb/d in 2008 to a previously estimated 5.5 mb/d in 2015, the new reality is that oil sands production growth will be about 300 kb/d through 2015. Economist David McColl is quoted as saying, “..over the next few years oil sands production growth will be almost at a standstill.”

Aside from oil sands production, the change in future production gains globally from new projects and work-over efforts is hard to quantify. The assumption I made is that production from new megaprojects will slow from the previously assumed magaprojects growth through 2011 based on weak oil prices and then pick up as projects that had previously been assumed to take place in the 2009 - 2011 time frame become shifted into the 2013 - 2015 area.

This analysis suggests there will be ample oil supplies in 2009 and 2010 but that tightness will come back to the market by the end of 2011 and very high prices will start to take hold by late 2012. The model projects extremely insufficient supply by 2013 which would require scarcity pricing of well over $100 - perhaps over $250 - to rectify.

Some of the general background assumption I made include:

1. There will be no rapid increase in oil production from Iraq or Nigeria. Political developments in both countries, including particularly the removal of American forces in Iraq by the end of 2011, offer little reason for optimism that above-ground conditions will improve markedly enough to result in a rapid escalation of oil production in either country despite substantial development interest, particularly in Iraq, from many IOCs.

2. There will be little reduction in oil demand from increased automobile efficiency through 2015. It appears that Plug-in Hybrids will not be available in any quantity for at least several more years. Thus, the number of 100+ mpg cars on the road has little chance of becoming significant before 2015 at the earliest. Moreover the bad economy and low gasoline prices have greatly reduced demand for fuel efficient cars now available on the market. Moreover, car sales in general are so low that replacement of old cars with new ones is much slower now.

3. Global oil demand will be boosted by continued rapid growth in China, India and other developing countries. Meanwhile, the bulk of demand destruction in OECD countries caused by economic declines will be over by the end of 2009 as the banking crisis is resolved and the down-sizing of OECD economies is completed. OECD demand will begin to come back slowly in 2010 - 2011 .

A Bleaker Scenario

Some analysts have been warning that the cancellation of new oil production projects will slow future oil production at a much faster rate than my model contemplates. What if they are right? What if much more scheduled new oil production capacity is deferred and it takes much longer for higher future oil prices to bring back on stream the megaprojects that have been deferred from 2009 - 20011 plans?

Here is an alternative model that shows both a slower rebound in global oil demand and also greater deferral of new oil production and a slower rebound in oil supply in out years coming from new megaprojects:

Compared with the more “optimistic” scenario first presented, this one indicates a far more negative supply situation occurring in 2012 and much more desperate global oil shortages in 2013 - 2015.

I would note that the global demand growth assumptions in this model from 2011 - 2015 are rather mild compared with the 1.5 - 2 mb/d growth that was experienced from 2004 - 2007.

Even Bleaker

What about the possibility that the economy does not recover in 2010. Suppose this is the really big depression? Let’s say the global economy keeps declining right through 2011 and doesn’t begin to level off until 2012. What would happen to oil supply, demand and price? Here are the numbers that might reflect that scenario:

Surprise! This far, far bleaker economic scenario has relatively little impact on year end spare oil capacity through 2015. Yes, a much more disastrous economy results in a bit more spare oil capacity by 2011 - about 500 kb/d. And it yields a slightly positive spare capacity number by 2012 instead of a negative capacity number. But spare capacity is still very negative by year end 2013 and increasingly thereafter. Similarly, the differences in years 2013 - 2015 are simply degrees of disaster. The implied oil price is huge in both economic scenarios.

What this analysis shows is the definitive effect that the decline rate - which does not change - will have on global spare capacity and the price of oil between now and 2015. The decline rate makes all the difference. No matter how bad the economy becomes over the next few years, no reduction in oil demand (which becomes less elastic over time) can off-set the ever-steady rate of decline in the production of old fields in determining the level of global spare oil capacity.

So the differences in economic performance imply only minimal differences for the price of oil. Whether spare capacity at year end 2011 is down to 2.1 mb/d or 2.6 mb/d is not important. In either case, it is a minimum of spare capacity (and clearly moving toward negative territory) and implies an oil price of over $100 per barrel. And the difference in 2012 spare capacity between -1.15 and .6 mb/d is the difference between a disastrous shortage and an acute shortage. They both imply a price of over $200 a barrel. Similarly the numbers in either economic scenario for the years 2013 - 2015 imply absolute disaster.

A Second Global Depression?

An obvious question suggested by the above analysis is whether the enormous oil price increases implied in any of the economic scenarios presented above may cause the global economy to halt its recovery and fall into another depression. I can’t see any interpretation of the data that would lead to a different conclusion.

So anyone who thinks that a new global bull market in stocks will take off from the ashes of destruction evident in 2009 - 2010 might want to temper her optimism because these numbers suggest two things to me. One is that there may be an important bear market rally once the economy stops falling down. Energy stocks should be major participants in such a rally. But the other thing is that after 2011 or so, with enormous oil supply deficits staring us in the face and threatening to just get worse, it might be better to own the commodity than to own equities.

Peak Oil: 2008

One implication of the above analysis is that it looks like peak oil production occurred before 2009, given that the expected future flows of oil from new oil production projects will be less than the decline in old fields each year, at least through 2015. With declines increasing slightly every year, the only possibility that peak oil has not already occurred is that at some point beyond 2015 the high price of oil will bring on enough new megaprojects and EOR projects to more than compensate for continually increasing declines in old fields.

What are other analysts saying?

Robert Hirsch, one of the first experts to warn about peak oil in his famous 2005 analysis of the peak oil problem, essentially agrees that peak oil production has passed. He wrote in the February, 2009 Energy Bulletin, that: “World liquid fuels production reached a plateau in mid-2004 and has fluctuated within a relatively narrow range in spite of mighty efforts to increase world production. In mid-2008, benefitting from the work of Campbell, Laherrere, Skrebowski, Aleklett, Simmons, Robelius, Gilbert, Bentley, Al Husseini, Deffeyes, Koppelaar, Birol, and others, I came to believe that world liquids production might stay on the existing plateau for the next 2-5 years and then go into a 3-5% per year decline.”

Merrill Lynch estimates that non-OPEC production has peaked according to a 2/3/09 Reuters report. It quotes Merrill analysts saying, “in Merrill’s base case scenario it estimates output decline rates of 5%, and it sees non-OPEC oil production stuck in the current 49 to 50 million bpd range in the same period. Should the credit crunch push decline rates to 6%, however, non-OPEC production could decline precipitously towards 47 million bpd by 2015 from the current levels. The commodity super-cycle is not over, just resting.

In summary, assuming the ongoing recession does not turn into a multi-year event where global oil demand is pushed down structurally for the next five years, the steep decline rates in OPEC and non-OPEC countries alike could put upward pressure again on oil prices as soon as 2010 or 2011.”

Dr Mahmoud Salameh of the Oil Market Consultancy Service is quoted as saying, “The global peak, he argues, “may have already been reached in 2004 if we factor in what I describe as ‘OPEC’s inflated proven oil reserves’.”

The same article reports that Chris Skrebowski believes that peak oil will be reached in 2010-2011. “Skrebowski says the issue is the need to bring on-stream new flows to replace the depletion of existing capacity. The “easy oil” that makes up most of existing capacity is declining fast and the new capacity coming on stream ­ often from “not-so-easy” oil - will not be replacing it fast enough from 2011 onwards.”

T. Boone Pickens has been widely quoted as saying that the maximum global output of oil is 85 mb/d, in which case peak production has already occurred. Boone repeated that prediction last week. Whether his number includes natural gas liquids, ethanol and other “all liquids” is not clear.

I posted a report on 12/1/08 about the peak oil predictions of Peter Wells and Charley Maxwell. Wells, who uses a bottom-up data base similar to Wikipedia’s megaprojects, believes that non-OPEC production has peaked. OPEC, he says, has the theoretical capacity to increase production from Iraq, Venezuela, Iran, Kuwait and Nigeria. However, among these countries only Kuwait is actually likely to increase production. While Wells uses 2015 as his target year for global peak all liquids, recent pullbacks from production projects might well have caused him to re-think his prediction to be more in line with the numbers I presented above.

Maxwell sees oil supplies peaking in 2011 with all liquids peaking within a few years of that. His most recent predictions of oil prices is consistent with the two analyses of supply and demand I posted above.

Technology: a Key Unknown Variable

All of the above must be tempered by noting that new and potentially disruptive technologies are lurking in labs around the world. Whether they be new batteries, ultracapacitors or other energy storage devices that could enable cheap, efficient cars or new cellulosic ethanol sources or other now unknown technologies for making synthetic fuels, the world is truly dependent on new technologies for getting us out of the oil bind that lurks in the inevitable decline of old oil fields.

If some such technologies were to become available tomorrow it would hard to cycle them through the economy fast enough to have much effect on the above analysis for several years. But you never know.

Comments

[beenburnedt...:]

Excellent article with many things to ponder but not enough information for a consensus. There are an awful lot of unknown variables--the biggest being the Obama administration's steps in the coming years. I work in the oil industry and my job is dependent on healthy capital expenditures for upstream, refining, and downstream projects which become upside-down propositions anytime crude prices fall consistently below $45.

Looking out to the 2011 or 2012 window for steep price increases may be too far for any economist to predict, but my hope for the benefit of the greater world good is that it climbs a modest incline starting in 4Q 2010 and sees several years of price equilibrium after that.

Mar 08 04:27 PM

[Perry1961:]

We could have protracted stagflation until oil prices reach a level that allows renewable energy to be competitive. Wish someone knew what level that would be.

Mar 09 03:11 AM

[lewisabroad:]

oil prices will continue to behave with exteme volatility - that is the only sure thing. Extremely high prices hit the real economy of import nations and result in economic downturn. Demand reduction from the resulting downturn = lower prices. price rebound will be huge in a recovery and has the potential to derail a recovery, setting the stage for another drop in price.
Long term the analysis is correct. However, when the price of oil reaches parity+switching cost of alternatives it will plateau at a new equilibrium point. By alternatives I mean grid-connected battery powered + nat gas. Until then it will be simple supply demand. Trying to put a number to it is a fool's errand, because nobody knows where the dollar will head in three years. When I say price, I am talking oil's equivalent to a basket of currencies (or relative to a basket of commodities if currencies globally are devalued).
The alternative scenario to switching to oil-free transportation is grim. this could be the case if switching costs are too high for a cash-strapped economy. The US is certainly in a dire situation. Hopefully the pain will give people the necessay motivation to work hard as nobody has really done in the last 80 years.

Mar 09 05:25 AM

[Adolf:]

The problem with this is that the decline rates are not historically supported.

Mar 09 07:12 AM

[The Greates...:]

Americans, if you’re surprised at the current world economy, don’t be. We live in a global economy. What affects the whole world affects us as well. 13 OPEC countries and 5 major oil companies have their finger on the pulse of the worlds economy. It is called a monopoly, we need to restructure the commodities market regulations ASAP. Call, write, email and fax your representative and tell them today.

Mar 09 09:00 AM

[The Greates...:]

There will be a large transfer of wealth in the coming years as the huge corporations finish off what competitors they have left. Then there will be only two classes of people, the very filthy rich and the ultra poor (in large numbers). 85 % of your government are millionaires. This last summer showed what a lack of competition will do in the market. (five very large oil and gas companies control a commodity that the whole world must have)

Mar 09 09:01 AM

[The Greates...:]

The fact that the oil companies sucked the living life out of the whole world seems to have fallen on deaf ears. Greed is ugly.

Mar 09 09:02 AM

[The Greates...:]

But what was great for the oil companies does not seem to be working for the rest of America. (or the world for that matter) Greed is ugly.
We have the worst unemployment in over 26 years, people are driving less then they have since the 1950’s, the stock market came just off the worst January and February in history and food cost increased more then 30% over last year. Does anyone know what the current national debt is or that over 46% of it is owned now by foreign countries. No one talks about inflation because they are scared to say how high it is or what the actual value of the dollar is today. We are looking at a long road ahead to say the least.

Mar 09 09:04 AM

[The Greates...:]

Why Congress looks the other way when is comes to gas and oil companies?

A total Campaign contributions from the oil and gas industry in 2008:

$23,500,000.00 to Democrats

$45,035,398.00 to Republicans
opensecrets.com

Mar 09 09:05 AM

[The Greates...:]

Special interests paid Washington lobbyists $3.2 billion in 2008, more than any other year on record and a 13.7 percent increase from 2007.

Mar 09 09:06 AM

[The Greates...:]

Oil needs to go the way of the dinosaur, it is a relic fossil of the past. New alternative fuels and energy sources are becoming more readily and affordable everyday and will replace oil as our energy source if we are smart as a species.

Mar 09 09:06 AM

[The Greates...:]

The only reason that our economy is in the state it is today is from the over inflated cost of oil, driven up by the speculators in the commodities market. They were buying it on the futures market, using the same big name banks and investment companies that had to have the $700 billion bail out (when the oil market collapsed), which 85% of Americans did not want in the first place. Not one other single commodity has the affect on the whole economy as the cost of a gallon of fuel. We need energy independence and we need it ASAP! Instead of placing alternatives on the back burner because the oil bubble has burst, we need to use this time to implement alternative fuel into our country now.

Mar 09 09:07 AM

[DocScience:]

On Mar 09 03:11 AM Perry1961 wrote:

> We could have protracted stagflation until oil prices reach a level
> that allows renewable energy to be competitive. Wish someone knew
> what level that would be.

Renewable energy will never be competitive with oil prices.
As oil prices rise, the price of everything else rises, which raises the prices to build renewables.
The only way renewables and society itself, stand a chance of having a future, is with massive government intervention into renewables.
Nothing has been done in the last 4 years, and there is no indication that the US will change policies for massive renewable assisstance, any time soon.

Mar 09 09:15 AM

[Mad Hedge F...:]

Oil prices here are a gift. Traders looking for the Next Big Play are keeping a laser like focus on two key commodities. Chinese stockpiling prompted copper to break out of its recent trading range to the upside to $1.70, taking lead producer Freeport McMoran (FCX) up 30% on the week. Crude rose 15% to a high of $46. These impressive moves happened during a week when global equity markets were in complete freefall. This suggests that the bulk of the world’s growth will be in emerging economies, and that the next round of commodity buying will be even more ferocious than the last. Since I believe that the future is all about the ascent of hard assets over paper ones, this is music to my ears.

Mar 09 01:12 PM

[pockyclips ...:]

Unfortunate, but true. Those that have the skill and talent will go to entertainment, not engineering.

Easy fame and fortune is the path these folks will take.
Games, pro sports, and movies will benefit.

Mar 09 02:07 PM

[Jack Walker:]

Jim,

Congratulations on a well prepared fundamental effort to forecast crude oil prices. We wonder if the fundamental approach is just too complicated with multiple unknown and politically influenced variables that preclude forecasting price levels with any confidence.

Until recently, we thought the best source of supply and demand data was generated at the NYMEX in the commodity futures markets. Recently our confidence in the market pricing forecast approach has been shaken by the apparent attempts of large speculators to circumvent margin, position limits and reporting requirements of the CFTC in an effort to obscure their activity. Until we get some additional information about the CFTC investigations that began last summer into OTC and ICE trading of crude oil contracts we remain skeptical about pricing data from the futures markets. If you have any information about these investigations, we would appreciate you sharing it with us.

Jack

Mar 09 03:39 PM

[anarchist:]

I heard Charlie Maxwell interviewed recently. Regarding alternative energy he said (and I paraphrase) There is little hope that solar and wind energies will ever become a significant contributor of energy in the United States. Even if their output was doubled as Pres. Obama wants, it still would be an insignificant energy contributions. Wind and solar have many technological delivery problems that seem to be insolvable in the foreseeable future. Maxwell went on to say that nuclear energy is the most logical step to solve our energy problems. The U.S. is way behind the curve as France and other countries already have a large percentage of their energy needs being provided by safe and relatively pollution free nuclear. Maxwell's thoughts on oil are outlined in the article above, he did however go on to say that in light of the U.S.s resistance to nuclear power the U.S. would feel the oil pinch that will be coming much worse than the rest of the industrialized world.
Charlie Maxwell has year after year been voted the best energy trader by his peers.


On Mar 09 03:11 AM Perry1961 wrote:

> We could have protracted stagflation until oil prices reach a level
> that allows renewable energy to be competitive. Wish someone knew
> what level that would be.

Mar 09 08:29 PM

[fatpitch2:]

Jim:

Thanks for this review!

I have a couple of random comments:

1) My personal suspicion is that a 4.5% depletion rate is optimistically low. I suspect the current rate is perhaps 5% - 6% and that it will rise in the coming years. Cantarell is, for example, depleting at double-digit rates.

2) Nuclear energy could do a lot for us; but we gotta get moving. I attended a presentation last night by Duke power, Areva, and several other US players in the nuclear field and the time line for building a nuclear plant is as follows: 6 YEARS of paperwork (environmental impact, public comment, NRC, ....) then 6 years to actually build the plant.

3) Nuclear and most alternative energy sources, as we all know do not produce liquid fuels, a real bummer in our current world of liquid fueled transportation.

4) Even if wind and solar COULD become major contributors, and I am skeptical .... we will need additional technology behind these producers to "smooth" out fluctuations in supply -- the winds stops blowing, it is a cloudy rainy day, .....

It's a huge mess ... and I am long energy

Mar 12 10:02 AM

[WayneinOregon:]

I've heard of some very promising developments regarding cellulose into ethanol conversion and biodiesels from algae. Other technologies show great promise as well.

Unfortuntely in the past, this type of research was not supported. Now that the government is likely to vigorously support these kinds of research efforts, I think there is a tremendous potential for a number of game changers to dramatically effect our need for fossil fuels.

In the short to medium term however, it certainly does appear that we will encounter oil shortages and subsequent higher prices. But nothing is for certain if the technological prowess of our country is unleashed.

Mar 16 12:01 AM

[baird2100:]

Eventually oil will be higher than we've ever seen it. Again not a question of if, but when. I think anyone with a little sense knows this. And personally I believe sooner more than later. 3-5 years and this will start to be a different world. Get busy living or get busy dying.

Apr 13 01:54 PM