Oil: $20 a Barrel? Or $200?

If the U.S. dollar strengthens and the global economy weakens as government stimulus runs dry, oil could plummet in a massive "head-fake" to $20/barrel.

Any discussion of the price of oil must factor in the relative value of the petro-dollar, a.k.a. the U.S. dollar. If the dollar plummets in value against other major currencies and gold, then oil could double in nominal price even as it remained constant when priced in other currencies or gold.

Setting aside speculative positions, the other major factor in pricing oil is supply and demand. Recently, a spate of mainstream media articles have heralded massive increases in supply in natural gas and oil.

America's Natural Gas Revolution (WSJ.com)

Betting Big on a Boom in Natural Gas (BusinessWeek)

In summer 2008 the U.S. and much of the rest of the world were consumed by talk of peak oil and natural gas and fears that high fuel prices would persist forever. Today analysts still worry about the oil supply but far less about natural gas. U.S. gas producers, capitalizing on a technological breakthrough, have in recent years unlocked an enormous volume of natural gas in the shale rock under Colorado, Oklahoma, Pennsylvania, Texas, and other states.

According to a July report by the Colorado School of Mines, the U.S. now holds 1,800 trillion cubic feet of natural gas, one third of it in shale, the equivalent of some 320 billion barrels of oil. That's more than Saudi Arabia's 264 billion barrels.

Whew--now that we have more fossil fuel than Saudi Arabia, I guess we have nothing more to worry about. Uh, count me skeptical. The technological breakthough is calling "fraccing" for hydraulic fracturing, a technique which has been around for decades.

Basically, water is used to fracture rock or shale, enabling the gas to seep to extraction wells. Chemicals pumped down the wells can also enhance recovery.

All this sounds fabulous--except for the practicalities which are glossed over. How do you collect gas flowing into hundreds of widely spaced wells? With a network of pipes. That isn't quite as easy or cheap as dropping a pipe into a supergiant Saudi reserve. So how much will it cost to tap these giant reserves of gas and feed the gas into existing networks of transport?

Exactly what chemicals are used? How much do they cost to pump down and extract? How do you get the water to the hundreds of wellheads?

And perhaps most remarkably absent from the happy news--how much of this new natural gas production will simply be offsetting declines in other mature fields?

Similar advances in oil recovery technologies promise another 100 years of oil--or so we are told here: Another Century of Oil? Getting More from Current Reserves (Scientific American October 2009; subscription required to read entire article online; visit your local library to read it for free)

Forecasts that global oil production will soon start to decline and that most oil will be gone within a few decades may be overly pessimistic.

The author predicts that by 2030, thanks to advanced technologies, wells will be able to extract half of the oil known to be underground, up from the current average of 35 percent.

Together with new discoveries, the increased productivity could make oil last at least another century.

Once again, the article (written by a global oil company executive) is heavy on promise and glowing hype and short on costs. Is all this fancy recovery technology free? If not, then how much does it add to the extraction cost of each barrel?

All this seems to suggest something which these articles avoid mentioning: there may be more fossil fuel that is recoverable, but it will no longer be cheap. None of these articles addressed the possibility that all this "new" production will simply offset declining production elsewhere, which means global production would simply stay constant rather than increase to match rising demand.

Also left unsaid is the trivial amounts of oil and gas being recovered from aging fields by the costly new technologies. The example cited in the article is a large field in California that was expected to be depleted year ago which still produces 80,000 barrels a day. That is good news, to be sure, but the extraction only makes sense if oil is over $50 a barrel, and 80,000 barrels is a drop in the bucket of the 20 million barrels the U.S. uses each day.

It would take dozens of such vast fields to replace the sagging production from supergiant fields in Mexico, the North Sea and the Mideast.

With prices elevated to the $80/barrel level, constant supply (at high prices) has created a global glut in oil and natural gas--there are literally no storage facilities available to store more gas and oil. This suggests that if the global economy resumes its deflationary spiral down next year, then a grand imbalance between supply and dwindling demand might cause oil to crash in price--unless the U.S. dollar declined concurrently.

As readers know, I am expecting the dollar to actually rise, which would exert downward pressure on the price of oil (in dollars, of course).

Correspondent B.C. was kind enough to submit this chart and commentary. The chart displays the price of oil adjusted to the CPI (consumer price index) in which 1974=100. In other words, the price is in constant dollars, not nominal dollars; the chart removes inflation from the picture. Thus if today's dollar is worth 33 cents in 1974 dollars, then today's $3 a gallon gasoline would be $1 in 1974 dollars.

click on chart for a larger version in a new browser window

Adjusted for inflation, we see oil at its recent nadir in 1999 had returned to the price levels of the late 1960s. The cost spike created by the 1980 Iraq-Iran war was actually higher in real terms than the spike last year to $147/brl.

Here is B.C.'s commentary on how the dollar's rise or fall could drastically alter the price of oil.

US dollar (USD) and CPI constant, the nominal price of oil would need to fall back to the $40s to reach the CPI- and USD-adjusted level where recessions bottomed and new reflationary growth cycles commenced since the '90s.

However, were the USD to rally back to the earlier cyclical high or to par, for example, coincident with another deflationary episode, the nominal price of oil would have to fall to the low to mid-$30s, to as low as the low to mid-$20s, to reach the adjusted recession low since the '90s and before the early to mid-'70s.

That the nominal price of oil has generally tracked nominal trend GDP growth adjusted for the USD, all else equal, oil in the $20s would not surprise me over the next 1-5 years, especially if we see another deflationary scare and stock market crash and economic collapse in China-Asia.

Thank you, B.C. If the dollar strengthens substantially, as many of us expect in the short-term, then oil would drop in nominal price for U.S. residents and increase for those paying for oil in other currencies.

If deflation and global recession were to take hold--that is, if all the quantitiative easing and borrow-and-spend pump-priming fails to ignite "organic" (real) growth, then the price of oil could be hit with two deflators: the rise of the petro-dollar (USD) and a supply which greatly exceeds falling demand.

I illustrated this "head-fake" drop in prices before the final arrival of Peak Cheap Oil in 2008:

Many other observers are similarly alive to the possibility that oil could drop in nominal dollars to $20/barrel in a deflationary "head-fake" and then rise to $200/barrel once supply fell below demand and the dollar resumed its decline in purchasing power.

Frequent contributor Cheryl A. submitted an excellent interview with oil analyst Stoneleigh on the Automatic Earth blog. Stoneleigh suggested that oil could fall to $20 and then subsequently rise to $500 per barrel once demand exceeds supply.

What we need to keep in mind is the relative value in nominal dollars. If the dollar were to suddenly lose 2/3 of its value against gold and other currencies, oil would suddenly cost $200/barrel to U.S. residents even as it remained constant to those buying oil with other curencies.

Inversely, if the dollar were to strengthen, oil could fall in half when priced in U.S. dollars and skyrocket when priced in other currencies.

The main point is simple: tracking the price of oil in constant (adjusted) dollars illuminates the real cost of oil in purchasing power.

Comments

[Dave Wrixon:]

I think what you have missed is the US demand for oil will not be essential. The US is going to have to consume less because it simply won't be able to afford it, but other economies noticeably the China and India will take up most of the slack. Demand in Europe will also continue grow because it has been more frugal with the resource due to more enlightened tax regimes, and therefore the scope to reduce consumption is much lower. Also there are an ever growing number of middle class consumers coming online in Eastern Europe.

Nov 05 03:48 AM

[aussiereader4:]

The chemical that is pumped down the well is carbon dioxide. You get two methanes for every molecule. It is the natural form of carbon capture and storage and has a great future. They will probably pay them to pump it down.

Nov 05 04:50 AM

[User 353732:]

The price of oil, natural gas, iron ore, corn or any other global commodity is, has been and will be volatile in both real terms in terms of that barbarous relic the fiat US dollar.
There are too many moving parts and interactions to make confident predictions. Demand, technological innovation, public policies, geo-strategic risks, risk appetites, real interest rates, view of the world about mid and long term conversion of resources to reserves , opinions about the electrification of transportation via nuclear power, majority views on inflation and currency debasement,at a minimum , combine to set the price.

For a season the price could be $20 in real dollars( not nominal dollars) but if so it will then assuredly also be $120 in real dollars, for a season.

Whatever the prevailing price of oil, it will be different in a few weeks or months. No one can "forecast" the price of oil with replicable success. Almost anyone can right once or twice and no one is right consistently.
What we do know is that the received wisdom about oil or energy in general is often wrong and wrong in both magnitude and direction.

Nov 05 05:28 AM

[parky:]

NOW THAT THE EXPERTS HAVE SPOKEN, PERHAPS SOME COMMON SENSE SHOULD BE ADDED. WITH SOMEWHERE AROUND 2.5 BILLION CHINESE AND INDIANS TRANSITIONING FROM BICYCLES AND MOTOR SCOOTERS TO AUTOMOBILES IT WOULD SEEM THAT OIL CONSUMPTION WOULD CONTINUE TO TREND UPWARD FOR SOME TIME. IN ADDITION A DISRUPTION OF PRODUCTION FROM THE MIDDLE EAST IS ALWAYS HANGING ON THE HORIZION. ONLY BEEN IN THE MARKET FOR 40 YEARS BUT I'LL VOTE FOR FURTHER INCREASES IN OIL PRICES OVER THE NEXT COUPLE OF DECADES - PROBABLY SUBSTANTIAL.

Nov 05 07:57 AM

[bartpr:]

i believe the last up move in oil to 140+ was because demand in 2008 oustripped supply. not by much, maybe 2mbpd. but if supply is limited and cannot be flexible at 86+mbpd, sharp rises in the futures market will bring the spot market price up eventually. if producers contract out future production in times of tight supply users will bid up future deliveries. since few have been able to gage market supply and demand there will be excess up an down. see the collapse to $30.

this is no place for me to gamble.

Nov 05 08:16 AM

[jerrydd:]

Oil has peaked, just look at the numbers. Only a fool would believe otherwise.

Since the price drop from the peak, E+P has dropped so when demand goes back up, there will not be supplies to meet it, driving prices up to about $150/bbl, when it will cause another world recession.

And it will keep doing this cycle until we get off oil.

Oil production will never keep up with the decline of old wells, we don't have the rigs to do it even if there was oil. Why is like refineries not being built is they know we will never produce, use that much oil again. The numbers don't lie but oil companies, countries do.

If we are smart, we will switch to EV/ hybrid drive for cars and NG for trucks, semi's as fast as we can before the downslope of the peak oil bell curve drives us into bankruptcy.

I've driven EV's for 14 yrs now at far lower costs than ICE's do. I use old forklift EV drive tech, lead batteries and composite uni-bodies as Ferrari, other of the most expensive cars do though I use medium tech composites, not Carbon Fiber.

My fuel costs are around 250mpg for my 2 seat sportwagon and 600mpg for my Harley size trike MC. Sadly to get mine I had to build my own.

EV drives for cars and NG for trucks, semi's is the future as we won't be able to afford anything else.

To invest in this Ford, Nissan are set to supply mass numbers of these just as oil hits it's peak price late next yr, will do very well. No other companies are ready to do this.

Nov 05 08:43 AM

[User 352448:]

The technical breakthrough for oil shale gas is NOT hydraulic fracturing, but rather the horizontal drilling techniques only recently have been available. That, in combination with improved hydraulic fracturing techniques, has enabled one of the biggest breakthroughs in decades.

Nov 05 08:51 AM

[Old Trader:]

Last week, when Chevron posted its numbers, the CEO noted improving demand in the foreign markets, which jibes with parrky's comment above. Addititonally, although China's appetitie is growing, so is India's; one doesn't hear as much about that.

Nov 05 09:12 AM

[Mad Hedge F...:]

hgs If you think oil is expensive here at $80, look again. The Department Energy chart below of US oil consumption per unit of output shows that, in fact, we are at a 40 year low in the price of crude. In other words, it takes half as much oil to produce a unit of GDP than it did in the late sixties, when 12 miles per gallon was considered reasonable, and only Lincoln Continentals got abused because they consumed a gluttonous six miles per gallon. This is the why current lofty prices are having a negligeable effect on a reviving economy. The other chart shows the price of oil in inflation adjusted terms. Again, we are at the high end of the range, but nowhere near the top. What’s the lesson in all of this? If the price of oil is not hurting now, then it will move a lot higher to where it does hurt big time. When the US gets back on track, and the emerging markets return to firing on all 12 cylinders, triple digit oil is a gimme, and new highs will easily be attainable. Then you can expect the current perfect correlation between rising stock and crude prices to shatter. Make sure you maintain exposure to the oil patch, either through majors like Chevron (CVX) (click here ), oil service companies like XTO Energy (XTO) (click here ), the Russian market ETF (RSX) (click here), or just the plain vanilla Oil Trust ETF (USO). If noting else, these names will help immunize your portfolio against the certainty of higher fuel prices. If you are wondering where the “W” recession might come from, this is it.

Nov 05 09:39 AM

[Ferdinand E...:]

Interesting until you got to the Scientific American article.

I gave a talk in Italy last week in which I ridiculed that article and its author Signor Maugeri. For all I know he might have been in the room, but if he was he was smart enough to keep his his mouth shut. If you want to read my take on this you can look at 321 or EnergyPulse.

As most people who contribute articles or comments to this forum know, GIVEN THE FUTURE DEMAND FOR OIL, IT IS SCARCE. Please remind the decision makers of this simple fact.

Nov 05 10:36 AM

[dwprice:]

All this adds up to..........natural gas transportation. Making this happen will create millions of jobs and give us a semblance of energy independence.

The ng business will be slow until it does. We are now making more gas than the market needs, storage facilities break records every week, and the industrial usage of ng is not rebounding enough to suck supply down. Cold winter or not, we will be above average supplies in the spring imo.

I would say tops $6 / thousand gas until we find ways to use more.

Nov 05 10:39 AM

[tuj:]

"The chemical that is pumped down the well is carbon dioxide."

Bzzz, wrong! The proppants used to frac the wells are highly proprietary and specific to each shale formation, ie. Barnett proppants are different than Marcellus. There are some 200+ chemicals that can/are used in solution.

Now in terms of oil recovery, the Saudi's pump water into their wells (oil floats), and CO2 is more of an enhanced recovery technique after the water quits working (see the Ghawar field).

Nov 05 11:57 AM

[Dave Wrixon:]

I grew up in Purbeck Dorset. For environmental reasons an offshore reservoir was exploited by horizontal directional drilling. That was when I was a kid. The bloody thing is now empty. New technology my arse.


On Nov 05 08:51 AM User 352448 wrote:

> The technical breakthrough for oil shale gas is NOT hydraulic fracturing,
> but rather the horizontal drilling techniques only recently have
> been available. That, in combination with improved hydraulic fracturing
> techniques, has enabled one of the biggest breakthroughs in decades.

Nov 05 03:38 PM

[ngass:]

Mr. Smith is naive. Quote: ".... oil in the $20s would not surprise me over the next 1-5 years, especially if we see another deflationary scare and stock market crash and economic collapse in China-Asia." What he missed is that oil companies around the world will stop pumping oil and do no exploration at all. Oil companies will not spend more Dollars per barrel of oil to produce than it sells in the market. Or does Mr. Smith think these companies are directed by Mother Theresa? Soon oil will become scares and prices will rise.

Nov 05 04:56 PM

[akapital:]

Nice polemically title should generate alot of comments like mine...

A rising dollar will merely keep oil prices (in dollars) in check.

A fallng dollar, oil remains a great hedge.

The third way, that nobody see coming is alternative energy coming on board.

So keep averaging down on any fall in oil, keep a position in alt energy, and that should rationalize any price your paying at the pump.

But what do I know, I am just a kid from Brooklyn...

Nov 05 06:16 PM

[perceptions...:]

Let me begin by saying that Oil does not exist in isolation and that there are many other factors involved.

I would suggest, however, that it is possible to glimpse some likely overall trends.

That said, if Oil were to remain the pre-dominant Global Energy source for the next 30-40 years, then Supply & Demand would suggest that the basic cost of Oil to the total GDP will increase significantly, over that time, given the general agreement that we are at or close to Peak Oil.

However, as the Costs of Oil Supply/Production escalate compared to total GDP, it will invariably reach an Oil Cost (based on a US$ Index) to GDP ratio, at which the Real Economy stumbles and heads back into recession.

In addition, the newer Deep Water fields and Unconventional sources, such as Tar Sands & Shale, the costs will be much greater & the EROEI will be much lower.

Given these facts and most likely after several more Oil Related Financial shocks, the time will come, in the not too distant future, when OIL/FOSSIL FUELS will cease to be perceived as THE VIABLE GLOBAL ENERGY SOURCE!

When that time comes, there will be a Tectonic shift away from the OIL/FOSSIL FUELS sector, as capital pours into a desperate search for alternative Energy sources.

As this occurs, investment in Exploration & New Technology for the OIL/FOSSIL FUELS sector will be decimated, causing the DEPLETION RATES for the OIL/FOSSIL FUELS sector to escalate rapidly.

The upshot of all of this is that both $20 & $200 are possible and may happen several times, over the short to medium term!

Nov 05 09:12 PM

[aussiereader4:]

you are correct, i am thinking of coal seam gas. By the way the CSIRO has developed a technique that uses solar energy to seperate the methane into carbon dioxide and hydrogen before it is combusted. This form of energy will be 'negative emission technology'. They will be paid on both sides of the energy eqation.


On Nov 05 11:57 AM tuj wrote:

> "The chemical that is pumped down the well is carbon dioxide."<br/>
>
> Bzzz, wrong! The proppants used to frac the wells are highly proprietary
> and specific to each shale formation, ie. Barnett proppants are different
> than Marcellus. There are some 200+ chemicals that can/are used
> in solution.
>
> Now in terms of oil recovery, the Saudi's pump water into their wells
> (oil floats), and CO2 is more of an enhanced recovery technique after
> the water quits working (see the Ghawar field).

Nov 06 01:34 AM

[bigbear4511:]

online.wsj.com/article...

On Nov 05 03:48 AM Dave Wrixon wrote:

> I think what you have missed is the US demand for oil will not be
> essential. The US is going to have to consume less because it simply
> won't be able to afford it, but other economies noticeably the China
> and India will take up most of the slack. Demand in Europe will also
> continue grow because it has been more frugal with the resource due
> to more enlightened tax regimes, and therefore the scope to reduce
> consumption is much lower. Also there are an ever growing number
> of middle class consumers coming online in Eastern Europe.

Nov 06 03:08 AM

[EVNow:]

Oil will not be in triple digits for long. When oil goes up so as to consume more than 4 to 5% of US GDP, US will go into a reccession.

And when that happens, the demand falls and the oil price falls. We have seen one cycle of this already.

Prepare for endless cycles of high oil price causing recessions which cause oil price to drop and then recover as the economy improves.

Until we find alternate ways of living.

Nov 06 11:15 PM