Oil Production: An Indicator Of Future Economic Growth Prospects

by: Zoltan Ban


Low global economic expansion since 2008 can be linked to liquid fuel production growth. Trend will most likely continue.

Global production of liquid fuels would have declined in 2013 without the US' increase of 1.2 mb/d, mainly on the back of shale oil, the effects of which will diminish.

Healthier growth rates may only return when current relationship between global liquid fuels growth and economic growth is broken, and growth becomes less reliant on it.

The negative surprise that the US first-quarter GDP handed us was quickly rationalized as a mainly weather related event. One thing that we can be sure of regardless of the reason why it happened is that previous 2014 forecasts for US growth have to now be revised downward somewhat. There is little hope now after a stagnant first quarter of reaching the 3% growth range forecast by various institutions for the year.

Looking at the bigger picture in order to get a better understanding of the overall context, the fact that 2014 growth will have to be revised down should not come as a great surprise. The US and global growth have constantly been revised downwards since 2007. 2013 was seen by many as the year when the economic crisis was finally put behind us and we are now looking at a few years of decent, if not outstanding growth. The IMF forecasts global growth to reach 3.7% this year, and 3.9% in 2015. That is a significant increase from 2013, when the world economy grew about 3% as well as a break with the 2008-13 period, which saw global average yearly growth under 3%.

Reasoning behind expectation of further downward revisions

According to EIA data 2013, global liquid fuels production growth was 0.6%, or just under 0.6 mb/d. If we are to exclude US liquid fuels production growth of 1.2 mb/d, the world would have been in a production decline. For 2014, it expects a global production increase of 1.4 mb/d and 1.3 mb/d in 2014 and 2015, respectively. US production is once more expected to contribute to most of the increase with year-on-year gains for this year of 1 mb/d and 0.7 mb/d next year (link).

Putting aside the fact that the EIA now expects the world outside the US to reverse the decline of 2013 and increase production as much as 0.6 mb/d in 2015, the expectations of US production increase continuing at such a robust pace contradicts many data points we have seen lately that suggest that the shale oil boom, which has been the main driver of the US production revival, is entering its maturity phase, with Bakken production per well declining since the start of last year at a pace of roughly 0.7% per month, as I pointed out in a recent article (link). The Eagle Ford formation is increasingly facing a fast-accelerating treadmill due to the fast rise in legacy production decline, which currently needs over 110,000 barrels per day of new production to be added each month just to keep production flat (link). In October 2013, the EIA reported 80,000 barrels per day in monthly legacy production decline for Eagle Ford. If this average trend of increasing legacy production decline continues to increase at the current monthly rate of about 5,000 barrels per day, by the end of next year, the legacy decline rate will be about 200,000 barrels per day, which most likely will mean that Eagle Ford's meaningful production increase will cease, or even start declining by then. I expect both fields will contribute far less to production growth this year and next than current mainstream forecasts project.

Aside from the two very prominent shale oil fields, there are very few bright spots to report in America's oil production regions. Alaska is in decline, the Gulf of Mexico is stagnated, while the onshore Permian in Texas is only inching up very slowly. There is some limited increase in liquids production coming from predominantly shale gas plays such as the Marcellus, but at the moment there is no field ready to take the place of Bakken and Eagle Ford as the main engines of production growth.

Source: EIA

(click to enlarge)Click to enlarge

Source: EIA

(click to enlarge)Click to enlarge

Source: EIA

As we can see from the EIA graphs, there is very little upward momentum in these important oil producing regions, therefore expectations of significant US production increase beyond this year will most likely fail to materialize. This means that the rest of the world, which recently saw a net decline in production, will have to reverse the trend and pick up where the US is currently leaving off.

Aside from potential for increase coming from resolution of conflicts in places such as Libya or improving relations with Iran, I see very little potential for global growth in production. In fact, countries such as Saudi Arabia are likely to favor lower production, not so much because they want to keep prices high or that they are evil as many would believe, but because they want to manage their fields with care and are aware that many of their aging giant fields can potentially be damaged through overproduction for prolonged periods of time. There are also many places in decline such as Mexico, the North Sea, Azerbaijan and others. I think a very good gauge of where global production is headed is the performance of oil and gas giant multinationals that operate all over the world where there is oil and they are allowed to participate by governments. As I pointed out in my last article, companies such as Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), Shell (NYSE:RDS.A) (NYSE:RDS.B) and BP (NYSE:BP) are all experiencing production decline.

Effect on the economy

It is very unfortunate that over the past half decade or so, the media as well as economists preferred to focus mainly on public policy as the main factor affecting economic growth instead of analyzing the underlying fundamentals. Thus, the question of why we are not witnessing a return to growth rates in the 5% range as we have seen in previous post-recession recoveries was always answered through the lens of political and ideological partisanship. These explanations have no value in terms of providing useful insight, but are extremely popular with audiences given the increased ideological polarization of our society.

In 2008, global liquids production as reported by the EIA was 85.7 mb/d. In 2013, it was 90.3 mb/d, therefore, average yearly supply growth was around 1%. Average economic growth in the 2008-13 period was just under 3%. I described many times already the relationship between economic growth and liquid fuels supply growth as the following relationship:

1.5% yearly efficiency gains + (% yearly increase in liquid fuel supply x 2) = average yearly potential global GDP growth.

Actual growth will always be somewhat less than potential growth. If we look at any set of years since 1994 when the current global economy took shape guided by the formation of the WTO, grouped by decade or half decade, we see that the model more or less fits. It is therefore a good indicator of how much global economic growth we can expect, based on assumption of future liquid fuel supply growth levels. If we assume that we are looking at supply growth that can meet any potential demand increase in the future, we can assume that liquid fuel supplies do not act as a constraint on growth. If there is a limit to average yearly increase in supply growth, let us say 2% per year for the decade, we can assume that our growth limit is 5.5% per year on average. If we assume no growth potential in liquid fuel supplies, 1.5% potential growth should be expected every year on average. This relationship may change in time due to technological changes, trade and other economic activity patterns, but for now we seem to be tied to this relationship, which unfortunately continues to be ignored, leading to unrealistic expectations and ultimately disappointment. Given continued tightness of liquid fuel supplies, it is possible that we will only enjoy the kind of economic growth we had in the past and desire to have again when the current relationship will be broken.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.