Deutsche Bank’s $150 Call: Peak Oil Light

Includes: DBO, OIL, USO
by: Jim Kingsdale

DB’s February 27th report, “100mb/d peak oil market”, was both a landmark and a disappointment. A landmark because important people pay attention to DB and because they became the first to question the conventional wisdom of range-bound oil prices. A disappointment because they pulled their punches on where they really think oil prices may go.

On Wednesday, DB had a conference call to discuss the report. The first two questioners were an Exxon Mobil (NYSE:XOM) executive and a Treasury Department official. In other words, The-Powers-That-Be were paying attention. Why the fuss? Well, it was a little like the Pope saying there may not be a God after all. $150 oil by 2010.

Heresy? Not so fast. DB, not wanting to offend clients’ comfort zones, modestly suggested they were only playing with an idea, not making a prediction. A DB analyst ended the call by saying that maybe their next intellectual excursion would explore the reasons why the oil price might drop to $30.

DB made some good points that might be news to the mainstream but probably not to my readers:

1. The U.S. economy wrung a lot of oil-intensiveness out during the ’70s oil shock when it took oil out of electricity generation and U.S. industry became much more oil-efficient. Those savings cannot be replicated no matter how high the oil price goes.

2. On the other hand, U.S. transportation is vastly inefficient and thus can and will reduce oil use as prices rise. This is the most significant available source of oil savings in the OECD world. Of course, DB probably meant to say “cars” rather than “transport”, since trucks which use 1/3rd of transport fuel do not have the same savings potential that cars do.

3. On the third hand (they are economists, after all) higher oil prices seem to have caused lower production of oil, not higher - the very subject we recently discussed here. We’ll come back to this point.

4. The greatest demand destruction from higher oil prices will be in India, China and the developing world other than oil exporters. It will cut their growth rates down by several percentage points. Sad to say DB fails to understand or at least take any note of the fact that the cruelest, if not largest, impact of higher oil prices is on poor people and poor countries around the world.

The Deutsche Bank thesis was not a prediction of supply, demand and price. Rather they said, “Look, it’s pretty clear that oil demand unconstrained by price could easily reach 100 mb/d by 2015. All liquids supply, assuming a 5% global decline rate, might also get to 100 mb/d by then. What’s the price that would destroy sufficient demand going forward so that we could live with 100 mb/d “peak”?

Without exploring alternatives they suggest that $150 might be that price and they say we may reach that price by 2010. $150 by 2010 seems to be a simple extrapolation of their view of the oil price curve of recent years. The essential idea seems to be that a $150 price is sufficient to cause the savings that the U.S. car market is capable of providing and also to squeeze substantial growth out of Chindia and related economies (but not those of the oil exporters, which we know are also growing like mad).

Why not $125 or $250? Because $150 puts oil at 10% of U.S. GDP. Why is 10% magic, not 9% or 20%? Who knows? There was a suggestion of science to DB’s use of this number, but I suspect even they would admit it was really pretty arbitrary.

Their conclusion seems to be that $150 oil could be some sort of equilibrium price that makes the world hunky-dory. Demand growth will collapse, mostly in Chindia and in the U.S. Supply might keep growing enough to meet a slowed demand requirement.

Not really much meat there.

Actually, if you read between the lines, DB is well aware that the “scenario” does not make much sense. They freely admit that if their observation #3 above is correct(essentially it’s my hoarding thesis and what they call the “second asymmetry”), then the likelihood of production ever reaching 100 mb/d is not great. In fact, they admit that even if hoarding were not becoming the guiding economic theory of oil exporting countries the world has never produced as much oil as will be required in coming years, given their assumption of a 5% decline rate.

Among the facts they ignore is that much of the increase in liquids supply will be oil that has a very low EROI compared with the past. Thus it will require a great deal of oil to make the new oil. That includes deep off-shore fields, CTL, tar sands, and biofuels. Thus, as was recently discussed here, the increase in supply causes its own dedicated increase in demand, resulting in far less effective new supply than the simple supply numbers appear to indicate.

So in effect, this report by DB is the first gentle nudge out of the nest for mainstream thinking on peak oil. It goes so far as to suggest that $100 is by no means a price ceiling and that at some point in the foreseeable future a peak in production will be reached.

But Deutsche Bank did not choose to follow the thought to its logical conclusions. DB seems to be saying the world was not created in one day and they feel their report did enough heavy lifting already. It is for someone else to completely remove the cobwebs from the eyes of conventional wisdom regarding peak oil. This was a start.