carbonates

Have We Reached Peak Oil?

As an exploration geologist I have changed my views to be more optimistic over the past few years. The reason: a new paradigm shift in both geologic thinking and technological ability that has resulted in HUGE changes of probable and possible natural gas reserves (if you don't get it- then you don't understand the new paradigm). To the extent that natural gas can replace oil, there will not be an extreme consequence from a decline in oil production. In reality, the bigger risk is demand outstripping supply since adding new oil production can take years.

For the most part, I still believe the real threat to oil production has nothing to do with geology, and everything to do with politics, which is why it will not follow Hubbert's Curve. We may be approaching peak political oil much sooner than we reach true peak oil production capacity. There are still many billions of barrels of oil that are not reachable due to political constraints all around the world.

My Oil Outlook

Your strategy certainly sounds valid and I agree that $58 oil seems a certain bet especially due to your #3 reason. But, I have followed USO since its conception and I concluded early on that it did not do a good job of following oil spot prices. I am still trying to understand why, but I just produced a graph comparing daily closing prices for WTI Cushing Spot with daily closing prices of USO over the last 3 years. What I see that bothers me is that USO has not followed the gains in spot oil prices for most of 2009 directly. USO has seen small net change while WTI spot has moved strongly upward. I don't know if this is because contango in the market is affecting USO, or something else. The bottom in WTI was 12/23/08 at $30.28 and USO closed at $30. USO made a bottom later on 2/18/09 at $22.86 while WTI was at $34.67. The disparity has continued to grow since then. This was the problem that kept me away from USO early on when it was still new.

I'm still more comfortable owning individual oil stocks, yet these certainly are not pure plays on oil and gas prices. I do use DUG as a very short term hedge against my oil stocks. At least with individual oil stocks I can pick and choose based on how well I understand their business efficiency. I'm still struggling to understand the price behavior of USO. For all I know, USO may have more upside potential than actual oil prices since USO is lagging behind oil at present.

Was 'Peak Oil' a Multi-Billion Dollar Hoax?

The difference I see between the Saudi's and anyone who has a reasonable understanding of peak oil, is simply one of time frame and price. For example, the recent price run-ups have created enough new exploration activity that in the most recent EIA report, the US added more petroleum reserves in 2007 than it produced. For natural gas, proven US gas reserves are at an all time high based on EIA reporting for the last 31 years. This is the direct result of new technology and a new geologic paradigm. How this technology change will play out in oil reserves is still unknown (currently it is mostly applied to natural gas), but there are examples that suggest it will add significant new reserves previously thought impossible to produce. On this point, I agree with Jum’ah.

The real question is how realistic 100 years really is, and at what price level we can expect. At $200 a barrel, it is very much more likely we have 100 years supply, as this will allow many now marginal operations to be profitable. The current price decline will definitely affect oil company future planning for the next few years, likely producing yet another traumatic upward cycle in prices as demand destruction abates and drilling activity slows to match current price levels.

I've attended a number of presentations like this from the Saudis for several years. This is not news. They have contended they can keep growing production slightly for several more decades. Yet only recently it looked as is they too had reached a current maximum capacity. They too rely on higher prices to be able to apply cutting edge technology and saying that they can keep producing 10 or more million bbls a day doesn't mean they will if oil hits $50. That also does not mean they can keep up with world demand when it grows faster than they can drill.

There are two things that are certain here. Oil is finite. Prices will change. Meanwhile, hang on because we are on a roller coaster ride that likely will see faster cycles than it has in the past. Oil prices have not decoupled from the world's economic growth rate (consumption patterns still match GDP), but still merely reflect it. That may be the nuance that those who came late to the "peak oil" picture did not understand. When demand outstrips production, and it will happen again, we can expect to see new record levels of high prices for oil, followed by increased production from new sources and demand destruction. Rinse and repeat. It isn't going to be a smooth curve.

Will Drilling Offshore Affect World Oil Prices?

While everyone is debating the results of exploring new areas with offshore drilling, no one is actually being honest and admitting that
1) these estimates of the "undiscovered reserves" are nebulous at best. As a geologist involved in these sorts of studies I can assure you the results could be dramatically different, either with much higher or much lower amounts, and the error bars in those sorts of studies would allow for about an order of magnitude of error in the figures. The amount of data that these sorts of studies are based on would be laughable to most other fields of study. We probably have more data for Mars than we do on some of these areas.

2) that the long period of time it takes to lease and then drill is partially filled with government delays- so the five or ten years it takes to drill- is actually more the result of government than industry. The time delays in drilling leases are often self-fulfilling prophecy by the politicians who are promoting the regulatory morass that exists rather than solving it.

Finally, while I too will be happy to see alternative energy supply a larger share of our energy needs, the biggest lie out there is that any of those alternatives can be developed faster than drilling for oil. If you think oil prices are high now, wait and see how high it is in ten years with continued restrictions on drilling in the US.

It is very conceivable that a large discovery in the offshore area could actually affect the market in advance of production. As it does begin to produce, only a few hundred thousand barrels a day can have a significant impact on market prices (as the frequent small supply interruptions do now), and it is wrong to say that small increments of supply do not affect prices, and do not have significant supply implications over many years. Keep in mind, about 15% of US production today comes from wells that produce less than 10 barrels a day from each well. We actually depend on these small increments for stability in the market.

Your mention of Iraq is something I consider ludicrous. It will very likely still be a decade before anyone is willing to situate a nicely lighted 175 ft tall oil rig motionless in one place for a month at a time like a giant target for attacks in the Iraqi desert. Infrastructure (pipelines, compressor stations, separators, water disposal, etc.) has to be built, since it either does not presently exist or is in disrepair, and that will take years while providing more targets for hostility. Iraq is not going to be any immediate solution (nor is it likely to be cheaper than offshore), and the Iraqis are barely able to supply themselves at present, while still importing large amounts of oil products.

How Elastic Is the World's Oil Supply?

Thanks for the link to the report. As someone on the supply side of the business, maybe I have some insight. Maybe.

"Based on these inventory figures, current prices, although high, are not prompting the
inventory accumulation that would be associated with artificially high prices."

I think the problem they are alluding to is that while market demand has dropped, it appears that market supply has fallen as well. In this business, falling supply is not necessarily related to market forces. There are lots of areas the world-around that are in declining production mode and even more that are politically-impeded. There are very few that are actually increasing their production, and this is not due to the market, it is mostly due to geology and engineering.

It takes time find new oil reservoirs and to drill new wells and add production using the newly justified economics of higher prices. Most oil companies (wisely) refuse to have faith in current market prices to predict economics of drilling new prospects, and whatever benchmark price they use (often only 50% of current prices) can determine whether or not a well gets drilled.

There are very few producers that have the ability to turn on the taps and produce oil at a higher rate just because prices are rising. The market impetus is there, but geology and engineering limitations do not always respond to market forces. Often, increasing production rates can damage a field and reduce long-term production. One of the few short-term responses in the market supply is often the oil moving in tankers, which can be diverted to different ports depending on prices while still in transit.

The problem is not the speculators, it is declining production and the failure of many producers to replace reserves- pointing to long-term problems and thus changing the market character from backwardation to contango. The speculators have merely reacted to the inability of the supply side to respond to the demand side in a timely manner.

For everyone who thinks the oil market is somehow a perfect market (and that speculators are the control), I like to use the analogy of the corn market. If you can predict the weather a year ahead, you can master the corn market. Oil is no different- except there are probably just about as many factors as those that affect the weather, and they are just as complex.

As for the previous comment on how prices of gasoline are not falling as fast as the price of oil -be very very glad. Gasoline prices never got up to an equivalent price of oil and were lagging behind strongly. Oil was selling for $3.45 a gallon at $145 per barrel, and a barrel of oil does not make 42 gallons of gasoline- it only makes about 25 gallons, meaning wholesale gasoline could have reached well above US$4.00 per gallon (that would have put retail above US$5/gallon)!!!

The Oil Bubble Will Meet the Same Fate as Tech, Housing

Unfortunately the facts (supply, demand, known reserves, production declines) don't really support your premise. Sure, demand destruction is likely, at least in the short term, but it is only a matter of time before production declines cause another supply crunch. This is real, folks. Take it from a geologist.

So You Think Oil’s Expensive Now?

These are only the events that would cause a short-term spike in price. Contrary to the rhetoric from Washington, there are major structural problems in the market that weigh much more heavily than these short-term events. Bigger and more important questions abound. Can the Saudis actually increase production or are they at peak? (With over 100 rigs operating, they are obviously working very hard to maintain production). Can the Iranians sustain production? They may be in decline. Will the Russians begin investing in infrastructure that is badly needed to reverse Russia's production decline? Will the US change its tax structure and cause oil production in the US (currently 25% of US consumption) to further decline? (a significant amount of US production comes from stripper wells that are marginally profitable under the current tax regime) Will Mexican and Venezuelan production continue to decline? Will the portions of the world that subsidize consumption (Venezuela, Middle East, China, Indonesia, India, Malaysia, Columbia, Mexico, Taiwan, Thailand, etc) of oil continue to do so, offsetting and preventing demand destruction? These types of questions are much more important and fundamental than these short-term and local risks. For example, until the Saudis can prove they can meet the projected new levels of production, it is apparent that the market does not really believe them. Since the majority of buyers in the market are currently commercial positions (industry participants) it seems likely they truly understand the short term risks but are much more uncertain about the long term factors, and that risk is probably being priced in incrementally as oil prices fluctuate. BTW, you forgot hurricanes. Another major Katrina/Rita hit on the Gulf would cause a major price spike. It is hurricane season.