The World Is Not Drowning In Oil

by: Zoltan Ban


Public debate on oil supplies has gone from one extreme to another. First it was peak oil, now it is the world of plenty, neither of which are correct.

The past two years demand outstripped supply, leading to OECD inventories declining. Supplies will continue to be tight for foreseeable future.

Long-term tight supply/demand picture will likely limit global economic growth to the 2.5-3.5% per year range.

In the past few years, the peak oil crowd suffered a dramatic argument setback due to the rise of the unconventional oil industry as well as the price effect on conventional fields, which gave the aging supply sources new life. Back in 2005 when conventional oil supplies peaked, wild attention grabbing statements captured our attention, which prophesied imminent doom as a result of global oil production supposedly having nowhere to go but down. A roughly 7% increase in global liquid supplies since then proved the most aggressive forecasts of doom very wrong, giving rise to a counterargument which is proving to be equally radical, aggressive and just as wrong, arguing that we are on the verge of an age of plenty.

According to recent IEA data, OECD oil stockpiles are now over 100 million barrels below the five-year average. In the fourth quarter of 2013, stockpiles were being drawn down at a rate of 1.5 mb/d. There is a reason behind this trend, which seems to be poised to continue. Global oil production in the last quarter of 2013 is forecast to be just one million barrels per day higher than it was in the first quarter of 2012.

In the meantime, oil demand rose by over two million barrels per day during the same period. Demand is outstripping supply by a very wide margin. The IEA forecasts the gap to close somewhat this year, on the back of continued increase in North American unconventional liquid fuels as well as a few other bright spots around the world. But then again the same upbeat message was transmitted through previous forecasts and it did not materialize.

Peak Demand?

Aside from forecasts of large volumes of liquid fuels coming online over the next few years, there was also a misguided idea increasingly gaining ground. The idea was that the higher prices combined with technological advances speeding up, will eventually lead to a peak in global liquid fuels demand (link). As I often stated, there seems to be an appropriate formula, based on the past relationship between global GDP growth and increase in liquid fuels demand that will within reasonable margins of error predict the average yearly long-term growth in oil demand. Technological and economic changes allow for roughly 1.5% global economic growth, without any need for increased liquid fuels supply. For every additional 1% increase in liquid fuels supply, we can count on 2% additional potential economic growth that can be achieved. I see no evidence so far that this formula is no longer valid. Since 2008 the global economy has been growing at roughly 3% per year and liquid fuels supplies and demand more or less fit in with the expectations derived from this formula.

Note: Global GDP data until 2012 is from UN while oil demand data is from EIA. Global growth for 2013 is IMF estimate and 2014 is IMF forecast.

The reality is that we cannot afford to extrapolate from the changing consumption habits of the developed economies and assume that the same thing is going on all over the world. We have a more or less stagnated population, a stagnated economy and less and less manufacturing and infrastructure building, as well as a growing inability of young people to enter the workforce. All these factors are pushing per-capita consumption of liquid fuels down, together with efficiency gains due to technological changes and none of these trends accurately describe what is going on in the developing world where the overwhelming majority of the world's population lives. Once the rest of the world looks more like the OECD club, perhaps then we can speculate about a peak in liquid fuels demand. That is not likely to happen for at least five decades. It is therefore imperative to continue growing liquid fuel supplies and especially oil.

Oil glut not likely ever again & supply constraints will limit long-term global growth:

As we can see from the chart, total global liquid fuel supplies are not surging ahead with a great deal of pace since the beginning of 2012. It is true that Iran sanctions together with Libyan disruptions due to violence there knocked out about 2 million barrels per day worth of global supply. It is also true that Saudi Arabia increased production in order to make up for some of the disruptions from fellow OPEC members (link).

The fact that Saudi Arabia increased production in past years to make up for lost production from other OPEC members makes spare production claims false, despite what EIA and others may claim. Increased capacity coming from Khurais and Manifa projects of about 2 million barrels per day is partly seen in production that is about a million barrels per day more than in 2010, as well as the need to make up for older declining Saudi fields. These two projects were the last two giant field additions to Saudi production, perhaps forever, because there are no more known giant fields yet to be tapped in Saudi Arabia. The fact is that any potential spare capacity is tied up in a civil war in Libya and a standoff between Iran and the Western World. The only way the oil tied up in those situations will make it to market is if the issues are resolved, therefore we cannot count on those supplies coming online whenever may be needed.

The EIA also envisions a 3 mb/d increase in non-OPEC production for the 2014-15 period. Here again, we have wishful thinking at work. According to its own tight oil drilling productivity report, it now takes 100,000 barrels per day in new production that needs to come online each month in the Eagle Ford field in order to make up for legacy decline from existing wells, or about 1.2 mb/d that needs to be added each year. That is the equivalent of almost twice as much that needs to be added to make up for legacy production decline in Saudi Arabia, where each year about 700,000 barrels of new production needs to be added to make up for declining wells.

According to North Dakota's monthly Bakken field report (link), average daily production per well started declining beginning with 2013. In 2012 about 142 barrels of oil were produced for every well per day. In 2013 less than 132 barrels were produced on average every day per well. This was the first yearly decline since hydraulic fracturing began in the field. I explained in more detail the reasons why this is happening and why year on year production increases will be smaller from now on in a previous article (link). The Bakken and Eagle Ford were the main drivers of global liquid fuel production increase over the past four years or so. There are now more and more signs that production growth from these fields is likely to disappoint in the coming years.

Implications for the global economy

On normal years, average liquid fuels global production increase will likely be around 0.5-1 mb/d. This means that global economic growth cannot exceed on average more than 2.5-3.5% annually, regardless of global fiscal, monetary and economic policies. In the event of a major disruption to oil supplies, such as Russian exports not making it on the market for a prolonged period due to the current crisis, deep global recessions are likely to occur, given that actual global spare capacity is already being used up to make up for disruptions already in progress. The global economy is not collapsing as many peak oil enthusiasts predicted, but neither is there an oil glut that removes any constraints on global economic growth as others suggested in the last few years. Tough times are ahead.

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.