2/6/2012 7:57 PM ET|
The real cost of 'peak oil'
No, we're not running out of oil, as some predicted. But petroleum -- like some other commodities, including copper -- is getting more expensive to find and produce.
Now that oil is a long way from the $145 per barrel peak it hit in July 2008 and nobody on Wall Street is predicting -- as Goldman Sachs did in 2008 -- that oil is headed to $250 a barrel, we're not hearing much about peak oil anymore.
The peak oil model, initially developed by oil geologist King Hubbert and used to predict a peak in U.S. oil production between 1965 and 1970, says that the production from an oil field grows exponentially over time, then peaks and finally declines. The model has been applied to individual oil fields, national oil industries and global oil production.
Back in 2008, the fiercest proponents of peak oil as a global model were predicting that the world would start running short of oil sometime around 2020.
Now that the world is awash in oil, the only people talking about peak oil are those who oppose the idea. They are dancing on what they depict as the grave of what they call a "theory" that wasn't worth the graph paper it was plotted on.
Well, I still think that the peak oil model is a useful description of what we see happening in the oil industry today -- even if West Texas Intermediate, the U.S. benchmark, closed at a twitch under $100 a barrel on Friday, Feb. 3. (Brent crude, the European benchmark, closed at $114.58.)
And, I'd go on to say that the peak oil model is the best way to understand what's happening to the prices of other commodities, especially copper. (Full disclosure: I predicted that oil would go to $180 a barrel shortly before it began its collapse from the $145 a barrel high in 2008. And full, full disclosure: The only one predicting $250 a barrel oil right now is Iran, which is threatening that prices will reach that level if developed economies impose tougher sanctions on the Iranian economy in an attempt to slow or stop that country's development of a nuclear bomb.)
Why peak oil still matters
Let me explain why I still find so much value in this "discredited" theory.
The most damage to the peak-oil model resulted from the overenthusiasm of its friends during the commodities boom that topped out in 2008. A view that I've called "hard peak oil" held that Hubbert's model had predicted that world oil reserves were about to go into decline, that oil production was about to plunge and that the world was about to run out of oil.
Those were all extensions -- unjustified in my view -- on Hubbert's model. Hubbert's formulation addressed only production rates and wasn't a prediction of the measured levels of global oil reserves. Hubbert's model used a relatively narrow definition of oil, not surprising in an era when the conventional oil production of Texas, California and Louisiana dominated the U.S. industry.
When oil companies continued to find oil and global reserves and estimates of global reserves continued to climb, peak oil theory took a ding. Then the global oil industry discovered huge, unconventional sources of oil in the Canadian oil sands and the tight shale formations of first the United States and then Argentina, China and Europe. That revived production in mature oil-producing countries, such as the United States, and made the theory look loopy.
But to see how useful a peak oil model can be to an investor, look at the latest quarterly results from the big international oil companies.
Spending more to get less
Production volumes fell 5% year-over-year in the fourth quarter. Full-year production was down 3% from 2010. Shell told shareholders that it would reverse that downward trend and increase production in the low single digits in 2012.
What interests me is how much money Shell will invest in its attempt to reverse declining production. Shell will increase its total capital investment to $32 billion to $33 billion in 2012 from $31.5 billion. The actual increase in the capital budget for oil exploration, development and production will go to $24 billion in 2012 from $20 billion in 2011. That's a 20% increase.
And what will Shell and its investors get for those bucks? If recent history is any guide, not as much as they used to get. Shell's return on average capital employed in 2011 fell to 15.9%. A few years ago, when oil prices were much lower, return on average capital employed checked in above 20%.
Shell has had trouble increasing production in recent years, but the drop in return on average capital employed is an industrywide problem. For example, Chevron (CVX, news), one of the international majors that has been most successful at adding reserves in recent years, showed a return on average capital employed 20% lower in 2011 than in 2008. Exxon Mobil (XOM, news), which is historically more profitable than its peers among the international majors, averaged a return on average capital employed of more than 27% from 2006 through 2010. In 2010, the company's return on average capital employed fell to what was still an industry-leading 22%. (Exxon Mobil's big acquisition of XTO Energy in June 2010 makes it tough to compare figures for 2011 with previous years.)
These trends are just about what you'd expect from the peak-oil model. As reservoirs mature, oil produced from them gets more expensive as companies have to invest more in methods to extract oil. As fields and national reserves mature, companies can continue to add new oil discoveries, but the cost of each new discovery is likely to rise.
And I'd add this corollary to Hubbert's original model: As oil prices rise, oil companies invest in unconventional oil reserves, but producing oil from these unconventional sources -- whether from the Canadian oil sands of Alberta, the tight shales of Eagle Ford or the deep ocean pre-salt formations off Brazil -- is more expensive than producing conventional oil. The world can certainly continue to expand its reserves of oil, but only by increasing its investment in exploration and development.
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Now that oil is a long way from the $145 per barrel peak it hit in July 2008.
So let me get this straight....in my area when OIL was $145 the pump price was $4.00 a gallon and now at $100 a barrel I am paying $3.49 a gallon. If my math is correct I should be paying $2.70 a gallon which is .79 cents less. So other than GREED I guess it is safe to say we are all getting the royal screwing at the pump...way to go Government & Wall Street!!!
Fact or fiction, peak oil is just another "tool" to explain away the rising cost of crude oil. What's that you say? A broken oil pipe..BAM, crude goes up another $1.00 a barrel....oh no, Iran isn't playing nice...BAM, crude goes up another $2.00 per barrel....a tanker truck hauling crude gets a flat tire...BAM, crude is up yet again. Bottom line, the number one thing that drives the cost of crude is profit (aka GREED). "Peak oil" or any other excuse that will create bigger profits, will work for the oil companies. Think about this. It's been a mild winter in the northeast this year. Less fuel oil for heating and crude is still over $100 per barrel. Last year, cold winter equals more demand for heating oil and my O my did you hear about that on the "street" and BAM, crude goes up again. It isn't supply and demand that drives crude oil....at the end of the day, its ALL about the mighty dollar, if you think otherwise then I have some theories to sell you!
I believe the peak oil arguments are still valid, the timeline is the only unknown. We cannot ignore the benefit that oil has brought to society, in that it is quite literally liquid gold. As stated by peak oilers, oil is the most dense energy supply mankind has ever known. The population of the world has skyrocketed during the time that oil has been exploited. And there is an eventual end to oil, especially when you look at required rates of production to keep up with not only current demand but future demand as well. With respect to the US, we have 5% of the worlds population and use 25% of the worlds energy. We are kidding ourselves if we think this way of life we've grown used to will last forever. The question is not for people Jubak's age or even mine. It's about what our kids will have to live with when the peak has finally passed.
The US government has investigated peak oil and concluded we need to start planning now. You can google the publically available reports.
These things seem apparent to me:
(1) People predicting the timing of peak oil have so far, been wrong.
(2) New sources of petroleum are still being found.
(3) The near future is often easy to extrapolate from the present.
(4) The distant future doesn't usually reflect current trends.
(5) The volume of the earth is not infinite.
(6) Petroleum is not regenerated in the earth on a human time scale.
Conclusions from these premises seem to be that though peak oil may or may not happen in our lifetimes, it will happen eventually.
We won't know when until the graph of oil production vs. time curves downwards long enough to show a consistent trend. The facts that production and reserves have continued to trend up over time does not mean this trend will last forever.
IMO, the real foreseeable problem is at what point does oil get so expensive, that it is not worth to use it as an energy source anymore? What impact will that have on the global economy and to living standards? I believe the high oil prices has already hurt the global economy to some degree.
If Americans possess nothing else of greatest value, they possess the most unusual ingenuity. So what if oil runs out? Is that the end for all of us? You bet not. In 30 years from now, gasoline powered vehicles will be the Edsels of energy options. As for Big Oil jacking prices higher, let them. Americans will run in droves to other sources of energy that now have a proven track record of success. And what's to stop one of our younger engineering and chemical engineering geniuses from coming up with a far more resourceful form of energy in the next decade?
Sometimes when a bully monopoly industry thinks they have American consumers boxed into a corner, that's when Americans are at their most ingenious best at finding options of survival. Change is the vein that channels the lifeblood of this country in the most effective, innovative way.
If we fall prey to the veils the oil monopoly has thrown over all of us, we cannot possibly hope to see our options.
Oh...forgot to mention the charts and graphs I saw showing the beginning of the decline were like 2012 to 2015....and even Jubak says 2020...so how can he say, as some "predicted" when we aren't there yet?
Additionally, Mr. Jubak addresses reserves...which is a fraction of the overall picture developed by the peakers. Then he downplays the decreasing trend in production which is actually the more important figure...since world demand is still rising!!!!
Just graph the price of gas from 1990 to 2000 and then extrapolate and see what you'll be paying in 2020. From what we are seeing with prices, the peakers were not at all wrong. They always said it won't run out overnight and what you'll see is ever incresing prices. What they did say is that when the peak actually does hit and companies can no longer "cook" the books, the demand curve will hit the production curve and noone really knows what the price will do then.
Mike Bris two posts on the money. Buffet says all cars electric in 20 years....back in a speech at Rice University in 2009. I would say he has better insight than Mr. Jubak with all due respect.
The tar sands and shale oil has been known about for decades. An oil patch friend of mine who has been in the biz for +30 years laughs when he reads people stating they were just "discovered". The technology (fracking) has even been around for decades and used on occasion in my area. The oil price has finally risen to a level where the cost of production is outweighed by the revenue stream. That is why these lesser quality sources of oil are being utilized. The reason price has risen is the low hanging fruit has all been picked. Lack of low hanging fruit has made it now a necessity to purchase ladders to reach the high up, harder to extract fruit. Some fruit in a tree can never be extracted just as oil. The fact the hardest to extract and refine oil is now being consumed is a blazing sign the fruit tree is about to be picked clean just as the world populations are booming. Don't forget the amazing rate at which the Chinese and Indians are trading in bicycles for cars creating even greater demand for the shrinking oil resources. This will speed up the rate at which it is exhausted.
Buffet hasn't become rich by being a fool. Cars, electricity, 2030.
When you are more than 5 decades old in age, you begin to see profit patterns far more clearly. So..in almost a century, Big Oil had a Black Gold Rush. They could fudge numbers and tell us oil is going to run out due to demand and up went the price of oil. Or, even better, they could at present use the excuse that oil production is down and up go the prices. Either way, their obscene profits still roll in...whether demand is too high or too low.
The problem for Big Oil today is as stated in this diatribe "finding new oil"...Is that the problem? Or, is it that Big Oil wants to expand drilling rights because it regularly receives billions in taxpayer subsidies. Kind of makes sense when your profits are what you'd like them to be that jacking oil prices and then helping themselves to taxpayer subsidies based upon a flimsy excuse that they need to "find more oil" would be an adorable way to reach their peak profit margins.
So...now, of course, the US government (read taxpayers) once again must help a corporation do what it's supposed to do on its own steam: earn profits. Let's see how fast Big Oil cronies in Congress jump on the "find more oil" bandwagon and pass legislation that will further increase US debt just so those Big Oil subsidies keep rolling in.
From an investment point of view, Big Oil saw its most profitable days when it began to export US Oil. This is the covert agenda they are after again. Their idea is to revisit the ability to produce so much oil that it can export at huge profits. One question remains: Where will they export it? The Middle East, Central and South America don't need it. So that leaves Europe. One problem with that. Will Big Oil reduce their prices to levels that are affordable for Europeans should they manage to pinch that market from OPEC? So, competitively, Europe isn't a good market for exportation either.
Then, there's the little matter of a reduction in demand in the US. Of course, Big Oil was thrilled when Detroit was producing millions of gas guzzlers. Big Oil profited most from that stupidity. But like all greedy monopolies, it jacked the price of gasoline and then the recession took away all of their well planned profit busting ideas.
Enter hybrids, smartcars, electric and natural gas powered cars....Big Oil's worst nightmare. Now, even major transit vehicles are already off the oil addiction. That leaves only the airline industry from which to profit. Giving American consumers such options for alternatives to oil is their real nightmare. Now, if Big Oil thinks it can continue its predatory price gouging, all that will do is make even more American consumers run to the alternatives. While Big Oil runs for the Kaopectate.
I tried to post a second comment but your filter blocked me, claiming that it looked like spam or a hyperlink. I've tried every modification I can think of to get past your gatekeepers but to no avail. Trust me, my post only looks like spam or a hyperlink to a very dumb algorithm. Please ask your techies to upgrade the filtering algorithm.
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