When Will Oil Prices Skyrocket Again?

Six month ago - when the world economy looked significantly rosier - I posted an analysis of projected supply and demand for oil going forward to 2015.  The analysis was based on the assumption of continued demand growth, continuing decline of old oil fields and expected new production from announced oil megaprojects.  I adjusted the magaprojects estimates for delays and  I concluded that:

if these estimates are at all closely correlated with reality we should expect oil markets to be tighter than at present through 2012 followed by even more need for demand destruction from 2013 through 2015.

I also offered an alternative scenario that included an unadjusted but smoothed curve of the Wikipedia expected annual megaproject supply which showed very substantial new projects coming on stream in 2008 and 2009.   Based on this scenario for new oil supplies I concluded: “These “unadjusted” numbers show ample supply of oil through 2009 followed by shortfalls in 2010 and very important shortfalls starting in 2011 - possibly even catastrophic shortfalls in 2012 and thereafter if decline rates are more severe than 4.5%.”

I also showed an alternative model using an adjusted smoothed version of the megaprojects curve to account for likely delays in project startups, delays in reaching peak production, and the addition of new small projects in the out years.  Based on such adjustments I concluded: “There will be unremitting stress in the oil price going forward and prices will escalate after 2010.”

In actual fact, the 2008 - 2009 economic debacle is expected to reduce global oil demand by millions of barrels per day (thus increasing global spare oil production capacity) and to simultaneously defer many megaprojects and smaller production plans further into the future.  So it now seems appropriate to look at the changed landscape and prepare an updated estimate for oil supply, demand, and price through 2015.

The question posed in my earlier post (9/1/08) was “when will the price of oil pop to perhaps $300 - $500?”  Now, as we live through a global depression, the question has become “when will the $35 - $50 oil price move through some “equilibrium” $70 - $90 price point and then pop back into the $100+ range, indicating a return of scarcity pricing?”

To answer that question I’ve gone back to the original data and tried to update it to account for the depression-related impacts of the global demand downturn and delays in both new megaproject startups and in EOR (extraordinary oil recovery) work-over production.

Here is a new projection that aims at estimating spare global capacity going forward.  Spare capacity in early 2008 was generally believed to be about 2 mb/d, virtually all of it in Saudi Arabia.  Here’s my estimate now:

Please note all the numbers in the above chart are simply my own assumptions aimed at answering the question: “what happens if the global depression peaks in late 2009 with growth in economic activity and global oil demand starting to recover slowly in 2010 and growing more or less normally after that - all assuming oil decline rates grow slowly and that new production from megaprojects and work-over efforts comes in at a lower rates than had been projected before the cancellation of many such efforts due to the lower oil prices now in place?”

My assumptions reflect three hypotheses about oil supply/demand.

1. Oil demand will be some 2 mb/d lower in 2009 than 2008, reflecting my guess that current estimates of a 1.5 mb/d decline from the IEA will turn out to be too low.  (Another analysis is here.)  I estimate that oil demand will  bottom out sometime in 2009/2010 and will grow from there.

2. Depletion of old fields will continue to increase steadily since it is a geological reality that is unaffected by above-ground considerations (other than by EOR projects that mitigate natural declines, about which I make no assumption).

3. New additional oil production from megaprojects and new EOR activity will be substantially weaker than had formerly been believed because so many projects have been put on hold due to lower prices.  It will probably take  1 - 3 years of much healthier oil demand than is currently the case and much higher pricing to bring back those projects and there will be considerable time lags before they can come on stream.

One example of the deferral of new oil production projects is the Canadian oil sands.  A study recently published in Oil and Gas Journal (3/2/09, pp. 20-23) indicates that instead of production growing from about 2 mb/d in 2008 to a previously estimated 5.5 mb/d in 2015, the new reality is that oil sands production growth will be about 300 kb/d through 2015.  Economist David McColl is quoted as saying, “..over the next few years oil sands production growth will be almost at a standstill.”

Aside from oil sands production, the change in future production gains globally from new projects and work-over efforts is hard to quantify.  The assumption I made is that production from new megaprojects will slow from the previously assumed magaprojects growth through 2011 based on weak oil prices and then pick up as projects that had previously been assumed to take place in the 2009 - 2011 time frame become shifted into the 2013 - 2015 area.

This analysis suggests there will be ample oil supplies in 2009 and 2010 but that tightness will come back to the market by the end of 2011 and very high prices will start to take hold by late 2012.   The model projects extremely insufficient supply by 2013 which would require scarcity pricing of well over $100 - perhaps over $250 - to rectify.

Some of the general background assumption I made include:

1. There will be no rapid increase in oil production from Iraq or Nigeria.  Political developments in both countries, including particularly the removal of American forces in Iraq by the end of 2011, offer little reason for optimism that above-ground conditions will improve markedly enough to result in a rapid escalation of oil production in either country despite substantial development interest, particularly in Iraq, from many IOCs.

2.  There will be little reduction in oil demand from increased automobile efficiency through 2015.  It appears that Plug-in Hybrids will not be available in any quantity for at least several more years.    Thus, the number of 100+ mpg cars on the road has little chance of becoming significant before 2015 at the earliest.  Moreover the bad economy and low gasoline prices have greatly reduced demand for fuel efficient cars now available on the market.   Moreover, car sales in general are so low that replacement of old cars with new ones is much slower now.

3.  Global oil demand will be boosted by continued rapid growth in China, India and other developing countries.  Meanwhile, the bulk of demand destruction in OECD countries caused by economic declines will be over by the end of 2009 as the banking crisis is resolved and the down-sizing of OECD economies is completed.   OECD demand will begin to come back slowly in 2010 - 2011 .

A Bleaker Scenario

Some analysts have been warning that the cancellation of new oil production projects will slow future oil production at a much faster rate than my model contemplates.   What if they are right?  What if much more scheduled new oil production capacity is deferred and it takes much longer for higher future oil prices to bring back on stream the megaprojects that have been deferred from 2009 - 20011 plans?

Here is an alternative model that shows both a slower rebound in global oil demand and also greater deferral of new oil production and a slower rebound in oil supply in out years coming from new megaprojects:

Compared with the more “optimistic” scenario first presented, this one indicates a far more negative supply situation occurring in 2012 and much more desperate global oil shortages in 2013 - 2015.

I would note that the global demand growth assumptions in this model from 2011 - 2015 are rather mild compared with the 1.5 - 2 mb/d growth that was experienced from 2004 - 2007.

Even Bleaker

What about the possibility that the economy does not recover in 2010.  Suppose this is the really big depression?  Let’s say the global economy keeps declining right through 2011 and doesn’t begin to level off until 2012.  What would happen to oil supply, demand and price?   Here are the numbers that might reflect that scenario:

Surprise! This far, far bleaker economic scenario has relatively little impact on year end spare oil capacity through 2015.   Yes, a much more disastrous economy results in a bit more spare oil capacity by 2011 - about 500 kb/d.   And it yields a slightly positive spare capacity number by 2012 instead of a negative capacity number.   But spare capacity is still very negative by year end 2013 and increasingly thereafter.   Similarly, the differences in years 2013 - 2015 are simply degrees of disaster.  The implied oil price is huge in both economic scenarios.

What this analysis shows is the definitive effect that the decline rate - which does not change - will have on global spare capacity and the price of oil between now and 2015.   The decline rate makes all the difference.   No matter how bad the economy becomes over the next few years, no reduction in oil demand (which becomes less elastic over time) can off-set the ever-steady rate of decline in the production of old fields in determining the level of global spare oil capacity.

So the differences in economic performance imply only minimal differences for the price of oil.   Whether spare capacity at year end 2011 is down to 2.1 mb/d or 2.6 mb/d is not important.  In either case, it is a minimum of spare capacity (and clearly moving toward negative territory) and implies an oil price of over $100 per barrel.  And the difference in 2012 spare capacity between  -1.15 and .6 mb/d is the difference between a disastrous shortage and an acute shortage.   They both imply a price of over $200 a barrel.   Similarly the numbers in either economic scenario for the years 2013 - 2015 imply absolute disaster.

A Second Global Depression?

An obvious question suggested by the above analysis is whether the enormous oil price increases implied in any of the economic scenarios presented above may cause the global economy to halt its recovery and fall into another depression.  I can’t see any interpretation of the data that would lead to a different conclusion.

So anyone who thinks that a new global bull market in stocks will take off from the ashes of destruction evident in 2009 - 2010 might want to temper her optimism because these numbers suggests two things to me. One is that there may be an important bear market rally once the economy stops falling down.  Energy stocks should be major participants in such a rally.   But the other thing is that after 2011 or so, with enormous oil supply deficits staring us in the face and threatening to just get worse, it might be better to own the commodity than to own equities.

Peak Oil: 2008

One implication of the above analyses is that it looks like peak oil production occurred before 2009, given that the expected future flows of oil from new oil production projects will be less than the decline in old fields each year, at least through 2015.  With declines increasing slightly every year, the only possibility that peak oil has not already occurred is that at some point beyond 2015 the high price of oil will bring on enough new megaprojects and EOR projects to more than compensate for continually increasing declines in old fields.

What are other analysts saying?

Robert Hirsch, one of the first experts to warn about peak oil in his famous 2005 analysis of the peak oil problem, essentially agrees that peak oil production has passed.  He wrote in the February, 2009 Energy Bulletin, that:

World liquid fuels production reached a plateau in mid-2004 and has fluctuated within a relatively narrow range in spite of mighty efforts to increase world production. In mid-2008, benefitting from the work of Campbell, Laherrere, Skrebowski, Aleklett, Simmons, Robelius, Gilbert, Bentley, Al Husseini, Deffeyes, Koppelaar, Birol, and others, I came to believe that world liquids production might stay on the existing plateau for the next 2-5 years and then go into a 3-5% per year decline.

Merrill Lynch estimates that non-OPEC production has peaked according to a 2/3/09 Reuters report.  It quotes Merrill analysts saying:

in Merrill’s base case scenario it estimates output decline rates of 5%, and it sees non-OPEC oil production stuck in the current 49 to 50 million bpd range in the same period. Should the credit crunch push decline rates to 6%, however, non-OPEC production could decline precipitously towards 47 million bpd by 2015 from the current levels. The commodity super-cycle is not over, just resting.

In summary, assuming the ongoing recession does not turn into a multi-year event where global oil demand is pushed down structurally for the next five years, the steep decline rates in OPEC and non-OPEC countries alike could put upward pressure again on oil prices as soon as 2010 or 2011.

Dr Mahmoud Salameh of the Oil Market Consultancy Service is quoted as saying:

The global peak, he argues, “may have already been reached in 2004 if we factor in what I describe as ‘OPEC’s inflated proven oil reserves’.”

The same article reports that Chris Skrebowski believes that peak oil will be reached in 2010-2011.

Skrebowski says the issue is the need to bring on-stream new flows to replace the depletion of existing capacity. The “easy oil” that makes up most of existing capacity is declining fast and the new capacity coming on stream ­ often from “not-so-easy” oil - will not be replacing it fast enough from 2011 onwards.

T. Boone Pickens has been widely quoted as saying that the maximum global output of oil is 85 mb/d, in which case peak production has already occurred.   Boone repeated that prediction last week.    Whether his number includes natural gas liquids, ethanol and other “all liquids” is not clear.

I posted a report on 12/1/08 about the peak oil predictions of Peter Wells and Charley Maxwell.    Wells, who uses a bottom-up data base similar to Wikipedia’s megaprojects, believes that non-OPEC production has peaked.  OPEC, he says, has the theoretical capacity to increase production from Iraq, Venezuela, Iran, Kuwait and Nigeria.  However, among these countries only Kuwait is actually likely to increase production.  While Wells uses 2015 as his target year for global peak all liquids, recent pullbacks from production projects might well have caused him to re-think his prediction to be more in line with the numbers I presented above.

Maxwell sees oil supplies peaking in 2011 with all liquids peaking within a few years of that.  His most recent predictions of oil prices is consistent with the two analyses of supply and demand I posted above.

Technology: a Key Unknown Variable

All of the above must be tempered by noting that new and potentially disruptive technologies are lurking in labs around the world.   Whether they be new batteries, ultracapacitors or other energy storage devices that could enable cheap, efficient cars or new cellulosic ethanol sources or other now unknown technologies for making synthetic fuels, the world is truly dependent on new technologies for getting us out of the oil bind that lurks in the inevitable decline of old oil fields.

If some such technologies were to become available tomorrow it would hard to cycle them through the economy fast enough to have much effect on the above analysis for several years.   But you never know.

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