TheGarcipian (99.29)

Consumption Junction, Part Four: Crude Awakening

June 04, 2008 – Comments (2) | RELATED TICKERS: EWW , EEM , XOM

Continuing on the theme from my last blog post, that being the craziness of $200/barrel oil, I found a very direct, informative web page with lots of answers to some of the questions I have in mind. Paul Horsnell, head of commodities research at Barclays Capital, answers many different questions about oil in this article here, entitled “Crude Awakening for Oil Consumers”. I thought he answered the questions very directly and with some well thought out replies. See what you think from some passages I’ve selectively reprinted below, statements which either back what I’ve written earlier or with which I agree now. Comments within square brackets or outside quotes are my own. 

On the massive reserves of oil shale in the Rockies, he writes: “The main problems with most non-conventional oil production is cost and lack of scale. There are huge reserves of oil trapped in shale, most particularly in the US Rockies, but large scale production is constrained by the availability of water. Because of this and other environmental and technical constraints, it is difficult to find scenarios in which the scale of shale production pushes on much beyond 1 mb/d by 2020. In other words, shale does not look like the back stop technology that will in itself limit oil prices. It is actually a very old industry; indeed the Scottish shale industry had its zenith back in the 1850s.”

On oil/tar sands: “Canadian oil sands are another case where the problem is that it does not seem that output can be ramped up so fast as to have anything but a marginal impact on something as large as the global oil industry. Oil sands are very energy and capital intensive [at a cost of about $40/barrel, significantly higher than the $5-$10/barrel for conventional oil], and have a very significant carbon footprint. They do appear to be something that might at the margin mitigate the rise in the price of oil rather than being important enough to bring long-run prices down.”

On U.S. estimated reserves: “If we simply divide estimated reserves of conventional oil by current consumption of oil, the answer that emerges is about 40 years.”  I’ve read other articles that have thrown that number around; perhaps he’s referring to the same ones(?). 40 years. That’s not much time, folks. Sure, higher oil prices will drive some conservation (a natural product of the supply and demand curve), but the global economy is built on the shanks and flanks of oil wells and oil-producing refineries. Do we really want to wait another quarter-century (as we’ve done since the 1979-1980 energy crisis) to begin serious research into viable alternative energy resources?

Horsnell points out that the bigger issue is not how much oil is left, but how fast it can be produced with current technology. He continues: “That issue, i.e. what is the maximum rate of oil supply that is likely in coming decades, is very much a live issue at the moment. With several studies, including that of the International Energy Agency, very much in progress, perhaps the only safe statement at the moment is that the maximum rate appears to be lower than was generally assumed even five years ago.”

On diesel: “Diesel has really been the Achilles heel of the global oil market this year, and the shock given to diesel consumers has been dramatically worse than for consumers of other oil products. Wholesale diesel prices are double what they were a year ago, while wholesale gasoline prices are up by a more modest 40 per cent.” 

From my employment as a “roustabout” working offshore for Shell Oil Company during a summer break from engineering college, I learned first-hand that diesel runs practically everything at the industrial level. It is the fuel of choice for many reasons. The Average Joe typically doesn’t see that unless they’re in that industry or in the field with blue-collar workers. Every time I go to refuel my gasoline-driven car, I’m thankful that I’m not driving a diesel engine, but wonder how devastating this energy crunch has to be for industries worldwide, particularly the transportation industry (trucking, railcar, bus, etc).

On commodities: “Emerging markets are relatively more important now, and are the key price setting areas across many commodities. In oil, for example, the current quarter looks like being the eleventh in a row in which OECD oil demand has fallen year-on-year. Yet prices have more than doubled over that period, given the continuation of demand from the Middle East and China in particular, and given the weakness in non-Opec supply. A process has been at work all this decade whereby commodities markets in general have become more global, and much less determined by US economic conditions alone. That is not to say that the US is unimportant, it most clearly is important, but it is to say that at the margin emerging markets have a powerful enough force to compensate over extended periods for weaker commodity demand from the US.”

On $200/barrel oil: “In our view, what is far more important than [$200/bbl oil] speculation… is the question of what is the long-term sustainable oil price. That price is the one that outlives the headlines, and is a long-term average that brings demand growth and supply capacity growth into line with each other. Currently the market is pricing in about $130 for that price... We would currently put it a little higher, but would note that perceptions as to what will be necessary to balance the market into the longer term are still shifting upwards.

We certainly believe that the current data flow supports the idea of longer term averages above $100. Further, should the flow of data in recent years continue to suggest longer-term weakening in non-Opec supply within the context of a world which needs to price carbon at realistic levels, then it would be unwise to yet rule out the possibility of much higher longer term averages. That outcome would be considerably more important than the widely reported idea of a short-term rush to $200 followed by a bust, but it appears to us that the longer-term issues are perhaps being lost a bit in some of the short-term media noise.”

I couldn’t agree more.