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Inexpensive oil vanishing at alarming rate
The United States is awash in shale oil. Iran, once OPEC’s second-largest producer, is slowly ramping up output. Oil consumption growth in the Western world has been somewhere between negative and flat since the 2008 financial crisis. The “peak oil” theory has pretty much vanished, along with The Oil Drum, the bible of peak oil believers. Rest in peace.
Or turn in your grave, for the oil price charts tell a different story.
On the New York Mercantile Exchange, crude oil futures are up 13 per cent over one year. Since 2009, they have climbed every year except 2012. In Europe, the Brent crude futures are flat over the year after rising three years on the trot. Brent, the de facto global benchmark, trades at about $108 (U.S.) a barrel; West Texas Intermediate, the North American benchmark, is at $97. For the sake of argument, let’s say the world is valuing oil at $100. You would think the price would be far less as the United States challenges Saudi Arabia for top producer status.
While the oil forecasters were pumping out bearish calls, the market itself has stuck to its triple-digit price outlook. Oil buyers apparently know the Western world’s economic recovery will boost consumption, since growth and oil use are aligned. That’s not all. They also know that the math doesn’t work: Prices can’t go into gradual, long-term decline, or even stay flat, when the world’s conventional oil fields are in fairly rapid decline.
Exotic production – oil sands, biofuels, natural gas liquids – are supposed to fill the gap. But this so-called unconventional production is highly expensive and quite possibly insufficient to cover the drop off in cheap, conventional production. Prices will rise to the point that demand will have to level off or fall. The “peak oil” and “peak demand” theories are really opposite sides of the same coin.
A few days ago, Richard Miller, the former BP geochemist turned independent oil consultant, delivered a sobering lecture at University College London that laid out the case for dwindling future oil supply. His talk was based on published data from the U.S. Energy Information Agency, the International Energy Agency, the International Monetary Fund and other official sources.
The data leave no doubt that the inexpensive oil is vanishing quickly. Conventional oil production peaked in 2008 at about 70 million barrels a day and is declining by about 3.3 million barrels a day, every year. Saudi Arabia pumps about 10 million barrels a day. The math says a new Saudi Arabia has to be found every three years to offset the conventional oil drop off. Good luck. Now you know why Russians, Canadians and Americans are so keen to lock up the Arctic, the alleged keeper of vast new reserves.
About one-quarter of conventional production comes from the 20 biggest fields and most of them are in decline, some precipitously. North Sea oil production peaked at 4.5-million barrels a day in 1999. This year’s production is forecast at between 1.2 million and 1.4 million barrels a day. The so-called Forties field, the North Sea’s biggest, has been losing 9 per cent a year for more than 20 years. Ditto two other North Sea biggies – Brent and Ninian.
Great Britain shed its status as an energy powerhouse about a decade ago, when it became a net energy importer. Its energy import bill is horrendous. Last year, Britain spent almost £22-billion ($38-billion) buying foreign oil, natural gas and coal.
Repeat all over the world, from Mexico to Indonesia. Indonesia’s oil production has been in steady decline since the mid-1990s, and the country has gone from oil exporter to importer, at which point it got kicked out of the Organization of Petroleum Exporting Countries. While new exploration and technologies will extend the life of some of the gasping old fields, the long-term downward trend is intact.
The conventional fields are running out of puff just as world demand is climbing again, which can only put upward pressure on prices. This week, the IEA estimated that oil demand will rise by 1.2 million barrels a day in 2014, or 1.3 per cent, to 92.4 million barrels.
The increase is driven by economic recovery and ever-rising demand in China and elsewhere in the developing world. China is willing to pay almost any price for oil because oil drives growth more than it does in the West, where energy use is less intensive per unit of economic output. China has also developed a love affair with traffic jams. The number of cars and motorbikes in China increased twentyfold between 2000 and 2010. It is forecast to double again in the next 20 years.
The oil shills, the tech geeks and most, but not all, oil companies would have you believe that non-conventional energy will fill the gap as the cheap, easy-to-pump oil heads gently into the night. It might, but at what price and cost to the environment? Or it might not at any price.
Deep-sea production is monstrously expensive and risky, as BP found out when its Macondo well in the Gulf of Mexico blew up. The Alberta oil sands also spew out more carbon dioxide than conventional production. Most biofuels, such as U.S. corn-based ethanol, are taxpayer-subsidized economic horror shows with dubious environmental benefits.
The peak oil crowd has thinned out, to be sure, but it won’t disappear. Gushing U.S. shale oil doesn’t mean oil is about to become cheap and plentiful. The fall off in conventional oil production is real, and scary.
Still unnoticed by a large part of the population is that we have been living through a period of relative impoverishment. Money has been squandered in welfare spending, bailing out banks or even — as in Europe — of fellow governments. But many people still do not feel the pain.
However, malinvestments have destroyed an immense amount of real wealth. Government spending for welfare programs and military ventures has caused increasing public debts and deficits in the Western world. These debts will never be paid back in real terms.
The welfare-warfare state is the biggest malinvestment today. It does not satisfy the preferences of freely interacting individuals and would be liquidated immediately if it were not continuously propped up by taxpayer money collected under the threat of violence.
Another source of malinvestment has been the business cycle triggered by the credit expansion of the semi-public fractional reserve banking system. After the financial crisis of 2008, malinvestments were only partially liquidated. The investors that had financed the malinvestments such as overextended car producers and mortgage lenders were bailed out by governments; be it directly through capital infusions or indirectly through subsidies and public works. The bursting of the housing bubble caused losses for the banking system, but the banking system did not assume these losses in full because it was bailed out by governments worldwide. Consequently, bad debts were shifted from the private to the public sector, but they did not disappear. In time, new bad debts were created through an increase in public welfare spending such as unemployment benefits and a myriad of “stimulus” programs. Government debt exploded.
In other words, the losses resulting from the malinvestments of the past cycle have been shifted to an important degree onto the balance sheets of governments and their central banks. Neither the original investors, nor bank shareholders, nor bank creditors, nor holders of public debt have assumed these losses. Shifting bad debts around cannot recreate the lost wealth, however, and the debt remains.
To illustrate, let us consider Robinson Crusoe and the younger Friday on their island. Robinson works hard for decades and saves for retirement. He invests in bonds issued by Friday. Friday invests in a project. He starts constructing a fishing boat that will produce enough fish to feed both of them when Robinson retires and stops working.
At retirement Robinson wants to start consuming his capital. He wants to sell his bonds and buy goods (the fish) that Friday produces. But the plan will not work if the capital has been squandered in malinvestments. Friday may be unable to pay back the bonds in real terms, because he simply has consumed Robinson’s savings without working or because the investment project financed with Robinson’s savings has failed.
For instance, imagine that the boat is constructed badly and sinks; or that Friday never builds the boat because he prefers partying. The wealth that Robinson thought to own is simply not there. Of course, for some time Robinson may maintain the illusion that he is wealthy. In fact, he still owns the bonds.
Let us imagine that there is a government with its central bank on the island. To “fix” the situation, the island’s government buys and nationalizes Friday’s failed company (and the sunken boat). Or the government could bail Friday out by transferring money to him through the issuance of new government debt that is bought by the central bank. Friday may then pay back Robinson with newly printed money. Alternatively the central banks may also just print paper money to buy the bonds directly from Robinson. The bad assets (represented by the bonds) are shifted onto the balance sheet of the central bank or the government.
As a consequence, Robinson Crusoe may have the illusion that he is still rich because he owns government bonds, paper money, or the bonds issued by a nationalized or subsidized company. In a similar way, people feel rich today because they own savings accounts, government bonds, mutual funds, or a life insurance policy (with the banks, the funds, and the life insurance companies being heavily invested in government bonds). However, the wealth destruction (the sinking of the boat) cannot be undone. At the end of the day, Robinson cannot eat the bonds, paper, or other entitlements he owns. There is simply no real wealth backing them. No one is actually catching fish, so there will simply not be enough fishes to feed both Robinson and Friday.
Something similar is true today. Many people believe they own real wealth that does not exist. Their capital has been squandered by government malinvestments directly and indirectly. Governments have spent resources in welfare programs and have issued promises for public pension schemes; they have bailed out companies by creating artificial markets, through subsidies or capital injections. Government debt has exploded.
Many people believe the paper wealth they own in the form of government bonds, investment funds, insurance policies, bank deposits, and entitlements will provide them with nice sunset years. However, at retirement they will only be able to consume what is produced by the real economy. But the economy’s real production capacity has been severely distorted and reduced by government intervention. The paper wealth is backed to a great extent by hot air. The ongoing transfer of bad debts onto the balance sheets of governments and central banks cannot undo the destruction of wealth. Savers and pensioners will at some point find out that the real value of their wealth is much less than they expected. In which way, exactly, the illusion will be destroyed remains to be seen.
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