Stock Market’s Shaky Foundation

According to the stock markets in the U.S. and in Europe, the world’s economy is not just in good shape, but is in the best shape it’s ever been.

Stock Market's Shaky FoundationThe S&P 500,  the Dow and Nasdaq continue to surge upward. The S&P 500 is now 20 percent above the peak it hit in 2007, a moment everybody now recognizes was heavily overvalued.

An 20 percent gain above the prior all time high is an enormous and unusual event. Surely, you are thinking, there must be an equally compelling story and loads of fundamental data to support such a bull market?

There really isn’t.

Not a lot has changed between the prior 2007 peak and today. From a fundamental standpoint, not much at all. Per capita income is only up 8.1 percent between now and then, and yet the equity markets are rallying like the biggest income boom in all of history has occurred.

Worse, the per capita income data is obscuring the fact that what little income gains have been recorded went almost entirely to the top 10 percent of the population. So there’s no broad prospering middle class to drive an economic expansion of the sort that stocks seem to be pricing in.

The main narrative today has nothing to do with anything fundamental. Rather, it centers on the idea that as long as the central banks of the west and Japan continue to print, everything financial will just continue to go up in price while — somehow — price inflation will remain tame.

Our view here at Prepare and Prosper is that this narrative is wrong in every respect; except, perhaps, for those engaging in short term speculation that ignores both fundamentals and history.

In the immediate term, stock prices gyrate based on various assumptions that are often completely disconnected from reality.

But over the medium and longer terms, fundamentals drive prices; as it is ultimately corporate income and ultimately dividends that determine the value we ascribe to equities, and it’s the prospect of future earnings growth that drive the price multiple.

The Big Picture

Over the long haul equities are nothing more than a means of sharing the wealth that companies create, which itself is a product of the extraction and processing of real things from the real world.

Everything we think we know about the ‘fair value’ of equities was developed over a period of time when the future could always be counted upon to expand exponentially.

You know, sayings like “Over the long haul equities return 10 percent”.

Such a statement can only be true in an exponentially expanding world where exponentially more things are being extracted from the real world as time goes on.  In a world where there is only so much ‘stuff,’ it’s not possible for said ‘stuff’ to always be present in expansive and expanding quantities.

A huge enabler of the economic expansion of the past century has been oil. Without a doubt, petroleum is the master resource for a global economy. And it is no longer cheap.  The reason why it is no longer cheap, and never will be again, is a larger story than we have time for here, but recent data should suffice to show that global oil has averaged more than $100 per barrel for more than three years. That’s 4x higher than the 1987-2004 average of $23 per barrel

The anemic economic growth in the OECD countries, with their horrible job creation statistics and generally tepid recoveries (at best), is the very predictable result of what you get when oil becomes expensive.

If you hold the view, as we do at Prepare and Prosper, that the future economy cannot possibly grow at the same rates as it did in the past, then equities are in for a serious correction at some point.

That day may still be far in the future. But there must always be an eventual reckoning between the number of claims on the world’s wealth world and the actual wealth itself.

Further increasing the risk for equities is the fact that, as claims on wealth, they are the least senior of the lot.  The holders of bonds and preferred shares come first.  So when we wander over to that other, and much larger, corner of the financial universe where debt resides and note that all forms of debt, but especially corporate debt, have continued to grow exponentially both before and after the great 2008 credit crisis, we see that equities are whistling past this part of the story too.

A huge proportion of all the new corporate debt taken on since that little hiccup in 2009 has been used to buy back shares and thereby goose (through accounting, not by value creation) the earnings per share numbers so widely reported by the financial press.

Eventually, though, all that corporate debt will have to be paid back, and that activity will drain future cash flows and earnings. Again, steadily rising – nay, exponentially rising – levels of corporate debt are a massive collective bet that the future will be exponentially larger than the present.

The only narrative I can imagine that can accommodate a long-term decline of per capita resources coupled to steadily worsening net energy from petroleum, AND simultaneously support the continued exponential expansion of claims against those resources, is one that steadily transfers this wealth into fewer and fewer hands.

After all, if relatively few people end up owning most of the remaining wealth, does it really matter to them that there’s less of it to go around on a per person basis?  No, not if they have plenty for themselves.

As the recent travails in Ukraine have showed us, there’s only so far that such a deranged, kleptocratic view can go before it breaks down.

Alternatively, and far more likely, there’s no actual rational narrative of any sort in play right now — and so the center mass of the investing world is simply operating off of untested and unexamined beliefs that mainly rest on the notion that a prompt and perpetual return to exponential growth is what the future holds.

Again, we see this as dangerously myopic. But sadly, this view is not only rampant on Wall Street, but it’s also prevalent with our government as well as endowments, pensions, and insurance pools — entities with long-term fiduciary responsibilities that really aught to be asking themselves some hard questions these days.

Conclusion

In summary, over the long haul — by which we mean the next decade — current equity prices are making a colossal bet that exponential economic growth, which itself is linked to cheap oil, is going to quickly resume and persist long into the future. Are you comfortable making that bet? we’re not.

Of course there are a lot of variables in play here; but one could do worse than to simplify one’s economic prediction down to this: Until and unless the global supply of oil gets a heck of a lot cheaper, anemic economic growth will persist and therefore the holders of expensive financial assets that are priced for perfection will be badly disappointed.

Cheap oil is vanishing



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The United States is awash in shale oil. Iran, once OPEC’s second-largest producer, is slowly ramping up production. Oil consumption in the Western world has been 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 – because the price of oil tell a different story.

On the New York Mercantile Exchange, crude oil futures are up 13 percent over one year. Since 2009, they have climbed every year except 2012. In Europe, the Brent crude futures are flat for the year after rising three years in a row. Brent, the de facto global benchmark, trades at about $113 (U.S.) a barrel. West Texas Intermediate, the North American benchmark, is at $106. For the sake of argument, let’s say the world is valuing oil at $110. With the abundance of shale oil in the United States – hundreds of billions of barrels (in theory) – you would think the price would be 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 know that prices can’t go into gradual, long-term decline, or even stay flat, when the world’s conventional oil fields are in decline.

Exotic production – shale deposits, oil sands, biofuels, natural gas liquids – are supposed to fill the gap. But this so-called unconventional production is expensive and probably 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.

Shale Oil Exploration

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 slowly declining. 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. That’s why the Russians, Canadians and Americans are so eager to lock up the Arctic. It’s hoped that the Arctic may contain vast new oil 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. Last year, Britain spent almost £22 billion ($38 billion) buying foreign oil, natural gas and coal.

Repeat this phenomena 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.

Conventional fields are running out of steam just as world demand is starting to climb, which can only put upward pressure on prices. The International Energy Association (IEA) estimates that oil demand will rise by 1.2 million barrels a day in 2014, or 1.3 percent, to 92.4 million barrels.

The increase is driven by increased economic activity in the developed world and ever-rising demand in China and in other countries in the developing world. China is willing to pay almost any price for oil because oil drives its 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 twenty fold 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. 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.

 

Peak Cheap Oil Rears Its Ugly Head

Peak Cheap Oil has been mischaracterized by calling it “peak oil”. It’s not about how many theoretical barrels of oil reside in the ground. It’s about how much of that oil can be recovered and processed cost effectively. What follows is an update on the Peak Cheap Oil front from Peak Prosperity.

Yes, I am talking about that tired old concept that was allegedly slain by American drilling ingenuity. It’s back in the news… if you know where to look.

I remain steadfastly interested in the oil outlook because everything, and I do mean everything, in our exponential monetary and associated economic system is hinged upon there being more cheap oil next year than there was last year.

If there is not, then every single assumption of future growth being made by the globe’s collective stock and bond markets is wrong. What I mean by that is the 350% debt-to-GDP ratio being held by the OECD countries in aggregate is a collective bet that the future will consist of very high rates of growth without any near or intermediate-term limits.

Further, a stock market with a price-to-earnings ratio (p/e ratio) that ranges from the 20s (S&P 500) to the mid-80s (small caps) is explicitly pricing in lots of future earnings growth as the justification for today’s prices. Because we sometimes need reminders to appreciate what ratios really imply, a p/e ratio of 80 means that an investor is willing to pay $1 today for a stock whose current earnings would require 80 years to accumulate that same dollar.

Whether or not that company would return 100% of its earnings to an investor is doubtful and extremely unlikely, so really anybody paying 80 times earnings for a given stock is making just one explicit bet: that that company will grow earnings enormously in the years ahead. That is, an explicit bet on future growth is being made.

The same is true for anybody paying 20 times earnings… or even 10 times earnings.

Recent actions by oil majors add further evidence to the claim that all the cheap oil is gone, and that our global society needs to prepare for much higher oil prices in the future. Or reduced supplies. Either way, this is an admission that the world is past the peak of cheap, high net energy oil.

The only thing that could delay a major rise in global oil prices within the next few years would be a serious retreat in the global economy that drops oil demand from current levels. Otherwise, oil prices will have to rise to balance supply and demand.

Either the global economy advances and then gets walloped by much higher oil prices, or it retreats and oil demand drops as a result. Take your pick. Do you prefer to be walloped now or walloped later?

Future Demand

To understand the potential trouble, we have to begin with demand so we know what must be supplied.

The United States Energy Department (EIA) has forecast that world demand for oil will be met with supplies that look something like this:

The first thing we note is the obvious decline in the orange wedge at the bottom, which is all conventional fields… or Cheap Oil. As that goes away, the EIA projects that the shortfall will be met by future discoveries in the gray wedge.

Well, hang on right there, what should we make of that gray wedge there, which is comprised of “Crude Oil Yet-to-Find and Found-but-Yet-to-be-Developed”?

Well, it’s not shale oil, or tar sands, or ultra-deep water; because those are all contained in the top dark-gray wedge labeled “Unconventional Oil.”

That light-gray wedge is just good old, regular conventional oil that the oil companies first need to find and then produce.

And it is not an insignificant wedge… it’s 38 million barrels per day. That’s nearly four new Saudi Arabias or ten new US-sized shale miracles. Of course, the finds from today’s US shale miracle will peak in 2021 and will have been in decline for 15 years by 2035 and be a bare shadow of their former selves.

So, as they say in the oil business, you have to find it before you can drill it. So let’s take a look at the largest oil companies to see how they are doing in filling that light-gray wedge.

Supply

Here’s where the story gets downright fascinating.

Note these recent headlines:

  • Shell cuts $9bn from CAPEX
  • Hess Announces $5.8 B 2014 CAPEX (Down From $6.8 B)
  • Oil majors under pressure to curb spending
  • Exxon to Cut CAPEX, Even as Production Costs Rise
  • Sinopec to Cut Capital Spending 4.2%

Exxon Mobil Corporation recently disclosed that its capital spending will decline to $39.8 billion this year from a peak of $42.5 billion in 2013. Excluding potential acquisitions, capital expenditures are expected to average less than $37 billion per year from 2015 to 2017.Royal Dutch Shell Plc had said it would slash capital budget and accelerate asset sales this year. Its capital spending, which totaled $46 billion in 2013, is expected to drop to around $37 billion in 2014, representing a nearly 20 percent decline.

United States-based Chevron had in December announced a $39.8 billion capital and exploratory investment programme for 2014, which is about $2 billion lower than total investments for 2013.

French oil major Total said it expects capital expenditure to fall to $26 billion in 2014 from $28 billion last year.

Italian oil giant Eni said it is cutting its four-year (2014-2017) capital expenditure plan by 5 percent to 54 billion euros ($74 billion.)

All told, every single one of the ten oil majors is planning on freezing or seriously cutting capital expenditures. This is the very lifeblood of their business… if you are not spending money to find and develop petroleum assets, you cannot grow production.

What does it tell us if Brent oil is trading at $110 a barrel and all ten oil majors are reducing their efforts to find oil?

Simply this: they have come to the conclusion that they cannot generate the necessary returns for their companies and shareholders at $110 per barrel. More bluntly, this means that the remaining plays that they have their eyes on are not sufficiently large and/or easy enough to justify pursuing them at $110.

Succinctly: Oil needs to be more expensive than $110 per barrel for the oil majors to become interested again in taking it out of the ground.

An Embarrassment of Production

Now, on to the idea that they have come across an embarrassment of riches that leads to falling investment…

This is a truly stunning chart. Instead of an embarrassment of riches, this chart tells the exact opposite tale. It reveals falling production since a high of 16.1 million barrels per day in 2006 to a current 14.0 million barrels.

And this was despite the increase in collective CAPEX from $50 billion in 2000 to a whopping $262 billion in 2012.

The decline rate of production across all the majors is running at about 5% per year, and this is with CAPEX increasing by 14.8% per year. That’s a double whammy of exponential badness right there.

Instead of an embarrassment of riches as the above article suggested, I see an embarrassment of production, and an expensive one at that.

Faced with this, the oil majors have effectively tossed in the towel and decided not to chase dwindling oil supplies at these prices.

Now let’s turn back to this chart from the EIA and turn our attention to the light-gray wedge comprising “crude oil yet to find…”:

That’s exactly the stuff that the oil majors are saying they are not going to be trying to get as much of going forward. Without increasing CAPEX, it’s safe to say there won’t be any growth at all in that gray wedge.

If there’s no growth in the gray wedge, then overall oil production will fall across the globe.

What will make more oil come out of the ground? More CAPEX expenditures.

What will make CAPEX go up? Higher oil prices.

Period.

End of story.

The Squeeze Box

At a minimum, we might expect that oil has to move to $120 to $130 per barrel in order to incentivize CAPEX to go higher.

This next chart from the Koptis presentation, the original source for which is Goldman Sachs, explains everything. It shows the price of oil that would be required for various companies to be cash flow neutral after paying dividends and for CAPEX.

Note that all of the oil majors are above that nasty, red, dotted line, and that explains why they are sacrificing CAPEX here.

But if the world economy is already straining under the burden of $110 oil, and it is, what might we predict would happen to it at $130? And what about after the oil majors exhaust all the $130 oil plays and then need $150 to move forward? What’s our prediction set for the world economy at $150?

The prediction is “nothing good, and a whole lot of bad.”

The weakness will spread, as it always does, from the outside in. The already-weak economic players will wither and fall off the tree. Already-challenged countries like Greece and Spain will only find their economic headwinds that much stiffer. The number of people on food stamps will climb as will the rolls of the unemployed. Weak, over-indebted companies, like those that are found occupying the junk bond section of the debt ladder, will fail and losses will mount.

And this will cause oil demand to fall. So on the bottom of our squeeze box we have rising oil production costs, while the upper portion of our box is the price for oil that our massively over-indebted economy can afford before it keels over.

The boundaries of that box are closing in. And that’s what the oil majors cutting CAPEX with Brent crude oil trading at $110 tells us in no uncertain terms.

So the price of oil will have to go up, and it will. And on the downslope of the Peak Cheap Oil curve, we will find that only those that can afford oil will be able to use it.

Conclusion

The really huge, gigantic predicament, of course, lies with the very system of money and credit we have that demands continued exponential growth for its very existence.

This chart is growing nearly perfectly exponentially with an R2 of 0.99 and leaving the math aside, that’s just a smoking gun of an indictment of our current monetary system, and by extension our economic system.

Nothing can grow exponentially forever. And without continued exponential growth in energy, it is game over sooner than might be true otherwise.

But if our money system cannot grow exponentially, is that really such a bad thing? Why do I predict and warn that such an eventual date with the reality of limits will be so disruptive?

I do this because every single time credit growth has even slowed down, our financial and economic systems have flashed major warning signs. In the one time that it actually went backwards in living memory, the entire system threatened collapse.

Add to this view the untested $700 trillion in derivatives, which some people think might actually tip a quadrillion—whatever that number means—and which are additive to whatever debt numbers we might toss around, and I’m pretty sure that really nothing very positive will result from the process of reconciling those figures with reality.

And what is the reality?

Simply this: the oil majors have said there’s nothing useful we want to pursue here with oil at only $110 a barrel.

That’s a quite interesting if not stunning development.

It means that we will get less future growth in oil supplies because even with a 500% increase in CAPEX from 2000 to 2012 we saw falling, not rising, oil production.

It is an easy prediction to make that less CAPEX will result in even less future production. That’s an easy prediction to make.

Following easily from that is the prediction that oil will have to rise in price because less supply with the same demand can only be resolved through higher prices.

The tacit admission by the oil majors that they cannot profitably pursue new oil opportunities at $110 a barrel is a stunning development—not to me or you, of course, but it should be a stunning development to anybody and everybody else paying the slightest bit of attention here.

The oil majors have tossed in the towel at $110.

Which means, of course, that when it comes to preparations, I’d much rather be a year early than a day late.

Peak “Cheap” Oil: Shale Oil Proves Peak Oil Is Indeed Upon Us

We have been skeptical of the many claims being made by the media about how a new energy bonanza is going to overtake the U.S. and eventually the world. The subject is the new shale formations in both natural gas and oil.

While these oil and gas plays are in some cases extraordinary, and the technology is amazing, many of the exuberant claims made in the media about the potential oil output of these plays are now being dialed back.

The reason? Just like any other resource, the shale plays were “high graded,” meaning the best ones were drilled first.

We contend that shale oil proves that Peak Oil is upon us. First, we would not be drilling them if there were anything better left to drill. The simple yet profound reason that we’re going after this more difficult and expensive oil is simply that the easy and cheap oil is nearly gone.

Rather than proving that Peak Oil is dead, as many have claimed, the new focus on shale plays indicates to us that we’ve indeed moved down the resource ladder to the next best (i.e., less good) options because the better ones are gone.

We think the technology and ingenuity on display in the shale plays is extraordinary. And I think, in the end, we’re going to drill all of these formations drynot just here, but elsewhere in the world. These are legitimate wells.

But they are not the same as the old conventional oil fields. Not by a long shot.

They are expensive. And they consume a lot of water and a lot of land. A typical shale play involves tens of thousands of wells with drill pads all over the placesomething that will pretty much prevent their widespread adoption in more populated areas of the world.

A Peak Oil Mistake

A mistake of the Peak Oil community (of which we are members) was in not qualifying statements about oil reserves and production in terms of price. Obviously, the higher the price goes, the more elaborate will be the attempts to get more oil from harder, deeper, and more expensive places.

That is, up to a point, the amount of oil that we will drill for will depend on price.

If, for example, oil were to suddenly fall to $50 per barrel or less and stay there, then there would be no more drilling in the shale plays, because the all-in cost of those plays is higher than that. In many formations, a lot higher than that.

Conversely, if the price of oil were to rocket up to $300 a barrel, then you’d see all kinds of marginal oil plays around the world suddenly begin to get tapped.

So the amount of oil we’ll ultimately get is a tricky function of price, actual reserves, technological developments, and geopolitical realities.

The actual argument that makes the most sense is to call for Peak Cheap Oil, which is something that we can quite confidently argue is now safely in the rear-view mirror.

And someday, no matter how much the shale oil plays ultimately contribute to the story, those, too, shall have their days of ascendancy followed by a terminal decline.

Oil “Peak” Delayed

It seems shale oil has pushed back the date of the arrival of the true worldwide “peak” in oil, possibly by as much as five to ten years.

This is new information that changes things some. But, unfortunately for a world still addicted to oil, not nearly as much as many had originally hypeder, hoped.

The 2008 global recession has had a profound impact on global oil demand. Shale oil formations have undoubtedly made a contribution to global supply. Together, these have served to lessen the global demand for oil to the extent that a (barely) tolerable price of ~$100 per barrel is balancing supply and demand for now, which is allowing Peak Oil to drift off into the distance for a few more years.

The way that global oil supply and demand have balanced has involved both increased U.S. production and reduced U.S. demand. As a result U.S. demand fro oil produced elsewhere on the globe has been reduced. This has allowed the rest of the world to compete for non-U.S. oil with relative ease.

Shale oil has produced nearly two million barrels per day (mbd) of increased domestic production over the past two years. That is two mbd, slightly more than 10 percent of daily use, that the U.S. does not have to import:

Shale has helped the supply picture. And it is a good thing, too, because if we look at global production of crude oil with the U.S. removed from the equation, we see this:

Virtually zero growth in oil production across the globe, despite a full doubling of expenditures by the oil companies on exploration and production and a near tripling of the price of oil.

If you want to understand why oil prices tripled, the above chart is really all you need to look at. It’s basic economics. Supply and demand are matched by price. If demand was rising (and it was) and supplies were stagnant (and they were), then price balances the equation.

To know when Peak Oil will finally be recognized across the world’s stage, we would need to know by just how much global economic growth is going to advance, what new discoveries will arrive, the price of oil, and whether or not the Middle East will stabilize or destabilize.

In short, we can’t predict any of these things with any sort of accuracy. But we can know that every oil find eventually depletes and that the new ones are less productive than prior ones. And that we’ve drilled the best plays first, so the future ones are likely to be less productive.

The Best Plays First

It’s important to note that the recent U.S. experience in drilling the Bakken, Eagle Ford, and Permian Basin plays should not be extrapolated across the 20 total U.S. shale basins known to exist.

The reason is that the remaining plays are certain to be of lower quality, more difficult/expensive to access, and/or lower yielding.

Conclusion

The shale plays prove that Peak Oil is real, rather than invalidating the theory.

We can say two things about shale oil:

  1. It’s more expensive than oil finds of the past
  2. We have drilled the best plays first

We will not ever see Cheap Oil again, at least not in a meaningful way (although perhaps a severe global economic slump could temporarily drive prices lower). We should be behaving as if fossil energy is rare, limited, and exceptionally valuable.

The best shale plays in the U.S. are already exploited. The most recent plays have been something of a disappointment. There may be a couple more that prove promising, but there isn’t anything like 20 Bakkens kicking around, as some want to believe.

Meanwhile, oil production from the rest of the world continues to chug along in a virtually flat line. And the U.S., even with its recent production gains, still imports roughly a third of its daily petroleum needs, which means the U.S. is just as dependent on the global oil situation as any other country. Possibly even more.

We remain convinced that a prime reason the world economy is not doing well, and why marginal states and countries are struggling, is that oil is no longer cheap, easy to find or produce.

Peak Oil – Fake or Real?

A mixed panel deconstructs the hyperbole.

Charles HallCharles HallProfessor Charles Hall, Emeritus Professor at State University of New York, College of Environmental Science and Forestry, USA

The world has recently been exposed to many optimistic estimates on the future of oil production and the media has eagerly picked up these projections. International Energy Agency estimates that by 2020, the USA is projected to become the largest global oil producer, to the extent that it is to become a net oil exporter by 2030. These perspectives are offered as an alternative to the pessimistic Hubbert curve projections that imply we are at, or near, maximum global production of oil. But if you dig into the rationales for this optimism, it is based principally on two concepts. There are new developments in the oil industry, specifically directional (horizontal) drilling and fracking, principally in the Eagle Ford play of Texas and the Bakken region of North Dakota and Montana. And, stated less frequently, the addition of other fluids to what is called oil, most importantly natural gas liquids, which are expected to increase as a result of fracking for gas. In fact, there has been little, if any, increase in the global production of conventional oil since 2005, and most of that has been in the USA.

Peak oil is the point at which the maximum rate of petroleum extraction has been achieved, after which production enters a terminal decline. It is based on the idea that oil is a finite resource. Marion King Hubbert introduced the model.The basic issue is that there is a huge difference between the quantity of oil left in the ground (a lot), and the amount of high-quality oil that can be extracted and refined at a significant energy profit (not so much). My research with colleagues has shown that global energy return on investment (EROI) of oil is declining. Oil that used to be extracted at a gain of 20–40 joules per joule invested is now being extracted at 10–20 joules per joule or less, as we have depleted the best resources. Hence, oil prices must rise.

The oil that we are exploiting now is deep, offshore, tight and heavy, and gives far less EROI. If current trends continue, it will take a barrel of oil to extract a barrel of oil. Economic profitability will presumably cease at an EROI of something like 6:1.

Jörg FriedrichsJörg FriedrichsDr Jörg Friedrichs, Lecturer in Politics at the University of Oxford, UK

I don’t think liquid fuel has peaked quite yet, but conventional crude oil certainly has. Increasingly, less easy oil is gushing from the ground. Given the world’s unquenchable thirst for liquid fuels, oil in the widest sense of the term will peak only once difficult and expensive sorts of unconventional oil like biofuels, tar sands, and shale oil cannot make up for the shortfall any longer. The question of when oil will peak, or has it already peaked, depends on whether the definition includes or excludes such expensive sorts. Prices for crude – especially Brent, but also West Texas Intermediate – have been hovering above $100 a barrel for quite some time. Despite all the enthusiasm about expanding oil production in the USA, shale oil is expensive to produce. Coal and gas can be liquefied, but this requires even higher oil prices not to mention the greenhouse gas emissions. If people were more consciously aware of the situation, prices would climb even higher. But few people are aware, and pump prices cannot be attributed to peak oil panic. Apart from short-term fluctuations, they largely respond to market fundamentals like supply and demand. Most people have short time horizons and prefer denial to worrying about fuel scarcity.

Simon SnowdenSimon
Snowden
Mr Simon Snowden, Lecturer in Operations and Supply Management at The University of Liverpool, UK

The idea that the rate of production of oil will slow is, I believe, true for a non-renewable resource, and is proven by the current fad for non-conventional sources. This is not to deny the abundance of hydrocarbons in Earth’s crust, as some argue, but it is possible to have scarcity among abundance. The reason for this is that peak oil is not just a geological phenomenon, it is a fundamentally economic question.

It is often reported in the press that the USA is set to produce as much oil as Saudi Arabia. Production costs are somewhere in the region of US$52–$113 a barrel for shale oil, and US$6–$28 a barrel for Saudi oil. So, even if there proves to be similar volumes, which is by no means clear, the difference in the cost of producing those barrels is significant. The market price for oil will need to remain high to induce production of these non-conventional sources, or governments will need to find ways of subsidising production.

There is an urgent need to address peak oil. However, the impact won’t always be negative, as companies will try to find new materials and reduce the impact of the price of energy on their operations.

Originally appeared on Materials World.