Turning point for oil, and us

There are big things happening just now in oil, which will affect literally everything, including of course all human “best laid schemes.”

If you don’t read anything else in this post, read Ron Patterson’s blog post “Why we are at Peak Oil Right Now“, Jeffrey Brown’s short commentary, and Matt Mushalik’s most recent post (“Peak Affordable Oil”).

The ways this turning point will affect us are indirect, opaque, delayed, and subject to intense deception and propaganda by companies, governments, and many other actors, most of whom understand what is going on only partially, or poorly. So it’s hard to see what’s going on, or what exactly will happen or when or how. But rest assured, things will happen. History is on the move, and the civilization we have built — such as it is — is at risk.  The field on which the Great Game is played is being tilted.  Business as usual is over.  We see only “as through a glass darkly,” but even that little bit is important.

I don’t have time to lay out the situation in detail, though we’ve been doing that from time to time since 2006 (and occasionally on this blog — please look at older posts for more), or to spell out the implications more.  The threshold fact I am trying to get across in this little sketch is first that there ARE implications — that part is hardly news — and second, that they are arriving.   Now.  That’s what’s new.

Oil is not just one resource among others.  Oil is irreplaceable in our civilization. All modern economies depend on large supplies of relatively cheap oil. Economic growth is strongly correlated with growth in oil supply. Nearly all post-WWII recessions are associated with oil price increases. Liquid fuels refined from crude oil are superior to all other fuels in energy density, ease of transport, and simplicity of use, meaning a large and critical fraction of our economy requires oil — not coal, not electricity from any source, not natural gas, not ethanol, not biodiesel, not biomass, and not even condensate produced at oil and gas wells, but crude oil. There are no scalable substitutes. If there were, it would take many tens of trillions of dollars invested over decades to convert our infrastructure, transportation systems, and land use patterns to utilize them. Production and installation of renewable energy equipment requires a functioning oil-based economy.  Operating nuclear power plants, let alone building them, requires plentiful, inexpensive oil.

Oil has about ten times the energy density of TNT. One barrel of oil does the physical work of a human working for about 11 years. Since U.S. citizens each consume, on average, about 22 barrels of oil per year, oil supplies each American with the energy equivalent of about 242 slaves.

Oil has been the master fuel in all the mobile elements of what we might call “the long 20th century,” which has been defined by oil. Everything in our civilization, especially our rather delicate financial arrangements, now depends, and with varying response times, on the availability of oil within a certain price window. Too high, and the non-oil part of the economy can’t pay for the oil it requires for “optimal” or “normal” growth as it is usually defined – say by the Congressional Budget Office (CBO) in its deficit predictions, used by Congress to define and allocate federal spending and taxes. If the price is too low, the oil industry won’t be able to pay for the production, transport, and refining of oil.  Oil fields, infrastructure, and personnel are constantly depleting, rusting, or aging and retiring, and everything must be continually replaced.

As the world’s easy-to-produce oil is gradually depleted, the price window between what is affordable to the economy we have built on the one hand, allowing economic growth, and what is necessary to stimulate new production on the other hand, gradually closes. (This can also be discussed in thermodynamic terms but let’s stick with money.) The more wasteful our economy – or the more unequal – the lower the affordable price. The more depleted the world’s oil fields, the higher the price necessary to procure the marginal barrel of oil.

The big news, which has been hidden for the past three years really and is now coming into the open in the form of the oil price declines of the past few months, is that the “Goldilocks” oil price window has closed. There is no “just right” price any more. Oil consumers cannot afford the marginal barrel of oil, and the price has collapsed to well below what it costs to produce oil in essentially all of the world’s new oil fields. Even before the price fell, many major oil companies were cutting back on their oil production investments, selling assets, and closing refineries. They are in business to produce money after all – they have to be – not oil.

The boom in tight oil (and bitumen from Canadian oil sands), which has been the only source of net new oil production in the world since 2011, has simply not been profitable for production companies, which as a result have been losing cash. They have financed their operations with an ever-expanding mountain of high-yield junk-bond debt, inflated by hype. OPEC’s low-cost producers meanwhile have not cut back their production to make room for the frackers but have rather kept steadily on. Oil demand in a weak global economy has not kept pace with the  increment of new oil provided to U.S. consumers by U.S. frackers, which has decreased U.S. import requirements, and so the price has collapsed.

According to the Bank of Canada, one-third of current oil production is uneconomical if prices stay at $60/bbl long enough, as Matt Mushalik informs us on his excellent blog. (Oil is at less than $50/bbl today.) Most analysts expect oil prices to remain depressed until at least the second half of this year. Nobody really knows what will happen, because oil price is, in the short run, very sensitive to economic conditions everywhere — which are unusually volatile, to speak euphemistically. We may experience price “whiplash,” as Orlov colorfully remarks:

Past some point high-priced producers will naturally stop producing, the excess inventory will get burned up, and the price will recover. Not only will it recover, but it will probably spike, because a country littered with the corpses of bankrupt oil companies is not one that is likely to jump right back into producing lots of oil while, on the other hand, beyond a few uses of fossil fuels that are discretionary, demand is quite inelastic. And an oil price spike will cause another round of demand destruction, because the consumers, devastated by the bankruptcies and the job losses from the collapse of the oil patch, will soon be bankrupted by the higher price. And that will cause the price of oil to collapse again.

And so on until the last industrialist dies. His cause of death will be listed as “whiplash”: the “shaken industrialist syndrome,” if you will.

Or then again we may not.  Global deflation is another possibility. You can see many others. One way or another, as Tim Morgan (Life After Growth) reminds us, not all the claims on future work and productivity in an oil-based society, claims which we denote by money, i.e. debt, will be honored. Pacta sunt non servanda in such cases.  Overall, value as originally defined must be destroyed or redefined. (So welcome, Zen. Welcome Thoreau, who said “You must get your living by loving.” There is a new economy waiting, latent right now, organized around solidarity, stewardship, and the timeless theme of “simple living and high thinking.”  Take it, or leave earth a cinder.)

Meanwhile there will be haircuts. The powerful few will get bailouts, the powerless will get bail-ins or simply raw expropriation until they decide to do something about it.  Another way to say it is that our civilization is entering a Chapter 11 bankruptcy process — still operating, but not all debts will be fully honored. The New Great Game is in part a game of musical chairs, though the “music” will be very discordant, and fatal to many. Meanwhile those who have printing presses (for money) will begin cranking them up faster under various names, which is happening.  Of course if the U.S. can force countries to accept, use, and hold freely-printed dollars, “we” will do that as much as possible.

Returning to the main story, peak conventional oil production occurred in 2005.  This delivered a noticeable shock to our economy, before (and quite likely contributing to) the “Great Recession” (named prematurely, surely). Steve Kopits, at the time Managing Director at Douglas-Westwood, explained a year ago that in 2005 various mileposts suddenly appeared in the history of oil: conventional oil production peaked; vehicle miles per capita in the U.S. began declining; U.S. vehicles owned per capita began declining, and U.S. airline departures declined as well (see slides 16, 32, 33, 37).

From 2005 to now, what modest growth in world oil supply we have seen has been entirely due to “unconventional” oil – oil from shale formations, from oil sands, and from ultra-deep offshore wells. This is very expensive oil, and it comes with all sorts of problems. Some of what is produced from shale formations is so light it is not even “oil,” as that term used to be understood. (It produces very little diesel fuel.)  All this is “extreme oil,” desperate oil, last-resort oil.

And we can’t afford to pay for it, even with weak environmental and transportation standards, so for the moment it’s being slowly priced out. Meanwhile, depletion and rust never sleep.

The upshot after all the numbers are crunched is that the second, permanent, peak oil crisis will begin this year. We’ve been in the eye of the hurricane; the second eyewall is approaching. Long-time expert observer Ron Patterson succinctly explains why here, in the simplest of terms.  (Please read!)

Mushalik’s conclusion, which is complementary, is this (emphasis added):

Using the assessment of the Bank of Canada, production of affordable oil at price levels up to $75 has peaked or is at peak since the turning point of 2005. This means that the global economy cannot grow “normally” again.

Jeffrey Brown’s recent short commentary on this situation on Patterson’s blog is worth quoting here in its entirety, as it portrays in a few stark lines the gravity of our situation. I have underlined a few passages for emphasis.

The Supply Side

Global Crude Oil Production Probably Peaked in 2005. Based on some plausible estimates for global condensate production, it’s quite likely that actual global crude oil production (45 and lower API gravity crude oil) has not materially exceeded the 2005 annual rate, even as annual Brent crude oil prices averaged $110 for 2011 to 2013 (and averaged about $100 for 2014). In other words, global crude oil production probably peaked in 2005, while global natural gas production and associated liquids–condensate and natural gas liquids–have so far continued to increase. [details here]

High Decline Rate in Existing Global Oil Production. The IEA puts the underlying gross decline rate in existing oil wells worldwide at about 9%/year. At a 9%/year gross decline rate, to just maintain existing oil production for 11 years, the global industry would have to put on line the productive equivalent of every currently producing oil well in the world, over the next 11 years.

High Decline Rate in Existing US Natural Gas Production. Citi Research puts the underlying gross decline rate in existing gas production in the US at about 24%/year. At a 24%/year gross decline rate, in order to just maintain existing US gas production for four years, the US would have to put on line the productive equivalent of about 100% of current gas production over the next four years. As an example of why this is a reasonable estimate, the observed year over year decline in Louisiana’s marketed natural gas production from 2012 to 2013 was 20%; this was the net decline, after new wells were added. The gross decline rate from existing Louisiana wells in 2012 would be even higher.

High Decline Rate in Existing US Crude + Condensate (C+C) Production. Given the high and rising percentage of US oil production coming from high decline rate tight/shale plays, a plausible estimate is that the underlying gross decline rate from existing US oil wells may be on the order of about 20%/year, which would be consistent with the Citi Research gas estimate. In any case, at a 20%/year gross decline rate, in order to just maintain existing US oil production for five years, the US would have to put on line the productive equivalent of about 100% of current C+C production over the next five years.

Global Net Exports of Oil (GNE) Probably Peaked in 2005. GNE, defined as combined net exports from the (2005) Top 33 net oil exporters, have been below the 2005 annual rate of 46 MMBPD (million barrels per day, total petroleum liquids + other liquids, EIA data) for eight straight years. GNE fell to 43 MMBPD in 2013.

The Demand Side

China & India (Chindia) Consuming an Increasing Share of GNE. The volume of GNE available to importers other than China & India fell from 41 MMBPD in 2005 to 34 MMBPD in 2013.

Surge in Chinese Oil Imports. Credit Suisse reports that Chinese oil imports were up 10% overall for 2014, with late 2014 oil imports surging to a 13% year over year increase, from December, 2013 to December, 2014.

Possibly Temporary Decline in US Net Oil Imports Contributed to Oil Price Decline. Based on four week running average data, US overall net oil imports fell from 6.2 MMBPD in the week ending 6/13 to 4.7 MMBPD in the week ending 11/07, a decline of 1.5 MMBPD in the US demand for net imports of oil over a five month period, putting considerable downward pressure on oil prices, However, US net imports have recently rebounded, hitting 5.9 MMBPD in early January, and most recently US net oil imports were at 5.7 MMBPD in the week ending 1/23 (all four week running average data). A significant increase in US liquids consumption has probably contributed to a rebound in net oil imports. The most recent EIA data show that US liquids consumption is up by almost one MMBPD from the same time a year ago.

Record Global & US Car Sales in 2014. US and global light vehicles sales hit record levels in 2014, and a plausible estimate is that the net increase in global light vehicles is running at about one million new vehicles per week (net being new vehicle sales less vehicles scrapped). In contrast, during the 2008 to 2009 oil price decline, global vehicle sales fell from 2007 to 2009, before rebounding in 2010.

It might be interesting to relay to you that the Department of Energy (DOE) also predicts a (flattish) peak in U.S. crude oil production, this spring.

Gail Tverberg’s commentary on our situation is also quite useful (“Oil and the Economy: Where are We Headed in 2015-16?”). Many people like her less quantitative approach, which includes questions nobody has answers for.

To see how deep we are into this turning point let’s go back to 2005, when not only did conventional oil production peak, and very likely crude oil production as a whole (ex condensate) peak, and also net oil exports peak, but also net C+C production peak, i.e. C+C production net of the oil used to produce the oil, which will amount to a small percent of production. That is, the oil (C+C) available to the non-oil economy peaked in 2005. A back-of-envelope calculation convinces me that peak net oil (C+C) per capita production also occurred in 2005, as did net oil (C+C) per dollar of world GDP.

There are many excellent analyses I could have cited here. As to what it “means,” and what will “happen,” who knows?

But meanwhile I encourage all to consider the reality that oil is going to start gradually leaving us, almost certainly this year, regardless of what happens from this point forward with price or demand.  And what that means is that oil is leaving some of us first, in domestic and in foreign policy terms.

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