George Monbiot recently made a major about-face on his peak oil stance, on the grounds that unconventional oil represents a new reality. The basis of his u-turn is a recent report on unconventional oil by Leonardo Maugeri, (former) oil executive at Italy’s Eni, published at Harvard University, where Maugeri’s a Senior Fellow at the John Kennedy School, Belfer Center, which we discussed here at TAE in Unconventional Oil is NOT a Game Changer. Continue reading “Peak Oil: A Dialogue with George Monbiot”
National Photo Co. Fossil Fuel 1920
Washington, D.C. “Penn Oil and truck.”
Oil prices have been falling.
This is no surprise to us here at The Automatic Earth, as our position is that the 2008 price peak will stand for a very long time, and that the rise from the 2009 low has been a counter-trend rally. Prices of many assets have been moving with the ebb and flow of confidence, and therefore of liquidity, in this era of extreme financialisation, and commodities are no exception.
As we have pointed out many times, prices do not reflect the fundamentals of supply and demand in any particular industry. If they did so, equities and different commodities would not move in relative sychrony, yet they have often done so.
Instead, prices reflect a combination of general confidence (or lack thereof) and the perception of future scarcity or glut, whether or not that perception is, in fact, accurate. Commodities top on fear of shortages. When there is a perception of scarcity, speculators bid up the price in advance of what the fundamentals would justify at that time, as they did in the run up to the 2008 price peak.
When the speculative bubble bursts, the sector is dumped and the price collapses as speculation goes into reverse. In 2008, commodities in general fell 58%, and oil prices plunged 78% in five months as the financial crisis sucked liquidity out of the system and the perception of imminent scarcity disappeared.
With the temporary resurgence of confidence from the 2009 bottom, liquidity returned, and, increasingly, so did the perception of scarcity for commodities in general and for oil specifically. Prices were bid up again, although not to the previous high, even though analysts extrapolating the trend forward were calling for a much larger commodity price spike than 2008.
Commodity prices in general peaked in May 2011 and continue their retreat.
Confidence is ebbing as the scope of the financial crisis centred in Europe becomes increasingly evident, and vulnerabilities in other regions and sectors of the economy emerge. Even the Chinese juggernaut (the primary driver of commodity demand) is visibly faltering.
Retreating liquidity and persistent economic weakness act to undermine commodity prices further. This process is far closer to its beginning than its end. As the global credit bubble of the last thirty years implodes, we will be heading right in to the teeth of liquidity crunch, economic seizure and another deflationary Great Depression. Under such circumstances, we can expect demand to be weak for many years, and with falling demand will come falling price support.
At the same time, in the case of oil, we are seeing a sharp reversal of perception – from one of scarcity to one of glut – as pundits discuss how technological innovations, including horizontal drilling and hydraulic fracturing, will increase global supply dramatically. De-conventionalisation of oil supply is touted as the solution to peak oil for the foreseeable future.
Euphoria particularly surrounds the projections for US production, with talk of the country becoming both energy independent and an exporting powerhouse – a New Middle East.
Thanks to the technological revolution brought about by the combined use of horizontal drilling and hydraulic fracturing, the U.S. is now exploiting its huge and virtually untouched shale and tight oil fields, whose production although still in its infancy is already skyrocketing in North Dakota and Texas.
The U.S. shale/tight oil could be a paradigm-shifter for the oil world, because it could alter its features by allowing not only for the development of the worlds still virgin shale/tight oil formations, but also for recovering more oil from conventional, established oilfields whose average recovery rate is currently no higher than 35 percent.
The natural endowment of the initial American shale play, Bakken/Three Forks (a tight oil formation) in North Dakota and Montana, could become a big Persian Gulf producing country within the United States. But the country has more than twenty big shale oil formations, especially the Eagle Ford Shale, where the recent boom is revealing a hydrocarbon endowment comparable to that of the Bakken Shale. Most of U.S. shale and tight oil are profitable at a price of oil (WTI) ranging from $50 to $65 per barrel, thus making them sufficiently resilient to a significant downturn of oil prices.
World oil production capacity to 2020 (Crude oil and NGLs, excluding biofuels)
From: Maugeri, Leonardo. “Oil: The Next Revolution” Discussion Paper 2012-10, Belfer Center for Science and International Affairs, Harvard Kennedy School, June 2012.
The difficulty is that an analogous scenario has unfolded before, in the natural gas industry. Out of sync with other commodities, the boom and bust in natural gas is giving us a glimpse of the future for unconventional oil. The extraction techniques are the same ones that have generated tremendous hype, while simultaneously setting up a ponzi scheme in flipping land leases, creating the perception of supply glut, crashing the price of natural gas in North America to far below break-even, amplifying financial risk for increasingly indebted producers, and threatening to put those same producers out of business.
This is the dynamic that is set to lead North America into a natural gas supply crunch over the next few years, as we discussed recently in Shale Gas Reality Begins to Dawn.Those involved in unconventional oil would do well to take note.
The drilling costs are high, as are the decline rates (“While some have been able to yield as much as 1,000 barrels a day, the rate then falls off to 65 percent the first year, 35 percent the second, and 15 percent the third”), and the EROEI is very low in comparison with conventional oil. As with unconventional gas, which suffers from the same obstacles, the industry is set on an accelerating drilling treadmill in an attempt to grow equity by expanding the reserve base with the cash flow generated.
Continued expansion is necessary to maintain the perception of company value. In other words, the industry is based on ponzi dynamics. So long as prices hold up, we can expect it to continue, but if we look at the broader economic context in conjunction with the lessons derived from unconventional gas, there is every reason to expect that the production boom is temporary, precisely because these circumstances will generate a price collapse.
Estimates of the price required for the new supplies to be economic vary. The consensus appears to be that there is a sufficient price cushion to withstand a fall, but producers are not anticipating a major one. Unfortunately for them, we can expect the perception of glut, combined with deepening economic depression, to force prices down to the cost of the lowest price producer, and quite possibly lower, at least temporarily. Companies on the unforgiving drilling treadmill will be facing increasing financial risk, and over the next few years, as over-extended and over-indebted companies go out of business, we can expect a supply crunch to develop.
The timescale is difficult to predict, as there are many factors with different timeframes to consider. Large scale deleveraging, which is set to unfold over the next few years, will have a tremendous impact on project capital availability, on demand, and on the affordability of operating and maintaining existing infrastructure. It will also be very difficult to build out new oil transport infrastructure to cope with changing energy supply patterns. The infrastructure mismatch will put continued downward price pressure on North American oil in comparison with international supplies, reducing the fungibility of oil.
North America has a long history of oil production and processing. Decades of producing oil and consuming lots of petroleum products have left the continent with a pretty good system of pipelines and refineries but pipelines are annoyingly stagnant things that tend to stay where you build them. And it turns out that the pipelines of yesterday are in the wrong places to serve the oil fields and refineries of today.
America’s oil infrastructure was built around two inputs some domestic production and large volumes of imports. You see, while the Middle East may be the biggest producer of crude oil in the world, most of the refining occurs in the United States, Europe, and Asia. There are two reasons for this. The first is that it’s easier to ship massive volumes of one product (crude oil) than smaller volumes of multiple products (gasoline, diesel, jet fuel, and so on). The second reason is that refineries are generally built within the regions they serve, so that each facility can be tailored to produce the right kinds and amounts of petroleum products for its customers…
…Remember how the US’s oil pipelines were designed primarily to move refined products from the Gulf region and the coastal refineries to inland customers? Well, those pipelines of yesterday now run the wrong way.
The production boom in shale oil has momentum, and that is likely to carry on for some time, even in the face of sharply falling prices, as has been the case for natural gas. The rig count in shale oil production is skyrocketing, even as the rig count for natural gas falls, and production lags rig count.
The quantity of recoverable oil has been considerably hyped, and this resource is not going to represent a game-changer. In fact it would not even if we were not facing economic circumstances set to crash production.
The estimated amount of oil in place (the resource) varies widely, with some suggesting that there could be 400 billion barrels of oil in the Bakken. Because of advances in fracking technology, some of the resource has now been classified as reserves (the amount that can be technically and economically produced). However, the reserve is a very low fraction of the resource at 2 to 4 billion barrels (although some industry estimates put the recoverable amount as high as 20 billion barrels or so). For reference, the U.S. consumes a billion barrels of oil in about 52 days, and the world consumes a billion barrels in about 11 days.
In addition, the enormous number of expensive wells required would takes decades to drill with the rigs available, even if considerable efforts were made to increase their number, meaning that the oil that is there would be produced very slowly.
Beyond the shale oil of the Bakken in North Dakota or the Eagle Ford in Texas, there are other forms of unconventional oil that form part of the North American production boom hype.
Robert Rapier again:
When some people speak of hundreds of billions or trillions of barrels of U.S. oil, they are most likely talking about the oil shale in the Green River Formation in Colorado, Utah, and Wyoming. Since the shale in North Dakota and Texas is producing oil, some have assumed that the Green River Formation and its roughly 2 trillion barrels of oil resources will be developed next because they think it is a similar type of resource. But it is not.
The prospects for some of these are significantly worse than for shale oil, especially where the EROEI is even lower. Colorados oil shale in particular is unlikely ever to amount to much. While shale oil is a liquid hydrocarbon trapped in low permeability source rock, which can be liberated through fracking, oil shale is not a liquid at all, but solid kerogen that requires tremendous energy inputs to be separated from the source rock. Those required energy inputs mean a rock-bottom EROEI. Costs in monetary terms are sky-high as well.
To generate liquid oil synthetically from oil shale, the kerogen-rich rock is heated to as high as 950 degrees Fahrenheit (500 degrees Celsius) in the absence of oxygen, a process known as retorting.
There are several competing technologies for producing oil shale. Exxon Mobil has developed a process for creating underground fractures in oil shale, filling these cracks with a material that conducts electricity, and then passing currents through the shale to gradually convert the kerogen into producible oil. Royal Dutch Shell Plc buries electric heaters underground to heat the oil shale.
Although estimates of the cost to produce oil shale vary widely, the process is more expensive and energy-intensive than extracting crude from Canada’s oil sands. Producers would require oil prices of roughly $100 a barrel before this capital-intensive process would be feasible on a commercial scale.
Shale oil may have an EROEI of approximately 4, while tar sands would come in at 3 and oil shale would be 2 or less.
Cutler J. Cleveland and Peter O’Connor – A comparison of estimates of the energy return on investment (EROI) at the wellhead for conventional crude oil, or for crude product prior to refining for oil shale
Humans are prone to grasp at straws and believe in fantasies rather than face unpleasant realities. Believing that unconventional fossil fuels can maintain business as usual is a fantasy. We cannot run our current complex society on low EROEI energy sources.
We are still facing peak oil, and, on the downslope of Hubberts Curve, we will be running faster and faster on our accelerating treadmill just to slow the decline in supply. Unconventional supplies with lower and lower EROEI are not going to change that picture, and the crash of prices that will happen thanks to economic depression will aggravate the situation considerably in the short term. We can expect prices to fall faster than the cost of production, and many corporate casualties to emerge as boom turns to bust, as it always does.
The next few years will be remembered for financial crisis, where it will be money in short supply rather than energy. As economic contraction proceeds, and purchasing power falls substantially due to the collapse of the money supply, demand for energy will – temporarily – fall a long way. Beyond that, as the deleverging comes to an end and the economy begins to stabilize somewhat (probably between five and ten years down the line), we are likely to see a supply crunch develop.
With that we are likely to see a major price spike, and the potential for resource wars will grow dramatically. Oil is liquid hegemonic power, and conflict can be expected to develop when it is perceived to be scarce. Thats not where we find ourselves today, but it is where the future is taking us.
The ending of extend-and-pretend is ushering in a new era of fear and uncertainty which is rapidly evolving into the next phase of the on-going credit crunch.
It is becoming clearer to many that the problems run much deeper than they had perceived, and more people all the time are realising the systemic nature of the risks we are facing. Fear leads to knee-jerk reactions. In financial markets, it leads to volatility and self-fulfilling prophecies to the downside. It leads to capital flight, and then to capital controls. Continue reading “Capital Flight, Capital Controls, Capital Fear”
The video Sunshine and Eclipse is a must see for anyone interested in economic history, and in the psychology of economics in the real world (as opposed to the ivory tower of modern neo-classical economics). The documentary is describing Canada in the period between 1927 and 1934, in other words, in the euphoric phase of the Roaring Twenties bubble and the credit implosion of the 1930s.
It is of far broader interest than Canada, however. It is fascinating to look at the insatiable optimism of the Twenties, the commodity boom, the expansion of trade and the sense that human beings had overcome adversity and created ever-lasting prosperity. In fact, the Roaring Twenties were simply a rediscovery of leverage, as are all credit bubbles. Continue reading “Then and Now: Sunshine and Eclipse”
This is the 1000th post at The Automatic Earth, so it seems appropriate to review our message and update our projections – to look back and then look forward. Since the beginning of TAE in January 2008, and before that at The Oil Drum Canada, our purpose has consistently been to warn people that a decades-long credit expansion is ending, and that, as a consequence, we are in the grip of a very serious financial crisis.
The first leg down (October 2007- March 2009) was just a foretaste of what credit crunch really means, and the long sucker rally has been enough to put people back to sleep again, secure in the mistaken belief that supposedly omnipotent central bankers could postpone any kind of reckoning indefinitely.
Financial bubbles are not a new phenomenon, but are in fact quite common in the historical record. Every few decades, a new generation rediscovers the magic of leverage, igniting a rapid expansion of credit, and therefore debt. Every time humanity experiences a bubble, it fails to recognise the pattern.
The lessons of the past are sadly never learned. Each time the optimism is highly contagious. In the larger episodes, it crescendos into euphoria, leading societies into a period of collective madness where risk is embraced and caution is thrown to the wind. Sky-high valuations are readily rationalised – it’s different here, it’s different this time.
We come to believe that just this once there might be a free lunch, that we can have something for nothing. We throw ourselves into ponzi finance, chasing the mirage of speculative gains, often through highly questionable and outright fraudulent practices. Enron, Lehman Brothers, and recently MF Global, are but a few egregious examples of what has become an endemic phenomenon.
The increasing focus on chasing speculative profits parasitizes the real economy to a greater and greater extent over time. After all, why work hard for small profits in the real world, when profits on money chasing its own tail are so much greater for so little effort?
Who even notices the hollowing out of the real economy, or the conversion of large amounts of capital into waste, or the often pointless depletion of non-renewable resources, or the growing structural dependency trap, when there is so much short term material prosperity to pursue? Continue reading “Look Back, Look Forward and Look Down. Way Down”
Chris Martenson recently posted a rebuttal to the deflationist take on commodities – Commodities Look Set to Rocket Higher. In contrast, our deflationary view here at The Automatic Earth, written at the end of August, is encapsulated in Et tu, Commodities?. To recap, our position is that commodity prices are coming off the top of a major speculative episode and consequently have a very long way to fall.
That is how speculative periods always resolve themselves. We argue, however, that this does not mean commodities will be cheap, even at much lower prices than today, given that the implosion of the wider credit bubble will cause purchasing power to fall faster than price. This means affordability worsening even as prices fall. Continue reading “October 3 2011: Commodities and Deflation: A Response to Chris Martenson”
Our most consistent theme here at The Automatic Earth has been the developing deflationary environment and the knock-on effects that will follow as a result. Now that the rally from March 2009 appears to be well and truly over, it is time to revisit aspects of the bigger picture, in order for people to prepare for a full-blown liquidity crunch. October 2007-March 2009 was merely a taster.
As we have explained before, inflation and deflation are monetary phenomena – respectively an increase and decrease in the supply of money plus credit relative to available goods and services – and are major drivers of price movements. They are not the only price drivers, to be sure, but they are usually the most significant. People generally focus on nominal prices, when understanding price drivers is far more important. A focus merely on nominal price also obscures what is happening to affordability – the comparison between price and purchasing power.
We have lived through some 30 years of inflationary times, since the financial liberalization of the early 1980s under Reagan and Thatcher initiated the era of globalization. Money freed from capital controls was free to look for opportunities worldwide, and the resulting global economic boom greatly increased trade, resource consumption, financial interconnectedness and the multiplier effect for monetary expansion. Continue reading “Et tu, Commodities?”
The nature of markets has long been a major focus here at The Automatic Earth. Whereas most commentators treat markets as being driven in some kind of rational fashion by external events, we have concentrated on the irrational endogenous dynamics and the role of sentiment in creating the perceptions that drive positive feedback loops – either virtuous or vicious circles. Sentiment, and therefore perception, can change very abruptly, with far-reaching effects. The events of this past week or so have been a prime example. Continue reading “Over the Edge Lies Fear”
In this era of global bubble-blowing we have seen speculative fever flourish in relation to many different asset classes. At the peak of a bubble the euphoria can be palpable, and the perception that ‘it’s different this time’ confers a sense of invulnerability that justifies throwing caution to the wind.
Speculators cease to worry about how much they pay for an asset, since they think someone else will always pay more later. Unfortunately for those caught up in powerful swings of herding behaviour, it’s never different this time. Boom inevitably turns into bust, because the supply of Greater Fools is not infinite after all.
Speculative financial flows seeking ‘alpha’ can overwhelm important sectors of the real economy. Price, driven by perception rather than by reality, significantly over-reaches the fundamentals. Demand is artificially brought forward. That apparent demand drives considerable mal-investment and a pathological level of risk-taking. When the bubble reaches its maximum extent and implodes, speculation moves into reverse and the sector is dumped.
The artificial demand stimulation disappears, leaving a demand vacuum. The scale of the mal-investment becomes obvious, and prices head for a significant undershoot of the fundamentals. A bubble that created virtual wealth temporarily, leaves very real economic wreckage in its wake. When a critical economic sector is affected, the fallout can be very painful. Continue reading “Get Ready for the North American Gas Shock”
Some time ago, Gonzalo Lira wrote a couple of interesting pieces on hyperinflation, and I promised to respond to them. This has taken me a while, as there is much material to go through, many arguments to pick apart, areas of agreement and disagreement, differences in definitions and matters of timing. The first article, How Hyperinflation Will Happen, is a long, thoughtful and detailed piece that I found interesting. There are many aspects I fundamentally disagree with, however, some for reasons of substance and others for reasons of timing.
Essentially the central proposition is that the US dollar is in danger of imminent demise due to a widespread loss of confidence, and that treasuries will be dumped en masse within a year, leading to hyperinflation, by which Mr Lira means price spikes. I do not see a loss of confidence in the dollar going forward, at least not soon. We have seen a long slide in the value of the dollar coincident with the rally in stocks. This is a reflection of a resurgence of confidence in being invested rather than being liquid, but this confidence is fragile and subject to rapid reversal. Continue reading “Debunking Gonzalo Lira and Hyperinflation”