Detailed Discussion of Oil and Gas Trends, Prices and Future Production

Credit to: Gail Tverberg, of: Our Finite World.  THIS IS A GLOBAL PERSPECTIVE OF OIL AND GAS PRODUCTION.     Boothe Global Perspectives consider her work excellent and pass it on as an excellent resource to oil and gas executives and planners. We credit her for most of the research of this article, but have made some editorial inserts along the way to deepen the perspective. 

The standard way to make forecasts of almost anything is to look at recent trends and assume that this trend will continue, at least for the next several years. With world oil production, the trend in oil production looks fairly benign, with the trend slightly upward.

If we look at the situation more closely, however, we see that we are dealing with an unstable situation. The top ten crude oil producing countries have a variety of problems.

Middle Eastern producers are particularly at risk of instability, thanks to the advances of ISIS (ISIL), conflicts in Gaza/Israel and the large number of refugees moving from one country to another.

Of the 10 world's biggest oil producers, with the USA the world's biggest consumer, 5 of them are hostile to the United States. This would suggest that the USA should consider three things: 1. Improvement of relations   2. Find new production sources through research and technology   3. Make massive investment and incentives available to renewable and 'non carbon' energy industries, to build a nation, independent of foreign sources for energy. 

Now take a look at U.S. production, which, if not for "Fracking", would be going down. In this chart "tight" would refer to natural gas.  (Note: Fracking may prove to be a short term flash in the pan, because the average well production shows significant declines after 5 years). 

Relatively low oil prices are part of the problem as well. The cost of producing oil is rising much more rapidly than its selling price, as discussed in my post Beginning of the End? Oil Companies Cut Back on Spending. In fact, the selling price of oil hasn’t really risen since 2011 because citizens can’t afford higher oil prices with their stagnating wages.

The fact that the retail selling price of oil remains flat tends to lead to political instability of oil exporters because they need retail sales to collect taxes required to provide programs needed to pacify their people (food and fuel subsidies, infrastructure, roads, schools, expanded research on new energy sources, water provided by desalination, jobs programs, etc.). Low oil prices make the plight of oil exporters with declining oil production worse, including Russia, Iran , Mexico, and Venezuela. Other nations such as Ecuador, send most of their production to the USA and need the hard currency to support their economies. Strangely of these four nations, the USA has bad relations with Russia, Mexico, Iran, Venezuela and Ecuador. One might think that the U.S. State Department would work on this, and except for Russia, better relations with is very feasible for most of them. Recently, the US and Iran have found common interests in opposing ISIS, and we are hopeful that this may bring a better relationship between these two nations. 

Many people when looking at future oil supply concern themselves with the amount of reserves (or resources) remaining, or perhaps Energy Return on Energy Invested (EROEI). None of these is really the right limit, however. The limiting factor is how long our current networked global economic system can hold together. There are lots of oil reserves left, and the EROEI of Middle Eastern oil is generally quite high (that is, favorable). But instability could still bring the system down. So could popping of the US oil supply bubble through higher interest rates or more stringent lending rules.

The Top Two Crude Oil Producers: Russia and Saudi Arabia. We see that Russia’s crude oil production tends to be a lot smoother than Saudi Arabia’s. We also see that since the third quarter of 2006, Russia’s crude oil production tends to be higher than Saudi Arabia’s.

Both Russia and Saudi Arabia are headed toward problems now. Russia’s Finance Minister has recently announced that its oil production has peaked and is expected to fall, causing financial difficulties for Russia. Russia is already facing other financial issues and new international sanctions will gradually increase Russian woes. In fact, if we look at monthly EIA data, we see that November 2013 is the highest month of production, and that every month of production since that date has dropped from this level. So far, the drop in oil production has been relatively small, but when an oil exporter is depending on tax revenue from oil to fund government programs, even a small drop in production (without a higher oil price) is a financial problem.  Some oil industry experts believe that Russia's brinkmanship in Ukraine may be distracting the people of Russia from economic issues. 

Notice that Iran's production has dropped, Russia has started dropping, but China's production is increasing.  There are several implications, with Russia perhaps wanting to put pressure on Europe and the Ukraine, Iran having internal infrastructure problems and political issues and also wishing to drive prices up to hurt the West and to increase Iran's hard currency.  China, is in need of cash during a time of recession or slow recovery. Plus China is facing a huge fiasco of vacant overbuilt commercial buildings and may see a massive disaster requiring billions of dollars of public cash to save the nation from a depression. China needs cash. The complex possible reasons and variables are almost like a game of darts, impossible to fully know and understand. 

Keeping Oil Production From Falling

Saudi Arabia’s quarterly oil production is quite erratic, compared to oil production of Russia. Part of the reason Saudi Arabia’s oil production is so erratic is that it extends the life of its fields by periodically relaxing (reducing) production It also reacts to oil price changes–if the oil price is too low, as in the latter part of 2008 and in 2009, Saudi oil production drops. The tendency to jerk oil production around gives the illusion that Saudi Arabia has spare production capacity. It is doubtful at this point that it has much true spare capacity. It makes a good story, though, which news media are willing to repeat endlessly.

Saudi Arabia has not been able to raise oil exports for years. It gained a reputation for its oil exports back in the late 1970s and early 1980s, and has been able to rest on its laurels. Its high “proven reserves” (which have never been audited, and are doubted by many) add to the illusion that it can produce any amount it wants. There are reports of needed infrastructure upgrades in Saudia Arabia's oil industry.  This is also true of Russia and Iran.

In 2013, oil exports from Russia were equal to 88% of Saudi Arabian oil exports. The world is very close to being as dependent on Russian oil exports as it is on Saudi Arabian oil exports. Most people don’t realize this relationship. It has political implications, and all of Central and Western Europe understands this clearly. American interests have been trying to get Europe to open up to fracking, to make them less dependent on Russia. But this could hurt US Exports of natural gas to Europe, and still much resistance in Europe to fracking.

The current instability of the Middle East has not hit Saudi Arabia's political structure yet, but there is increased fighting all around. Saudi Arabia is not immune to the problems of the other countries. According to BBC, there is already a hidden uprising taking place in eastern Saudi Arabia. Saudi Arabia, the USA and Iran all benefit from peace and stability and will spend much to achieve stability.

US Oil Production is a Bubble of Very Light Oil, (or natural gas from the Fracking boom).

The US is the world’s third largest producer of crude and condensate. Recent US crude oil production shows a “spike” in tight oil productions–that is, production using hydraulic fracturing, generally in shale formations.

If we look at recent data on a quarterly basis, the trend in production also looks very favorable, but it is short term since these "fracked" wells tend to only havw good production for an average of 5 years. 

There are many issues with the new production:

- The new production is so “light” that a portion of it is not what we use to power our cars and trucks. The very light “condensate” portion (similar to natural gas liquids) is especially a problem.

- Oil refineries are not necessarily set up to handle crude with so much volatile materials mixed in. Such crude tends to explode, if not handled properly.

- These very light fuels are not very flexible, the way heavier fuels are. With the use of “cracking” facilities, it is possible to make heavy oil into medium oil (for gasoline and diesel). But using very light oil products to make heavier ones is a very expensive operation, requiring “gas-to-liquid” plants.

- Because of the rising production of very light products, the price of condensate has fallen in the last three years. If more tight oil production takes place, available prices for condensate are likely to drop even further. Because of this, it may make sense to export the “condensate” portion of tight oil to other parts of the world where prices are likely to be higher. Otherwise, it will be hard to keep the combined sales price of tight oil (crude oil + condensate) high enough to encourage more tight oil production.

The other issue with “tight oil” production (that is, production from shale formations) is that its production seems to be a “bubble.” The big increase in oil production (Figure 6) came since 2009 when oil prices were high and interest rates were very low. Cash flow from these operations tends to be negative. If interest rates should rise, or if oil prices should fall, the system is likely to hit a limit. Another potential problem is oil companies hitting borrowing limits, so that they cannot add more wells.

Without US oil production, world crude oil production would have been on a plateau since 2005.

Canadian Oil Production is important.

The other recent success story with respect to oil production is Canada, the world’s fifth largest producer of crude and condensate. Thanks to the oil sands, Canadian oil production has more than doubled since the beginning of 1994.

There are environmental issues with respect to both oil from the oil sands and US tight oil. When we get to the “bottom of the barrel,” we end up with the less environmentally desirable types of oil and energy. This is part of our current problem, and one reason why we are reaching limits. Culturally, oil producers have opposed renewable energy such as Wind, Solar and conservation measures.  Time, resources, population growth and demand for energy will ultimately assure vast expansion of renewable energy, and the USA is well positioned to be a leader in Wind and Solar energy production.

Oil Production in China, Iraq, and Iran:

In the first quarter of 2014, China was the fourth largest producer of crude oil. Iraq was sixth, and Iran was seventh. Consider the oil production of China and Iran.

As of 2010, Iran was the fourth largest producer of crude oil in the world. Iran has had so many sanctions against it that it is hard to figure out a base period, prior to sanctions. If we compare Iran’s first quarter 2014 oil production to its most recent high production in the second quarter of 2010, oil production is now down about 870,000 barrels a day. If sanctions are removed and warfare does not become too much of a problem, oil production could theoretically rise by about this amount. 

Keeping Oil Production From Falling

China has relatively more stable oil production than Iran. One concern now is that China’s oil production is no longer rising very much. Oil production for the fourth quarter of 2013 is approximately tied with oil production for the fourth quarter of 2012. The most recent quarter of oil production is down a bit. It is not clear whether China will be able to maintain its current level of production, which is the reason I mention the possibility of a decline in oil production.

The lack of growth in China’s oil supplies may be behind its recent belligerence in dealing with Vietnam and Japan. It is not only exporters that become disturbed when oil supplies are not to their liking. Oil importers also become disturbed, because oil supplies are vital to the economy of all nations. It is another reason for these nations to invest time, research and incentives into new types of transportation systems and new types of renewable energy. Japan "gets it" and is expanding solar energy development aggressively.

Thanks to improvements in oil production in Iraq, and sanctions against Iran, oil production for Iraq slightly exceeded that of Iran in the first quarter of 2014. However, given Iraq’s past instability in oil production, and its current problems with ISIS and with Kurdistan, it is hard to expect that Iraq will be a reliable oil producer in the future. In theory Iraq’s oil production can rise a few million barrels a day over the next 10 or 20 years, but we can hardly count on it. This is another problem created by ISIS.

Oil Price Problem that Adds to Instability:

There is a mismatch between (1) the price oil producers need to extract their oil and (2) the price consumers can afford or are willing to pay. The cost of extraction (broadly defined including taxes required by governments) keeps rising while “ability or willingness to pay” has remained flat since 2007. The inability or unwillingness of consumers to pay high prices for oil (because wages are not rising very much) explains why oil prices have remained relatively flat, even while there is fighting in the Middle East. High prices for energy and food, can quickly lead to social instability, as we have seen in recent years.

When the selling price is lower than the full cost of production (including the cost of investing in new wells and paying dividends to shareholders), the tendency is to reduce investment in new production, one way or another. This reduction can be voluntarily, in the form of a publicly traded company buying back stock or selling off acreage or property.  Often we see mergers, of two companies, only resulting in a much larger big weak company.

Alternatively, the cutbacks in production can be involuntary, indirectly caused by political instability. War of political dictatorships can cause this. Sometimes it is in opposition to oil production taxes in oil exporting nations. If the oil price remains too low, taxes collected tend to be too low, making it impossible to fund programs such as food and fuel subsidies, infrastructure, desalination plants, and jobs programs, and incentives to keep food and energy costs low for the public. Without adequate programs, there tend to be uprisings and civil disorder.

It is clear that in 2014, we are out in “Wile E. Coyote Territory.” The broadly defined cost of oil extraction (including required taxes by exporters) according to oil companies now exceeds the ability of consumers to pay for oil. As a result, oil prices barely spike at all, even when there are major Middle Eastern disruptions. Consumers see oil at prices above $100 per barrel and see massive profits of oil companies, and doubt that the oil companies are struggling.

The reason why Wile E. Coyote situation can take place at all is because it takes a while for the mismatch between costs and prices to work its way through the system. Independent oil companies can decide to sell off acreage and buy back shares of stock but it takes a while for these actions to actually take place. Furthermore, the mismatch between needed or desired oil prices and charged oil prices tends to get worse over time for oil exporters. This lays the groundwork for increasing dissent within these countries.

With oil prices remaining relatively flat, (except during times or social or war disruption) importers become complacent because they don’t understand what is happening. It looks like  they have no problem when, in fact, there really is a fairly big problem, lurking behind the scenes. For example, BootheCompanies was commissioned to purchase several million barrels of oil for import to another nation, and found that China and India had already purchased excess capacity around the globe for their internal needs.

To make matters worse, it is becoming more and more difficult to continue Quantitative Easing, a program that tends to hold down longer-term interest rates. The expectation is that the program will be discontinued by October 2014.

The reason why the price of oil has stayed as high as it has in the last several years is because of the effects of quantitative easing and ultra low interest rates.

If it weren’t for these policies many experts believe oil prices would fall, because consumers would need to pay much more for goods bought on credit, leaving less for the purchase of oil products. See the recent post, The Connection Between Oil Prices, Debt Levels, and Interest Rates.

Big credit related drop in oil prices that occurred in late 2008 is now being mitigated by Quantitative Easing and very low interest rates.

Because of the expectation that Quantitative Easing will end by October 2014 and the pressure to tighten credit conditions, my expectation is that the affordable price of oil will start dropping in late 2014.  The growing disparity between what consumers can afford and what producers need tends to make the Wile E. Coyote overshoot condition even worse. It is likely to lead to more problems with instability in the Middle East, and a collapse of the US oil production bubble.

Conclusion:

We live in a networked global economy and this fact changes the way economic models work. Many people have developed models of future oil production assuming that the appropriate model is a “bell curve,” based on oil depletion rates and the inability to geologically extract more oil. Unfortunately, this is not the right model. Ben Boothe has said: "If the U.S. sneezes, Europe catches a cold. If China coughs, Asia cover's it's face." A global economy has efficiency but also carries with it global risks.

The situation is far more complex than simple geological decline models assume. There are multiple limits involved–prices needed by oil producers, prices affordable by oil importers, and prices for other products, such as water and food, and social stability. Interest rates are also important. There are time lags involved between the time the Wile E. Coyote situation begins, and the actions to fix this mismatch takes place. It is this time lag that tends to make drop-offs very steep.

The Changing Face of World Oil Markets

The fact that we are dealing with political instability means that multiple fuels are likely to be affected at once. Clearly natural gas exports from the Middle East will be affected at the same time as oil exports. Many other spillover effects are likely to happen as well. US businesses without oil could potentially, in bad situations have to cut back on operations. This could lead to job layoffs and reduced electricity use. With lower electricity demand, prices for electricity as well as for coal and natural gas will tend to drop. Electricity companies will increasingly face bankruptcy, and fuel suppliers will reduce operations. 

Thus, we cannot expect decline to follow a bell curve. The real model of future energy consumption crosses many disciplines at once, making the situation difficult to model. The Reserves / Current Production model gives a vastly too high indication of future production, for a variety of reasons–rising cost of extraction because of diminishing returns, need for high prices and taxes to support the operations of exporters, and failure to consider interest rates.

The Energy Return on Energy Invested model looks at a narrowly defined ratio–usable energy acquired at the “well-head,” compared to energy expended at the “well-head” disregarding many things–including taxes, labor costs, cost of borrowing money, and required dividends to stockholders to keep the system going. All of these other items also represent an allocation of available energy. A multiplier can theoretically adjust for all of these needs, but this multiplier tends to change over time, and it tends to differ from energy source to energy source.

The EROEI ratio is probably adequate for comparing two “like products”–say tight oil produced in North Dakota vs tight oil produced in Texas, or a ten year change in North Dakota energy ratios, but it doesn’t work well when comparing dissimilar types of energy. In particular, the model tends to be very misleading when comparing an energy source that requires subsidies to an energy source that puts off huge tax revenue to support local governments.

When there are multiple limits that are being encountered, it is the financial system that brings all of the limits together. Furthermore, it is governments that are at risk of failing, if enough surplus energy is not produced. It is very difficult to build models that cross academic areas, so we tend to find models that reflect “silo” thinking of one particular academic specialty. These models can offer some insight, but it is easy to assume that they have more predictive value than they do.

Unfortunately, the limits we are reaching seem to be financial and political in nature. If these are the real limits, we seem to be not far away from the simultaneous drop in the production of many energy products. This type of limit gives a much steeper drop off than the frequently quoted symmetric “bell curve of oil production.” The shape of the drop off corresponds to (1) the type of drop off experienced by previous civilizations when they collapsed, (2) the type of drop-off I have forecast for world energy consumption, and (3)Ugo Bardi’s Seneca cliff. The 1972 book Limits to Growth by Donella Meadows et al. says (page 125), “The behavior mode of of the system shown in figure 35 is clearly that of overshoot and collapse,” so it tends to come to the same conclusion as well.

The Appraisers tell us that a collapse in lending, or a troubled economic system could devestate values of all types of properties, creating risk of a global recession. Thus it becomes obvious that massive efforts to diversify, expand and create new "non carbon" energy sources, independent of both the economic system and of foreign imports for oil and gas be developed, to provide some hedge and an insurance against a possiblity of future debilitating economic issues. 

By Gail Tverberg,  of Our Finite World and additional research edits and comments by: The Boothe Companies