Saturday, August 7, 2010

Different takes on peak oil, same result – price spikes predicted

Two must-read interviews with energy market investors both point to a coming demand-driven spike in oil prices, despite professing differing views on peak oil.

Rick Rule, founder of Global Resource Investments, Ltd., speaks of “sharply higher world oil prices in the next 5 years,” and Charles Maxwell, senior energy analyst for Weeden & Co. that “oil will reach at least $150 a barrel around 2015.” It’s interesting that, despite professing different takes on the concept of peak oil, they end up at remarkably similar conclusions about demand outstripping supply within the next few years.


Different takes on peak oil, same result – price spikes predicted

Peak oil relates to the seemingly reasonable notion that output of a non-renewable resource will someday decline, with the вЂpeak’ being the time of highest production that cannot subsequently be beaten. Shell geoscientist M. King Hubbert (left) beginning in the 1950s, showed that oil output can be plotted as a bell curve; this relates to individual wells, regions and the world as a whole. It becomes a political issue over the questions of when this will happen, and how the world’s remaining oil should be handled. Nevertheless it’s an economic argument as much as anything, as the notion of peak oil essentially relates to peak cheap oil, as there will be a great deal of hard-to-reach oil still underground for centuries to come.

Currently, the global demand for oil is approaching its 2008 high of 86.6 million barrels a day, with the International Energy Agency (IEA) predicting it will reach 90-92 million barrels per day by 2015. Meanwhile, output is falling outside of Opec, and the IEA speculates that Opec spare capacity – their ability to quickly bring extra oil onto the market – is also dwindling. According to the IEA, “Effective OPEC spare capacity in this scenario begins to decline again as soon as next year, reaching 3.6 mb/d by 2015.”

Both Rick Rule and Charles Maxwell see oil as unsustainable, even though Rule is looking more at lack of investment and geopolitical instability, and Maxwell more at the restricted oil supply. Ultimately, neither view opposes the other.

The Gold Seek item, Interview: Rick Rule on Oil & Gas vs. Green Energy, contains a wealth of information about likely future demand for, and supply of, hydrocarbon energy sources.

Rule makes keen observations about the national oil companies, operated by sovereign governments, that are in the main “diverting substantial amounts of the cashflow from their domestic oil industries into other domestic spending programs that aren’t oil related, thereby starving their domestic oil industry of sustaining capital.” He sees this as the reason for declining output:

The consequence of that is that several countries, particularly Mexico, Venezuela, Peru, Indonesia and perhaps Iran, will cease to be oil exporters within 5 years, even if they start spending now, which they aren’t able to do. The impact of that is that as much as 20% of world export crude will come off of export markets and that could lead to a truly precipitous increase in price. The only hope that oil import countries have is that sustaining capital investments have increased in Saudi Arabia, the United Arab Emirates and Kuwait. These three countries, with the help of a resurgent Iraq (if it does resurge), are the importing countries’ only hope for moderated oil prices in the next 5 years. It’s my belief that production declines as a consequence of a lack of reinvestment will be greater than the production adds and I suspect we will see sharply higher world oil prices in the next 5 years.

Neither can he see the above named countries constraining their own domestic demand “in time to prevent an oil price shock.”

Notably, Rule regards the Canadian oil sands as a “geopolitical benefit,” while noting the barriers to massively ramping up production – essentially the supply of energy and water, as steam must be pumped into the reservoirs to force the bitumen out. He observes that the industry is currently riding high on historically low North American natural gas prices and leniency over its water use. As he sees it, “The industry has to address the fact that it has improperly treated water for a long period of time and it consumes much more water at lower input prices than it ought to.” It will also have to pay more attention to recycling water used in the mining process. He continues:

In an ideal world, one would build about 2 GW of nuclear capacity at the Athabasca oil sands in Northern Alberta, which is the largest oil sands basin in the world, because the byproduct of a nuclear power plant is steam. The steam from 2 GW of nuclear capacity would be worth about a quarter of a billion dollars annually. In other words, you would sell your waste product for a quarter of a billion dollars and the cash flow from the waste (steam) would amortize most of the construction cost of the power plant and the power that would be generated would back out all of the natural gas fired power used in the province of Alberta, freeing all of that gas for export or other uses (other than generating steam for the oil sands). Unfortunately, that set of circumstances isn’t politically appropriate. Right now, what happens in the oil sands business is that, because oil commands a higher premium as a consequence of its easy conversion into a motor fuel compared with natural gas, the process involves an arbitrage between high oil prices and low gas prices. Enormous amounts of energy are consumed to produce energy.

Rule cannot see North American natural gas prices remaining at such low levels for long, mostly due to the deepwater drilling embargo, but he can imagine a time when vehicles are run on natural gas. (As an aside, an interesting study published on The Oil Drum, Europe and Natural Gas - Are Tough Choices Ahead?, suggests that – for Europe at least – there “may be a shortfall in supply very soon, especially if sufficient new sources of supply are not found, or if natural gas is used as a substitute for other energy sources.” Many peak oil writers are beginning to question whether gas reserves are enough to make it the logical transition fuel that it first appears.)

Having said that, Rule sees the coming transition away from oil as an expensive process, with both gasoline and natural gas set to get much more expensive. As he sees it: “Oil prices will move up dramatically in the next 5 years. The transition from a hydrocarbon economy to some other type of economy will require massive investment in new technologies and I don’t think we will adapt quickly enough to avoid an escalation of oil and gas prices.”

Yet it’s interesting to note that Rule gives the following answer when asked what he thinks about “peak oil theory”:

Peak oil is more an economic and political phenomenon than it is a geological phenomenon. I think we’re past $40 peak oil but I don’t think we’re past $200 peak oil. There are technologies, as an example, miscible CO2 flooding to recover oil from allegedly depleted oil fields. There are new basins, albeit remote, frontier basins. There are new technologies that allow dry gas or LNG to be substituted for liquid oil. It’s an economic function because these technologies and substitutions require higher energy prices. At $200 oil, we’ve got lots of oil.

It’s quite disingenuous, really. He’s smart enough to know that peak oil theory does not postulate that all the world’s oil is about to run out: essentially, it’s the half way point, the end of cheap oil. While technology is making more oil accessible – more than Hubbert could have dreamed about – it doesn’t change the essential geological facts that a non-renewable resource cannot be extracted forever. Increasing use of technology did not prevent US domestic oil production from peaking, as predicted by Hubbert.

Meanwhile, the Seeking Alpha interview with fellow energy investor Charles Maxwell, Why We'll See $300 Oil by 2020, gets straight to the point about peak oil.

Maxwell starts off by talking how the US stockpile of petroleum products is high right now, probably as financial institutions are looking for a sound investment – which itself indicates that people consider it’s likely to rise in value – but that he sees a “tightening in the oil market” beginning around 2013. Led by driving demand from China, he sees oil demand passing supply by 2015.

He states that he still maintains his Business Week prediction from May this year of a coming dramatic spike in the price of oil:

Wall Street hasn't accepted yet that the oil reserves are so limited. I think oil will reach at least $150 a barrel around 2015; it could go to $300 by 2020. In the short term, my forecast for 2010 is $77 a barrel. (For 2011, my forecast is $75 a barrel.) I can't see an apparent good reason why oil rose from $67 last September to $87 this April. I'm not surprised oil prices are back down—the market was self-correcting.

(Many peak oil writers consider that demand destruction will keep the price of oil somewhere in the $150 to $200 range, just as the 2008 economic collapse drove down oil prices – the key term here is volatility, as the price of oil is likely to ricochet around.)

Maxwell regards Canada's Athabasca Oil Sands as a far greater source than US shale oil (“my geological research indicates that these fields are not perhaps as good as some people suggest.”), with this shale oil likely to peak within the next nine to 12 years. He does not regard that as immediate as it sounds:

Well, that's a good long time, because, as I calculated, we are in a lot of trouble in energy in the United States and around the world by about 2012-2015. That's where we can see the waves coming towards shore, and now we're scared. Then they hit shore around 2015, and I think we will have peak oil for three or four years—a plateau in the late вЂteens.

But by 2020, I expect that we will actually slip off the edge of that plateau, and as a world, we will have started slowly downwards. Each year we'll have some tiny percentage lower production than the year previous. At first it will start with maybe a 0.25 percent decrease. But in theory, we'd still have say, 1 percent per year increase in population and in wealth (as defined by trucks and cars), and so on.

So we'll have a theoretical demand for more oil, but we won't have the equivalent supply.

He sees the peaking of oil followed by that of gas and, hundreds of years later, of coal. The greatest dangers are psychological, he believes. However, he’s positive: “By 2025, people will begin to start understanding.”

It's interesting that both economists predict similar outcomes, despite taking different routes to get there. Either way we look at it, we are looking at a coming transition.

Jim Wright is Nashville Chamber’s Partnership 2010 co-chairmanEIA: From forecast of oil supply abundance to decade of stagnation

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