Welcome to the age of diminishing returns

Thursday, October 24, 2013

Crude oil: another collapse ahead?


Oil prices have been showing a downward trend, recently. Is this the start of a new collapse of the oil market?
(image above from oil-price.net)


In January 2008, I was writing on the blog of ASPO-Italy that, "...[oil] prices could very well increase over $100 per barrel and even much more, but will continue to be extremely volatile. A temporary collapse would be nothing to be surprised about, in which case everyone will say that the oil crisis was a hoax. For a while.(translated from Italian)

As you can see in the graph below (from Stuart Staniford's "Early Warning" blog), I was right: I had foreseen both the price spike and the subsequent collapse. I was right also in several other predictions about the oil market that I made in early 2008 (as reported here, in Italian). 



In making these predictions, I was not using a special crystal ball; just ordinary common sense. Oil prices and production, as in all markets, are determined by the interaction of offer and demand. In the case of non renewable resources, such as oil, offer is affected by depletion which makes the resource gradually more expensive as it is extracted. As a consequence, prices increase in order to maintain the profits of producers. But there is a limit to what customers can afford to pay. That was the cause of the 2008 spike: prices went above that level; demand collapsed and with it prices.

After the big spike, the oil market managed to rebound; prices returned to high levels and production reached new highs. During the past few years we saw the development a nearly static situation in which oil producers managed to obtain profits high enough to keep production increasing- but not at prices so high to bankrupt their customers (not right away, at least). But how long can this stasis last? Not forever, because resources are being gradually depleted and production costs can only keep increasing. 

That is true also for the "non conventional" fossil resources, which have been the main factor that has permitted to the industry to avoid a decline in production. These resources are expensive to produce and their booming phase may be already over. This is almost certainly the case for shale gas (see here, and here) and possibly also for shale oil (see here). With several of the world's economies in deep trouble, today we have the right conditions for a collapse of the demand that would lead to another collapse of oil prices. That, in turn, would lead to reduced investments in new resources and to a decline in production. It would be 2008 again and this time a rebound to high productive level would be much more difficult.

Is the recent decline in oil prices a symptom that this scenario is unfolding right now? It is still too early to be sure, but we can be 100% sure that if we see prices collapsing people will say - again - that the oil crisis was a hoax.





(note: Gail Tverberg develops similar considerations, although at a more general level, on her blog "Our Finite World")



8 comments:

  1. EIA provides oil production costs up to 2009 (http://www.eia.gov/tools/faqs/faq.cfm?id=367&t=6).

    Do you know where to find more recent data?

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  2. I think those are the latest estimates available. But let me ask to my conctacts

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    1. You may wish to give a look to this link (free after registration) courtesy of Ron Patterson:

      http://www.ft.com/intl/cms/s/0/ec3bb622-c794-11e2-9c52-00144feab7de.html#axzz2iehDWxiA

      They say that the marginal cost of oil production in non OPEC countries is around $104/barrel, so in case of a price collapse we are going to see quite a decline in production!

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    2. Also this link (courtesy of Nate Hagens)

      http://www.theoildrum.com/files/oilmajorscost_production_goldman.jpg

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    3. I don't understand the left graph. From the yellow line, current berak-even oil price for mayors is around 120$, rising fast. Are the "big six" extracting with a net loss?
      It seems quite strange, is not what they usually do

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  3. tutte le volte credo di non averla compresa. tuttavia, visto che qui la si cita, ecco la differenza in questione, quella tra depletion e decline. il declino produttivo nello sfruttamento di una risorsa può essere arrestato grazie all'introduzione di nuove tecnologie. in quel caso però la depletion aumenta, aumenta cioè il tasso di esaurimento della risorsa, ovvero il tasso di sfruttamento di ciò che è rimasto. quanto al prezzo, è vero che in ogni momento t o si è in grado di sostenerlo o si è fuori dal mercato, ma al di sotto di un certo livello non si potrà mai più andare, visto che quei prezzi sono necessari all'investimento nel futuro sfruttamento e in petrolio magari più difficile ... luca branchitta

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  4. I have been watching for a price spike, and the dip has been so confusing. Thanks for the explanantion Ugo. I think I understand it now?

    The cost of production is still very high, so would not result in a price dip. Neither is the market being flooded with excess oil. Which leaves a reduction in demand as the cause of the price dipping. A reduction in demand is due to not being able to afford the high price of oil, leading to a slowdown in manufacturing and economic woe. It seems to make sense why the price is dropping now.

    It's a shame the media is still trying to tell us the economy is growing.

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  5. Not this time, apparently...

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