Monday, October 20, 2014

Oil prices keep going down, but this is not good news

Originally published in Italian in "Greenreport" [14 October 2014]

Ugo Bardi

 

There is plenty of movement in the oil world: after five years of relatively stable prices, the legendary "barrel" is coming down from over $ 100 to under 90, and it looks like it will keep falling. What's happening? Has anyone found new resources? Or is it Saudi Arabia using the "oil weapon" to bring down Russia, the heir of the old "evil empire"?

In reality, it is nothing like that. There are no major new discoveries of oil in the world and the Saudi oil weapon is much less fearsome than it is normally described in the media. But, then, why are prices going down? There are good reasons, but we need to understand them and, more importantly, to explain why the likely future drop in oil prices would NOT be a good thing; indeed it could be a planetary disaster.

First of all, we should take into account that oil is a finite resource, but also that it is subject to the laws of supply and demand; it cannot escape the control of the entity we call "the market". So, we are seeing two contrasting trends in the oil market. One is the gradual depletion of the so-called "conventional" oil; that is liquid oil extracted at relatively low cost from wells. As a consequence, the production of conventional oil is static or declining almost everywhere. The other trend is the increase in the production of "unconventional" oil, that is combustible liquids which are obtained, for example, by treating oil sands, or biofuels, or "oil shale," the kind you obtain by means of the "fracking" process. 


Up to now, the rapid development of the production of unconventional oil - especially shale oil in the United States - has compensated ​​the worldwide decline in the production of conventional oil; it has, in fact, allowed production to keep growing. At the same time, many of the major economies are in recession and are reducing their energy demand. Italy, for example, has lost 25% of its oil consumption over the last five years, and the descent continues. Other economies, such as in Germany, are in trouble, even if not yet in recession. This causes a decrease in the world demand. 

So, the two factors - increase in supply and decrease in demand - go in the same direction: the market wants the price of oil lowered, and it goes down. We should also take into account that these phenomena are often heavily influenced by the perceptions of financial operators: if everyone thinks that the price of oil should fall, then it will fall. In practice, we risk to see not just a drop in oil prices, but also a true meltdown of the oil market, like that witnessed in 2008-2009.  

Many people would be tempted to believe that lower oil prices are a good thing, but it is not so. If we will see a repetition of the scenario of 2008-2009, the result can only be a disaster (as it was at that time). The problem is that oil resources are not all the same: to produce certain types of oil is very expensive. Extracting from tar sands or from oil shales, for example, is more expensive than extracting from traditional wells. So what happens if prices go down? It happens that extracting and marketing certain types of oil does not generate a revenue anymore. Then, those types of oil are not produced any more. Who would ever want to produce at a loss?  

In practice, if prices decrease, the world's oil production decreases: have you ever eard of "peak oil"? It is just this phenomenon: "peaking" does not mean running out of oil; absolutely not. It means that producing more oil is not as convenient as it was before, hence less is produced. Therefore, we see a peak in the production curve. That's peak oil.

And that's exactly what may happen in the near future. Oil at over $ 100 a barrel allowed the industry to maintain a fairly constant production - actually even to increase it slightly over the past few years. Oil at significantly lower prices does not allow it anymore, and it forces the industry to reduce production. This leads, among other things, to the closing of many refineries, as is happening in Italy.

In the end, it is perfectly possible that oil will cost less in the future, but also that we won't have the money to pay for it. There is nothing to do about that: it is the market, baby! But above all, the troubles come from our attitude that continues to make us believe that oil will last forever. It is not possible. Let's start thinking about that!







13 comments:

  1. Excellent, excellent post. You've hit the nail on the head.

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  2. Lot's of Americans seem to be crowing about how US innovation is taking down OPEC and driving down the price of oil, and putting the US in a stronger position. I have to admit that I am finding this difficult to get my hands around.

    http://www.foreignpolicy.com/articles/2013/10/16/the_end_of_opec_america_energy_oil

    http://www.nytimes.com/2014/10/21/opinion/joe-nocera-a-world-without-opec.html?hp&action=click&pgtype=Homepage&module=c-column-top-span-region&region=c-column-top-span-region&WT.nav=c-column-top-span-region

    "Since 2008, says Bernard Weinstein, an energy expert at Southern Methodist University, oil production in the United States is up 60 percent. That’s an additional three million barrels a day. Within a few years, predicts Morse, America will overtake Russia and Saudi Arabia and become the world’s largest oil producer.

    What’s more, according to another article Morse wrote, this one for Foreign Affairs magazine, “the costs of finding and producing oil and gas in shale and tight rock formations are steadily going down and will drop even more in the years to come.” In other words, the American energy industry might well be able to withstand further price drops easier than OPEC members."

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  3. 2015 will become very interesting. when ebola is really the black swan and peak oil is here , industrial civilication will go bust (recommend orlov's post to ebola). good for gaia but bad for humans. fast enough preventing earth from a runaway greenhouse effect? non-humans will hope for the perfect storm (ebola, peak all, climate change, nuclear meltdown, etc) in the next months...

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    1. Not sure Ebola qualifies as a "true black swan" since we have known about it for quite a while and have had plenty of time to prepare (even though we haven't) But a considerable amount of gold production comes out of West Africa so if the whole of West Africa starts to be affected (let alone becomes engulfed) by Ebola this could affect the supply of gold, force up its price enough and for long enough to create a "shorts squeeze" for some of the bullion and investment banks who have been manipulating it, and this could create other significant knock on effects in the (already teetering) financial system with serious repercussions (to start with by popping the U.S. stock market bubble) and doing other things which perhaps could be viewed as having "black swan-like" characteristics. And if Ebola seriously takes hold anywhere else outside Africa then all bets are off for the world economy. But Ebola also could end up doing very little though other not exactly black swan-like things such as peak oil could, and of course plenty of other true black birds also could come along with a fairly good probability. So I agree that 2015 is likely to be a pretty interesting year.

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  4. Wen the price goes down expensive wells shut down.
    The amount produced goes down. The wells open again.More produced, price goes down.

    This is only a problem when shut down wells never go online again because the price for maintaining the infrastructure during the low price period is too high. But on the other hand the infrastructure is in place anyway and when you do not use it for a year you can continue using it next year maybe with a month repair costs.
    I do not think that falling prices are a problem because they will naturally go up again. The only question is when.
    This will lead to some solutions of the "collapse staircase step size differential equation"

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  5. Most people do not see the absolute waste of money spent in the oil feild.They will tell you the cost of drilling but not the income of their employees.Many are paid in excess of 30000 a month yes a month.Perhaps a good drop in oil prices will jolt them back to reality.

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  6. Could this be a form of conservation of resources

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    1. It is. But it is an unplanned one

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    2. No, I meant a planned one...

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    3. Humans don't know how to plan

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  7. Yes, spot on. I suspect this is the low pressure point before the Hurricane hits. The market is a man made fiction that simply ignores silly little things like, oil being a finite resource or the fact that numerous expert reports including the those from the US Govt expect the fracking/ shale bubble to burst badly and soon. No. The market just looks at now and ignores those pesky little facts. SHTF time starts next year and really starts spraying around the room by 2017.

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  8. Reality is about to catch up with Economic fiction and the reality check will make all the combined previous disasters faced by mankind pale into insignificance. The scariest thing I've seen in along time is the human population time line superimposed over oil production. 6 Billion people only exist because of oil.

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Who

Ugo Bardi is a member of the Club of Rome and the author of "Extracted: how the quest for mineral resources is plundering the Planet" (Chelsea Green 2014)