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Robert Rapier's picture
Proteum Energy

Robert Rapier is a chemical engineer who works in the energy industry. Robert has over 20 years of international engineering experience in the chemicals, oil and gas, and renewable energy...

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Why $50 Oil Won't Last

In the past few weeks I have received numerous questions about the role of a “drop in demand” in the oil price decline. These questions are driven by many stories in the media that have referenced a drop in demand.

There are two primary reasons given for this so-called demand drop. One is that years of high oil prices have resulted in reductions in consumption through conservation and improvements in vehicle fleet efficiency. The second reason is due to the strengthening dollar, oil has become more expensive for many countries since oil is generally traded in dollars.

There are elements of truth behind both reasons. There has indeed been reduced oil consumption in recent years in most developed regions of the world. It is also true that the dollar has strengthened against many currencies. But despite the rationale that explains this drop in oil consumption, ultimately the data must support the narrative.

We have to keep in mind that the developed regions of the world aren’t the entire world. Despite this oft-repeated mantra about falling oil demand, there is no evidence that this is actually true. Last October, the International Energy Agency (IEA) reduced its forecast for 2014 global oil demand growth by 200,000 barrels per day (bpd). Their revised forecast was that global oil demand would only increase by 700,000 bpd from 2013.

Last week on CNBC the IEA forecast that “global growth in the demand for oil could modestly accelerate in 2015 to 910,000 barrels a day.” However, the article also noted that the World Bank had reduced their forecast for growth in the global economy for this year to 3%, down from their previous forecast of 3.4%.

What has happened is that these reductions in the forecast for oil demand growth or economic growth get mistranslated into forecasts of declining demand. I think we can all agree that if I gained 5 pounds a year each year for the past 5 years, but this year I only project that I will gain 3 pounds — I did not lose weight. I will be 3 pounds heavier than I was instead of 5 pounds heavier.

Consider that in the 5-year period of 2008-2013, the price of West Texas Intermediate (WTI) crude averaged $88/bbl. The price of Brent crude was even higher at $95/bbl over this period. These prices were much higher than the average oil price over the previous 5-year period, therefore we might expect that this had a negative impact on oil demand. This was in fact the case in the U.S. and E.U., but global demand increased, driven by increases in every developing region of the world:

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Despite much higher oil prices, global demand for oil increased by more than 5 million bpd in the past 5 years. In fact, global oil consumption has increased in 18 of the past 20 years.

Now, compare that with where most of the world’s oil production growth took place during that time period:

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This is why I maintain that oil below $50/bbl is simply not sustainable. If global demand was actually declining, it would be a different story. But with demand continuing to grow, and with the majority of the oil production added in the past 5 years coming from the shale oil fields in the U.S., there is simply not enough $50/bbl to meet demand. Consider the graphic from a Bloomberg story late last year that shows almost every shale play in the U.S. losing money at current oil prices:

 

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Now consider that companies in these shale plays are reducing their 2015 budgets, and layoffs are underway. The cure for low oil prices is low oil prices, and that cure will begin to take effect this year. I realize that we dropped into the $30′s in 2008, but keep 2 things in mind. Just over a year later we were back above $100/bbl, and at that time the marginal barrel was not $70/bbl shale oil. The cost to produce that last million barrels per day of demand is significantly higher than it was in 2008. Therefore oil will not — as I have seen more and more pundits predict — sink to $40/bbl and stay there. There may be a new norm for oil relative to what we have seen in the past 5 years, but it will be closer to $70/bbl than it will be to $40/bbl.

Link to Original Article: Why $50 Oil Won’t Last

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Hops Gegangen's picture
Hops Gegangen on Jan 26, 2015

 

The shale play gets a lot of attention, but there has also been considerable increase in production from Iraq and Russia.

I understand that some big projects in the Gulf of Mexico also resumed and will probably come on line. UAE plans to increase production.

Given that OPEC can no longer swing prices with small changes in production, and that in the long run they will be hurting for revenue, what is the likely move at the next OPEC meeting?

I could see them raising production quotas rather than lowering them as member counties become desparate for revenue.

 

 

 

Joris van Dorp's picture
Joris van Dorp on Jan 27, 2015

Great article Robert, Thanks.

OPEC did not reduce quotas recently I presume because they know what Robert Rapier knows: oil prices will rebound much sooner than many people are assuming, so OPEC should benefit now from low oil prices pushing out some of the competition while it can.

Long ago, during the time when “Peak Oil” was hotly debated while the oil price was still comfortably below $50, there was one thinker I remember who predicted that oil prices in a peak oil world would be an upward trending sawtooth, marked by precipitous downward spikes caused by bouts of intense demand destruction (AKA economic upheaval) combined with temporary production overshoots due to previous industry overconfidence in ‘permanent’ high prices, which would invariably be followed by spikes upward to a new record price environment as demand returned due to economic recovery (or money-printing, rather). This is almost exactly what has happened and is happening. I believe I first read this prediction of the upward sawtooth character of oil prices in the peak oil world around 2005, though I can’t remember the brilliant person who saw this ahead of time. (maybe it was Robert Rapier?)

At the time, there was also an analysis of the Ultimate Price of Oil, or the price of oil which (in the absence of alternatives) would still be affordable for (a semblance of) human civilisation. That price was far above $1000 per barrel! This price was calculated on the basis of comparisons of GDP, oil price and the utility of (oil-based) personal transport namely in the developing world. Or in other words: even if the price of oil was $1000, there would still be demand for it, if only to serve as fuel for the scooters of people in developing countries who use relatively little oil per person, but who greatly increase their income by being mobile even at such high oil prices.

ralpph allen's picture
ralpph allen on Jan 30, 2015

 

  Just as soon as they break Russia’s financial back then the oil prices will go up.  That is why the oil prices went down.   All the Saudi’s would need to do is stop pumping 10% of their oil and prices would go back to $100 and their revenue would nearly double.  This is a coordinated effort to force Russia out of the Ukraine and a side benefit is a swift kick at the Iranians and Venezuela. 
 

All the other reasons given by the media is propaganda to keep the sheep from realizing the truth about world politics.  They also did not tell you that Russia and China said keep out of Iran.  Russia is a short distance from Iran across the Caspian sea.  Also China can just sell their treasures and and stop trading in the dollar and this is the end of the US world dominance. 

But not to worry they are playing a dangerous game and your sons will shed their blood not the Oil exec sons.  Then you will wonder why you lost everything, house, job and savings.   They will blame the “Bad Guys” for their world games.   Why do you think that the Republicans have invited Netanyahu to talk without Obama so they can plan for the invasion since the sissie Obama is unwilling to start WW3.   They believe that with the Jewish vote they can win the election regardless of US impacts.  REAL men talk tough and start wars and don’t care about the poor or the environment.

 

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