Oil and Gas Depletion versus Demand Destruction – Price forecasts?
For those of you who follow oil and gas, I’d like some opinions on where we are right now in the big picture of depletion versus demand destruction. Specifically – and venally – I’d like some price forecasts (and associated time horizons) given your world view.
I will admit to being taken aback by the scale of price declines, which I had attributed to some demand destruction, but largely to deleveraging. I am beginning to think that demand destruction has been a more significant factor in the declines than I have previously been willing to admit. But since so much of my own money and liquid net worth is tied up in these assets, I am not sure that my thinking is as objective as it should be.
The economy is very closely tied to oil. We probably won’t see a significant price hike until the economy begins to recover. I would also venture to guess that if an event were to happen that pushes up oil prices significantly, then it might actually get people in an inflation-mode fervor and do something to stimulate the economy. Don’t underestimate this factor either. I am reading a fascinating book now that discusses the political motives and consequences of direct and indirect interventions in oil markets. The people running the show aren’t dumb, but they are often immoral. I would not find it completely shocking to have an oil crisis invented to ignite an inflationary mindset. That said, I see it as unlikely.
Right now, there is no question about it: demand has been destroyed faster than oil supplies have declined. The danger in this, though, is that there has been very little investment on the part of the oil companies. So the low price feels good now, but unless the economy continues to decline for years and years to come, we’ll eventually run into the ceiling of limited oil supply. That ceiling is getting lower every year, if not because of peak oil, then certainly now because of all the projects that have been put on hold. Predicting oil prices is very difficult. I would guess the price will get a good bit higher over the summer. What happens going into the fall and winter is a function not only of the economy, but also of the impact of any elevation of crude prices over the summer. It is hard to judge how the world might adjust to, say, $75 oil at a time like this.
Certainly with all the printing going on the 5 year outlook for crude prices would fairly bullish, though with all the overt government interventions we’ve seen lately, I wouldn’t be surprised if laws, and or international agreements step in to ration crude when the price gets "unacceptably" high and volatile. It is the volatility in energy prices that limits the confidence of companies to invest in projects, so unless things do stabilize a bit, there won’t investment and there won’t be as much oil down the road. The peak of oil production might ironically actually be do to demand aspects (massive recession), rather than limited supply at the critical moment.
The key to remember with energy prices is that the marginal cost curve is fairly steep. These means that relatively small changes in demand can have huge effects on price. This is a result of the way that oil fields decline. While nearly all fields can maintain a low output for decades, it is very very difficult to get a number of fields all peaking in sync to provide a high demand market. An excellent discussion of pricing issues, including graphs, can be found in this report below. It was published July, 2008.
My own feeling is that – despite the plunge in Natural Gas demand – we will see the sharpest price rebound come in that sector. The depletion rate on gas wells is very high – and even higher on the newer, more expensive to drill, shale plays – and virtually no one can profitably drill a well at current prices. So while there may be lots of shale gas to be drilled out there right now, no one can drill it at these prices. So the supply curve will shift to the left faster in gas than in oil.
The problem I have in predicting prices is that there are so many variables – currency risk , market manipulation risk, demand, depletion, and strangely shaped supply and demand curves – that you can be mostly right and still be on the wrong side of the investment decision.
Glen: You echo the thoughts of Matt Simmons re: "being mostly right" and still be on the wrong side. Simmons believes that conventional wisdom has been incredibly wrong on energy so much in the past and that has contributed to a great deal of the volatility inherent in the sector.
The gas markets are a lot different than oil, so I think they need to be looked at a little differently. All of the wonderful new gas technologies that we hear advertised have very steep decline curves which isn’t very good for risk / volatility concerns. Further, natural gas is expensive (mildly dangerous once in a while???) to ship as LNG, which greatly reduces its ability to be a truly "global" commodity. Further, my guess would be that natural gas demand fluctuates a bit less than oil. A great chunk of gas is used in electricity production, industrial agriculture fertilizer production, and industrial agriculture pesticide production. Demand has obviously contracted, but as near as I can tell, no one takes intercontinental vacations fueled on natural gas or luxurious 500 mile road trips on gas. My point is there are limits to the amount of demand destruction that can take place, at least I think so. Couple this with the importance of domestic supplies (and the lack thereof) and I more or less agree with you. Things could explode faster than oil.
Any thoughts on my reasoning?
The single best site on peak oil and oil related matters is "The Oil Drum". No BS there at all. I’ve never posted there becaus emost of the people who do have forgotten more about the industry than I will ever know. Check it out if you never have.
I am reading a fascinating book now that discusses the political
motives and consequences of direct and indirect interventions in oil
markets. The people running the show aren’t dumb, but they are often
Mike- what book are you reading?
The book is:
A Century Of War: Anglo-American Oil Politics And the New World Order
by: William Engdahl
Don’t be dissuaded by the title. This is not (at least so far) a wildly impassioned conspiracy theory book. What it does is discuss the interplay of large political and economic movements with the petroleum industry. I’m presently at the part that discusses the connections between the closing of the gold window and the energy crises of the 1970s. So far, the book has been filled with evidence and facts. My take home conclusion is that there’s a pretty big game afoot at this moment and it is dangerously naive to think that all of our leaders are both stupid and well-intentioned.
The questions that pop in my mind as a result of the evidence and assertions made by the book have thus far confused me. I guess I’m learning that the behind-the-scenes game can be pretty complicated at times.
a seasonal low for Nat Gas?
Oct/Nov is when the local gas companies try to get users to commit to certain price for the next year…wonder why?
From what I can gather…the dollar is expected to descend…and commodities to rise. Dollar down due to debt…commodities up due to increasinging demand? They tend to be inversly related..and both have good reason to go their own direction….
…that said…who knows? I talk, but don’t trade.
…check this guy’s UNG chart?
Yes, agree the Oil Drum Drum site overall is the best source. Experience suggest they and ASPO will provide the first clues using sound data analysis of this evolving picture.
1.) Past data shows production estimates for over 5 years of most countries have significantly been too optimistic to actual results by ~2 to 5%.
2.) In a macro supply-demand pull sense. If this continues and then world demand stops falling as past few months indicate, offer the numbers suggest from past trends above (point 1): A reasonable projection of supply shortfalls starting within a year…probably earlier. My previous estimate of a price run up starting first half of 2010 remains in place (with or without dollar devaluation).likely passing 2008 price records with spot shortages mid to latter half 2010.
There several folks who have good records of analysis that I read closely…Robert Hirsh, Sam Fourcher, Heading Out, Stuart Saniford, Gail The Actuary, to name just a few. Matt Simmons is good…but can be a bit zealous.
The comments section of Oil Drum posts are routinely just as good as the posts themselves.
FWIW…I’ve been a reader of Oil Drum for over 5 years. Have ~30% investments in energy (another 50% in PM) and no plans to change ATTM.