According to Goldman Sachs global oil supply went into deficit during May 2016 which probably explains the speculative behaviour on the paper derivatives markets. Oil prices in both WTI (West Texas Intermediate) and Brent rose during March, April and May, anticipating equilibrium later in the year. After an extended period of declining and low prices it looks like oil prices will lurch upwards, no doubt followed by prices at the pump.
During 2015 an unbelievable number of oil analysts were predicting many years of low prices, apparently confusing short term politically driven oil output policies with the fundamentals of the oil industry. They seemed to compound their errors by extrapolating US shale production forecasts using the sort of assumptions only appropriate to conventional onshore oil production. Anyone who knows anything about the economics of fracked oil knows that increasing or even maintaining production depends very much on establishing an increasing stream of new wells. Fracked wells typically peak in output in year two of production which is why we may well see some significant falls during 2017 and 2018. Even a significant increase in price may not be enough to stimulate the sort of production levels seen in recent years.
Short term it looks like oil prices will moderately increase but it’s the 2020s we ought to be preparing for. In true Spinal Tap fashion Saudi Arabia may have recently turned up the output dial to eleven in its strategy of containing Iran and hurting the US shale industry. But this policy can’t last given the unintended consequences of dismantling OPEC and depleting its foreign currency reserves at an alarming rate. It will need to scale output back not only for its own immediate domestic budget reasons but also because it doesn’t have infinite supply. Saudi has been increasing production in a world where current reserves are simply not being adequately replaced, not just in the Middle East but globally.
Peak conventional oil production is generally accepted as having occurred in 2006. Which is why there were many articles about Peak Oil during the 2006 – 2010 period. For a time it did look like all types oil, onshore, offshore, tar sands etc. might peak between 2012 and 2015. Oil market speculation pushed prices up to $140bbl in the period leading up to the global banking crisis in 2008 and the financial world took a breath. The US FED’s reaction to the credit issues in the banking sector had consequences for the oil industry. Trillions of US dollars were printed to bail out the banks but it was inevitable that some of this would find its way into the oil sector. An estimated $350bn helped finance the technology and infrastructure that made US shale happen. With prices between $80 and $120 hedge funds queued up to invest in aspirational US shale companies and an inevitable boom in output transpired. US shale has bought the world some time. A fortuitous set of circumstances and the profit motive added perhaps ten years to the Peak Oil window originally forecast for 2012 – 2015. Few are brave enough to forecast a new timeline but one thing for sure is that it will happen, and probably in our lifetimes.
Peak Oil is not about oil running out. There are billions and billions of barrels of the stuff all over the world, both discovered and undiscovered. Peak Oil is about output, price and EROI (Energy Return on Investment). Peak Oil is therefore about the affordability of oil in terms of its uses. We may have billions of barrels of oil offshore and in the Canadian tar sands but can we afford to extract it to run cars with? Can we afford the ongoing costs of cleaning the Canadian environment after the water and energy intensive process of converting it into usable energy? What is the point of having tens of billions of oil reserves if the energy we get from it equates to the energy we have to deploy to get the stuff out? This is what Peak Oil is really about. It’s not about running out of oil per se, but is about running out of affordable oil. Thus, as is suggested by recent price action we have probably already run out of oil at $30bbl. Even an artificially induced supply glut could not force the price below $30bbl for more than a few days.
A point also missed by the many oil analysts conditioned by the artificially induced supply glut of the last eighteen months is indeed whether we have actually run out of $60 or even $80 oil. If $60 to $65 is the break-even level for US shale then perhaps this this really the current Peak Oil price level. On the other hand most of OPEC oil producing nations and Russia need oil above $80bbl in order to meet their budget and social welfare commitments. Venezuela, for example, is generally recognised as having the largest oil reserves in the world and yet is edging perilously close to failed state status. While the nominal cost of actually producing oil in Venezuela is reputedly less than $15bbl, the implications of its social programmes suggest that ten times that amount is needed to keep its government and economy above water. Perversely its output has dropped by 300k – 400kbbls/day in the last twelve months, just at a time when it needed income the most. Theft, lack of maintenance and electricity problems have all contributed and are all aspects of an economy that doesn’t work when oil prices are too low.
The point here is that the current price of Peak Oil is not necessary set by a large volume producer such as US shale. Without an increase in prices Russia could be the next Venezuela, or perhaps even Saudi Arabia. Neither economy is working effectively at $40 to $50 oil; both are depleting reserves to keep their respective government and social programmes intact. Both need prices to rise before they effectively run out of reserves. With a prolonged period of low prices there is more than a chance that they will be forced to either borrow substantial amounts or face a Venezuela style meltdown which could have similar and concomitant impacts on oil output.
Where then is the actual 2016 Peak Oil equilibrium price? We know that it is above the $25 – £30bbl range; the market has already told us that. But when we factor-in all the political and economic dynamics of the oil market, is it actually $60, $80 or even above $100? Notwithstanding shale it is clear that the recent surplus is anomalous and artificial. Not only has output and pricing strategy created short term difficulties but it has also sown the seeds of a more structural supply deficit in the 2020s. The oil business appears to need prices in the $80 – $100 zone to justify ongoing investments in exploration and field development and to keep OPEC economies afloat in 2016. Unfortunately, not only have the low prices of the last eighteen months curtailed shale oil investment but conventional and offshore E&P (exploration and production) has also plummeted. This recent lack of investment in E&P will have consequences in the early 2020s and possibly even sooner. Watch for the headlines to switch from forecasts of oil at $25 (even $10bbl!) to oil at $150 or even $200bbl.
So why do I as a change and transformation specialist take such an interest in oil? I see the oil industry as something of a nexus point. Oil remains our most important commodity and still provides the energy that powers the world. Significant changes in the availability and price of oil have dramatic and often fairly immediate consequences for economies and organisations working within those economies. A global shortfall in output of a two or three million barrels of oil per day will have a major impact on its price and the price of everything that relies on oil for its production. A one to two million excess of supply over demand had the effect of reducing price from over $100bbl to nearly $25bbl at one point. A deficit will not only reverse this but when availability is an issue could well power the price way beyond that reversion point. Shale output may start-up again but the investors who recently lost money on their original investment are likely to be a lot more circumspect about pumping even more billions into such a volatile industry. Iran, seen as potentially a gap filler also needs billions of external investment before it could offer the sort of output extant before UN sanctions were imposed.
Thus it is not beyond the realms of possibility that prices will be back in three figures in the coming years and potentially higher than the $140 reached a few years ago. In the absence of a shale-like saviour these prices will have major implications for how organisations will operate. They will have transform themselves to work within a new oil energy restricted paradigm. Alternative energy investment will need to be accelerated, other operating costs reduced and alternative models of operating developed. Oil stands at the nexus of business strategy and change and will continue to do so until the world truly develops an alternative energy infrastructure that significantly reduces our reliance on this highly volatile energy source.
There are many Peak Oil sceptics around but I am obviously not one of them. Shale has bought the world some time and tens of billions of E&P investment might buy us some more but from where I am standing in 2016 that doesn’t look very likely. Peak Oil may not be a ‘now’ issue but I would be surprised if we get to 2025 without it hitting the financial headlines again.