Peak Oil — A Crisis Postponed

As the global economy goes, so goes oil demand. If the outlook for the global economy is not so good, oil consumption will stagnate or increase very slowly. If oil demand grows slowly or not at all, consumption will remain below the world's productive capacity, as measured in millions of barrels-per-day. If oil demand remains below the available supply, there will be no oil price shock.

A new oil price shock tells us that "peak oil"—an inability to grow supply to meet growing demand— has returned with a vengeance. The last time supply could not meet demand was in the years 2005-2007. The growing gap led directly to the oil price shock of 2007-2008. After July of 2008, the world economy unraveled, leading to the relatively low demand environment we have today.

Although this simpleminded explanation smooths out all the messy details, it is basically correct. So where do we stand?

The International Energy Agency has just released its 2010 Medium-Term Outlook reflecting its projections for the period 2010-2015. Here is the relevant text from the summary—

Although economic recovery has become re‐entrenched, in sharp contrast to last year’s back‐drop, concerns persist about its strength and durability. As a result, two oil demand scenarios are again presented. Using May 2010 OMR data as our starting point, we have developed two contrasting views on economic growth, with the lower variant also tempered by weaker assumed efficiency gains. Common features however are the predominance of both the non‐OECD countries and the transportation sector in driving demand growth.

In the higher GDP and efficiency gains case (the base case for our analysis), oil demand grows by an average of 1.2 mb/d annually (1.4%), reaching close to 92 mb/d by 2015. Oil demand recovers to pre‐crisis 2007 levels again by 2010. This presupposes GDP growth around 4.5% per year from 2010 onwards (in line with recent IMF projections) and a reduction in oil use intensity of 3% annually, near the level seen in the last five years.

But many voices still envisage a weaker path for global economic growth, amid world trade imbalances and the weakening impact on activity of aggressive fiscal consolidation. This suggests a lower GDP and efficiency gains case. Here, global GDP grows by a weaker 3% annually, while the progress in oil use efficiency is slowed by the weaker investment environment, pushing anticipated reductions in oil use intensity back to the 15‐year average, near 2% per year. In this case, annual oil demand growth averages 840 kb/d (1.0%), taking total global demand to 90 mb/d by 2015, with the re-attainment of 2007 demand levels deferred to 2011.

I am among those who "envisage a weaker path for global economic growth." In so far as the IMF always expects strong growth—after all, they are run-of-the-mill economists—we can safely ignore their projections. This is one set of bureaucrats (at the IEA) predicting a rosy future based on the optimistic views of another set of bureaucrats (the IMF).

I will not lay out the case for my pessimism here, but recent events in the United States (e.g. in the housing market) are among the many indicators of a global economic slowdown. Here's a chart of global growth from Thomas Berner, the Chief US Economist at UBS—

Source

World GDP is above "potential" (3.5%) but is tailing off. Considering recent events in the United States, China and the Eurozone, it appears that the IEA's 3% low annual growth scenario—or perhaps something much worse—is the best we can expect for the years 2010-2012.

The low growth scenario has oil demand growing at 1% per year (840,000 barrels-per-day) and assumes that oil intensity reductions are smaller than in recent years. That takes us to 90 million barrels-per-day (all liquids) in 2015. "All liquids" means any liquid fuel type, not just crude oil (e.g. biofuels, gas liquids). The IEA's term "oil" is a short hand for all liquids. (There will be a quiz later.)

In my view, the world will never produce 90 million barrels of liquid fuels on a daily basis. But I wouldn't mind being wrong—maybe we'll get to 91 or 92. These are mere details in the Grand Scheme of Things. The longer term outlook remains bleak. Sticking to my current view of never 90, that puts the next oil price shock nearer to the end of the 2010-2015 period than its beginning.

Thus I tentatively conclude that "peak oil" is a crisis postponed. Actually, I am fairly confident about this prediction, but it is always wise to hedge your bets. Nevertheless, I am going to wait a few months before I update my own "official" estimate of the situation as laid out in The Next Oil Price Shock. When I do update it, I will very likely push out the date of the next price shock one year to 2013 ± 1 year. If the global economy goes all to hell next year, I will push the date out further to 2014 ± 1 year.

Many of those concerned about the oil supply write or speak as though The End Is Near, or The End Is Here—I will not name names, although Matt Simmons comes to mind. Needless to say, I have seen many predictions of the Oil Apocalypse come & go.

The End Is Near, but not quite as close as some people think. On human timescales, which tend to be quite short, the deteriorating state of the global economy has bought us some time. I seriously doubt that governments will make wise use of that time. Preparing for the ongoing oil crisis would be a huge departure from their normal behavior, which here in the United States, consists mostly of making matters worse and then telling The People not to believe what they can plainly see right in front of them.

Comments

[Matt]

Very interesting. A question: does the postponement take into account any decreases in oil exploration/recovery/refining that may result from continued global economic instability?

[kolchack]

I mostly agree with theis essay with two big caveats. 1). That deepwater drilling is not sharply curtailed by the BP disaster, and 2). That the supergiant Gahwar oil field in Saudi Arabia does not suddenly go into a Cantarell (Mexico)-like catastrophic decline. Either or both of those events occurring will greatly speed up the effects of Peak Oil.

[The Prophet Nabob]

It's very disappointing to hear you repeatedly thumping the "end-is-near," "apocalyptic" straw man.

No one said the world was going to end. The world will not end. There will be no "apocalypse."

In fact, every time you issue a new oracle--"Thus I tentatively conclude that "peak oil" is a crisis postponed. Actually, I am fairly confident about this prediction"--YOU'RE the one being "apocalyptic."

"Apocalypsis" is the belief that certain people are vouchsafed visions of god's future plans for mankind. The word actually has nothing to do with "the end of the world."

The reason for the current recession is that oil supply peaked in the 2004-2009 time period. That's not a prediction, or an apocalypsis. It's an established fact.

You're right about one thing--oil will never reach 90 million barrels per day.

[Greg Pinelli]

First a correction..on my post the other day I meant to say the Fed will not inflate..it's out of their hands now....That really leads into what Dave has written today..He's precisely correct..the whole GDP growth hype and idea it will push oil use back up to and eventually past 2007 levels is absurd.

The world's economies are holding (and will hold) oil in a box with zero upside price escape. IF Treasuries or Reserve Banks attempt to inflate, interest rates will respond immediately and economies will contract faster than you can say "bond vigilantes." Oil will go thru some very severe price moves up and then plunges...but use will, at the end of the day, go nowhere.

If they don't inflate, the largest economy in the world (the US) will be preoccupied for a generation in deleveraging debt and keeping their heads barely at the water line. Oil will steadily decrease in price in this scenario. Peak oil serves as the floor underneath any dramatic and sustainable price drops...below a certain price (my guess, around $25 US)..the stuff may flow, but nothing..as in ZERO..new comes on line.

Once in a lifetime the realities of the past catch up to the fantasies of the future and a real ass kicking reckoning occurs...March 2009 was simply the set up.

[awb]

There are a few other issues which the author does not address. One is some discussion of the Export Land Model, wherein oil producing countries support local prices, their economy grows as well as their use of oil, and there is less oil to export. This can accelerate. Also the OECD nations are on depletion curves that will most likely steepen in the next few years. Thirdly, as mentioned above, there is far less exploration and development going on now due to the price collapse of 2008-2009, and the effect of this will start to be felt acutely in the next year or two.

[posconvex]

Any discussion about oil prices over the next decade must include an attempt to quantify emerging economy demand as an important driver at the margin. Here is a simple thought experiment using Chinese demand to give some idea of the magnitude of the supply issues we face:
- China moves from 3 bbls/person/year to the South Korean per capita consumption level of 17 bbls/person/year
- Transition takes 30 years
- No peak in global production

In next 10 years we must find 44 million BOPD. If you superimpose peak production on top of this demand profile using the following parameters oil prices would increase approximately 250% in real terms over next 10 years:
- Oil demand elasticity of -0.3
- Current production 84 million BOPD, current price US$ 80
- Peak production 100 million BOPD
- Post peak decline rate of 3-4%

If you want to try the model for yourself using your own assumptions it can be found at: www.petrocapita.com/index.php?option=com_content&view=article&id=128&Itemid=86

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