The oil price dilemma

Figure 1: Recent trend in global oil production [Source: Gail Tverberg, Our Finite World, 2012 ]

Figure 1: Recent trend in global oil production [Source: Gail Tverberg, Our Finite World, 2012]

A recent drop in world oil prices, has seen prices descending past the symbolic point of $50 a barrel. This is likely to prove a double edged sword, as I think we’ll all be learning soon enough. However, it has also led to yet more fuel to the self perpetuating myths regarding unconventional fossil fuels, with many in the media crediting Shale gas and shale oil with causing this price drop. Peak oil apparently is now dead.

Figure 2: Brent Crude Oil Prices since 2007 [Source:, 2015 ]

Figure 2: Brent Crude Oil Prices since 2007 [Source:, 2015]

Part of the problem here is that many forget that the price of any commodity merely reflects the current state of supply and demand for that commodity. Let us suppose for example, that you were to wander into a butcher’s shop on Christmas eve looking for a Turkey. Well assuming the butcher didn’t just laugh his ass off at you (all his regular customers put in orders months earlier!), you would be paying through the nose for a bird. Not because we’d hit “peak Turkey” but because demand was outstripping supply.

Similarly, if you went into the same shop on the 26th of December, you’d likely see the bargain bins overflowing with Turkey, now on sale at a knock down price. This drop isn’t due to any new supplies of Turkey (in fact its very likely Turkey production is winding down), but because retailers know that most people have stuffed themselves full of Turkey over the holidays probably won’t touch it again for many months, so they are anxious to clean out the freezers.

Obviously if the price goes a certain direction and stays on that course for several years, then this would be something we could be a little more certain on. So its important to put the current price drop in the right perspective. And that said, it has to be remembered that the price of oil has generally been trading at around $100 since 2006, excluding a few brief price drops here and there notably after the start of the economic crash. And this is despite the fact that the global economy has been going through one of the worst recessions in recent economic history, the sort of thing that would normally be expected to produce low oil prices.

Figure 3: Sources of non-conventional oil [Source: Miller and Sorell, 2013 ]

Figure 3: Sources of non-conventional oil [Source: Miller and Sorell, 2013]

But returning to Shale oil and the Tar sands, could they be behind this drop in price? Well, no, they still represent a fairly small share of the overall oil market. Globally, just over 80% of all oil production is what we’d call conventional oil, of the remaining 20% the bulk of this is Natural Gas liquids (NGL’s, the liquid portion of gas recovered from natural gas operations) with tar sands and Shale oil representing about 5% and the balance comes from Refinery Gains or minor sources such as biofuels. There is,, I would note, some controversy as to whether we should include NGL’s. Some authors argue that as you can’t put it in you’re car (its mostly stuff like Ethane and Propane) its fiddling the books to include it with oil. Others argue, that production of NGL’s is sufficiently mature that it should not be considered an “unconventional” source.

Either way, what most people would generally associate with the term “unconventional oil” (Tar sands from Canada, American Shale oil, Venezuelan heavy oil) is a tiny part of global oil production and clearly cannot drive the price to the extend suggested.

Furthermore, of the actual growth in oil production added since 2005, 47% of that growth has been either process gains at refineries and new or expanding field production in conventional oil fields. A further 31% has come from NGL’s, leaving growth in “unconventional oil” a mere 22% of recent growth in production.

I’m not denying that shale oil has led to a boom in parts of the US and a lot of money was made by some as a consequence. Its just the production from these sources are a tiny fraction of global output and is unlikely to have had any serious effect on prices. In much the same way that one hot dog stand at a football match is going to have a pretty profitable day, but that doesn’t means he’s going to feed tens of thousands of people with one small burger van!

Figure 4: Gains in production since 2005 [Source:, 2013 based on EIA data ]

Figure 4: Gains in production since 2005 [Source:, 2013 based on EIA data]

So what else could be causing this drop in price? Well on the supply side, as noted, there have been some gains from conventional oil fields, in particular in the field of Enhanced Oil Recovery from mature oil fields. Also Libya seemed to be bouncing back, at least until a few weeks ago. And the terrible events in Northern Iraq don’t seem to have dented oil production much….yet!

Meanwhile on the demand side, the EU is again looking jittery, which has likely sent many speculators running for cover. Russia was entering recession even before the drop in oil prices and even China is looking a bit worse for wear. Also advances in technology, such the latest hybrid and electric cars have resulted in vehicles becoming much more fuel efficient, reducing the demand for fuel.

So there’s lots of things going on that would be serving to reduce demand at a time when supplies have been increasing. It is a trend we’ve seen many times before in the oil industry, notably back in the 1970’s and then the 1990’s. Demand reaches stellar levels until its finally choked off by a lack of oil, generally followed by a recession. With the price of oil high, the Oil Majors and OPEC bet the farm on a series of expensive mega oil projects to cash in. With oil prices high, these net bumper profits, encouraging them to up their bets. Only for the oil market to become flooded, leading to a glut, leading to low oil prices, which usually sparks another economic boom….followed by a bust and the whole cycle repeats!

So its just business as usual play out, right? Well no. This drop in price is very different from past events. The one consequence of all of this fracking, as well as activity such as deep water drilling, enhanced oil recovery, etc. has been to greatly increase the operating costs for the major oil companies. As the graphs below illustrate the CAPEX (the money that oil companies spend on R&D as well as finding and developing new oil fields), has soared. Yet at the same time, the profit margins of the major oil firms has fallen. In short they are having to run faster to stand still.

Figure 5: CAPEX expenditure by oil companies by year [Source: Douglas-Westwood & Barclay's capital, 2014, via This finite world]

Figure 5: CAPEX expenditure by oil companies by year [Source: Douglas-Westwood, 2014, via This finite world]

Figure 6: Profit margin of the Oil and gas sector [Source: Citigroup Research, 2014 ]

Figure 6: Profit margin of the Oil and gas sector [Source: Citigroup Research, 2014]

Furthermore, drilling and production costs, the money it costs to keep things ticking over on these new oil developments (be they unconventional or otherwise) is now much higher than has traditionally been the case. Certainly a lot higher than the present price of $50 a barrel. Hence there’s only so long that the oil companies can sustain production from these fields.

Figure 7: The global cost of oil drilling per well [Source: Smart (2012) using EIA data]

Figure 7: The global cost of oil drilling per well [Source: Smart (2012) using EIA data]

And my spies tell me, that there’s already been dissent within the ranks. Even before the recent drops in prices, shareholders in many oil and gas companies were getting very worried about about this huge escalation in expenditure. Needless to say, we can assume they are even more worried now. Probably any time the business news comes on, more than a few start rolling on the floor and chewing the carpet. If I was to hear news of a group of angry persons approaching Kock Industries or Chevron HQ carrying several large crosses and a bag of nails, it would be safe to assume that they aren’t Greenpeace, nor some Christian group of re-enactors, but angry shareholders who’ve finally had enough!

Figure 8: Rates of CAPEX and R&D expenditure, by sector for S&P listed companies [Source: Goldman Sachs (2014), via ]

Figure 8: Rates of CAPEX and R&D expenditure, by sector for S&P listed companies [Source: Goldman Sachs (2014), via]

And this explosion in expenditure in the oil industry has also been sucking in capital from other parts of the financial system. As another graph from Citigroup shows (figure 8) the energy industry has gone from 11% of the S&P market’s CAPEX to 24% of it. And indeed when we look at just the shale gas/oil industry alone, its profitability v’s expenditure looks even worse that the rest of the industry. And most of that is financed by lots of dough from the financial services industry, who needless to say are panicking as we speak, over fears they might be left with a trillion dollars worth of Zombie assets.

And these fears of a “Zombie Apocalypse” also explains another difference between recent events and past oil price drops. In the past, during any supply glut, the Oil Majors assumed that they could rely on OPEC to cut production and stabilise prices. Given how dependant OPEC nations are on the price of oil (as oil exports are a large part of government revenue), it has generally been in their best interest to do so. However, at a recent meeting OPEC effectively said no to calls for a production cut.

Why OPEC did this is easily explained by putting yourself in their shoes. Why should they sacrifice market share just to keep the shale oil producers in business? In previous times, OPEC relied on the assumption that if they cut production nobody would be able to respond and fill in the resulting gap, guaranteeing that prices would rise. However, all of that fracking propaganda (which OPEC oil minsters have also been bombarded with) has left OPEC less certain of this. And ultimately they are gambling that the oil majors, with their much higher production costs, will blink first. After all, in any situation where there’s a price war, its usually the smaller company, with its higher operating costs, living on credit, who goes to the wall first.

Figure 9: Break even costs of oil production by various methods [Source: IHS-CERA (2006), via the Royal Society (UK) ]

Figure 9: Break even costs of oil production by various methods [Source: IHS-CERA (2006), via the Royal Society (UK)]

The inevitable end game is likely therefore to involve several of the oil major’s loosing their shirts, Middle East countries having to cut back their budgets and a complete halt or go slow on all new oil projects, along with an aggressive cost cutting program, resulting in numerous job losses. This could well render such debates as those over the Keystone pipeline, drilling in the ANWR or shale gas drilling in the UK all somewhat moot, as nobody will want to invest in these projects.

Of course this is also bad news for renewables, as cheaper fossil fuels makes it harder for them to compete. Quite apart from the danger that nervous investors worried about the risk of large losses in the fossil fuel side of the energy business might be reluctant to commit to large scale capital projects. Justifying energy efficiency measures also becomes harder. Although in the UK at least the unwillingness of energy companies to respond to these events by ending their monopolistic price gouging cutting utility bills does still make such measures worthwhile.

However perhaps long term, the real losers will perhaps rather ironically be the cornucopians. They will often point to the large reserves of unconventional resources and claim that “the magic of the market” will see those resources extracted. However this analysis ignores the realities of geology (only a fraction of these resources are actually recoverable) as well as the rules of market capitalism. Prices fluctuate as a result of supply and demand factors. And during the periods of low prices much of this unconventional fossil fuel will be rendered uneconomic. Hence much of the world’s oil and gas resources will probably always remain in the ground.

As the late Matt Simmons once pointed out, the best thing that could ever happen to the oil industry would be for prices to go to some extraordinary high value (say $200 a barrel) and stay there. Of course, whether we’d be prepared to pay that much and whether oil demand would remain at its current levels at such prices seems doubtful. Also the timeline between renewables becoming competitive against fossil fuels would drop, again rendering most of the fossil fuel reserves uneconomic.

However, any gains in production since 2005 does tend to undermine the suspicion that conventional oil peaked in 2006. That said, if you look at the data, its obvious the rate of production growth is definitely slowing. While there was an increase in global oil production of 12.7% between 1997 and 2005, between 2005 and 2013, despite all that money thrown at shale oil, the tar sands, EOR and numerous conventional oil projects, the result was only a 4.1% increase in production. Like I said, running faster to stand still.

Hence when this spurt in new production runs its course, and that’s not likely to take more than a few years, its very difficult to see how unconventional resources (which again are only 5% of production, and unlikely to ever exceed 20% of the total) replacing Middle Eastern oil. Once the major oil fields in the Middle East peak, its very difficult to envisage anything that’s going to replace them.

So rumours of peak oil’s death are perhaps greatly exaggerated.

About daryan12

Engineer, expertise: Energy, Sustainablity, Computer Aided Engineering, Renewables technology
This entry was posted in economics, energy, fossil fuels, peak oil, politics, power, Shale Gas, Shale oil, Tar Sands. Bookmark the permalink.

7 Responses to The oil price dilemma

  1. Pingback: Reserves v’s Resources | daryanenergyblog

  2. pendantry says:

    Followed a link here from your recent (very astute) comment on climatecrocks (partly because I don’t feature in your specified respondent type for that comment).

    Thank you for this very interesting article. I am, however, a tad confused by what I perceive as a contradiction in what you say:

    Hence there’s only so long that the oil companies can sustain production from these fields.

    So rumours of peak oil’s death are perhaps greatly exaggerated.

    … ah. I’ve just realised that I’ve misunderstood your final sentence. Emphasise the word ‘death’, and I think it becomes much clearer. At least, it does so in my confused mind, anyway. I think.

    I look forward to more insights!

  3. Mason Inman says:

    Great post! I agree that “rumours of peak oil’s death are perhaps greatly exaggerated.”

    You might be interested in my new book, The Oracle of Oil, the first biography of M. King Hubbert, the “father of peak oil.” It’s being published in April by W.W. Norton, and is available in the UK from Amazon, Foyles, Blackwells, WH Smith, etc.

    Also you might be interested in a couple of articles of mine in Nature on shale gas:
    “The Fracking Fallacy” (about the US)

    “Can fracking power Europe?” (about Europe, unsurprisingly)

  4. Pingback: America’s shale oil slow down | daryanenergyblog

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