As the price of oil reaches new highs just about every day ($100, $103, now how much will you pay?!?), analysts around the world are scrambling to figure out what's going to happen next. In that context, I received the following from Adam Sieminski of Deutsche Bank and thought it was fascinating. Adam is one of the top oil analysts in the world, someone I knew (and greatly respected) when I worked at the U.S. Energy Information Administration (EIA). The proprietary analysis below is from Adam's Deutsche Bank equity research colleague Paul Sankey. Adam -- who, by the way, does not fully agree with Paul Sankey on this -- has graciously granted me permission to quote from what Sankey has to say. My comments follow each blockquote and are in italics.
Leading oil executives, notably the CEOs of TOTAL and ConocoPhillips, are talking peak oil - and being specific: a maximum of 100 mb/d of oil supply, ever. (The current market is 88mb/d, growing 1.5mb/d per year.) By contrast econometric models - the IEA, ExxonMobil, our own - show world oil demand surpassing 100mb/d by around 2015. However typically these models assume supply will continue to grow, and do not address the issue of price. Here we assume the market is limited at 100mb/d - and speculate on what will happen to oil prices.
When I was a new world oil market analyst at EIA back in 1991, the "base case" forecast for world oil consumption in 2010 was 78.7 million barrels per day (bbl/d). By 1995, the forecast for 2010 had risen to 88.7 million bbl/d. Today, as the note above says, "The current market is 88mb/d, growing 1.5mb/d per year." That puts us on track for world oil consumption of around 91 million bbl/d in 2010, 13 million bbl/d above the forecast made in 1991 and 2 million bbl/d above the 1995 forecast.
With regard to price, the 1991 International Energy Outlook (IEO) projected a 2010 oil price of $33.40 per barrel (in constant, $1990). The 1995 IEO forecast a 2010 oil price of just $24.12 per barrel (in constant, $1993). Even adjusting for inflation, these forecasts obviously are far, far below the current West Texas Intermediate (WTI) price of around $100 per barrel. Obviously, something went wrong big time: first, demand was underestimated; second, oil production capacity was far overestimated in several countries. For instance, the 1991 IEO projected Saudi oil production capacity at 11.0-16.8 million bbl/d in 2010, with Iraqi production capacity at 5.0-7.6 million bbl/d and Venezuela at 3.5-5.3 million bbl/d.
The total production capacity for these three countries projected in 1991 was as high as 29.7 million bbl/d by 2010. Instead, what we're looking at in 2008 -- less than 2 years away from 2010 now -- is Saudi capacity of around 10.6 million bbl/d (I believe this is an overestimate), Iraq at around 2.1 million bbl/d, and Venezuela at 2.4 million bbl/d. That's a total of 15.1 million bbl/d for the three countries, a staggering 14.6 million bbl/d below the high end of the 1991 forecast. Needless to say, that's a huge supply constraint that was completely unexpected (at least by most "mainstream" government and corporate energy analysts) in 1991. During the 1990s, econometric modelers had assumed oil supply would grow to meet or even exceed demand for the indefinite future. In reality, supply has grown much more slowly and may now be leveling off, even as oil demand has surged in places like China, India, the Middle East -- pretty much everywhere. The result: much, much higher oil prices -- by a factor of three -- than forecast in 1991 or 1995.
One more point: in my 17 years at EIA, I found essentially no support for the idea of "peak oil." Heck, I didn't support it either, given that all of my mentors and friends essentially thought it was based on ignorance and/or lunacy. To the contrary, the underlying assumption behind long-term energy models was simply that there would always be enough oil to meet demand. At one point, EIA even projected Saudi production capacity reaching 22.5 million bbl/d by 2025 or so. Obviously, this was absurd, and I tried to argue against it (along with one or two other colleagues) but never got anywhere. The problem was that if Saudi production capacity was capped at 10 or 12 million bbl/d, the world oil equation simply didn't add up at prices that analysts or their political appointee bosses were willing to stomach. It was the same thing with the idea that the world's environment couldn't absorb the carbon emissions from all this oil consumption -- almost complete denial. Now, I'm not meaning to bash my former colleagues on this; they were overwhelmingly good, smart, dedicated people doing the best they could given the constraints they were operating under. However, I am meaning to bash the Bush "politicals," as well as a few clueless political butt-kissers in management (hint) who preferred to say "yes, minister" (or the equivalent), to "kiss up/kick down," to denigrate some of their best peoples' warnings, to believe the Saudis' patently ridiculous (and essentially unverifiable) claims -- pretty much anything to avoid the dire price and econoimc implications that would have flowed from an assumption of "peak oil" in any way, shape, or form. But that's a story for another diary, another day...
$100/bbl is not the demand breakpoint - we can go higher
Why is it different now from the 1979 rollover in demand, when at similar levels of economic impact, oil demand fell 20% in four years? There are two interesting complexities: asymmetric elasticity - substitution from power and industry has already been done & cannot be replicated - and reverse elasticity - high oil prices reduce oil supply (by funding resource nationalism) and increase (Middle East) oil demand. Prices can go higher, benefiting net oil exporters hugely.
Meanwhile, as if that's not challenging enough, the world today also faces a grave challenge barely even whispered about in 1979 -- global climate change. Today, the concept of mass conversion away from oil and towards even more carbon-intensive coal is extremely problematic. To the contrary, the world appears to be moving inexorably, albeit with great difficulty and resistance, towards a system in which carbon is capped, thus raising the price of fossil fuels.
Today, the answer to climate change, as well as to our "oil addiction," is massive energy efficiency gains in transportation and other sectors, combined with a huge push for clean, renewable energy sources like wind, solar thermal, tidal, wave, and geothermal. Nuclear power is another possibility, but this far more problematic than 1979, the year of the Three Mile Island nuclear accident and 7 years prior to the Chernobyl nuclear disaster. Those two accidents effectively put a halt to nuclear expansion in many countries. As the Deutsche Bank analysis notes, however, oil is not consumed much to generate electricity. Instead, oil is mainly a transportation fuel, which means we have to focus our efforts on plug-in hybrids and other technologies, combined with a change in development patterns (away from sprawl) in order to vastly reduce the amount of oil used per person. That's going to be a major challenge and is going to require the type of intensive, innovative, visionary political leadership that we haven't seen in many years and that our system isn't particularly geared towards. It certainly can be done, it's just not going to be as easy as it was in the late 1970s/early 1980s.
It's easy to get to 100mb/d demand; 100+ mb/d supply is hard
We can easily see oil demand exceeding 100mb/d by 2015, even with efficiency gains, both per unit of GDP and per capita, if prices do
not prevent it. Getting demand to that level is easy, but why is 100mb/d supply so hard? Simple, it's the declines. Not only is current supply showing no price elasticity, but also the treadmill is ramping up on an aging industry. Even with today's 5% decline rate, to sustain a 100mb/d oil market will require some 8mb/d of new annual supply growth, a level that has never been achieved.
A peak oil price of $150/bbl (nominal) in 2010?
We believe that in a supply-constrained world, where demand drives price higher, that the major net oil importers, namely China, other Asia and the US are key marginal breakpoint of demand. However, for the US, asymmetric elasticity implies a breakpoint higher than in the late 1970s, and current demand still growing supports this. We suggest around 10%+ of oil cost to GDP, around 2% above late 1970s and current levels; implying another $1 on pump gasoline prices, and oil at $150/bbl, and the cost 0.4% of annual GDP growth between 2008-2010. We think China and India annual GDP growth could be some 2%-4% lower if supply is constrained, because oil is a key input to economic growth.The short term is volatile as price seeks to destroy demand and the US teeters on recession. Overall, we are essentially oil bulls. The crux of our argument is that we have an oil supply problem and prices have yet to truly test demand. The relatively higher leverage to oil price strength of the mid-caps keeps us long Oxy, Suncor, and Hess, relative to mega-cap oils where valuation is arguably more attractive.
One problem is that short-term demand elasticity is low; think about how slowly people have changed their oil consumption patterns even at $3.00 per gallon (or higher) prices for gasoline. Certainly, if such prices were sustained over time, and perhaps more importantly if people believed that high prices would be sustained over time, we could eventually see significant changes in oil consumption patterns. Given the path-dependent nature of oil consumption (e.g., the sprawl pattern of development which has led to tremendous dependence on the automobile, SUV and minivan for suburban/exurban mobility), however, significant change in this regard will likely prove wrenching and politically problematic (you mean my 10,000 square foot home and my 100-mile commute in the Hummer aren't gonna cut it anymore?!? argh!!!!), to put it mildly.
Another problem/challenge is that the world oil demand curve is shifting outwards because developing countries are...well, developing! As China, India, and other populous countries move towards modern/Western consumption patterns, the pressures on world resources - including oil -- will continue to grow, eventually becoming (economically and environmentally) unsustainable. In fact, we may already be approaching such a point right now. If so, oil forecasts of $150 per barrel may seem conservative a few years down the road. Unless, of course, our government(s) step up to the plate, bite the bullet, and any other cliche you can think of for "displays leadership." If not, we could be facing a rough few years that potentially resurrect all the worst aspects of the 1970s (stagflation, oil crises) along with new ones (nuclear proliferation, terrorism, global warming). Those days of disco and leisure suits are looking better and better all the time.
P.S. Oh yeah, one other point I almost forgot to make: an oil production peak of 100 million bbl/d could start to really hit hard in just a few years. At annual world oil demand growth of 1.5-2.0 million bbl/d, world oil demand reaches will likely hit 100 million bbl/d in just 6-8 years or so. After that, demand will actually start to exceed supply. Or, at least demand would exceed supply if that were not, by definition, impossible under the laws of economics (supply must equal demand). Instead, what will actually happen is that the price of oil will skyrocket to "destroy" enough demand in order to balance the market. Until world oil demand growth is zero or even negative, prices will continue to rise as supply remains fixed at 100 million bbl/d. How high could oil prices go? The sky's the limit, really, but most likely high enough to induce a severe world recession and massive efforts aimed at replacing/substituting for oil. Let's just hope that, during the period while the world is scrambling to make up for (foolishly) lost time, there's no major oil supply disruption in Saudi Arabia or wherever. If that happens, we'll look back on the days of $150 per barrel oil and $4 per gallon gasoline as those sweet, halcyon days of yore.
And since it was still early in the morning when I posted the first comment, the coffee hadn't quite kicked my brain into gear yet, and there was a 2nd point that I had in mind that never made it to my fingers.
We talk about high prices and the lack of demand destruction, at least in the short term. At current prices, people still seem inclined to suck it up and pay the price. Shortages will provide a 2nd and independent motivating factor that will encourage people to use less. One danger is that shortages will lead people to try and hoard gasoline, but in the 1970's gas stations imposed limits on how much people could purchase at one time to try and limit this behavior. If this were to happen again in the near future, the person with the big SUV who thinks that they "need" 30 gallons/week may find it to be a real pain in the neck to keep this monster fed.
These days I fill the tank on my VW diesel about once every 3 weeks. I would like to get it down to once a month by riding my bicycle to work more often, and working from home. Not out of any desire to leave more for others - really out of a desire to improve my health and live a more carbon-free lifestyle. But even at my current consumption rates, fuel costs aren't a huge factor in my monthly budget.
One disagreement:
That's a total of 15.1 million bbl/d for the three countries, a staggering 14.6 million bbl/d below the high end of the 1991 forecast. Needless to say, that's a huge supply constraint that was completely unexpected in 1991.
It was completely unexpected, evidently, within the official community. However, when did Hubbert make his prediction of global peak oil? 1970?
Thus, just as EIA is utterly out of sync with reasonable forecasting (and has been for years), perhaps the (frequently excellent) analysts in the 1990s were also not looking to the literature in a meaningful way.
And, I must say, if you were the one pointing to and trying to get traction for Peak Oil in the 1990s (amid ever cheaper oil), another reason to respect you.
What I see for a near future is:
1) attempts to expand oil production in the deep, deep sea, in the Artic Ocean, the South China Sea, Antartica--- every inaccesible, expensive place imaginable, and it simply will not be enough, and producing countries will start keeping their oil for home consumption
2) possible famines, good old-fashioned starvation in many places--- our reserve supplies of, say, wheat and rice, are very slim and are being drawn down every year; some analysts admit humanity is about one harvest away from a serious shortage if there is a big natural disaster or an unexpected widespread virus that hits a food crop
3) wars in the mid-to-late 21st century may well be more over water than oil--- the photo recently published of Lake Meade (Hoover Dam in the American Southwest) is just one indication of a rapidly diminishing supply of the one natural resource life cannot do without, and aquifers world wide are falling rapidly, not the least in our own breadbasket mid-West; the problem is compounded by cllimate change and spreading drought--- China loses an area the size of Delaware every year to the Gobi Desert and the oceans are over-fished and produce decreasing harvests of fish.
World population continues to increase by an estimated 70 million annually.
These are the elephants in the room that are never discussed publicly by our political leadership. Including our candidates for President.
The modeling parameters may have been off, but it was also a lack of courage (by both political and career based management) to let the models run free and accept the results as the fell. However, I also wouldn't blame the management entirely - if they had predicted the current prices EIA would have been the laughing stock of the energy world. But they could've pressed the limits more than they did.
There are tons of ways we could set up the market for the power. We could model it on the regional transmission authority system. And this is just one idea. We could certainly do many different combinations of things. But we need to do something. Unfortunately, we always seem to deal with problems after they have become catastrophic. And currently the political environment across the river is not conducive to getting things accomplished.
There are a lot of great ideas and experimental vehicles out there, they just need to be pushed into the mainstream. tx2vadem is right - we need to stop pissing away our money on Iraq (and giving it away to the oil companies in the form of tax breaks) and start dumping it into these new ideas.
I feel for the next president. There are so many colossal issues just surrounding us, things that really dwarf healthcare and the current mortgage meltdown. The biggest mark against the Bush administration is all the time they have wasted on Iraq. Even from a security and strategic interest perspective, the whole affair was terribly short sighted. And now here we are 8 years later with this mess on our hands and no progress to speak of on dealing with any of these other issues.
The OPEC oil cartel meets on Wednesday and is expected to leave its production levels unchanged. The oil producing group had suggested last month that it might curb production soon to make up for a seasonal decline in oil demand.