What’s Going on with Low Gas Prices, Shale Oil, American Energy Independence, and OPEC?

Orlin Wagner/AP

(image source: Orlin Wagner/AP)

There’s a lot of confusion going on right now – as the price of gasoline in the U.S. is declining, we are becoming ever more complacent. Today we saw another steep drop in the price of oil to a four year low under $68/barrel. Is this a sign that peak oil is dead, and that we have indeed entered a new era of energy independence in the U.S., thanks to the fracking phenomena, giving us an expanding bonanza of shale oil and gas?  Today’s installment in our Holiday Smorgasbord series takes a look at these issues, and the significance of the decision made yesterday by OPEC to keep oil production at current levels.

The Collapse of Oil Prices and Energy Security

Let’s begin with this question: Why are oil prices collapsing, and why is gasoline getting cheaper? I think this is the question on many people’s minds. And then there is the further question, why might this be a problem?

There are a number of possible reasons why oil prices are decreasing. Check out Kurt Cobb’s piece to explore a number of these reasons. The reason that makes the most sense to me, and I think intelligent consensus has pretty much converged upon, is that OPEC is currently flooding the market with oil in an attempt to recapture market share from the higher cost unconventional shale oil being produced in the U.S.

Why might this be a problem? Ugo Bardi explained the situation quite well in a recent briefing he gave to the EU Parliament.  Bardi is a physical chemistry professor at the University of Florence, in Italy, and is a leading authority on resource depletion.

“I have to alert you that there is [an] ongoing crisis – perhaps much more worrisome – that has to do with crude oil. This crisis is being generated by the rapid fall in oil prices during the past few weeks. I have to tell you that low oil prices are NOT a good thing for the reasons that I will try to explain. In particular, low oil prices make it impossible for many oil producers to produce at a profit and that could generate big problems for the world’s economy, just as it already happened in 2008.”

Bardi further explains:

“Ultimately, it is the cost of production that generates the lower price limit. Here, we get into the core of the problem. As you see from the price chart above, up to about the year 2000, there was no problem for producers to make a profit selling oil at around 20 dollars per barrel. Then something changed that caused the prices to rise up. That something has a name: it is depletion.

Depletion doesn’t mean that we run out of oil. Absolutely not. There is still plenty of oil to extract in the world. Depletion means that we gradually consume our resources and – as you can imagine – we tend to extract and produce first the least expensive resources. So, as depletion gradually goes on, we are left with more expensive resources to extract. And, if extracting costs more, then the market prices must increase: as I said, nobody wants to sell at a loss. And here we have the problem…

So, you see that, with the present prices, a good 10% of the oil presently produced is produced at a loss. If prices were to go back to values considered “normal” just 10 years ago, around 40 $/barrel, then we would lose profitability for around half of the world’s production. Production won’t collapse overnight: a good fraction of the cost of production derives from the initial investment in an oil field. So, once the field has been developed, it keeps producing, even though the profits may not repay the investment. But, in the long run, nobody wants to invest in an enterprise at so high risks of loss. Eventually, production must go down: there will still be oil that could be, theoretically, extracted, but that we won’t be able to afford to extract. This is the essence of the concept of depletion. “

Read Ugo Bardi’s post: The Collapse of Oil Prices and Energy Security in Europe

For another view, see also Gail Tverberg’s piece on Oil Price Slide: No Good Way Out

Gail Tverberg:

“We have been hearing for so long that the problem of “peak oil” will be inadequate supply and high prices that we cannot adjust our thinking to the real situation. In fact, the two major problems of oil limits are likely to be shrinking debt and shrinking wages. The reason that oil supply will drop is likely to be because customers cannot afford to pay for it; they don’t have jobs that pay well and they can’t get loans.

In some ways, the oil prices situation reminds me of driving down a road where we have been warned to look carefully toward the left for potential problems. In fact, the potential problem is in precisely in the opposite direction–to the right. The problem gets overlooked for a very long time, because most of us have been looking out the wrong window.”

RelatedOil Price Slump to Trigger New U.S. Debt Default Crisis as OPEC Waits (Andrew Critchlow, The Telegraph)

Chris Martenson Crash Course, Chapter 21: Shale Oil

I’ve talked about shale oil a few times on this blog (Oil Company Woes: This is What Energy Depletion Looks Like, An Energy “Renaisance”?, Breaking: Go’vt Slashes Calif. Oil Estimate, and New Energy Report from IEA Forecasts Decline in North American Oil Supply), but this is very important, because, as Chris Martenson states, “the mainstream press has faithfully repeated every press and PR statement made by the shale producers,” and I believe the PR hype is misleading and very dangerous as it lulls us into a false sense that we’ll have an energy abundance for years to come, thanks to the miracle of hydraulic fracturing (“fracking”) . On the contrary, it is “expensive, over-hyped, and short-lived.”

And so let’s look at Chris Martenson’s Crash Course on Shale Oil. Martenson has a way of taking a complicated subject and presenting it in a way that is clear and easy to follow. This is a 28 minute video that provide some context for what follows below.

Check out the Peak Prosperity blog post and transcript on the Shale Oil Crash Course here.

An Energy System Under Stress and the Last Tango in Paris
On November 12th a cautious, mainstream, historically optimistic organization – the International Energy Agency (IEA) put out what is perhaps it’s most urgent warning yet in its major yearly World Energy Outlook report. As I pointed out in a previous post (Watching the Watchdogs: 10 Years of the IEA World Energy Outlook), the IEA has only very slowly come around to discussing possible supply disruptions. Serving the energy industry as well as trying not to offend mainstream political and economic sensibilities, and not wanting to disrupt financial markets, you can imagine a cautious approach to addressing issues such as peak oil or climate change.  And so, when they put out warnings, it probably means it’s very late in the game indeed.
In the above 39 minute video, IEA Chief Economist Fatih Birol calmly and methodically outlines the 2014 report, where we hear some of the following points:
  • Energy security is a heightened and growing risk – set to move up very high in the international policy agenda.
  • “…if the oil prices remain at the current (<$80) level, the capital spending in 2015 in the United States will decline up to 10% compared to 2014…a downward pressure on the investments in light tight oil (shale oil) as a result of these prices.”
  • Upward pressure on oil demand growth and downward pressure on price may lead to a growing reliance on Middle East oil, “where instability is the name of the game,” before 2020.
  • Regardless, we’re likely to see declining output from the U.S., Canada, and Brazil by 2020, by which time we’ll almost certainly be more dependent than ever upon the Middle East conventional oil to meet our oil supply demand [this after having stated in their 2010 report that conventional oil peaked in 2006. At that time they stated that it would be unconventional oil and natural gas liquids that would fill the gap and allow supply to grow through 2035].
  • The $550 billion in subsidies for fossil fuels needs to be reconsidered.
  • Climate talks scheduled to take place in Paris in 2015 may very well be our Last Chance to keep global warming to 2 degrees C.  This could be our “Last Tango in Paris.”

Fatih Birol:

“The main message, I believe, coming from our report, in terms of energy security there is a heightened risk, growing risk at present in a number of parts of the world that are strategically important from an energy perspective: Iraq, Middle East, Libya, North Africa, Russia, Ukraine – these are all signals to us, highlighting the importance of energy security and I believe energy security is set to move up high in the international policy agenda. Volatility  in the Middle East puts questions on the investment trends, and therefore it may well mean substantial challenges around 2020 for the oil supply…

“We do need to get a clear direction in Paris next year [2015 United Nations Climate Change Talks]. A “Last Chance in Paris,” we believe – like “Last Tango in Paris,” there is  Last Chance in Paris – and if we are not able to do that, we may well say goodbye to the world we used to see for several centuries. And we believe government policies, looking at the complexity and the amount of the challenges we are facing (energy security, climate change), government policies are crucial to steer the global energy system on to a better, safer course.”

Related: International Energy Agency Says: Brace for Impact (Tom Lewis, The Daily Impact)

OPEC Declines Action as World Oil Prices Hit Record Lows

The information above provides context for yesterday’s much anticipated OPEC meeting, where they declined to make any production changes. As Fatih Birol warned above, this non-action keeps a downward pressure on the oil price and poses big problems for the shale oil industry, which needs prices above $80 a barrel to keep their heads above water. And if the shale oil industry falters, so does the hope for even a short term respite from concerns about an adequate oil supply for world markets.

On NPR, Ari Shapiro introduced the story by saying “You don’t usually hear swearing when OPEC countries gather in the refined meeting rooms of Vienna, Austria. But the organization that once dominated world oil markets is now coming to terms with its dwindling clout.”

Reporter Peter Kenyon explained the problem: If OPEC were to cut production, they would cede market share to American producers of shale oil, whose current production has limited the ability of OPEC to control price. If OPEC does not cut production, that will hurt the less well-off OPEC producers who are in need of higher priced oil revenues. However, (as pointed out above), this more so hurts the Americans as OPEC tries to push the expensive to produce shale oil out of the market.

Kenyon quotes energy analyst Cornelia Meyer with the MRL Corporation, who confirms what is said by the varied sources above in this post: “You will obviously see less investment in the sector, especially with the shale oil production. They’re very cash flow driven. So if you see less investment there, that will translate pretty quickly in less production in the U.S.”

Listen to the story on NPR or read the transcript: OPEC Declines Action as World Oil Prices Hit Record Lows

And so we come to today, Nov. 28, 2014, where USA Today has just reported Dow ekes out record close; oil plummets 8.2%. “A barrel of Texas Intermediate crude was at $67.74 Friday afternoon Eastern Time — a whopping 8.2% drop.” In the short term, it’s a relief for consumers and markets, but the signals this sends for the medium term are troubling.

Related: See the various sources Bloomberg cites to back up their headline: Oil at $75 Means Patches of Texas Shale Turn Unprofitable

Again, as the recent IEA World Energy Outlook stated:

“The global energy system is in danger of falling short of the hopes and expectations placed upon it. The short-term picture of a well-supplied oil market should not disguise the challenges that lie ahead as reliance grows on a relatively small number of producers.”

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