Fwd: Museletter #271/December 2014
From: Scott Jackson (sjackzen46gmail.com)
Date: Tue, 23 Dec 2014 10:50:54 -0800 (PST)
Here's a Museletter from the Post Carbon Institute with an article by
Richard Heinberg explaining the "Oil Price Crash of 2014'. There's a link
in it to an explanation by Euan Mearns with several helpful charts, which a
visual guy like me appreciates.

I'll be interested to see if lower prices at the pump coupled with the
revised 5% economic surge in the last quarter leads to a jump in driving
and gasoline consumption during the holidays. There has already been a jump
in the sale of SUVs. (Do you suppose that many Americans aren't yet ready
to hunker down, as Bill McKibben suggests, and adopt a more sustainable

Scott Jackson
sjackzen46 [at] gmail.com

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From: Post Carbon Institute <newsletter [at] postcarbon.org>
Date: Tue, Dec 23, 2014 at 11:25 AM
Subject: Museletter #271/December 2014
To: Scott <sjackzen46 [at] gmail.com>

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*MuseLetter #271 / December 2014 by Richard Heinberg*

The Oil Price Crash of 2014
Oil prices have fallen by half since late June. This is a significant
development for the oil industry and for the global economy, though no one
knows exactly how either the industry or the economy will respond in the
long run. Since it’s almost the end of the year, perhaps this is a good
time to stop and ask: (1) Why is this happening? (2) Who wins and who loses
over the short term?, and (3) What will be the impacts on oil production in

*1. Why is this happening?*
Euan Mearns does a good job of explaining the oil price crash here
Briefly, demand for oil is softening (notably in China, Japan, and Europe)
because economic growth is faltering
Meanwhile, the US is importing less petroleum because domestic supplies are
increasing—almost entirely due to the frantic pace of drilling in “tight”
oil fields in North Dakota and Texas, using hydrofracturing and horizontal
drilling technologies—while demand has leveled off.

Usually when there is a mismatch between supply and demand in the global
crude market, it is up to Saudi Arabia—the world’s top exporter—to ramp
production up or down in order to stabilize prices. But this time the
Saudis have refused to cut back on production and have instead unilaterally
cut prices to customers in Asia, evidently because the Arabian royals *want*
prices low. There is speculation
that the Saudis wish to punish Russia and Iran for their involvement in
Syria and Iraq. Low prices have the added benefit (to Riyadh) of shaking at
least some high-cost tight oil, deepwater, and tar sands producers in North
America out of the market, thus enhancing Saudi market share.

The media frame this situation as an oil “glut,” but it’s important to
recall the bigger picture: world production of conventional oil (excluding
natural gas liquids, tar sands, deepwater, and tight oil) stopped growing
in 2005
and has actually declined a bit since then. Nearly all supply growth has
come from more costly (and more environmentally ruinous) resources such as
tight oil and tar sands. Consequently, oil prices have been very high
during this period (with the exception of the deepest, darkest months of
the Great Recession). Even at their current depressed level of $55 to $60,
petroleum prices are still above the International Energy Agency’s
high-price scenario
for this period contained in forecasts issued a decade ago.

Part of the reason has to do with the fact that costs of exploration and
production within the industry have risen dramatically (early this year
Steve Kopits of the energy market analytic firm Douglas-Westwood estimated
that costs were rising at nearly 11 percent annually

In short, during this past decade the oil industry has entered a new regime
of steeper production costs, slower supply growth, declining resource
quality, and higher prices. That all-important context is largely absent
from most news stories about the price plunge, but without it recent events
are unintelligible. If the current oil market can be characterized as being
in a state of  “glut,” that simply means that at this moment, and at this
price, there are more willing sellers than buyers; it shouldn’t be taken as
a fundamental or long-term indication of resource abundance.

*2. Who wins and loses, short-term?*
 Gail Tverberg does a great job of teasing apart the likely consequences of
the oil price slump here
For the US, there will be some tangible benefits from falling gasoline
prices: motorists now have more money in their pockets to spend on
Christmas gifts. However, there are also perils to the price plunge, and
the longer prices remain low, the higher the risk. For the past five years,
tight oil and shale gas have been significant drivers of growth in the
American economy, adding $300 to 400 billion annually to GDP. States with
active shale plays have seen a significant increase of jobs while the rest
of the nation has merely sputtered along.

The shale boom seems to have resulted from a combination of high petroleum
prices and easy financing: with the Fed keeping interest rates near zero,
scores of small oil and gas companies were able to take on enormous amounts
of debt so as to pay for the purchase of drilling leases, the rental of
rigs, and the expensive process of fracking. This was a tenuous business
even in good times, with many companies subsisting on re-sale of leases and
creative financing, while failing to show a clear profit on sales of
product. Now, if prices remain low, most of these companies will cut back
on drilling and some will disappear altogether

The price rout is hitting Russia quicker and harder than perhaps any other
nation. That country is (in most months) the world’s biggest producer, and
oil and gas provide its main sources of income. As a result of the price
crash and US-imposed economic sanctions, the ruble has cratered. Over the
short term, Russia’s oil and gas companies are somewhat cushioned from
impact: they earn high-value US dollars from sales of their products while
paying their expenses in rubles that have lost roughly half their value
(compared to the dollar) in the past five months. But for the average
Russian and for the national government, these are tough times.

There is at least a possibility that the oil price crash has important
geopolitical significance. The US and Russia are engaged in what can only
be called low-level warfare over Ukraine: Moscow resents what it sees as
efforts to wrest that country from its orbit and to surround Russia with
NATO bases; Washington, meanwhile, would like to alienate Europe from
Russia, thereby heading off long-term economic integration across Eurasia
(which, if it were to transpire, would undermine America’s “sole
superpower” status; see discussion here
Washington also sees Russia’s annexation of Crimea as violating
international accords. Some argue
that the oil price rout resulted from Washington talking Saudi Arabia into
flooding the market so as to hammer Russia’s economy, thereby neutralizing
Moscow’s resistance to NATO encirclement (albeit at the price of short-term
losses for the US tight oil industry). Russia has recently cemented closer
energy and economic ties with China
perhaps partly in response; in view of this latter development, the Saudis’
decision to sell oil to China at a discount could be explained as yet
another attempt by Washington (via its OPEC proxy) to avert Eurasian
economic integration.

Other oil exporting nations with a high-price break-even point—notably
Venezuela and Iran, also on Washington’s enemies list—are likewise
experiencing the price crash as economic catastrophe. But the pain is
widely spread: Nigeria has had to redraw its government budget for next
year, and North Sea oil production is nearing a point of collapse

Events are unfolding very quickly, and economic and geopolitical pressures
are building. Historically, circumstances like these have sometimes led to
major open conflicts, though all-out war between the US and Russia remains
unthinkable due to the nuclear deterrents that both nations possess.

If there are indeed elements of US-led geopolitical intrigue at work here
(and admittedly this is largely speculation), they carry a serious risk of
economic blowback: the oil price plunge appears to be bursting the bubble
in high-yield, energy-related junk bonds
that, along with rising oil production, helped fuel the American economic
“recovery,” and it could result not just in layoffs throughout the energy
industry but a contagion of fear in the banking sector. Thus the ultimate
consequences of the price crash could include a global financial panic (John
Michael Greer makes that case persuasively
and, as always, quite entertainingly), though it is too soon to consider
this as anything more than a possibility.

*3. What will be the impacts for oil production?*
 There’s actually some good news for the oil industry in all of this: costs
of production will almost certainly decline during the next few months.
Companies will cut expenses wherever they can (watch out, middle-level
managers!). As drilling rigs are idled, rental costs for rigs will fall.
Since the price of oil is an ingredient in the price of just about
everything else, cheaper oil will reduce the costs of logistics and oil
transport by rail and tanker. Producers will defer investments. Companies
will focus only on the most productive, lowest-cost drilling locations, and
this will again lower averaged industry costs. In short order, the industry
will be advertising itself to investors as newly lean and mean. But the
main underlying reason production costs were rising during the past
decade—declining resource quality as older conventional oil reservoirs dry
up—hasn’t gone away. And those most productive, lowest-cost drilling
locations (also known as “sweet spots”) are limited in size and number.

The industry is putting on a brave face, and for good reason. Companies in
the shale patch need to look profitable in order to keep the value of their
bonds from evaporating. Major oil companies largely stayed clear of
involvement in the tight oil boom; nevertheless, low prices will force them
to cut back on upstream investment as well. Drilling will not cease; it
will merely contract (the number of new US oil and gas well permits issued
in November fell by 40 percent from the previous month
Many companies have no choice but to continue pursuing projects to which
they are already financially committed, so we won’t see substantial
production declines for several months. Production from Canada’s tar sands
will probably continue at its current pace, but will not expand since new
projects will require an oil price at or higher than the current level
in order to break even.

As analysis by David Hughes of Post Carbon Institute
shows, even without the price crash production in the Bakken and Eagle Ford
plays would have been expected to peak and begin a sharp decline within the
next two or three years. The price crash can only hasten that inevitable
inflection point.

How much and how fast will world oil production fall? Euan Mearns offers
three scenarios
in the most likely of these (in his opinion) world production capacity will
contract by about two million barrels per day over the next two years as a
result of the price collapse.

We may be witnessing one of history’s little ironies: the historic
commencement of an inevitable, overall, persistent decline of world liquid
fuels production may be ushered in not by skyrocketing oil prices such as
we saw in the 1970s or in 2008, but by a price crash that at least some
pundits are spinning as the death of “peak oil.”
Meanwhile, the economic and geopolitical perils of the unfolding oil price
rout make expectations of business-as-usual for 2015 ring rather hollow.

*Thank you for your support in 2014, and my very best wishes for the
Holidays and the New Year. Richard*

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