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The next oil spike(s)

Written By: - Date published: 4:01 pm, April 13th, 2009 - 13 comments
Categories: economy, transport - Tags: ,

Remember the oil spike? Over the course of the last 4-5 years, oil kept on breaking records, culminating in a massive spike to reach $150 last June. Why did that happen? Some people want to dismiss it as just a speculative bubble but they forget that speculators come to a market that has a fundamental driver of price change. They magnify that price change (and speculation cuts both ways, right now, there’s negative speculation in oil through short-selling) but there’s a real reason for the price change.

That reason ought to be very worrying – our capacity to produce oil was not increasing as fast as our demand for the stuff. The consequence was that the spare capacity buffer evaporated, and that, in turn, prompted the price spike.

oil-capacity-crunch

Well, so what, some might argue. The price went up, it destroyed demand and prompted more investment in capacity. The buffer was restored. The price fell. That’s how markets are meant to work. Crisis over.

Not quite. Demand destruction came at a terrible price, a global recession and the capacity issue is not solved, indeed the economic situation has set us up for another capacity crunch in the near future.

Don’t believe me, look at what the International Energy Agency is saying. The collapse of the oil price and the drying up of credit worldwide have been a double punch on investment in oil production capacity. $100 billion in new oil projects has been cancelled because funding for them has gone and there are many other potential projects that can’t get off the ground when there is no credit and the extraction costs are too high to guarantee a profit based on current prices.

Oil projects take 5-10 years from initial exploration to commercial production, and existing fields’ production declines at predictable rates. That means we have a very clear idea now of what capacity will be like in coming years. Right now, we are not investing enough. The IEA has warned that because of this, there will not be enough capacity to meet demand as the world comes out of recession. They predict that the end of the recession will see demand recover particular from India and China, and that will see the capacity cushion disappear once more sparking another super-spike.

The oil market appears to agree. A barrel of oil for delivery in June 2010 is currently going for $129, compared to $50 a barrel for delivery in May 2009. Another oil spike is coming as soon as the economy starts to recover and it will slam the still delicate world economy back into recession.

Economics turns a single geologic peak into a prolonged series of alternating price super-spikes and deep recessions.

multi-spike

Every time the global economy gets back on its feet, the demand for oil climbs and approaches the stalling or falling capacity to produce oil, sending the price sky-high until the global economy cannot bear it any longer. The nature of private investment may only serve to worsen this trend. During the spikes, it will be all aboard for speculators drving the price higher and there’s investment in both oil capacity and oil alternatives. But come the economic crash the money dries up, the oil and oil alternative investment gets canned because the short-term profit has gone, so that the world stays oil dependent and short on oil production, ingredients for the next spike.

If this is how peak oil will manifest, it’s going to be a long and bumpy ride down for economies addicted to oil. Getting off as soon as possible would be wise.

Clinton Smith (PS in the past I posited that the oil spike caused the global recession by crippling the housing market. Others (eg these jokers) are arguing this in more detail. I’ll write a synopsis for The Standard some time)

[update: jarbury has a post on the same issues. He adds some important quotes from The Last Oil Shock

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13 comments on “The next oil spike(s)”

  1. Stephen 1

    Are you personally going to go long on oil then? Sounds profitable.

  2. Very interesting post. I agree the the world seems likely to end up stuck in an oil-spike, recession, oil-spike, recession, cycle unless we somehow wean ourselves from relying on oil so much.

    New Zealand’s greatest reliance on oil is for transportation, and in particular due to our automobile dependent cities. Even more reason to promote public transport.

    I have blogged on this exact issue in the last couple of days. People might find it interesting reading: http://www.jarbury.net/index.blog/1364571/peak-oil-transport-the-economy-etc/

  3. chris 3

    I’m looking into going long on oil after this, should cover the increse in petrol costs

  4. It all comes down to when the world’s economy comes out of recession, and how long it is before the next oil spike whacks it back into recession.

    If it takes longer than expected, then oil prices will still be low. Alternatively, if the economy recovers really quick and oil demand rebounds you will end up with a big spike, knocking the world back into recession and causing oil prices to plummet again.

  5. Good post and succinctly put. I have read a few people suggest that this is our future. It seems abundantly clear to me that peak oil has arrived.

    If I can simplify what will happen the earth’s economy will stagger onto its feet again, fuel consumption will rise, the price will spike, economic dislocation will ensue and we will be plunged into another recession. This process will continue to repeat.

    The only way out is to break our (the World’s) dependence on oil. This will have the associated benefits for New Zealand of reducing our carbon footprint and also reducing our balance of payments problems. Obama gets it. Key does not.

    So we need to build compact cities, boost up and electrify rail and stop building motorways.

    Why did I feel this surge of depression when I typed the last sentence?

    • jarbury 5.1

      I suppose that in NZ we’re somewhat lucky in that most of our oil is just for transportation, rather than for heating and power supply. This is why we really need to focus on revolutionising our transport system towards a future that is not based on oil-dependence. Labour had the right idea with electric cars, but they’re not really either a short-term (too expensive) or long-term (scarcity of resources to make the batteries) solution.

      Auckland is one of the, if not THE, most car dependent cities in the world. That needs to change, and it certainly won’t change with Steven Joyce stealing money from public transport to build super-highways.

  6. Rich 6

    The article on house prices vs oil is interesting, but I’m not sure on the directions of causation.

    I think that people’s willingness to live in exurbs has increased as a result of inflated house prices in central districts, coupled with the general fetishisation of home ownership. That asset bubble also caused people to demand to take on unrealistic debts, which the banking system facilitated (in NZ through fringe finance companies, elsewhere through complex financial products). The root cause of this was government’s refusal to constrain the asset price bubble, rather than the criminality of individuals in the banking industry, which appears to be the consensus promoted by left- and right- at the moment.

    In terms of policy measures that could help us with this, I’d consider that suppressing house price inflation and preventing development outside existing core metropolitan areas would be sensible. Also, as I suggested here a two-tier petrol pricing scheme would help limit the impact of oil schocks while reducing discretionary consumption.

    • Draco T Bastard 6.1

      he root cause of this was government’s refusal to constrain the asset price bubble,

      Which came about due to the rather stupid belief that the free-market would regulate itself. Such deregulation would be possible if people had full knowledge of the market and the banking cartel (and others) have made sure that that is impossible to get. Probably so that their criminal actions aren’t known.

  7. Rich 7

    It’s easy to come up with a conspiracy theory about groups of criminal bankers. Not dissimilar to what the ruling classes did in another time and country – throw some scapegoats to the wolves in the hope that they could carry on regardless.

    People are easily convinced (not least when the television has house pr0n for two hours a night) that everyone will benefit from the wonders of property “appreciation”. It was obvious to me that this was a bubble – you can’t have a stable society where a rentier class lives well off assets and the rest struggle to pay for somewhere to live.

    When an average house costs 4-5 times average earnings, the only way people can afford to buy will be by taking an imprudent loan. Banks and finance companies, trying to make profits, found a way to make those loans. The government could have stopped them, but didn’t because it was scared to kill the fiction that everyone had a chance of becoming a wealthy asset owner.

  8. “Obama gets it. Key does not.

    So we need to build compact cities, boost up and electrify rail and stop building motorways.

    Why did I feel this surge of depression when I typed the last sentence?”

    Probably because you know deep in your heart that Obama’s most important action so far has been to ensure the automaker bailouts are conditional on delivering the technology that the USA needs to break it’s oil dependency and the other options are either too slow, preposterously expensive or short sighted budget sacrifice.

    • Actually my depression is caused by our local leaders rather than by Obama.

      I agree with your comment about Obama’s plan. He has been as astute as his pre-election campaign suggested that he would be. At a superficial level I wanted him to go really hard and the (w)bankers and easy on the car manufacturers. I wanted him to hang bankers and preserve the jobs of auto workers.

      He has done the opposite.

      He has insisted on the preservation of the new technology. The possibility is that GM will go to the wall but a new company will emerge with the right to produce the electric volt. No more 4wds, electric cars only. This could have a significant effect on US fleet efficiency.

      As for my leaders, well, what can I say? They sabotaged the standards for lightbulbs on the basis of “freedom”. When William Wallace uttered that word I do not think that he meant the preservation of the ability to pollute the world.

  9. Snook 9

    Peak Oil has arrived – future growth is not possible. As Richard Heinberg has said in many interviews the world will suffer a series of depressions and each one will be progressively worse. Mankind has squandered this precious one-time gift of nature so we can feel pumped about how clever, important and wasteful we are.

    John Key needs to take the Steady State Economy 101 course and cancel all new motorway/highway construction – Transmission Gully would be our greatest folly riddled with fault lines as it is. Rail electrification, new rail feeder services and subsidised transport need to be implemented immediately so that people will think themselves crazy to even think of owning a car.

    Our petrol consumption needs to be rationed and everything to do with energy put on a wartime footing. As the investment banker Matt Simmons, author of Twilight in the Desert says, employers need to liberate their workers who can work at home and pay on productivity. This man has researched the Saudia Arabia reserves situation and believes the Saudis are sugar coating how vast their reserves are. Matt also says that most of the drilling rigs are knackered and at least 25 years old and are not being replaced.

    As for GM and Chrysler, they’re toast and should not be saved. These companies couldn’t make a fuel efficient car if they tried such is their Freudian preoccupation with size. Time for the auto workers and those in associated industries to retrain for rail careers and working on the land because fossil fuel based machinery will become an expensive white elephant with price spikes and possible disruptions to supply. The price of oil based fertilisers and insecticides have increased massively also so expect the price of food to skyrocket.

    There won’t be too much affordable fuel in the next few years when oil well declines such as these are considered. Ghawar is the largest oil well in the world and the amount of salt water injection required to keep up the well pressure for pumping has increased significantly.

    Fieldname, country (peak year) peak/present rates, decline %:

    Ghawar, Saudi Arabia (1980) 5588/5100, -8.73%
    Cantarell, Mexico (2003) 2054/1675, -18.45%
    Safaniyah, Saudi Arabia (1998) 2128/1408, -33.83%
    Rumaila N&S, Iraq (1979) 1493/1250, -16.28%
    Greater Burgan, Kuwait (1972) 2415/1170, -51.55%
    Samotlor, Russia (1980) 3435/903, -73.71%
    Ahwaz, Iran (1977) 1082/770, -28.84%
    Zakum Abu Dhabi, UAE (1998) 795/674, -15.22%

    If you don’t have a bike get one now, start walking and be prepared that your current job may not exist in a few years. A lot of people will return to working on the land and probably for a lot less money.

    Serfs up!

    • Snook, I presume you live in Auckland or Wellington. Only that half of the population instictively think “Rail electrification, new rail feeder services and subsidised transport”. Have a look at the MoT’s ongoing household travel survey. It reveals that the regions with the lowest use of cars for commuting are rural, and that’s without taking into account those who work at home, which is very common in rural areas. Basicly those who live in small towns live cloe enough to where they work so that they can and do walk or cycle to work, just like Copenhagen and Amsterdam.

      We don’t have to worry about city trucks and buses, they can easily swap their diesel engines with electric motors and lead/carbon batteries. Intercity trucks can be replaced by coastal shipping since there will be plenty of international ships lying idle. The railways won’t be able to quintuple it’s rolling stock fast enough to be of any immediate use.

      Half of our car travel, measured in km rather than time or number of trips, is for leisure purposes so it can be sacrificed for no financial cost. Unfortunately it will crash GDP, which pretty much confirms that GDP is a nonsense measure.

      Your last paragraph is absolutely spot on and the main reason why rail electrification, new rail feeder services and subsidised transport will be a folly of the same magnitude as Transmission Gully.

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