211. The price of oil: 4 – a rising road ahead

st pauls cathedral city of london england banking financial crisis 2008As the world begins hesitantly to emerge from this downturn, when and how strongly the recovery will manifest itself is still unknown. There are huge uncertainties remaining.

So why should energy costs be rising again already? Last week’s post about the oil price shock of 2008 described a fall from a $147 peak last summer to $34 in February 2009.

In concluding, I noted that although a $60 oil price looks ‘low’ today, in relation to past prices, it’s still way above the average.

In fact, the oil price has only exceeded $60 for some 15 months across the whole of recorded history. What has happened to keep the oil price high?

The answer is simple, and depressing. What’s happened is that another year has gone by. Another year when we did almost nothing to transform our energy infrastructure. Another year of oil depletion, with no meaningful initiatives or much co-ordinated action to diversify supply.

commerce street houston texas usa by roadsofstoneThe economic news has been dire for months. All around the world, we’ve driven less, manufactured less and made fewer flights.

Energy demand now stands around 2% lower than in 2008, but — and this is important — that only puts it back to 2006 levels.

Look at it another way. In the deepest recession we’ve seen for decades, we’re still using 98% as much oil as during the biggest of all the boom years in 2007.

Despite the bleak economic news last winter, when I looked outside the window there always were cars driving up and down the street. We kept our houses warm, and our factories running (well, most of them).

paris peripherique night by pichenettes at flickrdotcom crop3

The truth is that even within an economic downturn, our energy resources continue to be used up, on a daily basis, and at almost the same rate. But what’s more worrying is that we’re now making even less effort to replace them.

Amidst plummeting energy prices, investment in renewables has fallen. Several large companies have withdrawn from new wind farm projects altogether.

testing an offshore gas discoveryAcross the hydrocarbon industry, exploration has been hard hit, too. The number of active drilling rigs is down by a quarter. But for all the technological advances of recent years, you still can’t find hydrocarbons unless you drill.

It might seem surprising that an extractive industry with a 20-30 year production cycle should think on such a short-term basis. But the cash that global energy companies can invest across the year ahead largely depends on the amount of money they can pump out of the ground in the year before.

That’s why falling energy prices kill new investment. As profits fall and capital funding dries up, companies are forced to become more risk-averse.

dawn at london heathrow terminal 5 thedailyobsession netWithout exception, over the past five years the majors have quietly dropped their production growth targets — focusing instead on maximising returns from within their established production base.

The implications of that are easy to miss — but let’s state them clearly: amongst the likes of BP, ExxonMobil, Statoil, Total — none of these giant companies now expects to produce more oil tomorrow than they are pumping today.

Over the past decade, exploration for new reserves has increasingly been carried out by smaller independents. But offshore drilling is a capital-intensive business, and several of the more aggressive and innovative explorers have gone bust as their production earnings fell and credit facilities were withdrawn. Many others have struggled to raise new capital for exploration.

offshore drilling derrick galveston texas usa by mr t 77 flickrExploration drilling is a risky business, and today’s chastened banks are unsurprisingly reluctant to lend on projects without a sure return, especially when oil looks ‘cheap’ today.

And so another year has seen us draining our existing hydrocarbon reserves, whilst exploring less and canning new alternative energy projects which could replace them. With declining demand, the focus on diversifying and renewing our energy supply has fallen with it.

wind turbines zahara de los atunes cadiz spain by roadsofstoneFor now, the world produces enough oil to meet its needs. But the headroom between supply and demand is not great — and so the oil price is rising once again.

How far will it rise? A straight repeat of this year’s rise could see $100 oil by the autumn. Although a modest correction below $60 seems more likely, the signs are that once economic activity begins to recover, then $100 oil really will be here again before too long.

If demand starts to rise again in 2010, the certainties of continued oilfield depletion and reduced investment mean that energy supply will still be limited. It’s within this timeframe that a return to $100 looks more likely.

Looking ahead five years from there, we might expect oil prices to hit $200, with $400 in sight within a decade. And after that, you can just keep on going.

world oil price 1997 to may 2009 energy information administration

Those figures won’t arrive tomorrow, and a steady rising trend looks unlikely.

the future is unwritten by williamhartz flickrAs political and economic events unfold, there’ll be more troughs and peaks, driven by speculation and the ebb and flow of sentiment in parallel with the daily flow of news.

But the fundamentals will remain the same. We’re using up our oil, and making increasingly scant attempts to replace it.

That sounds depressing, yet there might be a flicker of hope as well. Perhaps the most hopeful news to emerge from the past year’s shocks is that rising energy costs have belatedly led consumers to start changing their behaviour, putting them far ahead of governments and industry who for now are doing very little.

commuter traffic on the a3 to london england by roadsofstoneOver the past year, new car sales have slowed dramatically. And behind the appalling UK figures lay one tiny hidden gem — that the average fuel consumption of new cars sold fell by 4.1% within the last year alone.

That compares with an annual decline of only 1.5% across the preceding decade. 2008 may have been the year when we finally made a gearshift towards greener vehicles.

One year of high energy prices has done more to focus consumer minds than the three decades of government initiatives which came before it. Consumer demand is finally forcing manufacturers to build more fuel-efficient cars.

Beyond a certain point then, economics still has the power to change the world. But as the calendar unwinds — can our consumer attitudes change still further?

eurydice by steve w flickrThe answer is — they’ll really have to.

Because higher oil prices are coming soon. And after that, they’ll likely keep on rising, far along the road ahead.

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36 responses to “211. The price of oil: 4 – a rising road ahead

  1. Pingback: 175. The price of oil: peak petroleum production and energy economics in a thirsty world « roads of stone

  2. Again, a very interesting view — and coming from an industry insider, one with plenty of credibility.

    That said, I’m a little surprised that you are so downbeat about environmental initiaves. I’ve just returned from the US, my first visit there for 3 years, and I was astonished at how much the green message has taken hold. I have seen a true shift in public sentiment that I recognise from the way attitudes changed here in the UK a few years ago, which in turn was some way behind mainland northern Europe.

    Yes, there is always a lag between the message and the action. We drove into Phoenix Arizona late one night, and even though we barely saw a single person on the streets, the city was lit up like a birthday cake. It was like someone had thrown a party but no one turned up. This has to change.

    But certainly in the big west coast cities, and in Boston, you can’t fail to notice the green shoots of environmental awareness, which is a crucial step towards real change. Additionally, they now have an administration publicly committed to addressing these issues. Obama has spoken several times about the need to produce a new generation of motor vehicles, and has made funds available for research and development.

    Maybe it’s all too late, or at least, maybe it will still take a long time to filter down to a true reduction in CO2 emissions and energy consumption, but I try to take encouragement where I can. We all know that a shift in US sentiment and US action is key to a change in the planet’s prognosis, especially as this is likely to have an influence on China’s thinking too.

    All that said, I agree that it is unlikely to come quick enough to have any short term effect on oil prices.

  3. Thanks again, RC. It’s great news that attitudes are changing across America, and the certainty that action will come is already apparent from President Obama’s language and commitment to a greener future.

    But you hit it in your last sentence. Because although it’s encouraging to notice more hybrid vehicles on American roads and wind turbines here and there, the mountain ahead in reducing our energy consumption is on a different scale entirely. We need radically to rethink our whole approach to energy consumption, and there’s alarmingly little time to do so.

    The oil price shock of 2008 can be helpful if it serves as a wake-up call to the world — and in part my message here is that I already think it has. As you point out, the way we think is changing.

    One small example comes from quite simple recent changes in the road tax system in the UK, where we are already becoming used to seeing cars advertised on the basis of their fuel consumption and CO2 emissions. Just two or three years ago, performance would have been the selling point.

    By limiting the growth of demand, modest initiatives like these can give us more time to build an alternative energy infrastructure.

    The higher fuel prices of 2008 were uncomfortable for consumers. For now, those pressures have receded, but it’s important to realise that they’re barely hidden beneath the surface. Above all the oil price shock of 2008 should teach us that the oil price is enormously sensitive to the perception of diminishing supply and to the state of demand in the Far East.

    The emerging economies may have stalled for now, but a return to growth in China and India and the inevitable nature of aspiration means that the potential for escalating energy demand in Asia is huge. Increasingly this seems certain to far outweigh the reductions in consumption in the West.

    Looking forwards, like you, I see much encouragement from the green shoots sprouting all around our feet. But the worsening outlook for hydrocarbon supply and demand leaves little scope for complacency.

    That’s why it’s quite likely that even the record high oil prices of 2008 may soon look like the utopian memory of another economic age.

  4. Have I missed your take on Drill Baby Drill?

    I’d be interested to read what actions you are taking given your relatively greater insight into the problem of resource depletion. I have a list of things I’d like to do but which aren’t quite easy enough to deal with without some real research.

    1. Install an electricity meter (I need to find out which to buy). I almost bought one the other day in Maplin but realized that the distance from the monitoring point (in a cupboard on the landing) to the display may be too far (it’s a wireless system).

    2. Downsize the car (rarely used). Problem is it’s a wrong hand drive BMW. This might be a waste of time from an economic POV. Car is 10 yrs old with low mileage.

    3. Invest in alternative energy / energy saving companies. But which?

    er… well, lower food miles etc.

  5. Hi, Wombats. Good to hear from you with some probing questions.

    Drill, baby, drill? Sarah Palin’s catch phrase (see these explanations by the Washington Post’s Pulitzer-winning cartoonist Ann Telnaes) touches obliquely on a fundamental truth — namely that you can’t discover or extract hydrocarbons without drilling wells.

    However, in the specific case of Alaska’s ANWR and the Florida coast of the Gulf of Mexico, I’d want to see extremely careful regulation of any drilling activities which were proposed. I also think the approach advanced during the US election to safeguarding America’s energy security through drilling in national parks and wildlife reserves was cynically unrealistic, focusing in hope on the speculative gains to be made by the companies involved rather than on any strong evidence of new fields awaiting discovery.

  6. Oil price leaps to year’s high — $71

    Predictions of $250 a barrel on fears for oil reserves, hopes of economic recovery and hedging against weak dollar

  7. Do you have any recommendations about where to learn more about alternative energy resources?

    The last snippet I heard was an argument about the viability of wind farms in the UK versus tidal generators in the Severn Estuary.

    There is a lot of information out there, but I ask myself, which has a good perspective?

  8. Hi David, and welcome back. There are several web publications which will help you keep up with new developments, although there is often a commercial angle to deal with.

    For an objective starting point, it’s hard to beat Wikipedia — try this article on renewable energy, which leads into a rather more basic summary of renewable energy in the United Kingdom.

    For more detail on UK energy, it’s really well worth checking out the Department of Energy and Climate Change website — in particular there is a raft of information on future power generation possibilities to be found within The UK Low Carbon Transition Plan.

    You can find a wealth of downloadable information on that page, including a consultation summary on the Severn Estuary tidal project, which provides an outline of the various schemes under consideration.

  9. Hi Roads, here’s one for you: $20/gallon

  10. PS I just noticed my note (above) about installing a new electricity meter. Coincidentally I finally did that today: I installed an Efergy.com Elite from Maplin (cost ukp35). Works well so far. They claim that merely monitoring usage typically results in a 20% saving, in which case the payback will be fairly quick.

  11. Thanks, Wombats — that looks fascinating.

    The approach of examining the economic effects in successive chapters each examining a range of different gasoline prices looks similar to Mark Lynas’ excellent book Six degrees — our future on a hotter planet, which analyses the effects expected for different temperatures up to the six degree anomaly which defines the upper range of global warming forecasts.

    The first few chapters of $20 per gallon can already be taken as read by Europeans. The petrol price in London today is 104.9p/litre — that’s $6.70/US gallon.

  12. That’s interesting news, too, about your energy meter, Wombats. On a less detailed scale, our domestic gas bill has begun to provide comparisons of usage with the corresponding period in the year before.

    So I can tell you that the result of our recent energy efficiency drive at home has resulted in us using 20% less gas for heating in Q2 2009 than in Q2 2008. Hooray !

  13. Just saw a headline that oil went above $74 today, a high for the year.

    Most branded gas in my area’s at $2.59-$2.65 right now (except for one full-service gouger at $2.69). Earlier this week I filled up for $2.05 per gallon, thanks to a supermarket promotion that gave 10 cents per gallon discount for every $50 spent. I’ll not see the likes of that price again anytime soon, right?

  14. I should have mentioned, if it wasn’t clear, the purchases and discounts accumulated over a few months. I almost never spend $50 in one trip and can’t fathom dropping $300 at a go.

  15. Thanks, Ella — yes, the momentum on oil (and gasoline) prices has been maintained throughout the summer, and well beyond the traditional end of the US ‘driving season’.

    Whether this will continue for the rest of the year probably depends on the economic news which emerges after the holidays are over. The London market certainly trades at very low volume at this time of year — one broker told me that this was because traders forgot even their own names during August. It seems that we are becoming just a little more continental in our habits each year.

    It’s not yet clear whether the few tentative signs of recovery are real enough to underpin a recovery this autumn. House prices in the UK have begun to edge up slowly once more. This follows the traditional seasonal pattern for now, and there is a chance it could be reversed in the autumn. The fear of a double-dip or ‘W’-shaped recession is probably the biggest downward pressure on oil prices right now.

    If, on the other hand, the recovery proves to be enduring, then the chances are that oil prices could rise further, towards $90 or $100 by the end of the year. That might look quite some way off from where we are today, and perhaps a modest correction back towards $60 seems more likely before we get there. But equally a summer oil price of $74 seemed a real longshot back in February, when WTI stood at only $34.

  16. For what it’s worth, I have an annual competition with a colleague, where at the start of the year we each make our best prediction for the oil price at the end of the year.

    My prediction for December 2008 was set at $137 and my colleague forecast just $40, so that there was almost $100 between our two outllooks. We were both right, but he won.

    In 2009, our estimates are much more closely pitched. My forecast was for $76 at year end, while my friend suggested $55 in December 2009. For now, the oil price lies close to my forecast mark, but as last year showed, anything can happen and I won’t be opening the Bordeaux in anticipation any time yet.

  17. Oil price back above $72 after OPEC meeting

    Just $4 shy of my $76 forecast for year end 2009 — but still just over 100 days to go …

  18. Key oil figures were distorted by US pressure, says whistleblower.

    International Energy Agency forecasts were modified to indicate spurious higher future production potential, claims senior official.

  19. Oil at post-crisis high.

    The price of oil rises to 2-year peak above $91 — highest since October 2008.

  20. Oil price dominates the markets
    ‘Analysts at Goldman Sachs and Deutsche Bank warned that the global economy would not be able to cope with oil trading above $120 a barrel for any period of time.’

    The US oil price has risen 15% in just 6 days.

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