The Bad News of Low Prices

There has been more than a hint of schadenfreude among peak oil skeptics in the last few weeks as Chevron announced a major new very-deep-water oil discovery in the Gulf of Mexico and the price of crude has fallen from a high of near $80 to its current price of close to $60. What explains the dramatic drop in prices? Observers have offered a few different theories:

1. Peak oil is a myth; there is really plenty of oil, and the new Gulf of Mexico field proves it.

To address this line of reasoning, one must ask, what, fundamentally, has changed in the world to cause such a rapid drop in prices? True, there was the “Jack-2” discovery; but Chevron is still unsure of how much oil they have really discovered or how much it will cost to produce, or how far off the production will be. Certainly, from an oil production perspective, the discovery seems like good news. But does it really offset the news from last year that the Kuwaiti Burgan and Mexican Cantarell supergiant oil fields—the second and third largest ever found—had peaked and were declining? Given that world oil production is has been flat for over a year, it seems a little premature to break out the champagne.

Nonetheless, it is possible that an unexpectedly mild hurricane season, the failure of war on Iran to materialize as scheduled and the gulf oil news combined to give some psychological relief to oil traders—which only supports a major argument of peak oil writers: that the “plateau” period of peak oil will be marked by a long term trend of ever higher prices combined with increasingly dramatic short-term volatility.

2. A whiff of deflation.

The economic news in the last month has not been good. Over the last two years an overgrown housing bubble coupled with skyrocketing oil prices and the threat of inflation forced the Federal Reserve to raise interest rates every time it met until it paused in August.

Now the housing bubble is bursting, and the economy appears to be slowing. Given the sheer size of the housing market, a full-fledged collapse could cause massive runs on banks and effectively bring down the world economic system as it did in the 1930s. The rapid contraction of money and credit caused prices to fall during the Great Depression; but so did salaries, and unemployment reached nearly 25 percent. Under this scenario, we may indeed see $35 oil again—but no one will be happy.

3. Conspiracy

There are a lot of people who believe that Republicans have orchestrated the recent drop in gas prices in order to win the November mid-terms. That’s probably a bit simplistic, but there are plenty of informed economists who believe that the financial markets can be manipulated, especially in the short term.

The biggest smoking gun is Goldman Sachs recent reweighting gasoline futures in its commodities index from 8.72 percent to 2.3 percent, which meant that funds which tracked the index were forced to unload 74 percent of their holdings.

Why manipulate the markets now? The answer is probably more complicated than a simple partisan ploy to keep Republicans in control of Congress.

A more likely explanation, predicted months ago by the analysts at Financial Sense, goes back to the bind that the Federal Reserve found itself in recently with the combination of a rising threat of inflation and an apparently slowing economy. Given that the housing market was crashing, the central bank simply couldn’t afford to keep raising interest rates; but with the price of gold and oil—two major markers of inflation—at all-time highs, they couldn’t afford to lose inflation-fighting credibility by pausing either. So they manipulated the markets to bring down short term commodity prices to allow for a pause in interest rates.

It seems to me that this scenario is not good news either, as it points to the fact that peak oil may be occurring precisely at the moment when the financial health of the world economy is profoundly disordered. The end result of this path, according to some economists, will eventually be a U.S. dollar currency collapse.

The worst thing about the recent price drop is that it has emboldened the cornocopians and has made the economics of investing in alternatives that much more uncertain. In a recent interview, Matthew Simmons argued that such wild volatility (and the recent wild volatility of the natural gas market) highlights the un-free, opaque nature of the energy markets. We are driving toward a cliff with our eyes shut. Three months (or three years) from now when energy prices are back up again, people will start to pay attention to peak oil again, but by that point even more precious response time will have been lost.

Comments

[Anonymous]

Chart on this page seems to predict peak oil around 2010. That's only 4 years away. In your opinion, is tha realistic?

http://blog.foreignpolicy.com/node/1929

[Lakis]

2010 might actually be optimistic. There are several respected commentators who argue that peak already occurred last year.

Broadly, there seem to be two approaches to figuring out the timing of peak oil. The first, the “bottom up” approach used by Matthew Simmons, Chris Skrebowski etc. works field by field to estimate what current production levels are, add new production coming on-line and subtract current depletion rates. Skrebowski’s view is that peak oil will most likely occur no later than 2010 if everything goes perfectly; but if there’s some major geopolitical disruption before then (war in Iran, major hurricane, etc.) it will likely happen sooner. CERA also uses this approach to come up with its estimate of a plateau between 2030 and 2040, but greatly underestimates decline rates of current fields, according to people familiar with their report.

The other approach uses petroleum geologist M. King Hubbert’s methodology. In 1956, Hubbert accurately predicted that U.S. oil production would peak between 1965 and 1970 (it peaked in 1970). At the time, he made his prediction based on a range of accepted estimates of ultimate recoverable reserves. In his book Beyond Oil, Kenneth Deffeyes, a one-time colleague of Hubbert, used a simplified version of Hubbert’s methodology he called “Hubbert Linearization” which derives the ultimate recoverable reserves (and hence the peak) not from reserve estimates but from cumulative production to date.

The main theorists who are using the linearization method are Deffeyes and several contributors to the Oil Drum website (www.oildrum.com)—Stuart Staniford, Jeffrey Brown (an independent petroleum geologist who goes by the screen name Westexas) and “Khebab”. Based on this approach, Deffeyes quite confidently says that peak oil has already occurred, in December of last year (amended from his original projection of Thanksgiving 2005). Brown and “Khebab” agree with him. They have done work showing that if using the Hubbert Linearization technique, one could have predicted post 1970 U.S. oil production with an accuracy of 99% using only data available up until 1970.

http://graphoilogy.blogspot.com/2006/03/m-king-hubberts-lower-48-prediction.html