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The Age of ‘Cheap’ Oil Is Over

by | published November 15th, 2010

In the daily exercise of following the energy sector, we sometimes lose perspective on what is actually happening longer term. As we have been over (and over), the price hike is coming, fueled by volatility and signaling an oncoming supply-constricted market.

And now, at last, the International Energy Agency (IEA) agrees.

Bad news for the market pundits. Great news for you.

The IEA Paints A Dark Picture

Last week, the Paris-based agency released its World Energy Outlook 2010 (WEO2010) (a free copy of the executive summary of the 630-page report is available here). The report sketches rising demand, declining conventional crude oil production, and the end of “cheap” oil.

Not that any of this should be news to readers of the Oil & Energy Investor

WEO2010 actually makes up the IEA’s estimates through 2035, the agency’s “New Policies Scenario.” For the first time, the report places greater emphasis on the position of government decision-making, in everything from carbon dioxide capture and storage to the support of new technologies.

And in some rather stark language, it points toward a major problem on the horizon, resulting from rising demand and a leveling of supply.

This is hardly novel. The trends are clear and are of great interest to the individual investor.

But WEO2010 does more than just confirm what we have been talking about for some time right here. It also places the message in some perspective.

The IEA reports that conventional oil production will never again reach its highest volume of 70 million barrels per day (a figure from 2006).

We have already witnessed more rapid increases in demand estimates from the IEA, the U.S. Energy Information Administration (EIA), and even from OPEC itself. All of these estimates are telling us that global demand will be pushing 90 million barrels a day in a few years, that total reserves from all conventional and unconventional (heavy oil, bitumen, oil sands, shale oil) sources will be stretched when the demand side reaches 94 million.

Translation? The age of cheap oil is over.

It has been over for some time, actually; it is just now that the international agencies are confirming its demise. From this point onwards, the world will be relying more on unconventional sourcing – sourcing that is more expensive and will increase pricing all down the line.

The IEA specifically says that the oil price necessary to balance the markets is about to rise.

In addition, the market is showing an increasing insensitivity of both demand and supply to that price.

In short, we traditionally would see rising prices prompting a decline in demand. However, WEO2010 says that end users are becoming resigned to these price rises. Of greater concern is the conclusion that rising prices are not stimulating the drilling of new supply, as had been the case in the past.

We are witnessing demand increasing despite the increase in pricing… and new supply from conventional oil wells not coming on-line to meet it. That simply results in a greater reliance on oil sands, oil shale, and heavy oil. And that will accelerate the price level even more.

But it is the composition of the demand that offers the most telling conclusion for investors…

Demand Figures Are Still Too Low

As we have noted here, the focus is moving quickly from the developed to the developing world.

Over the next 25 years, according to the IEA’s projections, 93% of all increasing demand will come from emerging markets. Over half of total demand will come from China alone.

The IEA report makes several conclusions:

  • Unconventional oil production will play an increasingly important role over the next 25 years, regardless of what governments do to restrain demand.
  • That production, especially from oil sands, emits more greenhouse gas emissions and therefore will require additional investment in technology to offset it.
  • Natural gas will occupy a pivotal role in meeting energy needs until 2035, with China becoming a main catalyst for conventional piped gas transport and liquefied natural gas (LNG) imports, as well as for development of massive shale gas and coal bed methane reserves.
  • World electricity production will grow more strongly than any other source of energy.
  • Renewable energy will increase its share, especially in power production. WEO2010 estimates that it will comprise one-third of the electricity generation worldwide by 2035, an amount equivalent to coal’s portion now.
  • Government subsidies to renewables and biofuels will increase as these sources become more mainstream and significant in national planning strategies.

The IEA is painting a more troubling picture in this report than it has offered in statements only a few years ago. However, the actual situation may be even grimmer…

I believe the demand figures projected by the agency are still too low. The traditional constraints of price and supply are not suppressing demand.

Governments in developing markets are also no longer restraining their own domestic energy demand increases, as much as they did in the past, out of inflationary fears.

First, because the weaker dollar has made the commodity dearer and the inflationary impact less. And second, that demand is a result of rising industrialization. You cannot cut that off without shooting yourself in the foot (economically, at least).

So there it is. The IEA is finally where we were months ago. Nice for them to confirm what we already knew…

The energy market is going up big time. An investor can profit from a well-structured portfolio emphasizing the above six points.

Sincerely,

Kent

P.S. For specific recommendations, take a look at my special broadcast from Friday. This is where you’ll find out what to buy right now (today, in fact), based on the three biggest changes about to hit the energy market. The sooner you act, the better. These “super shifts” are officially underway now. And very few people know about them yet.

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  1. www.monex.com
    December 20th, 2010 at 16:55 | #1

    Relationship between the quantity of a commodity that producers have available for sale and the quantity that consumers are willing and able to buy. The supply-demand model is a model representing the determination of the price of a particular good and the quantity of that good which is traded.

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