Why This Is Not A Peak Oil Crisis
In a 1956 paper, Shell research scientist Marion King Hubbert advanced the idea that U.S. oil production would peak in the early 1970s. Turns out, he was correct. Others began applying his approach to global production expectations, and the idea of “peak oil” was born.
Peak oil regards the genuine crisis as emerging when more than 50% of available oil has been extracted. It views the market price as accelerating once the peak hits… and a series of economic contractions issuing from that peak.
Now, if there is a constriction in availability, traders will jack up the price. That’s a simple matter of supply and demand.
In normal trading, oil prices emerge (essentially) from the cost of the next available barrel. However, in a supply-constricted environment, that changes to reflect the cost of the most expensive next available barrel.
Peak oil, therefore, views this as a matter of how much supply exists.
However, while this may become the issue at some point, I do not believe it is the problem now. Considerable oil remains available – both conventional (traditional oil fields) and unconventional (shale oil, oil sands, gas to liquids).
The crisis unfolding before us is not about the amount of oil but of the quality of that oil.
Put simply, the primary flow of crude internationally is of an inferior grade, coming from places beset with political, economic, and infrastructural problems, and requiring additional processing.
The higher prices now unfolding are not a result of insufficient supply, even with the current geopolitical unrest. They are the result of the additional costs needed to extract, transport, and turn that crude into the oil products we need.
As I said, there is plenty of oil out there. But the age of light, sweet crude (low viscosity – or resistance to flow – and low sulfur content) is certainly over. It is heavier, sourer (higher sulfur content) crude that dominates the market. And it is more expensive to process.
That is one of the costs accompanying the unrest in Libya right now. The country is one of the few places left on the globe where significant volume of light sweet is still available. Another is Nigeria – a country also known for its lack of political stability.
If we turn to unconventional sources to maintain the supply side of the equation, we move the costs of processing up even more.
The supply is there. But this supply that will cost more at the pump.
Not surprisingly, readers have sent in a number of E-mails this week related to this issue of supply versus cost…
Back to the Mailbag
Q: There is a report that current and future crude production here in the USA could handle all our energy needs well into the 25th century…. Out here in Kansas, we have fields of untapped crude. The same exists in eastern Colorado, Oklahoma, Texas, Nebraska, the Dakotas, as well as along the Mississippi River, and especially near the field of shale gas in western Mississippi. So why do we need foreign crude? ~ Phaedra
A: Phaedra, the primary reason we depend upon foreign sources for almost 70% of our crude is price. Foreign oil is cheaper than much of the untapped oil available within the U.S.
The U.S. is the most mature oil-producing region in the world. Traditional fields have been declining for some time. When “Hubbert’s Peak” hit in 1971 and 1972, the American market was producing about 9.2 million barrels a day. In 2011, conventional production may not hit even five million barrels daily.
Yes, there are reserves remaining, but the volume extractable at a competitive price is not increasing significantly.
As counterintuitive as it sounds, having supply available locally does not automatically mean it is the preferred option, especially if the cost of extracting it still exceeds the cost of importing equivalent volume from elsewhere.
Now, security of supply is another matter.
One may choose to produce at home to offset the uncertainty of events abroad. Combining North American sources of unconventional with the dwindling supply of conventional crude will address this issue. But it will also significantly increase the price to end users of the oil products.
This next mailbag question expands upon the use of unconventional to offset supply concerns…
Q: You have said that, going forward, more intense efforts will be concentrated on developing oil sands deposits. Do you think that Oilsands Quest Inc. (AMEX:BQI) is a good play in the next six to 12 months? The small (but well-positioned) company owns over 700,000 acres of oil sands property in the Alberta and Saskatchewan regions – more than anyone else in the industry. However, it hasn’t produced enough so far to justify its extensive land purchases. ~ Art
A: You’re right, Art. BQI’s production-to-acquisition ratio does not yet justify the land lease investments made.
However, there is another, more significant, reason why BQI will not be taking off any time soon.
It shares one essential shortcoming with a number of other small (“junior” and less) Canadian heavy oil/oil sands production companies. With a market cap of $190 million, it simply cannot develop the land it controls without a farm-in from a larger company with deeper pockets.
This looks like BQI may end up being an acquisition play in its own right.
I see nothing on the horizon here. Trading at less than 60 cents a share, it may be a speculative move. But don’t count on any buyers coming up to the plate in short order, even with crude oil prices increasing.
Once again, this is a matter of cost. Oil sands remains much more expensive to develop than conventional oil, and the synthetic oil realized requires much greater processing.
Q: Aloha, Kent. When the recent Libyan uprising began, domestic energy producers moved higher. The last two to three days, the price of oil has continued higher, but many domestic producers tanked. Chesapeake, for example, has taken a big hit after initially going up. I would think that outlook on domestic producers would be favorable given higher prices. I haven’t seen any discussion on this issue. Can you tell us what’s going on? ~ Ken
A: Ken, I must admit that your salutation alone entices me to go visit you in Hawaii…
But as to your question, it does point out a trend often seen in the very early stages of oil dislocation. The domestic producers will benefit from protracted increases in oil prices, as will the drillers of natural gas in North America.
Chesapeake Energy Corp. (NYSE:CHK) sits in the center of this unfolding largesse. It is the largest independent gas producer in the U.S. and has been increasing its oil production balance throughout the last year.
Then why aren’t companies like CHK increasing?
The initial trading period after a major change in oil pricing will usually produce broad market declines.
It is also often the oil sector itself that takes the biggest hit, regardless of where individual companies are positioned. That was certainly the case this time around.
Between February 28 and the close of trade on March 2, CHK lost almost 5%. It will probably decline another several percentage points before stabilizing… and resuming its upward climb. But until the dust clears, the market will paint with a very broad brush.
[Editor’s Note: Kent recommended CHK in his Energy Advantage in July 2010, and subscribers are sitting on gains of 63%. To learn more about the Energy Advantage, click here.]
On another note, I have been spending the past week up the coast from Montego Bay, Jamaica. Will have something to say about developments down here in Oil & Energy Investor next week…