The Weekend Wonk: Oil Industry Near Meltdown? No, Really This Time..

February 15, 2020

New video coming that has bearing on this – but there are increasing questions about the solvency of the global oil industry. The paranoid “peak oil” story of the early 2000s turned out to be overblown, but the new dynamic includes “unconventional” oil ie fracking, on one side, and the emergence of viable alternatives to oil and gas on the transportation side, beginning to squeeze the industry in the middle.

Interested in discussing this, as I think this is an important dynamic that is going to affect us sooner, rather than later.

Vice:

A government research report produced by Finland warns that the increasingly unsustainable economics of the oil industry could derail the global financial system within the next few years.

The new report is published by the Geological Survey of Finland (GTK), which operates under the government’s Ministry of Economic Affairs. GTK is currently the European Commission’s lead coordinator of the EU’s ProMine project, its flagship mineral resources database and modeling system.

The report was produced as an internal research exercise for the Finnish government, which until 2019 held the Presidency of the Council of the European Union. 

Signed off by GTK’s director of scientific research Dr Saku Vuori, the report is written by GTK senior scientist Dr Simon Michaux of the Ore Geology and Mineral Economics Unit. It conducts a comprehensive global assessment of scientific research into the state of the global oil industry with goal of determining how the risks of a global supply gap could impact mining and mineral production. 

The peer-reviewed report calls for the European Commission to consider oil as the world’s most important “critical raw material.” Despite offering a scathing critique of conventional peak oil theory, the report arrives at the shock conclusion that the economic viability of the entire global oil market could come undone within the next few years.

The plateauing of conventional crude oil production in January 2005 was one of the triggers of events leading to the 2008 global financial crash, according to the report. As debt built-up in the subprime mortgage sector, the crude oil plateau drove up the underlying energy costs for the entire economy making that debt more difficult to repay—and eventually resulting in catastrophic defaults. The report warns that “unresolved” dynamics in the global energy system were only temporarily relieved due to “Quantitative Easing”—the creation of new money by central banks. A correction is now overdue, it warns.

The report says we are not running out of oil—vast reserves exist—but says that it is becoming uneconomical to exploit it. The plateauing of crude oil production was “a decisive turning point for the industrial ecosystem,” with demand shortfall being made up from liquid fuels which are far more expensive and difficult to extract—namely, unconventional oil sources like crude oil from deep offshore sources, oil sands, and especially shale oil (also known as “tight oil,” extracted by fracking). 

These sources require far more elaborate and expensive methods of extraction, refining and processing than conventional crude mined onshore, which has driven up costs of production and operations.

Yet the shift to more expensive sources of oil to sustain the global economy, the report finds, is not only already undermining economic growth, but likely to become unsustainable on its own terms. In short, we have entered a new era of expensive energy that is likely to trigger a long-term economic contraction.

‘Quantitative Easing’ or QE as it’s often known in shorthand, consists of massive programs of money creation through central banks purchasing government debt. But the report warns that the scale of QE could pave the way for another financial crash as oil markets become unstable, most likely within half a decade. 

The role of QE in propping up the oil industry and wider global economy was not anticipated in traditional peak oil theory, which failed to predict the low oil prices endangering profitability. The report concludes that: “The era of cheap and abundant energy is long gone… Money supply and debt have grown faster than the real economy. Debt saturation and paralysis is now a very real risk, requiring a global scale reset.”

Although the world therefore needs to urgently transition away from fossil fuels, it may well be too late to do so in a way that avoids an economic crisis. And doing so will require industrial civilization as we know it to be fundamentally transformed: 

“To phase out petroleum products (and fossil fuels in general), the entire global industrial ecosystem will need to be reengineered, retooled and fundamentally rebuilt,” the report notes. “This will be perhaps the greatest industrial challenge the world has ever faced historically.”

Professor Nate Hagens, a former Vice President at investment firms Salomon Brothers and Lehman Brothers who now teaches ecological economics at the University of Minnesota, said he “finds the report quite plausible.” 

“But our institutions and policies and expectations are ‘energy blind’,” he told me. He believes that the report’s warning of a coming economic crisis is very likely. 

“We optimize around growth, which requires energy which requires carbon energy,” he said. “We have created approaching 300 trillion dollars in financial claims, on a finite amount of high quality resources… All in all, we’ve created too many claims for future energy and resources to support.”

The report offers the first independent public government assessment concluding that Saudi Arabia, once the world’s largest oil producer, is now probably approaching (and may already have passed) a production peak. 

The study cites accelerating rig counts amid disproportionately low oil output as mounting evidence of the Saudi oil sector’s declining productivity. It also cites data from the recent IPO held by the Saudi national oil firm, Aramco, indicating that production levels from the country’s largest field, Ghawar, is 1.2 million barrels lower than previously claimed, suggesting the field is nearing maturity.

Meanwhile, as Saudi Arabia has been unable to keep up with demand, US shale has stepped in, contributing to the vast bulk of new global oil supply since 2005—71.4 percent of it to be exact.

Geological Survey of Finland:

Today approximately 90% of the supply chain of all industrially manufactured products depend on the availability of oil derived products, or oil derived services. As the source material for various types of fuels, oil is a basic prerequisite for the transportation of large quantities of goods over long distances. Oil, alongside information technology, container ships, trucks and aircraft form the backbone of globalization and our current industrial ecosystem.

Approximately 70% of our daily oil supply comes from oil fields discovered prior to 1970. Most of global oil supply still comes from 10 to 20 huge oil fields. In 2006, 10 oil fields accounted for 29.9% of the global proved reserves. Since 2006, comparatively very small oil fields have been discovered. 74% of the current global oil reserves is geographically concentrated in what is termed the Strategic Ellipse, which is the Middle East and Central Asia. Peak oil discovery was in 1962, since then rates of resource discovery has been declining persistently. New discoveries are limited: the exploration success rate in 2017 was a record low of 5%, and the average discovery size was 24mbbls. A projected range for average decline rate on post-peak production is 5-7%, equivalent to around 3-4.5mb/d of lost production every year.

Currently the market is oversupplied. When the market returns to demand taking up all global supply, effective spare capacity could only shrink by just 1% of global supply/demand of 96mb/d, leaving the market very susceptible to disruptions. Oil demand is still growing by ~1mbd every year, and no central scenarios that have been recently assessed see oil demand peaking before 2040.

Of existing world liquids production, 81% is already in decline (excluding possible future redevelopments). By 2040, this means the world could need to replace over 4 times the current crude oil output of Saudi Arabia (>40mb/d), just to keep output consistently flat.

In January 2005, Saudi Arabia increased its number of operating rig count by 144%, to increase oil production by only 6.5%. This suggests that the market swing producer (as Saudi Arabia was seen) was not able increase production enough to meet increasing demand.

Global conventional crude oil plateaued in January 2005. This would prove to be a decisive turning point for the industrial ecosystem. Since then, unconventional oil sources like tight oil (fracked oil shale) and oil sands have made up the demand shortfall, where U.S. shale (tight oil, fracking with horizontal drilling) contributed 71.4% of new global oil supply since 2005. Global conventional oil production broke out of its plateau in late 2013 and has been able to expand in capacity, where deep off shore plays become more important.

Since 2008, the Shale revolution (tight oil or fracked oil) has increased global oil supply which stabilized increased demand. This was achieved with the application of precision horizontal drilling applied to the existing hydraulic fracking industry. US tight oil produced in August 2019 was 7.73 million barrels per day, approximately 8.37% of global supply. The U.S. tight oil sector accounted for 98% of global oil production growth in 2018. Future global demand growth is now dependent on the U.S. tight oil sector.

Fracked well average production increased between 2010 and 2018 by 28%, but also water injection (and therefore chemical and proppant use) increased by 118%. This is an average across the whole U.S. Tight Oil Sector. Hydraulic fracked wells (used in Tight Oil) go through four basic stages in their life cycle. The three biggest tight oil producer basins of Permian, Eagle Ford and Bakken are all still growing but are in the mature stage of their life cycles. Mature is the third of four stages, where the fourth is decline.

The productivity (per rig as measured by EIA) of the U.S. Tight Oil sector in 2018 is less effective than in 2016. This suggests that the U.S. Tight Oil sector is approaching its peak production reasonably soon. Due to well depletion in fracking, 5 399 new wells are needed to be drilled to keep the U.S. tight oil production consistent in 2019. Each year a similar number of new wells are required.

The environmental impacts of fracking tight oil and oil sands is being largely ignored. Most of these are related to water way pollution and destruction of forestation habitat.

Most oil producers in the U.S. tight oil fracked sector have a negative cash flow and struggle to raise capital to develop upstream infrastructure. This is unfortunate as to maintain production levels, continual new drilling is required (which requires capital). As such Q1 2019 performance of fracking oil producers was far below projections, suggesting further difficulties in this sector.

If the BRIC economies (Brazil, Russia, India and China) was to become as developed as the German economy in context of oil consumption, the BRIC economy 2018 oil consumption would have to expand by 254%. If the whole World was to become as developed as the 2018 German economy in context of oil consumption in 2018, the global oil consumption of 99.84 million barrels per day would have to expand by 117% and an extra 116.68 million barrels per day of oil would need to be brought to market.

Starting in January 2005, all commodity prices that the World Bank track to monitor the industrial ecosystem (base metals, precious metals, oil, gas and coal) blew out in an unprecedented bubble. The second worst economic correction in history, The Global Financial Crisis (GFC) in 2008, was not enough to resolve the underlying fundamental issues. After the GFC, the volatility in commodity price continued. This report makes the case that the GFC was created as the entire industrial ecosystem was put under unprecedented stress, where the weakest link broke. That weakest link was in the financial markets. The strain that created this unprecedented stress, was triggered by the global oil production plateauing. This made the oil market in elastic in form. This is postulated to have happened because the Saudi Arabian oil production was unable to increase production in January 2005, in spite a significant increase of operating rig count. If further analysis supports this hypothesis, then the GFC was created by a chain reaction that had its origins in the oil market.

Due to our dependence on oil, it may be the primary, or master raw resource. Oil has a more significant CRM profile (immanent shortage in context of a vital resource) than almost any other raw material supplying industry. It is recommended that oil, gas, coal and uranium are all added to the European CRM list.

There are a number of limiting factors coming into play on US “unconventional production” – notably the rapid increase in water demands for the process, and the precariously thin profit margins of the players.

Science Advances:

Unconventional oil and gas exploration in the United States has experienced a period of rapid growth, followed by several years of limited production due to falling and low natural gas and oil prices. Throughout this transition, the water use for hydraulic fracturing and wastewater production in major shale gas and oil production regions has increased; from 2011 to 2016, the water use per well increased up to 770%, while flowback and produced water volumes generated within the first year of production increased up to 550%.

The water-use intensity (that is, normalized to the energy production) increased in all U.S. shale basins except the Marcellus basin during this transition period. The steady increase of the water footprint of hydraulic fracturing with time implies that future unconventional oil and gas operations will require larger volumes of water for hydraulic fracturing, which will result in larger produced oil and gas wastewater volumes.

IEEFA – Institute for Energy Economics and Financial Analysis:

August 19, 2019 (Sightline/IEEFA) ‒ A review of 29 major fracking-focused oil and gas companies revealed meager cash returns in the second quarter of 2019, according to a briefing note released today by Sightline Institute and the Institute for Energy Economics and Financial Analysis (IEEFA).

The report, U.S. Fracking Sector Disappoints Yet Again, notes that only 11 of the 29 companies under review registered positive free cash flows. All told, the 29 companies generated just $26 million in aggregate free cash flows—too little to make a significant dent in the more than $100 billion in long-term debt they owe.

“There were winners and losers this quarter, but overall, the oil and gas sector is still underperforming on virtually every financial measure,” said Clark Williams-Derry from Sightline Institute who co-authored the briefing note.

The analysts found that:

  • U.S. fracking-focused oil and gas companies registered largely mediocre results during the second quarter of 2019
  • The E&Ps reported only $26 million in free cash flows from April through June 2019, a modest amount compared to over $100 billion in the companies’ long-term debt
  • Investors have soured on the sector, limiting the industry’s ability to tap into debt and equity markets.

“As underwhelming as these results were, they were an improvement over previous quarters,” said IEEFA director of finance Tom Sanzillo. “Still, investors would do well to remain skeptical and view the sector as highly speculative.”

I don’t pretend to understand the financial industry, but you can’t watch the financial press without picking up on substantial anxiety about the performance of the oil/gas sector.

IEEFA:

ExxonMobil is no longer in the top-ten list of the Standard & Poor’s 500 Index, according to S&P’s August 31 report of the standings.

For most of August, real-time coverage of the S&P 500 placed ExxonMobil eleventh and twelfth, removed from the top ten for the first time since the index was launched in 1957, based on available data.

It will also be the first time since the S&P 500 Index’s launch that there are no oiland gas companies in the top ten.

Absent a significant turnaround through the end of 2019, it will also be the first time ExxonMobil has fallen from more informal lists of the top ten most valuable companies in the United States in more than 100 years, according to IEEFA research.

16 Responses to “The Weekend Wonk: Oil Industry Near Meltdown? No, Really This Time..”

  1. Keith McClary Says:

    I didn’t find the “scathing critique of conventional peak oil theory”. It says that conventional oil is in decline and that alternatives such as fracking and tar sands are economically or environmentally unsustainable. Pretty much mainstream peak oil thinking.

    • Earl Mardle Says:

      Yep. I think they are right on song with PO. The point about it is that “conventional” ie affordable, oil production plateaued in 2005 and that contributed to the 2008 GFC. All completely in tune with Hubbert theory.

      Similarly, while “unconventional” oil has shown a boom in deployment, it has never been able to turn a profit because the well are reaching their peak and sharp descent before break even. The fact that “investors” have soured on the field is all the evidence you need that they have figured out that this is not going to be El Dorado and a new sunny upland of oil production.

      Peak Oil was never about “running out” it was always about oil affordable to an economy predicated on plentiful + cheap and the economic effects of the end of that model. And while renewables are not going to expand and replace FF use in any reasonable time frame to affect climate, they may well be just enough to be the last nail in the oil coffin.

      • J4Zonian Says:

        If clean safe renewable energy doesn’t “expand and replace FF use in any reasonable time frame to affect climate” then civilization and most life on Earth is doomed. It will be the last nail in all the coffins.

        • Earl Mardle Says:

          Almost. There is always the alternative of using less, hunkering down and not blowing our smoke in every direction just because we can. We don’t need to replace ALL of the energy we currently waste on our egos and distractions.

          • J4Zonian Says:

            …which is why I always say we need to replace fossil fuels with efficiency, wiser lives, and clean safe renewable energy. I’ve said it many times here. But even though I altered it slightly to reference your phrase, it doesn’t change the truth of the statement:

            “If clean safe renewable energy doesn’t “expand and replace FF use in any reasonable time frame to affect climate” then civilization and most life on Earth is doomed. It will be the last nail in all the coffins.”

    • Keith Omelvena Says:

      Exactly! Hardly a critique of paranoid peak oilers, when the references go on to describe peak oil in action? The only way total oil production has been able to expand, is by throwing unheralded financial resources at its’ continued growth. Financial resources incidentally, that will probably never generate a financial return. The more resources we throw at maintaining this production level, the steeper the production rate decline will be once initiated! An asymmetric seneca curve, rather than bell. http://m.startribune.com/schafer-shale-oil-passed-its-peak-without-making-money/567884742/?fbclid=IwAR27zDncHG8a0fpD1zYUZBcHlrahIpOGKEWPMFjV6fkU6IYFlmlry-8-hdY

  2. doldrom Says:

    Immanent shortage? Immanent is the opposite of transcendent.

    Perhaps the shortage is imminent

  3. redskylite Says:

    It will be an enormous task to replace the dependency many industrial nations have on oil and how ingrained the damned industry is in the world’s economy.

    Quote from Christoph Müller, B.S. Business Engineering:

    “If the petrodollar collapsed, the entire world would collapse with it into an economic crisis worse than the Great Depression. For a while.”

    However it must be done and quickly.

    Here’s some hope or hopium. (depends on the quality of leadership, education and voting choice.)

    “Petrol and diesel cars are anachronisms. Most countries banned their manufacture in 2030, but it took another 15 years to get internal combustion engines off the road completely.”

    https://www.theguardian.com/environment/2020/feb/15/best-case-scenario-2050-climate-crisis-future-we-choose-christiana-figueres-tom-rivett-carnac

    “This generation gives me a lot of hope because they don’t just take things as they are. They’re out there learning about different engineering systems and learning about solutions to big, gnarly problems and how they can make a difference.”

    https://insideclimatenews.org/news/12022020/inside-clean-energy-optimism-bp-efficiency-renewable-energy

  4. toddinnorway Says:

    The problem is the cost of developing new oil production is much, much higher than 50 – 60 dollars/barrel (today’ oil price). So the only rational economic choice is to NOT develop new oil, and simply deplete what we have until prices rise to the levels required to develop the new, VERY expensive oil.

    But as pointed out in the article, this will crash the broader economy. So really we have only one rational alternative and that is to replace oil with renewable solutions. All of the PV+wind+storage+electrified transport solutions are commercially available today. There is just a lack of willingness to change on the part of investors, business leaders, political leaders, and yes in fact, consumers.

    This will change almost overnight when 1-2 households on your street get the EV, the PV and so on, and tell their friends and neighbors how great it is. We are weeks or months away from this happening over broad regions on several continents. In many local markets it already has. This trend is now clear in sales statistics of EVs (UP) and sales of ICE (DOWN) in 6-7 major national markets in Europe, and 2-3 smaller markets that seem to set general public opinion.

    This explains why there is a rush of bullish buying of Tesla shares. They are perfectly positioned to exploit this, and years ahead of their competitors. They built a gigafactory in China in just 11 months, and now it can produce over 1000 EVs daily. Soon they will have one in Germany, the heart of the premium personal car industry.

  5. Gingerbaker Says:

    If Tesla is serious about having it’s own fleet of autonomous robotaxis, they will likely start erecting their own gigantic PV farms to provide themselves with the large amount of cheap electricity that fleet will require.

    No way they are going to settle for the national average of 12 cents per KwH when they can make it themselves for a small fraction of that.

    • toddinnorway Says:

      Exactly. They have a fully-integrated service platform that will leave their competitors dumbfounded.

    • rhymeswithgoalie Says:

      At some point the limiting factor will be transmission lines. I don’t know how they’re monetized, though.

      • J4Zonian Says:

        China has updated / optimized at least 80% of its grid for wind. If they can do it, so can the US, though because of Republican denial and delay, we’ll have to pay China for the various patented grid technologies they’ve beaten us to. Ah well, it’s interesting to be living in the times of Philip II the second, turning the US into a 3rd world country as we watch.

  6. rhymeswithgoalie Says:

    If the BRIC economies (Brazil, Russia, India and China) was to become as developed as the German economy in context of oil consumption, the BRIC economy 2018 oil consumption would have to expand by 254%.

    I’m hoping for a steeper S-curve in the uptake of EVs in pollution-fraught cities, both from mandates and their necessary infrastructure updates.

    Investors have soured on [US fracking], limiting the industry’s ability to tap into debt and equity markets.

    Yeah, baby. They’ve been chasing thinner margins as plays run tight.


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