Oil Painting By Numbers  

Sprott Asset Management has an interesting piece of analysis up that says that as far as they can tell, 2005 is the year (pdf) of peak oil production.

The dynamics in the oil market are changing so rapidly that it is a topic worthy of frequent visitation. The problem, as we see it, is one of mathematics – the numbers just aren’t adding up. Global oil demand is expected to increase by 1.8 million barrels per day this year (according to the IEA), and yet everywhere we look we see evidence that production is falling short of expectations. Countries that were supposed to grow production and be the “saviours” (Russia, Mexico, and perhaps even Saudi Arabia) are showing signs of peaking production, and countries that are already in decline are declining more rapidly that expected (U.K., Norway, and Indonesia). More and more experts (executives of oilfield services companies like Schlumberger and Baker Hughes for example) are now saying publicly that the average decline rate of the world’s oil wells is 8%! – a shockingly high hurdle to overcome with new production.

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The prospects for global oil supply look tenuous at best, but let’s not forget the demand side of the equation. Many interesting data points can be found here too. Chinese car sales in the month of May were up 24% year-over-year, and are expected to be up at least 15% for the year as a whole. Similarly, car sales in India were up 20% in the month of May. To put a historical perspective on what this means for oil demand, back in the 1950’s and 60’s when automobiles started to become ubiquitous in the Western world, oil demand grew from 10 million barrels per day in 1950 to 50 million barrels per day by 1970. Clearly, there won’t be enough oil to go around for this kind of automobile demand in developing countries as well.

Although the world for the most part is still in denial when it comes to the pending oil crisis, the markets haven’t been oblivious to these developments. Even though we are seasonally in a low demand period, the price of oil is quickly approaching $60 as we speak – an all-time high and an increase of $12 in the past month alone. The futures price of oil is now in contango (future price higher than spot) until 2007 and, early last week before the run-up in the spot price, was in contango all the way to December 2011 (the longest contract available). A contango in the oil market was practically unheard of as recently as the beginning of this year. However, the way events are unfolding, posterity may well show that buying a 2011 barrel of oil for $55 today was the bargain of the century!

How high can oil go? In a crisis the sky’s the limit. Even the threat of a shortage can send the price parabolic. Back in 1970 when US oil production unexpectedly peaked (nobody believed Hubbert back then), the price of oil shot up from $1 per barrel in 1970 to $12 per barrel by 1973. (This all happened before the Arab oil embargo.)

Overall I thought it was a good summary of the situation - but that last paragraph makes me wary, as the price rise they mention in the early 1970's was entirely due to manipulation by the oil companies. It would be ironic indeed if they are playing the same game again (the peak must happen one day of course, but I'm sure the oil industry would love to maximise their profits in the years leading up to the peak as well as afterwards).

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