Doing The Contango  

Jeff Vail has a post at The Oil Drum (and his own site) on the possibility of oil futures prices moving from backwardation into contango - "Has Peak Oil - As a Meme - Tipped ?"

Is contango even possible in oil markets? The conventional wisdom is no, at least not over a sustained period of time. The theory behind this is that if oil is selling for more two years in the future than it is today, then producers will use arbitrage. They'll buy a front-month oil future, sell a distant-month oil future, pocket the difference, take delivery of the front month oil and store it for delivery at the later date. This prevents oil in the future for selling for any more than the cost of storage of oil until that date, and when time-value-of-money is accounted for, that usually requires that future oil sell for less than spot oil.

Contango could exist if a few circumstances were met: present rate of oil production would need to be effectively fixed, there would need to be a consensus that future rate of production will be lower and that demand will remain highly inelastic, and there must be some impediment to storing today's oil to sell in the future. If all three of these came to pass, then the oil markets could be in significant contango and arbitrage would not be able to remedy the situation. Of course, it seems unlikely that these things (specifically the inability to store oil) will come to pass unless through some kind of political or regulatory move, but it is possible.

Because backwardation is the norm, and contango seems unlikely, I think it is highly significant that oil has gone from very large backwardation to nearly zero backwardation over just the last 6 weeks. It seems consistent to me with an emergence of Peak Oil awareness in the markets that led the market to the rejection of every reason for "normal backwardation" listed above except arbitrage (which can only maintain backwardation equal to the difference between storage cost and time-value-of-money).

It's common for backwardation to decrease rapidly in an environment of declining spot prices, but to my knowledge there has never been a decrease in backwardation as dramatic as we've seen in the past weeks in an environment of rising spot prices. I think it's something that requires explanation, and a growing acceptance of peak oil by the markets seems like the most valid explanation. And for that reason, I think the recent decrease in backwardation is, itself, an indicator of exactly that dawning awareness...

The FT has another article on peak oil - "Running on empty? Fears over oil supply move into the mainstream".

On a rainy day last month, four drummers, three guitarists, a bagpiper, two didgeridoo players and 186 others assembled in the rural English town of Cirencester to discuss turning their neighbourhoods into low-impact communities built around farming, arts and crafts and herbal medicine.

After communal meditation and a few speeches, those present gathered in small groups to discuss everything from transport without oil to engaging local politicians in the “Transition Towns” movement’s stated aim: reducing their carbon footprint in response to concerns over diminishing hydrocarbon reserves as well as global warming. The mood in the group discussing energy was sombre. One former civil engineer predicted the demise of the lightbulb within a decade and derided the idea that market forces and human ingenuity could save the planet, laughing it off as “the magic wand” theory.

For years, such meetings have been dismissed as eccentric. Most of the world’s oil executives, government ministers, analysts and consultants reject the “peak oil” theory – the notion based on the 1950s work of Marion King Hubbert, a Shell geologist, that crude production will soon enter terminal decline. They say it understates remaining reserves, plays down the contribution of technological advances and ignores the role of market forces in shaping future supply.

But with the oil price at a record $126 a barrel, more than 1,000 per cent higher than a decade ago, fears of the end of the hydrocarbon age have seeped into the mainstream. Many in the industry itself now accept that supply constraints are shaping the price as much as rampant demand. Calls for greater investment to ease these constraints formed the crux of many of the discussions at last month’s meeting in Rome between energy ministers of the world’s main oil producers and consumers. A few weeks later, analysts at Goldman Sachs and elsewhere, as well as ministers of the Opec oil cartel, predicted that prices could reach $200 within two years.

So are the peak oilists right? A series of recent events certainly appears to lend credence to those who argue that the world’s ageing oilfields are being sucked dry amid China’s and India’s determination to lift themselves out of poverty and the west’s reluctance to give up the luxuries of modern oil-dependent life.

The fact that Russia’s oil production declined almost half a percentage point in April, the first drop in a decade, was shocking enough news from the world’s second biggest oil producer, whose output was growing at a rate of 12 per cent just five years ago. But Russian oil executives have gone a step further: Leonid Fedun, vice-president of Lukoil, told the Financial Times the country’s production may have already reached its peak.

Just days later Saudi Arabia, the world’s biggest oil producer and by far the largest exporter, confirmed it had put on hold plans to increase the kingdom’s production capacity. Ali Naimi, Saudi energy minister, said the demand forecasts he was reading did not warrant an expansion past the 12.5m b/d capacity Saudi Arabia’s fields will reach next year, following a laborious investment of more than $20bn (£10.3bn, €12.9bn). King Abdullah, the country’s ruler, put it more bluntly: “I keep no secret from you that, when there were some new finds, I told them, ‘No, leave it in the ground, with grace from God, our children need it’.’’ ...

Mr Simmons’ work is potent fodder for peak oilists, who espouse their gloomy views of the future on websites ranging from those with an academic air to more alarmist ones that come complete with advertisements for freeze-dried food and survival guides.

Hubbert in 1956 correctly predicted that US production would peak between 1965 and 1970. His later forecasts proved less reliable, as did prophecies by his followers. The Hubbert model maintains that the production rate of a finite resource follows a largely symmetrical bell-shaped curve, meaning that post-peak life could turn quickly to economic turmoil followed by a horse-and-cart existence.

Mr Simmons knows his peak oil views have moved him towards the fringes of a business in which he used to occupy a far more central position. But he is not alone. T. Boone Pickens and Richard Rainwater, the billionaire US investors whose net worth is estimated at more than $3bn each, have profited from their view of peak oil, through their hedge funds of mainly oil and gas holdings. Last Thursday Mr Pickens placed a $2bn order for the first 667 of 2,500 wind turbines that he plans to erect on the Texas Panhandle as he goes about building the world’s biggest wind farm.

Fears over supply increasingly extend to the corner offices of international oil companies. James Mulva, chief executive of ConocoPhillips of the US, and Christophe de Margerie, his counterpart at Total of France, both recently said they did not think world oil production would ever surpass 100m b/d.

That is the amount of oil the International Energy Agency, the consuming nations’ watchdog, estimates the world will need in seven years’ time. By 2030, it will need 16m b/d more.

Mr Mulva and Mr de Margerie would take deep offence at being called peak oilists. But they, together with a rapidly growing number of industry executives and ministers, believe the world is running out of “easy oil” and that political barriers – such as Nigeria’s crippling unrest, the nationalisation that has stunted Russia’s energy industry and the international tensions that have for two decades stymied Iraq’s energy potential – are keeping companies from being able to exploit the 2,400bn-4,400bn barrels that remain.

Instead of preparing for Armageddon, they are using technologies such as horizontal drilling to squeeze more oil out of their old fields and looking for reserves in harsher terrains. But even they advocate that consumers, who rely on oil for everything from light to lipstick, should be less wasteful.

Industry executives admit that fields in the developed world, such as those in the North Sea and Alaska, are about to peak. (Sanford Bernstein believes production outside Opec will peak this year.) But they argue that unconventional fields, such as those in Alberta and in Venezuela’s Orinoco belt, hold more barrels of oil than Saudi Arabia, while the Arctic’s riches could be immense as well.

Natural gas, coal, corn, sugar cane, algae and turkey innards are promising alternative sources that could fuel China’s new love affair with the car, they say. Meanwhile the biggest oilfield, as Joseph Stanislaw, adviser to Deloitte Consulting, likes to point out, lies beneath Detroit. In other words, millions of barrels a day of oil could be saved if Americans traded in their gas-guzzlers for more efficient vehicles.

If anyone is arguing that corn ethanol or turkey innards (thermal depolymerisation) is going to fuel China's love affair with the car then I'd say they are out of their gourd - how do journalists come up with this sort of nonsense ? And algae based biofuels are still basically science fiction at this point in time (though hopefully not for much longer).

Regarding "peakist" web sites, I don't think they covered the full range of the spectrum - TOD probably qualifies as the academics and LATOC as the survivalists selling freeze dried food - but there is more variety than that out there.

Bloomberg reports that BP and Exxon lament there is not enough oil.

Never have so many oil and gas companies spent so much to produce so little.

That's the challenge facing Exxon Mobil Corp., Royal Dutch Shell Plc, BP Plc, Chevron Corp., Total SA and ConocoPhillips, which will spend a record $98.7 billion this year on exploration and production, Lehman Brothers Holdings Inc. estimates. Costs more than quadrupled since 2000 as explorers targeted more challenging reservoirs and demand rose for labor and material.

New supply from outside OPEC nations will meet about 20 percent of growth in world demand during the next four years, data from the International Energy Agency show. The lack of supply has traders betting oil will remain at about $120 a barrel for at least eight years, according to futures on the New York Mercantile Exchange.

The wagers are buttressed by delays at fields including Kashagan, a Kazakh deposit where the budget has more than doubled to $136 billion and the first production is eight years behind schedule. Waters frozen half the year forced contractors to build artificial islands, while care must be taken to protect workers from deadly hydrogen sulfide fumes emitted by the wells.

``The future is going to be very trying for the international oil companies,'' said Robert Ebel, chairman of the energy program at the Center for Strategic and International Studies in Washington. ``There's no more easy oil for them. Kashagan is a shining example of the problems they face bringing new oil into play.''