Wednesday, December 24, 2014

Year End Review of the Data

The furious bear market in world Oil prices took market participants by complete surprise. That's how markets work. Calling tops and crashes is impossible. Bottoms and recoveries are much easier.

Saudi Arabia, Goldman Sachs, the U.S. Treasury, The Federal Reserve Bank, Russia, The U.S. Department of Energy et al... all employ cadres of Mathematicians, Statisticians, and Analysts - and not one of them saw this bear market in Oil coming. Zip. Zero. Nada. Bupkis. Ugatz.

I have had nothing to say for most of this year. Speculating in the commodity markets requires discipline - sometimes you have to stay away from the table. When the markets do not jive with ones sense of the world it is better to keep your mouth shut and your hands in your pockets. I fear boom times. The end always seems to come when you least expect it and you are rolling (temporarily) in profits. Busts can be wonderful things - if you have any capital left to take advantage of them, that is.

So what happened with Oil?

In short: Too much Oil at the moment.

This moment will pass. It might take a year or 2... but $50 Oil assures $120 to $150 in 5 years or less.
$30 Oil will assure $200. That's how commodity markets work.

I spent the last couple of months talking with the Mad Scientist & Westexas and others, particularly folks working on the ground in the Bakken and Eagle Ford, asked for and was kindly granted by Darwinian vast amounts of data that he used for his assertions at his excellent site (thanks Darwinian!).

Before I get to my personal anecdotes and the observations from my contacts in the industry here is what the production data says (to me):

  • "Peak Oil" happened to conventional Oil sometime between 2005 and 2010. (Scroll down to graph showing "World Less USA Left Scale). The peakniks - Hubbert, Deffeyes, Simmons, Heinberg got this part right. 
  • There is a lot more non-conventional Oil and other liquid fuels than the peakniks had counted on (enough to move the needle on "peak" 8.3 years for 500 billion extra barrels), and in the final analysis it is ultimate recovery/production of every atom of liquid (or gas to liquids) hydro carbons, right down to ear wax, that really matters. (I bet you didn't know that ear wax is a hydro carbon. It is. No kidding!)
  • There is a lot more non-conventional Natural Gas than the peakniks had counted on (of this the "peak" needle might have a great deal more than 8.3 years to move... though I have not gathered enough data to give me great confidence to say more).
  • There was a great deal more "efficiency" that could be wrung from the system in the U.S. than the peakniks counted on.
  • It was non-conventional Oil production in the U.S. that kept the world from "Peak Liquids", which we may or may not be at or close to. Peak Liquids has happened in the Rest of World Ex U.S. (so far). If someone comes along and figures out some technical solution to really and actually improve fracking technology and recovery (despite claims, this has not happened yet. The technology has been around for a while, and improvements in recovery have been tactical and economic not physical) and raising ultimate recovery of Tight Oil from X to 3X or 5X, well, that will move the needle another decade (or 2).
  • "Total liquids" consumption in the U.S. peaked some years back (2008 give or take 6 months) and subsequently declined by several million barrels - even with the production increase of 4 MILLION barrels per day of tight oil and nearly 1 MILLION barrels per day of ethanol domestically. The economic "recovery" during this period was anemic at best, and we should be "thankful' (not really, but I will get to that shortly) for that and give all of the credit to increased production and consumption of Natural Gas to offset the decline in liquid hydro carbons.
  • Whatever industrial processes that Oil could be replaced with Nat Gas has happened for the most part. 5 years+ of $100 +or- Oil and $25 barrel of oil equivalent Nat Gas has likely been long enough and incentive enough to make what substitutions were economically possible . There will not likely be much more of this (in the near term, say 5 years) as we have increased our production and consumption of Natural Gas greatly - and yet our inventories have not risen. By mathematical necessity the "days of supplies" number must have declined precipitously - and cut our use of coal. Since all new power plant additions have been Nat Gas (little new coal power added of late) the 25% increase in Nat Gas production is spoken for and any discussion of exporting Nat Gas is just political posturing.

OK, there's the supply data. Back to the Oil price crash.

Oil prices are not sufficient to provide profit incentive to the U.S. Tight Oil production market. Ergo, these folks are going to lay down rigs, and in so doing they are, for now, going from the Well Manufacturing Business ("WMB") to the Pump and Collect ("PAC") business for a year or 2. Maybe 3. This means that Oil prices could literally go down to the cash flow costs of pumping and collecting - doubtful, but certainly possible. Which means Oil COULD go to the $20's! But fracking WILL come back to whatever extent is physically possible, and that will require $100+ Oil. For people with capital, foresight, and courage this is an important moment. Bear markets in Oil typically last 20 weeks. This Bear market is already 28 weeks old. Remember, the commodities futures market is a "zero sum game" - for every winner there is an equal and opposite loser. The folks selling or "shorting" oil have made a killing. At some point they take their football and go home. We are close to that point in time (if not in price).

How much is ultimately recovered from the Tight Oil fields? Is it 20 Billion barrels or less, as the critics contend? Or is it 200 Billion, as the Oil industry contends? Good question. I don't think it matters over the next 5 years, but I do think that that question will be answered in that time frame. I rather doubt the industry's assessment - for as long as the U.S. is not a command economy. (Think about the possibility that I am hinting about there.)

(BTW... all of these conspiracy theories of the U.S. and Saudi Arabia conspiring to destroy Russia/Putin... or Saudi Arabia purposely destroying the U.S. tight oil production... whatever... are all complete nonsense. Rubbish. No one saw this coming. This price decline caught EVERYONE by surprise and EVERYONE is running around trying to optimize their outcome. Nothing more. Nothing less. And in the process of trying to optimize their outcomes the powers that be will negotiate internally and externally and change their mind several times. That's just the way it is. 

Now, the unintended consequences of  all of this, and the parties abilities to benefit from these are another matter altogether.)

Cap Ex budgets of the North American Exploration and Production companies are being cut deeply, and North America is (or was) responsible for ALL of the growth in world Oil production for the past 5 years. This will not be undone overnight. Production growth in North America is going to come to a halt. The longer (and lower) the price of Oil stays the higher the inevitable rally will be. Peak conventional crude Oil is here. If Peak Non-Conventional Oil is here the ride back up will be the stuff of legend.

Peak Oil is NOT the end of the commodity price cycle. So far, Peak Oil has meant that the commodity price cycle for Oil is far more pronounced. I think that that will continue, if I may make use of understatement, for at least one more turn of the cycle.

Oh, and for those of you that think "Peak Oil" has been discredited, I would like to say that I have thoroughly reviewed the data from the US Department of Energy's EIA and the European IEA. The data completely supports the theory. The political and financial media, having not even bothered to look at the data, disagrees.

Here life long Oil man T. Boone Pickens takes CNBC journalists to task, telling them to look at the data (they don't) and further reminding them that he is an Oil man and they are a bunch of talking heads wearing pancake makeup. You can skip to the 4 minute mark. By the 6 minute mark Pickens looses his patience and reminds them, "I'm the expert, you guys, not you."

This is your media at work. Its not the price cycle of a commodity... its the proof that Peak Oil is a failed theory irrespective of what the data that that U.S. Department of Energy compiles might say

But let me take Pickens to task now:

"The world got along fine with $100 Oil."

People like me got along fine. But for the people occupying the lower 25% income strata in the U.S. $100 Oil was an unmitigated disaster for their economic and financial well being - but ONLY because we have constructed a system whereby people that cannot afford to own and operate a car are "non-citizens" (I just read Kuntsler's "The Geography of Nowhere". That was his term.) The world that these people occupy was not "fine" at $100 and will be even less "fine" at $175 - which is sure to come. Not that I have an answer - I don't. I do suggest that "we" think about a new living arrangements for people that will absolutely, positively be even worse off "non-citiznes".

And for the "drill baby drill" crowd - Here is your world:

Not exactly heaven on earth.

More soon.