Time to toll the warning bells
By Syed Rashid Husain
The crude world has now traversed the full distance. The inevitable has happened. The bubble has finally burst. Not long ago, the peak oil theory was in robust circulation. New converts were adding to the force and fury of the peak oil camp virtually on a daily basis. Things have changed completely within a very short span of six to seven months.
The tide is exactly on the opposite side today. The market’s obsession today with plummeting oil demand has been so pervasive that it has even fostered a new theory: Peak demand.
In the midst of rapidly falling oil consumption — which as per the IEA is set to contract again in 2009 — the first back-to-back contraction in 25 years. The global focus now is the issue of peak demand and not peak oil. And there exists a world of difference between the two extremes. What a transformation of fortunes indeed!
Much on the pattern the peak oil movement gained momentum when oil prices were rising, now that they have collapsed, some seem convinced oil demand hit its highest point last year in developed economies, never to return. They’re also pumped by the commitment of some governments to support conservation and invest in new alternative energy.
“There is a reasonable likelihood that OECD oil demand has peaked,” Peter Davies, former chief economist at BP PLC, told Reuters recently.
Antoine Halff and Veronique Lashinski, energy analysts at the US brokerage Newedge, said: “More and more analysts are sold on the idea that US oil demand peaked in 2007. The market meltdown is likely to entrench current demand losses not only in the US itself but in the world at large.”
And this realization, coupled with the softening markets is beginning to take its toll in more than one ways. OPEC now stands ready to make further output cuts in case crude prices continue to be subdued; in the second quarter OPEC expects an even deeper drop in demand. “OPEC is dealing with tough circumstances, the toughest in ten, if not 30 years,” said Raad Al-Kadiri of Washington-based PFC Energy. He has a point.
Crude oil prices during the three months to the end of March, Merrill Lynch estimates, could bottom out at an average of just $43 a barrel. Other investment and industry analysts at Deutsche Bank and at the China National Offshore Oil Corporation have predicted an average price of $40, or even lower.
The above scenario has a flip side too — and a scary one indeed!
At stake now are the future projects. For OPEC, and for international oil companies, low oil prices naturally lead to significant cutbacks in future expansion plans. Oil companies are keeping a wait-and-see stance justified by the easing of pressure on supplies. A number of projects are no more feasible. Investment has dropped off and, keeping in view the gap of roughly ten years between geological discoveries and bringing it to market, this definitely does not bode well for the industry.
In West Africa, termed by some as the next global oil frontier the expensive “deep-water oil is at risk of being deferred at current oil prices,” Nigerian Petroleum Minister of State Odein Ajumogobia warned at an oil exploration conference in Abuja.
The IEA is also concerned. Low oil prices and the lack of global liquidity to finance new hydrocarbon exploration and production are causing concern about future supplies and prices.
“We hear almost every day about a project being postponed,” says IEA chief economist, Fatih Birol. “This is a major problem.”
The IEA maintains that the average oil price needs to be significantly higher than in the past five years to encourage the development of new fields that are more costly to exploit, such as Canada’s tar sands, Siberian oil fields and deep-sea offshore reserves, as well as the construction of much-needed new oil refineries.
Estimates by Cambridge Research Associates point out that as much as four million barrels of future oil-productive capacity could be jeopardized if prices remain below $60 a barrel. Other analysts say that figure could be even higher if the figure averages less than $50 a barrel.
Randy Ollenberger, managing director of oil and gas research at BMO Capital Markets, said the global oil supply could decline by as much as 20 million barrels a day over the next three years if the oil industry stops investing new capital, whether by building new projects or sustaining existing ones, because oil prices are too low. This would dwarf a decline in demand of about 2.25 million barrels a day over the same period.
Jeff Rubin of CIBC World markets estimates that oil-sands project cancellations so far add up to the loss of one million barrels a day that was expected to come in the next five to 10 years. Around the world, he estimates, 40 to 50 new projects are vulnerable at today’s prices.
And this is happening at a time when the Russian oil production is also experiencing significant drop. Russian production went down 0.7 percent for the first time in 10 years, Vedomosti, a Russian newspaper reported. However, Russian exports during the year were reduced more dramatically by 6.2 percent over the previous years.
This leads us to another deduction too — the current low prices are not going to stay there long. The tide is in for another transformation down the road. Despite the lowering of raw material prices, especially steel, one is not witnessing a rush for rigs now that recession is eroding demand for fuel worldwide.
Sharp price rise by 2011-12 hence cannot be ruled out. Dan Lewis, research director at London’s Economic Research Council, recently said that an “oil crunch” is looming, a result of oil exploration projects being shelved during the current global economic crisis.
“The market is fixated on the demand side and ignoring the supply side, and if oil prices remain at these levels, what we will see is supply destruction that is much greater than the demand destruction than we have seen,” says Randy Ollenberger.
It’s the reason he doesn’t see oil prices staying at today’s levels for long.
“In the 1980s and through the 1990s, we had lower prices for protracted periods because we had excess supply over that entire period. We don’t have that today,” he said. “I think the turnaround here will be much, much quicker. Maybe not a turnaround in 2009, but by the end of 2009 we will see pretty clear evidence of the supply destruction.”
Jeff Rubin also predicts another oil spike to $100 a barrel toward the end of this year and into 2010, arguing that the recession may temporarily cut one or two million barrels a day from world oil demand, but will do nothing to stop the loss of nearly four million barrels per day this year from depletion alone. We are entering unknown waters again — time to toll the warning bells indeed.