Oil Rises, Oil Falls

The History of Oil Meets the Perfect Energy Trifecta
by Jim Puplava
www.financialsense.com

From the drilling of the first oil well in 1859, the oil industry has been locked into a perpetual boom-and-bust cycle. During the early days booms and busts were brought on by dramatic swings in the supply vs. demand equation.

From 2004 to 2007 world economies grew by close to 5% per year with a concomitant growth in oil consumption of 3.9% per year (Interagency Task Force on Commodity Markets, "Interim Report on Crude Oil," July 2008, p 3).

While demand grew by 3.9% per year, supply struggled to keep pace with demand. Non-OPEC supply growth slowed, OPEC's spare capacity shrank, and OECD (Organization for Economic Co-operation and Development) oil inventories fell. As a result any new supply disruption from hurricanes, to refinery shutdowns, to geopolitical events, exacerbated an already tight supply chain resulting in price spikes.

As the accompanying table illustrates, world oil discoveries peaked in the late 60s and have fallen in each succeeding decade. Recent discoveries have been fewer and smaller in size.

Oil Field Discoveries
It seems hard to conceive that a decade-long advance in oil prices driven by relentless demand and struggling supply could have been abruptly brought to an end. Has demand fallen to such an extent as to justify a 74% decline in price? If it is widely believed that speculators were behind oil's spectacular rise then are they behind oil's precipitous decline? If the decline in consumption is estimated to be 2–2.5 mbd then oil depletion rates alone would bring demand and supply into balance. If global observed depletion rates are running 6.7% with natural depletion rates as high as 9%, has demand fallen by a similar percentage globally?


As a result oil prices below $60 a barrel is leading to reduced capital spending by the energy industry on long-term investments. A fall in oil prices to $40 will only hasten capex reductions. Declines to $30 will lead to shut-ins, which approach cash operating costs for a sizable amount of production. According to IHS Herold, capital spending by exploration and production companies is expected to decline by 13% in 2009

During the next energy up-cycle prices are set to rise dramatically, and are likely to surpass the records set in July of 2008. The energy price curve is being reset as a result of accelerating depletion. Whereas in the recent cycle demand destruction did not occur until oil prices surpassed $100 a barrel, I believe this time around demand destruction will take place at much lower prices, perhaps in the $75–$85 range. The much-needed investments to slow down natural depletion rates are not being made. The industry's infrastructure is aging and rusting from the well bore, tank farms, pipelines, tankers, and refineries to drilling rigs. In addition, the energy workforce is aging and will have to be replaced by new geologists, engineers, and business executives. Where will the next energy employee crop emerge? University enrollments for geologists have declined over the last two decades.

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