Peak SOMETHING...just maybe not oil (yet)

Over on Flogblog, Frog reports that oil future prices are now higher than the present oil price. This configuration of pricing is referred to as "contango", apparently.

(Skip down to "Peak SOMETHING" if you want the 'punch line' to this post)

I love the way one can learn so many new things every day on the Internet. The way my mind works is to take pieces of information and play with them in a variety of configurations. What does this idea look like next to that idea? Is it plausible? How would human behaviour impact on the model thus constructed? Still plausible? Now let's go find out if it's also real. Almost certainly not, but along the way I'll learn a lot more and continuously refine my models. The model itself is really just a starting point for asking more questions in order to learn more. I also remember what I learn better if it all hung out on a continuously a-building infrastructure of compounding questions and answers. One aspect of this it allows me to challenge the received wisdom. It what we are being told actually true and correct? How else might the same facts be credibly interpreted?

So what follows is a bit of a romp through recent oil industry trends, with information and ideas assembled like a "Lego" set of pieces for constructing models to aid further understanding and investigation. This NOT a conclusion or assertion. It's speculative to aid thought and maybe discussion.

On the face of it, oil pumped out of the ground has been one of the biggest bonanzas in human history. It facilitated the creation of a global civilization built upon a foundation of apparently inexhaustible and inexpensive energy. The wealth thus generated has been enormous in historical terms, very likely dwarfing all that came before it.

The people who own or control oil are automatically among the most wealthy people on Earth. The more of it you own, the more wealthy and powerful you are. The Saudi royal family, inhabiting a sandy patch with barely 5 million people, are among the most powerful people around thanks to oil. "Rockefeller" and "Bush" are just two political dynasties built either directly on oil or connections to it. Wars have been fought over oil because wars can't be fought without it.

The only problem is, oil is a finite resource. An oil find of a "billion barrels" that took 60 million years to develop is barely enough to supply the world's fuel needs for two weeks at roughly 86 million barrels / day. A resource that is consumed in two weeks that took 3.12 BILLION weeks (60M x 52) to form isn't a resource with a long term future. It will flare brightly, like a camera flash in terms of geological time, and disappear. Come back in 60 million years for a refill.

Enter the idea of "peak oil". Peak oil is when you've reached the maximum you're able to extract and after that maximum, the amount you extract in each subsequent year will be less than the year before. You've peaked. Variables are extraction capacity and demand. How much can you pump on a given day and much do you need anyway. In practical terms it means little as far as shortages are concerned provided the daily supply remains greater than daily demand.

There is a lot of debate about peak oil. When the Iraqi reserves have barely been tapped and the Canadian tar sands are just becoming economic, can it be said that peak oil has really arrived? Maybe looking at the source isn't the whole story. Maybe it's a red herring entirely. Maybe the ability to extract and refine it are also factors.

There are several choke points between oil in the ground and petrol in your tank. Pressure on any or all of these over an extended period could easily result in a situation where concern develops that at some immediate future time supply will not meet demand and price goes crazy.

What impacts on production (besides a declining amount of oil in the ground)?

War or threat of war. Iraqi oil production was seriously impacted by the US invasion and subsequent insurgency. Israeli and American threats to unilaterally nuke Iran have the same effect. Iran wants to use the Euro, not the US$ so the resultingUS-lead sanctions have meant reduced investment there making matters worse. War in Sudan. Nigerian and other rebels have a role to play too.

Weather events. Oil isn't always in convenient places. Its is frequently under a lot of water. Many if not most of the oil rigs in the Gulf of Mexico were at least temporarily put offline by Hurricane Katrina. As climate change causes weather events to become more variable, the risk of interruption to oil production from weather-related events like storms or flooding rises.

Environmental concerns. The Canadian tar sands contain a vast amount of oil that has come to the surface and mixed with the soil. It can be extracted, but until recently was relatively expensive to do so. Even worse, in the long run, is that to extract it you must strip mine vast areas entirely in places so cold the environment is slow to recover from relatively minor disturbances, never mind stripping the top off the ground for any area the size of France. That a lot of this land belongs to other people at the moment or is subject to longstanding aboriginal land claims merely adds spice to the situation. Property rights tend to be overridden when oil is at stake. Those that want it tend to find a way to give themselves the power to take it, so let's assume this resource, too, no matter how destructive it may be, will ultimately be exploited. That sort of thinking is clearly seen here:

Last week, Goldman Sachs predicted oil prices would average $141 in the second half of this year and added that crude prices for delivery far into the future would also likely rise sharply as oil companies have trouble accessing new reserves to feed demand growth.

"This is due to 'the revenge of the old political economy' (resource protectionism), which imposes significant policy constraints on the free flow of capital, labor and technology that are substantially limiting supply growth," Goldman said in a report.

In other words, let them do what we want, where they want, when they want.....or you're limiting their potential for growth. Growth is the only imperative. Bugger everything else. When oil is the prize, prepared to be buggered unless you're very well organised.

Other factors like civil unrest and labour disputes tend to be more short term and the market can look past them beyond acknowledging any problems with brief price spikes until some general takes control or the union leaders are sent to jail and production resumes.

Cartels

So the most likely way to interfere with oil production is to run out or to simply not pump it for some reason. OPEC is a cartel, after all. Many is the time when I have seen someone shrug and say "We are doing all we can" with a smile on their faces while actually doing little or nothing. It isn't in their interest to see the price of oil fall while the US dollar is also falling against other currencies due to huge war budget deficits. It's like a discount on steroids. The US$1 trillion spent on utterly unproductive activity in Iraq is re-appearing as inflation.

Or, rising demand may really be exceeding the absolute ability to supply, even if total production is still rising and has not reached a peak. The result of that would also be an apparent shortage, too.

Speculators

Of course the price of oil might have noting whatever to do with supply of oil itself, but more to do with heavy interest from mega-funds speculating in oil futures. This appears to be the view of OPEC ministers who have declared oil markets to be well supplied and they do not intend to increase production prior to their next review in September.

Members of the Organization of the Petroleum Exporting Countries have repeatedly rebuffed calls for more supplies from consumer nations hard hit by the inflation in fuel costs, saying the rally is due to rampant speculation and not to any supply shortage.

On Tuesday, Venezuela Energy Minister Rafael Ramirez and OPEC Secretary General Abdullah al-Badri reiterated that they think oil markets are well supplied.

The next choke point is refining.

Oil refineries take a long time to build. This one just getting underway in Vietnam will apparently take 5 years to construct. In the energy-intensive US market no one has been building any. They have been shutting them down. As of 2005, no oil refineries had been built in the US for almost 30 years. In fact the number of refineries in the US fell from 324 in 1981 to 132 in 2005. Actually refining capacity at the expanded remaining refineries fell from 18.6 million barrels per day (bpd) to 16.8 million bpd. This would be despite rising levels of consumption. Demand for petrol rose 45% in that period. Refined oil products would have to be imported from elsewhere to fill the gap.

Is refining being choked to keep rices up? This BBC report makes it fairly clear that limiting refinery capacity has been used to inflate prices, a strategy now underway for a decade or more.

No new refineries

(US Senator Joe) Wyden uncovered several memos and internal documents from major oil companies. These charted the way that capacity in the US refining industry was reduced to maintain higher profits.

Wyden received one such memo from oil company Texaco, written in 1996. The company felt it was quite clear that petrol supplies needed "reducing."

"The most critical factor facing the refining industry on the West Coast is the surplus refining capacity, and the surplus gasoline production capacity," said the memo.

"The same situation exists for the entire US refining industry. Supply significantly exceeds demand year-round. This results in very poor refinery margins, and very poor refinery financial results. Significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline."

Enron pioneered artificial energy shortages as a means of infalting prices and thus profits in the 90's. It should come as no surprise that the oil industry was paying attention.

Thought Model in Oil Exec's Mind: With rapidly rising demand from India and China, how can we make oil prices do what electricity did in Southern California? Well, we can take refineries offline for good and fine-tune by closing others for maintenance when prices dip. We can drag our heals, creating a refining bottleneck. Doesn't matter how fast they pump it if we can't make it into petrol / diesel fast enough. We can try to build refineries in places that will see lots of environmental opposition (that way we get to blame greenies for any fuel shortages that eventuate and may be able to get laws changed to let us build where we want, if we want to).

A refining cartel appears to have created the effects of "peak oil" where no immediate "shortage" may exist (according to OPEC as above). No one will want to be blamed for that one so a forest of fingers pointing in all directions will be very much in evidence.

Peak SOMETHING!

There is a clear pattern emerging here. Almost everyone involved in the oil industry has a direct financial incentive to NOT supply enough oil or refined products. It's like a perfect storm: "Hurricane Cartel" aligned with an earthquake of speculation.

The consumers of these products are at their mercy with only political power in democracies as a means of seeking any redress, while at the same time big oil and big bank money wields huge influence in those same democracies. Especially if the country concerned actually has oil or an influential community of cash-rich speculators.

Peak oil? Maybe. Or it might just be Peak Greed.

OK...That's today's speculative model. I've found a fair amount of evidence to support it. I'm surprised and yet not.

[Update: Idiot Savant points to Paul Krugman's argument that the lack of growing inventories points to genuine supply / demand forces operating. Therefore, speculation can't be the cause, unless someone is buying all the oil and hiding it somewhere. It's a good point. One of the people responding to Krugman pointed out that perhaps the oil was being left in the ground.....and thus would not appear in inventories. Are people buying oil now further and further forward, to be pumped later and later? Is that why futures contracts are being bid up beyond current prices?

Depending on why it was in the ground, the reason would point to which of the various "causes" was to blame. Producers refusing to pump? Oil buyers paying for future oil that hasn't been pumped yet? Purchaes made that go into forms of inventory that aren't currently monitored? Some thing else? The bottom line so far as is that inventories appear to be at normal levels now and for the past several years oil has been rising in price, but people are nervous about forward supply. Yet oil so far has kept pace with demand. So why the high prices? Where is the circuit-breaker in this loop? Or is it the sum of all these factors that represents the whole? A pie is a pie - not a slice?]

Discuss, anyone?