Peak Oil Pulled a Fast One on Me

By Allan S. Christensen, From Filmers to Farmers:

I’ll admit that I was completely caught off guard by the crash in oil prices.

In short, oil’s price has crashed over 50% in the past half a year. This has primarily been due to 4 million barrels of oil added to world production levels via fracking in the United States since 2008, and because of a slowdown of various economies around the world who have thus demanded less oil. Both of these effetively increased supply, and so have contributed to a decline in prices.

First off, it’s worth noting that for the past three years or so, before oil’s recent crash, the price of crude has been bouncing around the $100 mark. This was a relatively expensive range, particularly in comparison to its long-standing rate of $20-$40 per barrel for more than a decade, before its gradual then meteoric rise to $147 in 2008.

Since oil is entwined with the price of pretty much everything nowadays, its changes in price can have a significant effect on economies (as we currently [mis]understand the term). With higher and higher oil prices sapping a greater percentage from expenditures – be it of “consumers” or businesses – a price point is eventually reached where goods become so expensive that those who can’t afford them anymore simply stop buying them. This is what is called “demand destruction.”

When demand dries up and fewer goods thus end up being bought and sold, a glut in oil supply results, which ends up crashing prices. This is simple supply and demand. Along with other factors, this is what happened after the $147 oil price spike in July of 2008, and resulted in oil tumbling down to $32 by December of that same year.

While the ensuing low oil prices get seen by some as a boon (via the expectation that consumers will have more money to spend on other things), the opposite problem actually kicks in – namely, “offer destruction.” Since many businesses get forced to close down due to crashing oil demand and so in effect fewer sales, and since a number of people get their hours cut or even lose their jobs, there often-times isn’t enough money to pay for oil and other goods, regardless of how low the prices go. This is what happened in 2009, gets referred to as being the Great Recession, and can be fairly described as “the beauty of the market.”

And this is where I got thrown off.

2005 is seen by some as the year that conventional supplies of oil peaked. It is because of this (and a few other factors, like speculation) that oil climbed to $147. Although prices subsequently crashed due to demand destruction, they eventually made their way back up, to the point that several unconventional forms of oil (shale oil/fracking, tar sands, and deepwater offshore oil) became somewhat profitable.

The problem with peak oil is that when (if?) growth kicks in again, and since more and more energy is getting used, soon enough the increasing levels of energy-use may very well butt up against maximum extraction levels, resulting in a shortage in supply and causing the whole demand-and-offer-destruction cycle to kick back in again.

As far as one theory goes, higher highs and higher lows will occur. That is, instead of maxing out at $147 per barrel, oil will reach, say, $200 per barrel, before crashing down to $80 or so instead of $32. And so forth.

And it is because of this notion that peak oil pulled a fast one on me. Expecting the higher high having to happen, what I didn’t clue into was that oil prices at a high enough level for a prolonged period of time would be enough to have a similar effect as a quick rise to $147.

Case in point, one can look at countries that have recently slipped into recession or simply haven’t gotten out since 2009 – Greece, Spain, Italy, Brazil, and so forth. Furthermore, some of the more robust and rich countries are seeing their growth wane – Japan, China, Germany, to name just a few. For what is a slowdown in Europe leads to fewer consumer purchases from China leads to less iron ore and coal bought from Australia.

Take a look at Italy:

(image courtesy of Resource Crisis)

Oil and gas consumption peaked in 2004 and has been on a decline ever since. According to Ugo Bardi over at Resource Crisis, “Italy is in full collapse.” One not only sees that industries are closing down, but also that restaurants are popping up in the attempt to attract the wallets of globe-trotting, placeless tourists, along with all the chic restaurant-hoppers. What is being witnessed, says Bardi, is “unreal.”

Unfortunately, and much like the aforementioned countries, if one is looking for solid explanations about these economic collapses from mainstream news sources, then one is pretty much out of luck. As Bardi then explains,

When the crisis is mentioned, different culprits periodically appear in the first pages of the newspapers: the Euro, the European Union, politicians, immigrants, government employees, bureaucracy, lazy workers, terrorism, femicide, Angela Merkel, Vladimir Putin, Silvio Berlusconi, and more. It is a cycle that never stops, it keeps turning, every time pointing at something – new or old – that the government will target to solve the crisis once and for all.

In turn, not only could low-priced oil usher in another Great Recession via a meltdown of the oil market, but the newly enshrined oil ventures are at serious risk of collapse, and whose bubble bursting could be akin to the recent housing bubble. (To be fair, I can’t imagine oil reaching that low if not staying there for very long, for the very simple reason that any number of unfortunate conflicts around the world could cause its price to increase overnight.)

Cost of oil production for various projects and countries
(image via The Oil Drum)

In short, many of the unconventional sources of oil require $100 prices in order to remain financially viable (or at least give that impression). Since many of the fracking plays in the United States are owned by independents who don’t have the financial reserves to weather a prolonged period of prices below costs of production, things could get hairy.

Since fracking is capital-intensive, drillers have borrowed ridiculous amounts of money in order to acquire leases, drill wells, as well as purchase and install processing equipment and infrastructure. And since fracked wells have steep decline rates, drillers have been forced to continually drill more and more wells to keep up the semblance of growth – and to keep the debt piling up. What’s resulted is a junk bond market possibly akin to what was witnessed a few years back with the housing fracas.

And not to let all the boosters off the hook, for it was once again an all-too-giddy media that kept itself busy cheering on the latest (fraudulent?) money-making scheme, pumping up all the debt with nary a peep about any possible consequences.

And so what’s going on now that prices have crashed? That would be sellers panicking to unload their energy-related junk bonds and other investments in unconventional oil and related industries, and it’s anybody’s guess as to how much of a collapse will occur in these fields – and if it’s significant enough, if they’ll even have a chance to recover.

And as mentioned earlier, a round of offer destruction is expected to kick in after a round of demand destruction. For instance, nearly 40% of the jobs created since 2009 in the United States have been in energy related fields, those being some of the higher paying jobs in the nation, a catastrophe to the U.S. economy if lost.

As John Michael Greer recently put it over at The Archdruid Report, “If I’m right, the spike in domestic US oil production due to fracking was never more than an artifact of fiscal irresponsibility in the first place, and could not have been sustained no matter what.”

United States oil production levels, in thousands of barrels per day
(image courtesy of Peak Oil Barrel)

What we might be about to find out is how vulnerable the United States’ shale boom is to low prices, and how profitable fracking actually is. Here’s Terry Lynn Karl in a recent conversation with Andrew Nikiforuk: “We are in a situation where oil supply limits can cause recessions, and oil supply gluts can cause stock market failures.”

The reasons to get off oil seem to be piling up. By Allan S. Christensen. This is the condensed version for WOLF STREET. For the full-length version, which is twice as long and includes a discussion of OPEC’s involvement, see: From Filmers to Farmers

“Stick of dynamite waiting for a match… which we now see with crashing oil prices.” Read…  This Giant Oil Company Is Headed for Disaster

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

  12 comments for “Peak Oil Pulled a Fast One on Me

  1. Julian the Apostate says:

    An excellent overview of oil market cycles. The interference of regulatory agencies and the NIMBY effect further complicate matters. I think when oil becomes too scarce someone in the private sector will come up with a viable replacement – assuming the central planners don’t completely succeed at throttling innovation.

    Wolf, thanks for the nod about the car biz…I’m sure we could waste an evening over beer or a good single-malt Scotch swapping crazy stories. Much of what I learned back then I still use, like “there’s an ass for every seat, but sometimes it takes a little longer for the ass.” “Ask for the order.” “In a negotiation, shut up shut up shut up. The first one to open his mouth loses.”
    “The most important thing to a woman buying a car is the color. It is an accessory like her purse or her shoes.”
    “What does a buyer look like?” And don’t leave money on the table.

  2. Limacon says:

    Substitute already in production. See

  3. DGM says:

    One of the tragic results of QE/Zirp induced creation of the inherently uneconomical fracking industry is the damage to the coal industry in Central Appalachia due to low gas prices. Along with this came government intervention in energy markets through bias regulation favoring natural gas and against coal fired generation. Thousands of jobs lost, real people with children to feed, clothe and educate

    • CrazyCooter says:

      As I have posted many times, coal was thrown under the bus by intent – which is to BK the companies, shed liabilities (pollution, pension, disability, etc), so insiders can pick up the assets on the cheap without the baggage.

      When nat gas prices eventually go back up to norms (or overshoot), coal will be fresh and ready for profits.



  4. Petunia says:

    Honey, I shrank the economy. The Great Recession has had a structural effect that is only now being felt. People were forced to cut back by the collapse of the main street economy and they are living with only what they really need. Incomes have fallen to a level that cannot support the middle class ideal. The decline in gas prices helps keep the lid on a politically intolerable situation. When the prices started to fall I was sure it was about the upcoming election. I am more sure now. It is about all the upcoming elections.

  5. CrazyCooter says:

    If I am not mistaken, the US put on almost 3 million barrels per day of production via fracking over the last several years. This offset an overall decline in global production to hold things flat at the global/macro level as far as production goes.

    Given the high decline rates of frack wells, and the voracious need for debt to fund it, we can safely assume that 3 million will become 300 barrels per day in just a couple of years (without new debt funded, money losing fracking). There will still be some activity, and the bulls will talk about INITIAL production instead of average production, real rates of return for capital invested, or production rates after 1, 2, or 3 years.

    The implosion of the energy junk bond market aside, oil is teed up to be extremely volatile in the coming months/years, despite what the DBag Saudi prince says.

    Demand is cratering because the global economy is cratering, but in doing so, the natural decline rate (~3 to 5% per annum) of conventional wells will continue unabated and the sugar bump of frack oil will quickly wear off bringing us to the post-peak debate which will surely take hold at some point not too far down the road.



  6. Julian the Apostate says:

    Is there any doubt left that the thieves in Washington are sabotaging this country INTENIONALLY? Not a one of them would be hired to be a janitor in a profit making business. We vent here and I sights like this but face it people we are in the minority. Violence and power are opposites. Where one holds sway the other disappears. The rule of LAW HAS CEASED TO EXIST. This has been the rule rather than the exception.
    We are all brothers and sisters of a moral system that every day moves closer to collapse. Once it does the MLK AND GHANDI MODEL WILL NOT WORK. That system presumes a state that has gone awry but still holds onto its basic tenets of human rights. Then we’ll be into the Cultural Revolution of Chairman Mao where anyone who resists breakdown conversion gets a bullet behind the ear. Given THAT scenario “live free or die” takes on a whole new meaning.
    Someone told Kurt Vonnegut once that he had written an anti-war book. Vonnegut’s response was “you might as well write an anti-iceberg book.” I am no seer, but the pattern forming is unmistakable, we all agree on that.
    I am 60 years old and I don’t want to change. Bummer. But I have changed, as much as circumstances allow. I know I will not panic because I’ve seen first hand that panic can kill you.
    Back in Roman times each Centurion carried a standard with his unit number on it. After the chaos of a battle he would plant his standard on high ground so that his troops would know where to regroup.
    When the Muppets are running around like Chicken Little you each must say Follow Me. I KNOW WHAT TO DO.

    • John says:

      To be fair,quite a lot of them were relatively successful business people before their ambition sent them in the direction of Washington…….

      • Mark says:

        Being a lawyer doesn’t count. If Congress was held to the same diversity standard as they force down the economies throat, we’d see tradesmen, sales people and others instead of a huge majority of lawyers focused on using the law for their benefit.

  7. A lot of this oil surplus I propose is due to US refinery gain, like taking a pot of cream, whipping it up, and saying you now have 3 pots of cream. Accept these 3 pots of cream have less net energy in them than the initial one pot of cream – due to energy used in whipping process. Similar argument applies with oil products.

    Once the IEA and/or EIA start publishing netenergy weighted forecasts (will have to do soon or later due to growth in unconventional product – price slump notwithstanding) this production gap should be largely revised away.

  8. Monoborracho says:

    It is a mistake to think that America’s new “fracking ” production will quickly decline when the drilling for new wells stops. It won’t. Yes, each well has a steep early decline curve, but the declining rate gets less and less each year. Many of these wells are several years old and are in a much shallower decline than their initial rates.

  9. At least this article mentions the term ‘Peak Oil’ rather than talking about nefarious Saudi Arabia or how the US is out to get Putin.

    Prices are consequence not a cause. Nobody ‘lowered the price’ of crude oil (and oily substances) in order to ‘get’ anyone (they got themselves). Buying cheap gas for the guzzler is useless if you have lost your job.

    The idea of wild swings in price is nonsense: where is the money for a high price going to come from? Banks are insolvent, so are a bunch of economically vital countries such as Japan, China, EU, UK, Indonesia, Russia, India, Brazil not to mention a bunch of perpetual runners-up such as Venezuela and Nigeria. Taken together the folks whose misfortune is to live in these places have seen their purchasing power fly away toward the wealthy (and to oil drillers) by way of policies and monetary easing (risk emerge in forex markets rather than repressed credit markets).

    Supply and demand is not a waterway with the funds flowing one direction only. Constrained supply can result higher prices w/ customers straining to keep up; it can also result in falling prices with customers ability to meet them falling faster.

    Bankrupt customers is why the oil price continues to fall (part of the reason), it is also why the price will continue falling. Structural problem in the economy = conservation by other means.

Comments are closed.