What are the economics of oil and energy now?

The last fifteen months or so have seen quite a change in the Crude Oil market.  Before then the debate on this blog covered a long period where it seemed that a Star Trek style tractor beam kept pulling the price of the Brent Crude Oil benchmark back to the US $108 level. Happy days for option writers but of course very expensive for you and I and the world economy with only the producer summoning a cheer. Then something changed and the oil price fell and at times plummeted which with the occasional retracement finds us this morning with Brent Crude just above US $49.

An old sparring partner of this blog the former Chief Economist of the Bank of England Spencer Dale he of (create) Inflation, Inflation Inflation fame has opened fire on the subject. So what do we learn? Well the first thing is that for the UK establishment there is no such thing as failure as his  departure from the Bank of England at Governor Carney’s behest has been followed by being made Chief Economist of British Petroleum. Also we get as near to an admittal of my critiques of his views as we are going to get.

many of my core beliefs about the oil market stemmed from what I had learnt at school and university.

Monetary policy too Spencer.

The Oil Market changed

One side of the argument is familiar as the regular cries of “peak oil” and supply reducing over time were replaced by this.

From a near standing start in 2010, US shale oil production has increased to around 4.5 Mb/d today.

There are of course shale oil efforts elsewhere on a smaller scale. But this had a big impact.

US oil production on its own increased by almost twice the expansion in global oil demand.

This drove the oil price lower and by a very large amount so we learnt that relatively marginal moves in oil supply/demand ( US shale oil is 5% of total world supply) have very magnified effects on the price in this instance of the order of ten to one.

Also we get an assertion from Spencer that much of shale oil is viable here at current price levels. Whether he actually believes that or whether this represents the interests of BP I do not know.

Peak Oil

In the language of the delightful Ms Taylor Swift this is like so over.

Total proved reserves of oil – reserves of oil which, with reasonable certainty, can be economically recovered from known reservoirs – are almost two-and-a-half times greater today than in 1980.

Perhaps Spencer is unaware of the fact that back then oil companies only bothered to search for a few years supply on a rolling pattern. Anyway we then get perhaps the most eye-catching of his quotes.

Put differently, for every barrel of oil consumed, another two have been added.

I am not sure whether the section on climate change is meant to please his old boss Governor Mark Carney who had a recent Road To Damascus type conversion on the subject or his new bosses at BP but the world according to Spencer is heading here.

But even so, the pace at which estimates of recoverable oil resources are increasing, together with growing concerns about the environment, means that it seems unlikely that all of the world’s oil will be consumed.

What about the oil price?

The analysis so far is a backwards looking explanation of what has happened or ex-post if you like. Back at US $108 there were plenty of assertions that oil supply was singing along with the band Muse.

Our time is running out
Our time is running out

Now apparently at US $49 we are told it will never run out! Can you see the problem which is akin to not seeing the wood for the trees? Also it ignores our relationship with oil which is summed up by the same song.

I wanted freedom
Bound and restricted
I tried to give you up
But I’m addicted

Improvements in technology

Whilst I am dubious about assuming that we will “never ever ever ever” (h/t Ms Taylor Swift again) find that oil is running out it is possible and indeed probable that for now and for a while things have changed. One sign of this is shown by looking at something which in other forms is a regular feature of this blog which is productivity.

Productivity growth, as measured by initial production per rig, averaged over 30% per year between 2007 and 2014

This assertion that such methods are like manufacturing where lessons learned can be applied almost as if on a production line leads to quite a few lines of thought. Firstly the economics of the world of shale oil may be better and perhaps much better than we have assumed. Secondly if this has been happening and has been recorded in the official US data then productivity elsewhere has been worse than we have thought. Thirdly the UK has got used to downwards pressure on productivity from the decline of North Sea Oil & Gas which shale oil could potentially reverse and send charging forwards. Also maybe the new higher output levels in the North Sea may be behind at least part of the UK’s productivity improvement in 2015 which is not quite so rosy a thought.

Price changes will be smaller

This is asserted rather against the evidence of the last year but the short-life of shale oil wells apparently leads to this.

its production characteristics should dampen price volatility,

After the 4% fall on Monday in the oil price that is hard to maintain let alone if we look back over events! We might expect more shale oil production should the oil price rise but we also need to note that some of the economics is dodgy especially for a world which is still undergoing the fallout from a credit crunch.

the vast majority of independent producers have negative cash flows; that is, they don’t generate sufficient cash from their operations to fund future investments.

In other words they have to borrow and borrow.Still it gets Spencer a chance to blow his own trumpet and slap his former central banking colleagues on the back.

It seems quite likely that the scale of funding that enabled the US shale revolution to expand at the pace it did over the past 4 or 5 years would not have been available had global interest rates not been close to zero, with central banks using large-scale quantitative easing to encourage investors to invest in riskier forms of assets.

Finally an area where QE has done some good perhaps! I expect central banking speech writers to be already noting that paragraph and getting ready to use it. it certainly beats the repetition of the word counterfactual! Mind you they had best take care as what could go wrong?

But the greater exposure of shale producers to the financial system means the oil market is more exposed to financial shocks.


As ever from our Spencer there are some useful thoughts but also a failure to see the bigger picture. Plainly the advent of shale oil changed things but in my opinion its impact on the oil price was magnified by two factors. Firstly the major banks withdrew from having trading desks specialising in oil and commodities and I do not think it was a coincidence that prices then fell pretty much across the board. This gives a different emphasis to the current disinflationary phase and indeed a different tinge to QE to that provided by Spencer as it was the liquidity provided by it that allowed a “punters city” to thrive.

The other factor is hinted at by Spencer Dale but in a world of fantasy and not reality. We were hardly likely to wake up one day and discover all cars were electric powered and if we did there would be the question of how we would generate that electricity. But there have been genuine improvements in renewable energy. Whilst there are white elephants such as offshore wind generation that relied on a rising oil price to ever look competitive solar power has made considerable advances. Morgan Stanley put it this back in January.

For the first time, the cost of generating electricity from the sun can compete with traditional sources of power in a number of key markets.

Now there are problems such as storage as battery technology has not kept up but over time it will have an increasing impact on energy supply.

There is a catch however which is that solar power relies itself on elements which are in relatively short supply. So the resources and green arguments are complex and rarely thought through. But if someone manages to produce solar power from readily available elements then the game does change.

Meanwhile how is the UK handling what is a complex area? From City- AM today.

Britain could be facing a winter of blackouts, with National Grid warning of the tightest winter power supplies in a decade…The country now has just 1.2 per cent of spare capacity in the system, down from 4.1 per cent last year.

So what we do not need this winter are cold calm days….

Oh and the actual National Grid report has just been published and the margin has “Hey Presto” gone to 5.1% which means that we are likely to feel the pain in our wallets as prices rise as more expensive production methods are bought in. Higher domestic fuel prices with a lower oil price? Of course we could have a mild winter and this does not matter but if we end up paying more we can be sure that nobody in charge will be responsible.


24 thoughts on “What are the economics of oil and energy now?

    • Hi Steve

      Thanks for the link which shows that there is a role for wind power (4.27% of UK grid output as I type this). However I saw a documentary on one of the ships used for offshore planting of the turbines and unless the oil price really soars and soars I find it hard to see that component ever being viable

  1. Hello Shaun ,

    Indeed the economics of oil extraction are some what complex but I’d posit that theres a fair bit of truth in the availability of QE and hot money that drove the US revolution

    It seemed that the NOC took a look and because they did not have access to QE but normal funds for the CAPEX that they decided to leave well alone

    There is much hang wringing now over the viability of the US companies to pay back their debt that some have speculated that the FED will again have to pump up the volume and buy worthless paper like MSBs again from the Banks invested in the Shale sector

    AS for the confusion about Resources and Reserves in oil , that is always a problem. After all as I suspect theres a lot more oil that can be extracted at $200 than $20 , so reserves swing with the price (!) but in the end the Resource base has not expanded much . Even Shell pulled out of the Artic ( price again ) . So as we use it up we find less to burn at $20 than $10 , and I dont normally pay much attention to spot prices but yearly averages . Remember your point about GDP and trade figures?

    As for the Grid , well theres a thought , if/when we get blackout it will be in Industry first and that will hit the balance of payments , wont it?

    When the consumer gets hit , no doubt it will be a Cilla Black moment ” surprise ,surprise ! ”

    Oh well sit back and keep some popcorn handy 😉


  2. Hi Shaun,

    Excellent analysis.

    Before renewables we have always relied on past sun’s energy with wood, coal and finally oil and gas, which we have harvested and used as and when necessary.

    Now renewables are predominately using current sun energy for instant consumption. Being able to save the energy in times of surplus and using it to supplement demand when required is IMO an underdeveloped area of technology. Like with food which is in abundance during the summer months, we have developed an array of preserving techniques including drying, salting, sweetening, freezing, canning, pickling etc., so we can consume it all through the year, I suspect we will do the same with energy storage, but with any technique we will always be battling EROEI.

    • from an engineering perspective Refrigeration is the THE big thing and that’s primary fueled by electricity from fossil fuels

      Surplus energy storage from surplus renewables electricity is the big one – all the tech so far have drawbacks

      The best thing would be to bring peace to the North African countries instead of political motivate wars – then we could build big on Solar ( yes I know theres still engineering drawbacks) and HVac line to Europe.

      Or build Nuclear , or not

      But we aint gonna rebalance the economy like the great Gordo said when he mouthed off about us building wind turbines as manufactured in the UK – we brought them from Germany instead, pfft!

      ( actually I dont think we can build Nuclear anymore but we can print paper for the Banks…… )



      • We used to invent these things from scratch and get them built. What stops us reusing the same blueprints or bettering them ? It’s only pessimistic can’t do thinking holding the UK back.

  3. It’s an interesting thought that oil is being “pumped long”, as it were – sold for less than the cost of extraction (which puts a big old question mark over the phrase “can be economically recovered from known reservoirs”: anything can be economically recovered if you don’t have to pay for it). The motivations are complex. Finding the oil takes investment (e.g., £5bn for the abandoned Shell Arctic exploration), equipment for exploitation takes another pile, and of course licenses are often on the proviso that the field is used by the licensee in a reasonable timeframe (ie, just claiming the oil and leaving it in the ground is frowned upon in many place where shale is a factor).

    So these independents (and not so independents) are betting that this period of low oil prices will expire before their lines of credit do. But with Saudi oh-so-willing to put pressure on Russia for their friends in the Whitehouse (and by a happy coincidence put many shale producers out of business) when will that be? Ironically, it will be after the US interest rate rise which will also put more pressure on all that free money that’s keeping the shale flowing.

    The question this all leaves me with is “how much of the 4.5 Mb/d being produced from shale in the US is actually economically recovered?”.

    According to this August graph from Reuters

    it comes down to APC, CLR, and PXD who are all relatively small operations with, presumably, lower overheads. Indeed, generally average production per well has gone up recently as lower production wells have been closed down, giving another opportunity to find some good news if someone really needs to.

    The good news is that all this is having a Darwinian effect on companies in what we could also term the Christina Aquilera effect:

    Makes me that much stronger
    Makes me work a little bit harder
    Makes me that much wiser
    So thanks for making me a fighter

    so if the oil price does ever go back up to $150, the lean, efficient operations that remain will be able to pump a lot of oil with substantial profit margins. Which will push prices down again, of course, unless some sort of “arrangement” can be made about ideal price and production levels. But that sort of thing is unlikely to happen in the oil market, isn’t it?

    • Hi TW and welcome to the comments section

      Thanks for the lyrics, I see that you are into the spirit already! As to the analysis it reminds me a bit of the railway companies in the UK back in the beginnings of the network when many were never going to be viable. it is an interesting business model where you pump oil for cash flow rather than profits.

      So what remains is leaner and meaner which is good however like Forbin I wonder about what happens to the credit flows for the others. Will QE4 buy them up in another example of socialising losses? Also it is another reason for the Fed not to raise interest-rates.

      There is no stable equilibrium in the oil markets which is why economists models do so badly.

      Oh and on the QE point who benefits the most from low oil prices? Once you think like that maybe the Bank of Japan could add shale oil debt to its buying program. It would be buying Dollars and selling Yen too.

  4. Hi Shaun

    A bit off topic but I was watching Mitch Feierstein of Planet Ponzi on the Keiser Report today and he thinks the central London boom peaked a year ago and mentioned that new flats in Battersea were already being reduced by £200K as they were not selling.

    • Hi Bob J

      Eeek! More seriously there was always going to have to be a flood of buyers to soak up the new builds. For those unaware of the extent of the building virtually the whole area from Battersea Dogs Home and the Power Station to Vauxhall is a building site. I wrote a piece a little while ago about one of the sites which was struggling so perhaps Mitch picked up on that particular one.

  5. Hi Shaun.
    The National Grid has a policy of charging power stations more to plug into the grid, the further they are from the centre of demand, you guessed it, London and SE England, so, at a time where there’s little in the way of wiggle room in terms of supply of electricity in the case of a cold, harsh winter, how much sense does it make to cause power plants to be unsustainable (if you’ll excuse my pun)?


    I’m buying a calor gas heater and 2 bottles tomorrow.

    • Hi therrawbuzzin

      That sort of pricing policy clashes with the obvious logic of putting a nuclear power station in a remote place. On and putting nukes under pressure to keep running regardless was one of the causes of the Chernobyl disaster.

  6. Commodities are getting a caning from declining demand and a lack of support as a result of QE wind down.

    It’s hard to see them ressurecting any time soon.

    Bodes ill for Oz property investors and the creditors of the shale producers.

    Gotta keep buying the dips???

    • Hi Dutch

      Perhaps more QE is on the way with the Bank of Japan an obvious candidate on the list and if the current “Open Mouth Operations” of the ECB fail to depress the Euro it too. Perhaps as I have suggested to TW above they could cut out the middlemen and buy some of the debt directly! Although to be fair they may say as it is the South China Territories that the Oz property debt is not their sphere.

  7. Paul Hodges .

    ‘There were record numbers at last week’s European Petrochemical Association annual meeting in Berlin. But most of the 2900 attendees were in subdued mood. Once again, it seems, the industry has chosen to sanction vast new investment at the top of the cycle, and will now suffer the consequences as it all comes online at the trough.
    This is why the China chill is so worrying. Petrochemicals, like the mining industry, has vastly over-expanded. And no other region or country can possibly replace China’s lost demand growth. I fear it will take a very long time, perhaps a decade or more, before supply and demand re-balance again. ‘

  8. Hi Shaun.
    I’m not sure that the productivity of manufacturing resources and economic productivity are measured in the same way. Output per hour worked is typically defined as Efficiency in manufacturing environments; Productivity is the product of Efficiency and Utilisation. Utilisation is worked hours/available hours. So Productivity = output/available hours

    Economic productivity defined as output per hour worked ignores Utilisation. Which is a tragedy for those on zero hours contracts who don’t work all their available hours. But then it’s easy to ignore Utilisation when your not paying for it.

    Whereas in the oil industry where assets like platforms cost millions Utilisation is certainly not ignored.

    • Hi Eric

      You make a very good point and I am sure the sharper manufacturers are well up to the job. As for economists and their economic models though many may well miss the distinction. In fact I would bet on it.

  9. The Templar site is brilliant and it also shows (EDF figures as well) how dependent we are on the French nuclear surplus. A really cold winter in France anybody? Is the interconnector (2Gw) guaranteed no matter what?

  10. ‘Also we get an assertion from Spencer that much of shale oil is viable here at current price levels’
    Wow, he has to be the only person I’ve met asserting that!
    Collective opinion seems to think it’s ~$65 and surely that aids in supporting the observed halving in the N.American rig count?
    Be interested to hear people’s thoughts to the contrary!

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.