Why Oil Will Hit $100/Barrel

Following the recent slide in oil prices, CNN is already jumping on the bandwagon with their story "Why oil won't hit $100." From the article:

"If this market can continue going lower without OPEC disrupting it, it's very possible that by 2010 we could be substantially lower than anyone is imagining," said Peter Beutel, an oil analyst at the consultancy Cameron Hanover. "Four to 8 years from now, we could come down and break $20 a barrel."

Beutel bases his prediction on the fact that oil is historically a cyclical commodity. In the early 1980s it hit $38 a barrel, far higher than today's price when adjusted for inflation, only to fall to $10 a barrel by the late 1990s.

. . .

EIA says by 2010 the amount of oil OPEC can pump should increase by 2 million barrels per day, largely driven by Saudi Arabia. The EIA, like most analysts, does not agree with the view that production has peaked or will soon peak in Saudi Arabia, although a small but growing number of experts say it might.

EIA says more oil from Central Asia and the Gulf of Mexico should offset production declines in the North Sea and and Mexico.

And co-called "non-traditional" fuels, such as oil sands from Canada and corn-based ethanol, are expected to double, going from the current 3 million barrels a day to 6 million barrels a day by 2010.

While demand is expected to continue growing, EIA says conservation measures should slow the rate of growth to 1.3 percent a year from 2 percent.

Let's just ASSUME that all of those assumptions are correct--which, by the way, I strongly question. A quick math exercise: 86 mbpd * (0.013 ^ 3) = 89.4 mbpd in 2010 based on 1.3% increase in demand each year. That's 3.4 mbpd that that needs to appear over the next three years. Where will it come from? The article calls for 3 mbpd to come from increases in "non-traditional" fuels like ethanol and oil sands. The article also expects a 2mbpd increase from OPEC, mostly from Saudi Arabia. IF both of those come true, then there should be 1.6 mbpd more spare capacity than exists today. IF either one of those fails (for example, if Saudi Arabian production has actually peaked), then there will be LESS spare capacity than today.

My opinion is that neither of those projections for new production will pan out. Analysis of Saudi Arabia suggests that they have already peaked, and if anything OPEC production will decrease over the next three years. While it does seem likely that ethanol production will increase--driven by politics and subsidy--when one accounts for the energy needed to produce that ethanol the increase may be meaningless.

There does seem to be good reason for the recent 7% drawback in oil prices. Technical analysis suggests that there will be strong resistance at the prior record level, and this is exactly what happened. The problem with using technical analysis to justify a prediction of the future is that NO ONE understands why, or even IF, technical indicators have meaning--best guess is some combination of group psychology among traders, a kind of self-licking ice cream cone. An economic slowdown--quite likely, in my opinion, in light of the current debt issues--could certainly curb the increase in demand for oil. However, it is my opinion that it would take a major recession to fundamentally change our driving habits, and it is by no means clear that such problems are in the cards in the very near future. In the interim, any savings from energy efficiency will likely be negated by Jevons' Paradox.

So do I think that oil will break $100? Certainly--the only question is whether that happens this year or four years from now, and assumes that we aren't using 2007 dollars to calculate that record. In the absence of a catastrophic economic collapse (which regular readers will know is something that I see as likely in the medium-term), oil prices will keep going up. They will keep oscillating around a steadily increasing supply-demand equilibrium, with a spread of perhaps $20 up or down. So we may hit $55 before we hit $100. But $100 is far, far more likely than $20.

Mexico Collapse?

My article on the Decline of the Mexican Nation-State is now up at The Oil Drum. This comes, as promised, as an update to my New Years prediction that 2007 would see the collapse of the Mexican economy. This article comes on the heels of a very significant--and largely ignored by the MSM--event: a string of rebel attacks on oil infrastructure in Mexico. Significantly, these attacks shut down production at several "just-in-time" production facilities of major international companies such as Honda, Kellogg's, Hershey's, and Nissan. It is not yet clear whether this was the goal of a highly advanced, effects-based targeting plan by these guerrillas, or just luck on their part. However, as the effects from these shut-downs ripple through the logistics chains of these multinationals, the ultimate economic impact of this attack will likely be enormous. The greatest danger is that the rebel group's own evaluation of this new targeting focus drives them to continue a campaign of attacks against oil infrastructure--the significant, if partially unintended, impact of these first attacks will strongly support exactly that conclusion.

The discussion on my article at The Oil Drum is already proving quite interesting, with some particularly important graphs courtesy of Khebab:





From the looks of things, unless something miraculous happens with production out of Chincopec and Ku-Maloob-Zaap fields in the next two years to offset decline in Cantarell, the situation is about to get much worse...

Geopolitical Vocabulary: Cabinda

Energy Intelligence Note: 12 May, 2007

A recent trend at Energy Intelligence has been assessing the geopolitical impacts of Peak Oil. While it is easy to discern these impacts today in places like Nigeria and Iraq, it may not be long before we must add a new term to our collective geopolitical vocabulary: Cabinda.

Cabinda is a small ethnic exclave of Angola. It is where most of Angola's oil is produced, and where most of Angola's future production increases will come from. It is also the only Angolan province with an active insurgency and independence movement. In my opinion, Cabinda--and Angola's oil production along with it--may be the next geopolitical casualty of Peak Oil. There haven't been any attacks on the oil infrastructure yet (unless Thursday's "suspicious fire" at a Total platform in next-door Congo turns out to be the first such incident), but the situation is the perfect tinder-box.

For more information on Cabinda, and on the potential for an "Oil Insurgency," see my article in today's Oil Drum: Cabinda: Prospects for an Oil Insurgency in the Angolan Exclave.

Nigeria Escalation

Energy Intelligence Note: 9 May, 2007

The situation in Nigeria is escalating--as expected, geologically-driven declines in oil production are spawning geopolitically-driven increases in disruptions from "above-ground factors." The recent attacks on major oil pipelines in Nigeria cut all oil flow to AGIP's Brass Export Terminal, taking a further 200,000 barrels per day off the market. On top of that, take a look at the latest unclassified figures on kidnappings in Nigeria, courtesy of the CIA:

2006:
Total Hostages (Unresolved): 66 (0)
American Hostages (Unresolved): 0 (0)

2007:
Total Hostages (Unresolved): 106 (17)
Amercan Hostages (Unresolved): 17 (5)

And 2007 is only half over! That represents a rougly 200% year-on-year increase in total hostages, and a huge leap in the "value" of these hostages, as reflected by the sudden shift toward higher-skill and western workers, as shown by the sudden prevalence of American hostages.

The coordinated nature of the recent triple pipeline attack suggests that broader, hierarchal organizations such as MEND are alive and well. This doesn't, however, mean that the kind of localized criminal organizations that I spoke of in my recent Oil Drum article on Nigeria are going away. On the contrary, it means that politically-motivated groups such as MEND must now differentiate themselves from the criminal gangs if they wish to put weight behind their political demands. If MEND and criminal gangs resort to the same tactics, there is no motivation on the part of either the Nigerian government or foreign oil companies to cave to MEND's political demands when this won't end the disruption caused by criminal gangs. MEND must pursue increasingly coordinated, high-impact attacks to give them a bargaining chip that is unique, a bargaining chip that is not shared by criminal gangs who won't participate in a cease fire. Logic dictates that differentiating themselves from criminal gangs requires a new targeting focus: offshore oil facilities. MEND has demonstrated a limited ability in the past to operate in the offshore environment. The Nigerian navy is certainly in no shape to effectively counter them. Expect a wave of significant offshore attacks to be the next major development in Nigeria. Offshore facilities are highly vulnerable and minimally defended--consider the destruction caused by mistake or malfunction at the Piper Alpha platform. Now consider how long it takes to repair a major offshore facility in today's economy. An attack on a major offshore facility is the next logical targeting choice, and MEND is at a critical juncture where it must demonstrate its political relevance or fade away as a centralized, unified organization.

A recent commen was right on the money: the geopolitical distruptions caused by geological peaking in oil production may provide exactly the cover necessary to avoid recognition of the geological forces driving these events. It's a challenge to make a scapegoat out of geological reality, but foreign terrorists and resource nationalism are easy marks!

Have the Kurds Abandoned All Hope of a Stable Iraq?

Energy Intelligence Note: 1 May, 2007

Salman Banaei recently published an analysis of Iraq’s draft Oil & Gas Law in the Association of International Petroleum Negotiator’s March issue of "Advisor" (also available via his Western Energy Blog). He shows how the draft law allocates control over production from “current” fields to the Iraqi National Oil Company, and that regional governments retain control over “undiscovered” fields. While regional governments can sign contracts with international oil & gas firms, the draft law ensures federal oversight by requiring approval of these contracts by Iraq’s Federal Oil & Gas Council (FOGC).

Recent events in Kurdistan, however, suggest that the Kurds may have other plans. UAE-based Dana Gas announced recently that they have agreed with the Kurdish Regional Government (KRG) to develop the Kormor gasfield (see graphic). The Kormor Field clearly falls under the draft law’s envisioned federal control, as it is a “current” field, discovered in 1928. The contract has not received FOGC approval, and it breaks the KRG’s promise to avoid signing new contracts until the end of May, to give the federal government time to pass the Oil & Gas Law.

What does this signify? It seems that the KRG is not satisfied with the division of gas fields between federal control (“current” fields) and regional control (“undiscovered” fields). This “current” vs. “undiscovered” designation seems to have little basis in geological reality, but rather is the political gloss given to the apportionment of existing fields, which is detailed in an annex to the draft law. Petroleum Intelligence Weekly reports that the KRG will reject the law if this annex remains as is. The decision to contract for development of the Kormor Field with Dana Gas prior to the official vote on the law suggests that the KRG believes the annex will not be changed, and that the law will not pass the end-of-May vote.

While none of this should come as a shock—Iraq is a sham Nation-State where mutually exclusive minimum requirements by the component national groups will prevent cooperation—it does carry significance. The prospects for a military solution in Iraq are as slim today as ever, and this failure to bridge the competing demand of Iraq’s many nations suggests that a political solution is no more likely. This reality may not seriously deter oil & gas production in the Kurdish region, where there is relative unity and security, but it will likely present a geopolitical barrier to developing the highly theoretical reserves of Iraq’s Western Desert. Furthermore, while it may be possible for the KRG to produce from their oil & gas fields, their export market is highly limited—the pipeline through Syria is non-functional, and the Turkish government is unlikely to help their rival with a viable export channel. The most viable market for Kurdish oil & gas is Iraqi domestic consumption, but reaching this market requires relying on a handful of critical pipelines that are frequent targets of insurgent attacks. It may be impracticable to market any increase share of oil & gas that the KRG may be able to exploit. Will this fact alone be enough to force them to compromise on their short-term selfish interest to form a viable Iraqi state that will benefit them in the long term by way of a valid export route? Is a willingness by the Kurds to compromise enough to bring together the rest of Iraq’s disparate factions in a similar spirit? Probably not—and the Kurds have probably considered exactly these issues in arriving at their decision to go it alone with regional production. Probably a wise choice for the Kurds, but an ominous sign for the future of the figment of Colonial Cartography that we call Iraq.

Five Geopolitical Feedback-Loops in Peak Oil

Energy Intelligence Note: April 23, 2007

It is quite common to hear “experts” explain that the current tight oil markets are due to “above-ground factors,” and not a result of a global peaking in oil production. It seems more likely that it is geological peaking that is driving the geopolitical events that constitute the most significant “above-ground factors” such as the chaos in Iraq and Nigeria, the nationalization in Venezuela and Bolivia, etc. Geological peaking spawns positive feedback loops within the geopolitical system. Critically, these loops are not separable from the geological events—they are part of the broader “system” of Peak Oil.

Existing peaking models are based on the logistics curves demonstrated by past peaking in individual fields or oil producing regions. Global peaking is an entirely different phenomenon—the geology behind the logistics curves is the same, but global peaking will create far greater geopolitical side-effects, even in regions with stable or rising oil production. As a result, these geopolitical side-effects of peaking global production will accelerate the rate of production decline, as well as increase the impact of that production decline by simultaneously increasing marginal demand pressures. The result: the right side of the global oil production curve will not look like the left…whatever logistics curve is fit to the left side of the curve (where historical production increased), actual declines in the future will be sharper than that curve would predict.

Here are five geopolitical processes, each a positive-feedback loop, and each an accelerant of declining oil production:

1. Return on Investment: Increased scarcity of energy, as well as increased prices, increase the return on investment for attacks that target energy infrastructure. Whether the actor is an ideologically driven group (al-Qa’ida), or a privateer (youth gangs in the Niger Delta), the geologically-driven declines increase the ROI for attacks on energy, which will drive both decisions to act, as well as targeting decisions for that action. This is a positive feedback-loop because attacks on energy infrastructure and supply drive up the price, which further increases the ROI for such attacks. John Robb's analysis of the September attacks on Mexican oil and natural gas pipelines suggest an ROI as high as 1.4 million percent.

2. Mercantilism: To avoid the dawning “bidding cycles” between crude oil price increases and demand destruction, Nation-States are increasingly returning to a mercantilist paradigm on energy. This is the attitude of “there isn’t enough of it to go around, and we can’t afford to pay the market price, so we need to lock up our own supply.” Whether it’s the direction of a pipeline flow out of Central Asia, defending only specified sea lanes, or influencing an occupied nation’s laws on Production Sharing Agreements, there are signs of a “new energy mercantilism” all around us. This is a positive feedback-loop because, like an iterated “prisoner’s dilemma” game, once one power adopts or intensifies a mercantilist attitude all others must follow suit or lose energy share. It will act to accelerate oil production declines because mercantilism prevents the most economically efficient production of a resource, accelerating the underlying problem of diminishing marginal returns. The rise of mercantilism is highlighted by the recent coverage of the race to control the Arctic, and its potentially vast hydrocarbon reserves.

3. “Export-Land” Model: Jeffrey Brown, a commentator at The Oil Drum, has proposed a geopolitical feedback loop that he calls the “export-land” model. In a regime of high or rising prices, a state’s existing oil exports brings in great revenues, which trickles into the state’s economy, and leads to increasing domestic oil consumption. This is exactly what is happening in most oil exporting states. The result, however, is that growth in domestic consumption reduces oil available for export. In states, such as Mexico, where oil production is also in decline, the “export-land” model predicts that oil exports will decline much faster than oil production—and this is exactly what is happening, with the latest PEMEX report showing 5% production decline year-on-year, but 11% export decline. Ultimately, the effects of the “export-land” model itself suffers from diminishing marginal returns—when exports shrink sufficiently, the oil-export revenue per capita will actually begin to decline (eventually reaching zero, no matter how fast prices rise), at which time the force behind rising domestic consumption will be eliminated. The likely unwillingness of governments to allow their valued oil export revenues to be totally consumed by rising domestic consumption will create pressure for domestic rationing, price-hikes, or uneven distribution of oil and gas domestically. We are already seeing this as many oil exporting countries are scaling back the subsidized pricing of domestic gasoline. The inequalities that will arise out of domestic rationing will act as a catalyst and accelerant to the last two feedback loops...

4. Nationalism: Because our Westphalian system is fundamentally broken, the territories of nations and states are rarely contiguous. As a result, it is often the case that a nation is cut out of the benefits from its host state’s oil exports. This will be especially apparent when the “export-land” effect reduces the total size of the pie to be divided, or as domestic rationing is introduced to maintain export revenues. As a result, nations or sectarian groups within states will increasingly agitate for a larger share of the pie. We see this already within Iraq, Iran (Khuzestan), Nigeria (Delta State), Bolivia (indigenous groups), etc. This process will develop local variants on the tactics of infrastructure disruption, as well as desensitize energy firms to ever greater rents for the security of their facilities and personnel—both of which will drive the next loop…

5. Privateering: Nationalist insurgencies and economies ruined by the downslide of the “export-land” effect will leave huge populations with no conventional economic prospects. High oil prices, and the willingness to make high protection payments, will drive those people to become energy privateers. We are seeing exactly this effect in Nigeria, where a substantial portion of the infrastructure disruption is no longer carried out by politically-motivated insurgents, but by profit-motivated gangs. This is the ultimate positive feedback-loop: infrastructure disruption further degrades any remnants of a legitimate economy, increasing the incentive to engage in energy Privateering, and compensating for any diminishing marginal returns in Privateering caused by enhanced security or competition from other privateers.

We may see some or all of these effects in any given area, and are already seeing this in some trouble spots. Some states, like Iraq, have been thrown into full-fledged “Nationalism” and “Privateering”-driven geopolitical disruption by the actions of an outside power—in this case, the US invasion was itself largely the byproduct of a shift towards energy mercantilism. This is just one illustration of the synergistic interrelationship among these feedback loops. The important take-aways are these:

1. So-called “above-ground factors” are driven by the geological reality

2. These geopolitical processes are positive feedback-loops

3. They will accelerate the decline in global oil production beyond that predicted by models derived from logistics curves.

Geologically driven decline follows a classic logistics curve, with a "long tail" of declining production continuing indefinitely. Geopolitical positive feedback-loops not only have the potential to accellerate that rate of decline, but can potentially drive it to zero in short order. Oil production requires certain threshold levels of economic functioning, security, and rule of law to proceed. These positive feedback-loops have the potential to cut off the "long tail" of declining production abruptly. It practically dogma in peak oil circles that peak oil doesn't mean the end of oil production, just the beginning of inexorable declines. In light of the potential impact of geopolitical feedback-loops, it may be time to reassess that idea, at least on a regional basis.

Has Russian Natural Gas Peaked?

Energy Intelligence Note: April 19, 2007

The US State Department’s Bureau of Intelligence and Research (INR)
reports that Gazprom Chairman (and Russia's Deputy Vice President) Dmitriy Medvedev is demanding Russia’s electric monopoly UES substitute coal-generation for gas generation. This is a reversal of the “gasification” policy of the ‘70s that attempted to reduce the environmental damage and transportation costs of coal-fired power plants. The obvious rationale for reducing domestic consumption is to make more natural gas available for export to Europe and elsewhere. Is this intended to obscure production declines, evidence that Russian natural gas production has peaked?

Gazprom’s existing fields are currently in decline:

The most realistic strategy to offset the sharp decline in production from existing fields is to bring production online from new fields at Yamal, Shtokman, and Sakhalin. These mega-projects, however, have experienced repeated delays and complications. Gazprom is bridging the gap by acquiring producing fields, masking the decline of existing fields. This may preserve the appearance of normalcy, but it doesn’t actually replace declining gas production.

Gazprom’s demands that UES shift to coal-generation can also be explained by simple profit maximization—more gas to sell on the foreign market, where it commands a higher price than under domestic price controls. This explanation, however, fails to explain the timing of Gazprom’s demand. It seems logical that if profit maximization was sufficient rationale to switch back to coal-generation, we would have heard of these demands years ago when this rationale would have been equally valid. Is the more reasonable rationale that Gazprom is scrambling to compensate for plummeting production, under the realization that their mega-projects will not live up to expectations? Europe may have an answer to this question next Winter.

Lessons from Nigeria on US Copper Thefts

Energy Intelligence Note: 16 April, 2007

A month ago I reported on the escalation of infrastructure disruption in Nigeria for The Oil Drum. The key trend that I identified was the shift from measured, politically-motivated attacks under the leadership of MEND (a negative feedback loop) to the financially motivated attacks carried out by a patchwork of profit-driven youth gangs (a positive feedback loop). As part of my conclusion—and probably the part that was taken least seriously—I noted that there is great potential for this same kind of profit-driven infrastructure attack within the US. Increasingly, it appears that this is exactly what is happening with the rising occurrence of copper theft from US utilities. How are these two situations similar, and what lessons from Nigeria are applicable to US infrastructure security?

In the past year, 7 people have been electrocuted while attempting to steal copper from active power lines within the US. In Chandler, Arizona alone, police have reported over 200 calls reported to copper theft, and the local Salt River Project, a water utility, suffered up to $400,000 in damage to their system from theft of copper “backflow-preventer” valves in their water pipes. Just last week, thieves broke in to an electrical substation in Calhoun, Georgia and stole copper components, resulting in a power outage to 1500 people. With the price of copper on the rise—currently over $3 per pound—the rate of copper theft from utilities is likely to continue increasing. Is this similar in any way to the disruption to the oil infrastructure in Nigeria, and what lessons can we learn from that situation?

In Nigeria, politically motivated attacks were previously controlled by two factors. First, they were a means to a political end, and the government could reign in these attacks by offer political concessions. Second, the political organization behind the attacks, MEND, had a vested interest in maintaining the long-term viability of Nigeria’s oil exporting capacity, creating a self-imposed limitation on their attacks. The shift to decentralized, profit-motivated youth gangs has removed these two limiting factors, and the problem is spiraling out of control. Similarly, US copper thefts are neither limited by political concerns nor an awareness of actors’ vested interest in the viability of US utility grids. Finally, just as Nigerian violence creates a positive feedback loop that increases the price of oil, further incentivising profit-oriented attacks in Nigeria, the spate of US copper thefts is a potential positive feedback loop. If authorities attempt to crack down on copper thefts by instituting new controls over the sale of scrap copper, they will increase the cost of legitimate scrap copper sales and drive up the black market price of scrap copper, increasing the incentive to copper thieves.

What lessons can we learn from the infrastructure attacks in Nigeria? While the comparison provides no obvious solutions to the problem of copper thefts, it does provide insight into certain aggravating factors. Nigerian youth in the Delta region are particularly vulnerable to the lure of profit-motivated attacks because of the dire economic situation there. Likewise, while further increases in copper price will drive copper thefts, a recession or other economic factors such as inflation will similarly increase the return on investment for copper thieves. As with the situation in Nigeria, as utilities upgrade facility security in response to copper theft, utility personnel risk becoming the most accessible target—either as a means of gaining access to copper stores, or when they are caught in the crossfire as copper thieves escalate their tactics and violence in response to greater security. Finally, as the return on investment for copper thefts increases, it is also likely that issue-oriented groups such as the Earth Liberation Front will choose copper theft as a way to simultaneously finance their operations and inflict damage on specific industrial utilities or consumers.