Monday, December 22, 2008

A Simple Explanation for Rising Oil Prices, to an Average Price of About $100 in 2008: Importers Bidding for Declining Net Oil Exports

By Jeffrey J. Brown

My frequent co-author, Sam Foucher, and I started warning, in January, 2006, about an imminent decline in world net oil exports. EIA data show that we are almost certainly going to see three years of world net oil exports below the 2005 rate, primarily because of collective declines by the top five net oil exporters—Saudi Arabia; Russia; Norway, Iran and the UAE—which account for about half of world net oil exports. Kenneth Deffeyes predicted that world crude oil production would peak in a range from 2004 to 2008, most likely in 2005. EIA show world crude oil production of about 74 mbpd (million barrels per day) in 2005, slightly less in 2006 and 2007, and 74 mbpd in 2008 (through September). Total liquids production is up slightly in 2008, which Matt Simmons attributes to increased natural gas liquids production, as the gas caps in many large oil fields are produced, in the last stages of depletion for these fields.

So, despite the fact that relative to 2005, we are going to almost certainly see three years of lower net oil exports, flat crude oil production and a slight increase in total liquids production, the conventional wisdom is that the increase in annual US oil prices from $57 in 2005 to about $100 in 2008 was due to “speculation,” while the recent sharp decline in monthly and daily oil prices was due to Peak Oilers being wrong about a near term peak in world oil production.

Part of the problem is that price information is instantaneous and accurate. Production data tend to be noisy (especially in the short term), delayed and subject to revision, so price, at least a falling price, is frequently used as a proxy for production (as noted above, rising prices are generally attributed to speculation, and not to fundamental supply/demand factors).

I have an alternative point of view. I believe that the increase in annual oil prices from 2005 to 2008 was largely due to importers bidding for declining net oil exports. As noted above, my co-author and I started warning about declining net oil exports in early 2006. Our most detailed work, a quantitative analysis of the top five net oil exporters was presented to ASPO-USA in 2007 and published in early 2008:

Our middle case is that the top five net oil exporters will collectively approach zero net oil exports around 2031, within a time frame from 2024 to 2039.

Our intermediate outlook is that the top five net oil exporters will be down to about 12 mbpd in 2015 (middle case) within a range from 7 mbpd to 18 mbpd, versus about 24 mbpd in 2005.

We have two years of EIA data for net oil exports from the top five, and we have monthly production data through September, 2008. The annual data for net oil exports from the top five are as follows:

200523.9 mbpd

mbpd= Million barrels per day. *Estimate based on data through 9/08

While we have evidence for a slight increase in net oil exports in 2008, it is to a level that is well below the 2005 rate, and other exporters in terminal decline, such as the UK and Indonesia, showed year over year increases, in their terminal decline phases.

What is interesting is a plot of average annual US oil prices versus annual net oil exports from the 2005 top five net oil exporters. Following is this graph, with oil prices on the vertical axis and with annual (EIA) net oil exports on the horizontal axis (this graph was inspired by similar world production graphs done by bloggers on The Oil Drum blog).

This graph shows, as one would expect, a strong correlation between rising oil prices and declining net oil exports. In my opinion, the rapid decline in monthly and daily oil prices in the latter months of 2008 was primarily due to the actual and to some extent, the perceived, decline in demand outpacing the long term decline in net oil exports—augmented by selling, forced and otherwise, of long oil positions, partly due to the contraction in credit.

I expect to see a combination of involuntary + voluntary reductions in net oil exports in 2009, which will probably cause the average annual oil price to exceed the average price of about $50 that the futures market is currently showing for 2009, and in my opinion there is a good chance that the average price in 2009 will exceed the average price of about $100 in 2008.

However, regardless of short term oil price fluctuations, the real problem for the economy is going to be after 2009. In my opinion, we will not have the volume of world net oil exports necessary to power a rebound in economic activity.

Instead of a desperate effort to keep our high consumption auto centric suburban way of life going, we need to be investing in things like rail transportation—especially electrified rail transportation, which can be powered by alternative energy sources like windpower.

However, this would force us to recognize that we live in a finite world, with finite fossil fuel resource. This is a difficult idea to sell since the finite world concept violates most people's concept of how the world works--which is that we can have an infinite rate of increase in our consumption of a finite fossil fuel resource base.

We can only hope for an outbreak of rational thinking in the months and years ahead.

Jeffrey J. Brown is an independent petroleum geologist in the Dallas, Texas area. His e-mail address is westexas The Net Oil Export slide was prepared by A. B. Silveus.