## Tuesday, December 23, 2008

### Peak oilers' mental meltdown

Although the oil price returned to $40.00 or so, it has already seen prices below$34.00 which is less than 23% of the peak price ($147.50) in July 2008, just five months ago. The decrease we have witnessed was by a factor of 4.5 which is a pretty amazing change for such a short interval. Most peak oilers have gone silent but there exists at least one peak oiler whom we know well and who used the recent events as evidence that the world will run out of oil soon, that the price will diverge, and that we need the leadership of messiahs like himself. Yes, his name is Alexander Ač. In his newest posting, he asks whether the Slovak government will revise its energy strategic plans. Their government plans the Slovak oil imports in 2030 to be twice as large as the current figures which sounds reasonable because Slovakia is exactly the kind of a country that may expect such an increase. Alexander's hysterical rant is composed of three sections: • Oil production will plummet and the depletion will accelerate • We need a global energy revolution • We have to increase the investment In the first section, he writes that the output is going to shrink dramatically. In the second section, he emphasizes that all energy in the world must be replaced by the ludicrous sources of energy. In the final section, he uses the recent drop of the oil price to argue that there will be no oil in the future because the investment will drop, and the price will therefore drift towards infinity. What Alexander Ač is able to write is just stunning and it shows that there is no meritocracy left in our society. In the 10th posting below the newest one, Alexander Ač writes that the oil price is soon going to surpass$500 per barrel

The real prices are smaller by a factor of twelve or so. His forecasts has failed so miserably that if his life depended on these forecasts, he would have been dead for quite some time. If he had made substantial investments, he would be broke by now.

However, Alexander is just an irrelevant grad student whose skull is full of dirt. But there are many similar people who are equally uncapable to evaluate the reality and their own miserable failures who are controlling all kinds of official institutions, including the hacks who have been named as members of Barack Obama's presidential team.

For any real application, the essential question is the future price of oil. Anyone who makes any decision or investment - a medium-term one or a long-term one - depends on this unknown piece of information.

Power-thirsty, mentally sick pseudointellectuals similar to Alexander Ač are completely unable to predict absolutely anything, their predictions systematically differ from reality by many orders of magnitude, but they constantly want their influence to increase. Alexander, could you please try to imagine the deep lake of excrements into which the world would immerse if you had any influence on it?

Do you understand the difference between gold and shit? It's been established beyond any reasonable doubts that your thinking and writing belongs squarely to the latter category.

Of course, the price oscillates because no one really knows how the supply and demand will compare next year or in 2015. But these oscillations are not a way to show that ultracommunist fanatics who want to regulate the world should be listened to because the world can't survive without them. Quite on the contrary, these price fluctuations are natural processes by which the invisible hand of the free markets regulates the situation.

Indeed, the investment into new oil fields (and alternative energy sourecs) is going to decrease markedly is oil price stays below \$50. But that's exactly the right thing that should happen because if the price is low, it means that oil is not that valuable - a tautology that the communist freaks simply can't ever understand - and it's simply not a good idea to invest much to obtain much more of this stuff.

Roughly speaking, a liter of oil is as cheap as a liter of bottled water. Whoever assumes that oil must be treated on par with gold is simply a moron, if he makes investments based on his theory, he should quickly become broke, and everyone should let the laws of Nature to remove such a failed life form from the visible surface of the Earth, in order to free space for others.

If oil ever gets more scarce, the investment into new oil fields and other energy sources will naturally increase once again and help to lower the oil price. At any rate, the last thing that the system needs are the hands of power-thirsty regulating fanatics, especially not those who have failed in all the predictions they have ever made in their lives and who don't even realize the relationships between the price and the value, the supply and the demand.

Finally, I want people to be responsible for their bad predictions and counterproductive interventions which means that I want someone to give failed people like Alexander Ač a proper thrashing.

And that's the memo.

1. There is nothing to suggest that the Peak Oil argument is a false one. The bottom line is that the production of light sweet crude peaked several years ago and no amount of new investment will be able to get the world to that level again. While we can increase the production of other fuels for a while (think ethanol, biodiesel or heavy oil) to offset the depletion of light sweet, that cannot happen until the price of oil increases substantially to justify the investment. The thing to remember is that while we are waiting we see depletion rates of 9% per year from existing fields, which is high enough to drop supply below demand over the next year or so unless one expects a global depression that is as bad as what we had in the 1930s AND an increase in the purchasing power of the fiat money at a time when all governments are resorting to the printing presses.

The collapse in oil prices is a very bad thing because it sends us a false signal that we can afford to be complacent at a time when there is a supply issue that will need a huge amount of investment. It seems to me that a low risk strategy would be to pay attention to the actual facts and to pick up shares in cash rich energy companies that stand to benefit from a price decline that will offer them very cheap reserves at a substantial discount.

2. Dear VangelIV,

the one-time decrease of light sweet output certainly does not imply that this figure it going to decrease forever.

Quantities are sometimes increasing, sometimes they are decreasing, although this notion might be an extremely revolutionary insight for many people.

In your last paragraph, you just repeat what I classify as the complete communists' inability to understand what the "price" means in a market economy.

Low price indeed does mean that consumers should be complacent now - and in predictable future - while producers should worry. A low price means that the markets think that the current levels of output and investment are too high for the last month's price.

Again, the reason that you think otherwise is that you misunderstand that the actual market price is what actually determines whether something is scarce or not.

As the price shows now, oil is not scarce and everyone who is unable to understand this elementary fact is an even cheaper organic material than oil.

Best wishes
Lubos

3. There is no 'one time' decrease in the production of light sweet crude. The peak for light sweet actually came in 2005 and cannot be surpassed because the old fields are depleting much faster than new fields can be brought on line.

Many people simply do not understand the energy sector. A great deal of our oil actually comes from very large fields that are older than 40 years and are well past their production peaks. While there are newer, smaller fields those fields have a steeper decline curve and cannot produce as much oil as the fields that they are trying to replace. Add to this the fact that we have used secondary and tertiary recovery techniques to prevent production from falling and you have a major crisis because once depletion takes off it will fall much faster than what we are used to. (Think of horizontal wells as bigger straws that are trying to extract liquids from the same sized reservoir as the older less efficient wells. While the production can be increased faster for a time all it does is rob the fields of future production.)

For the record, I favour the Austrian school of economics than I do the communist and socialist economists who get everything wrong almost all of the time. The Austrians point out that all economic activity in a market economy ultimately rests on the subjective theory of value. Prices are a matter of subjective opinion and can be extremely volatile, particularly when leverage is used in great quantity.

We have seen that the energy sector is hardly a free market. Up until 1970 the Texas Railroad Commission (TRC)regulated Texas oil production and coordinated its production quotas with agencies in other major producing states in order to fix American prices. (There were also restrictions on imports of cheaper foreign oil.) That changed in 1970 when American oil production peaked and quotas were no longer necessary. In the 1970s OPEC, which was modelled after the TRC, took over the job of regulating oil prices by setting quotas for its members. By shutting off capacity OPEC was able to drive prices much higher if it wished to do so.

In the 1980s we saw what Saudi Arabia could do when it opened up its valves and produced at record rates. The world was flooded with cheap oil and OPEC members were forced to go along with some of the policies that the Saudis wanted to adopt. In 1993 we saw the liquidation of Metallgesellschaft cause oil prices to collapse. The decline had nothing to do with the real market for oil; it was merely a case of forced liquidation of oil in the paper futures market at a time when there were few buyers. (The natural gas equivalent was the recent Amaranth driven collapse.)

The problem that we have now is that demand has caught up to supply and there isn't much excess spare capacity for the first time in human history. While some OPEC producers and a few other nations could increase production above current rates it would be at a cost to the future production of their ageing fields. At the same time non-OPEC production is in trouble. Russia has terrible infrastructure and cannot develop its eastern fields without massive investment that requires much higher oil prices. England peaked eight years ago and is soon going to be a net importer of oil. While Norway will remain an exporter its production is in steep decline and cannot be brought back to previous levels no matter how much investment was made. The same is true of most nations.

And let us not forget that the promise of production from new fields have proven to be very disappointing. The great Mexican discovery of 2005 was written down by 95% and the Jack Field is yet to be proven commercially viable. Even if it is viable, it would take at least a decade to get the oil flowing. Kashagan, which was supposed to start production in 2005 has proven to be a difficult project and won't start flowing until 2014 at the earliest. For the record, that is a much easier play to develop than the deep water fields that everyone has been hyping up recently.

The bottom line is that all of the activity in the paper markets is causing the prices to move far from what they would be if the larger players could not overwhelm the market by selling or buying contracts that they have no intention of making or taking physical delivery on. This means that the Peak Oil problem, which is real, will not be addressed in time to minimize the damage to a world that depends on plentiful cheap energy. I suspect that what we are seeing is a liquidation of some of the hedge funds that were caught on the long side at a time when global demand declined slightly. And while demand could contract further and drive prices lower, the depletion, the degradation of old infrastructure, and the cancellation of expensive development projects will ensure that supply will fall rapidly enough to ensure higher prices in the next year or so, particularly if the solar guys are correct about lower solar activity and possibly colder winters.

If you are interested I suggest that you look to a few good books on the subject. Two that I can recommend are Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, by Matthew R. Simmons and Hubbert's Peak: The Impending World Oil Shortage, by Kenneth S. Deffeyes. You might also be interested in the Hirsch Report, which you can find at http://www.projectcensored.org/newsflash/The_Hirsch_Report_Proj_Cens.pdf.

For the record, I am quite willing to listen to a critique of the Peak Oil thesis but have yet to find one that is credible. Most of its credible critics admit that the peak is inevitable but tend to argue that it is very far away. The problem with that argument is that the data does not support it.