A happy little doom-filled article which makes it very clear to me why the stuff we are doing to prepare and adapt for is urgent for survival.
The cost of new oil supply
By Chris Nelder
18 2012
http://i.bnet.com/blogs/offshore_eiffel-greg-evans.jpg
Numerous factors affect oil prices like supply and demand geopolitical
unrest natural disasters monetary policy and speculation as I detailed
in February.
But there is another factor exerting a continuous upward pressure on prices:
the substitution of unconventional resources for conventional crude.
When conventional oil hit its production plateau around 72 – 74 million
barrels per day at the end of 2004 but demand kept growing we turned to
various unconventional liquid fuels to make up the difference such as
natural gas liquids biofuels and most recently “tight oil” from shales
like the Bakken Formation in the U.S.
The above chart from an excellent new post by Gail Tverberg
our increasing reliance on unconventional liquids. The supply of crude (plus
condensates) flattened out while natural gas plant liquids (NGPLs) grew
substantially and “other liquids” (mostly ethanol) became significant
contributors to supply. The “processing gain” wedge really should be
ignored as it simply represents an increase in volume that results from
refining heavy crude oil into lighter fuels; it’s not actually additional
fuel.
The advent of tight oil in the U.S. has been hailed as the beginning of our
incipient energy independence although I have found no basis for such optimism in
the data. In fact this is the third or fourth time we have been treated to such
cornucopian stories. A few years ago it was biofuels that would save us from
peak oil and before that it was natural gas liquids deepwater oil heavy
oil tar sands and coal-to-liquids. One need look back no farther than 2005
to find plenty of pollyannish projections in reports from the EIA and IEA
and in op-eds in the Wall Street Journal. None of those projections panned
out.
The argument was that high oil prices would make these previously-uneconomic
resources viable and to a limited extent that has been true. What we didn’t
know then however was the pain tolerance limit of consumers. In 2008 we
found that limit as we approached $120 a barrel for oil and $4 a gallon for
gasoline. Prices are once again beginning to kill demand in the U.S. but
under a slightly lower ceiling because the economy isn’t nearly as strong
as it was in the first half of 2008. Now the ceiling is closer to $100 a
barrel.
The new floor
The new floor for oil prices is being set increasingly by the production
cost of these unconventional liquids. A few decades ago we could produce
conventional oil profitably in the U.S. for under $15 a barrel. But those
days are long gone for the U.S. and for most of the world (except a few old
fields in places like Saudi Arabia). As every major oil company has admitted
in the past few years the age of easy and cheap oil has ended.
As the cheap oil from old mature fields is depleted and we replace it with
expensive new oil from unconventional sources it forces the overall price
of oil up. This is because oil prices are set at the margin as are the
prices of most commodities. The most expensive new barrel essentially sets
the price for the lot.
Research by veteran petroleum economist Chris Skrebowski
Steven Kopits and Robert Hirsch details the new costs: $40 – $80 a barrel
for a new barrel of production capacity in some OPEC countries; $70 – $90 a
barrel for the Canadian tar sands and heavy oil from Venezuela’s Orinoco
belt; and $70 – $80 a barrel for deepwater oil. Various sources suggest that
a price of at least $80 is needed to sustain U.S. tight oil production.
Those are just the production costs however. In order to pacify its
population during the Arab Spring and pay for significant new infrastructure
projects Saudi Arabia has made enormous financial commitments in the past
several years. The kingdom really needs $90 – $100 a barrel now to balance
its budget. Other major exporters like Venezuela and Russia have similar
budget-driven incentives to keep prices high.
Globally Skrebowki estimates that it costs $80 – $110 to bring a new barrel
of production capacity online. Research from IEA and others shows that the
more marginal liquids like Arctic oil gas-to-liquids coal-to-liquids and
biofuels are toward the top end of that range.
My own research suggests that $85 is really the comfortable global minimum.
That’s the price now needed to break even in the Canadian tar sands and it
also seems to be roughly the level at which banks and major exploration
companies are willing to commit the billions of dollars it takes to develop
new projects.
Production costs soaring
Indeed production costs have been soaring since we began relying heavily on
unconventional fuels. This is the direct result of rising prices for
essential inputs like steel and diesel fuel (whose cost inflation is
directly tied to the rising cost of the underlying fuels like hard coal and
oil) of which ever-greater amounts are needed to drill and complete a new
well. Adding another mile of high-specification steel pipe to a deepwater
well or another thousand feet of drilling and well casing for a deeper
tight oil well adds significant costs.
Globally the cost of drilling a new oil well has gone parabolic:
http://i.bnet.com/blogs/cost-per-well-1960-2008-eia.jpg
Source: EIA
The cost of adding a new barrel of reserves – drilling to prove that the oil
is there and economically recoverable before actually producing it – has
also jumped sharply.
Source: EIA
(It’s unfortunate that EIA doesn’t have more recent data than 2008 for this
analysis because the sharp downturn at the end of this chart owed mostly to
the economic crash in the latter half of that year. Analogous recent data
from the oil patch suggests that the curves in the above chart should have
resumed their previous pre-crash trajectory by now.)
As production costs push ever closer to the retail price ceiling profit
margins fall. Consider Canada as an example. Oil production there will
likely turn a mere 5 to 8 percent annual return on equity for the next
several years according to analysis by ARC Financial
industry is broadly unprofitable” and would not be able to attract
reinvestment. Similarly University of Alberta energy economist Andrew Leach
operating profit margin of Canadian-owned oil and gas assets is now 7.7
percent while foreign-owned assets offer only a 5.5 percent margin. A far
cry from the heady ultra-profitable years of 2003 – 2005.
So while the press ever-anxious to assign blame for high oil prices
highlights the enormous profits that oil companies are making the fact is
that much of those profits owe to producing oil from wells drilled in a much
cheaper era and selling it in the new high-priced era.
This will not remain the case for many more years.
The 2014 – 2015 tipping point
Unconventional oil is currently just 3 percent of global supply. The IEA
projects that it will make up 6.5 percent of supply by 2020 and 10 percent
by 2035. As it gradually replaces cheap oil conventional oil its real
production costs will continue to push oil prices up. Eventually those
costs will cross with the pain tolerance limit of consumers.
Skrebowski sees rising costs outrunning the ability of economies to adapt to
higher oil prices by 2014 producing an “[b]economically determined peak[/b]” in
oil production. After that point prices will remain economically
destructive and render sustained economic growth impossible. At the same
time it will make new oil production harder to finance.
This matches well with numerous analyses of oil supply that project a major
tipping point around 2014 – 2015. At that point as I have reminded readers
repeatedly we will likely begin down the back of Hubbert’s Curve and see
net losses in global oil supply every year.
“Unless and until adaptive responses are large and fast enough to constrain
the upward trend of oil prices the primary adaptive response will be
periodic economic crashes of a magnitude that depresses oil consumption and
oil prices” Skrebowski concludes. “These have the effect of shifting
consumption from incumbent consumers – the advanced economies – to the new
consumers in the developing economies.”
So by all means we should celebrate the ability of high oil prices and
truly miraculous technology to bring us oil from under two miles of water
and another five miles of rock in the Gulf of Mexico; from previously
inaccessible deposits in the Arctic; and from low-grade resources like tar
sands and tight oil shales. That technology will mean that we won’t
literally run out of oil in the coming decades as depletion takes its toll.
But we should not imagine that it will bring us energy independence or bring
back the good ol’ days of $2 gasoline. What it will bring eventually is
oil for Asia as the U.S. and Europe are forced to park their cars for good.