Triangle of Mood …



 
Triangle of Doom 080113

Figure 1: The Triangle of Doom prediction chart updated to August prices (TFC Charts, click on for big): the high price of crude declines due to the decreasing solvency of crude consumers. At the same time, the cost of drilling increases steadily due to more difficult geology. According to the trend, in the near future — the end of next year — the amounts that customers can afford to pay for crude will be less than what drillers require to bring new crude- and crude substitutes to market. After that, there will be shortages as supplies are shut in.

This graph uses current market prices rather than relative amounts, it represents the best-case scenario, with managers avoiding serious policy errors. The indicated fuel cost squeeze would take effect at the end of next year. The conclusion offered by it is not pleasant as it indicates time to make fundamental changes has pretty much run out.

Serious errors would be triggering deleveraging or starting a destructive war that effects oil shipments. The outcome would either be panic bidding for crude that pushes prices upward to 2008- levels followed by an immediate crash as the effects of shortages ripple through fuel dependent enterprises. Alternatively, prices could simply collapse as bidders exit all markets or are denied access due to margin calls and disappearing liquidity — current chronic insolvency resolving itself as a credit crisis. Under such scenarios, the outcome would be long term shortages beginning at once with little- or no chance to make adjustments.

What is clear is that prices will not edge continually upward as such a rise would indicate increasing consumer wealth. Higher fuel prices are not met with ‘stored money’ (a stock) but instead by consumers gaining additional credit (a flow) with oil drilling firms borrowing against these same consumers’ accounts. For this reason, the oil businesses’ success is entirely dependent upon the economic well-being of their own customers.

Credit is only available to those who are worthy of it, those who are not buried under debt-service- and repayment obligations. Creditworthiness in turn is effected adversely by increased energy costs; this is ‘rationing by price’. Borrowers use credit as a license to access fuel marketplaces then as means to meet the bid price when the time comes to buy. The problem is the increased price of fuel is not paralleled by increased returns from burning the fuel. $120/bbl crude produces the same (negligible) goods and services as does the $20 variety. The price increase is a simple ‘entropy tax’ levied over time by consumers indirectly against themselves. This tax crowds out customers’ ability to service and retire debts taken on to meet the previous rounds of tax!

When the marginal fuel consumer becomes over-indebted the entire consumer sector becomes irretrievably insolvent. This in turn, becomes the undoing of the drilling industry … users inability to earn anything concrete by their waste of fuel they gain at great cost to themselves, their dependence upon loans and decreasing ability to repay, the creep of insolvency as costs multiply.

The best example of this process at work is Greece, which borrowed stupendous amounts of money in order to buy and waste fuel. The waste produced nothing for the Greeks with which to retire their debts. The Greeks spent their (borrowed) money, they burned the (borrowed) fuel. They can borrow no more which means they can never repay. All that is left to the Greeks is smog and some dented cars … memories of the ‘Good Old Days’.

The realization that extraction costs are lodged against the consumer’s credit worthiness is not widespread as most analysis tends to view the different energy system components as separate from each other. In other words, cars and car manufacture are not considered to be part of the energy industry. Nevertheless, an analytic consensus is beginning to emerge: here is Rune Likvern’s take, (The Oil Drum), not at all a surprise:

 
Triangle of Doom 2.0

Figure 2: The Brent and WTI prices of crude relative to credit flows and the resulting cost squeeze (click on for big). Note the change in price and volatility that occurred after the 1998 peak of relative oil availability. Extraction and the means to pay for it are inseparable, when costs of extraction rise the burden falls on fuel consumers who must borrow more to keep up.

 
Chris Nelder: (WaPo)

A number of analysts have argued that the floor on oil prices is now around $85 per barrel. It might vary from place to place. An existing well in the Bakken might be profitable when oil’s at $70 or $75. For Arctic drilling, prices might have to rise to $110 per barrel. But the floor is around $85.

But there’s also a price ceiling for what consumers are able to pay. I think that’s probably around $105 for West Texas Intermediate and $125 for Brent. This is why world prices have been bouncing around this narrow ledge between floor and ceiling since 2007. We have to keep prices in that range, not too high to kill demand, but not too low to kill supply. Again, that’s very consistent with the concept of what peak oil has always been.

 

Rune Likvern again, (The Oil Drum):

The present general deceleration of growth in debt, start of deleveraging and prospects from future expanded austerity measures, will continue to affect consumers’ affordability for expensive energy. As the oil companies are in the business to make profits (which are legitimate) and grow their wealth, they are simultaneously very dependent on the well being of consumers’ purchasing power to pay for expensive energy. If the consumers “fail” (due to affordability issues) the oil companies will hesitate to go after the remaining and more expensive oil/gas.

 

More Rune Likvern, who has given the topic a serious amount of thought:

A detailed look into the financial statements and balance sheets for several public oil/gas companies over the last 6-7 years reveals some unsettling developments. After the oil price started its growth with its apex of $147/Bbl in 2008, the oil companies started taking on more debt in a bid to develop supplies from more expensive sources. To pay for these (more) expensive prospects out of cash flow became increasingly difficult so companies turned to debt financing. Recently some oil/gas companies have been approaching their maximum capacities to take on more debt. This has likely been fueled by expectations for a continued growth in demand and a tight supply/demand balance that would support structurally higher oil/energy prices.

As companies approach debt saturation this causes erosion of their resilience (solvency) from modest declines in the oil price. Simulations for oil companies close to debt saturation reveal a disturbing prospect. A decline in the oil price (to say $70-80/Bbl) could require oil/energy companies, and their currently deployed strategies for growing supplies, to drastically reduce their capital expenditures (investments) in pursuit of debt service, cryptic presented in euphemisms like “targeting financial performance”. The outcome from this could for some time create a significant slowdown in additions of capacities that combat natural declines and thus make it difficult to create any growth in oil/energy supplies. Several major oil companies now admit that they are struggling with profitability and growth in production as reported here.

 

In other words, over-indebted oil companies facing price declines will be subject to margin calls. Steve Kopits, (ASPO):

… we hit peak production when the marginal consumer is no longer willing to buy the marginal barrel.

[…]

On the other hand, the cost of extraction and production has continued to increase.

 

Here is Charles A.S. Hall by way of Gail Tverberg, (Oil Price):

 
Cheese Slicer 1970

Figure 3: On this famous and influential graphic series, EROI (energy return on investment) is expressed as relative energy flows (click on for big).
 

… more debt tends to cause more demand, and thus higher oil prices. At these higher oil prices, oil tends to get pumped out more quickly than it would otherwise. But once a shift occurs from increasing credit availability to reduced credit availability, as it does about the time peak oil production is reached, then prices for all types of commodities tend drop. At these lower prices, oil production drops off more quickly than it would have otherwise.

 
Cheese Slicer 2031

Figure 4: Energy return declines as best energy is wasted first, more energy must be diverted upstream toward gaining diminished amounts of energy from underground. What is not always noted on charts is decreased energy density of new fuels such as natural gas plant liquids: volumes of fuel-like material increase but the amount of physical work that can be done with the fuel is reduced.
 

Nicole Foss (HT BJ):

… the financial system is critical to understanding how energy limits will play out in practice. Financial limits will be reached long before hard physical or geological ones. Finance is the global operating system, and we are watching a slow-motion operating system crash that is picking up momentum. Without functioning credit markets an economic seizure ensues. Demand will be sharply down and price will fall far faster than the cost of production, squeezing margins. It’s a recipe for no investment for years and years. When the economy tries to recover, it will hit a hard ceiling at a much lower level of energy supply.

 

 

It is no surprise to see this interactive analysis from Foss, Hall, Tverberg, Kopits, Likvun, Nelder along with Chris Skrebowsi, Jeffrey Brown and Richard Heinberg and others. Meanwhile, the mainstream media insists that fuel constraints are a problem of the past; they insist Peak Oil has been rendered obsolete and that the energy enterprise now faces ‘Peak Demand’. While the non-mainstream analysts concern themselves with cost which is the emerging issue, the mainstream tends to concentrate attention on technology, which represents goods a ‘white knight’ which can be sold.

It is therefore surprising to see Leonardo Maugeri in his latest article repeatedly expressing concern about the effect of cost on high technology oil production:

 

… the unique characteristics of shale oil – the drilling intensity in particular – make it extremely vulnerable to both price drops and environmental opposition in new and populated areas. (page 1)

… because drilling intensity is largely a function of the oil price, a significant dip in oil price may trigger a rapid twist in the shale oil boom. (page 1)

… Given the high price of oil of the last few years, however, companies have not shied away from aggressively drilling other areas and new prospects, a strategy that could probably be the first victim of a significant oil price downturn. (page 10)

… So far, however, the high price of oil has supported the extraordinary drilling effort brought about both by successful and less successful companies, but a sudden decline in oil price could put the weakest operators in danger. (page 13)

… But so long as technology and better understanding of shale formations do not further revolutionize the shale sector, the overall increase of U.S. shale oil production critically will depend on the continuation of a highly intensive drilling activity and on a relatively high oil price: something that no one can take for granted. (page 14)

… First and foremost, a sudden oil price fall in the short term will likely determine a significant contraction of oil drilling, starting with the most expensive areas of U.S. shale formations. In turn, this would lead to a drop in production. (page 14)

… On the other hand, the unique characteristics of shale oil – and in particular the drilling intensity it involves – make it extremely vulnerable to both a drop in price and environmental opposition … (a repeat, on page 18)

… First, a dip of oil prices could entail a fall of drilling activity and thus of U.S. oil production, whose entity should be commensurate with the size of the oil price decrease. Also, in the conventional oil sector, a substantial decrease in oil prices would entail a slowing of exploration and development, particularly in the Gulf of Mexico ultra-deep offshore, but also of mature fields whose re-development requires require substantial investments in costly technologies. (page 21)

… Any additional downward pressure on U.S. crude oil price prices could make the U.S. market unprofitable for part of the (imported) Venezuelan crudes and oblige the country to search for other outlets. (page 27)

 

Maugeri notes structural decline in fuel prices while misattributing the cause to increases in drilling efficiency:

The basic scenario variables I used for the elaborations made in this appendix are:

A. Price of oil (WTI nominal terms): $85 (2013), $80 (2014), $75 (2015), $65 longterm.

B. Per-well cost reduction: 8 percent per year through 2017

 

Maugeri is not clear about what he is comparing, within or between categories: the cost of one fracked well to another rather than fracked wells in general drilled into tight formations compared to conventional vertical wells. Industrializing the fracking process and gaining economies of scale by order(s) of magnitude cannot improve the dispersed characteristics of oil-bearing formations. Instead, as the most productive tight oil and gas formations are tapped then depleted, greater efforts at increasing scale will be necessary to repeat the process … entailing greater costs; from The Marginal Human last year:

– The recent increase of US oil output will level off. This will be ‘a big shock’ to the public which has been promised increased production and lower prices. There will be declines in conventional oil fields to offset gains from tight-oil deposits. Any gains in high-priced export market will be more than offset by losses in domestic markets as customers cannot meet the higher world price.

 

Maugeri:

A decreasing price of oil is consistent with my general view, expressed in “Oil, the Next Revolution,” that oil prices may fall in the future because of the accumulation of broad oil production capacity globally.

 

Maugeri does not provide any evidence that the ‘accumulation of broad oil production capacity’ is underway other than the expanding empire of dry holes that increasingly riddle the surface of Planet Earth. More holes do not equal more crude. Prices are falling because rationing by price works, because customers are exiled from the crude market by unaffordable prices and their own ‘successfulness’. Despite the massive flows of money capital toward energy extraction, the geometric increase in the number of wells, the hunt around the world, under the oceans and icecaps (what remains of them) for hydrocarbons, the latest in electronic aids and specialized equipment, the world’s crude and crude-like material output has remained more or less the same since 2005. Maugeri wishes away energy constraints because they will be unpleasant … he has entered the ‘Triangle of Mood’.

Leonardo Maugeri. “The Shale Oil Boom:
A U.S. Phenomenon” Discussion Paper 2013-05, Belfer Center for Science and International Affairs,
Harvard Kennedy School, June 2013.

Statements and views expressed in this discussion paper are solely those of the author and do notimply endorsement by Harvard University, the Harvard Kennedy School, or the Belfer Center for Science and International Affairs.

Whatever!

4 thoughts on “Triangle of Mood …

  1. Reverse Engineer

    Looks like the PAAHHTY is coming to a close and the keg is outta beer!

    On the upside, Diner Podcasts are growing exponentially in listeners, with just under 300 listening so far today in 50 different countries! Most current podcast is Part II of Ugo Bardi from Cassandra’s Legacy, who built the Seneca Effect model of resource depletion.
    http://www.doomsteaddiner.net/blog/podcasts/

    Also, you can now find us on Twitter @doomstead666.

    Steve, I’ll drop this article on the Diner tomorrow.

    That’s all the DOOM, this time until next time.

    RE

  2. Pingback: the long path continued | Brain Noise

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