Friday, January 09, 2015

Peak Oil is Still Real: Part 2

Having uncovered in my last post that production alone does not account for the price drop in oil, it should be noted that there are other variables affecting price. Certainly, investor sentiment makes a difference, especially when the Saudis announce they will keep pumping no matter what. However, the other side of this equation is demand.
Saudi Arabia needs to come back from two negative conditions: first, the threat of US shale oil; second, demand destruction. Their present course is perfect for overcoming both of these problems. Everyone sees the first of these and realizes that the Saudis have US oil shale producers in their cross hairs. However, few people are thinking enough about the demand side.
The influence of low demand on oil prices is probably equal to the influence of investor sentiment right now. In fact, these two are probably feeding off of each other, working with the unrestrained OPEC output to push prices lower. Now the first cause of demand destruction in oil comes from alternative fuel sources and conservation. This includes electric and hybrid cars, energy saving appliances, etc. However the other side of demand destruction is economic. A recessed or depressed economy will have a much lower demand for oil than a healthy economy.
While improvements in efficiency and alternative fuels are important, they are not as important as the economic drivers of demand destruction. And this is what the Saudis are ultimately fighting against. We've got OPEC increasing supply in a bid to raise demand by lowering prices. But demand isn't going to increase unless there is economic activity to justify the demand. US oil consumption dove off a cliff in the run up to the Great Recession and never came back. US petroleum consumption in 2014 is the same as 2013: 18.9 mbpd. This is 9% off from a high of 20.8mbpd in 2005:

And so the low oil prices say more about our economic weakness than anything else. When the US shale oil production drops because of low prices, a lack of supply while send oil prices right back to where they were and higher, possibly triggering another recession/depression. If US shale oil production drops 2 mbpd, OPEC isn't going to be able to make that up easily ASSUMING THEY'D EVEN WANT TO at that point.

Putting on my predictions hat:

Oil under-supply and resultant price shock will help precipitate a major financial crisis in 2016.

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