Arthur Berman: Why The Price Of Oil Must Rise

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Geologist Arthur Berman explains why today's low oil prices are not here to stay, something investors and consumers alike should be very aware of. The crazy-low prices we're currently experiencing are due to an oversupply created by geopolitics and (historic) easy credit, not by sustainable economics.

And when the worm turns, we are more likely than not to experience a sudden supply shortfall, jolting prices viciously higher. This will be a situation not soon resolved, as the lag time for new production to come on-line will be much longer than the world wants:

The same things that always drive prices in the end it’s always about fundamentals. The markets are peculiar and they change every day. But the fundamentals of supply and demand at some point markets come back to those and have to adjust accordingly. Not on a daily basis, maybe not even on a monthly basis. But eventually they get it right. So this oil price collapse is really straight forward as far as I can tell, and it has to do with cheap stupid money because of artificially low interest rates that resulted in over-investment in oil -- as well as lots of other commodities that are not in my area of specialty, but that’s what I see. And over-investment led to over-production and eventually over-production swamped the market with too much supply and the price has to go down until we work our way through the excess supply.

Now the wrinkle in all of this is that because the supply excess/surplus was generated by debt and a lot of correlative instruments, the problem is that the companies and the countries that are doing all this over-production need to keep generating cash flow so they can service the debt, which means they have to continue producing pretty much at the highest levels they possibly can which doesn’t really allow very much room for reducing the surplus. So that’s piece number one and then there’s the demand side. So the thing that drove all of this over investment and over production were high prices. And after a while people get tired of high prices and we see a phenomenon called demand destruction or you know as Jamie Galbraith calls it the choke chain effect. You know your dog runs out on a leash, eventually you know it stops and he chokes and so we’re dealing with that. People have changed their behavior because of high prices and then we add to the fact that people just change their behavior. I mean young people aren’t driving as much as they used to, they spend their time in a – you know on a smart phone more than they do in a car. We’ve got climate change issues. There’s considerable momentum toward cutting back on fossil fuels. Add it all together, demand is down, supply is up, it’s a bad situation...

We started this conversation with your important observation that we’re only talking about a million or million and a half barrels a day of oversupply. So we could go from over-supply to deficit pretty quickly, because we’re not investing in finding that additional couple of million barrels a day that we need to be discovering. So we’re deferring major, major investments. We’re not just deferring exploration; we’re deferring development of proven reserves. Capital cuts across the world represent 20 billion barrels of development of known proven reserves. And so we will get to a point, and we will, we most certainly will, where suddenly everybody wakes up and says “Oh my God we don’t have enough oil! We’re now half million barrels a day low." And what will happen? The price will shoot up. That’s the way commodity markets work. And everybody will say “Whoopee! Let’s get back to drilling big time." Well there’s a big lag. There’s a huge time lag between when the price responds and people actually get around to drilling and they actually start bringing the oil onto the market and it becomes available as supply, because they’ve been asleep at the wheel for you know for how many months or years. And so you know you can’t just turn a valve and all of a sudden everything is okay again

Click the play button below to listen to Chris' interview with Arthur Berman (56m:07s)

This is a companion discussion topic for the original entry at https://peakprosperity.com/arthur-berman-why-the-price-of-oil-must-rise/

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Wars are fought over and with oil. They are also fought with debt. Who and how is the next war financed? 
Can the printing press ramp up to infinity and beyond? What we are discussing is the oil/price ratio. 

If the Central Banks crank up the printing press and hand the currency to the oil extractors so that the war machine can operate that would destroy the purchasing power of the the working man. (Quaint concept right there.)

Conclusion: Wars can only be fought if the civilian population can get their daily can of beans. 

EDIT : The USA can be relied upon to do the right thing. After they have tried everything else. Or words to that effect. W. Churchill. 

The right thing is a massive investment in LENR research. 

 

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LENR
If only they worked…

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There may be nothing more to but sit  back and enjoy the low price of gas for now.

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This is amazing!  Oil with a $30 handle…!!!
This is going to really kill a bunch of producers…this downturn is now worse than the oil plunge in the mid 1980's.

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When I can, I try to catch the PP featured voices segment as part of my late night podcast sampler. While this particular interview was interesting, Arthur Berman's take on the situation wasn't anything new to me. His matter of fact approach to the subject could have been interpreted as cynical, but was, rather, a dose of reality that we all should come to appreciate. Good selection Chris and PP.
However, it's what wasn't said about the effect this will have on the economy long term. Here Arthur nailed it, perfectly:

And so we will get to a point, and we will, we most certainly will, where suddenly everybody wakes up and says “Oh my God we don’t have enough oil! We’re now half million barrels a day low." And what will happen? The price will shoot up. That’s the way commodity markets work. And everybody will say “Whoopee! Let’s get back to drilling big time." Well there’s a big lag. There’s a huge time lag between when the price responds and people actually get around to drilling and they actually start bringing the oil onto the market and it becomes available as supply, because they’ve been asleep at the wheel for you know for how many months or years. And so you know you can’t just turn a valve and all of a sudden everything is okay again.
If a pile of small US and Canadian producers bite the dust and Russia)68% of revenues from oil), OPEC, and others keep the "pedal to the metal" -- look forward to quite a ride. Prices will stay soft for quite a while until the bungee cord snaps back. My suggestion; get out the hole punch and put a couple more in your belt. If the FED keeps "pushing the string" with QE 4 and stagflation becomes the norm, the seed catalog may be your best money spent! (I wonder how much home brew I still have in the basement  -- better check!)
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Meanwhile Americans, as shortsighted and foolish as they are, go back to over-sized vehicles and long commutes.
My hopes for a gradual descent into whatever lies ahead diminishes by the day, as it looks more and more like we'll plunge into an abyss that creates havoc for all.  Even those prepped and prepared.

Appreciating every additional normal day we get at this point, like having a terminal disease with limited time left to live…

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The truth of what ails us isn't debt or interest rate suppression or so many other coping mechanisms…the nexus of our "problem" is an economic system premised on growth…but infinite growth in a finite world is a pretty tough trick to pull off. So, it was just a matter of time before something gave out… Global population growth started decelerating from the bottom up in the advanced nations and soon spread across advanced and developing alike and spread from the young up. Interesting to note that the 0-24yr/old population ceased growing across the OECD nations in 1982, the same year the Federal Reserve began what has been a 99.9% decline in the cost of credit and has resulted in spectacular increases in debt…all to maintain demand for a population whose growth is decelerating.
•Japan Peak 0-24yr/old population - 1955, 0-24 population has declined 41% since

•German Peak 0-24yr/old population - 1973, 0-24 population has declined 34% since

•S. Korea Peak 0-24yr/old population - 1981, 0-24 population has declined 37% since

Globally growth among 0-24yr/olds has fallen 80% and all net growth now occurs in Africa…

These are just some of massive declines among these nations and all are estimated to see their 0-24yr/old populations decline by 50%-60% from peak by the time we hit 2050 (and this assumes good economic growth between here and there…if things get rough, those numbers are likely to be far lower). Ultimately, these massive declines are working there way through the entire population…depopulation is well under way from the bottom up.

But China, Brazil, India…they'll save us, right???

•China Peak 0-24yr/old population - 1992, 0-24yr/old population has declined by 26% since (-152 million from peak!!!)

•Brazil Peak 0-24yr/old population - 2006, 0-24yr/old population has declined by 9% since

•India Peak 0-24yr/old population - Est. in 2017…and estimated to fall indefinitely thereafter.

By 2050, China and Brazil estimated to be down over 40% and India at 10% but picking up speed to the downside.

The above explains why central banks have seemingly gone mad…why governments worldwide are throwing dollars or Yen or Yuan or Euro's into the wind. Depopulation is coming from the bottom up and declining demand is inevitable. Unfortunately, central banks actions have retarded the business cycle and free money has created massive overinvestment and overcapacity which is now becoming so apparent in commodities and elsewhere (here).

Will Zero Hedge or Mr. Martenson or any outlet ever acknowledge how simple the issue we face truly is? They are welcome to run this story or you can read about it yourself…(btw, this is a non-profit blog and all proceed benefit Special Olympics).

Of course, the solution is likely also simple but god awful in it's implications…a global bankruptcy where all bad debts (aka, somebody else's assets and future income) are cancelled. Reset and hopefully start with an economic premise which can stand the test of time and not the desires of a few.

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Agreed, Uncle Tommy. 
What you say – that "Prices will stay soft for quite a while until the bungee cord snaps back. " is worth as much as the article.  Why?  Because we are all agreed, already, that oil prices will have to skyrocket in the future, relative to mean wages (if nothing else). 

 The problem is timing. 

And if I saw any forecast of timing in which I could have confidence, I'd be an oil buying fool just before it rose.  Why a fool?  Because I'd have an excellent chance of wasting my time and/or money.

…

Let me add something.  Yes, I read the articles.  But I come here mostly for the comments.  Arthur, Dave, T2H, UT… you all say a lot of things I disagree with.  But I do find gems among the sand.  And sometimes you say things that make me think twice.  I enjoy reading what you say.

 

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Via Mike Stasse
 

http://crudeoilpeak.info/no-glut-in-australian-petroleum-inventories
It’s all Good. Until it isn’t.
https://damnthematrix.wordpress.com/2016/01/12/deflation-revisited/

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I'm thinking that Arthur isn't quite right about the ability to add new production.  Shale reaction time is a whole lot faster than most of the other places.
For instance, there are a boatload of wells that are half-drilled; rather, drilled, and unfracked, and capped.  Right now, the backlog is 1000 wells in just the Bakken.  If we estimate 500-1000 bbl/day for the initial production, its something on the order of 500k-1M bbl/day additional production that could be brought online in a 3-4 month period (assuming 250 frack operations per month).

And again - this is just the Bakken.

Then there is Libya, Iraq's expansion, and Iran's expansion.

I'm guessing we'll have a volatile oil price ahead of us for the next 3 years.

For instance - if price rises high enough, and the desperate shale drillers are planning on fracking their wells, they'll short the living crap out of oil in order to lock in profitability "just in case."

Estimate: 30 contracts per well per month, say for 12 months, x 1000 wells worst case.  That's 360k contracts.  Open interest right now is about 1M contracts.  That'll definitely move price.

I really do think price stays below 60 for a while, unless we have a geopolitical event.

Great interview though.

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So back to the fundamentals:
we have 1-2 mln barrels of overproduction on a total of 90 mln a day.

This leads to a drop in the price of oil of about 50-70 %? Even for Saudi Arabia (or Russia) this must be a no-brainer, unless you really want to crush the balance sheet of an other nation (US / Shale?).

If Russia reduces it's production by 10-20 % they can have an increase in income of about ? 80 %? Why would Russia now sell it while they can earn a lot more when they leave it in the ground for an other couple of years?

Market share does not count for oil. When you buy a specific mobile phone, you get used to it. People / countries don't stick to specific oil brands. Even, refineries can't switch easily between different grades of oil.

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Have to keep the system going. All hands on deck. You too, Vlad.

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Good points, all debatable, here are the pieces I am working with:

  • Yes there are "ducks" (DUCs, pronounced 'ducks,' which mean "drilled but uncompleted") all over the place in the Bakken and Eagleford.  They can be brought on line quickly.
  • However, Arthur meant that capital is likely to flow in a more restrained fashion to the shale patch.  Once burned, twice shy and all of that.
  • With a lower rate of capital flow the rate of drilling expansion has to also slow.
  • Yes, there are places that *could* bring on more oil production, but may not.  Prime examples are Iraq, Iran and Libya, all of which are geopolitically sensitive and/or internally unstable.
  • World oil fields are depleting and the production declines associated with that depletion was in the range of 3% to 7% (and more) depending on the field(s) in question.  If we assume even a quite modest 4% rate of production decline and just apply that to conventional Crude + Condensate (C+C) that means a little over 3,000,000 barrels per day per year is disappearing and needs to be replaced.  Note that we could easily use IEA figures for decline rates and assume a 4,000,000 bpd or higher yearly loss rate.
Now it's no secret that infill drilling and new exploration efforts have been curtailed enormously in the past 1.5 years.  No oil company wants to spend 2 dollar to get 1 dollar back.  But that's the current price environment.  

So the upshot here is that all the new production that might be brought on line by various countries that hope are going to stabilize over the next few years will be essential to plugging the gap left by the lack of capital investment in other mature oil basin areas.

To summarize, even if the US could rapidly bring on line, for a few months, another 1-2 MBD of initial production, it will not be enough to offset the global declines brought to us courtesy of geology and a lack of investment with a helping hand from geopolitics.

My view is that no matter which trajectory the Shale Fields assume in the future, it won't be as steeply grand as the one seen between 2010 and 2015.  That was a rare confluence of super-easy money and still existing sweet spots…both in increasingly short supply going forward.

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Dave,

davefairtax wrote:

For instance, there are a boatload of wells that are half-drilled; rather, drilled, and unfracked, and capped.  Right now, the backlog is 1000 wells in just the Bakken.  If we estimate 500-1000 bbl/day for the initial production, its something on the order of 500k-1M bbl/day additional production that could be brought online in a 3-4 month period (assuming 250 frack operations per month).

Given the rapid rate of production decline for the wells in places like the Bakken (e.g. 50-70% decline in the first year with it more severe more recently link), even if they could complete the 1,000 backlogged DUCs you mentioned, they would have to then drill and complete 500-700 new wells in year 2 just to maintain the production levels gained in year 1.

New wells become very old, very quickly. All of those existing wells will mean very little in terms of production within another year or two. The point being that if this drags on another few years then any 'new' production will be starting from scratch in picked over plays such as the Bakken since the existing wells will be effectively dead. They can only increase production if they can drill and complete exponentially more wells each year. Else it is a struggle to even hold a steady output since they effectively have to 'run faster and faster just to stay in place' to paraphrase Lewis Carroll.

You are correct that they could theoretically bring a significant amount of production online quickly but they'd be hard pressed to maintain it for the reasons Chris listed.

 

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Hey Chris - all points you make seem valid. 
Still, if we flip the script and focus on the demand side…a collapse in demand seems a higher likelihood than incapability to meet demand.

Note that from '07-'13 China alone represented about 55% of growth in oil consumption globally…and they did this as their 0-64yr/old population growth was coming to an end (goes negative this year or next and continues so indefinitely).  So, how did China do it?  They quadrupled credit (debt) over that period from $7 T to about $28 T.  China alone created almost 40% of global credit over this period…totally unprecedented.

Now, China's sources of further credit (housing, ghost cities, major infrastructure (ie, 3 Gorges)) are pretty well wrapping up and played out badly…China's 0-64 population is turning rudely negative and all sources of population growth are 65+ (aka, the financial responsibility of their "one child").  Every year for the rest of our lives, there will be fewer Chinese under 65…and the same in Japan, S. Korea, Taiwan, Malaysia, etc. etc.

I'm just trying to outline why China (and many more engines of growth) not only won't grow but is likely to follow the same path as Japan, US, EU, etc. that all have seen large, sustained declines in oil consumption since their core populations began declining.  This is why a perfect storm in China but more generally across all of Asia, EU, N. America, and even S. America could result in far lower consumption than anyone imagines.  Not a great or happy forecast but is what it likely is.  The demand side is likely to fall far faster than the supply side…and a self reinforcing spiral event is already underway.

 

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There is an environment in which the Capitalistic system just is not applicable.
In war.

From comments above it would appear that everyone is stockpiling oil. (A DUC  is a reserve. )

Russia is pretty ho hum about exporting. That,  in spite of a falling Rouble. Maybe they have other things on their minds. Maybe they all have.  

Perhaps someone in Moscow has read the LTG report. 

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Chris,  first welcome to the site, I looked over your blog posts I noted from your parallel comments at ZH  and you clearly have done a lot of work on the 'stocks and flow's of population, parsing the world demographics of population data.  While I have no idea of the accuracy of your methodologies or your resultant  breakouts, I had some more general thoughts on your conclusions ie.  population and more specifically particular demographic tranches of population as  the primary driver of all secondary mechanisms such as credit, energy etc. 

trying to tease out cause and effect in a multifactoral complex system is a paradoxically difficult endeavor a sort of   what comes first chicken or egg sort of conundrum. 

It is clear from your position that you are making the a priori assumption that population drives energy consumption,  taken from a broad enough perspective I  would  argue that is backwards, As a matter of natural laws,  population is a function of energy.  You see this with sugar and Yeast, and humans and fossil fuels.  Have you charted the world population with the oil production curve?  it is a near perfect fit.

I would also add that if your rate of population decline figures are accurate, that is to my mind encouraging in the big scheme of things for both humanity and the planet.

Anyway, thanks for sharing your perspective and data!

mememonkey

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Its a question of timeframe, scenarios, and oil market price dynamics.
From a supply perspective, if we assume no major economic problems, then I think we have another few million barrels per day that could be added relatively rapidly, including the US shale fracklog.  This won't fix the problem of a major producer going offline because of war, but it should fix any more normal market demand response.  We also have an abnormally large amount of oil in storage - in tanks, and in ships.  That will also serve as a supply overhang that will need to be worked through.

From a price perspective, the hedges from the shale producers have largely expired.  Putting these hedges back on will result in a large number of "paper barrels" that will hit the market and put pressure on the price of oil.  This only happens if oil prices rise to (say) $60/bbl.

From an economic perspective, if we have any sort of near-term serious economic dislocation, that will result in more demand destruction which will also serve to push out the time of the oil price recovery.

I think the combination of the fracklog, the supply overhang, the potential for economic trouble, the potential for Iran's (and others) extra production, and the re-hedging of US production will push out the timeframe of Oil's Grand Price Recovery.

I see this just as a temporary situation.  Within (say) 3 years, I think we have big trouble, unless we've had some massive amount of demand destruction from a big deflationary storm.  But nearer term, I see a cap on oil prices for a while going forward.

In the near term, we might pop back up to $50-$60, but I don't see it going further than that for a while, unless a major producer "goes offline unexpectedly."  Which could always happen, of course.

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Hi memonkey - thanks and glad to join the conversation. I'm no economist or PhD…just an interested party. I found the explanations offered after '08-'09 lacking or incomplete though I took the Crash Course and was the best info I found and really helpful. Still, I began searching by myself and did my own research (what a nerd). Anyway, I started small and worked my way up only after exhausting all other options. I spent a lot of time looking at oil and energy as the cause but it never quite added up.  Interest rates, debt, US Treasury market, RE, etc. etc  The demographic piece was what tied it all together for me. You are welcome to read a couple of articles which try to tie peak oil consumption in nations with peak core populations. Was true or very near for most nations…but of course it wasn't just oil, it was economic activity in general…and that is when interest rate cuts incented ever more debt to maintain consumption. I suppose it would have made sense if population growth was to return, but alas nothing of the sort is happening.
http://econimica.blogspot.com/2015/10/economicsart-of-deception-vs_20.html http://econimica.blogspot.com/2015/10/forget-peak-oil-its-all-about-peak.html http://econimica.blogspot.com/2016/01/sources-of-growth-examined-and-found.html

Apologies for my poor writing and none existent editing…I just do this in my spare time and focus on content over style.

All the best

Chris