The Peak Oil Debate (USO, USL, OIH, DIG, DUG)

The Oil Drum blog has a great article summarizing the story behind the Peak Oil Theory (here).

When oil prices were rising spectacularly over the past decade (since the low in 1998), the peak oil debate was growing in intensity until it reached a crescendo as oil prices peaked.  Since then, oil prices fell dramatically and the debate was making fewer headlines.

The thing about the debate is, as this article says and the part that confuses most people, we have plenty of oil left.  Its just that the “easy” and cheap oil is running out.  The most recent major find was off the coast of Brazil, in extremely deep water.  Very few companies  have the equipment to extract at those depths.  Add to this the oil sands as mentioned in my previous post, and you quickly see that the cheap oil is running out.

I still hold by my previous statement: oil cannot sustain a price level above $80.  For further evidence of this I again defer to the article posted above:

Dave Murphy of The Oil Drum has shown that if the oil price goes much above $80 or $85 in inflation adjusted terms, the economy tends to go into recession.

The recession that follows higher prices weighs down on the price, bringing it back to a level of normalcy.

As firms realize that they cannot economically extract oil at a level above $80, they will be less inclined to go for big discoveries in hard-to-extract-from places, and supply will be wounded.

-AH

Disclosure: Long RIG, BP, KMP

Why Crude Oil will not Surpass $100 for the Foreseeable Future (USO, USL, OIL, /CL)

When commodities were racing for the moon last year, analysts were falling over themselves to offer higher and higher predictions for where the price of oil would go  until a price target of $300 was announced which coincided with the top in oil prices of approximately $148.

Since then the economy has ravaged commodity prices, taking them down to multi-year lows, before recovering slightly.  The question remains, however: can they regain their former strength?

When oil prices were rising, people foresaw unlimited demand from emerging economies such as China, coupled with uncertainty in supply as Saudi Arabia (among others) reported proven reserves figures that were called into question by many analysts.  Today, we see neither of those things.  Demand has been shown to be extremely limited as oil use fell dramatically during the recession due to reduced transportation of goods, and diminished consumer demand.  And it is supply that has been shown to be fairly unlimited, as supply constraints imposed by OPEC have been regularly ignored by its member countries and there has been little hurricane activity to jeopardize US production.  The huge find off the coast of Brazil in the fall of 2008 didn’t help the pro-peak oil-ers as that debate was raging in the media.

But, oddly enough, it is Canada that is throwing the biggest curveball in the global market for oil.  Canada has, mostly in Alberta, what they call the largest reserves in the world in a place called the Athabasca Oil Sands.  1.7 trillion barrels are locked in sand just below the surface, an amount that is comparable to the worlds current proven conventional oil reserves. This oil, however, is very expensive to extract, and current estimates put the break-even point at approximately $70 per barrel.  The environmental impact is also devastating, but that is an issue for others to discuss.

It is my belief that the availability of billions of barrels of expensive oil is having an effect on the price of oil that the world has not seen before.  Speaking very generally, when the price of oil dips below $60 or so, the oil sands will begin to shut down as they become uneconomical, decreasing the supply and causing upward pressure on the price.  Conversely, as the price jumps above $80, more and more oil sands operations become profitable, increasing the supply and bringing downward pressure on the spot price.  Because these operations take time to ramp up and down, we will not see the supply react immediately to this phenomenon, but it is the reason why I believe we will not see sustained prices of oil outside of the $60-80 range in the medium to long term.

-AH

Disclosure: Long USO