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Tuesday, February 24, 2015

Fundamentally Flawed - Chapter 9, Oil...As Global Credit Slows, Too Much Oil & Too Little Demand

by Chris Hamilton, February 2015

The below chart shows significant declines in oil consumption (yoy) coming from all across the OECD with only the US up (marginally) and S. Korea moderately up.

Source, US EIA

Oil consumption now vs. previous consumption.  S. Korea's increasing consumption is literally off the chart and Canada is still increasing it's consumption...but nearly all other advanced economies are declining and have been for quite some time.

Source, US EIA
The chart below clearly shows the OECD "advanced economies" are not advancing...with declining oil consumption and economic activity.  2014 consumption shows a global slowdown.
Source, US EIA
The next chart shows the current top 25 oil consumers and their present oil consumption as a % of their peak and also showing the year of their peak consumption.  The combination of the length and depth of the nations in red reduction in oil consumption is likely a strong indicator of negative organic growth (depression).  Those in yellow likely are suffering some type of recession while those nations in green likely have varying amounts of organic growth.
Source, US EIA
A quick look at the BRICS (Brazil, Russia, India, China, S. Africa) oil consumption vs. the US, Europe’s, and Japan’s oil consumption highlights the different directions these nations are headed economically.
Source, US EIA
Below is another view of oil consumption changes vs. population changes from 1980 ‘til 2013.
Source, US EIA, Population Source, OECD
The next chart shows that global production (ex-USA / Canada) has stalled since 2005 and the US and Canada are nearly responsible for all global production gains since 2005.  Strange higher prices incented no other region to significantly increase production?
Source, US EIA
US and Canadian producers are incented to bring more product to market, utilizing 4x's as many expensive rigs as the whole of the Middle East while producing 1/3rd the oil?
Source, US EIA
What about Saudi Arabia and OPEC?  Wouldn’t they be incented to bring more oil to market at the significantly higher prices?  In a word, NO!!!  The next chart clearly shows OPEC peaked its exports in 2005 and has been flat in exportable oil since.
Source, US EIA
And a quick check of ’14 shows total OPEC production is down slightly from ’13…no consumption data available yet but if trend continues, total exported OPEC oil will fall even further.
Source, US EIA
And the next chart shows Saudi Arabia’s exports are down…again, from 2005.  As with OPEC, overall production is up slightly but the Middle East is consuming far more oil leaving less net oil available for export.
Source, US EIA
Who’s flooding the world with oil?  Sure looks like the US and Canada are responsible for the increase in production while OPEC exports are sliding.
Source, US EIA
And below, a snapshot of global production gains over the past 3 years…nearly all the gains thanks to US Shale and Canadian tar sands increased production.

Source, US EIA
How did the US and Canada Increase Production?
The US has an average of 4.5x’s more drilling rigs than the entirety of the Middle East…and the US rigs produce a third of the total oil of those in the Middle East.  This should make a couple things clear…1) the US is much less efficient in producing oil (btw, the US has the lowest productivity of any global region on a per rig basis), 2) the durability of US / Canadian production gains is based upon ever higher rig counts simultaneously producing less oil per rig (low productivity, low efficiency, globally uncompetitive?…this is not the US I know!).  Or more simply put, the EROI (Energy Return on Investment) is collapsing the world over, but particularly in the US.  Energy production of 1000 barrels of oil per every one barrel used to produce that energy weren’t uncommon.  Presently, the US has the lowest EROI of any region and is down to sub 5 barrels returned for every one barrel input to produce that energy. 
Production growth in  America has been from “Tight Oil” shale while Canada is a combination of tight oil and tar sands. 
United States Production

What is “Tight Oil”?  Tight oil is generally production using hydraulic fracturing, generally in shale formations, often using the same horizontal well technology used in the production of shale gas. These new sources of oil are generally low quality, high cost, and generally short in duration.
The new tight oil crude is much lighter than traditional crude. According to the Wall Street Journal, the expected split of US crude is as follows:

There are many issues with the new “oil” production:
  • The new oil production is so “light” that a portion of it is not what we use to power our cars and trucks. The very light “condensate” portion (similar to natural gas liquids) is especially a problem.
  • Oil refineries are not necessarily set up to handle crude with so much volatile materials mixed in.  Such crude tends to explode, if not handled properly.
  • These very light fuels are not very flexible, the way heavier fuels are. With the use of “cracking” facilities, it is possible to make heavy oil into medium oil (for gasoline and diesel). But using very light oil products to make heavier ones is a very expensive operation, requiring “gas-to-liquid” plants.
  • Because of the rising production of very light products, the price of condensate has fallen in the last three years. If more tight oil production takes place, available prices for condensate are likely to drop even further. Because of this, it may make sense to export the “condensate” portion of tight oil to other parts of the world where prices are likely to be higher. Otherwise, it will be hard to keep the combined sales price of tight oil (crude oil + condensate) high enough to encourage more tight oil production.
  • 2009 through 2013 saw a rapid increase in US production, almost entirely from low quality, high cost new tight oil sources while conventional high quality, and low cost production maintained its long, gradual decline.
    How sustainable and profitable is this new “tight oil”?
In 2010, the hole left behind by fracking was only $18 billion. During each of the last three years (’11-’13), the gap was over $100 billion/yr. This is the chart of an industry with apparently steep and permanent negative free cash-flows: This is the huge problem with fracking shale oil and gas.  Due to the extremely high annual decline rates of the typical shale oil or gas well, companies must continue to spend a great deal of capital expenditures to replace what was lost.  It’s known as the DRILLING TREADMILL…. once you start, you can’t get off.
In one year the top 127 oil and gas companies spent $110 billion more on capital expenditures than they received from operations.  So, they acquired $106 billion in additional debt (a large percentage through the Junk Bond Market) and sold assets to make up the difference.
Not only are many of these oil and gas companies hiding the fact that their balance sheets are hemorrhaging debt, they also have a cozy situation with the Federal Government.  Basically, the Fed’s allowed them to defer more than half of their tax bill… and it’s a lot of money.  In a nutshell, the top 20 oil and gas companies still owe $16.5 billion to Uncle Sam in tax revenue.  Curious how all this will work out now that oil prices have collapsed?  Perhaps this offers some explanation or insight into the reasons US / Canadian production rose while no other region did likewise?

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