Oil Prices In A 'Peak Oil' Environment

Peak Oil can be defined at least 4 ways but one way is simple: Peak Oil is when supplies and stocks are enduringly tight relative to demand, and price slides are short but price hikes are long - until and unless the economy tilts into steep recession.

The most recent example of this was in 2005-2008 culminating in US Nymex oil prices at around $145 a barrel in July 2008, with little difference between Brent and WTI grades.

Today in March 2012 the oil importer countries of the OECD group, according to the energy watchdog agency the IEA are consuming about 46.25 million barrels per day (Mbd), under outright recession conditions in several EU27 countries, low growth in Japan, and only slow recovery in the US. The "magic" of recession cutting oil prices no longer seems to work, and with OECD consumption still 1.25 Mbd below the 5-year average for oil consumption by the 30-nation developed economy group, oil demand growth is now either certain or likely.

Taking the OECD group's total population of about 1.10 billion, this oil consumption rate is an average of around 15.3 barrels per capita per year (bcy). At the same rate of oil demand, China would consume 54.6 Mbd (real consumption in early 2012 is 9.3 Mbd) and India would consume 50.1 Mbd (real consumption in early 2012 is 4.3 Mbd).

While a few countries on the planet such as Saudi Arabia and UAE can consume as much as 30 - 32 bcy, there is no conceivable way the planet's entire population will ever reach the OECD's average per capita oil consumption rate. We can forget that and can call it Peak Oil, and we can move on to talking real.

OIL DEMAND SETS PRICES
The OECD with 14% of world population consumes slightly more than 50% of world total oil supplies - but the problem is that nonOECD consumption is growing fast, more than compensating the sluggish oil demand growth of the OECD driven by its sluggish and increasingly de-industrialized economic growth.

Over the decades since the 1970s oil shocks, various long-running energy policy initiatives inside the OECD group are theoretically aimed at using less oil, and the already 10-year-old green energy quest is promoted as "able to save oil". The net result in the real economy is different: economic recovery drives oil demand growth.

While shale gas output drives a context of massively underpriced US gas, future shale oil supplies are unlikely to grow fast, and are high-cost to produce, shutting out the perspective that shale oil can operate on oil prices, like shale gas acts on gas prices. Including Canada's tarsand oil and global deepwater oil, and small outputs of high cost GTL (gas to liquids), the IEA most recent Oil Market Report esimated that through 2011, world oil output growth on a net basis, after depletion losses and supply cuts due to civil strife, was 0.1 Mbd.Its forecast for global oil demand growth in 2012 is 0.8 Mbd, but this forecast assumes recession and semi-recession conditions linger in the US and Europe.

In the real economy, only recession cuts cut oil demand, and this is shown by the OECD group's oil demand only starting to recover now, in early 2012. Unlike the IEA forecast, of 0.9% global oil demand growth in 2012, the potential for growth attaining 1.5% or more on a volume basis is high. This would add some 0.6 Mbd to the IEA's current forecast of 0.8 Mbd growth.

Enter Iran: the slow moving process of operating oil embargoes on Iran, currently refused by India and China, and only partly operated by Japan and South Korea, could or might attain a cut of 0.6 - 0.8 Mbd in Iranian supply to importer countries by July. In the present Peak Oil context this is a clear signal for higher prices.

READING THE ECONOMY'S CRYSTAL BALL
Tell tale indicators of this Peak Oil are found far outside the oil patch. Brazil has for instance held back on increasing sugar-to-ethanol fuel conversion on strict economic grounds. Sugar as sugar, also yielding a range of food chemicals, is a better economic bet than substituting crude even at $125 a barrel. Sugar's price stays close-linked to oil on the upside as global non-oil commodities also gain support from oil.

To be sure, green energy boomers can promise us all-electric car fleets, but today's wind or solar-powered 6-cylinder sedan cars are rare in our streets, while world agriculture, shipping and aviation are very close to 100% dependent on oil, in the same way as the world's mining, plastics and petrochemicals industries.

For at least 4 years, in the run-up to the 2008 oil price peak the threat of Chinese and Indian demand "stealing oil from the OECD group" played as a background theme while the Asian Locomotive of oil-intense and fast economic growth in China and India was also hailed - sometimes by the very same analysts and economic talking heads ! Related to their average GDP per capita numbers, oil prices in China and India are at giddy heights, but the economic output they get from a barrel is also high.

We can then look at how China and India have raised their oil consumption this decade, during which prices almost only increased. China's national consumption in 2001 was 3.67 Mbd but at end 2011 was running at 9.3 Mbd for an average annual growth on a 10-year basis of 9.74%. India's average growth of demand since 2001 was more than 6%.

These growth rates are, to be sure, declining but for world oil supply any growth of world demand at even 1.5% a year, sustained over more than 3 or 4 years, is impossible to satisfy, because this would create a permanent Peak Oil context.

The acid test question is: can the world attain, and then sustain more than 95 Mbd of production ? This is the limit set by several major figures in world oil, such as Total Oil's CEO C. de Margerie, and we are getting there, fast