Oil Prices: Moving to Red Alert

Peak oil is moving back fast as permitted dinner time talk - and even office time action on futures and options. And the reasons are multiple, well known, but heavily discounted until now. Through late 2011, many times, the IEA's chief economist Fatih Birol has outlined how radically the IEA sees the oil price outlook. Lost in the climate crisis talk however, the oil price message was often sidelined. Birol's agency in November said this: "If fossil fuel (energy) infrastructure is not rapidly changed, the world will lose for ever the chance to avoid dangerous climate change", but the oil price punch line came later. Birol has many times provided the IEA's estimate of how oil prices levered up through 2011, despite the European crisis, near-recession in the US, recession in Japan and falling growth in China and India.

Oil price rises in 2010-2011 levered up the OECD's net annual oil import costs (after re-exports and refined product exports) by 30% to about $790 billion from around $625 billion in 2010. For year 2011, Brent grade oil import prices to the 3 largest world importer countries and regions - USA, Europe, China - averaged $111 a barrel.

Until late 2011, both the US EIA and IEA were only forecasting low level price growth in 2012, but the bets are now off.

THE DEMAND DRIVEN PINCH

Oil imports to the United States are expected to stagnate or decline over the coming years because of new fuel efficiency standards for cars and trucks, and an increase in domestic oil and natural gas production, but oil import demand in Europe, and especially China and India will continue growing in a supply-constrained environment.  For this reason, and apart from the geopolitical threats rising in the Middle East, both the EIA and IEA continue forecasting high oil prices - even very high oil prices.

Certainly since 2009, the IEA deliberately confuses the subject of limiting global average temperature rises to 2 degrees celsius by 2025 through cutting OECD fossil energy consumption enough to prevent CO2 levels rising above 450 ppm (0.045%) in the Earth's atmosphere - with the real issue of how to prevent oil prices hitting $150 a barrel by as soon as this year, 2012. We can expect it will rectify this in the near term.

The IEA presents what it calls unfavourable scenarios able to bring $200 a barrel oil by as early as 2015-2017 - without any special geopolitical tensions or pressure. The IEA signals little respite for energy consumers.

The OPEC link is clear: in November, the IEA repeated warnings of the "clear need" for more OPEC oil this year, and every year forward to 2017. While the US EIA's end year forecasts for oil prices in 2012 range through a more than generous $49 to $192 a barrel, underlining the critical level of uncertainty that exists in oil price forecasting, both the IEA and EIA assume that year-average oil import prices will steadily rise. As we know Goldman Sachs, since Sept 2011, forecasts a highly precise 2012 oil price target of $130 for Brent and $126.50 for WTI. Current IEA forecasts range from an unrealistically low $114 a barrel in 2015, to $212 in 2035, in current dollars. This implies 2015 prices well above $125, and 2035 prices in dollars of the day which could exceed $275 a barrel.

CAN WE KEEP PRICES DOWN ?

This switches the focus to global spending on energy infrastructures, and oil and gas E&P (exploration-production) in particular. For the IEA, a vast upsurge in oil E&P spending is presented as needed to head off Climate Change Armageddon, but the the real threat is oil prices spiraling up to $150 a barrel and staying there - even during low level or "contained" economic recession of the type operating in the US, Europe and Japan at this time. Optimistic forecasts say global energy companies are expected to raise oil and gas E&P spending nearly 10% this year, according to Dahlman Rose & Co., which estimates that despite sluggish economic growth and concerns about European and U.S. sovereign debt, spending will hit $595 billion. This however includes all sectoral financing operations like M&As and debt restructuring, and the narrowly defined number for real physical spending in 2011 and 2012 comes in at well below $400 bn - which is still below the most recent record year of 2007.

IEA studies and reports, since July 2011, claim that for every $1 of energy sector investment in recent years, from "vanity tech renewables" to oil, gas and coal, electric power and the flagging low-profile nuclear industry, this must be raised to $4.30 by 2017. This is a 330 % increase, with an implied or hoped-for target in global oil and gas E&P spending of $1.6 trillion-a-year, but the chances of this massive boost in energy sector spending happening are nearly zero.

The downturn in oil and gas spending was partly due to recession, but was also driven by a large rise in green energy vanity tech investment and spending, reaching its most recent peak of about $300 - $350 bn in year 2010, according to Bloomberg New Energy Finance. To be sure this tapering down quite fast now, but the potential for oil and gas sector spending reaching $1.6 trillion-a-year by or before 2017 is so low we dont even have to think about it.

The implication for oil prices is easy. World conventional, onshore, mature oilfield reserves and production capacity is falling, at dangerously high rates, probably around 3.3 - 4 Mbd: without deep and sharp, global scale economic recession we can only have Oil Shock defined as oil prices rising to previously unknown high levels. When we have sustained Oil Shock of that type we will likely have global economic recession - or inflation: the closed loop is so simple that even average political deciders can understand what is threatened !

ADD THE GEOPOLITICAL PREMIUM

Far more than any other basic commodity, with few and small scale exceptions oil remains "The Prize" of potboiler oil crisis book writers like Daniel Yergin and others. For the threatened oil shocks of the near term future, we can be certain that Arab Spring revolts, the Iran nuclear crisis, threats to Putin's power, and ever rising Chinese and Indian oil demand can or will play a major role in advancing the arrival of an economic event horizon. The economy has to absorb higher oil prices - but how will this happen ?

With the possible but unsure exception of Libya's regime change in 2011, military action to ensure oil supply security and push down prices has been a long story of failure, but this does not prevent the military option happening again. The major problem in the present context is time: surplus oil production capacity has continually fallen for as long as 7 - 10 years, according to the IEA and other sources, making it high risk to operate regime change military adventure in major oil exporter countries, due to loss of export capacity during the hostilities, certainly further raising world oil prices.

This re-shifts the focus to non-oil energy and oil-saving initiatives and programs in the major oil consuming, oil intensive economies, which is likely the "hidden agenda" of the climate crisis and green energy quest or crusade in recent years. Here we find a direct relation with oil prices - green energy development without heavy and permanent government subsidies needs much higher oil prices. Green energy delivers high priced energy, so if we want green energy, we must accept higher price energy.

For many reasons however, including geopolitical relations with oil exporters, political deciders in consumer countries will not engage in raising oil prices due to this being a green flag for oil exporters to seek higher prices. Likewise, oil saving programs operated either through raising oil prices, or only on a voluntary basis have usually failed and caused economic damage, in a global economy context where fear of limiting economic growth is stronger than the fear of high oil prices. The bottom line is that oil prices can rise to new "exotic" levels this year.