Edition Thirty Four – January 2015

Oil producers commit mass suicide

Why $75 is the right price for oil

The 2014 oil price crash explained

2 OilVoice Magazine | JANUARY 2015

Tech Talk - A gentle cough! by David Summers

6

Five energy surprises for 2015: The possible and the improbable by Kurt Cobb

9

How the U.S. could fight OPEC and win (and why it won't) by Kurt Cobb

11

The OPEC Conundrum by Euan Mearns

16

New York's Fracking Ban Reveals Energy Hypocrisy by Loren Steffy

23

Oil producers commit mass suicide by Andrew McKillop

26

Turnabout: OPEC shows U.S. oil producers who's boss by Kurt Cobb

30

Ten reasons why a severe drop in oil prices is a problem by Gail Tverberg

33

The oil price is all about ONE number right now by Keith Schaefer

45

The 2014 oil price crash explained by Euan Mearns

49

Greed explained: J. Paul Getty, Aristotle and the Maximum Power Principle by Kurt Cobb

57

Making sense of OPEC oil market politics by Gary Hunt

61

Why $75 is the right price for oil by Andrew McKillop

64

The high cost of low-priced oil by Kurt Cobb 68

3 OilVoice Magazine | JANUARY 2015

Featured Authors

David Summers

Bit Tooth Energy

While one of the founders of The Oil Drum, back in 2005, he now also writes separately at Bit Tooth Energy.

Kurt Cobb

Resource Insights

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude.

Euan Mearns

Energy Matters

Euan Mearns has B.Sc. and Ph.D. degrees in geology.

Loren Steffy

30 Point Strategies

A senior writer for 30 Point Strategies and a writer-at-large for Texas Monthly. Loren worked in daily journalism for 26 years, most recently as an award-winning business columnist for the Houston Chronicle, and before that, as a senior writer at Bloomberg News.

Andrew McKillop

AMK CONSULT

Andrew MacKillop is an energy and natural resource sector professional with over 30 years’ experience in more than 12 countries.

Gail Tverberg

Our Finite World

Gail the Actuary’s real name is Gail Tverberg. She has an M. S. from the University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.

4 OilVoice Magazine | JANUARY 2015

Keith Schaefer

Oil & Gas Investments Bulletin

Keith Schaefer is the editor and publisher of the Oil & Gas Investments Bulletin.

Gary Hunt

Tech & Creative Labs

Gary L Hunt is an energy technology expert with deep domain knowledge in oil, gas, power and water from 30 years’ experience. As practice leader at Ventyx, IHS, and Deloitte he leveraged software and analytics, data and domain expertise to provide advisory services and insight.

Let’s turn on the light.Look more closely at your basement with NEOS and discover what might be lurking below. Through multi-physics

imaging, NEOS maps variations in basement topography, composition and faulting, any of which can affect field

locations, EUR, or the level and BTU content of production. By illuminating your basement and seeing below the

shale, you’ll better understand thermal regimes and pinpoint where to drill for optimal recovery and economics.

Some of the world’s leading geoscientists are making brighter decisions with NEOS. Be the next.

Above, Below and Beyond neosgeo.com

YOUR BASEMENT IS FULLOF DARK SECRETS.

6 OilVoice Magazine | JANUARY 2015

Tech Talk - A gentle cough!

Written by David Summers from Bit Tooth Energy

When I last wrote about the global supply of oil, it was back in October, as the fall in

oil prices was developing. Since then the price has continued to fall, with prices now

below $60 a barrel. I was doubtful back then that the price would fall as far as it has,

and remain cynical that it will remain down for very long. Since this seems to go

against much current wisdom, let me explain why I remain pessimistic that the boost

to the global economy from access to cheaper fuel will continue for any great length

of time.

It depends on whose data you believe credible as to how much more oil is available

than that currently in demand. When looking at the numbers in the past I used a

number of roughly 1 mbd, but this is hard to realistically quantify. Why – well the

problem comes with the regions of the Middle East and North Africa (MENA) where

there are current conflicts. The ones of particular concern are Libya and Iraq,

although the fluctuating state of exports from Iran cannot be neglected. When the

Libyan conflict first impacted the export of oil from that country Saudi Arabia began

increasing its production to offset the loss in Libyan exports.

There came a time in September when Libyan exports, which had fallen to around

300 kbd from a high of over 1.6 mbd, shot back up to around 900 kbd. The EIA has

recently shown an inverse correlation between Libyan production and oil price:

Figure 1. Brent Oil Price and Libyan oil production (EIA )

7 OilVoice Magazine | JANUARY 2015

Thus, when an additional 600 kbd suddenly appeared back in the marketplace, it is

not surprising that it had an impact on prices. However while there was already some

surplus in the market (from increased production in the US etc, as I will comment on

below) the volume of the addition had a more significant impact on prices, and when

KSA decided not to reduce production this led the market to assume that we had

returned to plentiful sufficiency, and prices have continued to fall since.

However, this perception is already unravelling. Libyan conflict has continued to

embroil their oil fields. The Sharara field, which produces 300 kbd closed in

November as conflict overwhelmed it. At the moment two of the oil export terminals

are threatened, and with them another 300 kbd of oil. But it is not possible, at this

point, to predict what is going to happen in either location. There is little sign that the

conflict is any closer to resolution, meaning the production will continue to be

threatened into the foreseeable future. Sadly it is more likely that this will have

negative impact on oil production, so that it might be wiser to assume lower rather

than higher volumes coming from the country.

The situation is a little clearer and more optimistic in Iraq, where the pipeline through

Kurdish territory has lessened the impact of the Islamic State take-over of a large

swath of the country. The recent agreement between the Iraqi Federal Government

(IFG) and the Kurdistan Regional Government (KRG) approved early this month is

already raising questions over the volumes that the KRG will put onto the market.

The agreement calls for sales of around 550 kbd, but there is an additional 100 kbd

that is available, the status of which is unclear. The country is exporting,

overall, around 2.51 mbd and the pipeline to Turkey is currently carrying 280 kbd, but

is being boosted to carry 400 kbd, with an ultimate throughput of 700 kbd. Part of the

problem in assessing the market for this, however, in the short term is that the Iraqi

crude is often heavier and of relatively lower quality than the market average. This is

currently causing some marketing problems, leading the IFG to lower prices in order

to find a market. In neither case, however, is the current conflict likely to impact the

production for export, and while it is difficult to anticipate much production above 3.5

mbd. (The December OPEC MOMR suggests that they are producing 3.36 mbd at

the moment) we are unlikely to see any significant reduction in production going

forward. The significant growth in global production to meet a still predicted rise in

demand next year (albeit down slightly from previous estimates) will, therefore, not

come from OPEC, who still anticipate that they will produce, on average 400 kbd

less than they have this year. It is still expected that American production will

8 OilVoice Magazine | JANUARY 2015

continue to rise to meet expectations of increased global demand.

The problem, unfortunately, with that view, is that increases in US production are tied

to output from fracked horizontal wells that are expensive to drill, and have a

relatively short production life, with the majority of production coming in the first year

of operation. Thus, in order to sustain production, more wells must be drilled each

month to cover the loss in production from existing operations. The North Dakota

Department of Mineral Resources projects that 225 or more drilling rigs are needed

to sustain the growth of production from the state over the next three years (at which

time it will plateau at around 1.5 mbd). Presently there are roughly 180

rigs operating, with the count falling by the week, as the rewards, at present, do not

match the cost. The agency anticipates that the number will fall by an additional 40-

50 rigs by the middle of next year. Well completions are also falling by the month, as

the industry likely plans to wait out the current hiatus in prices. The impact of this on

even short term production should not be discounted. There has already been a

slight fall in production, rather than a gain, in October, and that will likely accelerate.

Without any gain in production, and in fact seeing the potential for a drop in US

production over the next year, then the anticipated surplus between oil supply and

demand will likely disappear. Remember that the MENA nations are seeing a growth

in their internal demand for oil (in the KSA this has already passed 3 mbd) so that if

they had no impetus to reduce production and exports in the face of falling prices, so

they are unlikely to increase production when prices pick up. (They haven’t before).

When will this all happen? Well I got the size of the price fall wrong, so don’t hold me

to the exact timing, but I would anticipate that when we see the start of the driving

season next year, the oil market will tighten rather quickly. Following that (given the

inertia in getting production back in the US) we will (as I have been expecting for a

couple of years) see the global concern over supply start to be a significant factor in

2016.

View more quality content from Bit Tooth Energy

9 OilVoice Magazine | JANUARY 2015

Five energy surprises for 2015: The possible and the improbable

Written by Kurt Cobb from Resource Insights

The coming year is likely to be as full of surprises in the field of energy as 2014 was.

We just don't know which surprises! I am not predicting that any of the following will

happen, and they will be surprises to most people if they do. But, I think there is an

outside chance that one or more will occur, and this would move markets and policy

debates in unexpected directions.

1. U.S. crude oil and natural gas production decline for the first time since 2008 and

2005, respectively. The colossal markdown in world oil prices has belatedly been

followed by a slightly smaller, but nevertheless dramatic markdown in U.S. natural

gas prices. The drop in prices has already resulted in announcements from U.S.

drillers that they will curtail their drilling operations significantly next year.

But drilling that is already contracted for will likely go forward and wells waiting for

completion will be completed. It can be costly to pull out of drilling contracts. And,

failing to complete already successful wells and bring them into production is

downright foolish since the costs incurred in drilling the wells including future debt

payments remain. In those circumstances, some revenue at lower prices is

preferable to no revenue at all.

Having said all that, scaled-down drilling plans when combined with what's left in

drillers' immediate inventory both to drill and complete may not be enough to

overcome the prodigious production decline rates from existing wells in deep shale

deposits of oil and gas which have provided almost all the recent growth in U.S.

production. The decline rates are 60 to 91 over three years for tight oil plays and 74

to 88 percent over three years for shale natural gas plays.

If low prices continue for a second year, the cheers for "Saudi" America will

disappear. It was never to be anyway. What America has left is high-cost oil and

natural gas. And, even at high prices both were likely to peak and decline in the next

10 OilVoice Magazine | JANUARY 2015

5 years. Now, low prices may bring peak production rates in the coming year for both

U.S. oil and natural gas--peaks that may never be seen again.

2. World crude oil closes below $30 per barrel. I think that such a price would only

last a short time unless the world is in the throes of the next Great Depression. But

since OPEC has reaffirmed that it will continue to pump oil at current rates until non-

OPEC production declines, look for this game of chicken to create increasing

inventories of oil worldwide for several months. The underlying cause for rising oil

inventories is slowing economic growth in much of Asia, especially China, and

economic stagnation in Europe and Japan. Any pickup in worldwide growth would

send oil significantly higher than where it is today as oil demand increases.

3. Developments in solar thermal energy show that it can solve the storage problem

for electricity from renewable energy. The difficulty with renewable energy supplying

electricity is that electricity is very expensive to store (and so we do very little of this).

Storage is important because renewable energy production comes when the wind

blows and the sun shines, but not always when we need it. A breakthrough in solar

thermal may be in the offing that would overcome previous limits on temperatures

generated by solar thermal capture devices and make it possible to store heat

cheaply enough to run solar electric generating plants around the clock at high

output.

4. A climate agreement in Paris calls for binding greenhouse gas emissions limits.

Expectations are exceedingly low for next summer's international climate conference

to be held in Paris. The aim is to agree on binding limits for carbon emissions for the

world's nations. Few people think that will happen no matter what the urgency of the

matter.

But we cannot know what climate events might occur between now and the Paris

conference that would change the outcome. It would have to be big, on the order of

an ice shelf plopping into the ocean, dissolving and raising sea-level enough to

notice. Nevertheless, I would say that such a disturbing event becomes more likely

with time and might be necessary to move the world's nations to a binding emissions

agreement.

Even some progress in the direction of a binding agreement will have the world's

energy analysts talking about stranded assets, a reference to the oil, natural gas and

coal that would have to be left in the ground in order to avoid breaching agreed limits

11 OilVoice Magazine | JANUARY 2015

on carbon emissions. That would have significant consequences for the companies

whose work is extracting and refining hydrocarbons.

5. Oil prices reach $100 per barrel before December 31, 2015. This is the other

extreme from surprise No. 3. Almost all analysts expect oil prices to remain low, and

many believe we are now entering a new era of cheap oil. (I, of course, don't buy it.)

An earlier and more dramatic drop in production than anticipated and a greater rise

in demand than anticipated could easily bring prices back above $100. I think this is

more likely to happen later in 2016. But the timetable for a return to prices above

$100 could be accelerated by many factors not now apparent.

I regard none of these events as likely which is why they would be surprises. But

even one of these surprises would result in large financial gains or losses for many.

And, either of two of them--binding greenhouse gas emissions limits or a

breakthrough in renewable energy storage--would have giant consequences for the

entire world.

View more quality content from Resource Insights

Written by Kurt Cobb from Resource Insights

OPEC has declared war on American oil production with the intention of making the

country more dependent on imported oil and on oil in general. By refusing to cut

production in the face of weakening world demand, the cartel has allowed oil prices

to fall more than 35 percent since mid-year to levels that are likely to make most new

oil production in America's large shale deposits unprofitable. That could not only halt

growth in U.S. production, but may lead to an actual drop because production from

How the U.S. could fight OPEC and win (and why it won't)

12 OilVoice Magazine | JANUARY 2015

already operating deep shale wells declines about 40 percent per year.

The United States could chose to fight back and possibly win this war with OPEC by

employing one simple, big move. But, I can confidently predict that the country will

not do it. Why? Because it involves a tax, a tariff actually.

Back in 1975 then-Secretary of State Henry Kissinger proposed that the world's oil

importers adopt a floor price for oil. The purpose was threefold: 1) encourage

domestic oil production, 2) accelerate the development of alternative energy sources

by making their price more competitive with oil and 3) encourage conservation of oil

and oil-derived products such as gasoline and diesel fuel.

The easiest way to achieve the floor price, of course, would be to slap a sliding tariff

on imported oil. The formula for such a tariff would be simple: The floor price minus

the price of imported oil unless the price of imported oil equals or exceeds the floor

price, in which case, the tariff would be zero. Imposing a tariff that keeps U.S. oil

prices above, say, $100 per barrel would only return the domestic price of gasoline

and other refined products to their level of just six months ago. Presumably, that

wouldn't be much of a shock to consumers.

I suspect, however, that Kissinger's proposal would be about as popular today as it

was when he proposed it. Back in 1975, it never got off the ground. This was, in part,

because the Europeans and the Japanese objected that, unlike Americans, the two

had few oil resources that might be exploited as a result of such a price guarantee.

In the end, America was unwilling to go it alone.

Ironically, since that time the Europeans and the Japanese have opted for high taxes

on energy including motor fuels--taxes that have had the effect of achieving

Kissinger's objectives two and three, alternative energy development and energy

conservation. Americans have maintained low energy taxes which in part are

responsible for the fact that the average American uses twice as much energy as the

average European.

An oil tariff could actually garner considerable well-heeled, heavyweight political

support from two unlikely bedfellows: the domestic oil industry and the renewable

energy industry. The domestic oil industry, of course, would love a tariff because it

protects the industry's high-cost deep shale deposits from the competition of cheap

OPEC oil imports. The cartel's price suppression strategy specifically targets the

13 OilVoice Magazine | JANUARY 2015

high-cost hydraulic fracturing or fracking in deep shale deposits that has been largely

responsible for the rise in U.S. oil production from a low of 5 million barrels per day

(mbpd) in 2008 to 8.8 mbpd as of September this year.

The renewable energy industry might well join the oil industry in supporting such a

tariff because a high oil price makes alternatives to oil more attractive.

But individual, commercial and industrial consumers of oil and oil products would

object to higher prices. Industrial users, in particular, would complain that they must

compete against other industries abroad that pay less for their petroleum products

(though this might not be true in such high-tax places as Europe).

Another group would almost certainly object to such a tariff: those concerned about

the environmental damage associated with fracking for oil. High domestic oil prices

would only encourage exploitation of more deep shale deposits across America, and

that would necessarily result in broader environmental effects. These activists might

well argue that a hefty carbon which would tax oil and all other carbon energy

sources would be better targeted for reducing energy consumption and spurring

alternatives to fossil fuels--with no need for an import tariff that encourages domestic

oil production. But, recent history suggests that such a tax remains politically

implausible. So, the question is: If the tariff were to be adopted, would the support

provided to alternative energy be an acceptable trade for the damage done to the

landscape?

Of course, anti-fracking activists will retort that they'd like to ban fracking altogether

while the country speeds up deployment of alternative energy. But, the chances for

such a ban, either federal or state, while not zero, are probably smaller than the

chances that the United States will enact an oil tariff.

The beauty of the oil tariff is threefold: 1) The mechanism for collecting it is already in

place. 2) It doesn't mandate exactly how people should go about reducing their

petroleum use; it only incentivizes them to do so. And, 3) it makes significant

headway in addressing one of America's greatest vulnerabilities, our dependence on

foreign oil and on fossil fuels in general. We'd get all this with one tax.

Getting agreement for an oil tariff would be a grand bargain of the first order. It would

require a sort of Alice-through-the-looking-glass transformation across the United

States. Oil industry captains--who tend to have libertarian leanings and who have

14 OilVoice Magazine | JANUARY 2015

consistently and publicly denounced excessive government regulation and taxes--

would have to champion a new tax. The renewable energy industry would have to

embrace its new partnership with the oil industry.

Environmentalists might have to be appeased with new, much stricter environmental

standards for fracking and with assurances that enforcement would be vigorous.

(The oil industry would look foolish opposing such standards when it is being given

such a big financial gift--one that would enable it easily to pay for better

environmental practices.) And, the oil-consuming industries and the public would

have to take the attitude that the tariff is the right thing for the country because it will

force all of us to do the right thing: conserve and seek alternatives to oil and oil

products.

The most likely course, however, is that no such tariff will be adopted. As a result

America's oil industry will slip into a slump. The country will become more dependent

on imports and oil in general. And, when oil prices rise again--as they surely will--the

industry will go right back to fracking America's deep shale deposits at full speed

without any additional environmental safeguards.

Where is Lewis Carroll when you need him?

View more quality content from Resource Insights

SUPPORTING THE DEVELOPMENT OF NATURAL RESOURCES

rpsgroup.com/energy energy@rpsgroup.com

Operations Support | Technical Studies | Advisory Services Project HSE & Risk Management | Training

16 OilVoice Magazine | JANUARY 2015

The OPEC Conundrum

Written by Euan Mearns from Energy Matters

When OPEC met on 27th November they decided to leave production unchanged

and to not meet again until June 2015. This at a time of volatility in oil markets and

plunging price that leaves many OPEC member states facing budget deficits, some

large and unmanageable.

In this post I take a look at the oil production and consumption history of OPEC and

find that historically OPEC has been as much controlled by markets as to be in

control of them.

17 OilVoice Magazine | JANUARY 2015

Figure 1 Oil production data for OPEC member states. Indonesia and Gabon have

both left OPEC. The situation in 1998 was very similar to that in 1973 (see text for

details). The $1000 question is whether 2014 is reminiscent of 1979?

Data

There is no satisfactory, easily accessible complete data set for OPEC oil production

and consumption. The EIA archives begin in 1980, a bit too late to be helpful. The

IEA data I have were transcribed from the monthly Oil Market Reports by Rembrandt

Koppelaar and begin in 2002. The BP data begins in 1965 providing the longest time

series and reports production for all OPEC countries. But does not report oil

consumption for 5 countries – Iraq, Libya, Nigeria, Angola and Gabon.

BP report annual crude+condensate+natural gas liquids (C+C+NGL) and I elected to

use this data since it is easy to use, even although it is incomplete. Oil exports are

deduced from the difference between reported production and consumption which is

an imperfect approach.

History

OPEC (the organisation of the petroleum exporting countries) was founded in 1960

by Iran, Iraq, Saudi Arabia, Kuwait and Venezuela. They were soon joined by several

other countries and the membership today is twelve strong. Countries have come

and gone, most notably Indonesia in 2009 since it became an importing country in

2003. Gabon left in 1995.

OPEC first flexed its muscles in 1974 in response to “western” assistance given to

Israel during the Yom Kippur War of 1973. This sent the oil price sky rocketing from

$17 (1973) to $55 (1974) (all prices adjusted to $2013). Surprisingly, OPEC at this

time, did not cut production and the punishment was delivered by an oil embargo.

But up until 1973, OPEC had been expanding production year on year to meet

growing global demand. In 1974, production was not increased and was held

constant for the following six years supporting the artificially raised price (Figure 1).

The second oil shock of 1979 actually had nothing to do with OPEC but was caused

by the Iranian Revolution that sent the price up from $50 in 1978 to $101 in 1979.

Careful examination of Figure 1 shows a slump in Iranian production from 1978

through 1979 and 1980. This was initially partially offset by increased output from

18 OilVoice Magazine | JANUARY 2015

OPEC who at this time wanted to protect their markets from overpriced oil. The price

remained over $100 in 1980 but it then turned downwards, partly in response to the

recession caused by the high price and to new supplies that were coming on stream

all over the world, most notably in the North Sea and Alaska. Sound familiar?

1980 marked the end of oil shock era and the beginning of an 18 year bear market

for the oil price that would collapse to $31 by 1986 and carry on down more slowly to

$18 by 1998, actually spending some time below $10 that year. From 1979, with

prices collapsing, OPEC cut production dramatically for 6 successive years without

managing to halt the slide. But then in 1986 OPEC increased production,

precipitating the final price rout. From then on, OPEC began to exert control over the

oil market rebuilding market share despite prices that continued to slide. Sound

familiar? By 1998, OPEC production had returned to 1979 levels and the price had

almost returned to pre-1974 levels. Market equilibrium had been restored.

The nadir of 1998 was a bleak time for the oil industry. I was running a small service

company at the time and remember it well. This was pre-information age era. Few of

the people I knew in the industry then understood what had just happened and even

fewer imagined what was to follow. Enter the era of mega-mergers.

1998 marked the beginning of the great oil bull run that would see daily price peak at

$148 in 2008 and the annual price peak at $115 in 2011. This bull run was not

caused by OPEC manipulation of events or war but by a simple supply and demand

dynamic where rising price has maintained market equilibrium.

Standing back to look at Figure 1 we see some remarkable similarities between the

situations in 1973 and 1998. OPEC had just increased production significantly to

over 30 Mbpd in each case. The oil price was chronically weak in each case. And in

each case in the following years OPEC maintained constant production and the price

soared. The situation today is not identical to 1979 but it does rhyme. This time

OPEC market share and oil price are not at risk from new giant fields like Prudhoe

Bay, Brent and Forties but from US shale oil.

Consumption and Exports

While many oil watchers will be familiar with the roller coaster OPEC production

data, less are familiar with the monotonic rise of OPEC oil consumption (Figure 2),

especially in the big population countries: Saudi Arabia, Iran, Venezuela and

19 OilVoice Magazine | JANUARY 2015

Indonesia – the latter leaving OPEC when consumption overtook production in 2003.

For the eight OPEC countries with data, consumption was 1 Mbpd in 1965 and has

grown to 8 Mbpd in 2013.

Figure 2 A common feature of oil producing nations is a thirst for oil. OPEC is no

different and has witnessed soaring consumption as prosperity and populations have

soared. No data for Iraq, Libya, Nigeria, Angola and Gabon.

20 OilVoice Magazine | JANUARY 2015

Figure 3 Because of rampant home demand (Figure 2) oil exports from selected

OPEC countries are in decline, a trend that is expected to continue. No data for Iraq,

Libya, Nigeria, Angola and Gabon.

Despite raising production to meet rampant demand since 2005, rampant home

consumption has meant OPEC exports (selected countries) going into slow decline

(Figure 3).

The End of OPEC?

OPEC has had a huge influence on global oil markets and thereby the world

economy, but as shown here has been buffeted around by market events as much

as it has managed to control them. We have entered a new period of uncertainty.

The organisation can be divided into three groups of countries: 1) the dysfunctional –

21 OilVoice Magazine | JANUARY 2015

Iraq, Iran and Libya where future production is just as likely to be controlled by

politics than by design: 2) the declining countries – Algeria, Nigeria, Angola and

Venezuela where resource exhaustion has sent production of conventional crude

into reverse (Figure 4) and 3) the super wealthy gulf states – Saudi Arabia, Kuwait,

UAE and Qatar where production is still rising to cover for falls elsewhere (Figure 1).

How long this can go on for is anyone’s guess. The power of OPEC will increasingly

be placed in the hands of these countries who have the capacity to increase

production and the wealth to withhold it as they see fit. The other countries are along

for the ride.

Figure 4 Just because a country exports oil does not make it immune to the resource

depletion that causes production to peak and then decline as observed in many

countries around the world. These four countries have all experienced production

decline in recent years. This is not necessarily terminal for these countries, but low

22 OilVoice Magazine | JANUARY 2015

oil prices will likely accelerate this process.

The press release from the 166th meeting is worth reading and this paragraph

caught my eye:

Recording its concern over the rapid decline in oil prices in recent months, the

Conference concurred that stable oil prices – at a level which did not affect global

economic growth but which, at the same time, allowed producers to receive a decent

income and to invest to meet future demand – were vital for world economic

wellbeing. Accordingly, in the interest of restoring market equilibrium, the Conference

decided to maintain the production level of 30.0 mb/d, as was agreed in December

2011. As always, in taking this decision, Member Countries confirmed their

readiness to respond to developments which could have an adverse impact on the

maintenance of an orderly and balanced oil market.

This pretty well sums up the OPEC conundrum. But note the closing sentence. They

have elected to take no action but reserve the right to act nonetheless. Expect to see

the super wealthy group of gulf producers cut production well before June 2015.

View more quality content from Energy Matters

23 OilVoice Magazine | JANUARY 2015

New York's Fracking Ban Reveals Energy Hypocrisy

Written by Loren Steffy from 30 Point Strategies

When I visit New York City, I often get a headache from the pollution. I notice that

the governor hasn't banned the use of cars. In fact, of all the things that cause

pollution in New York State, Gov. Andrew Cuomo last week chose to ban hydraulic

fracturing, the process used to extract oil and natural gas from shale rock deep in the

earth.

The decision came after a six-year moratorium on fracking in the Marcellus Shale

formation upstate. New York officials decided that fracking could contaminate the air

and water and pose a threat to public health.

First of all, it's important to understand that Cuomo has not banned fracking as he

claims. Instead, he's banned all oil and gas drilling activity in the state. In a report

used to justify the ban, state health officials fretted over fracking's purported dangers,

but never distinguished how fracking differs from conventional drilling in terms of its

environmental impact.

The report mentions water contamination and surface spills. In fact, the water

contamination that has occurred at fracking projects in other states has been the

result of poor wastewater disposal or failed well casings – the tubes that are

designed to project the water table as the drill bit passes through. These aren’t

problems unique to fracking, and most states in which drilling is common already

have regulations to address them.

The report also cites concern about an increase in earthquakes. While this matter

has been studied separately, even the author of that independent study called for

more research on the issue.

Given the moratorium that was already in place, the ban does little to hurt energy

companies directly. But it may encourage more cities and states to jump on the ban

24 OilVoice Magazine | JANUARY 2015

wagon. The industry’s long-standing public relations failures in addressing public

concern about fracking are coming to roost.

That’s already happened here in Texas. Just last month, the town of Denton, north of

Fort Worth, banned fracking within its city limits. Denton sits on the edge of the

Barnett Shale formation. A few miles to the west, in the same formation, Houstonian

George Mitchell perfected the process we now know as fracking over an 18-year

period beginning in 1980.

The difference in Denton’s ban was that it resulted not from vague studies about

“public health” but from residents’ anger at drilling companies’ disregard for the local

quality of life. Companies argued that since they had the right to drill, they could do

so any way they wanted. They could drill next to parks and schools, they could drill

adjacent to people’s homes, and they didn’t care if the process was disruptive.

Residents of Denton are not opposed to drilling for oil and natural gas, they’re

opposed to it being done with a callous disregard for their community and their

quality of life.

That ban now faces legal challenges from state regulators and the oil industry, and

most predictions are that it won’t stand. New York, too, can look forward to years of

litigation over the issue, during which time it may have to actually provide legal proof

of the health threats it continues to claim are unique to fracking.

Of course, while it bans fracking, New York will undoubtedly continue to belch forth

pollutants from the streets of Manhattan and other cities. Neither the governor nor

the public health officials have taken steps to lessen the state’s consumption of fossil

fuels.

In fact, it may even double down on its ongoing hypocrisy of mooching the benefits

of cheap energy from neighboring Pennsylvania, which has shown far more

pragmatism in its energy policy than Cuomo has with his political pandering.

The Marcellus is primarily a natural gas formation, and natural gas prices remain

depressed. By banning fracking, New Yorkers have basically assured that additional

supplies won’t be coming to market and depressing prices further. Cuomo may have

inadvertently provided price supports for the very energy companies he’s trying to

keep out of the state. In theory, all his constituents ultimately could pay more to heat

25 OilVoice Magazine | JANUARY 2015

their homes than they would have if he had lifted the moratorium.

Either way, New Yorkers will continue to enjoy lower prices for gasoline and continue

to switch from heating oil to cheaper natural gas thanks to fracking in other states.

Cuomo’s decision to ban fracking simply underscores the point that New Yorkers

remain blissfully oblivious to the tradeoffs they make every day when it comes to

energy. No wonder my head hurts every time I go there.

Loren Steffy is a managing director with the communications firm 30 Point

Strategies. He is a writer at large for Texas Monthly, a contributor to Forbes and the

author of Drowning in Oil: BP and the Reckless Pursuit of Profit and The Man Who

Thought Like a Ship.Follow him on Twitter: @lsteffy; on Facebook or

at lorensteffy.com.

View more quality content from 30 Point Strategies

26 OilVoice Magazine | JANUARY 2015

Oil producers commit mass suicide

Written by Andrew McKillop from AMK CONSULT

Everyone's A Loser, Baby

David Nelson, former Lehman Bros chief analys speaking on Aljazeera.com's 'Inside

Story', December 11 said that at least in the short term, and possibly for the long

term, OPEC has decided to commit collective suicide by setting a strategy of "keep

pumping and hope". The programme quoted a Saudi oil spokesman as saying the oil

market "will sort itself out".

Inchallah, to be sure, but the high gain positive feedback of savage write downs on

inflated oil-linked assets, and oil sector de-leveraging to cut debt as loan costs soar

on risky assets could upstage that cozy philosophical approach. World Bank oil

specialist Mamdouh Salameh, also interviewed on 'Inside Story' said that Saudi

Arabia's national budget needs high priced oil to support government spending,

exactly like Russia, Canada, Iran Nigeria, Iraq, Venezuela and a list of other export

producers getting anywhere from 35% to 85% of their total government revenues

from oil. In the US its shale oil producers, according to Salameh, could perhaps live

with $65 or $70 a barrel, but not much less, although in fact that also concerns the

cost of loans to shale producers, which will certainly get more expensive.

Saudi Arabia, Salameh said, needs around $90 a barrel, like Russia, but other

producers like Iran, Iraq, Nigeria and Venezuela need as much as $125 a barrel to

keep their governments alive and kicking. Both in Iraq and Nigeria, battling Islamic

insurgents, this has a clear national security handle. For David Nelson, these are the

Loser Countries and a minority. Major importers including China, Japan and India,

and major European importers will get a boost for consumer spending in particular

and their economies in general, if oil prices stay below $60 per barrel for the next 12

- 18 months. He called this is a major transfer of wealth at the global level, and the

net upside of cheaper oil will be bigger than the downside. Other speakers on 'Inside

Story- - and a host of similar programs and features in world media at this time -

however argue that this oil price crash is not just a story of overproduction or

sluggish demand, or geopolitical action notably aimed at weakening Russia and Iran

27 OilVoice Magazine | JANUARY 2015

(if not ISIS!), but a long-maturing global shift away from oil and fossil energy. Long is

the keyword.

E Sometimes Equals MC Squared

In theory and (repeat) only in theory the oil price crash should trigger a swath of

falling dominos across the so-called "tradable asset space". Overpriced oil was as

critical to the financial industry bubble economy as overpriced housing and real

estate still are. Taking the example of oil and gas sector financing, overall capital

expenditure or "capex" in the sector, which sources such as 'Oil and Gas Journal',

Barclays and Citigroup placed at around $725 billion in 2013-2014, but only $200

billion in 2005-2006, (about 60% of it in the USA and 40% in the rest of the world),

could easily shrink back to 2006 levels. With leverage, more precisely with de-

leverage, the crash of nominal asset values in the sector could be, as they say,

"awesome" for the bank-broker-insurance companies feeding off the splurge. Not

only oil producers and the finance "industry" fear the petrodollar glut morphing to

famine - central bankers fear the deflation that will be caused by cheaper energy.

High-priced oil at least bolstered global demand, fed whatever inflation still existed,

and gave the financial "industry" easy pickings like making "no brainer" bets on rising

oil prices - that always rose. Until very recently, overpriced oil was "forever".

Financial spillover and knock-on from a rapid crash in oil prices could also be

awesome for national debt funding, for example rising bond rates on OPEC and

nonOPEC country loans, with the pain intensified by currency devaluation of the

"petromoneys". But sectors favored by cheaper oil - like airlines and shipping - could

lever up in an impressive way, measured as increased equity prices for airline

companies and a slowing of the rout in world shipping. Food producers and retailers

of low-grade "meals for the masses" like McDonalds or Burger King, who convert oil

to pseudo-food, could get a fillip for their bottom lines, like the equity prices for any

other "high BTU" economic sector such as carmaking.

Claims by some analysts like Salameh in the Aljazeera programme, are an article of

faith for the International Energy Agency (IEA) and for OPEC's Secretariat. They say

that cheaper oil will rapidly pull global oil demand upwards, despite a host of reasons

to doubt that. The simplistic argument is that falling capex in oil and gas, plus rising

demand on the back of cheaper oil firing economic growth will soon cause another

oil price explosion.

28 OilVoice Magazine | JANUARY 2015

As it did (not do) following the 1986 oil price crash? Looking for models and

precedents, the 1986 oil price crash and its sequels including about 15 years of

cheap oil could be tried - and found wanting. In theory an awesome event, the 1986

price crash had dramatically little impact on the world economy - or on geepolitics.

Cheap oil for example and notably did nothing to slow the deindustrialization of the

“mature western economies" and the rise to industrial supergiant status of China -

which in any case was fuelled by coal, not oil.

The financialization of the economy proceeded and today's financial leverage built

from overpriced oil is vastly bigger than in the cheap oil era of about 1986-2002.

Another major and "perverse impact" of cheaper oil was in economic policy.

Following the 1986 oil price crash (a 67% decline in 6 months), sweet-and-low oil

prices merely served to bolster a decade of slow economic growth in the "mature

economies" at growth rates which themselves slowly declined. But this process was

called "the Clinton boom years" for equities due to equities de-linking themselves

from the real economy and floating high and free.The crisis years of 1998-2001

period, starting with the Asian and Russian meltdowns were a partial correction.

Keep Equities Growing

Today, the financialized meta-economy or degutted husk economy is vast, and so

detached from the real economy that a 1986-style oil price crash, on "prima facie

grounds" should have absolutely no impact, except to stimulate equity growth! In

particularly financialized "empty husk economies" like the UK, the heroic struggle will

continue to keep house prices rising despite the minor price-shaving impact of

cheaper energy on construction industries, and crony governments will siphon the

benefit of cheaper oil by holding back on any tax and duty cuts on energy, or raising

tax and duties on energy until the bitter political end.

The real and major impact of the current oil price crash is likely to be financial and

geopolitical, not economic. Falling dominos in the finance "industry", triggered by oil

price falls could be impressive in their impact, even impacting broad-brush indexes

like the FTSE and S&P 500. The OPEC states and Russia are in the firing line for

being forced to install their own austerity programs, which for Saudi Arabia and other

Gulf producers could mean less generous funding for the gory civil war they finance

in Syria.

One unsurprising impact of the 1986 price crash was a massive retreat from oil

29 OilVoice Magazine | JANUARY 2015

sector development - from exploration and development through downstream

petrochemicals, surely fitting the IEA and OPEC Secretariat narrative of cheap oil

setting the scene for another oil price explosion. However, geopolitcal claims for the

benefits of an oil price crash include the sequels following the 1986 price slump. The

1980-1988 Iran-Iraq war was shortened due to both sides losing oil revenues, and

the crash accelerated the collapse of the USSR in 1989. Concerning the Iran-Iraq

war (Iran is now aiding the Baghdad government in its life and death struggle with

ISIS) , both protagonists were starved of petrodollars, but Iraq was bailed out by the

Gulf states, including Kuwait. Everybody knows the sequels of Kuwait demanding full

repayment of its war loans to Saddam Hussein's Iraq! The demise of the Soviet

Union is difficult to attribute mainly to falling oil and gas revenues but the experience

on Russian society of a long, lost decade of economic hardship through the Yeltsin

years likely included the later "price hawk" attitude to oil by Putin's administrations.

What we might conclude at this time is that a series of financial, economic and

geopolitical events and processes driven by the oil price rout will unfold. Overall,

deflation and a further slowing of economic growth may take the driver's seat, as well

as a major shake-up in the financial sector. However, the geopolitical impacts may

be large and long-term, this time around, but will need time to exert themselves.

View more quality content from AMK CONSULT

30 OilVoice Magazine | JANUARY 2015

Turnabout: OPEC shows U.S. oil producers who's boss

Written by Kurt Cobb from Resource Insights

To paraphrase Mark Twain: Rumors of OPEC's demise have been greatly

exaggerated.

Breathless coverage of the rise in U.S. oil production in the last few years has led

some to declare that OPEC's power in the oil market is now becoming irrelevant as

America supposedly moves toward energy independence. This coverage, however,

has obscured the fact that almost all of that rise in production has come in the form

of high-cost tight oil found in deep shale deposits.

The rather silly assumption was that oil prices would continue to hover above $100

per barrel indefinitely, making the exploitation of that tight oil profitable indefinitely.

Anyone who understood the economics of this type of production and the dynamics

of the oil market knew better. And now, the overhyped narrative of American oil self-

sufficiency is about to take a big hit.

After weeks of speculation about the true motives behind OPEC's decision to

maintain production in the face of declining world demand--which has led to a major

slump in oil prices--the oil cartel explicitly stated at its most recent meeting that it is

trying to destroy U.S. tight oil production by making it unprofitable.

One of the things a cartel can do--if it controls enough market share--is destroy

competition through a price war. Somehow the public and policymakers got fixated

on OPEC's ability to restrict production in order to raise prices and forgot about its

ability to flood the world market with oil and not just stabilize prices, but cause them

to crash.

The industry claims that most U.S. tight oil plays are profitable below $80. And,

drillers say they are driving production costs down and can weather lower prices.

OPEC's move will now test these statements. The current American benchmark

31 OilVoice Magazine | JANUARY 2015

futures price of about $65 per barrel suggests that OPEC took into consideration the

breakeven points cited in the linked article above.

It is largely Saudi Arabia which enables OPEC to have production flexibility since the

kingdom maintains significant spare capacity, declared to be in the range of 1.5 to 2

million barrels per day (mbpd). OPEC says in its "World Oil Outlook 2014" that all of

OPEC has about 4 mbpd of spare capacity, though one analyst recently put the

number at 3.3 mbpd.

Whatever the precise number, in practical terms Saudi Arabia is the Walmart of

world oil markets, able to affect a price drop at the turn of a few valves or through

failure to turn them off in the face of falling demand. In this case, the country did not

turn off any of its production in response to weakening world demand. Nor did other

OPEC members. Having twisted enough arms in the most recent OPEC meeting,

Saudi Arabia got its way with a commitment from OPEC members to hold production

steady, thus putting further pressure on the oil price in the wake of falling

demand. Both of the world's major oil futures contracts fell by 7 percent after the

announcement.

The effect has been far greater in North Dakota than the ongoing drop in futures

prices would indicate. That state, which is at the center of the U.S. tight oil boom, is

far from refineries and pipelines. Oil producers use expensive rail transport to carry

their oil to market. The result is that North Dakota producers face a significant

discount at the wellhead. For October the average discount was $15.40 per barrel

below the U.S. benchmark Light Sweet Crude futures price. If we take that discount

and apply it to last Friday's close, that would imply that North Dakota producers are

now receiving $50.59 per barrel--a level unlikely to be profitable except for the most

prolific wells.

If prices remain that low, OPEC will almost certainly achieve its objective of

preventing significant investment in new production in the state. Other major tight oil

production is centered in Texas, closer to pipelines and thus not subject to discounts

of this magnitude. Still, with oil around $65 per barrel, it is likely that production

would rise very little in Texas in the tight oil plays, if at all. Deposits outside

the "sweet spots" currently being drilled are almost certainly uneconomic at such

prices.

If a prolonged low price leads to painful and permanent losses for owners of shares

32 OilVoice Magazine | JANUARY 2015

and bonds of the tight oil drillers--and for those invested directly in actual wells--there

will be less appetite among investors to rush in even when oil prices recover. That's

precisely what OPEC is counting upon. It knows that free cash flow (cash earned

from operations minus capital expenditures) for independent drillers has been wildly

negative since 2010. The furious drilling of the past few years has been financed

largely by share issues and debt rather than earnings from previous wells.

At these new low oil prices, it's unlikely that many investors will be willing to put more

money to work in the tight oil deposits of America. That will make it hard for drillers to

fund new drilling since they have insufficient cash being generated by current

operations. In addition, with oil prices significantly down, many independent drillers

may have a hard time paying off their debts, let alone paying the costs of drilling a

large number of new wells. And with yearly field production decline rates in tight oil

areas of about 40 percent--which simply means that no drilling for a year would

result in a 40 percent decline in production--drillers have to drill a large number of

new wells just to make up for production declines in existing wells BEFORE they get

to new wells that actually add to the overall rate of production. A significant drop in

the rate of drilling in U.S. tight oil plays could actually result in lower overall U.S. oil

production.

Lower oil prices tend to increase demand for oil as people can afford more energy

for consumer and industrial purposes. So, OPEC is fully expecting demand and then

prices to rise over the medium term--but not, it hopes, soon enough to bail out tight

oil drillers.

All things being equal, lower oil prices tend to increase economic activity and may

help Europe and Asia avoid a recession by lowering energy costs significantly. But

all things may not be equal since at least one analyst believes the current rout in the

oil markets could lead to cascading defaults that start with the junk bond debt of oil

drillers and move through banks heavily invested in oil company debt. That, in turn,

could cause a general stock market collapse. Thus, instead of promoting economic

growth, low oil prices would be the cause of the next stock market crash and the next

worldwide recession.

Such a recession would likely sink oil prices further, putting extreme financial

pressure on OPEC members less well-endowed than Saudi Arabia. And, it would

upset OPEC's timetable for a return to higher prices and profits--delaying it perhaps

for years. It would also put another nail in the coffin of the American oil

33 OilVoice Magazine | JANUARY 2015

independence story--one that even the ever-optimistic U.S. Department of Energy

never believed at high prices--by moving many of the U.S. oil plays previously

considered viable into the uneconomic category.

View more quality content from Resource Insights

Ten reasons why a severe drop in oil prices is a problem

Written by Gail Tverberg from Our Finite World

Not long ago, I wrote Ten Reasons Why High Oil Prices are a Problem. If high oil

prices can be a problem, how can low oil prices also be a problem? In particular,

how can the steep drop in oil prices we have recently been experiencing also be a

problem?

Let me explain some of the issues:

Issue 1. If the price of oil is too low, it will simply be left in the ground.

The world badly needs oil for many purposes: to power its cars, to plant it fields, to

operate its oil-powered irrigation pumps, and to act as a raw material for making

many kinds of products, including medicines and fabrics.

If the price of oil is too low, it will be left in the ground. With low oil prices, production

may drop off rapidly. High price encourages more production and more substitutes;

low price leads to a whole series of secondary effects (debt defaults resulting from

34 OilVoice Magazine | JANUARY 2015

deflation, job loss, collapse of oil exporters, loss of letters of credit needed for

exports, bank failures) that indirectly lead to a much quicker decline in oil production.

The view is sometimes expressed that once 50% of oil is extracted, the amount of oil

we can extract will gradually begin to decline, for geological reasons. This view is

only true if high prices prevail, as we hit limits. If our problem is low oil prices

because of debt problems or other issues, then the decline is likely to be far more

rapid. With low oil prices, even what we consider to be proved oil reserves today

may be left in the ground.

Issue 2. The drop in oil prices is already having an impact on shale extraction

and offshore drilling.

While many claims have been made that US shale drilling can be profitable at low

prices, actions speak louder than words. (The problem may be a cash flow problem

rather than profitability, but either problem cuts off drilling.) Reuters indicates that

new oil and gas well permits tumbled by 40% in November.

Offshore drilling is also being affected. Transocean, the owner of the biggest fleet of

deep water drilling rigs, recently took a $2.76 billion charge, among a “drilling rig

glut.”

3. Shale operations have a huge impact on US employment.

Zero Hedge posted the following chart of employment growth, in states with and

without current drilling from shale formations:

35 OilVoice Magazine | JANUARY 2015

Figure 1. Jobs in States with and without Shale Formations, from Zero Hedge.

Clearly, the shale states are doing much better, job-wise. According to the article,

since December 2007, shale states have added 1.36 million jobs, while non-shale

states have lost 424,000 jobs. The growth in jobs includes all types of employment,

including jobs only indirectly related to oil and gas production, such as jobs involved

with the construction of a new supermarket to serve the growing population.

It might be noted that even the “Non-Shale” states have benefited to some extent

from shale drilling. Some support jobs related to shale extraction, such as extraction

of sand used in fracking, college courses to educate new engineers, and

manufacturing of parts for drilling equipment, are in states other than those with

shale formations. Also, all states benefit from the lower oil imports required.

36 OilVoice Magazine | JANUARY 2015

Issue 4. Low oil prices tend to cause debt defaults that have wide ranging

consequences. If defaults become widespread, they could affect bank deposits

and international trade.

With low oil prices, it becomes much more difficult for shale drillers to pay back the

loans they have taken out. Cash flow is much lower, and interest rates on new loans

are likely much higher. The huge amount of debt that shale drillers have taken on

suddenly becomes at-risk. Energy debt currently accounts for 16% of the US junk

bond market, so the amount at risk is substantial.

Dropping oil prices affect international debt as well. The value of Venezuelan bonds

recently fell to 51 cents on the dollar, because of the high default risk with low oil

prices. Russia’s Rosneft is also reported to be having difficulty with its loans.

There are many ways banks might be adversely affected by defaults, including

Directly by defaults on loans held be a bank

Indirectly, by defaults on securities the bank owns that relate to loans

elsewhere

By derivative defaults made more likely by sharp changes in interest rates or

in currency levels

By liquidity problems, relating to the need to quickly sell or buy securities

related to ETFs

After the many bank bailouts in 2008, there has been discussion of changing the

system so that there is no longer a need to bail out “too big to fail” banks. One

proposal that has been discussed is to force bank depositors and pension funds to

cover part of the losses, using Cyprus-style bail-ins. According to some reports, such

an approach has been approved by the G20 at a meeting the weekend of November

16, 2014. If this is true, our bank accounts and pension plans could already be at

risk.1

Another bank-related issue if debt defaults become widespread, is the possibility that

junk bonds and Letters of Credit2 will become outrageously expensive for companies

that have poor credit ratings. Supply chains often include some businesses with poor

credit ratings. Thus, even businesses with good credit ratings may find their supply

chains broken by companies that can no longer afford high-priced credit. This was

one of the issues in the 2008 credit crisis.

37 OilVoice Magazine | JANUARY 2015

Issue 5. Low oil prices can lead to collapses of oil exporters, and loss of

virtually all of the oil they export.

The collapse of the Former Soviet Union in 1991 seems to be related to a drop in oil

prices.

Figure 2. Oil production and price of the Former Soviet Union, based on BP

Statistical Review of World Energy 2013.

Oil prices dropped dramatically in the 1980s after the issues that gave rise to the

earlier spike were mitigated. The Soviet Union was dependent on oil for its export

revenue. With low oil prices, its ability to invest in new production was impaired, and

its export revenue dried up. The Soviet Union collapsed for a number of reasons,

some of them financial, in late 1991, after several years of low oil prices had had a

chance to affect its economy.

Many oil-exporting countries are at risk of collapse if oil prices stay very low very

long. Venezuela is a clear risk, with its big debt problem. Nigeria’s economy

is reported to be “tanking.” Russia even has a possibility of collapse, although

probably not in the near future.

Even apart from collapse, there is the possibility of increased unrest in the Middle

East, as oil-exporting nations find it necessary to cut back on their food and oil

38 OilVoice Magazine | JANUARY 2015

subsidies. There is also more possibility of warfare among groups, including new

groups such as ISIL. When everyone is prosperous, there is little reason to fight, but

when oil-related funds dry up, fighting among neighbors increases, as does unrest

among those with lower subsidies.

Issue 6. The benefits to consumers of a drop in oil prices are likely to be much

smaller than the adverse impact on consumers of an oil price rise.

When oil prices rose, businesses were quick to add fuel surcharges. They are less

quick to offer fuel rebates when oil prices go down. They will try to keep the benefit

of the oil price drop for themselves for as long as possible.

Airlines seem to be more interested in adding flights than reducing ticket prices in

response to lower oil prices, perhaps because additional planes are already

available. Their intent is to increase profits, through an increase in ticket sales, not to

give consumers the benefit of lower prices.

In some cases, governments will take advantage of the lower oil prices to increase

their revenue. China recently raised its oil products consumption tax, so that the

government gets part of the benefit of lower prices. Malaysia is using the low oil

prices as a time to reduce oil subsidies.

Most businesses recognize that the oil price drop is at most a temporary situation,

since the cost of extraction continues to rise (because we are getting oil from more

difficult-to-extract locations). Because the price drop this is only temporary, few

business people are saying to themselves, “Wow, oil is cheap again! I am going to

invest a huge amount of money in a new road building company [or other business

that depends on cheap oil].” Instead, they are cautious, making changes that require

little capital investment and that can easily be reversed. While there may be some

jobs added, those added will tend to be ones that can easily be dropped if oil prices

rise again.

39 OilVoice Magazine | JANUARY 2015

Issue 7. Hoped for crude and LNG sales abroad are likely to disappear, with

low oil prices.

There has been a great deal of publicity about the desire of US oil and gas

producers to sell both crude oil and LNG abroad, so as to be able to take advantage

of higher oil and gas prices outside the US. With a big drop in oil prices, these hopes

are likely to be dashed. Already, we are seeing the story, Asia stops buying US

crude oil. According to this story, “There’s so much oversupply that Middle East

crudes are now trading at discounts and it is not economical to bring over crudes

from the US anymore.”

LNG prices tend to drop if oil prices drop. (Some LNG prices are linked to oil prices,

but even those that are not directly linked are likely to be affected by the lower

demand for energy products.) At these lower prices, the financial incentive to export

LNG becomes much less. Even fluctuating LNG prices become a problem for those

considering investment in infrastructure such as ships to transport LNG.

Issue 8. Hoped-for increases in renewables will become more difficult, if oil

prices are low.

Many people believe that renewables can eventually take over the role of fossil fuels.

(I am not of view that this is possible.) For those with this view, low oil prices are a

problem, because they discourage the hoped-for transition to renewables.

Despite all of the statements made about renewables, they don’t really substitute for

oil. Biofuels come closest, but they are simply oil-extenders. We add ethanol made

from corn to gasoline to extend its quantity. But it still takes oil to operate the farm

equipment to grow the corn, and oil to transport the corn to the ethanol plant. If oil

isn’t around, the biofuel production system comes to a screeching halt.

Issue 9. A major drop in oil prices tends to lead to deflation, and because of

this, difficulty in repaying debts.

If oil prices rise, so do food prices, and the price of making most goods. Thus rising

oil prices contribute to inflation. The reverse of this is true as well. Falling oil prices

tend to lead to a lower price for growing food and a lower price for making most

goods. The net result can be deflation. Not all countries are affected equally; some

experience this result to a greater extent than others.

40 OilVoice Magazine | JANUARY 2015

Those countries experiencing deflation are likely to eventually have problems with

debt defaults, because it will become more difficult for workers to repay loans, if

wages are drifting downward. These same countries are likely to experience an

outflow of investment funds because investors realize that funds invested these

countries will not earn an adequate return. This outflow of funds will tend to push

their currencies down, relative to other currencies. This is at least part of what has

been happening in recent months.

The value of the dollar has been rising rapidly, relative to many other currencies.

Debt repayment is likely to especially be a problem for those countries where

substantial debt is denominated in US dollars, but whose local currency has recently

fallen in value relative to the US dollar.

Figure 3. US Dollar Index from Intercontinental Exchange

The big increase in the US dollar index came since June 2014 (Figure 3), which

coincides with the drop in oil prices. Those countries with low currency prices,

including Japan, Europe, Brazil, Argentina, and South Africa, find it expensive to

import goods of all kinds, including those made with oil products. This is part of what

41 OilVoice Magazine | JANUARY 2015

reduces demand for oil products.

China’s yuan is relatively closely tied to the dollar. The collapse of other currencies

relative to the US dollar makes Chinese exports more expensive, and is part of the

reason why the Chinese economy has been doing less well recently. There are no

doubt other reasons why China’s growth is lower recently, and thus its growth in

debt. China is now trying to lower the level of its currency.

Issue 10. The drop in oil prices seems to reflect a basic underlying problem:

the world is reaching the limits of its debt expansion.

There is a natural limit to the amount of debt that a government, or business, or

individual can borrow. At some point, interest payments become so high, that it

becomes difficult to cover other needed expenses. The obvious way around this

problem is to lower interest rates to practically zero, through Quantitative Easing

(QE) and other techniques.

(Increasing debt is a big part of pumps up “demand” for oil, and because of this, oil

prices. If this is confusing, think of buying a car. It is much easier to buy a car with a

loan than without one. So adding debt allows goods to be more affordable. Reducing

debt levels has the opposite effect.)

QE doesn’t work as a long-term technique, because it tends to create bubbles in

asset prices, such as stock market prices and prices of farmland. It also tends to

encourage investment in enterprises that have questionable chance of success.

Arguably, investment in shale oil and gas operations are in this category.

As it turns out, it looks very much as if the presence or absence of QE may have an

impact on oil prices as well (Figure 4), providing the “uplift” needed to keep oil prices

high enough to cover production costs.

42 OilVoice Magazine | JANUARY 2015

Figure 4. World “liquids production” (that is oil and oil substitutes) based on EIA data,

plus OPEC estimates and judgment of author for August to October 2014. Oil price is

monthly average Brent oil spot price, based on EIA data.

The sharp drop in price in 2008 was credit-related, and was only solved when the US

initiated its program of QE started in late November 2008. Oil prices began to rise in

December 2008. The US has had three periods of QE, with the last of these, QE3,

finally tapering down and ending in October 2014. Since QE seems to have been

part of the solution that stopped the drop in oil prices in 2008, we should not be

surprised if discontinuing QE is contributing to the drop in oil prices now.

Part of the problem seems to be differential effect that happens when other countries

are continuing to use QE, but the US not. The US dollar tends to rise, relative to

other currencies. This situation contributes to the situation shown in Figure 3.

QE allows more borrowing from the future than would be possible if market interest

rates really had to be paid. This allows financiers to temporarily disguise a growing

problem of un-affordability of oil and other commodities.

The problem we have is that, because we live in a finite world, we reach a point

where it becomes more expensive to produce commodities of many kinds: oil

(deeper wells, fracking), coal (farther from markets, so more transport costs), metals

(poorer ore quality), fresh water (desalination needed), and food (more irrigation

43 OilVoice Magazine | JANUARY 2015

needed). Wages don’t rise correspondingly, because more and more labour is

needed to provide less and less actual benefit, in terms of the commodities produced

and goods made from those commodities. Thus, workers find themselves becoming

poorer and poorer, in terms of what they can afford to purchase.

QE allows financiers to disguise growing mismatch between what it costs to produce

commodities, and what customers can really afford. Thus, QE allows commodity

prices to rise to levels that are unaffordable by customers, unless customers’ lack of

income is disguised by a continued growth in debt.

Once commodity prices (including oil prices) fall to levels that are affordable based

on the incomes of customers, they fall to levels that cut out a large share of

production of these commodities. As commodity production drops to levels that can

be produced at affordable prices, so does the world’s ability to make goods and

services. Unfortunately, the goods whose production is likely to be cut back if

commodity production is cut back are those of every kind, including houses, cars,

food, and electrical transmission equipment.

Conclusion

There are really two different problems that a person can be concerned about:

1. Peak oil: the possibility that oil prices will rise, and because of this production

will fall in a rounded curve. Substitutes that are possible because of high

prices will perhaps take over.

2. Debt related collapse: oil limits will play out in a very different way than most

have imagined, through lower oil prices as limits to growth in debt are

reached, and thus a collapse in oil “demand” (really affordability). The

collapse in production, when it comes, will be sharper and will affect the entire

economy, not just oil.

In my view, a rapid drop in oil prices is likely a symptom that we are approaching a

debt-related collapse–in other words, the second of these two problems. Underlying

this debt-related collapse is the fact that we seem to be reaching the limits of a finite

world. There is a growing mismatch between what workers in oil importing countries

can afford, and the rising real costs of extraction, including associated governmental

costs. This has been covered up to date by rising debt, but at some point, it will not

be possible to keep increasing the debt sufficiently.

44 OilVoice Magazine | JANUARY 2015

The timing of collapse may not be immediate. Low oil prices take a while to work

their way through the system. It is also possible that the world’s financiers will put off

a major collapse for a while longer, through more QE, or more programs related to

QE. For example, actually getting money into the hands of customers would seem to

be temporarily helpful.

At some point the debt situation will eventually reach a breaking point. One way this

could happen is through an increase in interest rates. If this happens, world

economic growth is likely to slow greatly. Oil and commodity prices will fall further.

Debt defaults will skyrocket. Not only will oil production drop, but production of many

other commodities will drop, including natural gas and coal. In such a scenario, the

downslope of all energy use is likely to be quite steep, perhaps similar to what is

shown in the following chart.

Figure 5. Estimate of future energy production by author. Historical data based on

BP adjusted to IEA groupings.

Notes:

[1] There is of course insurance by the FDIC and the PBGC, but the actual funding

for these two insurance programs is tiny in relationship to the kind of risk that would

occur if there were widespread debt defaults and derivative defaults affecting many

banks and many pension plans at once. While depositors and pension holders might

45 OilVoice Magazine | JANUARY 2015

try to collect this insurance, there wouldn’t be enough money to actually cover these

demands. This problem would be similar to the issue that arose in Iceland in 2008.

Insurance would seem to be available, but in practice, would not pay out much.

Also, I learned after writing this post that bail-ins were mandated for US banks by

the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010. In the

language of the summary, bank depositors are “unsecured creditors,” and are thus

among those to whom the burden of loss is transferred. The FDIC is not allowed to

borrow extra funds, beyond bank funds, to cover this loss.

[2] LOCs are required when goods are shipped internationally, before payment has

actually been made. They offer a guarantee that a buyer will be able to “make good”

on his promise to pay for goods when they arrive.

View more quality content from Our Finite World

The oil price is all about ONE number right now

Written by Keith Schaefer from Oil & Gas Investments Bulletin

There is only ONE number in the oil price saga that’s important to investors. It’s the

same number the Saudis are tracking.

That is: how much did US oil production increase in the last week.

That number is released every Wednesday morning at 10:30 EST in the weekly EIA

(US Energy Information Administration) put out by the US government.

46 OilVoice Magazine | JANUARY 2015

Investors can find that data right here—the direct link is: Weekly US Oil Production

Increase (just scroll down to the bottom or click on the excel file)

The global oil price will have its biggest 30 minute move of the week right at 10:30

am right then—both the international Brent benchmark and the US domestic WTI

(West Texas Intermediate) price.

Why is this number so important?

Because it’s very clear in Saudi communications they want to put a bridle on

galloping US oil production.

(Notice I didn’t say OPEC. The Saudis don’t care a whit about other OPEC countries.

Members like Nigeria, Algeria, Venezuela are either so corrupt or so unable to cut

production that the Saudis ignore them—as they should.)

The Saudis are watching this US production number like a hawk—as they should.

The unbridled oil production growth in the US from the Shale Revolution has

disrupted oil flows and prices like nothing else since the OPEC embargo in the early

1970s.

Everyone has seen this chart of US oil production:

That’s a very steep upward curve right now. US oil production is on a RAPID

increase. Here’s the excel file from the weekly EIA report, and I added a third column

and calculated the weekly change in production for the last few months:

47 OilVoice Magazine | JANUARY 2015

There have been a couple times that US production has dropped a couple weeks in

a row this year.

For the Market to begin to think the oil price has bottomed, it has to see US

production drop AT LEAST THREE weeks in a row.

Only God knows when that might happen.

Improvements in fracking are STILL increasing flow rates per metre drilled—five

years after the Shale Revolution really took off.

This is increasing cash flows and reducing break-even costs for tight oil producers.

Exports of US refined products continue to hit new highs—now over 4 million barrels

a day.

Personally, I don’t think the Saudis start to collect other OPEC members to talk

48 OilVoice Magazine | JANUARY 2015

about cutbacks until the price is low enough that American oil production growth

slows down—a lot.

By the way, this number is always a true surprise to the Market.

Gas production can be estimated with pipeline flows (in fact US energy consultant

Bentek out of Denver Colorado puts out a daily estimate of US natural gas

production) but with the weekly Wednesday morning oil number—there is no way to

“game” that number.

What are not-so-relevant numbers?

1. Overall, all-in costs for oil and gas production. These numbers are great for

PhDs, academics or first year college economics students. But for investors

they are meaningless. In the short term during a rout like this, there is no

bottom—especially with financial derivatives deciding much of the price

movement.

2. The price that various OPEC countries need to balance their budgets. Like I

said, the Saudis are the only relevant producer in OPEC and they don’t care

about the other countries in the cartel (yet)—so investors need not bother with

this statistic either.

EDITORS NOTE–The lower Canadian dollar has shielded close to half the drop in the price of oil. So their cash flows could surprise the Market in early 2015. I have a new report which outlines my Top 3 Juniors that will the biggest and fastest inflows as oil finds a bottom. It’s where the easy money will be–and soon. Click Here to be positioned to profit.

View more quality content from Oil & Gas Investments Bulletin

49 OilVoice Magazine | JANUARY 2015

The 2014 oil price crash explained

Written by Euan Mearns from Energy Matters

In February 2009 Phil Hart published on The Oil Drum a simple supply

demand model that explained then the action in the oil price. In this post I

update Phil’s model to July 2014 using monthly oil supply (crude+condensate)

and price data from the Energy Information Agency (EIA).

This model explains how a drop in demand for oil of only 1 million barrels per

day can account for the fall in price from $110 to below $80 per barrel.

The future price will be determined by demand, production capacity and

OPEC production constraint. A further fall in demand of the order 1 Mbpd may

see the price fall below $60. Conversely, at current demand, an OPEC

production cut of the order 1 Mbpd may send the oil price back up towards

$100. It seems that volatility has returned to the oil market.

50 OilVoice Magazine | JANUARY 2015

Figure 1 An adaptation of Phil Hart’s oil supply demand model. The blue supply line

is constrained by data (see Figure 4). The red demand lines are conceptual. Prior to

2004, oil supply was fairly elastic to changes in price, i.e. a small rise in price led to a

large rise in production. This is explained by OPEC opening and closing the taps.

Post 2004, oil supply became inelastic to price, i.e. a large change in price led to

marginal increase in supply. This is explained by the world pumping flat out. Demand

tends to be fairly inelastic and inversely correlated with price in that high price

suppresses demand a little. Supply and price at any point in time is defined by the

intersection of the supply and demand curves. 72 Mbpd and $40 / bbl in 2004

became 76 Mbpd and $120 / bbl in 2008 as demand for oil soared against inelastic

supply.

Figure 2

Followers of the oil market will be familiar with the recent evolution of oil supply and

price shown in Figure 2.

51 OilVoice Magazine | JANUARY 2015

Figure 3

What is less widely appreciated is that a cross plot of the data shown in Figure 2

results in the well-ordered relationship shown in Figure 3. Oil supply and price are

clearly following some well established rules. This relationship led to Phil Hart

developing his model shown as Figure 1.

52 OilVoice Magazine | JANUARY 2015

Figure 4

Separating the data into two time periods brings more clarity to the process at work.

The data define a fairly well-ordered time series beginning at January 1994 at the

bottom left rising slowly to January 2004 and then steeply to the Olympic Peak of

July 2008. The financial crash then caused the oil price to give up all of its gains

returning to 2004 levels by December 2008.

53 OilVoice Magazine | JANUARY 2015

Figure 5

The second time period from January 2009 to the present shows some different

forces at work. Starting in 2009 some new production capacity was built. This was

not in OPEC and is concentrated in N America where the light tight oil (LTO) boom

took off supplemented by steady expansion of tar sands production. Prior to 2009,

the production peaks were of the order 74 Mbpd. Post 2009 peaks of the order 77

Mbpd were achieved. About 3 Mbpd new capacity has been added. In May 2011

there is a significant and curious excursion to lower production not accompanied by

a fall in price. This coincides with Libya coming off line for the first time and the loss

of 1.6 Mbpd production. It seems possible that this coincided with weak demand and

the fortuitous loss of production cancelling weak demand leaving price unchanged.

The EIA are always running a few months behind with their statistics these days, not

ideal in a rapidly changing world. Thus we do not yet have the data to see the recent

crash in the oil price. But we know the price has fallen below $80 and production is

unlikely to be significantly changed. So, how do we explain production of roughly 77

54 OilVoice Magazine | JANUARY 2015

Mbpd and a price below $80?

Figure 6

Figure 6 updates Phil Hart’s model (Figure 1) to take account of the oil supply and

price movements of the last 5 years. Capacity expansion is achieved by adding 3

Mbpd to the former, well-defined supply-price curve (blue arrow). There is no a-priori

reason that this curve should hold in the new supply-price regime, but for the time

being that is all I have to work with. The red lines, as described in the caption to

Figure 1, conceptually represent inelastic demand where high price marginally

suppresses demand for oil. The recent past has seen oil priced at $110 with supply

running at about 77 Mbpd as defined by the right hand red coloured demand curve.

Reducing demand by about 1 Mbpd brings the price below $80 / bbl (red arrow).

55 OilVoice Magazine | JANUARY 2015

The Recent Past and the Future

Old hands will know that it is virtually impossible to forecast the oil price. The

anomalous recent price stability of $110±10 I believe reflects great skill on the part of

Saudi Arabia balancing the market at a price high enough to keep Saudi Arabia

solvent and low enough to keep the world economy afloat. The reason Saudi Arabia

has not cut production now, when faced with weak global demand for oil, probably

comes down to their desire to maintain market share which means hobbling the N

American LTO bonanza. Alternatively, they could be conspiring with the USA to

wreck the Russian economy? But Saudi Arabia is not the only member of OPEC and

the economies of many of the member countries will be suffering badly at these

prices and that ultimately leads to elevated risk of civil unrest. It is not possible to

predict the actions of the main players but it is easier to predict what the outcome

may be of certain actions.

1. If demand for oil weakens by about a further 1 Mbpd this may send the price

down below $60 / bbl.

2. If OPEC cuts supply by about 1 Mbpd at constant demand this may send the

price back up towards $100 / bbl.

3. Prolonged low price may see LTO production fall in N America and other non-

OPEC projects shelved resulting in attrition of non-OPEC capacity. This may

take one to two years to work through but with constant demand, this will

inevitably send prices higher again.

4. Prolonged low price may see many specialist LTO producers default on loans,

risking a new credit crunch and reduced LTO production. This would likely

lead to a major consolidation of operators in the LTO patch where the larger

companies (the IOCs) pick up the best assets at knock down prices. That is

the way it has always been.

5. Black Swans and elephants in the room – with conflict escalation in Ukraine

and / or Syria-Iraq and a new credit crunch, all bets will be off.

View more quality content from Energy Matters

Lloyd's Register and Senergy have come together combining 250 years of wisdom, quality and integrity with dynamic, innovative, inquisitiveness.

LR Senergy work in collaboration with clients, blending skills and experience to offer new solutions from reservoir to refinery and beyond. Find out more at www.lr-senergy.com

together further

57 OilVoice Magazine | JANUARY 2015

Greed explained: J. Paul Getty, Aristotle and the Maximum Power Principle

Written by Kurt Cobb from Resource Insights

Regular readers know I often write about energy, and while this piece may not at first

blush seem like an energy story, you'll soon see that the quest for an ample supply

of energy is, in fact, at the heart of human greed.

Greed is often said to be a central cause of our ecological and social ills. It motivates

excessive and injurious exploitation of the planet and thus threatens the existence of

many species including humans themselves. It leads to excessive economic

inequality and the social ills presumed to be associated with that inequality. And, of

course, greed is regarded as not just bad for the biosphere or society; it's bad for the

soul and therefore earns a place on the list of the seven deadly sins.

Many people are convinced that greed is learned and therefore can be unlearned or

not taught in the first place. Others believe that greed is simply an inherent evil in

humans, part of the human condition.

Someone once asked oil tycoon J. Paul Getty how much money is enough. He

replied, "A little bit more." The fictional financier Gordon Gekko in Oliver Stone's film

"Wall Street"--who is best known for the phrase "greed is good"--gives a different

answer: "It's not a question of enough, pal. It's a zero-sum game - somebody wins,

somebody loses. Money itself isn't lost or made, it's simply transferred - from one

perception to another." Finally, I offer the words of Noah Cross, a character played

by John Huston in the film "Chinatown." Cross is asked what else such an

enormously wealthy man as himself could possibly want, and he replies: "The

future."

58 OilVoice Magazine | JANUARY 2015

In these three quotes we have the essence of Howard Odum's Maximum Power

Principle. (See, I told you we would come back to energy!) Essentially, what Odum

observed is that living systems--humans, for example--seek to maximize their energy

gain. Now, in modern society, the way humans primarily gain access to energy is

through money. Money, it turns out, is merely what allows us to command energy--in

the form of humans, machines, or even animal power--to do what we want it to do.

Money is essentially a method of assigning "energy credits." And, energy, of course,

can used be to make us a product, render us a service, or provide either of these to

someone else as a gift or in fulfilment of a contractual obligation. Without energy,

nothing gets done.

Many people believe as J. Paul Getty did--that one can never have enough money

(read: energy). But, Gordon Gekko enunciates an important implication of the

Maximum Power Principle: People will compete with one another for the available

energy supplies (in the form of money or other types of wealth). And, Noah Cross, in

ways both literal and figurative, shows us just how far people are willing to go to

have an impact on the future, to insure the continuation of their genetic line and their

vision for their community.

Despite our modern pretensions, we humans are still all part of an evolutionary

process that pushes us to compete for survival and for the propagation of our genes.

Access to energy (and all of its products and services) confers advantages in this

contest. And, energy in the form of wealth provides a special intangible advantage:

increased social status which can be an asset when pursuing sexual partners.

Wealth attracts members of the opposite sex because it implies the ability to care for

a spouse and for any offspring and provide many advantages such as ongoing

access to better health care, nutrition, education and social opportunities.

Aristotle noted that the desires of men are unlimited. He also claimed that "the

amount of household property which suffices for a good life is not unlimited." Aristotle

is most often associated with the notion of the golden mean. Simply stated, it

signifies not too much and not too little in all things.

59 OilVoice Magazine | JANUARY 2015

Thus, Aristotle's vision seems contrary to the Maximum Power Principle. Why would

anyone intentionally limit the amount of energy available to oneself? There is

probably a theoretical limit to the amount of energy that might be useful to any one

human being. The entire energy output of the Sun, for instance, would likely be

beyond the capability of one human to manage and use to gain advantage. But, the

world has many billionaires who find no end of ways to spend their accumulated

energy credits and who often populate the world with many heirs from many

marriages.

What possible force could counteract the drive for dominance and self-propagation

and thus the desire to maximize one's energy gain to facilitate that dominance?

There is research which suggests that beyond a certain point of energy consumption

(around 100 gigajoules per year per person), quality of life measures for modern

societies barely improve. But that's for society as a whole, not the individual.

As it turns out, we humans have a long history of contemplative traditions, both

religious and secular, traditions that preach simplicity and often poverty as a way of

life. These traditions eschew worldly goods or at least maintain that each person

should have just what he or she needs for a good life and no more. How do such

traditions square with the Maximum Power Principle? The people who adhere to

these traditions, after all, voluntarily and consciously choose to consume less energy

than they might otherwise be able to.

There may be a clue in that. Our default instinctual response is to seek advantage

over others. Yes, we may cooperate where that seems the wisest course or where it

is apparent that we cannot dominate the situation. But, even within one group or

nation, there is simultaneous cooperation AND competition. But, we do not ordinarily

cooperate to REDUCE our access to resources.

So, we might say that such voluntary and conscious choosing is the next step in

evolution. But, how can it be? Such a way of life has been a feature of many

civilizations throughout history. It is already a feature of evolution in that those who

choose such a way of life have not died out. It may be that such a path is an

adaptive response which optimizes human survival over time. This is merely

speculation. But it would explain why self-abnegation is so persistent across cultures

and across time. When humans need the gene that tells them to reduce their

resource use, it is there.

60 OilVoice Magazine | JANUARY 2015

But there is another claim made for the simple life, for a life which seeks only what is

sufficient to thrive rather than to dominate. Quite often those following this path say

they are happier than they were when following the path of continual acquisition of

wealth and status. That claim, however, would seem to make millions of years of

human evolutionary development appear pathological--unless you realize that

natural selection optimizes life for survival and propagation, not happiness.

Therefore, our default behaviors are tuned to help us survive and pass on our genes,

not necessarily bring us contentment (as is evidenced, in part, by the modern divorce

rate).

That is not to say that there isn't some happiness in mere survival and certainly

some in the process of creating and rearing new life. But, this is not the kind of

happiness that those preaching simplicity mean. They mean an enduring, deeply felt

and persistent sense of satisfaction in an entire way of life.

A friend who used to serve very wealthy clients for a Wall Street brokerage firm once

remarked that even as clients doubled or tripled their wealth, they seemed no

happier. Such is the drive for dominance that many people continually seek invidious

comparisons with others. Even though such comparisons may bring about enhanced

social status, they do not seem to result in any deeper contentment.

Whether that part of us which allows us to find happiness with less, which allows us

to loosen the chains of our drive for dominance and replace them with cords that

bind us to others for mutual benefit--whether such an outlook will be awakened

among more than a small sliver of the population is an open question. The evidence

is not promising. The ruthless tend to get ahead and are often held up as examples

of how to live.

But the story isn't over. With the challenges that humans now face in climate change,

resource depletion, soil degradation, water scarcity and myriad other issues

impinging on human survival--all of which have their origins in excessive energy use-

-we may find that the cooperative and abstemious strains within us may be called to

the fore. Or we may find that these problems simply lead to a Hobbesian war of all

against all.

61 OilVoice Magazine | JANUARY 2015

So, the question is: Do we--meaning the human species as a whole--have any

choice in the matter? Or are we as a species destined to live by the Maximum Power

Principle to its seemingly inevitable and calamitous conclusion--a story in which the

drive for maximum energy gain is no longer adaptive, but rather dangerous to the

continued existence of humankind?

Our actions will be our answer.

View more quality content from Resource Insights

Making sense of OPEC oil market politics

Written by Gary Hunt from Tech & Creative Labs LLC

SOURCE Chatham House

Saudi Arabia has always provided the adult supervision among the 12 OPEC

members. The November 27th meeting in Vienna was no different as OPEC refused

to cut production targets from the present 30 million barrels a day. But the reality that

global oil prices have fallen more than 30% is hitting OPEC members in their wallets

62 OilVoice Magazine | JANUARY 2015

making for more tension going into this meeting.

Saudi Arabia and its Gulf allies Kuwait, UAE, Qatar stood their ground saying they

wanted to let the market find its own balance and that meant lower prices for a while.

For the Saudi’s and the Gulf states this is an inconvenience but for many oil

producing states lower sustained oil prices are a crisis.

Iran, Venezuela, Mexico, Algeria, Libya, Iraq and other OPEC members depend

more heavily on oil income and lower oil prices are hurting their budgets hard. They

argued strongly for a production cut to bring the price of oil back nearer to $100 per

barrel. All OPEC’s members would like to see oil prices stay in the $100 per barrel

range but there is a big shift underway in oil markets and the Saudi’s are also

making a big shift from defence to offense to deal with it.

OPEC is caught in the a big shift in world oil markets reflecting fundamental

changes:

1. Market discipline among OPEC members. The Saudi’s grew tired of being

taken advantage of by their OPEC partners who often cheat on production

targets taking Saudi market share. Leaving production targets in place forces

all OPEC members to face the music of lower prices.

2. OPEC and Non-OPEC member competition. Non-OPEC crude oil

production growth is coming largely from the Caspian region, Russia and the

United States. Russian and Caspian crude is finding a market in China

because of their locational advantages. But it is the US supply growth from

the shale revolution under way that presents the biggest threat to OPEC

market power.

3. Regional energy competition between the West, Russia and China. Even

though China’s economic growth is slowing its energy appetite is still huge.

Lower oil prices are like winning the lottery for China. It will strike hard

bargains with Russia stung by Western sanctions. China is pouring capital

into Caspian infrastructure to assure its access. US shale supply growth is

reducing its oil imports and only infrastructure congestion and political

correctness prevent the North America from further expanding crude oil

exports. These factors limit the use of energy as a political weapon by Russia

and other Middle East oil suppliers changing the market dynamic in the

Kingdom’s favour.

63 OilVoice Magazine | JANUARY 2015

4. Weak Global Economic Growth Increases Oil Market Competition. The

economic fundamentals tell us that world oil demand growth has weakened in

China, the EU, Brazil and Russia. Overall world crude production is projected

to grow at an annual rate of about 1%, with OPEC production expected to

grow at annual rate of 1.4% but so is its domestic demand. But OPEC faces

increasing global competition from North America and fears the spread of the

shale revolution worldwide.

By letting prices fall, Saudi Arabia is forcing price discovery to test the real price

band for the current market conditions. The Kingdom is betting the market will find its

own equilibrium—they just don’t know where or when. Current speculation is oil

prices may fall another $10 before the squeeze sets in—we’ll just have to ride this

out and see what happens—that seems to be the prevailing view.

Meanwhile, since the Saudi’s can afford the lower prices better than most others this

price discovery process brings other advantages for the Kingdom. It reduces market

share erosion from the inevitable cheating after OPEC production cuts. It squeezes

weaker players out of the market and puts pressure on the US onshore producers to

defer CAPEX, cut OPEX, and sets up a distracting consolidation wave as weaker

players sell acreage or themselves to stronger players.

Who gets hurt by lower oil prices?

The US EIA reports that the December 2015 WTI futures contract price decreased

by $7.56/bbl, less than the decline in futures contracts for WTI crude oil delivery in

December 2014 and June 2015. The market seems to be baking lower oil prices into

its short term hedging calculus.

For the Saudi’s there are geopolitical calculations in this multidimensional game.

Both inside OPEC and out the biggest impact of lower crude prices is to opponents

of Saudi Arabia especially

Iran (negotiating a nuclear deal with the West the Saudi’s do not want);

Russia (meddling in its near abroad as Putin attempts to put the Soviet

superpower toothpaste back in the global power tube);

Iraq and Syria (seen as proxies of Iran given the US weakness in the region);

and the

US (where slowing down the shale revolution threat is a bonus).

64 OilVoice Magazine | JANUARY 2015

Saudi Arabia refused to cut the world oil production target of OPEC because it

wanted to demonstrate that it can, because it was in its own market share self-

interest to do so, and because the consequences of doing so are much worse for its

market rivals and geopolitical adversaries than its own.

Tough love! Smart politics! Good business!

Why $75 is the right price for oil

Written by Andrew McKillop from AMK CONSULT

Putin's Prayer

A large number of oil pricing experts - taking this to mean the interaction of oil,

finance and the global economy - would likely agree that $75 a barrel is a reasonable

and sustainable price. One expert who might agree is Citigroup's Edward L. Morse,

but I do not speak for him. For almost any major or minor oil producer and exporter,

$75 a barrel, under present conditions, would be manna from heaven. This would

include all OPEC states, Russia, Norway, Canada and Mexico, US oil producers (not

only of shale oil), and UK North Sea producers.

Taking this last group of stressed oil producers, leading experts on British offshore

oil and gas including Robin Allen and Sir Ian Wood have come out in the British

press with doomster forecasts on what it would mean for British offshore oil

producers if current prices held for 1 year or more, ahead. Wood's forecast is the

loss of about 35 000 jobs and a huge cutback in development and maintenance

spending in 2015-16. The decline of UK oil production would go into overdrive - just

View more quality content from

Tech & Creative Labs LLC

65 OilVoice Magazine | JANUARY 2015

in time for the next bounce of global oil prices! Treasury receipts, for example, would

also decline faster than expected as output decline was accelerated.

The only upsides for much cheaper oil - prices of $50 a barrel or less - are simply

claims. One is that higher cost producers would be squeezed out - what we can call

the Saudi "philosophy", but the ironical real world result would be an acceleration of

oil's decline as a share of world energy simply due to accelerated decline of world

total output of oil. This would simply extend the 30-year decline trend of oil in world

energy - mostly due to periods of blatantly overpriced oil, making oil economically

insecure as well as physically insecure, and accelerating its substitution.

For mass media and the consumer horde, the supposed upside of an oil price crash

is cheaper fill-ups at the fuel station forecourt for the family car, and basically nothing

else. Expecting major cuts in transport costs, food production costs, fertilizer and

pharmaceuticals production costs and market prices are all easy to dismiss. Minor

impacts perhaps, but no major fall in final market prices when governments have

taken their tax cuts and corporations have taken their windfall profit gains.

The claim that much cheaper oil will produce much higher economic growth, either

nationally or globally, is even easier to dismiss. The global economic impact of the

57% oil price crash in 1986-1987 followed by over 15 yers of ultra-cheap oil did less

nothing for economic growth in the most oil-intensve economies - the OECD group of

richer countries, then taking over 50% of world total oil output for around 15% of the'

world's total population. Global economic history shows that "the growth economy"

exported itself from the OECD group, to China, India, and other emerging

economies, and especially so for China. As we know, China's energy economy

through the key period of around 1985-2000 and still today can be summarized by

one word. Coal.

Oil, the Dollar and Gold

To be sure, suggesting a "nice price for oil" using dollars as the currency has its own

dangers. For easily-analysed reasons and already easy to prove, falling oil prices

tend to bolster the world value of the US dollar in the short term. This is of course

illogical, but is a fact, meaning the appreciation of the USD due to falling oil prices

will sooner (rather than later) unwind and reverse. It was therefore no surprise at all

that during the 1985-2000 cheap oil period, and most famously by way of the Plaza

Accord, the US reacted to the uncontrollable aggravation of its annual trade deficits,

66 OilVoice Magazine | JANUARY 2015

including but certainly not only due to oil imports, and was forced to browbeat and

force its major trade partners to revalue their moneys. Most spectacularly this

concerned Japan. This could or might have been the real "coup be grace" death

blow for the Japanese "expert growth economy" and the start of Japan's economic

decline which continues to this day. As we know, the essential basic goal of

"Abenomics" is to drive down the world value of the yen.

Overpriced oil following the Arab oil embargo of 1973-74 (called "Arab" but including

Iran and Venezuela!) most certainly underpinned the first version of Petrodollar

Recycling, directly used by the US Treasury to rationalize and engage a massive

increase in dollar-printing, starting a runaway process of "fiscal incontinence", well

described by David Stockman. Incredibly, this continued after oil prices crashed in

1986-87, and continues to this day!

The Oil Shocks of 1973-74 and 1979-81 were also green lights for a massive growth

of oil prices in US dollars, feeding off President Nixon "de-linkage" of gold from the

dollar before the first oil shock, helping destroy the notion of a "right price for gold". If

we were to try being logical about falling oil prices, today, a real but not massive

increase of gold prices in US dollars would come about, but the gold price and "what

it means" is an even more convoluted subject than the "right price for oil"!

However we can be 100% sure and certain the USA is not seeking a stronger dollar,

more like the opposite, and a arise of oil prices to $75 a barrel would tend, if

anything, to slow or reverse the recent increase in the world value of the dollar. To

be sure, exactly the same applies to the euro and yen, making it hard to have a triple

devaluation - of the USD, EUR and JPY - against anything except oil and gold.

World Oil Output and Oil Prices

This could seem an easier subject than the above, but is not. Oil is definitely

overpriced, even at $60 a barrel, in energy-economic terms, comparing the price of

oil energy with energy from coal or natural gas, and in a few "niche' sectors, solar

energy, wind power, geothermal energy, biomass and other renewables. In a large

number of end-use sectors, energy conservation is still cheaper than oil energy, as

well as coal and natural gas energy.

Also, the argument heavily detailed by the IEA and other sources - that high oil

prices ensure continued global oil production and export growth - can be turned

67 OilVoice Magazine | JANUARY 2015

upside down. The oil, even if it is overpriced, is produced, supplanting cheaper and

more efficient alternatives, handicapping the economy by imposing and forcing the

wrong energy choice. High oil prices also distort national (and international)

investment choices - as Vladimir Putin suggested in his December 18 Kremlin

conference. The oil is produced and is quite easy to sell, so this happens to the

detriment of better investment alternatives, both in the energy sector and outside it.

The OPEC states, in particular all suffer from the "curse of oil", for example the

wanton neglect of national agriculture.

The UK offshore oil sector, like its Norwegian counterpart is a classic example of

malinvestment and over-investment, one example being the extreme high costs of

final decommissioning and safe removal of gigantic and cumbersome offshore oil

installations, making the downside and exit-from-oil an expensive prospect.

Not yet on the press and media radar screen, any sustained period of oil prices

below about $50 a barrel will inevitably produce a major fall in world total oil output,

further accelerating the global shift away from oil energy. Not at all ironically but

automatically this would cause an epic "spike" of oil prices, setting the scene for

another oil price crash - and the value of all other assets hung on the shaky clothes

hanger of overpriced oil.

The solution, which we have to admit is utopic would be a return to oil prices around

$75 a barrel and a programmed, agreed and planned global energy transition.

View more quality content from AMK CONSULT

68 OilVoice Magazine | JANUARY 2015

The high cost of low-priced oil

Written by Kurt Cobb from Resource Insights

As a consumer of oil, you may regard recent sharp declines in the world oil price as

a blessing. But...

If you work in the oil industry, you will not.

If you work in the renewable energy industry, you will not.

If you work in the energy efficiency business, you will not.

If you work to address climate change, you will not.

If you have investments in the oil industry (and nearly everyone does through

pensions or 401k plans), you will not.

If you live in a country that exports a lot of oil (not just Saudi Arabia, but Mexico,

Canada and Norway, too), you will not.

The declining price of oil is supposed to have a balanced ledger of winners and

losers. But we may be on our way to finding out that in the long run we will have a

much larger list of losers than winners.

And, the list will lengthen if the price continues to fall, and especially if it stays down

for a long time. (Low prices are not necessarily an indication of future abundance.

Remember that oil reached $35 a barrel at the end of 2008 before returning to record

average daily prices in 2011, 2012 and 2013.)

Now here is something to contemplate. Is the price of oil falling because we can no

longer afford it? This is not an idle question. Record high average daily prices for oil

in the last three years have been an unrecognized cause of sluggish overall

worldwide economic growth. That subpar growth appears to be exhausting itself

now, particularly in Asia and Europe. In dampening growth, high oil prices sewed the

69 OilVoice Magazine | JANUARY 2015

seeds of their own demise by ultimately dampening demand.

But, low oil prices will make it even harder to secure future oil supplies. The oil

industry was already cutting back its exploration budgets before the price plunge.

The industry said that there were not enough profitable prospects available even at

$100 per barrel. What happens to industry exploration and development budgets

with oil prices now around $60? Without exploration there can be no new production;

and without new production, oil supply falls automatically.

Now, exploration and development are not being cut to zero. But they are being cut

substantially. And, as with any mineral exploration, there is no guarantee of success-

-even less so with cutbacks. With existing oil production worldwide declining around

4 to 5 percent per year, the industry already had a huge task keeping production

growth just barely positive. Now, that will be almost impossible if oil prices remain

low.

What that means is supply will likely stagnate or even shrink. Barring a deep and

prolonged economic slump now (which would send oil prices even lower and keep

them there for some time), as demand for oil reignites, we're setting up for another

big price spike later that might then send the economy off a cliff into a serious slide.

For now, those in the renewable energy business are finding it more difficult to be

competitive with lower-cost oil. Energy efficiency business owners must tell their

clients that many efficiency measures will have a longer payback period while oil

prices stay low. Both these outcomes send us in the wrong direction.

And, there is climate change. When petroleum products are cheap, there is less

incentive to use them parsimoniously. All things being equal, that means more oil

products are burned which produces additional greenhouse gas emissions.

Now, regarding the financial consequences of low oil prices, one could say, "Well, if

you've chosen to work in the oil industry or if you've staked your whole country's

future on the price of oil, then that's just your tough luck. Some of the wealth that

flowed to you is now going to start to flow back to me."

And therein lies a problem. If that money flows too quickly away from the oil industry

and the major oil exporters, it could create a financial cascade in the debt markets, in

the world's stock markets, in the currency markets--oh wait, it already has. The

70 OilVoice Magazine | JANUARY 2015

question is how far will these disruptions carry, and will they cascade in a way that

leads to a recession or depression.

One can be passive in the face of such events. But, a smarter plan would be to

implement something along the lines I proposed last week--an oil tariff that keeps

prices high and so keeps renewables and energy efficiency attractive. In fact, a

system that keeps all carbon-based fuels high-priced would do more to move the

world toward a sustainable energy system than all the current renewable energy

subsidies combined. And, it would prevent the kind of price manipulation now

engaged in by OPEC from wrecking havoc on any plan to move toward a renewable

energy society.

It is just such disruptions in the fossil fuel markets that make us believe things that

aren't good for us--that we can somehow burn cheap oil and forget about climate

change. That cheap oil will go on forever. That cheap oil is a sign that the

marketplace solves all problems (rather than creating new problems that it can't

solve by itself).

We can celebrate lower gasoline, diesel and heating oil prices now. But like any

overindulgence, we will pay for it later. When a pusher offers a junkie a discount on

his drugs, we shouldn't take it as an act of kindness.

View more quality content from Resource Insights