Rodgers has no doubt that China understands peak oil and expects future supply disruptions, which is why it’s accumulating foreign assets and diversifying its import options.

Peter Dea, the president of oil and gas exploration and production company Cirque Resources LP, made the same point a bit more obliquely, rhetorically asking if China had no doubts about the future of oil, why would they have recently outbid Exxon Mobil for new drilling in Ghana?

Putting a finer point the difference between the strategies of the U.S. and China, Dea wryly observed that the U.S. has potential for offshore drilling for natural gas, but “it won’t be developed until the U.S. takes energy resource planning as seriously as China does.”

That doesn’t appear to be in the offing any time soon. Washington doesn’t seem to understand the commodity markets at all, Matthews said, nor the shrewd moves that China is making. While Japan already has a strategic mineral stockpile, and China is quickly amassing one, the U.S. is selling off its key minerals: “The lack of knowledge and concern over it in Washington is horrifying, and I can’t explain it,” he moaned.

Well, I have explained it: America has no energy plan, and we won’t have one until we give up our fantasies about energy independence or drilling our way out, admit that oil is peaking, and get serious about planning accordingly.

While America was busy with its hallucinated wealth meltdown and trying to raise some cash by selling assets at garage sale prices, just one of China’s three major oil companies, CNPC, secured 75 resource projects in 29 countries.

Another of the three, energy giant China National Offshore Oil Corporation (CNOOC), just bought oil assets in the US for the first time. The size of the deal for four deepwater exploration licenses in the Gulf of Mexico was undisclosed, but Norway’s Statoil, the seller, characterized it as “small.”

Still, the purchase is bound to make it more difficult for China to maintain a low profile as it snaps up resources.

Perhaps that’s why it has begun trying to cover its tracks: China OGP, an oil industry newsletter issued by Xinhua news agency, recently announced that it would no longer publish data on China’s stockpiles of crude oil, gasoline, and diesel. (As if that data weren’t hard enough to get already! Killin’ me.)

The lesson on China for retail investors should be clear: Buy domestic reserves while they’re cheap, and hold ‘em, hold ‘em, hold ‘em.

Until next time,

http://www.getreallist.com/

We are at the 87th Percentile in barrels in storage, and we are at the 96th Percentile based on the 23.91 days of usage in storage. Distillate inventory increased by 349,000 barrels, to 167,725,000, the 99th Percentile. We are up 6,108,000 barrels from 13 weeks ago and up 39,374,000 barrels from last year.

We currently have 47.34 days of usage in storage, the 98th Percentile. Gas inventory increased 2,560,000 barrels to 210,837,000 barrels, the 70th Percentile.

We are up 1,083,000 from 13 weeks ago and up 12,742,000 barrels from a year ago. Days of usage are at 23.84, the 72nd Percentile. The Crude Oil inventory will match last year’s level, in 11 weeks. Prices then were $46.47, $31 less than current prices.

In 15 weeks we will be comparing a Heating Oil price of 119.67 cpg compared to the current price 200.35 cpg, and inventory will be 26 mm barrels higher. In 7 weeks Gas inventory will be about equal to last year. Price was 84.40 cpg, a 108 cpg lower than now.

In a few short weeks inventories will be about the same as last year, if they do not change, and price if it does not change, will be extremely over priced. The market is at extreme risk for a sharp break on a comparative basis. If demand does not improve sharply and if production does not drop we have a problem headed towards us on price.

If we have inventories increase, and there is no demand increase, price will look more than very high, on a year over year basis. Distillate demand must increase and that is not happening. Production must drop sharply and that too is not happening. Ultimately, if these two things do not change we end up looking at a huge inventory, too much production and little demand.

A price collapseRefinery inputs fell again and we are now sitting at the 3rd Percentile this week, Distillate production is at the 71st Percentile with the HO Crack Spread at the 48th Percentile.

Gas production is at the 75th Percentile and the Gas Crack Spread is at the 8th Percentile. The Ho Crack Spread remains high considering production levels but the Gas Crack has dropped dramatically.

Production has not fallen much so the Crack Spreads have fallen. Over production, low demand eventually leads to price problems. Current demand levels warrant lower than the current production levels. The production levels we have seen dictate a demand increase of 10% ore more and that is not here.

HO and Gas production must be decrease. If, production compared to demand for products, remains at these levels price and processing margins will not hold these levels. We will see pressure on price and the potential for a price collapse is increasing.

Concealed Clues

At the same time, another transformation was taking place.
The edges between the solid data and the gray zone gradually became sharper. Over the last few years, the agency’s estimates for peak oil production fell from 120 mpbd to 105 mbpd, but oddly, their forecast for the date of the peak remained stubbornly around 2030. Curves were gradually flattened, but reached the same point. Simple head-scratchers like that.
The language of the reports also grew in clarity and intensity, alarming critics. By last year, it had become downright shrill: “The world’s energy system is at a crossroads” . . . “global trends. . . are patently unsustainable”. . . “the era of cheap oil is over”. . . “Time is running out and the time to act is now.”
This year, they admitted what many of us had already figured out: Non-OPEC supply has basically peaked. Despite this, IEA still forecasts global oil supply will rise from 84.6 mbpd in 2008 to 105.2 mbpd in 2030.
They then devoted fully half the report to a “450 Scenario” in which a vigorous global investment in efficiency, renewables, carbon capture, and nuclear power averts global disaster by keeping atmospheric CO2 concentration below 450 ppm, with a price tag of $26.5 trillion (in 2008 dollars).
The good news now is the situation isn’t quite as dire as we thought it was last year. Their cost forecast has come down from $35 trillion, and they now think the world will only need to come up with 45 mbpd in additional crude capacity (another four Saudi Arabias) not 64 mbpd (another six).
Indeed, the divisions between reality and fantasy in this report grew sharper still. They worry at length about the effect of the global financial crisis on investment in new energy supply, yet still imagine the world will spend about $1.5 trillion a year on new supply infrastructure.
While envisioning a massive investment in efficiency and renewables in the 450 Scenario, they observed that low oil prices, receding investment in cleantech in 2009, and general economic malaise could mean slower growth rates for the solutions.
They forecast that OPEC alone would come up with 17.5 mbpd in new supply—85% of the global increase—but expect the Middle East to spend only $1.9 trillion out of a global total of $25.5 trillion.
In an extremely dubious scenario, they see global natural gas supply growing faster than demand, eventually resulting in a massive glut. At the same time, they published for the first time a detailed, field-by-field analysis of nearly 600 major gas fields, accounting for 55% of global production. It showed an average 5.3% post-peak decline rate for the world’s largest gas fields, and a global production-weighted decline rate of 7.5% for all post-peak fields—very similar to the decline rates they published (again, for the first time) last year on oil fields.
While noting that nearly all of the growth in global energy demand will come from the developing world, and that much of the investment capital needed to obtain their 450 Scenario will need to be invested there, they also expressed significant uncertainty about those prospects.
Most telling, however, were the comments made in the press conference at the report’s unveiling.
When a reporter asked why they’re still sending a signal that the world will come up with another four Saudi Arabias of supply in their Reference Scenario when no one believes that is possible, IEA chief economist Fatih Birol tipped his hand:
This is not the scenario we think is — first of all — likely; this is not the scenario that we want to happen. . . This is the scenario that, if it happens, we are going to have an accident in terms of climate, in terms of energy security, and other things, and it is the reason why we are pushing the 450. . . We push the 450 not only for the climate change reasons. . . it is also for the energy security reasons. And it is the reason why our ministers in October have endorsed our work in general. . . We think this [report] is a driver for [developing policy around climate change].
Essentially, he admitted that they deliberately tilted the report toward climate change with an expressly political purpose: to motivate capital and policy in the direction of a decarbonized energy supply. And they did that because it was politically expedient, with all eyes now on the upcoming Copenhagen summit on climate change.
Finally, the agency’s highly-nuanced, limp denial of the whistleblower allegations was well salted with impassioned pleas to reckon with their 450 Scenario, reiterating that “the era of cheap oil is over.” Birol even emphasized that the IEA had decided to make their data on oil depletion available on its web site for the world’s free and transparent examination—a clue that was not concealed, but painted in fluorescent orange.
The Climate Change Stalking Horse

I have considerable sympathy for the IEA. It’s not easy to follow your heart and tell the truth for the benefit of humanity while the boss man is glaring at you and pulling a finger across his throat. Of course their report is politically distorted.
Yet, as I highlighted the key points in the report’s executive summary and mentally ticked off the articles I’ve written on each one over the last few years, I realized how far the IEA has really come. They may have no choice but to walk a tightrope in an intense global spotlight, but they’re backing into the truth as quickly as they think they can. For that fact alone, despite its flaws, this report gets my thumbs-up.
Regarding the IEA’s Reference Scenario, my view remains basically unchanged from what I said this time last year: “Here’s my prediction: their 2010 report will state that the new peak is only 95 mbpd, at a cost of over $30 trillion. And by 2012, they’ll admit that the peak was in fact in June of this year, at 87 mbpd. By 2030, fully 20 years past the peak, world oil production will likely be under 70 mbpd.”
As for the 450 Scenario, I continue to believe that climate change is a backwards approach to the problem. I have seen no serious rebuttals to the studies by Kjell Aleklett and David Rutledge calling into question whether the world can even get to 450 ppm when peak oil, and then peak gas and peak coal, are properly considered. (Currently, no climate change scenarios have any cognizance of fossil fuel peaking whatsoever.)

In e-mail correspondence this week, Aleklett told me that he will soon have two new newspaper articles published in his native Sweden (which will be translated to English) that demonstrate on scientific bases that all of the IPCC scenarios are wrong.
But even that is not important.
Climate change is merely a stalking horse for the IEA. Whether we focus on energy or on climate, the ends are largely the same. And the IEA has astutely recognized that there’s a whole lot more public momentum and investment money to be focused on climate change than there is on dour old peak oil.
What the 2009 WEO Really Means

I could go on for pages and pages, as I have in the past, pointing out the discrepancies and critiquing the scenarios. But that’s not really what this report is about.
Never mind the outlandishly optimistic oil and gas production scenarios. We can throw out the 450 Scenario, as well. They’re wrong, and we all know it—wink wink, nudge nudge.
The IEA doesn’t believe either one of its scenarios any more than they believe humans roamed the earth with dinosaurs. Some stories are meant to be read as parables.
The internal message of the 2009 WEO is clear: The world is facing an energy crisis of epic proportions. The path we’re on is precarious and unsustainable. (The word “sustainable” occurs 18 times in the report, which I’m sure is a record, and Birol repeatedly emphasized the phrase “energy revolution” in his comments.) There is a way to avert disaster, but it’s going to require the world to commit an incredible amount of capital to the energy sector for many decades to come. And if we fail to rise to the challenge, we’ll be dead in the ever-rising water.
That, of course, is our entire raison d’être here. To motivate capital, rise to that challenge — and make some cheese in the process.
Until next time,

Chris

Let us know what you think!

Gail the Actuary on November 11, 2009 – 10:17am
Thanks, Sam! This is really a nice post. Explains a piece of the puzzle that all of us have been wondering about.

ROCKMAN on November 11, 2009 – 10:37am
Sam — I’m sure all appreciate your effort. Took some time no doubt. A question that perhaps you can only answer qualitatively: China has been acquiring rights (via contracts and direct ownership) of oil production around the globe for some time. The volume is difficult to estimate but the amount would seem to represent a reduction in the supply side of your model at least for the rest of the consumers out there. Of course, it also represents a volume that China wouldn’t have to acquire on the open market. Can you offer any hint to the potential magnitude of this situation with respect to your model?

Sam Foucher on November 11, 2009 – 11:27am
I was supposed to look at it in this post but that was way too long for a single post, part 2 will be posted tomorrow and will look at the Non-OECD demand. I think the Non-OECD is effectively outbidding oil through various mechanisms (not open market mechanisms).

Will Stewart on November 11, 2009 – 2:09pm
Great article, keep up the good work. Could I also request in the future that parameters in formulas have a little one liner explanation?

greenJamie on November 11, 2009 – 10:31am
Great post – it has clarified a few points I was wondering about.

“Some suggest that we are willing to and capable of moving away from oil” – I can see that those who are into wishful-thinking would like to interpret the recession induced reduction in demand as a signal we are safe from our dependence on oil. It is just that: wishful thinking.

westexas on November 11, 2009 – 10:44am
(Now everyone can see why Sam does the mathematical heavy lifting on our joint papers.)

It probably helps to show some specific examples, especially in regard to the export market. Saudi Arabia, at least based on annual data through 2008, is world’s largest net oil exporter; the US is the largest OECD net oil importer and China is the largest non-OECD net oil importer.

I think that the Saudis tried–as best they could–to restrain the price of oil from 2002-2008, and they significantly increased net exports from 2002-2005, but then from 2006-2008 their net exports fell below the 2005 rate, with 2008 (when oil prices averaged $100) actually falling below their 2004 net export rate (when oil prices averaged $42).

As one would expect, US consumption and net imports fell, in response to higher oil prices, but then we have China (their most recent data show monthly net imports of about 4.5 mbpd).

Saudi Net Oil Exports (EIA):
US Net Oil Imports:
Chinese Net Oil Imports:

Standard economic principles have demonstrated that price is a function of supply and demand. The same is true for the recent  oil prices fluctuations we have witnessed over the last few years,namely the equilibrium between supply and demand. However, the following conundrum has not been resolved: are oil prices high due to greater demand or too little supply? This ambiguity allows for vastly divergent interpretations of the same data and depending on the agenda you are trying to push, will easily support either.

Lately, the concept of “Peak demand” has been suggested in a multitude of recent articles that unfortunately do not qualify their analysis of the status quo. Some suggest that we are willing to and capable of moving away from oil. Are we?

A few years ago, some analysts lectured us about the effect of oil prices on the creation of new oil supply. Now that this argument has clearly failed, they have decided over night that we don’t need oil anymore. In this debate, it is important to distinguish between demand (what you want or need) and consumption (what you get based on your ability to buy). Following this logic, consumption is “satisfied demand”. Conversly, we can define the “unsatisfied demand” or “excess demand” that has been suppressed. Below the fold, I’ll show that the key driver behind the priceincrease since 2002 has been excess demand combined with unresponsive supply.

OECD Demand

In this analysis, I follow an approach similar to the one proposed by Ye et al. (pdf) using a model defining a desired inventory level. The consumption trend observed between 1990 and 2001, when the market was well supplied, can be easily and accurately modeled by a linear trend taking into account monthly fluctuations: The fit result is shown as the magenta line illustrated on Figure 1 below. The above model will

define normal demand levels assuming low oil prices. The OECD consumption has strongly reacted to higher oil prices and is now almost 10 mbpd the level expected by my nominal demand model.

Figure 2. Observed OECD consumption and nominal demand model (monthly, total petroleum products),

volumes in million barrels per day (mbpd). data from the EIA.

Looking at the residuals Ct-Dt, the fall in consumption from the desired level is even more telling:

Figure 3. Difference between the nominal demand models and the observed consumption (monthly, total  petroleum products), volumes in million barrels per day (mbpd). Data from the EIA.

I make the following assumptions:

1. because oil prices were so low during the 1992-2001 period (i.e. virtually no excess

demand), I will call “nominal demand model” the linear model defined above.

2. The difference between nominal demand and observed consumption is an estimate of the excess demand: EDt=Dt-Ct

Plotting the excess demand against oil prices clearly shows why prices rose until the financial collapse last year. Before 2002, prices and excess demand were contained within a tight cluster around 20$/barrel – evidence that the market was well supplied and at equilibrium. The red line shows that prices increased by $20 per 1 million barrels per day of excess demand between 2004 and 2008.

Figure 4. OECD Excess demand versus oil prices (WTI).

One could argue that the nominal demand model defined above is not stationary and has been affected by structural changes in demand. Unfortunately, the only way structural changes in demand could be estimated is if the oil prices of tomorrow would go back to $20 a barrel for a few years within a pro-growth and healthy business environment. Only then could a new nominal demand model be estimated; those conditions won’t be satisfied anytime soon. Peak demand would suggest that the demand model would change over time, but then the level of unsatisfied demand would go down, bringing down prices with it. Actually, the severe recession we are currently in since the fall of 2008 has destroyed demand as a result of high unemployment rates and reduced credit availability. Looking at the price model on Figure 3, a return to the $70-

80 range is equivalent of a demand destruction of around 3 mbpd for all of the OECD.

What about Spare Capacity?

Spare capacity, mainly provided by OPEC, is the amount of oil that can be made available within

30 days and sustained for at least 90 days (EIA definition).  Looking at the available spare capacity and the excess demand estimate, it is obvious that OPEC spare capacity has become deficient since 2002, and that the surge in excess demand coincides with the increase in oil pricesas shown on Figure 5.

Figure 5. Oil prices (right axis) and estimated excess demand along with EIA estimate for OPEC spare capacity

(left axis).

So What is Causing High Oil Prices?

As an interesting exercise, I looked at the causation between oil prices and demand/supply indicators. Causal search algorithms systematically investigate patterns of conditional dependence and apply the Causal Markov Condition to reconstruct the graph of the data generating process (A good overview is available here). I define the following quantities:

P: Monthly oil prices

S: Monthly oil supply

C: OPEC spare capacity (EIA)

D: Excess demand

I used the remarkable TETRAD IV software (family of software for causal modeling originating with Peter Spirtes, Clark Glymour, and Richard Scheines at CarnegieMellon University) available online. I split the dataset in two periods: 1998-2002 period when prices where relatively low and 2003-2008.

1998-2002 period:

Figure 6. Graphical causal model for the period 1998-2002

Spare capacity is dependent on prices and excess demand. Prices and excess demand are independent unconditionally; but are dependent conditional on spare capacity. In short, OPEC spare capacity was playing a buffer role in order to absorb excess demand.

2003-2008 period:

Figure 7. Graphical causal model for the period 2003-2008

Price is dependent on supply and excess demand. Supply and excess demand are independent unconditionally; but are dependent conditional on prices. Spare capacity is independent of all the other variables at 5% significance.

Conclusions

Lower consumption does not mean lower demand, nor does it mean the increase in alternate sources of energy. If it did, it would be akin to saying that an alcoholic is sober implies he has effectively dealt with his addiction. It may be that he is sober because he has simply exhausted all of his options for obtaining additional alcohol.  Also, I think it is important to differentiate between  the following two causes of demand destruction:

1. Recession induced demand destruction (e.g. business going bankrupt, rising unemployment,

etc.), or

2. Long-term structural changes in demand (e.g. increase in the average car mileage, increase efficiency, etc.)

In my opinion, the latter cause of demand destruction is the approach to take and can be implemented through adequate government policies  (e.g. higher CAFE standards). When people are unemployed, energy efficiency is the last of their concerns. If we do not proactively implement demand side policies and instead wait for high prices to take their toll, social unrest and  higher government deficits are likely to make things more challenging, or even completely unmanageable.

Anemic supply growth, only a preamble to peak supply, was enough to create our present troubles. Wait until supply growth is negative! We have enough data from the OECD to draw the following conclusions:

1. Sluggish supply growth is the main driver behind the 2002-2008 oil price increase. OPEC spare capacity has become irrelevant or at least unresponsive.

2. Nominal demand is between 3 and 5 million barrels per day above  production capacity.

3. Prices are increasing by $20 for every million barrels per day of excess demand.

4. OECD consumption is very elastic to oil prices.

5. Non recession induced peak demand  is not supported by the data.

6. The financial collapse and the current economic recession has at least reduced demand by 3 million barrels per day for the OECD.

In my next post, I will look at the non OECD demand.

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