This note was originally published at 8am on February 01, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
"In my humble opinion, we should now have reached peak oil. So it is high time to close this critical chapter in the history of international oil industry and bid the mighty peak farewell."
- Ali Samsam Bakhtiari, Vice President of the National Iranian Oil Company
To say that oil makes the world go ’round is an understatement. Every day we consume almost 85 million barrels of oil. At $112 per barrel, the current price of Brent oil, this is $9.3 billion of oil consumed every day, or $3.4 trillion per year. Global GDP is estimated at just over $65 trillion, so the cost of oil itself, setting aside additional refining, distribution, and marketing costs for oil and oil products, is more than 5.2% of global GDP.
A meaningful move in the price of oil has a clear and definite impact, all things equal, on GDP. While it is not a zero-sum game, as global consumers spend more on oil and energy products, they clearly spend less in other areas.
The value of the U.S. dollar is a key driver of the direction of oil. In fact, the correlation of Brent to the U.S. dollar on a three year duration is -0.67. Globally, oil is priced in U.S. dollars, so dollar down equates to oil up, and vice versa.
As we’ve reiterated many times, dovish U.S. monetary policy is a key driver of the price of the U.S. dollar. In turn, as noted above, the U.S. dollar inversely drives the price of global commodities priced in U.S. dollars. Keith has started calling this The Bernanke Tax. By keeping interest rates and monetary policy at levels not seen even in the Great Depression, Chairman Bernanke is explicitly adopting a weak dollar policy. As oil and other commodities prices inflate, they take global GDP share. Unfortunately, what’s good for the oil company, is negative for the consumer.
In the United States, The Bernanke Tax is seen most directly on purchases of gasoline for motor vehicles. According to a recent report in Scientific American, Americans spent more than $490 billion on gasoline in 2011. This was an increase of more than $100 billion over 2010, despite the number of miles being driven in the United States remaining relatively flat. In aggregate, U.S. consumption of oil as a percentage of GDP very closely parallels the global numbers at just over 5%.
The other key factor, setting aside geopolitical concerns for the time being, in analyzing oil is global supply, specifically the idea of peak oil. U.S. geologist M. King Hubbert is widely considered the father of peak oil theory. Hubbert first created peak oil models in 1956 to accurately predict that United States oil production would peak between 1965 and 1970. Models have since been used to predict, with reasonable accuracy, the peak of various fields and regions around the global.
Tomorrow, at 11am EST we will be hosting a conference call with geologist and renowned peak oil theorist, Jeffrey Brown, in a presentation call titled, “Peak Oil: Fact or Fiction?”. (If you don’t subscribe to our energy vertical and would like details on the call, please email firstname.lastname@example.org . Obviously our research isn’t pro bono, but our Head of Sales Jen Kane will work with you.) Jeffrey has prepared a detailed presentation that outlines the case and support for peak oil, and much higher oil prices.
Despite the rapidly accelerating price of oil over the last decade, the concept that global oil production is peaking is far from mainstream. In fact, investors polled at a Credit Suisse energy conference revealed that 94% of investors believe that peak oil is at least twenty years or more away or will never occur. As well, energy company earnings only make up 12% of SP500 earnings versus 30% in 1980.
Peak oil advocates point to a multitude of supporting evidence to defend their case. The historical evidence revolves around looking at the production of a number of the world’s largest oil producing areas, most notably the North Sea and the continental United States. An analysis of the peaking of these oil producing areas follow very similar patterns of decline, which are supporting evidence of M. King Hubbert’s models. In effect, oil is a finite resource, which on a global basis has very predictable decline patterns.
The other, and more obvious, support for peak oil is simply the price of oil. Over the course of the last decade, the price of Brent oil is up 454%. In a typical commodity market without supply constraints, or really any type of market for that matter, production should increase to create greater supply to offset dramatic price hikes. In the last decade global oil producers have seemingly been able to grow production at a level that offset accelerating prices. The domestic natural gas market is the contra example of this as accelerating prices routinely lead to more production and a natural correction in price.
The counter case for peak oil is that there is more oil out there, we simply have to explore to find it and invest to get it out of the ground. In fact, our friend the ever thoughtful Peter Orszag, recent penned an article for Bloomberg flagging the impact that development of fracking technology in the United States has had on oil production by increasing access to so called “tight oil”. As Orszag writes:
“In 2010, oil companies produced 5.5 million barrels per day of domestic crude [in the U.S.]. The Energy Information Administration estimates that figure will rise to 6.7 million barrels per day by 2020, mostly because of the continued development of tight oil, in combination with the development of offshore resources in the Gulf of Mexico.”
Assuming that EIA’s forecasts prove correct, U.S. oil production is on a path to grow 22% over the next decade and reach aggregate daily production levels not seen since 1994. If this occurs, the idea of peak oil becomes seriously questionable.
So, is peak oil fact, or fiction? We will dig into this debate tomorrow morning at 11 am EST with peak oil expert Jeffrey Brown. While these types of discussions are rarely conclusive, this conference call will outline the key theory behind peak oil, which will enable us to evaluate its validity as data points reveal themselves in the coming years.
Regardless of the side you are on in the peak oil debate, J. Paul Getty left us with one truism about oil:
“Formula for success: rise early, work hard, strike oil.”
I’d actually add to that slightly:
“Formula for success: rise early, work hard, strike oil, AND subscribe to Hedgeye.”
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research