What, Me Worry About Peak Oil?

Guest Post by Art Berman

Congress ended the U.S. crude oil export ban last week. There is apparently no longer a strategic reason to conserve oil because shale production has made American great again. At least, that’s narrative that reality-averse politicians and their bases prefer.

The 1975 Energy Policy and Conservation Act (EPCA) that banned crude oil export was the closest thing to an energy policy that the United States has ever had. The law was passed after the price of oil increased in one month (January 1974) from $21 to $51 per barrel (2015 dollars) because of the Arab Oil Embargo.

The EPCA not only banned the export of crude oil but also established the Strategic Petroleum Reserve. Both measures were intended to keep more oil at home in order to make the U.S. less dependent on imported oil. A 55 mile-per-hour national speed limit was established to force conservation, and the International Energy Agency (IEA) was founded to better monitor and predict global oil supply and demand trends.

Above all, the export ban acknowledged that declining domestic supply and increased imports had made the country vulnerable to economic disruption. Its repeal last week suggests that there is no longer any risk associated with dependence on foreign oil.

What, Me Worry?

The tight oil revolution has returned U.S. crude oil production almost to its 1970 peak of 10 million barrels per day (mmbpd) and imports have been falling for the last decade (Figure 1).

Figure 1. U.S. crude oil production, net imports and consumption. Source: EIA and Labyrinth Consulting Services, Inc.
(Click image to enlarge)

But today, the U.S. imports twice as much oil (97%) as in 1974! In 2015, the U.S. imported 6.8 mmbpd of crude oil (net) compared to only 3.5 mmbpd at the time of the Arab Oil Embargo (Table 1).

Table 1. Comparison of U.S. crude oil imports, production and consumption for 1974 (Arab Oil Embargo) and 2015 (Today).
Source: EIA and Labyrinth Consulting Services, Inc.
(Click image to enlarge)

Production of crude oil is higher today by 7% but consumption has grown to more than 16 mmbpd, an increase of 32%. At the time of the Arab Oil Embaro, consumption was only 12 mmbpd.

So, consumption has increased by one-third and imports have doubled but we no longer need to think strategically about oil supply because production is a little higher?

We are far more economically vulnerable and dependent on foreign oil today than we were when crude oil export was banned 40 years ago.

What, me worry?

Figure 1. Alfred E. Neuman. Source: moneyandmarkets.com

Peak Oil

While the world was focused on an over-supply of oil and falling prices over the last 18 months, world liquids production peaked in August 2015 at almost 97 mmbpd (Figure 2).

Figure 2. World conventional and unconventional liquids production. Source: EIA, Drilling Info, Statistics Canada
and Labyrinth Consulting Services, Inc.
(click image to enlarge)

Average daily production of 95.5 mmbpd for 2015 exceeds EIA’s Annual Energy Outlook 2015 forecast (April 2015) by 2.6 mmbpd!

Conventional oil production peaked in February 2011 at 85.3 mmbpd (Figure 2) and non-OPEC conventional production peaked in November 2010 at 49.8 mmbpd (Figure 3).

Figure 3. World conventional and unconventional liquids production showing OPEC and non-OPEC conventional production.
Source: EIA, Drilling Info, Statistics Canada and Labyrinth Consulting Services, Inc.
(click image to enlarge)

It’s not important whether this is the final, maximum world production peak or not. It is a signal about a trend that needs to be acknowledged and incorporated into our evolving paradigm about oil supply.

Peak oil production was accelerated by a confluence of factors. Zero interest rates in the U.S. and Middle East supply interruptions before 2014 caused high oil prices. Easy money caused over-investment in the oil business. Over-production and weakened demand resulted in the collapse in world oil prices. OPEC’s reaction and decision to produce at maximum rates have created the “perfect storm” for peak oil production several years before it would have occurred otherwise.

All oil producers are losing money at current prices but companies and countries are producing at high rates. Indebted conventional and unconventional players need cash flow to service debt so they are producing at high rates. OPEC is producing at high rates to maintain or gain market share. Everyone is acting rationally from their own perspective but from a high level, it looks like they have all lost their minds.

Peak oil is not about running out of oil. It is about what happens when the supply of conventional oil begins to decline. Once this happens, higher-cost, lower-quality sources of oil become increasingly necessary to meet global demand.

Those secondary sources of oil include unconventional (oil sand and tight oil) and deep-water production. The contribution of unconventional and deep-water production has grown from about 15% in 2000 to approximately one-third of total supply today, and it will probably represent more than 40% by 2030.

Despite a popular belief that tight oil is price-competitive with conventional oil production, it is not (Figure 4).

Figure 4. Slide from Schlumberger CEO Paal Kibsgaard’s presentation at the Scotia Howard Weil 2015 Energy Conference.
(Click image to enlarge)

Figure 4 is from Schlumberger, a company that knows the costs of its global customers. It shows that tight oil is the most expensive source of oil, followed by deep-water and other offshore oil. Conventional oil from onshore and OPEC middle eastern sources is the lowest cost oil.

Schlumberger did not include oil sands in its chart because it is difficult to compare the costs of a manufacturing operation to the cost of drilling individual wells. Existing mined and SAGD oil sands projects, however, break-even at approximately $50 per barrel although new SAGD projects require about $80 per barrel.

Figure 4 reflects costs in 2014. Although cost and efficiency improvements since 2014 probably apply equally to all plays, Table 2 shows late 2015 costs and reserves for key tight oil operators.

The principal tight oil plays–Bakken, Eagle Ford and Permian basin–break even at $65 to $70 per barrel oil price today.

Table 2. Key operator weighted-average estimated ultimate recoveries (EUR) in barrels of oil equivalent and break-even oil prices. Drilling and completion (D&C) costs used in the economic calculations are shown. Economics also include an 8% discount. Details may be found at the following links: Bakken, Eagle Ford and Permian.
Source: Drilling Info & Labyrinth Consulting Services, Inc.
(Click image to enlarge)

Although EUR is higher and break-even prices are lower for certain operators and core areas of the plays, Table 2 reflects representative average values for operators with the highest rates and cumulative production. If the price of oil increases, service costs will also increase and the production cost will be higher. Efficiency gains are largely behind us as new well production per rig has flattened in the last quarter of 2015 (Figure 5) so it is unreasonable to expect costs to decrease much further.

Figure 5. Tight oil new well production per rig. Source: EIA & Labyrinth Consulting Services, Inc.
(Click image to enlarge)

The economics of tight oil plays require spot oil prices that are double and wellhead prices that are triple current face values. Excluding new SAGD projects, tight oil is the world’s most-expensive and, therefore, marginal barrel of oil and its cost of production today is more than $70.