Expect low oil prices in 2020; tendency toward recession

Energy Forecast for 2020

Overall, I expect that oil and other commodity prices will remain low in 2020. These low oil prices will adversely affect oil production and several other parts of the economy. As a result, a strong tendency toward recession can be expected. The extent of recessionary influences will vary from country to country. Financial factors, not discussed in these forecasts, are likely also to play a role.

The following are pieces of my energy forecast for 2020:

[1] Oil prices can be expected to remain generally low in 2020. There may be an occasional spike to $80 or $90 per barrel, but average prices in 2020 are likely to be at or below the 2019 level. 

Figure 1. Average annual inflation-adjusted Brent equivalent oil prices in 2018 US$. 2018 and prior are as shown in BP’s 2019 Statistical Review of World Energy. Value for 2019 estimated by author based on EIA Brent daily oil prices and 2% expected inflation.

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US 2015 Oil Production and Future Oil Prices

Oil production can be confusing because there are various “pieces” that may or may not be included. In this analysis, I look at oil production of the United States broadly (including crude oil, natural gas plant liquids, and biofuels), because this is the way oil consumption is defined. I also provide some thoughts regarding the direction of future world oil prices.

Figure 1. US Liquid Fuels production by month based on EIA March 2016 Monthly Energy Review Reports.

Figure 1. US Liquid Fuels production by month based on EIA March 2016 Monthly Energy Review Reports.

US oil production clearly flattened out in 2015. If we look at changes relative to the same month, one-year prior, we see that as of December 2014, growth was very high, increasing by 18.0% relative to the prior year.

Figure 2. US Liquids Growth Over 12 Months Prior based on EIA's March 2016 Monthly Energy Review.

Figure 2. US Liquids Growth Over 12 Months Prior based on EIA’s March 2016 Monthly Energy Review.

By December 2015, growth over the prior year finally turned slightly negative, with production for the month down 0.2% relative to one year prior. It should be noted that in the above charts, amounts are on an “energy produced” or “British Thermal Units” (Btu) basis. Using this approach, ethanol and natural gas liquids get less credit than they would using a barrels-per-day approach. This reflects the fact that these products are less energy-dense.

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Why oil under $30 per barrel is a major problem

A person often reads that low oil prices–for example, $30 per barrel oil prices–will stimulate the economy, and the economy will soon bounce back. What is wrong with this story? A lot of things, as I see it:

1. Oil producers can’t really produce oil for $30 per barrel.

A few countries can get oil out of the ground for $30 per barrel. Figure 1 gives an approximation to technical extraction costs for various countries. Even on this basis, there aren’t many countries extracting oil for under $30 per barrel–only Saudi Arabia, Iran, and Iraq. We wouldn’t have much crude oil if only these countries produced oil.

Figure 1. Global Breakeven prices (considering only technical extraction costs) versus production. Source:Alliance Bernstein, October 2014

Figure 1. Global breakeven prices (considering only technical extraction costs) versus production. Source: Alliance Bernstein, October 2014

2. Oil producers really need prices that are higher than the technical extraction costs shown in Figure 1, making the situation even worse.

Oil can only be extracted within a broader system. Companies need to pay taxes. These can be very high. Including these costs has historically brought total costs for many OPEC countries to over $100 per barrel.

Independent oil companies in non-OPEC countries also have costs other than technical extraction costs, including taxes and dividends to stockholders. Also, if companies are to avoid borrowing a huge amount of money, they need to have higher prices than simply the technical extraction costs. If they need to borrow, interest costs need to be considered as well.

3. When oil prices drop very low, producers generally don’t stop producing.

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Why “supply and demand” doesn’t work for oil

The traditional understanding of supply and demand works in some limited cases–will a manufacturer make red dresses or blue dresses? The manufacturer’s choice doesn’t make much difference to the economic system as a whole, except perhaps in the amount of red and blue dye sold, so it is easy to accommodate.

Figure 1. From Wikipedia: The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

Figure 1. From Wikipedia: The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

A gradual switch in consumer preferences from beef to chicken is also fairly easy to accommodate within the system, as more chicken producers are added and the number of beef producers is reduced. The transition is generally helped by the fact that it takes fewer resources to produce a pound of chicken meat than a pound of beef, so that the spendable income of consumers tends to go farther. Thus, while supply and demand are not independent in this example, a rising percentage of chicken consumption tends to be helpful in increasing the “quantity demanded,” because chicken is more affordable than beef. The lack of independence between supply and demand is in the “helpful” direction. It would be different if chicken were a lot more expensive to produce than beef. Then the quantity demanded would tend to decrease as the shift was increasingly made, putting a fairly quick end to the transition to the higher-priced substitute.

A gradual switch to higher-cost energy products, in a sense, works in the opposite direction to a switch from beef to chicken. Instead of taking fewer resources, it takes more resources, because we extracted the cheapest-to-extract energy products first. It takes more and more humans working in these industries to produce a given number of barrels of oil equivalent, or Btus of energy. The workers are becoming less efficient, but not because of any fault of their own. It is really the processes that are being used that are becoming less efficient–deeper wells, locations in the Arctic and other inhospitable climates, use of new procedures like hydraulic fracturing, use of chemicals for extraction that wouldn’t have been used in the past. The workers may be becoming more efficient at drilling one foot of pipe used for extraction; the problem is that so many more feet need to be drilled for extraction to take place. In addition, so many other steps need to take place that the overall process is becoming less efficient. The return on any kind of investment (human labor, US dollars of investment, steel invested, energy invested) is falling. Continue reading

What the new 2011 EIA oil supply data shows

The US Energy Information Administration (EIA) recently released full-year 2011 world oil production data. In this post, I would like show some graphs of recent data, and provide some views as to where this leads with respect to future production.

World oil supply is not growing very much

Figure 1. World crude oil and other "liquids" supply has dropped below the 1983-2005 trend line in recent years. Actual data is from EIA International Petroleum Monthly, through December 2011.

The fitted line in Figure 1 suggests a “normal” growth in oil supplies (including substitutes) of 1.6% a year, based on the 1983 to 2005 pattern, or total growth of 10.2% between 2005 and 20011. Instead of 10.2%, actual growth between 2005 and 2010 amounted to only 3.0% including crude oil and substitutes.

The shortfall in oil production relative to what would  have been expected based on the 1983-2005 growth pattern amounted to 4.7 million barrels in 2011. This is far more than any country claims as spare capacity. This is no doubt one of the reasons why oil prices are as high they are now. These high oil prices tend to interfere with economic growth of oil importing nations.

The shortfall in growth especially occurred in crude oil. Figure 2, below, shows crude oil production separately from substitutes.

Figure 2. World oil and other liquids supply, broken out into crude and condensate, natural gas plant liquids, other liquids (mostly ethanol), and processing gain (increase in volume from refining heavy oil), based on EIA data.

Between 2005 and 2011, crude oil production rose only 0.5%. It was mostly the substitutes that grew.

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