With so much going on with Europe's debt crisis, the continuing disaster and economic contraction in Japan, and the potential for a very hard landing in the Chinese growth miracle (which is in the running as my favorite "black swan candidate" for 2011), I am going to return our attention to oil in this report. The next report will assess the developing and unfolding debt crisis that will drag down most of the developed economies at some point, and this report will provide essential context for understanding why this result is inevitable and when it will occur.
The Next Oil Shock
The only thing that could prevent another oil shock from happening before the end of 2012 would be another major economic contraction. The emerging oil data continues to tell a tale of ever-tightening supplies that will soon be exceeded by rising global demand. This time, we will not be able to blame speculators for the steep prices we experience; instead, we will have nothing to blame but geology.
Back in 2009, I wrote a pair of reports in which I calculated that we’d see another price spike in oil by 2010 or 2011, based on some assumptions about global GDP growth rates, rates of decline in existing oil fields, and new projects set to come online. Given the recent price spike in oil (Brent crude over $126, now at $115) and recent oil supply data, those predictions turned out to be quite solid (for reference, oil was trading in the low $60s at the time).
One part I whiffed on was in my prediction that the world community would have embraced the idea of Peak Oil by now and begun adjusting accordingly, but that’s not really true except in a few cases (e.g. Sweden). Perhaps things are being differently and more seriously considered behind closed doors, but out in public the dominant story line concerns reinvigorating consumer demand, not a looming liquid fuel crisis.
How the major economies can continue proceeding with a business-as-usual mindset given the oil data is really quite a mystery to me, but that’s just how things happen to be at the moment.
At any rate, with Brent crude oil having lofted over $100/bbl at the beginning of February and remained above that big, round number for four months now, we are already in the middle of a price shock. It may not be a perfect repeat of the circumstances of the 2008 oil shock, but it's close enough that the risk of an economic contraction, at least for the weaker economies, is not unthinkable here. Japan, now in recession and 100% dependent on oil imports, comes to mind.
Looking at the new data and reading even minimally between the lines of recent International Energy Agency (IEA) statements, I am now ready to move my ‘Peak Oil is a statistically unavoidable fact’ event to sometime in 2012, which tightens my prediction from the prior range of 2012-2013.
Upon this recognition, the next shock will drive oil to new heights that are currently unimaginable for most. First, $200/bbl will be breached, then $300, and then more. And these are in current dollar terms; any additional dollar weakness will simply be additive to the actual quoted price. By this I mean that if oil were to trade at $200 but the dollar lost one half of its value along the way, then oil would be priced at $400.
Stampeding Into a Box Canyon
In 2009, I wrote a special report on oil that explored the interplay between energy and the economy. At that time, the stock market was in the tank, global growth was in a freefall, and things looked gloomy.
But I knew that thin-air money is not without its charms and that we’d experience a rebound of sorts. Here’s what I wrote:
I am of the opinion that these trillions and trillions of dollars, which, along with their foreign equivalents, are being applied to “ease the credit crunch,” will eventually find their mark and deliver what feels like a legitimate rebound in activity. All those trillions have to eventually go somewhere and do something.
For now, debts are defaulting faster than the various central banks and governments can inject new money and borrowing activity into the system. Banks aren’t lending because there are very few compelling loans to make, especially if future losses have to actually be carried by the bank making the loan.
But this won’t be true forever. Sooner or later, all the trillions of new dollars will trot out of the barn, begin to gallop, and then thunder off, creating the appearance of a healthy advance.
It will be a cruel illusion, though, as this stampeding herd of money is headed straight into a box canyon.
Money is only one component of growth. As we’ve strenuously proposed, energy is a necessary prerequisite for growth.
Well, here we are a couple of years later, with those trillions and trillions out of the barn and stampeding off trying to create some real and lasting economic growth. As we score these efforts, it appears to us that the amount and type of growth that has been achieved is underwhelming, to say the least.
Housing remains in a serious slump, wage-based income growth is poor, Europe remains mired in a serious debt crisis, Japan has slumped back into recession, and the US fiscal deficit is a structural nightmare. Worse, GDP growth is relatively tepid and would be negative, deeply negative, without all the deficit spending and liquidity measures.
As predicted, all that thin-air money, once released into the wild, had a mind of its own and created a serious bout of commodity inflation, especially in food and fuel, which is now seriously impacting the poor and middle classes.
So it’s hard to call the trillions and trillions ‘well spent.’ I was hoping for better results.
Yet we can’t call the re-flation efforts a complete failure, as we are not in a serious, destructive deflation, and we’ve all been granted a bit more time to get ourselves prepared in whatever ways make sense. The gift of time has been invaluable, and for that I am grateful. But in terms of creating a true and lasting economic miracle? It turns out, once again, that 'printing' money electronically is no more effective than calling in the silver coin of the realm, making each unit slightly smaller, and then re-issuing it. Real economic growth has not been created.
What has happened is that false demand, spurred on by trillions in thin-air money, has also spurred on renewed demand for oil, hastening the day that a geologically inspired supply/demand mismatch will finally arrive.
We are driving at a high rate of speed into a box canyon.
World Crude Supply
Before we get into the specifics of where I think the immediate trouble lies in the world oil data, let's take a moment to look at the big picture.
There are a number of ways to look at the petroleum data. The one I prefer to look at is something called 'crude + condensate' (C+C), which leaves out things like ethanol and natural gas liquids, both of which are converted to 'barrel of oil equivalents' (BOE) and added to the C+C to yield total liquid fuels. The reason I like to focus on C+C is that this is mainly conventional oil, the cheap and easy stuff, and it gives us a better idea of where we are in the Peak Oil story.