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Is the Oil Industry Dying?

Museletter, August 2016
Talking about “peak oil” can feel very last decade. In fact, the question is still current. Petroleum markets are so glutted and prices are so low that most industry commenters think any worry about future oil supplies is pointless. However, the glut and price dip are hardly indications of a healthy industry; instead, they are symptoms of an increasing inability to match production cost, supply, and demand in a way that’s profitable for producers but affordable for society. Is this what peak oil looks like?

Aside from forecasts regarding the timing of the inevitable moment when petroleum production would max out (yes, many of those forecasts proved premature), the peak oil discussion more importantly highlighted three key insights, all of them as valid now as ever:

1. Oil is essential to the modern world.
Energy is what enables us to do anything and everything, and oil is currently the world’s primary energy source. But oil’s role in society is even more crucial than that sentence might suggest. Nearly 95% of global transport is oil-powered, and if trucks, trains, and ships were to stop running the global economy would grind to a halt almost instantly. Even electricity (which is the other main energy pillar of commerce and daily life) depends on oil: coal mining, transport, and processing depend on oil; much the same is true for natural gas, uranium, and the components of solar panels and wind turbines.

2. Oil is hard to substitute.
A colleague, the energy analyst David Fridley, and I recently finished a year-long inquiry into details of the necessary and inevitable transition from fossil fuels to renewable sources of energy. While lots of sunshine and wind are available, not all the ways we use energy will be easy to adapt to renewable electricity. Some of the biggest challenges we identified are in the transport sector. Electric cars are certainly feasible (more are on the road every year), but batteries alone can’t power heavy trucks, container ships, and large airplanes.

There are other possibilities (including biofuels and hydrogen-based fuels made using electricity), but these are likely to be much more expensive and will require large energy inputs for their ongoing production. Moreover, transitioning to them will take major investment and infrastructure build-out occurring over two or more decades.

3. Depletion of oil (and of other non-renewable resources) tends to follow the low-hanging fruit principle.
Humanity has been extracting oil on an industrial scale for 150 years now. At first, all it took was identifying places where petroleum was seeping to the ground surface, then digging a shallow well. Today, globally, millions of old conventional oil wells lie depleted and abandoned. The primary remaining prospects for production include heavy oil (which requires expensive processing); bitumen (which must be mined or steam-extracted); tight oil (produced from low-permeability source rocks, which requires hydrofracturing and horizontal drilling, with typical wells showing a rapid decline in output); deepwater oil (which entails high drilling and infrastructure costs); or arctic oil (which has so far mostly proven cost-prohibitive). All of these options entail rapidly growing environmental costs and risks.

It’s that third point that helps explain the disturbing recent evolution of the petroleum world. Most industry analysts focus on oil prices, and it’s clear on this score that the market has gone seriously weird in recent years. In 2001, petroleum sold for about USD$20 a barrel, a price that sat well within a fairly narrow band of highs and lows that had bounded price for roughly 20 years following the politically generated oil shocks of the 1970s. But, by the summer of 2008, the price had ascended to the unprecedented, dizzying altitude of $147; then (following the cratering of the global economy) it plummeted to $37. Following that, prices gradually recovered to around $100, where they remained for nearly three years before sliding again, starting in mid-2014, to the high $20s, from which they have partially rebounded to today’s approximately $40.

The recent highs (above $100) are incomprehensible, until we recognize that the oil industry’s costs of production have skyrocketed in the past decade. Throughout the first decade-and-a-half of the new century, demand for oil was growing rapidly in Asia. Normally, the industry would have simply ramped up its supplies of conventional crude to satisfy the needs of new car buyers in China and India. But output of conventional oil topped out in 2005; all the new supply growth since then has been from hard-to-reach or low-grade resources. Producers didn’t resort to these until demand outstripped supply, raising prices and justifying the far higher rates of investment that are required per unit of new production. But that meant that, henceforth high prices would have to continue if producers were to turn a profit.

When oil was selling for USD$100 per barrel, many tight oil projects in the United States were nevertheless only marginally profitable or were actually money losers; still, with interest rates at historic lows and plenty of investment capital sloshing around the financial industry, drillers had no trouble finding operating capital (David Hughes of Post Carbon Institute was one of the few analysts who questioned the durability of the “shale gale,” on the basis of meticulous well-by-well analysis). The result of cascading investment was a ferocious spate of drilling and fracking that drove levels of U.S. oil production sharply upward, overwhelming global markets. The amount of oil in storage ballooned. That’s the main reason prices collapsed in mid-2014—along with Saudi Arabia’s insistence on continuing to pump crude at maximum rates in order to help drive the upstart American shale-oil producers out of business. The Saudi gambit mostly succeeded: Small-to-medium-sized U.S. producers are now gasping for air, and, as their massive debts come due over the next few months, a wave of bankruptcies and buyouts seems fairly inevitable. Meanwhile, in the continental U.S., oil production has dropped by 800,000 barrels a day.

It might not be far from the mark to suggest that we are witnessing the early stages of the thermodynamic failure of global industrial society.

Indeed, the entire petroleum business is currently in deep trouble. Countries that rely on crude oil export revenues are facing enormous budget deficits, and in some cases are having trouble maintaining basic services to their people.

The worst instance is Venezuela, where hunger is rampant. But hard times have also fallen on Nigeria, the Middle Eastern monarchies, Russia, and even Canada to some degree. The oil majors (Exxon, Shell, Chevron, etc.) are still somewhat profitable because a significant portion of their output still comes from older, giant oilfields; but a large and increasing segment of their remaining profits now goes toward debt servicing. And their existing oil reserves are not being replaced with new discoveries.

Any way you look at it, the industry faces a grim future. Even if prices go up, there is no guarantee of recovery: Investors may be shy to rush back to oil since they have no assurance that a price rout won’t recur in months or years. After all, when prices are high enough to generate profits (which is very high indeed these days), they are also high enough to destroy demand—which is also vulnerable to recessions, the growth of the electric vehicle market, and meaningful climate policy. It’s simply unclear whether the global economy can consistently support an oil price that’s sufficiently robust to pay the industry to extract and refine the kinds of resources that remain.

Again, most oil commentators look at all of this through a purely economic lens. But it may be helpful to think more in terms of thermodynamics. Oil, after all, is primarily useful as a source of energy. And it takes energy to get energy (it takes energy to drill an oil well, for example). Energy profits from oil extraction activities were once enormous, and those energy profits got spread throughout society, wherever oil was used. Now, petroleum’s energy profitability is falling fast.