free html hit counter Peak Oil Debunked: 383. THE FALLING COST OF PRODUCING OIL

Thursday, December 04, 2008

383. THE FALLING COST OF PRODUCING OIL

Peak oilers are a restless bunch, working round the clock to turn anything and everything into another reason why we're doomed. You'd think that a massive $100 dive in the price of oil, and an ever-growing glut of the substance, would shut them up for five minutes, but no such luck. First we were doomed because of high oil prices. Now it turns out we're doomed because of low oil prices. Yup, the latest doomer talking point is that the plummeting price of oil will make it uneconomical to produce the "expensive" oil, so we're in big trouble.

This view has a couple of problems. First of all, if the price is dropping, that means there's no demand for the expensive oil. Ergo, it's no big deal if we don't produce it. In fact, it's better all around if we don't produce it because that will: (a) save more oil for later, and (b) reduce pollution and CO2 emissions.

Second, and more important, is the erroneous assumption that "expensive" oil is somehow inherently expensive, and that high costs will stay high as the price of oil drops.

In fact, high oil production costs have been driven primarily not by geology or EROEI, but by the same bubble dynamics that made the price of everything go up. Numerous projects were cancelled in the last year or two because the industry was overheating. Rigs, steel, white collar expertise, manual labor, materials, shipping -- everything was too expensive, and project budgets were ballooning out of control. Now that the bubble has popped, construction costs will come back down to earth. The smart players will do their project construction now, at bargain basement prices, and reap the benefits in the next cycle of high oil prices. That's the secret to riding the oil wave: build when costs are low, and pump when prices are high.

The peak oilers are fretting as if oil prices going down the toilet is some kind of new phenomenon. They still haven't caught on: oil is a cyclical business. Always has been for the last 150 years. As previously noted, the grizzled veterans have seen it all before:
"We're a cyclical business," David J. O'Reilly, chief executive of ChevronTexaco, the second-largest American oil company, said in a telephone interview, "and at the high end of the cycle it makes sense to get the company in good shape and strengthen our balance sheet. "History tells us that what goes up also goes down."Source
Consider the oil sands. In 2006, the average cost of producing a barrel of oil in Alberta was 32USD. Here's the breakdown (click to enlarge):


Up through the summer of 2008, costs in Alberta skyrocketed due to the fever of speculative bubblenomics:
"Labour shortages and increased material costs have created a hyper-inflationary environment within the oil and gas industry in Alberta. With the sheer number of oilsands projects, together with the future Arctic pipelines and conventional oil and gas developments in Alberta, labour demands in Canada will be pushed to their limits," he said.Source
The "high costs" we keep hearing about were actually driven by hyper-inflationary conditions, and are now coming down. Contrary to the naive view, production costs are not fixed. In Alberta, the primary drivers of high costs are steel and labor:
Five years ago [i.e. 2003], the capital cost of building a project that mined bitumen and processed it into high-quality crude was around C$40,000 per barrel of production, reckons Andrew Potter, a UBS Securities analyst. The same project today could cost C$180,000 per barrel, or around C$18 billion for a typical 100,000 barrel-a-day development.
Soaring raw material prices, notably for steel, have played a big role. Oil sands will likely find some relief here: Steel prices have slumped three-quarters from summer highs as major consumers - China in particular - rein back demand amid fears of a global economic slowdown. But the main culprit is labor.Source
Steel is already down the toilet, and wages aren't set in concrete, particularly in a time of deflation and surging unemployment. The only reasonable conclusion is that the cost of producing in the oil sands is (or will soon be) rapidly dropping, together with the price of oil.

And that's when the smart firms kick into gear:
The collective impact of project delays may work out rather well for companies that still decide to push ahead.

Through its affiliate Imperial Oil Ltd. (IMO), ExxonMobil is still sticking to schedule for the C$8 billion Kearl oil sands mine.

"[While] some of the other oil sands projects may be slowing down or whatever, that could actually provide some benefit to us in respect to lower cost, both for raw material and services," David Rosenthal, ExxonMobil's vice president of investor relations, said on a conference call Thursday.Source
And (hat tip to OilFinder):
6. Is there a benefit for Hyperdynamics to have a lower oil price?

My Answer:

Yes. I don't think the price will drop to lower levels than we have seen in years past and so I will take it either way at the moment. Actually, I would prefer the price of oil to stay lower until we make a discovery, and then I would like it to go up for the benefit of Guinea and our shareholders. I know this is a capitalistic statement and I apologize to any Socialist reading this. The lower the price of oil, the easier it is to secure some of the critical resources necessary to do the exploration work, such as drilling rigs. Moreover, we can secure the resources at lower costs. Obviously, if the price of oil is $147 per barrel, drilling rigs are receiving a premium and are working continuously. A lower price of oil could actually allow us and our partners to obtain a rig sooner and at more reasonable cost. This is especially true for us due to the economics of our prospects. The potential volumes in our prospects can make up for much of a lagging price of oil.Source
It reminds may of a famous saying by Konosuke Matsushita (founder and former President of Panasonic):
好況よし、不況さらによし
Good times are good. Bad times are even better.
by JD

40 Comments:

At Friday, December 5, 2008 at 4:49:00 AM PST, Blogger JD said...

As always, please use the Name/URL option (you don't have to register, just enter a screen-name) or sign your anonymous post at the bottom. The conversation is better without multiple anons.
Thank you!
JD

Also, I've banned Carl for being a moron. To ensure that he stays banned, I've temporarily turned on comment moderation, but will pass through all comments as quickly as I can. Sorry for the inconvenience. I'll switch back to the usual system ASAP.

 
At Friday, December 5, 2008 at 6:04:00 AM PST, Blogger Ari said...

It's really remarkable to me that none of the PO people have managed to catch on to the notion of "diseconomies of scale."

It's really not that hard to figure out.

 
At Friday, December 5, 2008 at 7:33:00 AM PST, Anonymous AndrewRyan said...

Great post JD. It's amazing to me that the PO doomers are actually spinning low oil prices as bad news and of course, TEOTWAWKI. It really shows what their true motives are - spinning current events to spread doom. I guess always thinking the world is going to end is a good way to add excitement to their boring, insignificant lives.

Why are the doomers fretting about tar sand projects going offline anyways? I thought the tar sands were a myth and had a negative EROEI!

The doomers can't have it both ways. Back in July they were salivating over $147 oil and acting like the crash was near. You'll notice LATOC is almost all financial news now on the front page as well as their forums. That should tell you something. Of course, quack jobs like Ruppert are still spinning today's events as related to PO, but a lot of the PO movement is losing steam. The doomers are forgetting two things:

1. We will have more oil for the future by today's decreased demand (as you mentioned)
2. There's no reason why more expensive projects like tar sands won't go back online when it again becomes profitable to do so.

I can't find the link at the moment, but there was a great news article on CNN that basically said that the big oil companies knew prices were going to crash, and that is why they didn't invest more in some of the expensive projects such as tar sands. They were lambasted for it, but the big oil companies got the last laugh, as they aren't losing nearly as much as the smaller, independent companies that invested in getting expensive oil.

Found the link: http://money.cnn.com/2008/11/14/news/economy/oil_production/

 
At Friday, December 5, 2008 at 11:11:00 AM PST, Anonymous Bill said...

I don't subscribe to peak oil, but I'm open to the idea. JD, how do you think oil prices at 40 dollars a barrel and less will affect countries like Mexico and Saudi Arabia, where a significant portion of their GDP is dependent on oil? Can a country like Mexico, where easy-to-find oil has peaked, and new reserves are hard to come by on the cheap, survive at such low prices?

 
At Friday, December 5, 2008 at 2:26:00 PM PST, Anonymous AndrewRyan said...

Bill, doesn't it cost Saudi Arabia $1 a barrel to produce oil from their fields? Oil prices were low for decades and Saudi Arabia did just fine. I'm not sure about Mexico though. I know Iran and Venezuela both are very dependent on oil exports, so they might be hurting. Their sympathy card is in the mail.

 
At Friday, December 5, 2008 at 2:45:00 PM PST, Anonymous benny "MAOG" cole said...

Oil may go to $10 a barrel. It will be The End of the World as We Know It.
Or, the end for the cesspool of oil speculators and websites that created the oil scare.
But, give it 10 years or so, and they will be back.

 
At Friday, December 5, 2008 at 6:49:00 PM PST, Blogger wchfilms said...

It's just silliness. Anyone that ignores supply and demand (doomers), the most basic economic principal there is is just laughable. Lord.

Hint that most people here don't need: whenever somebody says X (dot com stocks, home prices, oil) is only going up, SELL IT. Then when it gets cheap again, buy it.

 
At Friday, December 5, 2008 at 6:51:00 PM PST, Blogger wchfilms said...

And I do think oil is a pretty good purchase at the current price. I'm thinking it's going to $30, but it's very hard to time it, so DCA into it.

 
At Friday, December 5, 2008 at 8:41:00 PM PST, Anonymous Mike S. said...

The problem with boom and bust is it really messes up your investment cycles, especially when there are long lead times to bring new production on line.

The companies that have cash in the bank can build capacity in the lean times and be ready to ramp up in a hurry when demand comes back up. And it will.

In the mean time, demand falls, prices of a relatively inelastic supply also fall. Econ 101 wins again.

The only risk I see is that some marginal fields may shut down for good, as some oil production enhancement techniques are such that once you start, you can't stop, as production will not come back if you try to restart the well again. That is part of the reason for the inelastic supply. Since we are talking about a field on its last legs, it's also not a huge amount of oil in the larger scheme of things.

 
At Friday, December 5, 2008 at 11:33:00 PM PST, Blogger JD said...

benny,
Your predictions continue to be spot on. We've penetrated the $30 barrier:

"Dubai Oil Price Falls to a 46-month Low
Saturday, December 6, 2008 13:18:14

The price Dubai crude oil has fallen to the 30-U.S. dollar-level for the first time in nearly four years.

In Singapore, the spot price of Dubai oil traded on Friday closed at 38-dollars, 91-cents per barrel, down more than two dollars from the previous day."
Link

 
At Saturday, December 6, 2008 at 6:53:00 AM PST, Blogger Barba Rija said...

You forget that the real fuel for doom is change. People fear change. I've even read many blogs since some months ago that also try to instill the idea that Obama will bring a depression to the US. It would be funny, if it wasn't so sad, for even if this recession is steep, I can't blame Obama for it, as he's not even the president yet!

It doesn't stop people pre-blaming him for what's gonna happen badly.

The same in the Global Warming thing.

I think that people stopped looking at evidences and at clear facts and checks for things happening in the present or already in the past. People today are always projecting their opinions on what's going to happen in the future.

It's the zeitgeist, probably. The speed of change is very fast, nowadays. But it still annoys me that people take their own opinions for granted, they are simply too sure of themselves and still don't understand that the future is really, really, very, truly hard to predict.

 
At Saturday, December 6, 2008 at 7:27:00 AM PST, Blogger JD said...

future is really, really, very, truly hard to predict.

I agree, but I think we're living in a new era with the Internet. Its democratizing effect is very destabilizing. Lately, an embryonic thought keeps nagging at me in the back of my mind. Maybe the best way to express it is that "the lunatics are taking over the asylum".

Even 5 years ago, the media had a much stronger hand in shaping the agenda and public opinion. There was a strong foundation of media decorum which mob mentality couldn't break through. Now, the article by the MSM is just the appetizer, with the main course being 500 comments by ordinary people taking the piss out of the article.

Now everybody in the world can talk shit about the system (powerful institutions, people etc.), and there's nothing the system can really do to control it. It's true in the financial system, where players are free to turn against it -- destroy it by shorting and cannibalizing it etc. Or fuel bank runs in the myriad, unpredictable ways those can occur in the 21st century. That's where the system is flawed, in a way. It's built on individual freedom which, of course, also entails the freedom to spit on the system and destroy it.

It's self-fulfilling prophecy, a strategy based on nothing except mass psychology. Yet it's quite effective. That's why the doomers and the shit-talkers keep making categorical statements about the future. They're waking up to the increasing impact they can exert through the Internet. It's not about being right. It's about wounding the system they hate. Every prediction is like making a small cut. Like a greasy guy on the corner, who has a grudge against the bank saying: "Psst. I used to work at that bank. I'd take my money out if I were you." Not such a effective tactic in the old days, but now the internet gives that tactic (and its many variations and elaborations) some real mojo.

 
At Saturday, December 6, 2008 at 7:56:00 AM PST, Blogger JD said...

This article is a classic example in the same vein. It came up on Google news the other day, as though it were any other news story about electric cars. But actually it's just a blog article written by a complete moron who literally makes up every statistic in it. And then, when challenged for citations, just flatly lies and says the stats are from the DOE. You got to read it to believe it. It's like Carl on steroids. But I guess that's where going, isn't it? Why bother looking anything up at all? Who needs a real journalist, when you can have "Joe the Blogger", or a whole army of misinformed, lying "Joe the bloggers" who all support and high-five each other, and have nothing but contempt for the facts? Not saying we're there yet, of course, but the trend is definitely moving in that direction.

 
At Saturday, December 6, 2008 at 11:22:00 AM PST, Blogger Ari said...

JD,

I think you bring up an interesting point, but fail to mention something: the MSM is in moving in with the lunatics.

All the MSM blogging (from the damn reporters!), the increasingly poor standards of reporting, and the willingness of the MSM to let the nutters get on TV and say what they want shows to me that they're content with the way things are going.

It's interesting how fearful the Founding Fathers were of mob democracy. The Internet is a good example of why they felt that way.

 
At Saturday, December 6, 2008 at 11:42:00 AM PST, Anonymous benny "MOAG" cole said...

JD-
Well, I am saying $10 for effect, I don't know if it will really go that low. But, if 1998 is an indicator....
Really, one just has to look at crude oil demand following the 1979 price spike, or the 1998 Far East financial troubles....the current situation (unfortunately) looks far worse....
But, yes, the world will be producing much too much oil for several years, and there is no place ti store it all...$10 is a possibility.
It is lamentable to read YOD now. Not one editor says ,"You know what? This glut could last for years, and maybe we need to reconsider the role that price plays in demand, and demand plays in price. Obviously, we totally missed this bath in oil."
I hope for a global recovery soon. But this seems universal, this downturn. It is ugly.

 
At Saturday, December 6, 2008 at 8:45:00 PM PST, Blogger wchfilms said...

It's hard to see $10 oil just because the sheer amount of new money in the system ... yes, lots is being destroyed by the collapse of mortgages, but the fed is doing their best to replace it which should (at least roughly) keep it at parity.

Interesting points, JD, about the blogs and stuff. The fact that Google News freely intermixes them with "news" stories flabbergasts me. And there is no way to shut that off, so basically I just stopped going there.

Blogs have their use, but they aren't really news for the most part, they are analysis and meta-analysis of news.

In the financial crisis, it's weird reading stuff online because it seems like the world has ended. Then, I go out to lunch or whatever in the real world and it looks exactly the same as before!

 
At Saturday, December 6, 2008 at 8:46:00 PM PST, Blogger wchfilms said...

I think in the broad sense, having something like Google News is kind of absurd... so, what, am I really supposed to read a thousand stories, basically becoming my own personal news editor, to figure out what is going on? It's crazymaking. The media does (or did) have a valuable filtering role.

 
At Saturday, December 6, 2008 at 11:25:00 PM PST, Blogger JD Walters said...

Thanks AndrewRyan for passing on that CNN article. I was tempted to join the doomers in their latest spin of how low oil prices were actually a bad thing because it would discourage investment. But reality has a way of making you come around.

So true about the risks of the democratization of the MSM. It's a sad little ritual over at the TOD to read the Drumbeat (which despite its bias for doom-and-gloom is really a unique and valuable source of energy-related news), then watch about 200 comments accumulate, most of them from people who don't know what the hell they're talking about. All they do is rant vaguely about those darn evil corporations and idiots who are running the country into the ground, etc. No reflection, no insight, just one big orgy of disinformation and fear-mongering.

Then again, we kind of do the same thing over here, except maybe a bit smarter:) I know I always value anything from Benny Cole. Now that guy has his s--t together.

 
At Sunday, December 7, 2008 at 4:50:00 AM PST, Blogger FR said...

Is anyone still worried about Peak Oil? Seriously? I'm actually worrying about the opposite problem: very low gas prices stalling our efforts toward fuel efficiency and alternatives.

 
At Sunday, December 7, 2008 at 6:44:00 AM PST, Blogger sniperslaststand said...

Sort of first independent test drive of the pre-release new BYD F3DM dual mode plug-in hybrid, most likely the first PHEV to enter volume production.

Translated by Google Translate from Chinese to English are the part 1 and the part 2

Key specs:
- price on Chinese market: more or less 17000EUR/22000USD, twice the price of BYD ordinary cheap small family car, the F3 with a petrol engine. So it's gonna cost a little less than a Prius and similarly to the petrol powered VW Golf/Jetta. The BYD F3DM comes with an "automatic gearbox".
- all electric range: 100 km/60 miles
- weight: 1,5 tonnes
- battery weight 230 kg
- dimensions: length=4533mm, width=1705mm, height=1490mm
- 0-62mph (100kph): 10,8 sec
- top speed: 160 kph/100mph
- combined peak power: 125 kW/165HP
- combined peak torque: 400Nm

Car can apparently be run in electric-only and hybrid mode. The reviewer says when using battery only, the electric system can generate peak power of 110kW/150HP with torque reaching 370Nm. Apparently, this can be boosted with a 25kW generator powered by the 1.0 50kW engine, more or less making for specified peak power (figures don't add properly). It seems though that the F3DM can deliver 10,8 sec acceleration time in the electric-only mode, 150HP should be enough for it in a 1,5 tonne car.

The reviewer complains that after exhausting the battery, the 50kW 1.0 liter petrol engine extending the range is a bit weak for powering for the car. I can't figure out whether, as the battery is depleted, the engine powers the wheels directly or via a generator and an electric motor pair.

BYD claim some sort of 10 years of battery life as far as I remember.

Well, considering the price and performance, when they start the production we can say they've cracked it and overtaken all the other giant manufacturers. BYD makes a lot of ferrous batteries used in consumer electronics so I believe they know what they're saying considering the battery lifespan.

Maybe then an affordable plug-in hybrid car is here.

 
At Sunday, December 7, 2008 at 8:14:00 AM PST, Anonymous Babun said...

This view has a couple of problems. First of all, if the price is dropping, that means there's no demand for the expensive oil. Ergo, it's no big deal if we don't produce it. In fact, it's better all around if we don't produce it because that will: (a) save more oil for later, and (b) reduce pollution and CO2 emissions.


I believe the argument here is the difficulty of bringing oil to the market in a timely fashion after oil demand picks up again if investment is deterred as a result of low prices.


Second, and more important, is the erroneous assumption that "expensive" oil is somehow inherently expensive, and that high costs will stay high as the price of oil drops.

In fact, high oil production costs have been driven primarily not by geology or EROEI, but by the same bubble dynamics that made the price of everything go up.


Are you claiming that unconventional oil isn't expensive to develop as compared to conventional oil?

 
At Sunday, December 7, 2008 at 10:53:00 AM PST, Anonymous Freddy Hutter said...

Like most bubbles, the 2008 crude price episode was the culmination of many factors: record Demand, lagging refinery capacity, supply chain entanglements, the last hurrah of the investment banks, and a dash of fear.

Rumours of Peak Oil flourished. As did misinformation on rig availability and labour pools. It was the perfect storm.

Based on fundamentals, the peak contract price of $134/barrel was never justified. Nor economically sustainable. Windfall profits became the main price componenet.

At TrendLines, we share your view on Costs, JD. Demand destruction is clearing out the fringe marginal cost producers, and Price is again reflecting the conventional sources.

With recent adaptations of our Barrel Meter to include a 5-yr Target, it can be seen that my sentiment favouring at least 1-yr of softness in costs is evident. This would be the first diversion from the secular trend in costs: http://www.trendlines.ca/monthlyreport.htm#barrel

Avg extraction cost is down to $20, and perhaps headed to $20/barrel as the global recession pares back the irrational exuberance...

 
At Sunday, December 7, 2008 at 10:57:00 AM PST, Anonymous benny "MOAG" cole said...

JD-

I am red-faced! Please!

I will tell you one thing; I hope I am wrong. I hope the world economy comes roaring back, and oil markets strengthen.

Even so, I don't think any price above $100 a barrel is sustainable. People start adjusting, buying less. Alternative supplies come on stream. It may take a few years, as energy markets are huge and short-term inelastic. But consumers eventually start using less, just as supplies react to the higher prices and become more flush.

OPEC and speculators may be able to stretch the string above $100. But eventually, the fundamentals come home to roost.

Note to wchfilms; I see the recession. Many storefronts in L.A. now empty. seeking tenants. Condos for sale, no buyers. My ex-wife and her new hubbie lost their home, moved into an apartment. The guy had pulled out his 401 k money to buy the house (they have family, otherwise it might be worth a chuckle). Auto lots of some years standing are closed. No restaurants have "help wanted" signs on them, like they used to.
My clients are architects, and they have been cutting staff, by 30 percent.
Cardboard, once picked up by pick-up truck collectors, now lies around in big piles in industrial districts. Why? China no longer wants the cardboard, and there is no money for collecting it anymore.
Believe me, this is ugly, and it is just starting. I hope you continue to dodge the bullet, and all readers of POD also fare well.

 
At Sunday, December 7, 2008 at 12:07:00 PM PST, Anonymous stats79 said...

Is anyone still worried about Peak Oil? Seriously? I'm actually worrying about the opposite problem: very low gas prices stalling our efforts toward fuel efficiency and alternatives.

Apparently you are or you wouldn't be concerned about greater fuel efficiency and alternative energy.

Also, I'm absolutely stunned by the negative comments about the blogsphere from a blog that is nothing if not a contrarian, non-mainstream antidote to current mainstream groupthink.

 
At Sunday, December 7, 2008 at 5:04:00 PM PST, Anonymous Freddy Hutter, TrendLines said...

Since 2004, my Barrel Meter (and economic) model has used the premise that crude price cannot exceed $70/barrel for over 24 months w/o bringing on either Demand Destruction or an american Recession. It has withstood the test of time, but as alternative energy sources and substitutions become available, this threshold will eventually rise. It's all about consumer Disposable Income.

To correct my earlier post, our Cost base is currently $20 on the Barrel Meter, down from $23 and on its way to $14/barrel next Autumn.

 
At Sunday, December 7, 2008 at 5:26:00 PM PST, Blogger FR said...

stats79,

No, I am not concerned about Peak Oil. I'm concerned about the American obsession with the automobile for a variety of reasons, the most important being the 35,000 people a year who die from auto accidents. (Trains are much safer.) I am also worried about our continuing dependence on foreign energy and carbon emissions. Peak Oil, in my book, would have been a good thing. (I never bought into the doomer argument that we were headed for a "Mad Max" world.) It would have forced us to do what we should have been doing anyway. It turned out to be too good to be true.

 
At Sunday, December 7, 2008 at 5:33:00 PM PST, Anonymous Oilfinder said...

You're welcome once again JD. ;-)

Here's another one, regarding those Brazilian sub-salt discoveries:

LINK

"But authorities said they expect production costs to fall with the global economic downturn as equipment and services become cheaper."

 
At Sunday, December 7, 2008 at 7:28:00 PM PST, Blogger Ari said...

Will development of projects continue?

It depends. A lot has to do with how corporate finance works, and I'd also be concerned with the cost of money right now than the price of oil. It doesn't seem to be stopping too many projects, though. Still, it's useful to consider the discount rate when discussing these things. Alas, most people in the PO world don't seem to realize that such a thing even exists.

 
At Monday, December 8, 2008 at 5:09:00 AM PST, Anonymous David Rennie said...

Peak Oil is an irrelevance given that we have vast amounts of oil shale and coal that can be converted to oil for less than $60 / barrel. Oil companies will not invest in these technologies as long as they can produce all the oil they can sell for far less than this. The oil companies have no interest in keeping oil prices low and therefore are happy to perpetuate the myth of peak oil to maintain high prices. It is the cost of using oil thaat is our problem. We cannot afford to keep using the oil and polluting the planet. The oil companies make much greater profits if we purchase less oil but pay far more for it.

 
At Monday, December 8, 2008 at 5:29:00 AM PST, Anonymous Anonymous said...

Looking at DOE stats net imports for 2008 are only down 2.3% (domestic production fell 2.3% as well) from 2007 and inventories are up by only 6.7%. Seeing that OPEC controls about 50% of production and Russia's announcement that it's going to cooperate with OPEC it's pretty clear that crude is going to be going backup up, probably to $70-80 level, maybe higher.

 
At Monday, December 8, 2008 at 2:04:00 PM PST, Anonymous Brother Cadfan said...

Nice to see Freddy Hutter bringing some interesting comment!

Cheers!

 
At Monday, December 8, 2008 at 3:01:00 PM PST, Blogger Ari said...

Anon,

It makes sense, really. Geology and EROEI effectively remain the same now (as x variables). On the other hand, price has fallen considerably (y variable.)

We're still pumping most of the same oil, but the prices have fallen. It makes sense, therefore, that the most likely cause of much of the price run-up was a combination of diseconomies of scale and the speculation factor. It seems to me that a lot of commodities during the "great 2008 bubble" were in contango, and at least a portion of the price was due to this.

However, I think that a good portion of the price, beyond the speculatory factors, was caused by diseconomies of scale kicking in for a lot of projects. That's not to say that that was a bad thing per se, but that it caused the price to go up due to the short run demand jump (in part phantom demand generated by hedge funds and whatnot.)

I tend to believe this because demand hasn't gone down as much, on the margin, as the price. This suggests strongly to me that much of the price was not driven by marginal demand changes in the short run, but by the above factors.

Proving this, of course, is a bit beyond a simple post in the comments section.

 
At Monday, December 8, 2008 at 3:06:00 PM PST, Blogger JD said...

Ari,
That last anon was Carl. That's why I nuked him. Thanks for the rebuttal, though. :-)
JD

 
At Monday, December 8, 2008 at 10:44:00 PM PST, Blogger Richard said...

So PO is to Peak Oilers the way religion is to some - a convenient excuse that they can use to explain seemingly opposite outcomes as being tied to a single cause.

They just have no idea. Earlier this year, they were apparently 'predicting' $200/barrel prices. Now that's all gone to the cats, they're clutching to the motive as being something that they predicted - that low oil prices are somehow indicative of PO.

All I can do is laugh. Of course, that would be horribly naive of me and I should really be better focusing my efforts of scaring myself to death at the prospect of a life of self-sufficiency without industry, so I think I'll go back to worry about PO - along with the boogeyman and the bedbugs.

 
At Tuesday, December 9, 2008 at 9:14:00 AM PST, Blogger Ari said...

JD,

Understood.

The truth is, I don't know for certain how much of a factor commodities being in contango was for explaining price. Similarly, I can't say for certain how much of a factor diseconomies of scale were.

Or how much of it was genuine scarcity.

Or anything.

Unlike the PO pundits, I know how much I don't know. The thing is, teasing out variability in messy systems (and oil is VERY messy) is very hard.

I do know, however, that price has fallen to less than half its previous high, and that demand is not 50%. This suggests, at least on the surface, that there is some diseconomies of scale (more expensive to produce at high levels in the short run with a sudden run-up of demand), and that futures markets may have played a role. The fact that there was a quick drop in price after the i-banks shit themselves is arguably an example of an inflection point in price.

However, like I said, it's messy. I'll admit that I can't say for certain why prices do what they do, and I challenge everyone else to be willing to admit this as well.

 
At Tuesday, December 9, 2008 at 12:49:00 PM PST, Anonymous Peak Silly said...

Natural gas bonanza wages are definitely going down in Colorado and I would imagine the same is true of oil. So the guys who quit their $40K city jobs to go make $120K are going back to $40K. I recently read a book (Belly Up) that touched on the last Texas oil bust and how rigs that were priced in the millions one day were worth nothing but scrap the following week. Amazing!

It'll be really interesting to see if $5/gas does have a permanent effect on people and how many long-term alternative energy/transportation projects stay online. My town started bus service last year and people keep using it despite the fall in gas prices. But the buses are clean and pleasant to ride unlike a recent experience I had on the Los Angeles Metro - YUCK! I guess the bus driver's union forbids the drivers from throwing out either trash or urinating drunks.

I will probably put 25% my 401K into oil around $30/bbl and will try not to look at it again for 30 yrs. If nothing else, at some point inflation will bring up the price.

 
At Tuesday, December 9, 2008 at 9:51:00 PM PST, Anonymous Anonymous said...

Ari,

Thanks for the insight. I looked up dis economies of scale on Wikipedia and it was very enlightening. So, If I understand your explanation, increasing oil prices lead to the development of new projects which started out being less efficient but over time were optimized to be more efficient thus lowering the price of oil? So this surge in efficiency caused the price of oil to drop which in turn caused the speculative bubble to burst?

 
At Wednesday, December 10, 2008 at 1:36:00 AM PST, Anonymous soylent said...

"...along with the boogeyman and the bedbugs."

Bedbugs are nothing to poke fun off, they've been making a bit of a comeback in recent years actually.

 
At Wednesday, December 10, 2008 at 7:02:00 AM PST, Blogger Ari said...

Anon,

Actually, no. The recent drop in price at least appears to be a combination of a drop in demand, reduction in the speculation factor, and a general slowing down of the entire commodities basket. Even if the POites seem loathe to admit it, commodities all seem to move together (and not because of oil.)

The diseconomies of scale issue is not something that would have been dealt with as quickly as the bubble. At least not on the way up... On the way down, however...

I just think that it's a widely overlooked factor, especially when we talk about overheating demand in a relatively short period of time.

 
At Saturday, December 13, 2008 at 7:21:00 PM PST, Anonymous Oilfinder said...

Another (potential) one:

Petro-Canada moves closer to a cheaper Fort Hills

 

Post a Comment

<< Home