Tuesday, December 6, 2011

Economics - Why Oil Prices Will Fall

I posted a while back Five Reasons Why Oil Prices Will Fall.  I want to follow up with the Number One Reason why Oil prices will fall over time. 

It appears the shale gas revolution that has been on going in North America has dramatically changed the energy landscape for Natural Gas (NG).  I would point to this blog post (Click Here) on NG over at Carpe Diem blog.  The shale gas revolution has dramatically transformed the energy picture from where North America was running out of NG five years ago to being awashed in NG today. 

NG production in the US just reached a new all time last week according to the EIA (Click Here).  You can also see the dramatic increase in production in the last five years due to the shale gas paradigm shift. 

With NG prices currently around $3.25/mcf in Canada, and $3.40/mmbtu in the USA, NG is very, very cheap relative to Oil.  (You can consider a mcf approximately equal to mmbtu)

On an energy equivalent basis natural gas has 1/6th the amount of energy as a barrel of oil.  So to compare apples to apples we need to multiply our NG prices by six to compare correctly. 

So at current prices, NG is available as an energy source for roughly $19.50/bbl or you can get the equivalent amount of energy from a barrel of oil for $101/bbl (WTI).   That is over 5 times the cost for the same amount of energy. 

Can you imagine how much cheaper our vehicles would be to run if we used NG instead of oil?  As  Scott Grannis has said, "It is hard to underestimate the degree to which cheap and abundant natural gas is going to transform U.S. manufacturing and energy generation in the years to come".

Now NG is cleaner a much more plentiful energy source than many oil.  Since the cost is over 80% cheaper than Oil, NG will eventually become a very common energy source.  It's hard to justify paying 5 times more for the same amount of energy in the long term. 

Of course utilizing NG as a common energy source will take years happen.  We would need new technology and infrastructure.  The infrastructure will take time to build, but given the economics the ball has already started rolling.  If you think this is all fanciful thinking, Click Here to see what Encana thinks about the future. 

Paradigm shift are hard to spot and some people deliberately stick their head in the sand and refuse to accept the change.  I must admit that I wasn't a believer in the shale gas revolution until very recently.  The stubbornly high production data is simply too overwhelming to neglect. 

What about the Big Energy Picture?

I read an interesting short booklet almost 10 years ago, called the age of energy gases or something like that.  While I found the little booklet kind of stupid, it did take a philosophical look at the form of energy man has used throughout history.  If you go back a couple hundred years or so we used 100% solid energy sources.  These would be wood, coal, and other solid forms of energy (typically burned).  Once we got onto liquid energy forms like oil, the percentage of our energy consumed from solid forms has constantly fallen.  We currently use a very little amount of solid energy as a percentage of our total energy sources. 

Today Oil is by far the largest energy source, but as the book pointed out it will never reach 100%.  The book drew something like a bell curve with energy liquids reaching somewhere around 60-70% of our energy needs and then eventually entering a terminal decline just like energy solids.   

Finally, the book described the age of energy gases.  In this phase both solid and liquid forms of energy are in decline and energy gases become the most common energy source, eventually reach 100% of our energy usage. 

While I found this historical study of our sources of energy quite stupid at the time, I am wondering if the guy who wrote it isn't such a quack after all.  We seem to be able to access more and more gas reserves every day.  If we could unlock unconventional gas sources we would be accessing huge energy sources. 

My only question that remains is how atomic energy (uranium) fits into the big picture. 

Kevin Graham

P.S - Here is an interesting article that sums up my thoughts above:


  1. Another post without any real "meat", or as Kevin would probably type it, "meet".

    The supply / demand picture is tight - very tight... smart analysts keep saying the same thing: the fundamentals won't allow oil prices to fall. http://video.cnbc.com/gallery/?video=3000058614.

    And the incremental cost of getting a bbl out of the ground continues to increase. Do you think oil companies will keep investing their capital if oil prices fall and they lose money on each incremental project? No, of course they won't! Which is why any fall in prices will be temporary. From now until eternity. See p 4: http://www.iea.org/papers/2011/Flyer_RtoR2011.pdf

  2. Did you see the Exxon Mobil release about their view on the future of energy demand? Pretty interesting. Hopefully natural gas catches on in a big way, good for everyone really.

  3. Oil prices have quite a bit of room to drop. The shale gas revolution is playing itself out again in shale oil with all the major gas players now chasing liquids and applying the lessons they learned from gas. Just look at the presentations coming out of PWT, ECA, DVN, CHK, EOG. It's the same story everywhere as all these former gas companies are looking to become more oily. Think of the following analogies between the shale gas revolution and the shale oil revolution:

    -Shale gas was first proven in the late 1990s in the Barnett Shale. After the play was unlocked and the technology proven the number of formations that could targeted grew and the technology improved further. Likewise, shale oil go it's start in the late 2000s in the Bakken, and now a large number of new oil shale formations are in the early stages of development, and the technology is improving rapidly. Shale oil is shale gas on a 5 year time lag.

    -As shale gas production grew, North American gas prices, which historically commanded a premium to world prices, started to trade at a discount, and as production grew, so did the discount. Likewise, West Texas Intermediate is now trading at a growing discount to Brent.

    -The US went from being in gas crisis to having enough supply to last a hundred years. Gas imports to the US dropped dramatically. Likewise, oil imports to the US are beginning to drop at a rapid pace.

    This story is familiar and we all know how it turned out for the gas producers. At least they had option of increasing liquids production, but what are they going to do when liquids prices drop?