Thursday, February 7, 2008

Shell Oil Drops A Bomb


Shell's Shocking Prediction

by Justice Litle, Editorial Director, Taipan Publishing Group
Whither crude oil? With so much going on, the black stuff hasn’t gotten much attention in a while.
The last big headline came in the first week of January, when crude futures touched $100 a barrel. Since then, the oil story has been dominated by economic slowdown and subprime. Crude futures have been stuck in a $15 range or so since mid-October.
On the bearish side of things, crude oil demand is headed into a seasonal low period. Refining rates have fallen to a 22-month low, as Americans tighten their belts and cut back on gasoline. There is also concern that Asian demand could drop if the global economy slows.
But there are bullish factors in place, too. OPEC is doing its best to keep a tight line, refusing to let the price of oil fall too hard or too fast. They learned their lesson in the late ’90s, when good-faith efforts to increase supply led to a price collapse.
There’s also the currency issue. The U.S. dollar is showing short-term strength right now, but the inevitable long-run direction for the dollar is down. When the Gulf countries get shed of their inflationary dollar pegs -- as they eventually must -- that will put more pressure on the greenback. Since oil is priced in dollars, the long-term trend of dollar weakness drives the price of oil higher (along with plenty of other hard assets priced in dollars).
Americans Collect Millions in “Oil Reimbursement” Checks
After years of vicious price gouging, Big Oil is set to make “reimbursement payments” that could help fund your retirement.

Then you have the ongoing global demand issue. For all the talk of U.S. recession, and the fears that slowdown in America could spread to emerging markets, the price of oil hasn’t fallen that much. The current price of $89 a barrel is only two or three days’ trading away from the nominal all-time high.
Geopolitical concerns have also been back-burnered by subprime. The markets haven’t been paying attention to hotspots like Iran or Venezuela lately; accordingly, neither have we. But a period of calm doesn’t rule out the danger.
There are many more hidden problems bubbling away just beneath the surface. Latin America is in the grips of a regional energy crisis. Russia is making Europe uneasy with its aggressive expansion in natural gas. The oil-producing regions of the Niger Delta walk a constant knife edge of violence. Those are just a few off-the-cuff examples.
Good Times, Bad Times
Yet the news is very good for some. Exxon Mobil, for example, reported the largest corporate profits in history last week. Exxon’s take for 2007 was a whopping $40.1 billion. Fourth-quarter profits alone were a record $11.66 billion.
Those numbers don’t tell the whole story, though. Exxon’s production costs are also rising fast -- up 30% in the fourth quarter year on year.
Rising costs explain why Exxon’s 2007 profits were only slightly higher than 2006. In the year prior, Exxon made $39.5 billion, with oil prices trading mostly between $50 and $70 a barrel. The price of oil was a little lower in 2006, but costs were lower, too. There were also fewer headaches with countries like Venezuela tearing up the old contracts and taking a bigger piece of the action for themselves. Those headaches are only set to get worse.
An Empty Shell
Exxon continues to put on a confident face, but at least one oil major is sounding the alarm.
Royal Dutch Shell warned last week that its oil and gas production would fall for the sixth consecutive year in a row. Oil and gas reserves are a depleting asset; if reserves aren’t replenished faster than the rate of depletion, the asset runs out.
In other words, you can think of these oil majors like giant swimming pools. Extracting and selling the oil is like draining water from the pool. Ongoing exploration and production efforts are like adding to the pool. If the pool drains faster than it fills up, then naturally it shrinks -- and eventually threatens to run dry.
Shell’s pool of reserves has been shrinking for nearly the full decade. There is hope that things will turn around in 2010, when some big new projects come on line. But Shell’s management is done with trying to put a shiny happy face on things.
Seven-Year Countdown
In fact, Jeroen van der Veer, Royal Dutch Shell’s CEO, is flat-out worried. On January 26, he predicted that oil and gas demand could permanently overtake supply within seven years.
The geopolitical consequences of a permanent supply and demand imbalance are staggering. If van der Veer is correct, the world could be dealing with mass shortages and sharply higher prices by the year 2015.
The hikes we’ve seen these past few years came at a time when global oil output and global oil demand were roughly balanced. With developing world economies booming, the cost of oil rose sharply due to a “lack of slack” in the system.
Today there is still enough oil for everyone, but just barely enough, with potential for delivery problems at the margin. This is why small production delays are a potentially big deal. When there is very little slack in the system -- no room for error between supply and demand -- any little shortfall means prices have to rise.
What van der Veer predicts is a different and more frightening world. If demand increases to the point of permanently outstripping supply, that puts the world in “energy crisis mode” virtually around the clock. Oil-thirsty countries would get locked into vicious bidding wars for resources. Petrocrat dictators would become even more powerful. The odds of large-scale military conflict would significantly increase.
Not About Running Out
Note, too, that this equation isn’t about running out of oil entirely. It’s about keeping up with the pace of demand. The two scenarios are very different. Shell’s CEO isn’t saying that all the oil will be gone by 2015. He’s saying there’s a real danger that we won’t have enough of it to go around.
This ties in to a common misconception regarding peak oil theory. Many view the peak oil idea as suggesting the world is literally going to “run out” of oil -- that there won’t be any left. But this isn’t the real problem at all.
The real problem is that, by 2015, world oil consumption is projected to grow to 97 million barrels per day. By 2030, the projection is 118 million barrels per day. If the world’s energy producers can’t meet those projections -- if they fall short by even a modest amount -- then we are staring down the barrel of a global energy crisis.
Our only real long-term options (apart from perpetual crisis and energy-related warfare) are twofold.
We either find more oil more quickly and efficiently than before, or we find ways to cut back on fossil fuel consumption -- turning to alternatives like nuclear, solar, geothermal, biomass and so on. The ultimate answer will probably be a mix of both.
And so, in the short run, oil is in a temporary trading range. In the intermediate term, upside bias probably favors downside. In the long term, opportunities in both alternative energy and traditional oil and gas industries look very bright.

No comments: