Before there were refrigerators folks kept drinks cool by putting them into clay jars that had been soaked in water. The evaporation of the water from the clay cooled the container and its contents, which today includes wine bottles. On the other hand, for many years artisans have taken clay in a slightly different form, shaped it and baked it and provided the teacups which keep the liquid inside until we drink it.

Two different forms of the same basic geological material, with two different behaviors and uses. Why bring this up? Well, there is a growing series of articles which continue to laud the volumes of oil and natural gas that the world can expect from the artificial fracturing of the layers of shale in which these hydrocarbons have been trapped for the past few million years. It has been suggested that there is no difference between this “unconventional” oil and the “conventional” oil that has been produced over the past century to power the global economy. And yet, despite the scientific detail which some of these critics discuss other issues, they seem unable to grasp the relatively simple geologic and temporal facts that make the reserves in such locations as the Marcellus Shale of Pennsylvania and the Bakken of North Dakota both unconventional and temporally transient. Let me therefore try again to explain why, despite the fact that the oil itself may be relatively similar, the recovery and economics of that oil are quite different from those economics involved in extracting conventional deposits.

But before getting to that, let’s first look at the current situation in North Dakota, using the information from the Department of Mineral Resources (DMR). According to the January Director’s Cut the rig count in the state has varied from 188 in October, through 186 in November, and 184 in December, to 181 at the time of the report. Why is this number important? Well, as I will explain in more detail later, the decline rate of an individual well in the region is very high, and thus the industry has to continue to drill wells at a rapid rate, just to replace the decline. (This is the “Red Queen” scenario that Rune Likvern has explained so well.) The DMR recognize this by showing the effect of several different scenarios as the number of rigs changes.

For example, they project that 170 rigs will be able to drill around 2,000 wells a year. At that level, and with some assumptions about the productivity of individual wells that I am not going to address here, but which Rune discussed, I would suggest that it is irrational to expect that new wells will continue to sustain existing first year levels as the wells move away from formation sweet spots. Yet, accepting their assumptions for now, DMR project that the 170 rigs will generate the following production from the state:

United States oil consumption in 2012 will be about 4.7 million barrels a day, or 20%, lower than it would have been, if the pre-2005 trend in oil consumption growth of 1.5% per year had continued. This drop in consumption is no doubt related to a rise in oil prices starting about 2004.

Oil prices started rising rapidly in the 2004-2005 period (Figure 2, below). They reached a peak in 2008, then dipped in 2009. They are now again at a very high level.

Given the timing of the drop off in oil consumption, we would expect that most of the drop off would be the result of “demand destruction” as the result of high oil prices. In this post, we will see more specifically where this decline in consumption occurred.

A small part of the decline in oil consumption comes from improved gasoline mileage. My analysis incidates that about 7% of the reduction in oil use was due to better automobile mileage. The amount of savings related to improved gasoline mileage between 2004 and 2012 brought gasoline consumption down by about 347,000 barrels a day. The annual savings due to mileage improvements would be about one-eighth of this, or 43,000 barrels a day.

Apart from improved gasoline mileage, the vast majority of the savings seem to come from (1) continued shrinkage of US industrial activity, (2) a reduction in vehicle miles traveled, and (3) recessionary influences (likely related to high oil prices) on businesses, leading to job layoffs and less fuel use.

Fifty years ago I began my undergraduate studies at the University of Leeds in the UK. It is not something I particularly dwell on, but the stories out of Beijing describing the air pollution in the Chinese capital this week brought back a memory. This story on CNN notes that visibility in Beijing has been cut to under 200 yards. Back in Leeds in December of 1962, the air quality had registered the highest levels of sulfur dioxide that had ever been recorded as air conditions generated smogs covering large parts of the country. What made it personal for me was that I lived about a mile from the University and had to walk there through the smog that covered the city. Despite it being daylight, there came a point where I could not see my hand with my arm outstreched (and I still vividly remember doing this). Crossing the Park to the University, there were cries in the mist as folk fell over some of the now invisible decorative iron edging along the walkways. From that time on, the air quality regulations took increasing effect and before long, the black buildings that I had walked past on my way through town were being cleaned and brought back to their original white condition, which they have retained in the years since.

Immediately after the Second World War, Britain needed the coal to power the reconstruction of the country, but during the time I was in college it was already clear that the days of unrestricted mining were over and that the transition to other fuels had already begun. It was not the air pollution in Leeds that was the driving force for the regulations, however, but more likely the presence of similar smogs in London and the South where those who governed the country lived. The major legislation began after the Great Smog of 1952. In a four-day period at the beginning of December, the combination of a fog, an inversion in the immediate atmosphere, and the increased use of coal fires to provide additional warmth generated a smog that is blamed for the immediate death of around 4,000 people and a strong influence on the consequent death of some 8,000 others.

I bring this up because the air pollution in both Beijing and in New Delhi is reaching levels where the government is beginning to move to help abate the immediate problem. In both capitals it is a combination of vehicle exhaust and power generation that is driving the problem, whereas back in the UK fifty and sixty years ago, vehicular exhaust was not nearly as much of a problem as burning coal. Yet I suspect that although these problems in Asia are not yet at the levels they reached in the UK, that they may be less tractable to solution.

Burning coal to generate power remains a relatively simple process, as does mining of the coal, for which a realistic estimate would suggest that there remains, for now, a plentiful sufficiency. (That latter point is, however, disputed by some). The EIA has recently pointed out that we are at a point where China will consume about half of the global supply of coal each year.

At the rate of increase reported, it is likely that the two lines will cross before the end of this year. However, it should also be noted that India has been importing more thermal coal than China (a projected 118 million tons for 2012, in contrast with the 102 million tons imported by China). And as Mongolian coal becomes more available, so India may take over parts of the international supply that now flows to China from Australia, Indonesia and Africa.

Executive Summary

In January 1995 there was a total of 1738 oil and gas rigs drilling globally (excluding the former Soviet Union (FSU). By February 2012 that number had more than doubled to 3850. Global C+C+NGL production grew from 68 to 84 million bpd (24%) over the same period.

Global drilling for oil and gas is dominated by North America, in particular the USA. In January 1995 there were 737 oil and gas rigs drilling in the USA, 42% of the world total. By October 2011 this figure had grown to 2010 rigs, 55% of the world total.

Proportionally, the USA has increased it's drilling effort compared to the rest of the world and currently benefits from lower oil prices, significantly lower natural gas prices and higher economic growth than many OECD peers.

Does the rest of the world need to wake up and to drill baby drill?

The overall structure of the global rig count data is controlled by North America. The fall in drilling activity in 1998 was due to chronic low oil prices less than $10 / barrel; the fall in 2001 was due to recession in wake of the dot com bust and the fall in 2008 was due to the financial crash. The annual cyclicity in the data comes from Canada, where drilling is reduced during the Spring thaw. The near term peak of 3850 rigs was in February 2012 and it remains to be seen how the fall in drilling activity since then pans out. It is possible this is linked to a realisation that drilling shale is not profitable. The huge switch from gas to oil drilling post-2009 is discussed below the fold.

Oil Watch posts are joint with Rembrandt Koppelaar.

A person might think from looking at news reports that our oil problems are gone, but oil prices are still high.

In fact, the new “tight oil” sources of oil which are supposed to grow in supply are still expensive to extract. If we expect to have more tight oil and more oil from other unconventional sources, we need to expect to continue to have high oil prices. The new oil may help supply somewhat, but the high cost of extraction is not likely to go away.

Why are high oil prices a problem?

1. It is not just oil prices that rise. The cost of food rises as well, partly because oil is used in many ways in growing and transporting food and partly because of the competition from biofuels for land, sending land prices up. The cost of shipping goods of all types rises, since oil is used in nearly all methods of transports. The cost of materials that are made from oil, such as asphalt and chemical products, also rises.

Leanan has noted the API report of the continuing drop in US oil demand. It would be wrong, I believe, to explain this purely by reference to the increased efficiency of vehicles now on the road, nor would it be realistic to expect that these changing conditions will result in a lowering of gas prices.

To explain the rationale behind these thoughts requires reference to two sets of data. The most potent is the behavior of the Kingdom of Saudi Arabia (KSA), but before discussing their actions the story begins with the changes in the miles travelled reports that are issued by the Federal Highway Administration each month. Driven by a comment on recent versions of that plot, it is worth revisiting the summary of the rolling total of miles travelled in the United States, with the October 2012 plot being the last available.

Executive Summary

Oil production and consumption data reported by JODI (Joint Organisations Data Initiative) is reported to JODI by national governments giving us reason to believe that this may be the most reliable data set upon which to base interpretations about national and global oil supply and demand. However, the JODI data set is incomplete. 15 countries that report production data to JODI have incomplete returns since the project began in January 2002. Furthermore, there are 15 countries for which the EIA (US Energy Information Agency) report data that do not report to JODI at all. Based on the observation that JODI and EIA C+C (crude oil + lease condensate) data for OECD countries are very closely aligned we have used EIA data to patch the gaps in the JODI data set. This has produced a very close alignment between JODI and EIA global C+C data (Figure 1) and since the JODI data is based on returns from national governments, this in turn provides confidence in the veracity of the EIA data which is more complete and easier to use.

The IEA (International Energy Agency) and BP (British Petroleum) do not report C+C separately and so cannot be compared to the EIA and JODI (corrected) C+C data. However, there is good alignment between EIA, IEA and BP for C+C+NGL since January 2002 although the IEA data is currently >2 million bpd higher than the EIA and this reporting gap will one day need to be closed (Figure 2).

Figure 1 Patches for missing JODI data taken from the EIA results in good agreement between global C+C production estimates for JODI and the EIA.

Oil Watch posts are joint with Rembrandt Koppelaar.

It is the beginning of a New Year, and belatedly, I hope that all readers find this new period to be one of prosperity, health and happiness. It would be encouraging if the portents for our energy future would point in that direction, but unfortunately I can’t see nearly as much optimism in that regard as do others who are similarly reviewing where the global energy supply numbers are going. This week the EIA's ”The Week in Petroleum” is illustrative of the optimistic vision.

This plot is from the new Short-Term Energy Outlook from the EIA, which projects the numbers through to 2014, at which time: the Agency anticipates that US domestic production will rise to 7.9 mbd, the highest since 1988. Growth is expected to extend beyond just the Bakken:

In particular, drilling in tight oil plays in the Williston (which includes the Bakken formation), Western Gulf (which includes the Eagle Ford formation), and Permian basins are expected to account for the bulk of growth through 2014. Williston Basin production is expected to rise from an estimated December 2012 level of 0.8 million bbl/d to 1.2 million bbl/d in December 2014. Western Gulf Basin production rises from an estimated December 2012 level of 1.1 million bbl/d to 1.8 million bbl/d in December 2014. Within the Western Gulf Basin, roughly 0.4 million bbl/d of the oil production is outside of the Eagle Ford formation. The Western Gulf Basin accounts for more than half of the onshore domestic liquids production growth due to a comparatively large amount of liquids coming from both oil and gas wells compared with the other key production basins. The Permian Basin in West Texas, which includes plays such as Spraberry, Bonespring, and Wolfcamp, is a third key growth area. EIA estimates that crude oil production from the Permian Basin reached 1.2 million bbl/d in December 2012. Permian Basin production is projected to increase to 1.4 million bbl/d in December 2014.

The overall global concerns for production include a relatively small potential for production growth from the larger oil producers in the world (with the possible exception of Iraq), while there remains an increasing turmoil that began with the “Arab Spring” and continues to spread with ongoing and growing impacts that are likely on Middle Eastern oil production. But it is the story of American production that continues to gnaw at my worry bead string.

Most of us have heard that Thomas Malthus made a forecast in 1798 that the world would run short of food. He expected that this would happen because in a world with limited agricultural land, food supply would fail to rise as rapidly as population. In fact, at the time of his writing, he believed that population was already in danger of outstripping food supply. As a result, he expected that a great famine would ensue.

Most of us don’t understand why he was wrong. A common misbelief is that the reason he was wrong is that he failed to anticipate improved technology. My analysis suggests that there were really two underlying factors which enabled the development and widespread use of technology. These were (1) the beginning of fossil fuel use, which ramped up immediately after his writing, and (2) a ramp up in non-governmental debt after World War II, which enabled the rapid uptake of new technology such the sale of cars and trucks. Without fossil fuels, availability of materials such as metal and glass (needed for most types of technology) would have been severely restricted. Without increased debt, common people would not have been able to afford the new types of high-tech products that businesses were able to produce.

This issue of why Malthus’s forecast was wrong is relevant today, as we grapple with the issues of world hunger and of oil consumption that is not growing as rapidly as consumers would like–certainly it is not keeping oil prices down at historic levels.

What Malthus Didn’t Anticipate

Malthus was writing immediately before fossil fuel use started to ramp up.

On December 3 and 4 I attended Opal Financial's 2012 Clean and Green Investment Forum. I was invited to moderate a panel on "Market Outlook for Renewables vs Fossil Fuels". Forum participants included many investors and strategists with an interest in energy issues as well as a few entrepreneurs and others with a more academic interest. I had conversations with an interesting mix of people in both the oil and gas industry as well as alternative energy. This post consolidates my notes to give you a sense of some of the dominant themes in energy investing today.

Rather than give a blow-by-blow recap of the meeting, I'll organize the information into several topics that capture the mood of the forum:

1. Government regulation and incentives
2. Utility scale solar & wind
3. Resiliency and distributed solar
4. New technology
5. The fracking revolution