Record Oil Supplies?

Jim Brown
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The American Petroleum Institute (API) said last week that U.S. oil supplies rose to the highest levels in 31 years for the month of May. In the EIA report for May 27th crude oil in inventory rose to 373.8 million barrels and a level not seen since mid 2009. Before 2009 you have to go back to 1990 for a higher inventory number.

The reason for the rise in inventories is two fold. Since the 2008 recession that resulted in a 9.1% technical unemployment rate and the 16.5% U5 unemployment rate the consumption of gasoline in the USA has slowed dramatically. Post recession the rising gasoline prices have continued to weigh on consumption. With nearly 20 million people out of work the amount of daily commuting has dropped considerably.

Moody's 30-year chart of oil inventories

This lack of consumption coupled with the increase of production from Canadian Oil Sands and shale oil plays like the Bakken, Eagle Ford and the Marcellus has allowed inventories to increase to the point where storage is starting to be a problem.

The employment problem is not going away any time soon. The pace of job creation is extremely anemic for this stage of a normal recovery. Recessions as the result of a financial crisis always take longer to recover but recent economics suggest we may not even be in the recovery stage yet.

The Philly Fed report and the New York Empire survey last week posted numbers that represented a contraction of activity in those regions consistent with a new recessionary dip. The fear of a double dip recession had nearly evaporated until high gasoline prices in April and early May slammed the door shut on recovery hopes. Now those fears are returning and thanks to the problems in Japan and Europe they are being magnified in the local press.

If the economy is weak today as a result of the Japanese earthquake then we should begin to see a rebound in the numbers in the July reports. That could be a big question mark because we are seeing an increased number of earnings warnings and signs the U.S. consumer has gone back into hiding at the blue collar level. Wal-Mart and other stores that sell to that demographic are reporting declines in same store sales as a result of higher fuel prices in addition to the high unemployment levels.

Does this mean oil prices are about to fall off a cliff even further than they fell last week? I don't believe so. At least we have not seen any fundamental reasons for a continued decline in oil prices. Barclay's and Dahlman Rose both raised their estimates for spending on oil and gas exploration in 2011 to more than half a trillion dollars for 2011. The $529 billion estimate from Barclay's was significantly higher than the $490 billion they forecasted in December.

The reason for these rising numbers is the increased activity because of higher oil prices. Demand may be sluggish in the USA but it is rising quickly in Asia, Africa and Latin America. The IEA raised their estimate for demand for OPEC oil in Q3 by 400,000 barrels per day to a level that is 1.5 mbpd LESS than OPEC is currently producing.

This is the golden age for oil companies. With Brent over $113 and expected to rise to $130 by year end the race to produce more oil is accelerating. Unfortunately the deepwater oil and oil produced from harsh environments and expensive shale wells is costing more to produce. It is estimated the marginal cost of oil discovered today is $85 per barrel. If oil prices decline below that level those projects will be put on the back burner until prices recover. They should not have to wait long because any oil discovered today in an offshore deepwater environment will not likely be ready for production or another 5-7 years thanks to the extreme cost and complexity of producing oil in more than 5,000 feet of water.

Wells in the Gulf are being drilled to record depths and at temperatures that are melting drill bits. The Blackbeard well being drilled by McMoran in the Gulf is targeting depths over 34,000 feet at a cost of more than $190 million and this is actually a shallow water well in only 70-feet of water.

Costs are going up but so is demand. The U.S. is in a funk compared to the rest of the world. Eventually our economy will begin to improve but it may take years to return to any semblance of normal. During that period the demand from around the globe will continue to rise and force our fuel pries higher. This will slow our recovery and prolong the pain.

The U.S. is the largest oil consumer in the world so any tightness in crude supplies will affect us more than anyone else. This is something analysts have warned about for years. You can't have 5% of the population and consume 23% of the oil and be insulated from the global impact of shortages.

Some believe the rest of this decade could be a lost decade for the U.S. with lackluster growth and a rising poverty class. I could easily see that happening, especially given the changes that need to occur to cut government spending and reduce the budget. When the government cuts spending people get laid off. We also know there will likely be a tax hike soon depending on how the 2012 elections play out. What we don't need is higher taxes in a near recession. We already have higher taxes in the form of $4 gasoline and we can see how that is working to depress the economy.

The IMF cut its growth prospects for the U.S. last week to 2.5% in 2011 and 2.7% in 2012. Obviously the IMF does not have a good record of predicting economic outcomes but I think they could be high in this case. The Fed will publish its quarterly economic update on Wednesday and analysts believe they will slash estimates based on comments from Fed officials like "frustratingly slow" and "uneven" progress. Estimates for unemployment may rise to 9.4% from 8.4% in the last forecast.

The IMF is predicting global growth at 4.3% for 2011 including a 9.6% target for China. Which do you think has a bigger impact on global oil demand? China with 1.3 billion people growing at 9.6% or the USA at 300 million growing at 2.5%. Obviously China is the main factor here. Chinese oil demand has grown by 800,000 bpd in May over May 2010. They are only track to grow by 1.0 mbpd in 2011 and another 1.2 mbpd in 2012 despite the current effort to slow their inflation rate. India is right behind them.

India's Oil & Natural Gas Corp just announced plans to spend $39 billion starting in 2012 to meet exploding demand for oil in Asia's third largest economy. India is just getting into the global land rush for oil. While India is a decade or more behind China in modernization the move into the technological age is accelerating rapidly. Some believe India will eventually outpace China to become the biggest economy on the planet and consume the most goods. Obviously that is decades away but the acceleration has begun. When the resource wars begin late in this decade those will be the two 800-lb gorillas going at it head to head.

The U.S. needs to accelerate its exploration and production of reserves closer to home and partner with Brazil and Mexico to develop their assets. Having production close to home will be easier to protect than crude coming from half way around the world from unstable countries. North America is expected to see production increase by 1.5 mbpd by 2016 with the majority of that coming from Canadian oil sands. Mexican production is expected to decline by another 400,000 bpd by 2016 due to the lack of major projects in the pipeline. Mexico is handicapped by laws that prevent foreign companies from independent exploration and without the profit motive to drive exploration they could cease being an exporter by the end of the decade.

BP released their annual energy report showing oil demand rebounded sharply in 2010 by +2.7 mbpd after declining in 2008 and 2009. Production only rose by +1.8 mbpd. Demand rose to 87.4 mbpd in 2010. It is expected to rise to more than 89.3 mbpd in 2011 and more than 90 mbpd in 2012 assuming we can find the production to meet those numbers.

The IEA said they don't expect Libyan production to be fully restored until 2015 due to damage to oil facilities and pipelines. Current production is 200,000 bpd, down from 1.4 mbpd. Knocking a million barrels per day out of our existing production capability is going to hurt as we head into the high use third quarter.

I continue to get emails from readers that disagree with the concept that supply shortages are just around the corner. Most believe we can just poke a few more holes in the Gulf and have all the oil we need a few weeks later. Only a little bit of research would show that a deepwater discovery in the Gulf takes a minimum of 5-7 years and sometimes 10 years before significant production begins. Over that period global demand is increasing at the rate of 1.5 mbpd. Do the math and you will see the fallacy of that view.

Readers may not believe everything I discuss in these pages but I am firmly convinced the U.S. may be stumbling like a drunk through this recovery process but the global economy is on track and steering us towards a global conclusion to the peak oil story.

Jim Brown

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The OilSlick Newsletter is based on the expectations for global oil production of light sweet crude to peak and begin to decline in the 2012-2013 timeframe. I am calling this "Peak Sweet™" instead of Peak Oil. This is the point where global production of conventional light sweet crude supplies can no longer be supplemented by enough oil sands production, deepwater oil production, biofuels and natural gas liquids to offset the decline in existing fields. The roughly 6% annual decline of existing production due to depletion is larger than the rate of new discoveries and new production being added each year. The Peak Sweet™ countdown clock is ticking and time is growing short. Peak Oil will arrive shortly thereafter. Are you prepared?