Countdown to 100$ oil (14) – Greenspan acknoweldges peak oil

Jerome a Paris

19 years ago

Greenspan had a big speech on oil (via the Energy Bulletin) two days ago.

Journalists focused mostly on his upbeat pronouncement that higher oil prices would have a real, but limited, impact on growth.

I would like to focus on some ignored parts of his speech which deserve a new countdown diary, despite the lack of headline-generating spot oil prices.
The key paragraph of his speech is the following:

In early August, prices for delivery in 2011 of light sweet crude breached $60 per barrel, in line with recent increases in spot prices. This surge arguably reflects the growing presumption that increases in crude oil capacity outside OPEC will no longer be adequate to serve rising world demand going forward, especially from emerging Asia.

To parse the Greenspeak, that means that non-OPEC oil supply increases will be unsufficient in view of demand growth. It’s not exactly peak oil for all oil production; it’s not even peak oil for non-OPEC producers (as he talks about inadequate “increases”); but it is still an important acknowledgement: supply from the non-OPEC world cannot keep up with demand. Call it the weak version of peak oil, maybe, but it’s there.

The other interesting point to note is that Greenspan flags a very important price indicator, which is usually ignored by the press.

As the numbers provided on this page make clear, markets are expecting prices to remain in the 60$/bl range for the next 5-6 years. This is VERY different to what you had in the past when, irrespective of what the short term price (driven by events and volatile) was, the long term prices would gently come back to what was then the long term expectation for oil prices, around 18-20$/bl. No longer. The market does not believe that we will “go back to normal” any time soon (“normal” being what happened since the mid-80s, which is the experience span of most traders at best).

The fact that Greenspan flags this price means that he understands pretty well what’s going on, it’s simply, as usually, well dissimulated in obtuse language behind a few easier to digest soundbites for the general public.

Let’s see what else is hidden in his speech:

How did we arrive at a state in which the balance of world energy supply and demand could be so fragile that weather, not to mention individual acts of sabotage or local insurrection, could have a significant impact on economic growth?

This seems like a banal acknowledgement of recent news. It is really more than that. He is stating that there is no supply cushion and that small events have direct macro-economic consequences. This is a big deal.

Although the production quotas of OPEC have been a significant factor in price determination for a third of a century, the story since 1973 has been as much about the power of markets as it has been about power over markets. The incentives to alter oil consumption provided by market prices eventually resolved even the most seemingly insurmountable difficulties posed by inadequate supply outside the OPEC cartel.

Here, he renews his faith in the markets to solve the problem. I note the adjective “seemingly unsurmountable” to describe the situation in the 70s and, implcitly, today. It took a pretty big economic crisis for the “markets” to solve what was an artificially created supply crisis. Today, the crisis is not artificial (no supply surplus avialable anywhere), so any “pure” market solution (i.e. price driven and not regulation-driven) will likely be more painful than in the 70s. Of course, we’ll find substitutes to 600$/bl oil. But can we find substitutes to 30$/bl oil or even to 60$/bl oil without economic pain? That question is not answered.

the opportunities for profitable exploration and development in the industrial economies are dwindling, and the international oil companies are currently largely prohibited, restricted, or face considerable political risk in investing in OPEC and other developing countries. In such a highly profitable market environment for oil producers, one would have expected a far greater surge of oil investments.

Again, Greenspan is acknowledging what many of us doomers and gloomers have been saying: “the opportunities are dwindling”. Reserves are running out is, again, what it means. BigOil is running out of places where to invest. Their record profits are the swan song of a dying industry.

because of the geographic concentration of proved reserves, much of the investment in crude oil productive capacity required to meet demand, without prices rising unduly, will need to be undertaken by national oil companies in OPEC and other developing economies. Although investment is rising, the significant proportion of oil revenues invested in financial assets suggests that many governments perceive that the benefits of investing in additional capacity to meet rising world oil demand are limited. Moreover, much oil revenue has been diverted to meet the perceived high-priority needs of rapidly growing populations. Unless those policies, political institutions, and attitudes change, it is difficult to envision adequate reinvestment into the oil facilities of these economies.

So, no investment from the OPEc countries either… They don’t see any benefit to do so? Why would that be? I suppose he suggests that they think that oil prices will go down as demand is cut by greater efficiency and that surplus capacity would be unneeded, but he also leaves the door open to simpler explanations, notably that they don’t need to produce more oil to get more income as prices are inexorably rising.

But the point is – Greenspan is saying that oil production will not increase because nobody is investing in the sector near enough to what would be needed, oil majors because they cannot, and oil countries because they won’t (they “have other priorities”, maybe…)

We can expect similar increases in oil efficiency in the rapidly growing economies of East Asia as they respond to the same set of market incentives. But at present, China consumes roughly twice as much oil per dollar of GDP as the United States, and if, as projected, its share of world GDP continues to increase, the average improvements in world oil-intensity will be less pronounced than the improvements in individual countries, viewed separately, would suggest.

After repeating many times that energy efficiency will allow us to live with these dwindling supplies, Greenspan drops his last bombshell, in the above paragraph: the simple fact that China, an inefficient energy user, is growing a lot faster than the West, means that the average energy-efficiency of the world economy is going to decline, even if all countries improve their individual efficiency

This is a fundamental insight. Basically, it says that China’s demand for energy is growing. Even if it grows slower than its economy (thanks to efficiency), that demand is growing, and, as China becomes a bigger chunk of the world economy, the absolute size of that increase is world-significant. Even if we all make efforts, the simple fact that China is on a high growth trajectory means that oil demand will keep on growing, thus putting unbearable pressure on the market.

In fact, the only way to balance the markets, as suggested by Greenspan, would be a collapse of Chinese growth, an event which would likely have massive repercussions within China and outside of China.

So yes, get ready for 100$/bl oil and more. Even Greenspan implicitly ackowledges it.

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