But then, in 1999, something happened: the UK’s North Sea production hit peak… that tipping point after which reservoirs go into decline, setting in motion both reduced production and progressively higher costs related to extracting the remaining oil.

While the experience of North Sea oil production provides yet another useful example of the validity of the Peak Oil theory, what concerns us today is a critical but usually overlooked aspect of the discussion; exports.

At the time that the North Sea peaked in 1999, the U.K. was exporting 1 million barrels of oil per day. By August 2004, it had become a net importer.  What happened to cause the situation to turn around so quickly?

To understand the importance of exports when discussing peak oil, ask yourself the question: “What’s more important: the fact that global oil production is falling… or that the oil exporting nations are cutting off their exports?”

While the two questions are clearly linked, it is the nuance of the export question that clearly matters the most.  Especially if you live in a country such as the U.S., which currently imports about 70 percent of its oil.

Which brings us to the Export Land Model (or, ELM as I will refer to it from here).  The basic thesis expressed by students of the ELM is that, to fully appreciate the impact of peak oil, you cannot look only at the production declines so presciently anticipated by ML Hubbard in 1956.   You also have to look at the rate of local consumption and the importance of that consumption on the ability of a country to export their oil.

The ELM graph here looks at both sides of the equation, and the result as it applies to exports.

As you can see, for illustrative purposes the ELM assumes that, after a country’s oil production hits peak it will decline at a rate 5 percent annually at the same time that local consumption increases by 2.5 percent. The red line then shows the impact those two metrics will have on the ability of the country to export its excess production. Using these assumptions, the ELM shows that exports reach zero in nine years.

Real world data shows that the metrics used in the ELM are quite conservative. The chart below plots the hypothetical ELM against the actual data from the United Kingdom and Indonesia. While the ELM forecast hypothesizes nine years between peak to the end of exports, Indonesia’s exports ceased seven years after peak, and the UK’s exports stopped just six years after peak.

The important take away here is not that the UK and Indonesia are no longer receiving the oil export income of the good old days — that is entirely a localized concern.

Rather it is that the global market is now deprived of those exports; between UK and Indonesia alone, the change over the last decade alone amounts to a swing in the wrong direction of a total of 2 million barrels per day.  And those are just two of a number of important countries that have swung from exporters to importers in recent years.

China, for example, became a net exporter in 1993, the result of flattening production against skyrocketing consumption. Over the last decade alone, China’s oil consumption has almost doubled, to about 8 million barrels a day, about half of which is now imported.

So, again, while people tend to focus on production, they are overlooking the impact on exports forecasted by the ELM.  In the case of China, they went from a net exporter in 1993 to importing 4 million barrels a day today… with those imports projected to rise another 50 percent over the next 10 years.

This is what’s creating so much international competition for the remaining supplies of oil. And why the trend for higher energy prices is so well entrenched. And if the ELM is right, things are about to get far worse… far sooner than many people expect.

Regards,
David Galland
June 10, 2008

Oil Exports was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Taxes are a big problem here, but the bigger one is heating fuels. With winter right around the corner and crude oil hitting record highs of almost $83, prices here are surging. Our natural gas and heating oil bills here are going to be three times as much this year and basically that will break the bank for many in this tiny country. The problem is just getting worse as Russia tightens the screws on its natural resources in the region.

Now, Peak Oil may be very familiar to you as a Whiskey reader, but another peak phenomenon may not — Peak Food. Russia recently announced it may curtail wheat exports due to low global stockpiles and that has sent wheat to above $9, driving everything from bread to pasta exponentially higher. The worst could be yet to come.

I have to go chop some more wood for our stoves now. Really, I’m serious. Peak Oil is here. Peak Food will be here soon, too.

What is Peak Food?

There have been few markets in my almost 20 years of trading that have been as exciting as the grain markets have been over the past two years. In my opinion, the best is yet to come.

In the commodities world, energy, metals, and stock indexes have been the most active futures contracts — and the most talked about — for years. But like so many things in the commodities industry, that’s changing too.

Sure, oil and gold commentary still rolls off the lips of the various business news channel anchors. But nowadays, in the same breath, you may hear them talking about corn, wheat, or even soybeans. Why the sudden change?

The big push by individual speculators, hedge funds, and others into the agriculture sector in such a short time has been unprecedented. A great deal of this move is a direct result of the ethanol boom and the record corn prices it has helped to generate.

It’s pretty ironic that the modern commodities markets owe their success to the original grain markets that started it all. Back only a couple of decades ago, there was no such thing as an energy futures market or a stock market index. In fact, the grain markets were the first organized futures contracts when many of the exchanges started trading. As the markets developed, grains took a bit of a backseat and the financial and energy commodities seemed to take the lead.

Now with the emergence of the electronic trading market and the ethanol boom, grain futures are soaring. The global demand for agricultural and soft commodities is so significant that these markets are not only important, they are vital for price discovery once again.

The simple facts of the matter are that the global population is exploding and exponential increases in demand from countries like China and India are straining a system that is already overloaded by demand and has been taxed by weather problems globally.

The wheat crop has been hit especially hard this year as droughts, floods, disease, and even frost have taken their toll. Wheat has risen to $9 a bushel, and $10 is entirely possible later this year. Meanwhile, the soybean complex is also soaring, as pent-up demand, especially from China, is keeping this market very well supported.

It’s important to realize that not only do we have exponentially higher demand for soybeans from a growing world population, but we also have the increased feed demands of a growing cattle population in answer to more demand for beef. Soybeans are also a victim/beneficiary of the biofuel boom.

Combine all of these factors and throw in a little disease and bad weather and you have a recipe for a very hungry world, indeed…and much higher prices.

High Food Prices Giving Consumers Indigestion

This has been an incredible year for agricultural commodities, and many “experts” have been telling me for the last year that I was crazy to buy these commodities at such high levels.

Of course, they started telling me that when corn was at $2.20 a bushel and wheat at $5.50. Today, corn is trading solidly over $3.50 and wheat is trading close to $9. The bad news for wheat supplies just keeps rolling in. In the latest round of bad news, Australia slashed its harvest forecast 31 % because of dry weather. Wheat is surging as importers line up to buy whatever wheat they can. Global inventories are heading for a 26-year low.

Soybeans have outperformed expectations, too, as global demand has put a solid floor underneath prices.

Is all the bad news priced into the grain markets at this point, and have we finally seen the top for the grain rally? Think again. The biggest disaster for the grains may just be getting started.

According to my sources at farms in Minnesota and Iowa, diseases may be setting in, and this could be devastating to the wheat, bean, and corn crops.

Corn could be hit hard after a long summer, and hot and dry conditions and hail affected corn yields in Minnesota. The weather conditions favor the development of a disease called ear rot. Reports of ear rot have been coming in from several different areas, and the quality of grain that comes off these affected fields will almost certainly be reduced.

Meanwhile, things over in the bean patch are not faring much better. According to reports, early defoliation and death in patches of soybeans has occurred recently in fields across Minnesota.

According to Agriculture Online, “Although numerous soybean fields have started to mature and have suddenly turned yellow in the past week or so, it is obvious in many areas that the yellowing and plant death have been accelerated well beyond what would be typical.”

Sure, bean and grain prices are very high already — in fact, some of the prices we have been seeing for the agricultural commodities in the last few years are nothing short of astounding. It’s important to recognize, though, that demand has also been astounding. Demand is almost certain to outstrip supply, especially in wheat and soybeans. So even though we are seeing record prices, they may climb further as we head into winter. Therefore, some exposure to the agriculture sector in your portfolio seems like a prudent idea.

Clearly, the agricultural bull market is far from over, but that’s not to say that we won’t see some extreme volatility. Overall, though, the indications are pretty clear that staple commodities like grains are going to be more in demand and less in supply as time goes on.

So my forecast for the grain markets is as follows: Higher, but volatile.

The really nice thing about commodities trading is that it’s just as easy to bet on falling prices as on rising prices. So when the time does come, as it does in every market, we will be just as eager to go short and try to profit on the downside. For now, though, the trend is our friend and the trend is up.

What’s Next for the Grains and Soft Commodities?

As I told my Resource Trader Alert readers in the beginning of the year, the grains started out as a supply-and-demand market, and then a weather market and then go back to supply and demand when we actually get to harvest.

So right now, all those wild swings you’re seeing in soybeans and wheat are based on weather, more or less. We had hot, dry weather, and beans rallied hard. Then some rain came, and the beans fell dramatically, and then recovered a little. This pattern will most likely continue all the way until harvest.

I am glad my Resource readers grabbed half profits on their soybean options pretty much at the high of the move. Nice! We still have plenty of time on these, and as I said, it’s a weather market. And even though it’s autumn now, the heat hasn’t gone away from many parts of the country. I continue to look for any value play in the grains that may be another good addition to the Resource portfolio, but there are few bargains out there anymore.

The soft commodities, specifically sugar, are showing some good support here at these levels. Funds have come back in, and as oil prices were trading close to $76, it helped sugar, too. If you would like to see how my readers have benefited from the sugar trade, then please click here to subscribe to Resource Trader Alert.

Keep a close eye on oil. It could be a major mover for all the commodities, as we are getting back up to the record high, and that could have a ripple effect. What that will do, I’m not sure. I guess we will find out together. I will be monitoring the situation closely.

I will tell you, too, that I liquidated half of my crude 2009 recently for my infant daughter and, by my estimation, the profits would pay for her first year at USC or NYU. The good news for me is she will likely study at the University of Tartu, near our home in Estonia, and that (at least for now) is my favorite price: FREE.

Yours for resource profits,
Kevin Kerr

September 24, 2007

The Edible Portfolio was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Shocked, Shocked

“I was shocked,” said Mr. Hofmeister, “at how many people actually believe in the Peak Oil theory.” Was he really shocked? Or perhaps he was, as the inspector of police noted in the movie Casablanca when he learned that people were gambling in a certain saloon, merely “shocked, shocked.”

Shell’s Mr. Hofmeister cannot be unaware of Peak Oil theory. The Peak Oil theory was, after all, pioneered in the 1950s by a geologist named M. King Hubbert (1903-1989), who worked for none other than Shell. It is not quite like the guy who runs General Electric dismissing the import of Thomas Edison or the development of the light bulb, but it is in the same ballpark.

Shell’s geologist Hubbert based his Peak Oil concept on the rather obvious point that you cannot extract oil that you have not discovered from the ground. So Hubbert reviewed mountains of data concerning oil discoveries, and oil extraction and production, dating back as far as the 1860s. Hubbert noted the common trend in oil field development for a new field to come online and oil production to increase as the field was drilled and developed. But then, over time, the inevitable effects of depletion would kick in and cause the overall production of the oil field steadily to decline.

Hubbert’s Curve

In the days before sophisticated computers and elaborate spreadsheet programs, Hubbert crunched his own numbers. He cumulated the reserve figures for oil discoveries in the U.S. and the production histories of thousands of U.S. oil fields dating back almost a century. Hubbert observed and demonstrated, through a process called “reserve backdating,” that most major oil discoveries in the U.S. had occurred by the 1930s. That is, even though reserves may not have been listed on a company’s books until much later, they were, in geological fact, part of the original discovery many years before. And Hubbert focused on the point that after the largest oil fields had been discovered, in terms of both surface area and volume of calculated reserves, the “new” discoveries thereafter tended to be smaller oil deposits, or extensions of previously discovered oil fields and oil-bearing trends:

In a paper that he prepared and delivered in 1956, over the objection of several Shell executives, Hubbert postulated that total U.S. oil production would increase until about 1970 and then reach a “peak,” from which it would then steadily decline in volume over time:

Hubbert updated his 1956 predictions in the early 1960s and came up with essentially the same forecast of U.S. oil production peaking by 1970. Hubbert did not anticipate the 1968 discovery of the oil field at Prudhoe Bay, Alaska. But his numbers were prophetic, and eerily accurate, for the lower 48 states. Almost on cue in 1970, overall U.S. oil production peaked and commenced its long trend of irreversible decline, barely changed even by the development of Prudhoe Bay in the 1970s. Thereafter, the U.S. has imported more and more conventional oil to meet its daily needs:

So the discovery side of Peak Oil theory holds that mankind has identified and located, if not actually discovered, most of the conventional crude oil that there is to find in the crust of the Earth. The production side of Peak Oil theory holds that mankind has produced, and, of course, consumed, something near half of it. In terms of really big Peak Oil numbers, out of a worldwide resource base of conventional oil that is estimated by some knowledgeable commentators at about 2.2 trillion barrels, about 90% has been discovered and about 1 trillion barrels have been extracted and consumed over the past 150 years or so.

Bell-Shaped Curve

Mathematically, the history of oil production in any given region is a bell-shaped curve, with “tails” on each side and a relatively rounded top in between. In a very general sense, the initial increase of the first half of the curve is mirrored by the decline phase on the other side. It is like saying that “what goes up must come down,” but it is all rooted in the concept that you cannot produce what you have not discovered.

Applying Hubbert’s methodology to the global resource base, the world’s oil industry currently appears to be at the top of the Hubbert curve. Each day, the world’s oil industry is pumping the known oil reserves out of the crust of the Earth at a rate of about 1,000 barrels per second, or 85 million barrels per day, or about 31 billion barrels per year. And the global economy is consuming or otherwise burning up almost every drop of that oil. (Some very small fraction goes into storage, such as for the Strategic Petroleum Reserve of the U.S. or comparable reserves in other nations such as China. This oil, too, will eventually be burned or otherwise consumed.)

The balance between global supply and demand is precarious, such that if just a couple of hundred thousand barrels per day of production (near a rounding error from a production base of 85 mbd) go offline, there can be significant price moves, as occurred last August when BP closed the Alaska pipeline. Or consider what the traders call “political risk,” such as the result of hostilities closing a maritime control point such as the Straits of Hormuz. If even one oil tanker were to, say, hit a mine in the Persian Gulf, oil prices would skyrocket within hours.

The Edge of Secure Supply

Shell’s Mr. Hofmeister knows all of this. At a recent speech he gave in Pittsburgh, for example, he began his talk with a rather gripping story that dealt with the supply of refined product, as opposed to crude oil. But the story illustrates the point.

According to Mr. Hofmeister, in the aftermath of hurricanes Katrina and Rita in 2005, almost all of the U.S. Gulf Coast refineries were down due to flooding and other storm damage. Shell had 300,000 barrels of refined product in storage at its Baytown, Texas, refinery, which was essentially the only supply available to the entire U.S. Southeast region, but there was no electricity with which to run the pumps. Whoops!

Shell employees and contractors were working feverishly to rig up electric generators at the Texas facility, but it was a race against time, over a 48-hour period, until the Plantation and Colonial pipelines — – the major trunk carriers for refined product between Texas and the Southeastern U.S. — went dry. If word escaped of the predicament, Shell executives believed that many members of the consuming public would have panicked. Then panic-buying would have immediately kicked in and rapidly drained whatever fuel was left in the supply system. The entire Southeast, home to about 60 million souls, could have been caught in a situation in which there was be no fuel available anywhere. It fell to Shell’s Mr. Hofmeister to call the U.S. secretary of energy and deliver the bad news.

But like the cavalry arriving near the end of a John Ford Western, Shell’s hardworking people hooked up the Texas facility with electric power, with all of about 12 hours to spare. Shell started pumping gas into the pipeline system. There were, you may recall, spot shortages of fuel in the Southeast, but no regional lack of product. Still, as Mr. Hofmeister put it, it was a close call and the U.S. was and remains “on the edge of secure supply.”

Same Thing With Crude Oil

Mr. Hofmeister’s story concerned gasoline, but he could have told the same story with respect to crude oil or natural gas. The Gulf of Mexico hurricanes of 2005 wrecked oil and gas production facilities all along the littoral, to the point of toppling over offshore structures that are the size of World War II aircraft carriers. The hurricanes churned the water column down to the seafloor, and ripped up or displaced underwater pipelines, subsea production equipment, and much else of the Gulf Coast oil infrastructure on which the U.S. relies for energy supply. In addition to the damage to property, tens of thousands of members of the oil industry work force were displaced from their homes and job sites by hurricane damage. The Gulf Coast oil industry still has not recovered, 18 months later.

So yes, “we are on the edge of secure supply” from prospect, to drill bit, to pipeline and refinery, to the gas pump. And a lot of people are starting to figure that out and think about it.

Peak Oil theory is one way of making sense of quite a bit of what goes on in this world, beginning with the supply of conventional crude oil and with implications for the rest of the energy mix of the world’s advanced industrial societies. There is a certain geological coherence (even elegance) to the idea of Peak Oil, and a mathematically demonstrable basis to the concept.

So it should not “shock” anyone, let alone the president of Shell Oil Co., that “many people actually believe in the Peak Oil theory.” In fact, I think that Peak Oil theory makes Mr. Hofmeister’s job easier. Once people understand the key issue behind the nation’s energy supply, it is more probable that they will be willing and able to design a solution.

Until we meet again…
Byron W. King

February 16, 2007

Peak Oil Shock was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.