The Coming Oil Train Wreck: First stop: Mexico?
By Tony Allison, December 22, 2008
Only a true contrarian can worry about high oil prices, shortages and global economic shockwaves when the price of oil has fallen from $147 to under $40 per barrel in less than six months and gasoline is now less than $2 a gallon! I should be singing “Happy (driving) days are here again,” but I’m not. The facts speak otherwise, and the time for preparation and mitigation is growing short.
Aside from a few Paul Revere’s such as Matt Simmons, there is precious little media alarm or urgency over an issue that is historic in nature and monumental in scope. The stark IEA (International Energy Agency) report released this fall was mostly ignored in the media, other than to highlight that 2009 will feature “demand destruction.” Other headlines touted “Goodbye to the oil supercycle.” The message sent to the public; lower oil prices ahead, problem solved. Unfortunately, the critical message of 9.1% global oil depletion was ignored.
The first line of the IEA report set the tone. “The world’s energy system is at a crossroads. Current global trends in energy supply and consumption are patently unsustainable- environmentally, economically, socially.” The last line of the report set the agenda. “Time is running out and the time to act is now.”
Permanent supply destruction
The global oil depletion crisis will last much longer than the current credit crisis, severe as that may be. Credit can be created, and savings can be rebuilt over time. Sadly, oil, created over millions of years, is finite. Oil is a one-time gift that will likely be wrapping up its brief lifespan as an energy source some time late this century. The problems begin, however, when global oil production peaks, and evidence is building that the peak may have occurred in 2005. The average age of the top 20 oil fields in the world is now 59 years.
Oil prices may not rise significantly in 2009, as economies deflate and weaken around the globe. However, temporary demand destruction does not hold even a small candle to permanent supply destruction. To add to the problem, exploration and production around the world is downsizing, as the dramatically lower oil prices make projects uneconomical. Looking at the current 9.1% estimate of global depletion, combined with shrinking levels of drilling and exploration, the medium term outlook is daunting. According to the IEA report, “There remains a real risk that underinvestment will cause an oil supply crunch. The gap now evident between what is being built and what is needed to keep pace with demand is set to widen sharply after 2010.”
The red line (oil prices) is now considerably lower (approximately $40 a barrel for the February contract), and if the trend follows, domestic investment (blue line) will be much lower in 2009. This does not bode well for future supply.
Looking out longer term, to 2030, the math gets ugly. Current global oil production is 72 million barrels per day. According to Simmons, if the world spends a fortune (many trillions) trying to mitigate the depletion rate, it is estimated global production will fall to 25 million barrels per day by 2030. Without the mitigation, world production will plunge to 9 million barrels per day. If those numbers are not a wake-up call to the world, the coming shortages will certainly provide it.
Simmons has stated that we need to find “four new Saudi Arabia’s” just to keep global production flat in the coming decades. The best geologists in the world with the latest high-tech exploration equipment haven’t been able to find one Saudi Arabia. The chances of them finding multiple super-giant oil fields, and soon, are not overly promising.
Mexico- the first domino to fall?
Mexico has long relied heavily on Cantarell, the super-giant discovered in 1976, and until recently the world’s second largest oil field. Cantarell is unique in that it formed as a result of a massive meteor that crashed into the ocean off the Yucatan Peninsula over 60 million years ago, forming the Chicxulub crater. This is thought to be the meteor that radically changed the earth’s climate, killing off 75% of the species on earth, including the dinosaurs. Over millions of years, the massive crater eventually produced over 30 billion barrels of oil.
In the mid-1970’s angry shrimp fishermen, led by Senor Cantarell, stormed the Pemex offices in Veracruz, complaining about oil oozing out of the sea bed, ruining their shrimp nets and demanding compensation. Pemex had no wells in the area, but that was soon to change, along with the fortunes of Mexico.
As of May 2005, Cantarell was producing 2.2 million barrels of oil per day (65% of total Mexican production). Today the figure is roughly 900,000 barrels per day. The most troubling aspect is that the decline rate is accelerating, estimated at 2.5% per month currently, or 30% annually.
No oil exports after 2009?
According to Matt Simmons, by the end of 2009, Mexico will no longer be an oil exporter. If Simmons is correct, it will be very difficult to replace the oil revenue that has supported 40% of the Mexican budget. The Mexican government has recently taken the unprecedented step of voting to allow foreign oil companies to explore for oil in Mexico. In a country that celebrates the 1938 nationalization of its oil industry as a federal holiday, it was clearly an act of desperation. Promising offshore discoveries in Mexico will likely take decades to bring to production, according to Simmons, due to the extreme depths and massive technical challenges.
Unfortunately, it may be too little too late to replace the rapidly disappearing Cantarell production. In as little as 12-24 months, the effects may be felt both in Mexico and the US. Replacing the 1.3 million barrels per day the US now imports from Mexico won’t be easy (the US imports 1.4 million barrels per day from Saudi Arabia by means of comparison). For Mexico, the problems run much deeper, as they must quickly diversify their economy or face wrenching economic and social dislocations. The adjustment period will likely bring great change and tumult, perhaps across the border as well.
A crossroads coming
Be it late 2009, 2010 or even 2011, the price of energy is virtually a lock to head back to its old highs and likely well beyond. Deleveraging and psychological forces can rule the markets for any short term period. Looking ahead, the fundamentals will prevail, as they always do. As economies around the world are printing money for huge stimulus programs, oil companies are shuttering production. Combined with a 9.1% depletion rate, the imbalances are growing. A crossroads is coming, where demand will re-ignite at some point and supply will have difficulty catching up. We have a liquid fuel crisis. We are decades from electrifying the transportation system, and wind, solar and nuclear will not solve a liquid fuel shortage. At least in the US, the best opportunity appears to be rapid conversion to natural gas-powered transportation.
It seems almost nonsensical to speak of high energy costs and shortages in this deflationary environment. But given that the global economy recovers one day, the seeds of higher prices have already been sown. An investor with a longer term time horizon should own well-managed oil production, exploration and service companies, especially at these much lower valuations. The resource these companies bring to market is growing ever scarcer, and will be desperately needed for decades to come. The peak-oil train wreck will be a crisis for many, but a great opportunity for others. While the current recession/depression may be long and hard, investors must look beyond and invest on the coming geological realities. As a citizen, it is also important to begin preparing for a difficult energy future, whenever it arrives.
Hit the ground running
The new Obama administration wants rapid change into renewable energy sources. Those changes are expensive and will be difficult to sell at low oil prices. Government policies will likely encourage higher oil prices. Of course official acknowledgement of global oil depletion carries many political risks and would raise havoc with many of his supporters. As dire as the longer term situation appears, would any politician take severe political measures before shortages strike? Not likely. Thus, don’t expect to hear much about peak oil or global depletion from the next administration, at least initially. However, they will know the facts as well, and must begin working on all aspects of energy creation on day one. It would be politically wise for President Obama to link fossil fuel depletion and global warming and work on the issues as one package.
Enjoy the holidays, and the inexpensive gas at the pump. But keep a watchful eye out for the train heading our way.
U.S. stocks extended losses Monday, with the consumer-discretionary and energy sectors hit hardest after Walgreen Co., the nation's largest drugstore chain, reported disappointing results and Toyota Motor Corp. forecast a loss for the year.
The Dow Jones Industrial Average fell 73.27 to close at 8870.54. The S&P 500 Index was down 11.78 to close at 919.21. The Nasdaq also closed lower, ending at 1616.74, down 30.66.
Crude-oil futures fell Monday to below $40 a barrel as demand concerns outweighed news that the Organization of Petroleum Exporting Countries could cut production further.
Gold for February delivery, the most active contract, closed up $9.80, or 1.2%, at $847.20 an ounce on the Comex division of the New York Mercantile Exchange. It rose 2.1% last week.
© 2008 Tony Allsion