Gas Use at Five Year Low but.....

The weekly report from the Energy Information Administration (EIA) was released yesterday, and the headline that was picked up by the media was that gasoline usage over the July 4th holiday hit a five year low, and dropped 3.3% from last year to 9.347 million barrels a day. This fits in nicely with my thesis that oil prices are ridiculously over priced, and was a source of considerable joy for me when I read it last night. The chart is below.



Now it is no secret that I am bearish on oil prices, and have received considerable contempt and scorn for this position. However, there was another nugget of data in the EIA report that was stunning and not supportive of my bearish position. It would be easy for me to ignore this data, as it seems that the media has, and just see what I want to see in the report, but then I would be guilty of what I frequently accuse oil bulls of doing. I try my best not to ignore data, or mine it to find want I want to find in it.

The EIA also reported that U.S. Crude Oil Production fell to 4.96 million barrels per day for the week ending 7/4/2008. On a four week moving average, production was 5.09 million barrels per day. This is the lowest production measured on a weekly basis since July 2006.



One component of my bearish thesis on oil prices is that domestic oil production will begin to move higher over the next few years due to all the exploration and development being done, and this data point would seem to contradict my position. Now it would be expedient for me to dismiss this as a one week aberration, or as some sort of holiday weekend related drop, but I will not do that and will take the data as it stands and incorporate it into my thinking on the oil supply and demand situation.

Japan Export Slowdown

Japan just released its May trade surplus report, and although it beat expectations, it was down for the third straight month, hurt by rising prices for the Oil that Japan imports.

While exports to China and the rest of Asia were strong, analysts said the gain was a little deceptive, as shipments to China were artificially boosted after the recent earthquake on May 12.

Even more important was that:

1) Exports to the U.S. fell 9.5% as demand for Japanese cars and other products slowed.

2) Exports to Europe were down for the first time in 31 months.

Is this more evidence that the decoupling theory is not valid? Last week it was reported that exports from Singapore to the developed world were down as well.

Here is a list of important questions to answer:

Is it possible that the economic recession in the U.S will lead to a decline in Consumer spending on discretionary items?

Is it possible that this decline in consumer spending will be exacerbated by the increasing price of gasoline and food?

Is it possible that some Asian economies, who are heavily dependent on exports, will not be able to export as much as in the past because there aren't as many buyers?

Is it possible that these Asian economies will not grow as fast as in previous years or as much as the market or pundits expect?

Is it possible that when these Asian economies don't grow as fast, they will use less energy (oil) than the market expects?

Is it possible that the supply and demand fundamentals for oil will not meet the market expectations and we will have a surplus of oil over the next 12 months leading to a rapid rise in inventories?

Is it possible that I am out of my mind?

Oil and the Great Deception - Part Three

"Oil Production in the United States is in a permanent decline."

This is one of the loudest of all claims by oil bulls, and the one stated with the most smug self satisfaction, a seemingly impregnable statement that no one with even half a brain could possibly refute. This claim is usually made in conjunction with some comment about M. King Hubbert, and his prescient statement about the aforementioned peak, complete with the required head bowing and reverence for the so called "messiah" of the peak oil movement.

How can anyone deny this after all?

According to the Department of Energy web site, domestic oil production peaked in 1970, at 9.6 million barrels per day. On a Monthly basis, it peaked in November 1970, at 10.4 million barrels per day. However, this doesn’t tell the entire story.

1) Production in the U.S has stopped declining and was flat in 2007 vs. 2006. While there is some noise in the numbers due to recent hurricanes, it is estimated that in 2008, production will again be flat before a large 4.1% increase in 2009. The chart below shows the reversal in this decline.



2) During a four-year period, from 1982 to 1985, domestic production grew every year, a legacy of increased oil exploration while prices were high in the late 1970’s and early 1980’s. The total percent increase in domestic production was 4.65%.

Here is a chart from Google Docs. Although hard to see in the chart due to the scale and my technical incompetence in trying to remove the lower numbers, production did increase before tailing off once prices collapsed.



3) Domestic oil production also increased in 1977 and 1978, including a whopping 5% in 1978.

4) Domestic oil production increased 10.3% from 1976 to 1985, from 8.1 million to 8.9 million barrels per day.



5) Recently, sequential production has increased for four straight months (December 2007 to March 2008), although still down on a year over year basis. And yes, I understand that four months does not a trend make, just thought I would mention it.

Why am I wasting time writing this?

To demolish cherished beliefs held by millions of investors who rely on others to do their homework for them. Stop regurgitating what you hear on TV, and do your own god damn research.

What you should really be thinking about is that if production can actually increase in a mature basin like the United States, then imagine what could happen in areas of the world that are at the cutting edge of exploration.

Now before you your make your comments about how stupid I am or how I just don't understand, please read the following about things I am specifically not saying, so please don't accuse me of this:

1) I did not say that U.S production will ever reach its previous peak of 10.4 million barrels reached in 1970, just that production could head up again due to increased exploration.

2) I did not say that it is easier to find oil in the United States.

3) I did not say that the possibility of a small increase in production in the United States will solve all of our supply problems.

Oil and the Great Deception - Part Two

"It is getting much more expensive to find Oil these days."

While it is true that it is getting more expensive to find oil, one has to examine whether that increase is of a permanent nature as many argue. The reason that it is getting more expensive to find oil is mainly because service, drilling and other costs are sharply increasing. While this may seem like a circular argument at first, my intention is to demonstrate that the cost of finding oil is rising to a cyclical peak, and that it is not secular in nature.

All the data shows that the cost of finding Oil is rising sharply. Why? Very simply because of a self reinforcing boom in exploration and production, which led to a capacity shortage in oil services and drilling as demand for rigs and services increased faster than supply. Other costs, such as for steel, or the acquisition of existing producing properties has also increased for the same reason, a shortfall in capacity in various sectors, or an imbalance between supply and demand.

It is therefore, a cyclical increase in the cost of finding oil, not a secular or systemic one. If the exploration and production sector cuts drilling significantly, say 30-40%, then extra capacity will flood the oil services and drilling market leading to a plunge in prices and then the cost of finding and developing oil will decrease.

This argument is supported by data from many sources.

The Energy Information Administration (EIA) study entitled Oil and Gas Lease Equipment and Operating Costs, which has data from 1976 to 2006. The chart below demonstrates the cyclical nature of oil services.



Look at the green line back in the early 1980's when the cost index fell from 123.3 to 82.6 in just five years. This study does not include drilling and completion costs. If you included these, the cyclicality would be even more pronounced. Also, this data is only through 2006. The green line currently is significantly higher.

The same trend can be seen in the HS/Cambridge Energy Research Associates (CERA) Upstream Capital Costs Index. The latest monthly release from May 2008, shows that "the latest increase raised the index to 210 points from its previous high of 198. The values for the UCCI are indexed to the year 2000, meaning that a piece of equipment that cost $100 in 2000 would cost $210 today."



This index tracks "the construction of a geographically diversified portfolio of twenty eight onshore, offshore, pipeline and LNG projects."

As an example, five years ago, it may have cost $ 250,000 per day to lease a rig to explore deep offshore. Today, if you can find one it may cost you $800,000 per day. According to Cambridge Energy Research Associates (CERA), dayrates can be 30-40% of the cost of an offshore well.

So in a sense, it is getting more expensive to find oil, but people who say this are either ignorant of the reason why or being disingenuous to further their investment case. Bullish investors use this as an excuse to justify that oil prices have to stay higher because the cost to find oil is higher.

Please understand that I am not predicting that this these various cost indices will turn down soon, only stating for the record that they can turn down, and have turned down precipitously in the past once capacity catches up to demand.

If you argue that the cost of finding Oil is permanently higher, then you are accepting the argument that industries that have been intensely or even pathologically cyclical for 100 years are no longer subject to those conditions. This is a bold statement to make and you better be damn sure you are right.

Please read my earlier post of the fallacy of demand growth in emerging markets.

Dear Mr. T. Boone Pickens

World oil supplies won't exceed 85 million barrels a day because of high depletion rates of existing wells, Pickens, the founder and chairman of Dallas-based BP Capital LLC, said yesterday in a speech at Georgetown University. "There is only 85 million barrels of oil globally in the market coming a day and I don't think you can increase that 85 million," Pickens said. (April 2008)


World oil supply rose to 86.6 million b/d in May, up nearly 500,000 b/d from April's 86.11 million b/d as production rose from OPEC, China and the former Soviet Union, the International Energy Agency said Tuesday. OPEC raised its crude supply to 32.31 million b/d last month, up from 31.91 million b/d in April, the IEA said in its latest monthly oil market report. (June 2008)