The Jubilee

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  • March 2015
    M T W T F S S

Our energy predicament

Posted by Alex Krainer on March 25, 2015

In the wake of last year’s oil price collapse we are once again reassured about an overabundance of cheap oil. This could only be a temporary aberration. Below I present the reasons why the prospects are grim and the price of oil is likely to rise multi-fold in the next few years. The consequences for the western societies will be serious.

During the 19 years of my career in commodities I have observed time and again how significant price changes shape the prevailing market narrative. By narrative here I mean a shared interpretation of the way key causal forces affect market events. Market fundamentals – available bits of relevant data and information – are the building blocks that mould our understanding of what’s going on, but what we do with them depends on how we evaluate their relevance and credibility. This is never a straightforward process, so at any one time we can entertain more than one possible interpretation of market conditions. However, when some market goes through a significant and sustained price dislocation, the price itself acts to validate certain bits of information while discounting others. At such times, interpretations converge and a shared core narrative takes hold. This may not be a controversial assertion, but it is important to recognize that while narratives may explain the recent past, they don’t necessarily predict the future. Attributing a predictive quality to a narrative is an illusion borne out of our belief in a stable world where future resembles the recent past.

As a young oil market analyst in the 1990s, I pretty much expected that available fundamentals data gave us a factual account of the world; that “bullish” information would lead to a rise in oil prices and “bearish” information would lead to their decline. Thus, an increase in demand for oil should cause oil prices to rise. So would shortfalls or interruptions to its supply. Conversely, falling demand or increasing production should cause prices to fall. Often however, market fundamentals seemed largely in discord with the price action. For example, in late 1990s, global economic growth was in full swing and the demand for oil was rising. Meanwhile, capital markets favored technology and telecom investments and funding for new oil production and refining facilities around the world tightened. As a result, demand was expected to progressively outstrip supply, pushing oil prices significantly higher in the future. Contrary to those expectations, oil prices more than halved from around $24/barrel in the early 1997 to below $10/barrel in 1999. Market participants’ need to reconcile the supposedly bullish fundamentals with collapsing oil prices gave rise to stories and rumours about massive stocks of unsold oil and vast tank farms around the world, full to the brim. As prices fell toward $10/barrel, the bearish narrative became entrenched and many traders thought that oil could halve again to $5/barrel. But stories about huge unsold oil inventories (in effect rumors given credence by the declining price) proved unfounded and after bottoming out in 1999 oil prices tripled to $35/barrel during the next 20 months even as the world economy slipped into recession and demand for oil contracted. Again, the market sought to reconcile these contradictions with a new narrative to fit the events: we heard about falling production of oil fields around the world, rising production costs, shortage of refining capacity and growing demand from emerging economies. One of the biggest stories affecting the market was the Peak Oil Hypothesis. Not that this hypothesis was just then formulated catching everyone by surprise: it was already published in 1956 and subsequently popularized in the 1970s. Its reemergence in 2005 and 2006 reflected the markets’ need to explain the record high oil prices.

In the second half of 2014 we experienced another oil price collapse. This time the narrative involved the hype about US fracking boom which pushed up oil production as well as slow growth in global demand due to recession. On top of this, it is understood that Saudi Arabia delivered the coup de grace to the oil price by flooding the market with excess oil or refusing to curb output amid an existing supply glut. The newly entrenched narrative got so bearish that many analysts see oil price dropping further, perhaps toward the $20/bbl range where it might stay for some time. But again, prevalence of the bearish narrative doesn’t mean that prices will remain low for long. In 1997 nobody expected the oil price to half over the following two years, but it did. In 1999, bearish sentiment was almost universal, just before the price rallied by 350% from $10/bbl to $35/bbl over the next 20 months and pushed on to above $140 by 2008. Today, there is nothing to suggest that in spite of the bearish consensus, another unexpected price dislocation could be imminent. We should therefore explore those oil market fundamentals that could shape up a new bullish narrative if prices start heading upward.

Saudi Arabia’s reserves and production capacity

Neither U.S. fracking boom nor the slow demand growth can explain the timing of the recent oil price crash. We’ve known about fracking since at least 2009 and the “boom” part became quite apparent by 2011. The weakness in global demand wasn’t news either, so what did happen in June 2014 when oil prices started falling? Supposedly, the collapse had something to do with Saudi Arabia’s refusal to curb excess production for whatever reason – there is no shortage of explanations. However, a closer look at Saudi Arabia’s oil production and her reserves should put us in doubt whether the kingdom actually has the abundant reserves and spare capacity to move the oil markets at will. Confidential U.S. Embassy cables from Riyadh released by Wikileaks [1] confirmed that Saudi Arabia’s output is in decline and the kingdom has been facing mounting challenges to replace its declining production levels. One of the cables from 2007 recapitulates U.S. Consul General’s meeting with Mr. Sadad al-Husseini, Aramco’s Executive Vice President for Exploration from 1992 to 2004. This cable reveals that Saudi Aramco sought to raise production to 12.5 million barrels per day by 2009. In spite of a massive $50 billion investment in expanding production, Aramco never came close to their 12.5 mb/d objective. In fact, in 2009 Saudi output fell to below 8 mb/d and has never surpassed 10 mb/d except for a brief period in 2013. The same cable suggests that Saudi Arabia also grossly overstated its reserves. Presently, Saudi Aramco claims that they have 790 billion barrels of oil resources and expect this figure to hit 900 billion barrels by 2025 [2].

Ghawar – the world’s largest oil field is nearing collapse. The inserts below the map show declining oil production in the kingdom even as the country’s rig count tripled between 2004 and 2007!

Ghawar – the world’s largest oil field is nearing collapse. The inserts below the map show declining oil production in the kingdom even as the country’s rig count tripled between 2004 and 2007!

Saudi oil may be close to running out

Given that 100 billion barrels have already been extracted since 1979 [7], Saudi Arabia may be close to running dry! This is largely confirmed by the figures provided by Mr. Husseini as cited in the Riyadh U.S. Embassy cables. Namely, Mr. Husseini asserts that in 2007, Saudi Arabia had 64 billion barrels of remaining oil reserves, that these reserves would last 14 years (until 2021), after which Saudi output would enter a period of steady decline that no amount of effort would be able to stop. The stark reality of these figures was further corroborated in a recent report by Citigroup [8] which concludes that failing to discover major new oil fields, Saudi Arabia might cease to export oil altogether by 2030 – mere 15 years from now!

Shale oil and the “fracking” boom

Over the last decade, a new oil drilling technology raised hopes that the “shale revolution” could offset declines in conventional oil and gas production. Hydraulic fracturing of shale rock formations, or “fracking” started to take off around 2005 in the United States. Technology’s early success reversed American production decline, adding well over 4 mb/d to U.S. oil output [9] and making U.S. the third largest oil producer after Saudi Arabia and Russia. This innovation incited a great deal of optimism and also much hype. Countless reports and articles endorsed fracking and put forward claims that:

  • the U.S. would soon become energy independent
  • S. oil production would surpass Saudi Arabia’s
  • the state of Texas would produce about a third of global oil supply
  • the U.S. would become an oil exporting country again.

In some ways, results from fracking surpassed expectations but grounds for optimism have since largely eroded as important limitations of fracking became apparent. To begin with, early assessments of recoverable deposits were overly optimistic. A case in point is the Monterey Shale in California. In 2011, the U.S. EIA claimed it had 13.7 billion barrels of oil resource. Later assessments found that only about 3% of those quantities (some 600 million barrels – about a week’s worth of global demand) are economically recoverable. Likewise, EIA initially estimated that Pennsylvania and New York’s Marcellus Shale had 410 trillion cubic feet of shale gas resources. Subsequently, US Geological Survey determined that only 84 trillion cubic feet of Marcellus Shale Gas were technically recoverable. An even smaller fraction of this is recoverable economically.

Drilling experience further showed that shale oil wells deplete ten times faster than conventional wells [10] and maintaining production requires enormous and ongoing capital expenditure to drill new wells. To be commercially viable fracking depends on high oil prices and abundant low-cost capital. Finally, fracking is very controversial from the environmental perspective and its development has encountered increasing pushback from communities that suffer adverse impacts like air and water pollution and earthquakes.

While early industry reports suggested that shale revolution would help push peak oil 40 years or more into the future, this optimism has turned out unwarranted. The International Energy Agency, which in 2012 estimated that U.S. production would keep growing beyond 2030, conceded more recently that U.S. shale oil production would peak around 2020 (significantly, this report [12] was published in June 2014, pre-dating the imminent oil price collapse). Even the upbeat U.S. Energy Information Administration recently curbed their initial optimism. In its 2014 World Energy Outlook, EIA warned that the U.S. shale boom in fact masked threats to world oil supply and that global energy system is in danger of falling short of expectations. This is a polite way of saying, “we’re in serious trouble and fracking isn’t going to save us.”

Revisiting the peak oil hypothesis

In the aftermath of the 2008 financial crisis, oil prices collapsed from over $140/bbl to below $40 in a few short months. Although they subsequently recovered, they haven’t regained the 2008 peaks, capped perhaps by the ongoing weakness in the global economy and the growing optimism about fracking. As a result, concerns about peak oil faded from the narrative and from the minds of market participants. Still, the reality of peak oil has not faded, and it will seep back into the narrative in the near future.

As a reminder, peak oil refers to the point in time when the worldwide oil production irreversibly passes its maximum point, followed by an unstoppable decline. Again, note the terminology: we are talking about declining production, not the “resources,” or even “reserves” which have mushroomed over the years as calculation methods and definitions of oil changed. Conventional oil production peaked between 2005 and 2009 [13] with at least 37 oil producing countries already experiencing significant declines in production. A chart prepared by the EIA for a U.S. Department of Energy conference in 2009 shows the agency’s projected global output decline through 2030 against projected demand [14]:

Trouble: the far end of this chart is only 15 years from today!

Trouble: the far end of this chart is only 15 years from today!

Today, oil production is declining at a rate of between 4% and 9% per year, depending on whom you ask. But even at the low end of these decline estimates [15], it turns out that to keep oil production from falling, we would need to develop and put into production the equivalent of Saudi Arabia’s entire output every 3 years! While this does not take fracking into account, it is now clear that fracking can’t fill the 43-million-barrel-per-day gap marked in the above chart as “unidentified projects.” It might buy us a bit of extra time – but only if oil prices rebound significantly and remain at much higher levels than today.

EROEI and the diminishing returns on energy investment

The world’s energy predicament appears graver still when we analyze it in terms of the energy return on energy invested, or EROEI. International Energy Agency’s 2014 special report “World Energy Investment Outlook” asserts that meeting world’s energy needs will require investing $48 trillion through 2035. That sounds like a lot, but framing that investment in dollar terms is deceptive. Dollars can be printed in any amount as needed, but producing oil requires the investment of real capital including materials, equipment and qualified labor. It also requires energy.

In the 1930s and 1940s, oil producers obtained a return on energy invested of about 100:1 at the well-head. In other words, for the investment of 1 barrel of energy they obtained 100 barrels from the ground. This is what “cheap,” easily extractable oil was. Today, the world average is down to 15:1 and in the U.S. it is 11:1. Best shale oil basins yield an EROEI of 6:1 while deeper shale wells and tar sands yield 4:1 or less. Biofuels like ethanol from Corn yield 1.5:1 or less.

The energy we must invest to obtain new energy can not be printed and our declining EROEI numbers reflect the diminishing returns from investment in energy production. As more and more resources are required to generate the same amount of liquid fuels, energy production is becoming ever more expensive to society in real terms. And as it becomes more expensive in real terms, it must also become more expensive in nominal or dollar terms. That it has recently become cheaper in dollar terms can only be a temporary aberration.

Sources and quality of information

My research to try and establish facts about oil supply and demand led to many dead-ends where you must take the information at face value and hope that it is true. For example, we’ve all heard (again) about tanker-fulls of unsold crude oil floating around the world. Ultimately, this information is based on hearsay. For example, Bloomberg reported [16] how oil companies are seeking supertankers to store 20 million barrels of crude oil (this sounds like a lot, but represents a few hours’ worth of global demand). Bloomberg got this information from a Greek shipping company – essentially, some dude simply said so! But this bit of information was picked up by numerous analysts and treated categorically as a fact to explain the oil supply glut. This reminded me of Thomas Friedman’s story about how he filed temperature reports for Beirut as a correspondent for the New York Times [17]:

I estimated what the temperature was, often by ad hoc polling… Gathering the weather report basically involved my shouting down the hall or across the room: ‘Hey, Ahmed, how does it feel out there today?’ And Ahmed or Sonia or Daoud would shout back, ‘Ya’ani, it feels hot.’ … So I would write, ‘High 90 degrees.’

Friedman’s reports were then duly included in UPI worldwide correspondence from Beirut. Once published in reputable newspapers as the New York Times, Washington Post and others, they appeared as facts in black-on-white, but as Friedman confesses, the figures were merely his own lazy guesstimates. I suspect that much of the information that gets into compelling-sounding oil market analyses comes from surveys conducted with similar rigour. Once they are cited by respected institutions however, they gain the validity of hard facts with which persuasive narratives can be contrived giving us the sense that we understand what’s going on in the world and why. I suspect that often we don’t.

All too often, narratives tend to be skewed by an invisible bias which determines which “facts” are included in the story and what significance they are given. In the aftermath of the recent oil price collapse, the need to explain facts on the ground created the bias that led a majority of analysts to pick facts with bearish implications to come up with a compelling narrative explaining the collapse. Bullish “facts,” like the declining oil output simply got ignored for the occasion. Reading over many such articles and research reports I’ve noted that there are at least three constituencies with their inherent biases looking at energy markets:

  1. Energy industry and their investment bankers. Their reports tend to be upbeat-to-exuberant: there’s plenty of oil, production is going through the roof, fracking technologies are improving by the day and production will keep growing to infinity.
  2. Government agencies. Their reports tend to be cautiously upbeat, both about the available oil reserves and the ability of new technologies to develop new projects and resources feasibly.
  3. Academic institutions, particularly UK-based ones. Their reports tend to be positively alarmist and frequently evoke global climate change, the need to move away from fossil fuels and shift to alternative energy sources.

Each of these groups produce professional and credible-looking reports with neatly tabulated figures and interesting charts, but often leading to very different conclusions. Between the lines, it is not difficult to discern the root of each group’s bias. Oil industry and their bankers want to attract investment capital. Government agencies want to favor dominant industries and avoid stirring alarm among their constituents. And academic institutions – ever devoted to pursuing unvarnished truth – at times put out reports that reach pre-formulated conclusions requested by groups that fund their research.

Peak oil from military organizations’ viewpoint

There is however, one group that doesn’t have an overriding financial stake in the energy markets, and that is the military. I think we can get closer to the truth by researching about how various military organizations look at energy-related issues. In the last few years I have come across three different reports – one by the German Army’s Bundeswehr Transformation Center [18], one by the U.S. Army Engineer Research and Development Center [19], and one by UK’s Ministry of Defence [20]. Each of the three reports considers the peak oil hypothesis with utmost seriousness and treats the notion that we have run out of cheap, easily extractable oil as a hard fact with grave consequences for the world economy, societies and global security. While the U.S. Army report doesn’t mention “peak oil” as such, it is based on the notion that “The days of inexpensive, convenient, abundant energy sources are quickly drawing to a close… ” and discusses the likely consequences and contingencies for the U.S. Army.

The German Army’s report similarly affirms that the world is facing peak oil and future scarcity of crude oil. It notes that all of Germany’s key oil suppliers are past peak production and discusses the likely consequences in matter-of-fact but rather dismal terms. For example, the report sees peak oil as a global problem that could lead to breakdown of supply chains and global trade. It notes that high energy prices could disrupt the financial markets, leading ultimately to a collapse of economies, mass unemployment, infrastructure collapse, famine and a total system collapse. Is this too dramatic? Perhaps, but if we consider that in terms of calories, about 50 times more economic output is produced by fuels than by labor [21], it is clear that we are facing very real risks of major economic and social disruptions.

UK Ministry of Defence’s report is also in agreement about peak oil, stating that “the imminent passing of the point of peak ‘easy oil’ will mean that hydrocarbon-based energy prices will rise significantly out to 2040.” MoD’s report projects that oil prices are likely to reach $500 per barrel. Consequences of the energy crunch might result in food shortages and a scramble for commodities and resources. While this report was released in 2012, we have meanwhile seen another indication of the seriousness with which peak oil is regarded by the UK establishment. Namely, UK Government’s Department of Energy and Climate Change (DECC), Bank of England and Ministry of Defence among others, have in secrecy conducted an ongoing peak oil workshop since at least 2009. In 2010, The Observer has invoked the Freedom of Information Act to obtain the policy documents related to these workshops, but the DECC declined to release them, stating in a letter dated 31 July 2010 that these meetings are “ongoing” and “high profile” in nature. High profile indeed. Only a few weeks ago, none other than the Governor of the Bank of England, Mark Carney was in Riyadh to inquire about the future of oil and oil prices [22]. When the governor of one of the world’s most powerful central banks takes such personal interest in an issue, we can safely discard any happy talk about oil and assume the situation is grim.


Although oil market narrative presently remains bearish, during major price dislocations, it is the price action that leads the narrative, not the other way around. The big picture shows that we are in an intractable energy predicament, but because of the prevailing bearish bias much of the credible bullish facts are simply ignored and left out of the narrative. They haven’t faded from the reality however, and positive price action in the future could change the narrative very rapidly. If renewed concerns about peak oil enter into that narrative – as they likely will – energy prices could bounce back with a vengeance and reach new peaks over the next few years. The consequences for investors and for societies around the world will be very serious and long-lasting.


[1] “US embassy cables: is Saudi boom reaching its limits?.” The Guardian, 2 February 2011. –> – peaking at these cables is quite interesting; they indicate that one of Saudis’ greatest challenges is attracting bids from any contractors and finding sufficient qualified manpower and engineering talent to develop the new projects needed to maintain oil production.

[2] Reuters (via Gulf Business): “Saudi Aramco’s Oil Resources to Grow to 900 bn Barrels by 2025.” 19 November 2014 <>

[3] “Recoverable” doesn’t necessarily mean “economically recoverable,” which would imply that the value of extracted oil should cover the costs of exploration, drilling, extraction, transportation and a certain return on invested capital.

[4] A case in point is the Monterey Shale in California. In 2011, the U.S. EIA claimed it had 13.7 billion barrels of oil resource. Subsequent assessments found that only about 3% of those quantities (some 600 million barrels) are economically recoverable. Likewise EIA initialy estimated that Pennsylvania and New York’s Marcellus Shale had 410 trillion cubic feet of shale gas resources. Subsequently, US Geological Survey determined that only 84 trillion cubic feet of Marcellus Shale Gas were technically recoverable. An even smaller fraction of this is recoverable economically.

[5] This methodology was required by the U.S. Securities and Exchange Commission, but was last performed on Saudi Aramco’s reserves in 1979. After the control of Saudi Aramco passed from the American management to the Saudi Petroleum Ministry no further surveys using this methodology have been conducted.

[6] Oil reserves are classified as proven if there is 90% confidence of them being recoverable with existing technology and under current economic and political conditions. Reserves are probable if there’s a 50% confidence of them being recoverable. For possible reserves, there has to be at least 10% confidence of recoverability under existing circumstances.

[7] Saudi Arabia Crude Oil Production by Year: – according to the U.S. Energy Iformation Administration figures, Saudi Arabia extracted 96.21 billion barrels from 1980 through 2013. At 9.5 million barrels per day, the total through 2014 rises to 99.68 billion barrels of already extracted oil.

[8] Evans-Pritchard, Ambrose: “Saudi oil well dries up.” The Telegraph, 5th September 2012. –

[9] According to EIA, U.S. shale oil production attained 5.2 mb/d in December 2014!

[10] According to a comprehensive analysis by David Hughes, oil geo-scientist and 30-year alumnus of the Geological Survey of Canada the average well output for the seven major shale basins declines from 60% to 91% during the first three years of production.

[11] “World Energy Investment Outlook” – OECD/International Energy Agency, June 2014 –

[12] Idem.

[13] In its 2010 edition of International Energy Outlook, U.S. Energy Information Administration (EIA) proclaimed that oil production from conventional sources probably peaked in 2006.

[14] “Meeting the World’s Demand for Liquid Fuels – A Roundtable Discussion” – U.S. EIA, April 7, 2009 –

[15] Production decline of 4% translates into about 3.4 mb/d each year – 10.2 mpbd shortfall every 3 years! Saudi Arabia’s output is now less than 10 mb/d.

[16] Nightingale, Alaric and Naomi Christie, “Oil Trades Storing Millions of Barrels at Sea on Slump.” – Bloomberg, 9 January 2015. – – On a side note, it appears that Bloomberg has been particularly prolific in publishing articles with bearish implications for the oil market.

[17] Friedman, Thomas. “The Lexus and the Olive Tree.” New York, Anchor Books, 2000.

[18] “Armed forces, capabilities and technologies in the 21st century” – environmental dimensions of security

Bundeswehr Transformation Centre – Future Analysis Branch; English language version (112 pages) is available here:

[19] “Energy Trends and Their Implications for U.S. Army Installations” – U.S. Army Engineer Research and Development Center (ERDC), U.S. Army Corps of Engineers, September 2005 – unfortunately, this report is no longer available. An article about the report – “U.S. Army: Peak Oil and the Army’s Future” by Adam Fenderson is available at

[20] “Strategic Trends Programme: Regional Survey – South Asia out to 2040,” UK Ministry of Defence – Development, Concepts and Doctrine Centre (DCDC), October 2012. – DCDC is MoDs think tank within the Defence Academy site at Shrivenham. – The report utilised the input of a range of government agencies and departments, including the MoD’s Strategy Unit, the Defence Science and Technology Laboratory, the Cabinet Office, and the Foreign Office – as well as two private institutions, Standard Chartered Bank and Now & Next. Decc is notably missing from the list of contributors. A copy of the report is available here:

[21] Lees, Andrew “In Search of Energy” – The Gathering Storm (2010).

[22] Durden, Tyler. “What Saudi Arabia Told the Bank of England About Why Oil Crashed and Where it is Headed Next.” – ZeroHedge, 16 March 2015 – the article relates prepared remarks by Dr. Ibrahim Al-Muhanna, Advisor to the Minister of Petroleum and Mineral Resources of Saudi Arabia at the Institute of International Finance Spring Membership meeting.


6 Responses to “Our energy predicament”

  1. brad said

    Great article with a lot of important points about the perception of the oil markets, although still too little is addressed about the demand side. Most oil narratives continue to focus on oversupply as the key factor for current conditions and how this influences the direction of prices. Like you mentioned in the article, after years of explosive growth of the shale boom since 2005, could the increase of North American supply really abruptly send oil suddenly tumbling only since June 2014? Is it too much of a shot in the dark to discuss the massive credit expansion and artificial demand created out of China in the last 5 years as they continue to unwind their own debt bubble now propped up by the countless ghost cities they built? What about deflationary pressures in Europe, or the recession in Japan which is the world’s third largest economy? Inevitably your prediction will be correct over the long term as all finite resource will likely be headed north in price. The question of your timing though may be too soon to tell. Producers will continue to flood the market with oil in the short term to cover their existing debt obligations and will compete to the death at current prices to do it. Until these bankruptcies are in full swing, can we really expect the taps to be turned down? Not to mention will demand remain stable or could it potentially contract further as well? Either way great article with tons of sources.

  2. Fred said

    Excellent analysis. Thank you.

  3. Dee said

    Followed your link on ZH, i concur with your analysis and want to thank you for the links regarding the defence department studies, they are new to me.

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