Just a mainstream hint that limits the precipitous rise in oil prices

Last week, a Bloomberg writer at the very end of an article explained that the “only solution” to high gasoline and diesel prices is recession. While I’m not accusing the author of advocating degrowth – that would be too radical for a mainstream trade publication – his analysis points to a key and obvious cause of today’s high oil and other commodity prices: he doesn’t there’s not enough to go around.

There’s an old adage in the oil industry that the solution to high prices is high prices. The logic is that high prices will do two things: 1) reduce demand as those who cannot afford high priced petroleum products will reduce their spending and 2) incentivize more exploration and production as companies seek to increase production to take advantage of high prices.

The big question today is whether the second mechanism can actually increase oil production enough to bring prices down. In a recent survey, a slew of oil executives said their production plans were not dependent on current prices. Many cited the desire of investors in publicly traded companies to receive larger dividends and to benefit from corporate share buybacks (which tends to raise stock prices as fewer shares are available for trading ).

It is instructive that 9% of survey respondents cited an oil price of $120 a barrel as the level at which they would consider increasing production. And keep in mind that they are NOT talking about $120 a barrel for a few months but an average price over many years because it can take many years to bring big projects into production and those projects can produce for many years after the start of production. . If this is the hurdle that even a tenth of the world’s oil producers believe they face, it doesn’t bode well for a substantial increase in production.

“Environmental, social and governance issues” were only cited by 15% of executives for limited output. I have long argued that, for the oil industry, these problems were only part of the cost of doing business. If prices are high enough to overcome these costs, that is, to pay the additional cost of compliance, the industry will drill for new oil.

But that doesn’t seem to be happening even with such high oil prices. One executive told Bloomberg, “Whether it’s $150 oil, $200 oil or $100 oil, we’re not going to change our growth plans.”

If oil executives don’t react to high oil prices as they did before and insist that even prices twice as high as today won’t budge them, there could be another force at work, namely geology. It is becoming more and more expensive to extract the remaining oil.

Those who follow the industry closely enough already know that oil from shale plays in the United States is more expensive to extract than conventional oil. The same is true for tar sands oil found in Canada.

A straw in the wind if there ever was one is Shell’s abandoned effort to find oil in the Arctic off the coast of Alaska. The company shut down its Arctic project in 2015 after spending $7 billion. The company cited environmental regulations. But, as I said, it’s really just a cost of doing business. With prices high enough, a company will simply pay the costs of compliance. Perhaps just as important were the logistical challenges and harsh conditions. Project Arctic stumbled in 2012 when a large rig ran aground and stalled operations for nearly three years.

Deep shale oil wells, tar sands, arctic and deep sea offshore oil are the new frontiers of oil exploration. This new frontier is more expensive and technologically more difficult. Recent comments from oil executives may be a tacit admission that limits are upon us in the oil business. And, there is perhaps no better illustration of these limitations than the fact that global oil production – using the standard definition of oil which is crude oil, including rental condensate – peaked in November 2018, long before the COVID pandemic destroyed oil demand. Even with today’s renewed oil demand, production remains significantly below that peak – 79.6 million barrels per day (mbpd) versus 84.5 mbpd at the 2018 peak.

It is true that significantly higher oil prices than today could make these leaders change their minds. But prices of say $150 or $200 a barrel would almost certainly induce a deep recession which would cause oil prices to fall. And this means that such price levels are not sustainable. This is a pretty good illustration of the limitations we now face.

Image: Desert Oiler Exxon. Satirical image created in Photoshop to illustrate the concept of peak oil. (2007) by azrainman via Wikimedia Commons https://commons.wikimedia.org/wiki/File:Exxon_desert_tanker.jpg

Steve R. Hansen