Thursday, December 30, 2010

Deutsche Bank: $125 oil spike in 2012

This morning I read the Deutsche Bank report The End of the Oil Age: 2011 and beyond: a reality check.  This is by analyst Paul Sankey and coauthors.  Overall, the report is a pleasure to read: smart, interesting, broadly researched, well balanced.  I highly recommend it to anyone interested in how peak oil is really likely to play out.  Their thesis is similar to mine in broad strokes:  oil production/demand will not rise too much more, the world will stay heavily auto-focussed, but there will be a shift to increasing electrification of the vehicle fleet.

There are some differences in detail in their view, and one concerns their thinking about the next oil shock, where I think they are missing a key point.  Their basic schema of the next oil shock is similar to mine: as demand rises particularly in China, the Middle East, and the rest of the developing world, OPEC spare capacity will be used up, and then there will be another price spike.

To turn this general view into a forecast, you need an estimate of how fast demand will grow ahead of the price shock, an estimate of how much spare capacity OPEC has, and an estimate of how much price shock it will take to cause a break in consumer psychology and promote sharp changes in behavior on the demand side.  Their demand growth forecasts are sensible.  However, for spare capacity they have this chart:

The first column is the "official" spare capacity, and the second column is Deutsche Bank's own more sceptical estimates of spare capacity, which totals to 4mbd.  However, even this second column assumes Saudi spare capacity was 1500mbd in 2008, and that capacity exists and is available to be deployed to mitigate prices in 2011/2012.  But, while we might debate endlessly whether it existed in 2005-2008 (and indeed some of us did spend a lot of 2005-2008 debating that exact question), what is indisputable is that it wasn't deployed to moderate prices in that time frame.  Prices rose over $140, but Saudi production never went over 9.5mbd.

One possibility is that declines in North Ghawar etc were severe enough that they simply couldn't produce more.  I lean toward that theory but haven't been able to prove it beyond a reasonable doubt.  Another fairly sensible theory is that Saudi Arabia as a matter of policy holds some spare capacity back in case of a true geopolitical emergency (eg a revolution or civil war in another OPEC member), and won't deploy that just to moderate prices in a tight market.  But either way, to argue that this capacity will be available in 2011/2012, you need a theory for why Saudi Arabia will behave differently than they did in 2005/2008.  And I don't see Deutsche Bank advancing any such theory.

And of course, if you take out that 1.5mbd, then that pushes the oil shock forward.

On the other side, of course, lately we've been seeing increases in non-OPEC production.  The Gregor McDonald thesis that non-OPEC has surely peaked already is starting to look a little shaky.  And if so, then that could push back any shock.

Another question is what price level will cause a break in market psychology on the consumer demand side.  Sankey et al's view is the market is now primed and will respond more strongly to a lower price level than in 2005-2008.  Hence their view of a $125 limit to the shock (and rather a short shock at that, since they don't show it affecting the annual average in 2012 in the graph I excerpted at the beginning of this piece).  This is very much a matter of subjective guesstimation of course, but my gut feel is different - I think people have to some degree become habituated to gas in the $3-$4 range (in the US, or the corresponding ranges in other countries), and it will take a sustained break of a few months significantly above $4 to cause major shifts in behavior.  So I think the shock, whenever it finally comes, will need to get into the $150-$200 range to impress people significantly enough.


KLR said...

1.5 mb/d is what the EIA gives for 2008 OPEC spare capacity in its Short-Term Energy Outlook. Current figure they give is 4.73 mb/d, close to DB's. True shut-in capacity for OPEC from July '08-Aug '10 is 1470.14, KSA accounts for 1160 kb/d of that. Then you have putative new output from projects like Hawiyah/AFK/Khurais, which have nameplate capacity of 310/500/1200 kb/d respectively. Of course these couldn't be utilized in 2008, they weren't online yet, or were barely so. The 1st two mentioned would've accounted for 610 kb/d in 2008.

Anonymous said...

If opec has no oil to sell, it has lost it's capacity to import. What does this imply for their society, and the importing countries? I don't hear this discussed.

Kenneth D. Worth said...

Once again, Stuart, I think you are spot on. There is no guarantee that OPEC can produce at the 2008 levels again, especially after three years. And there simply was not any good reason for holding anything back when oil was at $148.

It will surely take something more than $125 oil to cause a major economic contraction such as that we saw in 2008. Oil price shocks can have an effect at lower levels as a percentage of GDP. Several recessions (1990, 2000) seem to have been caused by a doubling of the oil price from much lower levels.

We also will be lacking the economic effects of a banking crisis and real estate construction collapse, which exacerbated the downturn in '08.

It is equally plausible to postulate a slow strangulation of the developed economies by $150 oil that stays elevated after perhaps a spike to $175.