Prospect of Oil Supply Collapse

As an old oil hand, I was seriously disturbed five years ago when it was almost impossible to develop a payback time for shale oil production.  Since then it has continued to go missing as massive amounts of cash was spent on the industry.  This suggests that we now know.  It is never at the present pricing regime.

This could not be worse news.  It means that our vulnerability to supply disruption is rocketing while elasticity is dropping.  US shale oil has merely postponed our day of reckoning by a few years while the decline in conventional oil production actually accelerates.

Right now we are swapping dollars in the oil industry at best and the ship is clearly leaking.

The only good coming out of all this is that massive amounts of money are coming home to be spent drilling more wells.  Obviously this allows repatriation of US currency and there is enough out there to keep this up for quite a while.

Peak Oil: It's Baaaack

By Nick Hodge | Wednesday, March 12th, 2014

Over the past few months, I've been sharing my concerns about shale oil.

Namely, that it's more comparable to a Ponzi scheme than any sort of boom.

I've articulated the reasons for my thesis, including fast decline rates, the amount of new rigs and wells needed, and a cost of production that's been higher than the price of sale for some time now.

I've also shared recent evidence that this theory is proving correct, from horrid earnings reports — citing the reasons I just mentioned — for oil majors across the board to the fact that mainstream media outlets are starting to put the dots together, running stories like:

"Big Oil Companies Struggle to Justify Soaring Project Costs" —Wall Street Journal

"Dream of U.S. Oil Independence Slams Against Shale Costs" — Bloomberg

"Why America's Shale Boom Could End Sooner Than You Think" —Forbes

"What Happens When The Shale Boom Ends?" — Christian Science Monitor

After my last article on the subject, I got an email from a sophisticated investor-friend of mine worth hundreds of millions of dollars — some even say a billion. His subject line was: "Awesome Article on Shale." Here's what he had to say:

Nick, I think you're right on with your views toward shale oil. Good job. Now tell me what that means looking forward for oil and gas prices and what it means for the conventional light crude producers?

All the best...

So I typed up my thoughts for him, and I'd like to share them with you today:

Predictions are tough, especially with a still-struggling economy. If I had to say, prices at least need to rise to the marginal cost of production at $115ish. Trouble with that is anything over $110 for a sustained time causes recession, which of course would send prices lower making projects unviable once more.

It's classic peak oil. It never went away, we've just been able to paper over it with free money for the past half decade.

Seems like the majors realize the gig is up. They're selling unconventional assets in a big way, wanting to mitigate risk and capex by getting back to conventional. Still, conventional peaked in 2005 and that strategy seems like a last-ditch effort.

When the peak hits, I see it as the reset button the world badly needs to purge itself of all the debt, paper, and invented financial instruments. Depends on the response of course, but I see the masses waking up and getting antsy.

Anyway, the core strategy has never changed. Land, ag/food, water, resources/metals, self-reliance/protection. You can try to play the spike in oil prices when it comes, but timing is always tough.

A colleague of mine named Steve St. Angelo has written an exclusive report on this for my readers. It's attached.

Shale Shoes Keep Dropping

As if on cue, news keeps coming out that supports this very view.

Last week, Maria van der Hoeven, CEO of the International Oil Agency, sat down for an interview with the Christian Science Monitor. Here's her response when asked if the promise of unconventional oil and gas is overhyped:

The light tight oil revolution in the United States is changing the geographical map of oil trade. But we also mentioned [in an IEA analysis] that this growth would not last — that it would plateau, and then flatten and go down. That means that from 2025 onward, it's again Saudi Arabia and the Gulf states that will come back.

In the analysis she cites, the IEA found that independent shale producers will spend $1.50 drilling this year for every dollar they get back. And it will take 2,500 new wells a year just to sustain output of 1 million barrels a day in North Dakota's Bakken shale. Iraq could do the same with 60.

In total, U.S. drillers are expected to spend more than $2.8 trillion by 2035 even though peak shale production will occur a decade before that. It's a treadmill to nowhere.

Take Sanchez Energy, which will spend $600 million this year drilling in the Eagle Ford — twice the amount of revenue it earned in 2013.

I don't know about you, but where I come from, we don't invest in companies that are spending twice what they're bringing in. But that's happening across the board when it comes to shale oil and gas.

What's more, the Institute for Sustainable Development and International Relations is out this week with a woefully underreported study on the impact of shale oil and gas on the U.S. economy.

The report was blunt, stating there is "no evidence that shale gas is driving an overall manufacturing renaissance in the US." It found the cumulative long-term effect of shale on U.S. gross domestic product (GDP) will be less than 1%.

And that's not 1% per year. The report found shale oil will add just 0.84% to U.S. GDP between 2012 and 2035. For comparison, cosmetics add twice that to the GDP each and every year.

It also found that the economic implications of shale on economies outside the U.S. would be even worse.

It's my view that free money and low interest rate policies from the Fed have led to the illusion of cheap energy. Slowly but surely, more and more people are realizing how the trick has been pulled off.

And the economic turmoil created when the market realizes shale drillers are putting out $1.50 for every $1.00 they get back — coupled with fast-spreading unrest in the rest of the world — will make precious metals the place to be once more.