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Dark Times For Black Oil

Commodities / Crude Oil Jun 02, 2012 - 06:20 PM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleCurrent and rising, but always belated recognition of reality is that the economy isn't coming around like we hoped, that we have what PIMCO's chief Mohamed El-Erian calls a global synchronized slowdown: this can only push oil prices down. The euro's belated shrinkage against the dollar can also only push down oil prices, for a wider range of reasons than many think, of which only some are cast in stone as the Brent-WTI premium.

This premium supposedly measures and reflects tighter oil supplies and bigger geopolitical stress on oil supplies east of anywhere from New York, but it will soon measure the unsurprising fall of European oil demand - and the surprising fall of oil demand growth in Emerging Asia. The narrowing of the premium, which happened in a spectacular way in the run-up to the $147-a-barrel price peak in mid-2008, can and will also happen on the downside. The WTI price is the target for how far down Brent can fall, and the WTI price will also fall.

The new reality is different and sombre for oil. The pace of oil saving, substitution and replacement in the world east of New York - and east of Berlin - is growing fast.

According to the IEA, Bloomberg New Energy Finance, sector analysts such as Ernst & Young and regional cleantech specialists like Green Purchasing Asia, the combined global total for new investment and subsidies to alternate and renewable energy, in 2011, was probably north of $300 billion, of which around $65 billion was subsidies. Using these information sources, China slightly outspent the US on clean energy, in 2011 but the fastest growth of non-fossil energy development until end 2011 was in Europe.


Comparing this spending with global spending on oil and gas exploration and production (E&P), estimated by Citibank to be running at around $275 bn per year as of Q1 2012, but with a rising chance this is headed for shrinkage, shows the bang for the buck or barrels oil equivalent for the buck the world obtained from this fossil and non-fossil energy spending. The results are what we might expect. While shale gas is a clear winner, and stranded gas/LNG development can also be highly profitable, both by energy yield and by forecast future earnings, oil investment returns trail well behind leading cleantech/green energy opportunities on both these criteria, that is energy and earnings performance. Alternate energy's maturity profile is steeper than nearly all analysts were forecasting as recently as midyear 2011, measured by what counts: the bang for the buck.

The current trend for cleantech-green energy spending in a sector that is rippling wider all the time is terrible for exposed corporate producers and financial players in the clean energy space - - since the turn of the year, in Q1 2012, less investment and lower subsidies have cut monthly average spending to the lowest since the recession low-point of 2009. This might seem good for fossil energy, including oil -- but for buyers and users of green energy the good times are here right now in the shape of prices-per-kilowatt or the price in barrels of oil equivalent output that were forecast for 2015 or later, as recently as midyear 2011.

Bankruptcy protection now applies to many of the world's biggest producers of solar photovoltaic and wind energy equipment producers - the same way it applies to a string of big name airlines - which keep on flying exactly the same way alternate energy industrialists keep on producing.

Upstream of this, governments in most OECD countries, and in China and India, are only in pure crisis conditions - like Spain and Italy - taking their feet off the subsidy gas pedal, for a host of reasons including simple and straight job creation. One key example is Germany with its "Energiewende" transformation plan, which employs more than 350 000 persons. This program has gone so far and fast that it already delivers "free power Sundays", as in late May. With a combined wind + solar power capacity now about 52 000 MW, and growing, the nation's need for power on any windy and sunny day of low demand, as at weekends in May, is only about 38 000 MW. So the power is free because neighboring countries, like Poland and France, cannot or will not handle that much cheap supply. And Germany AG keeps on producing the clean energy equipment !

To be sure, solar and wind electricity production Europe almost exclusively saves on coal, gas and nuclear power generation - not oil - but this is not at all the case anywhere east and south of Berlin. As the cleantech surge migrates East, its ability to cut into oil demand, and slow the growth of oil demand, will begin to heavily show in the figures. Energy data worldwide are already showing the outlyers of this endgame for Black Oil.


At the same time as the unexpectedly rapid success of Europe's energy transition plan - call it a renewable electricity program powers on and up - this massive surge in renewable energy supply is taking place in some countries, like Spain, that are in deep recession. The recession driver of falling oil demand is powerful in these countries: across Europe, since 2006, not only the PIIGS but other countries, like the UK, have cut their national oil demand 20% or more.

Worse for oil, any growth in its demand in Europe is becoming a folk memory not only of the Good Times, but also of the times before energy transition. Driving oil out of the energy mix, for so long an empty slogan or hope, has already started happening, albeit through recession. With each year the trend continue, the potential for bounce-back gets weaker.

Alternate energy spending in China and India is also in high gear, but unlike the OECD countries this growth (for China the NEA target is 1000% growth of solar power capacity by 2016) can and will further shave their growing oil demand. Unlike the OECD countries, oil-fired power production still features in the Emerging and developing economies, and is sometimes a large slab of their national capacities: against oil-based power using oil at nearly $100 a barrel (or $75 quite soon) wind, solar and other new and conventional renewables (like hydro) are often so competitive they do not need feed-in tariffs. Above all their "fuel" is free, and that is the ultimate difference.

This target for applying ever-cheaper renewable power systems is the real low hanging fruit for chasing oil out of the energy mix, in Emerging Asia and other devloping countries.

The next cuts in global oil demand may be deep: through clean energy development to be sure, but also through energy saving and efficiency raising, and straight fuel substitution using natural gas to power almost all forms and types of transport, except airlines. Taking global bulk and container shipping, for example, this sector had more than a decade of 7%-a-year oil demand growth until 2009, racking up global marine oil demand to more than 5 million barrels per day, about 15% more than the total oil demand of Japan, the world's third-biggest economy.

Gas fuel substitution, even clean coal fuel substitution for the marine segment is highly possible or even probable. In addition and apart from "slow steaming" to trim the massive oil demand of 100 000 horsepower behemoth container ships burning 3500 litres of fuel per hour, other techniques to slow the sector's oil demand are in progress - even using sail and kite assist, for ships that often now sail at around 18 - 20 mph (15 knots), the same as fast wind-driven clippers of the 19thC !

In the US, still the OECD's most oil swilling economy, higher gasoline prices are today what they were not as recently as 2008: today they trigger car buyers to crowd into car showrooms and buy a new car -- always using less fuel -- instead of triggering them to give up all intention of buying a  car. Forward estimates for the US car fleet's oil need are mostly flat, and may even fall - especially if the fleet also dieselizes, as has happened en masse in Europe where some leading economies, like Germany and France now have around 75% of their car fleets running on diesel.


The outlook for oil is bad, but the supply side changes not only include runaway growth of alternate and renewable energy -- they also include the global gas boom. Like we know and T. Boone Pickens knows there are 'historical impediments' to replacing oil with gas in car fleets but as mentioned above the transport energy shift can start with heavy road transport and could possibly also start with marine transport.

Asian consumers and political deciders, showing a classic trend of last-in but first-out for innovation and change, are more open and ready to accept running their cars, buses, trucks and trains on gas - even if LNG supply prices in Asia still run as high as $16 per million BTU, compared with gas priced at under $3 in the US. While US gas prices will rise, global LNG prices are set to fall at least 30% by 2020 according to the IEA. When or if the Asian shale gas boom arises, we can add at least one double digit to this forecast price crash.

The results of this pincer-like attack on oil and its role in the energy mix are shown by the real outlook for oil demand growth: fractions of 1%-a-year are the real underlying trend, with no remission unless an unlikely global economy surge happens. The smallest increments of new supply, now including rising perspectives for Brazilian and Guyanan deep offshore, new east African producers, and to be sure US shale oil output can and will place serious limits on oil price growth, outside the only hope which remains for price boomers, of geopolitical crisis windows.

The price downside is never too easy to forecast. Through 2008-2009 the economic crash was more openly reported by media - 2009 was not an election year ! Market mechanics always swings prices to the extremes each way, but today and going forward we have the energy, economic and financial fundamentals in place for faster and further decline of Black Oil. The near-term price floor is likely  $75/b for WTI before producers start to squeal, but because this price level is now the feasibility-price for many, even most deep offshore, tarsand and shale oil plays, falling oil prices also accelerate the end of Black Oil. As oil prices fall further and financing gets tighter, Black Oil digs itself further down into a hole - call it a grave, not a gusher - because if the oil simply isn't produced and isn't there, and is always too expensive folks will find a way of not using it !

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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