For the sixth month in a row, the International Energy Agency has raised its short-term demand forecast for oil. Herein lies a major issue. Take a look at a plot of the last six months: (Click to enlarge):
Heres a plot for monthly adjustments over the baseline forecast. These are all additive, contributing to the final state of the demand forecast in the earlier chart.
Ever increasing demand in the US and now in China fuels most of this increase. The US Energy Information Administration (EIA) then subsequently announced that it expects oil demand to grow by 50% by 2025, jumping from the 81 mbpd reflected in the chart above to 121 mbpd. By then, projects the EIA, it will be the US, China, India and the rest of developing Asia sucking up 60% of those additional barrels.
This is beginning to look a bit like Internet bubble finance and accounting. What do I mean?
In the heyday of the Internet frenzy, Things were different. Normal business economics did not apply. We had companies with no revenue valued at mega-millions. We had companies with revenue that were losing bucketloads of money everyday valued at billions. How? Things were different. If you were not a believer in the New, you simply didnt get it. Decrepit old fossil.
As we all know to our pain, the fun and frenzy of the Internet did not repeal basic economics and math. The market crashed.
Here we have a situation where demand and supply are inching ever closer together. Thats scary even in a calm situation. Factor in the geopolitics of oil and it becomes even scarier. No margin for error at a time when the likelihood of error is high. Thats one major reason the price of oil -- and hence gasoline -- is so high.
Now step back a minute. Based on the forecasts, global oil production needs to increase by 50% to meet that increase in demand. Where is that going to come from? The uncertainty about the answer to that question is another major reason the price of oil is rising and probably is going to continue to do so.
There is no definitive answer to that question. There is a school of analysis that says global oil production is soon to peak. In other words, we begin a slow global decline in our ability to extract the finite amount of oil from the ground. This peaking occurred with US oil production in 1970. (You can see that chart in an earlier posting.) There is another school of analysis that strongly disagrees. There is a related school that says that advances in technology and ways of deriving oil from other sources will make up the gap, and that were cool for another 100 years. (No climate change pun intended.)
I get nervous when I see a flow chart that has a black box with Magic Happens Here to describe a critical process. The other thing to keep in mind about alternative sources (sand and shale) is that it is currently fairly expensive from an economic point of view, from an energy point of view and from and environmental point of view to make that conversion. There will be oil, but it will be expensive oil.
The accuracy of the projections as to when we hit peak depend to a great deal on the accuracy of the estimates of the reserves. In other words -- how much oil actually is in the ground to be extracted? There wont be replenishment so this is what we have to work with. Estimates of reserves, even from highly respected and trained professionals, are all over the place. Some vary by one trillion barrels of oil.
That is a pretty big swing. I dont think my investors, even in the heyday of the Internet, would have been comfortable with that much spread in the forecasts.
Where does that leave us? Uncertain. Uncertainty drives up prices. Tight supply drives up prices. At best, were in a new era where the price of oil will continue to rise.
Very high prices driven by scarcity tend to have their own regulating effect. If the world tips over into a recession, well, demand for oil is going to drop. Thats not a very attractive scenario -- especially not to the developing world that is just beginning to hit its stride. Unfortunately, resource wars have been a feature of human history. A global resource war for oil would be quintessentially nasty.
The good news is that we can actually do something about this situation. The key is to focus on action NOW, not someday. Urgency, not complacency. An Apollo program or a Manhattan Project mentality (and funding). We need concerted effort from all the stakeholders: buyers, vehicle manufacturers, energy companies, government. Consumers and businesses.