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Big Oil Companies Should Adopt a Self-Liquidation Strategy (project-syndicate.org)
173 points by jseliger on Dec 27, 2015 | hide | past | web | favorite | 104 comments

The article ignores some realities. 1) The major OPEC producers need to recover far more than their lifting costs. Their oil revenues subsidize the rest of the economy and is their bulwark of social stability. Some estimate that Saudi Arabia needs $90/bbl. 2) Technological adaptation to the low price regime is happening as we speak. The years of $100/bbl oil developed expensive innovations, and now we are seeing those prices reduced to their marginal costs. 3) Almost no other country can use these new technologies as profitably as the US and Canada can. The US and Canada have a private mineral ownership regime, as well as a production and refinement infrastructure no other country will be able to match soon.

The US has a LOT of small- and intermediate-sized oil companies competing actively right now, on all these dimensions, to lower their costs so they can continue to operate profitably even in the current price environment. Most are succeeding.

The break even price is estimated at current pumping rate vs gross profit; but Saudi Arabia can relatively easily increase their pumping rate. The cash cost for the Saudis per barrel is sub $5. So they can up their production rate to handle the difference; they are incentivised to do so if they truly believe that their reserves will become a stranded asset.

In contrast after running and royalties cash costs in the US are up towards $30/bbl and Canadian oil sands towards $40/bbl. But, the size of wells using these technologies are smaller. And, those wells cost more to discover, and tap. This means US / Canadian oil is more affected by marginal cost, both in terms of price flexibility and liquidity (both cash and oil).

And the biggest threat, in the medium term, to oil prices is some of the range of alternative energy sources. Solar costs are coming down quite rapidly. Wind is coming down but more slowly (a chunk of this is in real rather than nominal terms; depending on currency). And nuclear in time will probably come down if increasing investment leads to predicted efficiency gains.

Oil isn't going to disappear overnight, but it does have a bordering on existential threat in the medium term. The only largely protected part of this market I can see here is large scale transportation, i.e. sea and air transport.

Oil, even at current prices, is significantly more expensive than natural gas and coal for generating electricity. Apart from remote communities oil isn't really used to generate electricity. Oil is valuable because of gasoline. Solar/Wind/Nuclear are competing in a completely different market.

The real threat to the medium/long term value of oil is a good battery.

It's a problem to consider these separate. All energy and certainly all carbon fuels are fungible to a degree. Oil is easier to transport and bottle. Gas is more location and infrastructure dependant.

If Gas prices rise or oil prices drop, we'll use oil for electricity generation too.

Solar, wind, and nuclear don't provide a threat to fuel used for transportation, which is a major percentage of how it's used.

Until battery tech gets within a decent percentage of a gas tank. Commercial batteries are currently worse than gas tanks, but catching up fast. If they get to 20% volume/weight/price of a gas tank I would predict a switch is going to happen very very fast.

Currently commercial batteries are price limited (about the price of a gas tank + filling up the gas tank 400 times, which would keep a normal car moving for 5-10 years), and weight limited at about 5% of the energy/weight of a gas tank. Given how it's evolving, I'd expect another 2-3 years before the necessary technology becomes available.

I think 20% will be about the turning point because while gas tanks provide a 1000km range, if you can charge at home, then what's the problem with 200km range, decreasing to 160km over 2-3 years ? Especially if you can solar charge (and combined with a house battery ... watch out)

And Teslas don't count. Anything over 20000$ starting price just isn't going to start the migration.

Its not just the batteries and cars. Can the grid really handle the huge increase in demand ? How much investment needs to be done to upgrade it? How long will that take?

The grid should be fine with a few upgrades and implementation of charging strategies:

"The short-term impacts for most utilities should be minimal and localized. There is a possibility, however, of isolated impacts on some distribution transformers and secondary drops, particularly in neighborhoods with older distribution systems including underground systems."


Edit: added quote.

And not just the main grid, which is not that hard to upgrade, but we're talking about also upgrading the grid and transformers on every street in the western world.

That won't cut it for industrial use (trucking, airlines, shipping, etc). For these things where fuel is a major cost, a swap to batteries is untenable until they are cheaper or equal either via heavy carbon taxes or an improvement in battery tech well beyond the 20% number you have in mind.

Electricity is already way cheaper than gasoline per mile. All that's required for it to be an existential threat to gasoline is a drop in the price of battery tech (much like what happened to solar).

That's been true for a really, really long time. Battery tech being the limiting factor has been the issue since the first battery powered vehicle was invented in the late 1800s.

Qatar did have a gas to aircraft fuel conversion process, but not really cost effective.

That's not their marginal cost though. They may need $90/bbl to balance their budget, but they don't need $90 to pump the next barrel.

Agree, that was my point. It's not relevant to talk about their marginal cost as if you could ignore their need to balance their budget eventually.

True. But let's play this out. If they can't balance their budgets, their government collapses (like Bankruptcy) and is replaced by a new Government that doesn't offer the same panem et circenses. New Government outsources oil production (like House Saud did some 70 years ago) and then the true marginal becomes the needed cost.

Then we have civil war and big chunk of Saudi oil is off the market and prices rise again.

That's pretty interesting about the new technologies and how small businesses can still operate profitably in the current price range. Where did you read about this?

I work in the drilling data industry and have access to data as well as anecdotal observations. But there are lots of published articles e.g. [1], [2]

[1] http://www.nytimes.com/2015/05/12/business/energy-environmen...

[2] http://www.worldoil.com/news/2015/8/12/oil-at-30-is-no-probl...

Look in that data and tell me how many companies are hiring. These companies are treading water. They are furlough-ing people, laying people off, getting bought by bigger companies looking for a bargain, etc, etc, etc.

Oh, absolutely. They are adapting.

Huge numbers of US oil companies are filing for bankruptcy right now, and many are not profitable even at zero debt. I am not sure where your "most are succeeding" figure comes from.

Thirty-six [1] is not "huge numbers". There are literally thousands of oil and gas companies in the US. I repeat, most are succeeding.

[1] http://www.slideshare.net/MarcellusDN/haynes-and-boone-llp-o...

It feels like the author hasn't read The Innovator's Dilemma.

In it, the author talks about a number of "stable" industries that had existing product lines with the R&D, customers, and sales processes to back them up. They were so invested in those structures that as innovations in their industry came along, they missed the innovations. It wasn't because those innovations were bad - many were great - but they didn't fulfill their existing customers' requirements. And so instead of trying to develop new markets (hard!), they ignored the innovations.

As a result, new entrants - without the cash cows to worry about - applied those innovations in new areas, building new markets. As those new products caught up with the requirements of the older products, those old customers switched to the new products.

I think the next great innovations in energy aren't going to come from the oil companies.

It's nothing nefarious, just the simple realization that most of their customers can't use [choose: solar, wind, nuclear, etc] for a variety of reasons. As those other energy sources change, improve, and simplify, those customers may be able to change but we should be looking for the new entrants building the new markets first.

It seemed like he understood that to me. This quote basically covers it:

> Yet, as one BP director replied when I asked why his company continued to risk deep-water drilling, instead of investing in alternative energy: “We are a drilling business, and that is our expertise. Why should we spend our time and money competing in new technology with General Electric or Toshiba?”

I think that's why the primary argument is that they should cease R&D entirely and just distribute profits to shareholders until they run out.

The argument being made is really Levitt's marketing myopia argument which at least used to appear in pretty much every Marketing 101 course. [1] The argument is that you should define yourself as a transportation company rather than a railroad (or an energy company instead of an oil company).

The problem with this argument is that it doesn't always apply very well. Yes, Kodak had distribution channels for photographs. But very little about the company gave it any particular advantage for digital photography from a technology perspective.

Somewhat ironically, Fujifilm--notwithstanding some recent success in relatively niche camera products--has largely weathered the post-film era by applying its technology to medical products and the like.

[1] http://academy.clevelandclinic.org/Portals/40/LHC%20Myopia.p...

Yes, Kodak had distribution channels for photographs. But very little about the company gave it any particular advantage for digital photography from a technology perspective.

Yet they completely owned the pro digital camera space in the early 90s. Their problem was that they chose not to build on this lead since they didn't want to cannibalize their more profitable film business.

The author should have done some basic fact checking.

From the article:

> "more sophisticated than nineteenth-century “nodding donkeys.”"

That type of fields are getting rare. EOR [1] techniques are being applied everywhere. Although, AFAIK, some countries, such as Venezuela are somewhat backwards in their application of EOR. They wanted to nationalize oil fields and not invest in them, and look what happened.

> new technologies such as hydraulic fracturing (“fracking”)

Fracking [2] is now 40 years old "new" technology. The only reason it became popular in last 10 years was high oil prices.

[1]: https://en.wikipedia.org/wiki/Enhanced_oil_recovery

[2]: https://en.wikipedia.org/wiki/Hydraulic_fracturing

Well let's be clear.

1. What he said was true about nodding donkeys. OPEC countries are starting to use EOR, but most of their fields do not require it. Some countries like Saudi Arablia do have heavy oil and they are starting to invest in these areas, but that does not invalidate the authors point - that the U.S./Canada can help with that shift.

2. re: fracking being new. almost all reporting calls fracking "new", but they really are referring to the new form of fracking where it's done horizontally through shale. It's a minor misconception that can be forgiven considering the intent is really "new fracking technology".

Edit: here's a good video showing horizontal fracking -> https://m.youtube.com/watch?v=O0kmskvJFt0

1. 19th century well implies at most a few hundred feet depths. There just aren't spots left on earth where such a well would still yield meaningful amounts of oil.

2. Principal driver behind those horizontal wells is money. Those wells cost 2-3x more to complete. Horizontal tech has advanced, but in the end that advancement has been dollar driven. Expensive oil made it economical.

The distinction being made is in the technology required for OPEC wells. Conventional oil fields (most OPEC Wells) require the same tech that 19th century wells did. Just because you go a little deeper doesn't change the tech.

I agree oil price played a major role in developing horizontal tech, but it's become more about the cost being driven down and is why the U.S. is still doing it at $35 a barrel (which is, on a relative basis, the same as 10+ years ago). Either way I don't think your point #2 works against anything I've mentioned.

> is still doing it at $35 a barrel

They'd still be doing it at any loss figure above operational costs to maintain cash flow. The cost to drill the well is already sunk. So it makes sense to operate the well at heavy loss. Some money is better than no money.

> Either way I don't think your point #2 works against anything I've mentioned.

My point was the economic reasons were why horizontal drilling became feasible. It could have been done in the eighties if oil prices were high enough back then.

The cost to drill a well is not sunk when they haven't drilled the well yet.

Well some companies are in fact drilling wells at a loss, but only because they have to pay bills while they pray for oil prices return and potentially survive this supposed rough patch. However, that says more about their debt situation than it does the cost of horizontal drilling.

Bottom line is that some companies are in fact making a profit drilling horizontal shale wells @ $35 barrel.

I don't know anything about oil, but it seems unrealistic to claim to be able to predict markets. Liquidating all your reserves at current price is unlikely to be seen as a wise move. (And wouldn't selling more oil than the US uses annually impact prices somehow?)

If you magically had knowledge of the range of prices over 10+ years you could do all sorts of money making things.

Edit: Looked into this a bit. Futures on oil 2 years out are already over $50. So "the market" is far less certain then the author. I'd also imagine quite a bit of damage to oil producers if the price stays low. After they shut down, why wouldn't the price rise?

> I don't know anything about oil, but it seems unrealistic to claim to be able to predict markets.

The author's position is less about predicting markets than it is about "if you're operating a horse & buggy business in 1885, you're best off winding it up". The debate here seems to be about whether 'today' is 1885 or 1855 or 1825, so to speak.

Eh, I would argue that it's different from buggy whips, because there is a (somewhat) limited supply of oil.

The idea being that if it turns out you are off by a few years (or a few hundred years) in the buggy whip vs. car situation, and buggy whips are a thing for a while longer, well, it's not that hard to ramp up buggy whip production. I mean, you've got some training effort, sure, but there are more buggy whips to be made.

The idea is that oil is different, simply because there's only so much of it. If it turns out you planned wrong and have to come up with a few more year's worth of oil, and you are out? yeah, you have a serious problem.

As an aside, the hole in my argument is what was shown by oil shale. There is a lot more oil available at $100 a barrel than there is available at $20 a barrel. but the point is that at some point, we'll actually run out of the stuff, and even before then, we won't be able to make more oil the same way we had made more oil in the past; to get more oil, periodically, you need to come up with new ways of getting oil, usually at great expense.

He clearly states a price range of $30-50 and the entire argument is built on that the price won't go up. (Otherwise why sell at 36?)

The much weaker argument of "over decades oil will have less importance" doesn't seem to be his argument at all.

Not clear what you mean in your edit, but you might be reading too much into the futures price.

The futures market by itself doesn't provide a magical way of predicting the price of oil in 2017. Roughly, since oil can be stored the best predictor we have for the price of oil in December 2017 is the current spot price, adjusted for borrowing costs and storage costs.

Let's say the current price is $40, and it costs $10 to store a barrel for 2 years. If the 2017 price were too high, say $100, you could make a profit by borrowing $50, buying a barrel and storing it, and selling a futures contract today; in 2017 you would collect $100, pay back $50 + interest, and would still make a profit.

So -- again roughly -- the futures price is as good a predictor as the current spot price. E.g. if we had an oracle that told us of a sudden shortage in 2017, that would cause an increase the futures price, but it would also immediately cause an increase in the current spot price.

The article is calling for a "sell low" strategy [0]. The author is mistaking low oil prices as from lack of demand. This is part of the story, but a small part. The major factor is high supply, mainly from Saudi Arabia [1]. The motive is not entirely clear. Most think its a fight for market share, with Saudi hoping Russia, Venezuela, US fracking, Canadian oil sands, or other middle east players blinking before the Saudi's.

They are probably right, that other players have high expenses, less cash on hand, and will have to fold first. Certainly US shale is hurting, and practically no new oil sand projects are starting in Canada. In fact, this probably signals a good time to buy new assets, for companies prepare for this.

What I think Saudi/ OPEC is missing from the equation is that market share is not something that can be won long-term. US shale may have to cut back this year, but I think the time scale to turn production back on is about one year once prices return. Oil sands are a longer-term investment, but this also means that low prices don't cut production - the expensive investment has already been made.

Another major thing the article is missing from the equation is the demand side. Decrease in demand at the moment has come from efficiency investments that were economically driven by high oil prices. People bought smaller cars, took fewer road trips, and invested in home insulation. With oil prices lower, many of these things become less economical. Demand will increase, prices will go up.

[0] - http://www.nasdaq.com/markets/crude-oil-brent.aspx?timeframe... [1] - http://uk.businessinsider.com/saudi-arabia-has-no-plans-to-c...

Aren't OPEC essentially trying to starve out the competition (shale, fracking, solar, wind, etc.)? They are basically flooding the market with cheap oil and thereby making all the alternatives economically unattractive?

Western oil interests are probably right to spend on discovery then, since they'd believe OPEC can't pump forever and non-OPEC sources will be profitable in the future and will take years to develop. This is probably where the author and oil executives differ in their belief, that there will be a market for oil in the future.

However the author doesn't present any evidence to suggest non-oil sources will be sufficiently more profitable, less expensive and widely available in the future. Further, there is no evidence presented that a non-binding climate change agreements will destroy the oil market.

If you're looking for evidence that non-oil sources will get more profitable, less expensive and widely available in the future, Ramez Naam has a series of excellent blog posts (with lots of cited data) that are a good starting point. The first is from mid-August of 2015, and the last in mid-October, so they are timely as well:

1. http://rameznaam.com/2015/08/10/how-cheap-can-solar-get-very... 2. http://rameznaam.com/2015/08/30/how-steady-can-the-wind-blow... 3. http://rameznaam.com/2015/10/14/how-cheap-can-energy-storage...

Great analysis. Everything there points to realistic challenges that put a renewable energy led future at least 50 years out (imho). This is great for the future and clean energy technology companies but I'd suspect oil executives to be sizing up their slice of the world energy pie. I'd guess the future looks pretty good for oil for a few more decades.

> Aren't OPEC essentially trying to starve out the competition (shale, fracking, solar, wind, etc.)?

My understanding is that OPEC has largely been a tragedy of the commons. The members all gain by limiting sale volume, but each member has an incentive to cheat and overproduce their quota. Historically, Saudi Arabia has underproduced to make up for the cheating and to hold the price line, but it sounds like they got fed up with doing that, and decided to show the other OPEC countries what life without OPEC would be like.

In regards to the competitors you mentions, you really have to split them into two groups: auto fuel and electric power generation.

OPEC really has no effect on electric power generation, mostly because no one burns oil for electricity. The main hydrocarbons people burn are coal and natural gas, and they're already really cheap.

It may be that Saudi Arabia wants to harm the shale-oil businesses, particularly the debt financed ones. I don't really know much about the business, but the thing to remember is that even if a business goes bust - its asses don't disappear. They get bought up by someone else. The high prices may discourage discovery work. The effect on currently producing wells is more difficult to predict.

> since they'd believe OPEC can't pump forever

In 50 years, OPEC will still have oil even at current consumption. But consumption is shrinking as energy production is already shifting to renewables and cars will have converted to electro/hydrogen by then.

Maybe in certain countries, but the big picture is that worldwide barrels/per/day consumption is continuing to increase:

2014: 92,086,000

2013: 91,243,000

2012: 89,846,000

2011: 88,974,000

2010: 87,864,000

Almost all that increase in consumption is attributable to Asia. Any downturn in the curve will be attributable to the economy of China slowing, not renewables taking the place of oil.

I don't disagree that the consumption of renewables is growing rapidly, but that doesn't mean they're making a dent in oil consumption. They may down the road at some point, but right now they're a spit in the ocean.

Indeed that is the expectation, but to be more specific however they won't keep over producing forever. Oil prices won't be low forever and western oil interests should be claiming rights on new wells that will produce for a long time to come.

Also I am curious, do you have evidence that suggests consumption is shifting away from oil to renewables?

Yeah of course, just look at the rise of solar e.g. in Germany. Thanks to Chinese price dumping, solar cells are cheap as f..k now. Already, gas plants are shut down in Germany and only kept alive as "backup plants" (of course by the consumer who pays extra fees)

Any citation? Since I'm not in Germany the anecdote is lost on me.

Cars won't convert in large numbers if oil-based fuel is a cheaper option.

Doesn't it take something like $5 of electricity to "fill up" a Tesla (250 miles or so?) That would be like buying gas at $0.50 a gallon. The other side of the coin is the high cost of the battery pack (something like $30K), but that should come down drastically once the Gigafactory is online.

Everyone prefers to pay more over time vs make a larger capital investment.

No. That's why we have credit markets because some people like the opposite. These can then be converted to rentals.

True, but once cleaner cars are even remotely close In cost they will no longer be subsidized, instead the dirty ones will be taxed or banned.

The yearly road tax for a "dirty" car where I live is about $1000. If that was 2k or 3k they would be off the roads within the year...

Only if you do not count in the environmental impact of burning oil.

You can always convert an Otto-engine car to gas fuel, and by 2050 we will be able to mass-synthesize gas from hydrogen - actually we are able to do so right now, we just don't have large scale plants for that.

This is a common misconception. OPEC isn't unified and the Saudi strategy is far more ambitious; they aren't trying to choke out the frackers and other high-price producers, they're trying to choke out the environmentalists. 5 years of prices at this level will put millions more SUVs on US highways and will make maintenance of existing oil-fired infrastructure appear more economical than investment in new clean energy alternatives (solar, wind, etc as you said). Additionally, they get to kick the Iranians in the nuts, which is in line with their stategic goals, squeeze the Russians and the Venezualans, which makes them more popular with the US government which will already be happy about the economic boost from low prices, and yes, they would hopefully be one of the strongest producers standing when oil prices rise again.

There is a potential flaw I spot in this piece. The author likens the self-liquidation strategy to what the big tobacco companies did. The problem I see with this is that tobacco is a luxury item. For many, oil is an every day necessity.

This leads into the liquidation issue. If companies such as BP were to liquidate, what would happen? The author mentions that non-oil countries should focus on providing resources and knowledge on oil extraction, but would that be enough to prevent price gouging? If there are no competitors selling oil, I could see the prices skyrocketing once the competition has liquidated all of their reserves. Would our knowledge, tools and "know how" be enough to prevent a monopoly on oil? Our only fallback would be to charge more on the services the author suggested we offer instead of oil.

I think the issue that this and a few other comments have is that by "self-liquidation strategy" the author doesn't literally mean sell every company asset as quickly as possible. It means recognize that the market for petroleum is going to decline and mostly go away before the OPEC states have all depleted their reserves. Therefore, BP et al should not invest in finding more reserves, and instead just focus on extracting all the money they can from what they have.

Note I'm not taking a stance on whether or not the author is right, but I think that if he is, there are enough players to prevent price gouging, and if anything we'd see prices fall due to no one wanting to be left with stranded assets.

If I were to stereotype smokers I wouldn't call the a group of luxury item buyers. I know tobacco isn't a necessity but the anacedata point from me would be that poverty and tobacco use are closely correlated.

Luxury traditionally means "optional" in this context. People can generally live and work without tobacco. Industrialized countries currently require oil, although this is changing.

Industrialized countries will require oil for a long time yet but it does seem that it is in the process of losing its special status as a lynchpin commodity and turning into "just another commodity" like aluminum or iron ore.

OK, here's the question: Who will buy all those supposedly worthless assets and provide that "tsunami of cash" to the shareholders of oil companies?

A fire sale of assets of questionable value is only going to prove their worthlessness and they will have to be marked down very quickly on the balance sheets of oil companies.

The result will not be a tsunami of cash but a tsunami of bankruptcies.

From TFA:

> If a consortium of private-equity investors raised the $118 billion needed to buy BP at its current share price, it could immediately start to liquidate 10.5 billion barrels of proven reserves worth over $360 billion, even at today’s “depressed” price of $36 a barrel.

Their oil reserves alone are worth nearly 3 times the market value of the company. The other assets you talk of could even have a negative value of $100b and the equation still works.

It just doesn't add up. If their reserves are actually worth that much to a private equity investor, why are they supposed to be so worthless to BP (and Shell and Exxon ...) that it should liquidate itself?

These assets are either profitable or not. If they are profitable, why sell them? If they are not profitable, why buy them? It can't be both. Not for an entire industry that is.

Yahoo has been trading well below its book value for a while. If you believe that the company is about to destroy a lot of money by spending it on unprofitable R&D then it makes sense to value it at less than its current assets. (Obviously current management will spend on R&D because they believe it will ultimately produce more value than it costs, but maybe the market disagrees).

I have no problem with the "investing too much in exploration" part of his argument. But avoiding overinvestment is not what unleashes the tsunami of cash he's talking about. It's asset sales that should bring on that tsunami of cash.

What is the break even of oil companies' proven reserves after not overspending on investment? That is the all important question. If that break even is below future long term oil prices, as he seems to suggest, then these assets are worth exactly $0.

Money needs to be spent in order to extract the reserves. They don't have all that oil sitting around in a tank somewhere, it has to be pumped out of the ground.

He's ignored costs. 10.5 billion barrels * $36 = $378 bn. But they probably cost something like $25 a barrel to extract so $115bn, plus financing costs because it would take say 10 years to get it and sell it, say 6% interest reduces the NPV to $65 bn. A lot of businesses would look great if you could assume they were worth potential sales with no costs attached.

What's worse - the oilco usually operates under a Production Sharing Contract or some kind of resource rent tax/royalty regime. Often, the oilco share of the oil is less than 50% of production. So, unfortunately for BP etc, the revenue will be way less than what the article suggests.

We will still need oil for things like polymers (e.g. plastics), drugs, and thousands of other applications.

About 7/8 of petroleum becomes fuel of one sort or another. The other products wouldn't keep the oil business alive, except in a vastly reduced form.

You can make plastics out of natural gas , and there's a shift to that happening. Also for some plastics some companies are starting to use biotech. And as for drugs, there are alternative routes to oil , at least at the research level - but it's a far easier problem, since it's less cost sensitive(per volume).

Oil is generally not used to make plastics.

That said, nearly everything else is, at least indirectly.


Distinguishing NGL from petroleum is fairly disengenuous, and it's one of several games that's played with NGL reporting in US fossil fuels reporting. They're treated as oil where convenient to do so, as not oil otherwise (much of the touted increase in US domestic "oil" extraction in recent years has been NGL, where it's treated as "oil", but here for plastics, EIA treat them as "not oil").

No, NGL isn't the fraction of crude oil that's synthesised into motor fuels such as gasoline, kersone (jet fuel), or diesel. But it does come from petroleum extraction, and if you're not extracting petroleum from the ground, you're not getting NGL -- dry up one source, and you're drying up the other.

That leaves natural gas, and I'd have to do some conversion to sort out what fraction of plastics production is represented by the billion cubic feet or so of gas EIA mentions. And yes, other carbon feedstocks, including ag waste or captured / segragated carbon could conceivably feed plastics.

One of the stark realities of climate change is that as the effects get worse, there will be increasing oil and fossil fuel divestment. Makes no sense at all to me to be investing mid/long term in a source of energy that everyone ultimately wants to see removed. Short term, until we create a credible alternative, oil is still a good investment to work with.

The present price regime isn't remotely sustainable. Pretty much full stop. Never reason from a price change.

Once you dismantle industrial capacity on a large enough scale, it's never coming back. See also the circumstances surrounding the last oil boom/bust in the 1980s.

This headended in the SNL crisis.

> Mark Carney, Governor of the Bank of England, has warned that the stranded-asset problem could threaten global financial stability if the “carbon budgets” implied by global and regional climate deals render worthless fossil-fuel reserves that oil companies’ balance sheets currently value at trillions of dollars. This environmental pressure is now interacting with technological progress, reducing prices for solar energy to near-parity with fossil fuels.

I'm very interested to see some medium term outlooks (10-30 year) from the oil industry recently. Anyone have any? The stranded assets problem is already starting to wreak havoc on utilities[1]. If we can only burn about half or less of what currently exist in reserves[2], why isn't there more chatter about it on the medium or long term?

[1]: http://www.thestreet.com/story/14661/1/electric-utilities-st...

[2]: https://en.wikipedia.org/wiki/Carbon_bubble

Whoever wrote this seems to be predicting the present while having no awareness of how the petroleum industry works. Yes, they've outlined what most majors are doing to different degrees in different areas. However, you're stupid not to keep your ability to operate when oil prices come back up. (Caveat: I'm an exploration geologist at a "western major", so I do have a somewhat slanted view.)

First off, let's get something out of the way. The current price environment is every bit as artificially low as $120/bbl oil was artificially high. Saudi Arabia is deliberately producing at very high rates to keep their market share and drive companies that can't operate at $40/bbl out of business. They want to be able to maintain their control over global oil markets in the future, and they're in a geologically unique position of having huge reserves that can be produced at high rates and are economic at very low oil prices. Therefore, they've flexed their muscles with the knowledge that unconventionals can't keep up.

Most majors are operating on the assumption that oil will be back in the ~$60/bbl range within two years.

This is reasonable for several reasons.

1) Unconventional oil production _will_ decrease significantly over the next year. Unconventional wells have very rapid decline rates.

2) It's not clear that Iran's production coming onto the global markets can offset the decline in unconventional production. Iran has huge reserves in what should be a relatively cheap operating environment, they they also have aging infrastructure.

3) Saudi Arabia is likely to drop production once US unconventional-focused companies are no longer a threat.

Next, yes, they've outlined a strategy that all of the majors are following, albeit to less of an extreme. To be precise:

> For Western oil companies, the rational strategy will be to stop oil exploration and seek profits by providing equipment, geological knowhow, and new technologies such as hydraulic fracturing (“fracking”) to oil-producing countries. But their ultimate goal should be to sell their existing oil reserves as quickly as possible and distribute the resulting tsunami of cash to their shareholders until all of their low-cost oilfields run dry.

The first half is exactly what every major, non-national upstream oil company does. We provide the know-how to 1) find, 2) develop infrastructure to produce, and 3) efficiently recover hydrocarbons to countries who don't have a national oil company with the know-how or capital to do it on their own.

Next, most of the equipment and services portion of that isn't provided, developed, or controlled by oil companies. It's done by service companies (e.g. Halliburton, Schlumberger, etc). The in-house knowledge oil companies have is mostly around geology and managing huge infrastructure projects. (I'm biased towards exploration and I'm dramatically oversimplifying there.)

Finally, yes, most companies are selling a lot of assets right now. However, you only sell what you don't think you can operate economically in the current price environment. You're typically selling it to someone who can operate it more efficiently or who has a different idea of the potential for enhancing reserves. At any rate, finding a buyer for the stuff you'd want to sell most is difficult, and a lot of the rest is currently profitable.

"Wasting money by seeking new reserves" is just a silly statement. If we don't keep exploring, we'll wind up in the same boat we were back in the early 00's. It takes decades to go from exploration to first production. You cut back on major capital expenditures for exploration, but you don't stop entirely.

I think this is pretty much what he said in his previous article on pricing going lower.


Basically saying future pricing will stable at ~$50, anything higher will create opportunity for US Shale Oil companies, anything lower they will not be able to sustain their own economies.

( I actually said something similar / if not the same and got downvoted >< )

Which got me to think, why aren't countries buying lots of cheap oil now and store them somewhere if they know prices will bounce back to $50+ in two years time? Or do setting up the infrastructure cost more then then $15 oil savings.

Maybe because most countries are running deficits - they would have to take out additional loans. I guess it's the same reason poor people buy crappy shoes instead of investing into quality long-term footwear - too many current problems to think of long-term solutions far in the future.

In a nutshell, everyone has already bought all of the cheap oil they can store. There's a very small amount of storage globally compared to the size of the surplus. (It's not a small amount in absolute terms, it's just that the production surplus is currently very large.)

"Proved reserves" (developed and undeveloped) are also a large component of how an energy company is valued by Wall Street.

Regardless of the current price environment, it's important to keep a portfolio of potential exploration opportunities.

I'd be interested in seeing a breakdown of the lifespan of oil using transport. A car might have a 15 year lifespan so we can't see a massive change in petroleum use until that time.

However boats, trains and planes have at least double that lifespan.

Because of capital investments, surely an alternative to oil is still 20 years away?

> Because of capital investments, surely an alternative to oil is still 20 years away?

It depends what you mean by alternative. The day when the last gallon of oil is burned may not ever even happen, but the day when 20% of things that currently burn oil have been replaced with something else could be very soon, and 50% only a few years after that, etc.

Oh so we're going to start burning more oil ? That sucks.


(Note that you can currently see it in action. Fossil fuel usage is very near an all time high while prices dropped 75% due to oversupply)

The current market situation with oil is very strange. My guess is OPEC sees the writing on the wall regarding climate change, i.e. that not all of the reserves in the ground can be used, and have decided that they're going to pump as much of theirs as they can before some law is passed that will turn what's left in the ground into a pumpkin.

So now what we need is that law. A cross-subsidy would be perfect: Tax fossil fuels and use the money to subsidize fossil alternatives.

Oil is cheap now, so the tax wouldn't pinch much, but it would make alternatives more attractive for anyone in a position to make that choice (e.g. buy an electric car). Which would then correspondingly reduce demand for oil, which would reduce the price of oil. Then we can keep oil prices from crashing by increasing the tax, which provides more money for the subsidy, which makes oil comparatively even less attractive, which reduces demand for oil, and so on until we're off of oil. But the price of gas never needs to go back above ~$3/gallon -- it's just that by the end the $3/gallon you're paying is $2.50 of tax and the tax is paying for everybody to get an electric car.

Trains are feasible to run on electricity, since they run on fixed tracks and you can have overhead cables or 3rd rail configurations. There is no realistic chance that ships and planes will not use petroleum fuel for the foreseeable future.

Aviation and marine fuel demand is only a small fraction of global demand.

Think about it; for most of history shipping was entirely wind-powered. Clearly not comparable to today's massive freighters, but don't rule out new technologies finding a way to harness more wind and sun at sea.

And at the end of the day if there's a surplus of renewable electricity, it can be converted into high density fuels such as gas or diesel. That technology exists today; it can only get better especially if a cost incentive existed.

That's pretty much political though. Nuclear powered cargo ships have already worked, and Russia says they're putting theirs back into service in a bit.

Although if foreseeable future means obvious stuff, then yes, the huge number of non-nuclear ships means it'll take a long time even if everyone liked the idea tomorrow.

Nuclear powered civilian ships are not going to be generally viable in our lifetimes due to real safety and security concerns that go beyond mere politics. Operating a nuclear reactor requires more, and more highly trained, crew members. Plus you need constant armed security on par with what land-based nuclear power plants have. Those additional costs outweigh any possible savings on fuel. Russia operates only a few of them on limited service in areas where security isn't a major concern, and they don't really try to make a profit.

The long-term future of merchant shipping will probably be larger, more efficient ships running on liquid fuels (biofuels or direct chemical synthesis), plus automated auxiliary sails.

As a human being that needs inexpensive, reliable energy to live a good life, I hope they don't do this!

Up until the fracking boom, oil companies were adopting that strategy, they weren't replacing reserves through exploration as fast as they were depleting them, and they were using cash to buy back stock, and other companies that had reserves that could be acquired cheaper than drilling for them.


I think the big change in the market is fracking, some lifestyle change toward less driving and energy intensity, not so much alternatives yet. But it could happen.

This author seems to be confused as to the realities on the ground, and engages in over-simplified analyses of the actions of various parties. If he really believed what he was saying, he would be shorting oil stocks and futures; but this piece really seems to be more like a Thomas Friedman prognostication (, which is to say a simplistic faux-intellectual self-indulgent scribbling).[1]

He seems to be reading what can only be described as 'the worst microeconomics textbook known to man' if he believes the quote below. All economists I have ever heard of believe that people (countries, and companies) should diversify their portfolios and hedge against risks, and that even if that were not true, politicians are largely mercantilists.[2]

>"Of course, the real world is never as simple as an economics textbook. Geopolitical tensions, transport costs, and infrastructure bottlenecks mean that oil-consuming countries are willing to pay a premium for energy security, including the accumulation of strategic supplies on their own territory."

Then he proceeds to read the minds of oil company executives, which is interesting, because I'm betting they know a lot of things this author does not, and they are no fools. In addition, an oil executive would have to be deaf, dumb, blind, and ignorant to believe in constantly rising oil prices after the last 10 years, and most of them seem quite intelligent and aware of reality.

>"That is precisely the strategy of self-liquidation that tobacco companies used, to the benefit of their shareholders. If oil managements refuse to put themselves out of business in the same way, activist shareholders or corporate raiders could do it for them. If a consortium of private-equity investors raised the $118 billion needed to buy BP at its current share price, it could immediately start to liquidate 10.5 billion barrels of proven reserves worth over $360 billion, even at today’s “depressed” price of $36 a barrel. There are two reasons why this has not happened – yet. Oil company managements still believe, with quasi-religious fervor, in perpetually rising demand and prices. So they prefer to waste money seeking new reserves instead of maximizing shareholders’ cash payouts. And they contemptuously dismiss the only other plausible strategy: an investment shift from oil exploration to new energy technologies that will eventually replace fossil fuels."

TLDR; This article is just click-bait, and we should all disregard it. This man is no Andy Grove.[3]

[1] https://en.wikipedia.org/wiki/Thomas_Friedman

[2] https://en.wikipedia.org/wiki/Hedge_(finance)

[3] http://watercoolernewsletter.com/the-revolving-door-test-how...

From a financial standpoint, this is poor advice. Reserves and equipment represent real options, giving big-oil the right,but not the obligation, to extract in the future. Even if these costs cannot be recouped at the current market price, this has value because of oil's volatility (just like stock options with exercise prices above current prices). The fall in oil price (and expected future prices) reduces the quantity of profitable real options, but plausibly not to zero.

Question for those who might know: Is analysis that the oil price depression will result in a significant economic recession just FUD, or is it grounded in truth?

With proper monetary policy, there is no reason to expect it would cause a recession in America. The reason people in the business press are concerned about it is because deflation is associated with recessions. But usually recessions are caused by demand-driven deflation (people demanding less goods, which leads to the prices of goods decreasing), while this is a supply-side deflation (suppliers providing more goods, which leads to prices decreasing). As you can imagine, when people demand less, fewer goods are created, which is a recession, but if people are given more for the same price, MORE goods are created, which is not a recession.

Scenarios where a fall in the price of oil triggers a recession are possible. For example, with bad monetary policy from the Fed you can always get a recession if they do the wrong thing, and drastic changes in oil prices could make that more likely by leading us into a more volatile environment, where past trends could be broken. More likely is that it could lead to deflation in the Eurozone, and since the European Central Bank isn't very good at monetary policy, it could lead to a further Eurozone recession because of sticky wages. If that recession were bad enough it could cause failure of the economies of one or more European countries and trigger global recession.

It's also possible that one or more oil-exporting nations could default on their sovereign debt (Russia, Venezuela), which could cause a panic-driven global recession.

Even granting the questionable base assumption that the sector fully implodes: Cheap(er) energy across all industries versus one industry segment collapsing is a win for the industrialists.

FUD. Elevated energy costs are a tax on everything.

Next time you're at the mall, consider that for every 100 cars you see, those drivers have an additional $100,000-150,000 to spend vs. peak has pricing.

"""In a normal competitive market, prices will be set by the cost of producing an extra barrel from the cheapest oilfields with spare capacity."""

This seems wrong as the marginal price is determined by the utility of an extra barrel of oil for the consumer not by production cost. Sounds like a fall back to the labor theory of value (aka classical economics and/or Marxism) to me.

I find it very difficult to take a shareholder seriously when his advice is for a company is to give up, sell all their assets, and give them to... ahem... shareholders.

Sure, there are reasons to do so, but they better be unassailable... like bootlegging equipment in 1933, or horse and buggies in 1908.

> strategy of self-liquidation that tobacco companies used

Does anyone have a source for that?

Doesn't seem so crazy. If your industry isn't viable any more: liquidate rather than hang around. We all know what Alphabet (Google) would do if it owned some company that was in decline.

That the business is in decline is the bone of contention here. The author doesn't present evidence that the market for oil is in decline. He suggests as much referring to projections of long term low oil prices but ignores realities. Low prices can be fixed on the supply side as well as demand.

I don't believe there is compelling evidence to suggest clean energy is making substantive inroads against oil. Short term analysis seems to suggest oil consumption will increase[1]. Past actuals suggest renewable energy as a percent of total energy had declined over the last 50 years[2].

At the moment OPEC are essentially overproducing and are telegraphing that they will cut supply in the future[3] as they expect prices to rise. This is a vote of confidence for higher prices and economic growth in the future which is hardly a reason to start selling off reserves now.

[1] http://www.eia.gov/forecasts/steo/report/global_oil.cfm [2] https://en.m.wikipedia.org/wiki/Renewable_energy_in_the_Unit... [3] http://www.wsj.com/articles/opec-report-suggests-oil-price-r...

Oil isn't in decline. There may be some alternatives to oil that are newly viable, but you still have billions of engines that aren't going anywhere.

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