Puru Saxena

Despite the ‘demand destruction’ hype, it is interesting to note that during this severe global recession, worldwide oil usage has dropped by a minuscule 2.7%. So, what will happen when the world comes out of this recession? Who will rise up to the challenge and meet our insatiable thirst for energy? These are critical questions not many are willing to ask.

According to the US Department of Energy, liquid fuel demand in the developed nations peaked in August 2005 at 41.89 million barrels per day. Since then, it has plunged by 3.6 million barrels per day to 38.27 million barrels per day. However, you may want to note that despite these tough economic conditions, consumption has been extremely resilient in the emerging world. For instance, demand in the developing countries peaked in October 2008 at 46.33 million barrels per day and it is down by only 0.36 million barrels per day! I am amazed that the worst global recession in decades has barely managed to shrink energy demand in the developing world. Whilst this is wonderful news for the energy investor, it is a terrible sign for society.

At present, our world is using up roughly 84 million barrels of liquid fuels per day and for the moment at least, there is sufficient supply to meet demand (Figure 1). However, when economic activity picks up, it won’t take much for demand to zip right past supply. Remember, it is much easier to increase usage, but it takes a long time to ramp up production. So, unless this is a permanent global recession (which I doubt), it is inevitable that the price of oil will go up significantly over the medium to long-term.

Figure 1: Supply and demand – balanced for now

Crude Oil Demand and Supply

Source: www.yardeni.com

On the supply side of the equation, let me be clear. If I was asked to pick the biggest threat to a sustainable economic recovery, Peak Oil would top that list. Remember, Peak Oil doesn’t mean that we are running out of oil reserves, crude will be around for decades. However, ‘Peak Oil’ does imply that we are dangerously close to peak global oil production. ‘Peak Oil’ also means that rather than experiencing a burst in oil supplies as many expect, from here onwards, we will witness sharp declines in global flow rates. In a nutshell, the era of cheap energy is over and the price of crude oil will rocket higher over the coming decade.

Now, many skeptics will argue that if Peak Oil was real, the price of oil wouldn’t have dropped to roughly US$30 per barrel in last autumn’s stunning crash. Valid point; but let us not forget that the spectacular plunge occurred at a time when global economic activity virtually came to a standstill. Let us also keep in mind that last autumn’s crash in asset prices was caused by a total freeze in credit and the associated asset liquidation. Whilst I agree that the final action in crude oil’s parabolic blow-off last July smacked of speculation, I can assure you that speculation alone couldn’t have created a multi-year boom whereby the price of crude oil went up by almost 1500%! As you can see from Figure 1 above, supply clearly fell short of demand between 2005 and 2008, and this is why we had a magnificent bull-market in crude oil.

Make no mistake, global demand for liquid fuels will rise again – and if my homework is correct, supply won’t be able to keep up. If you ignore the noise and review hard data, you will observe that the vast majority of the world’s most prolific oil provinces are now past peak production and in a state of permanent depletion. According to the BP Statistical Review of World Energy, out of the 54 oil producing nations and regions in the world, only 14 are still increasing production. Alarmingly, 30 oil producing nations and regions are definitely past their peak output and the remaining 10 appear to have modestly declining production rates. Put another way, when weighted by production, Peak Oil is already a grim reality in 61% of the oil producing world!

Still not convinced about Peak Oil? Then review Figure 2, which charts the expected combined flow rates for crude oil, lease condensates and Canadian Oil Sands. As you can see from the grey shaded area, production is about to decline by roughly 5 million barrels per day by 2012.

Figure 2: Has crude oil production peaked?

Peak Crude Oil Production

Source: The Oil Drum

Ironically, Figure 2 also plots the optimistic (almost laughable) forecast made by the International Energy Agency (IEA) in its “World Energy Outlook 2008”. Interestingly, in last year’s “World Energy Outlook”, the IEA stated that in order to fulfill its optimistic projections, the world had to install 64 million barrels per day of new supply by 2030 or the equivalent of six times the Saudi Arabian output! Furthermore, the IEA declared that the energy industry had to invest hundreds of billions of dollars every year to achieve this favorable outcome.

Now, I can understand that the IEA is a government-funded agency so it has to paint a rosy picture, but it is ominous that the energy watchdog failed to mention where this surplus oil would come from!

Well, I guess you get the idea. Global crude oil production has probably peaked, new discoveries have dried up and there is a shortage of capital for investment purposes. Apart from these factors, if you believe the energy optimists, all is well in the energy industry and the price of oil is about to drop to zero!

After years of extensive research, I have no doubt in my mind that unless global demand stays weak forever, we will see supply shortages in the not too distant future. And before that occurs, the price of crude oil will stage an explosive rally. Accordingly, I suggest that all my readers allocate a large proportion of their investment portfolio to upstream energy companies and to businesses in the energy services sector.

Finally, in the energy complex, the price of natural gas is still scraping along its recent crash low and this is a fantastic long-term investment opportunity. As we approach winter in the Northern Hemisphere and heating demand picks up, we are likely to see a big rally in the price of natural gas. So, investors may want to allocate capital to this unbelievably inexpensive commodity.

Regards,

Puru Saxena
for The Daily Reckoning

You May Also Like:


Higher Oil Prices the “New Normal”

Brian Hicks

Oil prices have bounced more than 150 percent off their December 2008 lows, despite the fact that inventory levels remain at historically high levels. Does that mean the oil price is out of whack? Not necessarily.According to Goldman Sachs, robust 2010 oil demand growth will deplete these inventories over the next 12-to-18 months and diminishing […]

Puru Saxena

Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs. 

He also publishes a widely read economic report, Money Matters, which is available from www.purusaxena.com

  • Robert

    Surely supply always equals demand? the only variable is price. If this is not the case where are the 100’s of millions of barrels of oil discrepency between demand and supply being stored?

  • Lukas

    Natural gas is in steep contango, so it’s not so easy to capitalize on cheap NG prices.

  • Bloomer

    There is an abundance of natural gas reserves in North American. As the public becomes convinced high oil prices are here to stay, I see growth in natural gas usage, in transportation, industry, power generation and home heating.
    The conversion from oil to natural gas will take time, as infrastructure has to expand to meet growing demand. However, I do agree the time is now to invest in natural gas.

  • James

    Bloomer,

    Natural gas is usually found as a by product of oil production. Natural gas set on top of the crude oil which is found on top of salt domes. Now, where is this surplus natural gas supposed to be if we can’t even find new sources of Crude Oil?

Recent Articles

Why a Strong Dollar is the Mortal Enemy of Gold and Oil

Frank Holmes

Gold and oil are down because the US dollar is up, despite all the inflationary pressures the Fed has put on it. What's going on? Today, Frank Holmes, breaks down the U.S. economy’s current direction with several important charts. Plus, he's got a mining play for you that's prospering despite the current sentiment...


Bill Bonner
Confessions of a Newsletter Man

Bill Bonner

Being a financial newsletter writer certainly has a few advantages. Namely, it affords one the opportunity to comment on the financial markets without having to take them seriously. Today, Bill Bonner looks back on what drew him to this business, and the unique and entertaining cast of characters he's met along the way. Read on...


Extra!
The Most Important Factor of the Swiss Gold Initiative

Grant Williams

The Swiss Gold Initiative has the the Swiss National Bank in a panic. Should the referendum pass, the SNB will be responsible for ensuring that 20% of its total assets are held in gold. That's an awful lot of yellow metal. Today, Grant Williams puts that number into perspective and explains how it could affect the gold market...


How Solar Power Could Heat Up Your Portfolio

Greg Guenthner

Regardless of how you feel about the "green energy movement" there is no denying that solar power is becoming more mainstream. As it closes in on price parity with conventional electricity, more and more people are turning to solar as a viable source of energy. And that's great news for solar stocks. Greg Guenthner explains...


R.I.P. Tapir (5/22/13 – 10/29/14)

Greg Kadajski

The Tapir, beloved pig-like mammal and financial machination, quietly passed away at 2:00 p.m. EST on October 29, 2014. He lived a misunderstood life and was held responsible for many things entirely out of his control. Nevertheless, he will be missed by all who thought they knew him...