Thursday, April 25, 2013

Fracking and Tar Sands Will Not Resolve Peak Oil

All of the oil in the world was created from carbon-based fossils over a period of millions of years, and all of it sits in the upper regions of the earth's crust. Like cream that rises to the top of milk, all of the best, purest oil — known as light-sweet crude — also sits at the top. That makes it the easiest, and cheapest, crude to extract.

Due to its higher quality, light-sweet crude is the most sought after grade of oil in the world. It is used to make gasoline because it contains a minute percentage of sulfur.

Petroleum containing higher levels of sulfur is known as sour crude. The impurities need to be removed before this lower quality crude can be refined into petrol, thereby increasing the cost of processing. This results in a higher-priced gasoline than that made from sweet crude oil. As a result, sour crude is typically processed into heavy crude oil, such as diesel and fuel oil, rather than gasoline to reduce processing cost.

A major problem faced by the oil markets today is that there is very little refining capacity available to process these heavy sour grades. Additionally, light-sweet crude is being depleted at a much faster rate than its heavier, sour cousin. The increase in the spread between light sweet and heavy sour crudes indicates that there is a serious supply problem for light-sweet crude.

Simply put, the planet is not creating any more pre-historic animals and, as such, it is not creating any more light-sweet crude. This is a challenge for a world that is so utterly dependent on crude oil, particularly the light-sweet variety.

Despite the wishful thinking of the masses, oil is a finite commodity — though this is a most unfortunate and difficult reality.

As the U.S. Geological Survey bluntly stated, "The simple inescapable fact is that the world's supply of petroleum is finite and nonrenewable."

Consequently, oil continues to trade at $90-$100 per barrel. This is a primary reason that our economic recovery is, and will continue to be, so sluggish. Why is the high cost of oil a problem?

High oil prices also raise the cost of food. Oil is used in numerous ways throughout the processes of growing and transporting food. But it's not just food that's affected; the shipping cost of all goods is higher, as are the costs of all materials made from oil, such as asphalt and chemical products.

So the high cost of oil is being felt throughout the economy. Simply put, oil affects everything.

Though we have seen significant swings in the price of oil over the past decade, the overarching trend has been toward higher prices.

Inflation-adjusted oil prices reached an all-time low in 1998, even lower than the price in 1946. Then, just ten years later, oil prices were at an all time high — above the 1979-1980 prices — in real, inflation-adjusted terms (although not quite on an annual basis).

By 2012, annual oil prices were higher than at any other time except 1980, during the second oil crisis.

This is having a huge impact on the U.S. economy.

Despite doubling their worldwide investment in oil production from $300 billion to $600 billion, oil companies have been pumping nearly the same amount of oil out of the ground since 2005, according to economic analyst Chris Martenson.

“If you want to have economic growth you’re going to need growth in oil consumption,” says Martenson. “Oil is the lifeblood of any economy.”

Fast-growing economies, like China, Brazil and India, now demand more oil than the U.S., Japan and Europe combined.

Let's look at this problem a little more closely.

The combined crude oil production of the five main international oil companies (Exxon, BP, Shell, Chevron and Total) hit a historic high in 2004. Since then, it has fallen by 25.8%, despite large increases in investments. That can rightly be described as stunning.

In 2005, global crude oil production reached 73 million barrels per day. To increase production beyond that, the world had to double spending on oil production. By 2012, spending had reached $600 billion, yet the price of oil has tripled. For all that additional expenditure, the oil industry has only raised production 3 percent since 2005, to 75 million barrels per day.

That's a horrible return on investment.

The world can no longer increase its production of “easy” oil; many of the older fields are stagnant or declining.

Of the world’s four super-giant oil fields, three are officially in decline: Mexico’s Cantarell, Russia’s Samotlor, and Kuwait’s Burgan. The fourth is also in decline. Though Saudi Arabia officially denies these claims, we know through Wiki-Leaks that this is indeed the case.

In fact, the pace of decline in mature oil fields is accelerating. Mature OPEC fields are now declining at 5 to 6 percent per year, and non-OPEC fields are declining at 8 to 9 percent per year.

As a result, the world is spending a lot of money to eke out additional production from hard, expensive sources like Alberta’s tar sands or tight oil in North Dakota. However, unconventional oil can’t compensate for that decline rate for very long. Even all the growth in U.S. tight oil from fracking, which has produced about 1 million barrels per day, hasn’t been enough to overcome declines elsewhere outside of OPEC.

We’re relying on low-quality oil resources to compensate for the decline in cheap, high-quality oil. One of the implications of Peak Oil is that as production starts to falter, we need much higher prices in order to sustain production. And that’s exactly what’s happened since 2005.

Despite optimistic media reports, fracking for shale oil is highly energy-intensive and is a net energy loser. Net energy is what's left over after new energy resources are found and extracted. The inescapable fact is that conventional oil is used to extract shale oil.

Though North American shale oil is said to be abundant and is expected to lower prices, petroleum costs reached a new annual record in 2012. The reality of shale oil doesn't live up to all the hype.

This is how describes the hype surrounding fracking:

"We’re being told that — thanks to technological advances like hydraulic fracturing and horizontal drilling — the US is undergoing an energy revolution, leading us in a few short years to become once again the world’s biggest oil producer and an exporter of natural gas.

The reality is that the so-called shale revolution is nothing more than a bubble, driven by record levels of drilling, speculative lease & flip practices on the part of shale energy companies, fee-driven promotion by the same investment banks that fomented the housing bubble, and by unsustainably low natural gas prices. Geological and economic constraints — not to mention the very serious environmental and health impacts of drilling — mean that shale gas and shale oil (tight oil) are far from the solution to our energy woes.

Shale plays suffer from the law of diminishing returns. Wells experience severe rates of depletion, belying industry claims that wells will be in operation for 30-40 years. For example, the average depletion rate of wells in the Bakken Formation (the largest tight oil play in the US) is 69% in the first year and 94% over the first five years.

This steep rate of depletion requires a frenetic pace of drilling, just to offset declines. Roughly 7,200 new shale gas wells need to be drilled each year at a cost of over $42 billion simply to maintain current levels of production. And as the most productive well locations are drilled first, it’s likely that drilling rates and costs will only increase as time goes on.

William Engdahl, an award-winning geopolitical analyst and strategic risk consultant, provides an equally sobering perspective on the shale energy mania:

Some say America’s shale energy revolution will provide gas for a century and create millions of new jobs. The only problem with this picture? It’s built on myths, lies and Wall Street hype.

The costs and economics of shale gas in the US are actually negative.

Shale Gas, unlike conventional gas, depletes dramatically faster owing to its specific geological location.

The Wall Street bankers backing the shale boom have grossly inflated the volumes of recoverable shale gas reserves and hence its expected duration. Independent conservative estimates are that recoverable shale gas is about half what the industry claims on its financial statements.

Real well extraction data are now available that show shale gas wells decline at an exponential rate, and will run out far faster than being hyped.

The problem with tar sands is much the same. The cost to produce a unit of energy from tar sands is much higher than traditional oil. The net energy returned from tar sands is terrible. It is the most expensive oil because it is the lowest quality oil and is the most difficult to extract and refine.

If any of this is surprising, even shocking, to you, it's likely because the mainstream media has been hyping fracking, shale oil and tar sands as the panaceas to our nation's insatiable energy demand. Yet, these "remedies" are not actual solutions; they are merely empty promises.

Middle East oil producers and exporters are acutely aware of the problem that is Peak Oil, and they are no longer publicly denying it.

Dr. Robert L. Hirsch, a Senior Energy Advisor at MISI, recently attended a Peak Oil conference in the Middle East and had this to say about the experience:

The fact that a major Middle East oil exporter would hold such a conference on what has long been a verboten subject was quite remarkable and a dramatic change from decades of Peak Oil denial.

The going-in assumption was that “peak oil” will occur in the near future. The timing of the impending onset of world oil decline was not an issue at the conference, rather the main focus was what the GCC countries should do soon to ensure a prosperous, long-term future.

Among the findings at the conference:

• Shale oil in the U.S. is so much foolishness and does not invalidate Peak Oil. We definitely must worry about peak oil.

• High oil prices will impact the world even before the onset of Peak Oil.

Chris Nelder, SmartPlanet's energy columnist, describes the issue this way:

Peak oil was never about “running out.” That’s a strawman argument. The word “peak” in peak oil simply refers to the maximum production rate of oil. While oil producers constantly trumpet new discoveries and rising reserves, they tend to avoid talking about production rates.

Reserves are meaningless if they don’t amount to an increasing rate of production. If you had a billion dollars to your name, but could only withdraw $1,000 a year, would you be worried about running out of money or paying your bills?

The benchmark price of Brent crude shot from $31 a barrel at the beginning of 2004 to $111 a barrel at the end of 2012. It was a very powerful indicator.

This tripling of oil prices resulted in a mere 5.4 percent increase in supply; world production in November 2012 was just 3.9 million barrels per day over the January 2004 level, according to the Energy Information Administration.

A total of $2.4 trillion in capital expenditures from 1995 to 2004 produced 12.3 million barrels per day of additional oil production. However, from 2005 to 2010, the same amount of spending produced a decline of 0.2 million barrels per day. Why?

Because “each marginal barrel will be more expensive and will require more equipment and services to extract,” said John Westwood, the chairman of energy consulting firm Douglas-Westwood.

According to a March 4, 2013 article in the Oil & Gas Journal, the supermajors have been spending about $100 billion dollars a year, collectively, on exploration and production since 2008. That spending resulted in a 25.8 percent decline in oil production since 2004. Leaving out the Russian oil assets of Tymen Oil Company (TNK), which BP acquired in 2003 and subsequently sold to pay for the damages of the Deepwater Horizon disaster, the supermajors’ production actually has been declining since 1999.

Chris Nelder went on to say the following:

The underlying problem, of course, is that production from the world’s old (and cheap) oil fields is continuously declining at over 5 percent per year — another dirty little fact that the oil majors studiously avoid discussing. Thus, global oil production is a treadmill, where you have to run just to stay in place.

The industry plans to respond to this stubborn reality by drilling like there's no tomorrow.

In a leaked powerpoint document from the Society of Petroleum Engineers, the SPE says the gas and oil industry will drill more wells in the next decade than they have in the last 100 years. That is a telling indicator about both supply and demand. It could also be fairly described as frightening.

With a clear memory of oil reaching a high of $145 per barrel in July of 2008, some people may view current prices as a relative bargain. Yet, prices are still historically high.

"A person might think from looking at news reports that our oil problems are gone, but oil prices are still high," writes Gail Tverberg on, citing Ten Reasons Why High Oil Prices are a Problem.

"In fact, the new 'tight oil' sources of oil which are supposed to grow in supply are still expensive to extract. If we expect to have more tight oil and more oil from other unconventional sources, we need to expect to continue to have high oil prices. The new oil may help supply somewhat, but the high cost of extraction is not likely to go away."

Her piece is an excellent read and is highly recommended.

The "drill baby drill" crowd mistakenly believes that the solution to our nation's oil problem lies far to the north, in Alaska's frozen Arctic tundra.

It is estimated that 10.5 billion barrels of oil lie beneath the coastal tundra of northeastern Alaska, the Arctic National Wildlife Refuge (ANWR).

At present, the U.S. uses about 7.3 billion barrels of oil a year. Do the math: that's less than a year and half's supply.

Yet, not all of the oil under the earth is recoverable.

In 2010, the U.S. Geological survey estimated that there are 896 million barrels of technically recoverable crude oil in ANWR. However, these are classified as prospective resources, not proved. In comparison, the estimated volume of undiscovered, technically recoverable oil in the rest of the United States is about 120 billion barrels.

The total production from ANWR would be between 0.4 and 1.2 percent of total world oil consumption in 2030. Consequently, ANWR oil production is not projected to have a meaningful impact on world oil prices.

No matter how hard anyone tries to spin it, the problem will always be that oil is a finite, non-renewable resource. As such, supply will increasingly lag demand and prices will continue to rise, affecting every aspect of the U.S. and global economies.

The U.S., a nation that got used to the notion of unlimited abundance throughout the 20th Century, will have to resign itself to higher prices for everything. It's all tied to oil. The best solutions are conservation, efficiency and renewable energy. Smaller, lighter cars will help, as will electric vehicles.

But higher oil prices are here to stay and oil will become increasingly more expensive in the coming years. There are no magic bullets and no universal cures.

It's a matter of realigning our priorities, conserving what oil we have at present, and continually adapting to a new, more challenging, normal.

Wednesday, April 03, 2013

The Federal Reserve: Making Money From Nothing

At its core, money is a medium of exchange, a unit of account and a store of value. A currency with a commonly recognized value can be used to buy the goods and services we want and need. Like all other things, the value of money is determined by its quantity and availability.

For centuries, people used gold as money. In order to buy something, they had to carry around pieces of the heavy, yellow metal. But that was impractical, especially if someone needed to make a large purchase requiring a significant amount of gold. So people decided to leave their gold in a bank and instead use pieces of paper that would represent their gold. That paper could then be taken to a bank and exchanged for gold.

Gold is a form of commodity money, a currency thats value is based on the value of an underlying commodity. Gold is durable, portable, easily stored, highly recognizable and difficult to counterfeit, which made it an ideal commodity money throughout the world over many centuries.

But, beginning in 1933, the U.S. government decided that we could no longer exchange our dollar bills for gold. From that point forward, dollar bills have merely represented the concept of money.

However, until 1971, U.S. currency was still backed by gold. Foreign governments were able to take their U.S. currency and exchange it for gold with the U.S. Federal Reserve. That changed when President Nixon effectively took the U.S. off the gold standard by ending the convertibility of the dollar to gold in August of 1971.

From that point forward, our money has been fiat money, meaning its value has been declared by the government to be legal tender. In essence, it must be accepted as a form of payment within the boundaries of this country, for "all debts, public and private."

Fiat money has value because the government says it does.

Not only is there no longer any gold backing our money, there aren't even bills for most of the money that exists. Most money is simply an idea. Banks don't even have all the money that's allegedly in the accounts of their depositors.

Most money isn't physical; it is merely created electronically. Think about what happens when you pay your mortgage, rent, utility bills, car payment or monthly insurance. No cash — no physical money — ever changes hands.

M2, the broadest measure of our money supply, had increased to $9.61 trillion in October 2011, the latest month for which data is available. However, as of December 2010, only $915.7 billion (about 10%) consisted of physical coins and paper money.

The other 90% is just numbers in bank databases, on computer screens.

The truth is, our money is created out of nothing. It is merely loaned into existence.

Every six weeks, the Federal Reserve's Open Market Committee convenes in Washington D.C. to discuss the health and performance of the economy. By controlling the amount of money in our economy, the Fed can influence interest rates. More money usually results in lower rates, while less money typically has the opposite effect.

More money (or lower rates) generally makes it easier for businesses and individuals to get loans. This allows businesses to expand or new businesses to start up. That ultimately translates into more jobs and a stronger economy.

But, more money can also result in inflation. For example, if there's a hundred dollars in an economy and you create a hundred more, every dollar is suddenly worth half as much. That's inflation.

Money must correlate to the amount goods and services produced in an economy, particularly the things that people want. If there is too much money chasing too few goods and services, money loses value. It's not so much that prices are going up. Rather, the purchasing power of money is going down.

That is why simply printing new money will not create wealth for a country. Money must be in balance with the supply of goods and services in the economy for it to maintain its value, or purchasing power. If the Fed issues too much money, its value will go down, as is the case with anything that has a higher supply than demand.

Over the thirty-year period from 1981 to 2009, the U.S. dollar lost over half its value. This is because the Federal Reserve has intentionally targeted a low, stable rate of inflation.

On January 25th, 2012, Fed Chairman Ben Bernanke announced a 2 percent target inflation rate. Bernanke had previously stated that central banks seek an inflation rate between 1 and 3 percent per year.

Between 1987 and 1997, the rate of inflation was approximately 3.5 percent and between 1997 and 2007 it was approximately 2 percent.

Yet, even at an annual inflation rate of 2 percent per year, the dollar would lose 20 percent of its value in just one decade.

But that doesn't deter the Federal Reserve.

The Fed injects billion of dollars into the economy via the banking system. It does this by purchasing government bonds from the banks. Big banks typically have billions of dollars in Treasury bonds just sitting around on their books because these bonds have long been viewed as the safest, surest investment.

But having billions of dollars just sitting around on their books doesn't suit the banks. At least the bonds they sell to the Fed earn interest. So, the banks are inclined to loan out this new money to make even more money. After all, that's what banks do. And that's how all of this new money enters the economy.

But a large supply of new money doesn't create demand. To create demand, the banks need to lower their lending rate to encourage businesses and individuals to borrow. The hope is that an increased level of borrowing will create an economic expansion. But, as we've recently seen, that doesn't always work as planned.

When the financial crisis was in full swing in the fall of 2008 and the economy appeared poised to crater, the Fed ramped up its money printing to unprecedented levels.

Since that time, the Fed has done things it had never done before. And it's done them on a scale that has dwarfed anything ever attempted before in its history.

NPR's Planet Money put it this way:

The sheer amount of new money that the Fed created was unprecedented. From the time we went off the gold standard of 1933 until 2008, the Fed had created a net total of $800 billion. In the months after the financial crisis, that number nearly tripled to almost $2.4 trillion.

[The Fed was] spending more newly created money in just 15 months than [it] had created in its entire history up until 2008.

However, getting all these trillions of dollars into the economy required more than just buying Treasuries. The Fed decided to buy home mortgages as well, in the form of mortgage backed securities. The intention was to prop us the plummeting housing market.

The danger of this extraordinary and historic Fed intervention is that it will result in debilitating inflation, resulting in the dollar losing significantly more of its purchasing power.

At some point, the Fed will have to find a way to get all those trillions of dollars out of the economy before serious inflation takes hold. Instead of buying bonds, the Fed will begin selling them, which it will attempt to do in an orderly fashion without flooding the market and driving down their value. Again, think supply and demand.

The Fed is able to create trillions of dollars out of thin air on its own authority. Congress doesn't debate it or vote on it. The president doesn't approve it. There's no public input. The Fed is independent and is able to act of its own accord.

Though the Federal Reserve is subject to Congressional oversight, its chairman is appointed by the president, and its name includes the word "federal," it is not actually part the federal government.

It's important to understand that the Federal Reserve isn't federal at all. It is an independent institution comprised by 12 regional banks, all owned by big private banks. Yes, the Fed is privately owned and actually has stockholders.

As the long-time Chairman of the House Banking and Currency Committee Charles McFadden said on June 10, 1932: “Some people think that the Federal Reserve Banks are United States Government institutions. They are private monopolies.”

Consider that when you're evaluating or scrutinizing any decision made by the Fed.

We should never forget that the Fed started the financial crisis that tanked the economy. By keeping interest rates too low for too long, the Fed inflated the housing bubble. And it now appears that it has initiated a bond bubble and a stock market bubble as well, which is an odd occurrence.

Money usually shifts between bonds and equities, typically favoring one or the other, given the particular economic circumstances or appetite for risk. But, right now, there is so much money flooding into the financial system that it is flowing freely to both the bond and equities markets.

At this point, it's pretty clear that the Fed is again blowing yet more massive bubbles that could once again tank the U.S. economy — except that next time will likely be even worse since the economy is still on such weak legs.

The Fed cannot print this economy back to health. At this point, that should be clear. To the contrary, this massive monetary expansion could have some horrible consequences.

As history repeatedly shows, printing money is the road to ruin. It devalues money and causes a loss of confidence. If everyone stops believing in their currency, it has disastrous results. The whole monetary system is built on trust. Once that trust is gone, the value of money goes away with it.