Dear Greg,

Japan has been putting a lid on its oil consumption since 1980 and like Europe has never consumed more than it did in 1979, apart from one year or two in 2000. Japan's demographics as well as strong technology improvement in transport efficiencies should see Japan's oil demand keep to a structural decline. And with Japan being a leader on hybrid technology my guess is that the dowtrend in Japan's oil consumption should accelerate.

To make sure it is well understood the Peak Demand paper refers to demand for petroleum having peaked in 2007 and keeping lower for a considerable time. Not for total energy demand having peaked. Total energy demand should keep on increasing and the more so as more renewables finds their way to market. 

1. All fields deplete yet technology is constantly improving and is yielding greater extraction rates. These Enhanced Oil Recovery technologies can have substantial impact on production (see attached chart for example). The average yield worldwide is about 30% recovery. I have no doubt that the average will keep on improving. in 1960 total oil reserves were estimated at 300bn bbl yet over the following 40 years 760bn bbl have been produced!
2. Again technology allows us to get oil from new frontiers that we couldn't possibly explore a mere 10 years ago. Example deep offshore subsalt discoveries in Brazil (up to 100bn bbl?) or Palaeocene rock discoveries in the North Sea.
3. Some areas of the world have still not been surveyed. 2/3 of Libya has not been surveyed, a greater part of the empty quarter hasn't, very deep offshore etc.
4. The impacts of geopolitics have been appalling for oil production. In fact we currently live in an upside-down world where oil companies are chasing after the most complex and tech intensive fields whereas the majority of the oil to be available lies in easy onshore regions. Iraq comes to mind which could triple production rates or Iran who could produce a third more as it did before the revolution, etc. 

The bottom line is not a problem with the amount of oil stock which is huge (over 1 trillion barrels in Venezuela alone) but with flows, i.e. production rates. Technology, Investment and Politics are the main hurdles or enablers.

So I'd like to think of the cup being half full rather than half empty as our Peakoil friends think.

You should be able to get reports on estimated costs from the IEA, McKenzy, the Oil Journal and any other specialized publications. 80% of all oil production cost are below $20/bbl. If you look at the $/bbl paid for M&A in 2007 you will find that all deals went for less than $17/bbl valuation. If oil companies accept to sell themselves for less than $17/bbl that should tell you that $90/bbl is simply not the cost of the marginal barrel. But if a company wants to explore and produce from the most hostile and complex regions then there’s no end to how much it may cost. The question is whether that oil is required and in truth it isn’t thus the projects costing $90/bbl simply won’t see the light of day.

Dear Gavekal,

Would it be possible to ask Ahmad if he can send me the study, or the article in which it is established that the cost of upgrading bitumen to higher-quality liquid is 5$ in Venezuela (as he writes in the last week's Energy Weekly)?

We should remember to use the yearly average price, which still stands at $110 for the Benchmark. Even if we subtract a good $10 for lesser quality crudes, most producing nations and IOCs are still within the $100 average so far.

Where it will get interesting is next year. My guess is that austerity budgets will become the buzz word for those that can; for those that can’t it will be painful. Yet the relationship is not as straight forward, for example inflation is clearly falling and fast. That was the biggest problem in most oil producing nations. Ditto the US$ is now rising so in real terms the fall in oil prices is not as bad as it seems.

In fact if oil stabilizes within the $60-$65 average next year, providing that the $ keeps on climbing, my guess is that most producing nations will do nearly as well in real terms revenues and certainly much better on the inflation side. While the net effect will be somewhat negative it will not be the end of the world. Obviously there are always nations who have a knack for blowing it-up whether oil is at $150 or at $10 a barrel ---but that can’t be helped.

Watching the oil price fall I was wondering at what point places like Russia + middle east start to get into trouble in terms of cash flow/budget deficits etc?   I seem to recall a figure of $50-60/barrel for Saudi Arabia.  Must have implications for a price floor + political/social unrest + cash flows into SWFs (remember those?!)

That’s because the IEA is still overestimating demand by 500kbd. Once it revises it down spare capacity will de-facto increase. The IEA publishes its data once a month only but the situation is moving fast. Also data gets revised.

OPEC’s production is reported by various specialised data vendors, among them Reuters, Platts, Argus etc. OPEC 10 supply in September was 30.4Mbd + 2.37Mbd; out of Iraq makes 32.77Mbd. Total OPEC capacity is 35.17Mbd. Its spare capacity in Sept was 2.4Mbd therefore. If OPEC cuts by 1Mbd to year end its spare capacity will be 3.4Mbd. if you add 900kbd of new fields in Saudia that’s 4.3Mbd. if you remove a very generous 500kbd of decline in older Saudi fields the Net is 3.8Mbd spare capacity for next year on the OPEC side alone.

These are the numbers I’ve come up with and that seems to be close enough to consensus.

However much Dreyfus, Campbell and Simmons argue it is a matter of fact that demand is collapsing. So I guess they’ll have to revise their peak oil theory further in the future, which is a good thing if you think about it.

The IEA is a bit behind the curve to put it mildly. I personally assess world demand in September close to 85.8 not 86.5. the IEA overestimates US demand and is trying to catch-up. In any case yes there’s been supply disruption in the US Gulf of Mexico from two hurricanes and a greater part of the deficit in Sept is due to oil being held at sea. There has been supply disruption in the Caucasus as well in the Baku pipeline that blew up in Turkey. As a result stocks were drawn down in Europe.

Demand in the US is appalling as it is in the rest of the OECD. Still some question marks over EMs demand. I believe China is taking advantage to store a bit of oil in its SPR too. End year 2008 will show zero growth in demand or close enough to zero and ditto for next year if not negative demand. As a result OPEC spare capacity is climbing and should reach an extra 1Mbd for a total of over 3Mbd. That excludes the 900kb of new Saudi fields. So the total should be close enough to 4Mbd. Remember that tight supply demand balances were one of the main arguments for the bull-run. That is easing now.

The cost of production of unconventional oil is bound to be falling as all cost factors are falling the world over. I do not believe it ever reached $90 but even if it did due to demand falling the marginal barrel is now found at a lower marginal cost anyway.

Right now we are seeing a huge amount of deleveraging across all markets. In my view oil has removed all the excess speculation of the first half of this year and is now trying to find fair value in a fast changing environment. The bull-run and all the news that fed it is gone. You’ll need to re-assess much closer to fundamentals. For now demand is done, inventories are rising. The next step is for buying to ease and inventories to ease and OPEC to cut and spare capacity to rise. That should translate into a bearish price environment especially more so for next year. We won’t see $100 anytime soon, all things equal. The big inflation play with oil is dead and over.

I hope that helps. Do not hesitate to ask questions on the Energy Weekly publication too as I try to get closer to the trading environment.

Dear Greg,

short answer as i'm writting a piece onthat precise issue:

1. Demand has been damaged irreversibly like after the second oil shock. we are now in a period of seeking alternatives forms of transportation and production. there's a slight demand increase from cash rich countries to rebuild storage but that 's just a blip.

2. we will remain below $100 for a considerable time as we progress into a deflationary period.

3. it needs not cause pain to rich oil countries if the dollar keep appreciating. while their revenues will be somewhat less, in real terms they should be perfectly acceptable especially to those country that peg to the $. (see last week GaveKal Weekly Energy).

more answer to come in an AdHoc early next week