The Changing Face of World Oil Markets

U.S. field production of crude oil, by source, 1860-2013, in millions of barrels per day. Source: Hamilton (2014).

James Hamilton is out with a new paper "The Changing Face of World Oil Markets

"The run-up of oil prices over the last decade resulted from strong growth of demand from emerging economies confronting limited physical potential to increase production from conventional sources... My conclusion is that hundred-dollar oil is here to stay," Hamilton writes.

UK-based Reuters writer John Kemp is already on Twitter promising a response and I'm looking forward to it (Update: Here it is (7/28/14)). Kemp is one of the very few optimists in the Peak Oil debate that presents arguments better than "Technology & Innovation... trust us!" I rarely agree with Kemp, but I do enjoy reading his work. Last year, he took on Art Berman and others with "Skeptics are wrong to bet against shale expansion"

You can follow the debate on Hamilton's paper in the always useful comments section of Hamilton's blog. 

After Hamilton's academic credentials were questioned in the comments, a response by Steven Kopits is worth reprinting in full below:

Jim is the pre-eminent macroeconomist covering oil markets. That’s why the International Energy Economists Association singled Jim out for his contributions to the field just a few weeks ago. There are others in this top group: Lutz Killian, Michael Kumhof of the IMF (vastly under-appreciated), Dermot Gately (now retired) and probably me (although I am not a professional economist). These are economists, not commodity analysts. Neither the IEA nor EIA has anyone at this level; nor do the oil companies. Nor does CERA (IHS) or PIRA.

As regards Goldman: They are clearly at sea with regards to their thinking about oil markets.

Here’s Jeff Currie, Head of Global Commodities Research at Goldman Sachs, from a July 22 note:

“Over a decade ago, there were two types of supply constraints: 1) technological constraints that prevented engineers from accessing oil they knew existed, such as shale, oil sands and ultra-deepwater and 2) political constraints such as exorbitantly high taxation in Russia, bans on foreign investment into the oil sector in places like Mexico and Saudi Arabia, bans driven by environmental goals, and outright civil unrest that made investment too risky. Either the technology or the politics had to change in order to create new supply. Think of it as a race between the engineers and politicians.

As it turned out, the engineers won.”

In natural gas, this may be true, at least in the US. And even that you have to take with a grain of salt. In the late 1990s, nat gas averaged around $2.20 / mmbtu, which should be about $3 in today’s money. Nat gas is $3.80 today. Engineers did not make natural gas cheaper in real terms, compared to the pre-2000 era. Not even in the US.

As for oil, if engineers were so successful, why have E&P costs been rising at an 11% pace after allowing for technological improvement. The engineers are not losing, they’re getting creamed, when we consider the economics of the industry as a whole. Nor is it clear that shale oil is cheap. Bernstein (who are much better analysts than the Goldman team right now) calculate the marginal shale barrel in the US at $111. WTI today was at $102.

The politicians are not throwing in the towel because the price of oil has collapsed. They are throwing in the towel because their vaunted engineers have been unable to control E&P costs. Jeff knows that. It’s in Goldman’s own reports. But he doesn’t understand the logic. Goldman doesn’t use a supply-constrained model. If you try to explain what’s going on with a demand-constrained approach, you end up with rather tortured arguments, much along the lines of Jeff’s.

If you use a supply-constrained model, it’s pretty simple. Once you get to the carrying capacity price, price increases depend on increases in purchasing power, not marginal cost. If you’re an exporting petro-state (with an NOC), you’ll be facing the same cost pressures facing the IOCs, ie, your costs will be rising faster than your revenues. If you want to increase net revenue, you have to increase production (exactly the opposite of the 2003-2011 period, when the overwhelming share of revenue increases came from increased selling prices ). Hence the pressure to open up access to heretofore closed or restricted economies (a point I make during the Q&A of my Feb. Columbia University presentation). OPEC and other exporters will need increased production to increase revenues. You should not, however, assume that production in these places is easy to increase in the short, or even medium, term.

So, if you’re thinking that Jim is somehow on the periphery of the professional debate, you’d be wrong. On the academic side, he is literally at the heart of it.