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Energy into the Future October 27, 2014

Posted by shaferfinancial in Finance.
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Let me start off the post stating two facts:
1. I don’t invest/speculate for short term movement, but take Buffett’s advice to invest as if you are throwing the stock into a drawer for 10 years.
2. No one has ever been able to predict oil prices in the short term [less than 3 years]. Just look at the oil price predictions from 1 year ago if you don’t believe me.

Production

I will start off with a few facts and then go into my opinion. World-wide almost all wells are producing less oil than they were. So we have a world wide per well decrease in production for the last decade that is increasing. This is true if we are talking the Saudi’s, North Sea, or even tight oil which has the highest depletion rate by far. So in order to increase oil production there must be an increase in wells drilled. No getting around that fact.

Over the last years there has been thousands of new oil wells drilled in North America because of the improvement in technology in fracking tight oil. But tight oil wells have a depletion rate as high as 40% for the first year alone, so in order for them to increase production NA shale oil players need to dramatically increase well drilling going forward. This is unsustainable as the best plays are drilled first and the lesser plays are starting to be drilled now. In order for their to be a decade long increase in production in tight oil, there either has to be several major discoveries the size of the Permian Basin and/or a dramatic increase in the technology. Neither are likely in my mind.

There has been much discussion on the majors moving to fracking tight oil, but that is really limited to two domestic majors, Chevron and Exxon with Exxon seemingly waiting to pick up some leases out of bankruptcy. Shell and BP have recently stated that they are ramping up their offshore drilling. And of course the nationals are for the most part dependent on offshore to ramp of their production. The truth is that for oil companies, they need to do everything they can to keep production up whether its onshore, fracking, or offshore. If they don’t then oil production will go down as their existing oil wells deplete.

Consumption

Worldwide consumption of oil products continues to increase. This is on the back of China/Asia increasing GNP and India increases in GNP. China GNP went up last quarter 7.2% [higher than most predicted], while India went up 5.5% [again higher than expected]. USA went up a little over 4%. Europe stayed flat and might be going into a recession while Japan also remained flat. Worldwide the predictions is for a 3.5% GNP increase for 2015 [again look at how badly prognosticators did last quarter before you put any confidence in that number].

Hear is my prediction: Worldwide consumption of oil will continue to increase for the foreseeable future.

So this is a pretty simple equation for me. Consumption will increase, while production will continue to need more wells drilled to keep up with the world-wide consumption. Can NA shale oil drilling keep up with the increased demand and the lowering production of existing wells world-wide? No not even close.
World wide consumption was 90.4M barrels a day in 2013. Likely to be in excess of 93M in 2014. Increase in USA production from 2013 to 2014 is expected to be around 1.5M barrels a day. OPEC can manipulate its production over a fairly tight range to account for short term variations, but many believe the Saudi’s [largest OPEC producer] is running pretty close to full bore.

Now add in that companies have to plan out 5-10 years in advance to create production level. So they need to have big drilling projects starting now to maintain their production. Where will they get this oil? They have to go to the biggest reserves which are mostly offshore.

Nothing I have seen over the last year has changed any of that analysis. Not the drop in oil prices over the last few months, not the increase in production in NA tight oil.

What we are seeing is folks trying to predict something that they can’t [oil production and consumption and oil price]. It is all just noise. Barring a world-wide depression consumption will increase. The oil has to be drilled to produce. The major oil companies will drill where there is oil whether it is in NA or offshore.

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