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Is Shell’s Lower Oil Forever Really So Unrealistic?

“Royal Dutch Shell PLC’s chief executive drew a collective gasp with his “lower forever” comment as one recent story put it.”  Funny, in 2012 when I said at an OPEC conference that the price was likely to return to the $50-60 range, it was not even taken seriously enough for gasps:  the moderator actually thought I was joking, and an oil company CEO replied, ‘Well, you hate to call someone an idiot’ apparently unaware I’ve been called much, much worse.

Of course, it’s true that prices are not as low as I predicted in a 1997 report published by the Gas Research Institute, when my argument was that a $23/barrel price (in 2015$) was sustainable over the long run, deviating from that only in response to political disruptions of supply.  (An oft-recited fact by my critics.)  Of course, none mention that in 1989, when I argued in Economist Intelligence Unit report “Oil Prices to 2000″” that the next decade would see slightly lower prices, the Petroleum Economist referred to it as a “heretical” view.  (I was correct.)

My mentor, the late Morry Adelman, ran into the same sort of thing throughout his career.  He began researching petroleum economics in the 1950s, and relied on the thought he expressed in 1986 as “Diminishing returns are opposed by increasing knowledge, both of the Earth’s crust and of methods of extraction and use.  The price of oil, like that of any mineral, is the uncertain fluctuating result of the conflict.”

Nonrenewable resources, for all the talk of their being finite, have never shown a tendency to rise in price except during economic booms or supply disruptions, after which they revert to earlier levels.  The Bronze Age ended three millennia ago, yet copper is still plentiful and cheap enough to use in pennies.  Petroleum, even with Rockefeller, the Texas Railroad Commission and the Seven Sisters at various time controlling the price, never experienced a long-term rising trend.

However, supply disruptions in the 1970s and 2000s caused the price to rise and inspired policies of resource nationalism, which constrained supplies from the producing countries with cheap oil.  They were supported in this by the thinking of those like the first U.S. Secretary of Energy, the late James Schlesinger, who argued that oil in the ground appreciated in value better than money in the bank.

Which is true:  if you choose the right time frame.  But if you withhold oil when the price is high, you will typically lose money.  Colleague Anas Alhajji once pointed out that someone who bought a case of beer in 1980, took the money from the bottle deposit and put it in the bank, by 1998 would have 42% of the cost of the full case of beer.  But someone who had bought and stored a barrel of oil would have lost 83%.

Many in the industry learned this lesson after the crashes of 1986 and 1998, so that when prices began to rise in 2003/4, the industry called for capital discipline with CEOs warning that high prices were cyclical in nature.  Increased spending at a time of high activity would only drive up costs, several argued, and so they wouldn’t try to poach skilled workers or sign expensive equipment leases.  That, however, didn’t last for very long.

What’s more incredible is that while decrying rising costs in the upstream sector, many began to attribute them to geology:  the easy oil is gone, and with costs at $100/barrel, prices below that level were unsustainable.  Which was more or less nonsense, despite being widely believed.

This has all happened before, specifically in the 1980s.  After the Iranian Revolution sent oil prices soaring, instead of declaring it a transient event, the consensus insisted that “The gas lines and rapid increases in oil prices during the first half of 1979 are but symptoms of the underlying oil supply problem; that is, the world can no longer count on increases in oil production to meet its energy needs.”  (From an August 1979 Central Intelligence Agency report.)

And instead of expecting some price weakness, most thought that price increases had only begun.  The figure below compares oil price forecast from a 1980 Stanford meeting of the Energy Modeling Forum, where only one model (Nazli Choucri’s IPE, which I was the assistant on) saw prices dropping in the near term.  None was even close to accurate, and I have the dubious honor of bragging [sic] about a 2000 oil price forecast that was “only” off by about 300%.

When prices failed to continue rising, it was said that they were “low.”  The New York Times in 1982, when oil prices were still four times the historical norm, referred to “The Dark Side of the Oil Glut.”  The OECD Observerin October 1985 contained an article arguing that the then-current price of $60/barrel (in 2015$) was too low to allow enough investment to provide adequate supply.  (Sound familiar?)  Two months later, the price had dropped by 40%, where it remained for 15 years.

Which generated numerous warnings of the negative impact of supposedly low prices.  Robert Hirsch, later a proponent of the peak oil theory, published a warning in Science magazine in 1987 about “The Impending United States Energy Crisis” caused by low oil prices, as did Donald Hodel, in a 1994 book Crisis in the Oil Patch.  Neither seemed to understand that pre-1986 prices were very high.

Current forecasts (from EIAs 2016 International Energy Outlook) mostly foresee a recovery to the $70-80 range in the next few years (figure below; I have interpolated the points in the survey).  Needless to say, my forecast still receives a fair amount of derision because, well, oil is finite you know.  (It isn’t, actually.)But if you consider the forecasts with a little historical context, as the next figure does, the consensus looks a little less reasonable.  Essentially, most appear to believe that the unusual situation of the 2000s will be the norm in the long-term.  Even without shale oil, this appears unlikely to me.

But if you consider the forecasts with a little historical context, as the next figure does, the consensus looks a little less reasonable.  Essentially, most appear to believe that the unusual situation of the 2000s will be the norm in the long-term.  Even without shale oil, this appears unlikely to me.

Long-term oil prices could be in the range of $100 or more, but only if there were external restrictions on oil supply, whether due to resource nationalism, nimbyism, or extended and extreme political instability in producing zones.  There is also a chance that extended recession could keep prices below $30 for a lengthy period, or that burgeoning production of cheap shale oil would leave them depressed.

But for now, the growing push among countries like Iran, Iraq, Mexico and probably soon Venezuela to attract upstream capital should help ensure that the price remains moderate, as always, barring major political disruptions.

(These arguments, and the data, can be found in my book The Peak Oil Scare and the Coming Oil Flood.)

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