Date: June 2012: FuturePundit: Marginal Oil Production Cost Nearing $92 Per Barrel

Energy analysts at Bernstein say the marginal cost of oil production, already $92 per barrel, is nearing $100 per barrel.

The marginal cost of the 50 largest oil and gas producers globally increased to US$92/bbl in 2011, an increase of 11% y-o-y and in-line with historical average CAGR growth. Assuming another double digit increase this year, marginal costs for the 50 largest oil and gas producers could reach close to US$100/bbl.

Their analysis does not include OPEC or former Soviet Union producers. But this does not matter. Since the former SU and OPEC aren't going to grow their production fast enough to meet rising world demand the marginal cost of the other producers will determine at what price rising demand and market price will meet.

This rapidly rising marginal cost of production is what Peak Oil looks like. Peak Oil is going to happen because marginal cost will go too high for the world economy to afford to pay what it takes to boost production. At that point oil production will start falling. I originally expected peak production to happen at a much higher price for oil. But the European debt crisis, the deceleration of Chinese economic growth, and the continued weak US economic recovery make me think peak global oil production will happen at a price not much higher than current oil prices.

The costs of tight shale oil is very high and high oil prices are needed to keep it flowing.

"The United States is producing an awful amount of oil from tight shale and tight sands reservoirs... If oil prices send a signal and drop below the $90-$80 level it is going to be uneconomic to drill those well. So drilling will stop immediately," said Michel Hulme, fund manager at Lombard Odier.

How high an oil price is needed to start world oil demand headed on a downward slope? Higher or lower than the current price range near $90-100?

Is this occurring because of actual increased costs, I wonder, or the global currency-weakening race?

On the one hand I would assume the numbers are inflation-adjusted, so if the inflation stats are accurate then the global currency weakening race would have no effect. But on the other hand, I don't think the inflation figures published by the government are accurate... so you may have a point.World production figures also look a lot like a big flat peak. 2005 wasn't quite the peak as it turned out... but the monstrous effort required just to maintain at (or slightly above) that level give us the flat shape of the top of the bell-shaped production curve.

Why don't you put your money where your mouth is and make a bet with Julian Simon. He hasn't lost yet.

Since these figures are not in constant dollars (i.e., dollars that factor in inflation), they are meaningless.Of course the marginal rate increases, partially (mostly?) because the dollar depreciates.

As people appear to be wondering, I can state that yes, even from where I sit on top of the currency pile, gasoline prices (we call it petrol here in Australia) have been increasing. While prices have not regained their 2007 peak, they have been trending up since 2008, despite the somewhat silly strength of the Australian dollar.

The AUD is only silly-strong because everybody else's governments are acting like wayward feudal monarchs. Thanks for the feedback, though, it's good to know.

There is a cost feedback here that's important:

When oil drilling suddenly jumps, the cost of all the resources needed (skilled labor, rigs, pipes, etc) will rise to meet demand (until there is time for additional supply of these resources to develop). That means that in the medium term the marginal price of oil production will tend to be equal to the market price of oil, whatever that price is...

I am skeptical of the "Peak Oil" concept. The increase cost of producing oil is in large part caused by the devaluation of the U.S. dollar. Since oil is traded in U.S. dollars and the U.S. dollar has declined in value, it costs more U.S. dollars to buy each barrel of oil. In other words, oil is not expensive. The U.S. dollar is cheap.

Likewise, if you think of gold as being an alternate currency to the U.S. dollar and the Euro, the cost of oil has actually declined since an ounce of gold will purchase more oil today than it would have five years ago. The devaluation of the U.S. dollar also explains why the Euro has not more substantially devalued. The Eurozone is a mess, but the U.S. economy is not much better.

I've been assuming we're at the peak now and have been since 2005. What we've seen since 2008 is increasing oil prices without any real increase in production. An increase in demand will push up prices and might increase production, but high prices will also result in a lot of improved efficiency and substitution that will help keep a lid on demand. So I think we're at the peak now and any further production increases won't be very significant. The current production plateau will continue more or less as it has up until the point where it goes into decline.

Randall

It is more than unlikely that Julian Simon would not have lost a second bet to a sky-is-falling crackpot such as Paul Erlich. One thing Simon was well aware of was monetary inflation and its disasterous effects on an economy. Recall that he did stipulate for the bet to be inflation adjusted. He also understood the structure of an economy; how the factors of production were deployed, how they interacted and the effect this had on costs. Simon was a careful analyst who did not walk into the trivial rhetorical traps set for him by the likes of Erlich and Holden. Anyway, Julian Simon died a while back, so it is not possible to engage him in discussion. The reality remains that he won the bet and Erlich lost and lost it bad. The results of a second bet are pure supposition as one was not designed, agreed upon or entered into by the parties to the original. End of story.

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SLK is correct. Monetary inflation results in price rises. It is accompanied by destruction of wealth and erosion of savings. What you need to understand is that the effects of monetary inflation do not occur instantaneously across all sectors of an economy at the same instant. Nevertheless they are all but inevitable. It is merely a matter of time. As was well said, "Slowly at first the water she heats, suddenly then, frog finds he being boiled alive."

SLK's analysis regarding the state of the US and Eurozone economies is sound. Were it not for counterparty risk, this would be an opportune time to be engaging in shorting the guts out of both of 'em.

Sione