A Little Historical Background

Non-OPEC production has been on a rough plateau since 2004. It fell slightly in 2005 then increased a bit in 2006 and 2007. For 2008, the US Energy Information Agency (EIA) predicted that non-OPEC production would increase ~1 million barrels per day. Non-OPEC producers certainly had a price signal from high oil prices to increase their production in 2008. But instead, overall non-OPEC output was down ~300,000 barrels per day (b/d). In December, the EIA predicted an increase of ~400,000 b/d — with much of that occurring in the US, Brazil, and Azerbaijan. Such an increase would require OPEC producers to keep their production at current levels or to drop even further to maintain current prices amid the recession.

But the non-OPEC production increase the EIA expects could evaporate just like in 2008 or even worse. Norway expects its oil production to fall ~9.7% — which means a drop of ~200,000 b/d. Mexico expects production ~3 million b/d, or a drop of ~170,000 b/d. The UK will probably fall at least another 100,000 b/d. And now Russian production is more suspect. If their output falls 2%, that means a drop of ~200,000 b/d. That 700,000 b/d of non-OPEC declines may be difficult for other producers to offset. And the low price signal supports little new production to offset mature field declines.

US production is projected to increase by ~400,000 b/d on less hurricanes and some new fields ramping up. But the first week of US production was below its 2008 level — so we will have to see big change for EIA projections to become reality. The supply constraints do not equate to a scary first half of 2009 because demand has fallen so dramatically. But if economic recovery tries to pick up in the second half of this year or in 2010, we shouldn’t count on large increases in non-OPEC oil to fuel it.

Bottom line: The potentially declining non-OPEC supply picture is another reason we should all help Obama transform the US energy system through a Green Stimulus Package. Economic growth can be securely built on the efficient use of renewables for future demand growth and through substituting some of the carbon-emitting fossil fuels upon which we now depend.

Onwards in the Sustainable Energy Transition!

The weekly natural gas report showed strong growth in inventories due to mild temperatures and some recovery in Gulf production post-Ike. This report, along with dollar strengthening today, will likely pressure natural gas prices to remain below $8 per MBtu in the near-term.

In oil news, Russia’s September production remained below last year’s level for the ninth month in a row, all but guaranteeing that 2008 will be the first year since 1998 to exhibit falling production. Russian lawmakers have reduced taxes to incentivize higher production, but they may run into the same relentless declines that have faced other countries like Mexico, Norway and the US. If that is the case, we will become very dependent on OPEC to supply larger amounts of oil — a precarious energy future to say the least.

Tomorrow, I will discuss two reports that just came out: 1) warning of a potential electricity capacity crisis in the US within the next ten years and 2) Google.org’s plan to replace fossil fuels with solar and wind energy.

Onwards in the sustainable energy transition-

Another major story that emerged today was Mexico’s announcement that its oil production continued its rapid decline. Their main oil field, Cantarell, managed less than a million barrels per day of production in July — less than half its production a few short years ago. At 974,000 barrels per day, Cantarell production has dropped more than a third from last July. New production at key fields such as Chincotepec and Ku Maloob Zaap can only offset part of the decline from Cantarell — threatening our major source of imports to become a net importer themselves within a few years. On top of that, the President of major oil and gas producer Russia said today that they are not afraid of a new Cold War after they recognized the breakaway Georgian territories of Abkhazia and South Ossetia.

With hurricanes, oil production declines, accelerating melting in Greenland’s glaciers, and political gaming — it’s clear that a sustainable energy transition must become a higher priority for the US and all other oil importers.

A more recent conflict raises the specter of energy wars again. There is an enormous risk that nations’ dependence on energy as consumers or as revenue sources may ignite open warfare for resource control. With current oil prices, the commodity makes up a multi-trillion dollar chunk of the global economy. And since world transportation is more than 90% dependent on oil, a lack of the stuff can bring an economy to a halt. The recent Russian incursions into Georgia alters the control of Caspian oil routes to the West through major pipelines. The Caspian has been and is projected to be one of the key sources of growth in global oil production while other regions like the North Sea and Mexico decline. Russia’s current President, Medvedev, was a leader of the largest natural gas firm in the world, Gazprom, showing close ties between that nation-state and its key energy firms. If Russia controls the Caspian flow, then they can negotiate higher priced contracts with their customers in Europe and elsewhere.

And if we let the energy situation get further out of hand, future conflicts worldwide could be exacerbated by importer or exporter nations who fight proxy or direct wars in energy producing regions to gain greater negotiating power for their contracts. This nexus between resource scarcity/volatility and war shows even further benefits for demand reduction and renewables substitution to reduce our dependence on foreign oil. Today’s theme: A sustainable energy future is a crucial ingredient for peace.

When I say debate the plan’s merits, I will not focus on whether it works as a vehicle to win the election – though that may be the most important factor under consideration for both parties. I will rather talk about whether such a plan can help US citizens handle the difficult spike in energy prices.

We have just over 700 million barrels (Mb) of oil in Louisiana salt caverns. The SPR was set up as a response to the oil shocks of the 1970s when embargoes caused serious shortages of oil in the US and other major importing countries. The SPR is a useful tool in the case of future embargoes or major oil disruptions. For instance, if there were an attack on Iran and the country responded with a blockade that curtailed 3 million barrels per day (Mbd) of flow — a release of ~1.5 Mbd for several weeks could help replace the Saudi Arabian oil that we would lose access to. Assuming somewhat quick resolution that allowed most of the oil to flow again within a few months (a la the first Gulf War), the SPR release would help avert a physical shortage and bullish chaos in oil prices during that period. The SPR would unquestionably help maintain some stability during a difficult time.

But what about the current situation, when the oil market is characterized by the last six years of rapid demand increases that producers struggle to supply? The benefits versus costs of an SPR release at this time are more ambiguous, since it acts as a temporary band-aid to what may be a much deeper problem of oil supply stagnation (and even imminent decline).

The proposal: Since I have not seen the exact details of Obama’s plan I will estimate his proposal is similar to ones put forward by members of Congress. Averaging ideas in their discussions, I will consider a 50 Mb release over 100 days (September 1-early January) at .5 Mbd that lowers the SPR by ~7% to ~650 Mb.

1. Will it help reduce prices?

Maybe in a miniscule way. This would reduce our import need by ~4% (.5/12.5), but prices are determined globally — where .5 Mbd is less than .6% of global oil flow. Based on an equation I have put together that matches supply/demand balance to prices over the last 15 years, this change may reduce prices by ~3% or 10 cents/gallon. So, the change may reduce average drivers’ gas bills by ~$14 during the 100 days.

But there are no guarantees that prices would be reduced significantly because a futures market would discount the oil today by the fact that less oil is available in the SPR tomorrow. And OPEC producers may welcome the .5 Mbd addition to the world market by reducing their own production by an equal amount to maintain current prices, thus making the SPR release impotent. It is in their interest to do such cuts to maintain their astronomical revenues.

2. Will it generate optimal revenue? The release (or sale to refiners) could generate ~$6 billion (50 million barrels*~$120/barrel) in revenue.

The opportunity cost of releasing the oil in 2008 would be the 7% less security and reduction in assets for the future. If we think that prices should be heading down in the future then releasing oil makes financial sense as the federal government would make higher revenue selling it to the market now and would help to mitigate a temporary market imbalance. But if the demand/supply imbalance were long-term as current trends appear to support, then our government may miss out on the opportunity to sell our SPR at a higher price in the future. For instance, the 50 Mb would generate $12.5 billion (not $6 billion) if it were sold to a $250 per barrel oil market. But we need to discount that opportunity with a discount rate (let’s say its 3.5%/yr, so if the price of oil increases faster than 3.5%/yr then it is not a sound decision based on long-term revenue potential to sell it now versus later as a nominal $250/barrel in 2028 is ~the same as $125/barrel in 2008).

3. Would an SPR release help the economy avert a major recession?

The last question is whether an SPR release would act as a sort of stimulus package to help relieve temporary economic difficulties, helping to lower the inflation rate and giving consumers a few more dollars to pay off their credit card debt or contribute to their mortgage payment. But the case could also be made that such a release will give people the counterproductive idea that it’s OK for them to stay addicted to oil at current levels.

In sum, an SPR release is set up to provide temporary relief to mitigate supply deficits. As long as Obama’s proposed release isn’t too large, such a policy probably couldn’t cause much harm and may do some good. But the big picture remains: increased oil demand in emerging economies and Middle East producers while oil production is declining throughout most of the non-OPEC world make US consumption levels dangerously high. Our oil focus needs to be on the efficiency and deployment of plug-in hybrid electric vehicles and transit/bike/ped infrastructure throughout the next two Presidential Administrations at least. And of course such a focus could help us mitigate the threat of rapid climate change as well.

Since gas prices are almost four times what they were when Bush came into office, you’d think it would be easy for Democrats to mobilize public outrage over energy prices for a change of the guard to their choice of Obama. But how that plays out remains to be seen. I hope that the big picture remains in view. Just as today’s Russian production totals for July at 1% below last year remind us, supply is struggling to keep up with demand. The biggest lever we have is our ability to transport ourselves and our goods more efficiently. And we can act in a matter of weeks to lower our bills, rather than wait years to see ANWR and offshore oil change our prices by a few small percentage points.

Let’s choose the sustainable energy transition.