Edition Forty Five December 2015

Latest US Jobs Report Means Oil At $100 In Early 2017

Why Oil Will Crash Again in 2016
Oops! Low oil prices are related to a debt bubble

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Adam Marmaras
Issue 45 December 2015

Manager, Technical Director

Hello readers,
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Welcome to another edition of the OilVoice

Magazine. This month we have the usual
quality insight from Kurt Cobb, Alahdal A.
Hussein and Andreas de Vries - just to name
a few.
It's been a very tough year for the industry.
Even now we're hearing of the massive layoff
numbers in Houston and the North Sea, and
the situation is quite brutal. How many of you
are considering changing careers? Is
there any good news out there?
There is talk of things getting better in Spring,
but that could be false hope. Does anyone
really know when the price of oil will return to
something economically viable? I know I'm
asking a lot of questions in this intro, but I'm
only mirroring the conversations I hear
colleagues having. The future is very
uncertain.

Read on your iPad

You can open PDF documents, such
as a PDF attached to an email, with
iBooks.

This month we've added some extra

advertisers to our pages so be sure to read
through right to the end.
Have a great Christmas
Adam Marmaras
Managing Director
OilVoice

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Table of Contents
Why Oil Will Crash Again in 2016
by Andreas de Vries

Expecting The Return Of High Oil Prices? Think Again... Here's

Why
by Alahdal A. Hussein

10

OPEC Can't Win

by Euan Mearns

15

Oops! Low oil prices are related to a debt bubble

by Gail Tverberg

20

Oil price forecasts based on myths, not proper analysis

by Paul Hodges

33

This Is The Only US Shale Play Doing What It's Supposed To

by Keith Schaefer

37

Latest US Jobs Report Means Oil At $100 In Early 2017

by John Richardson

43

LNG - the Coolest Player in the European Gas Game

by Patrik Farkas

40

Exxon: We knew climate change was a real threat (but we didn't

want you to)
by Kurt Cobb

41

Why Oil Will Crash

Again in 2016
Written by Andreas de Vries from Andreas de Vries
In 1950 the American mathematician and economist John Forbes Nash, Jr. earned
his PhD with a dissertation that explained why markets can gravitate towards a suboptimal equilibrium. What is now known as a Nash Equilibrium results when all
economic actors know that a different strategy would be better for them, but they
also know that this different strategy will only be better for them if all other economic
actors also change their strategy, as a consequence of which no-one will do
anything.
This situation is effectively what caused the oil price crash of 2014. As I documented
in 'The trends that will keep the oil price below $60/B', the historically high oil price of
the period 2000 - 2013 caused a massive influx of money into the oil & gas industry.
This money was used by the oil & gas industry to increase production capacity,
under the assumption that economic growth would increase global crude oil demand
to such an extent that the market would be able to absorb the additional barrels.
Since 2008, however, economic growth has largely disappointed. (Pretty much every
quarter since the IMF has had to revise its global growth forecast downward.)
Consequently, a crude oil supply glut built up. To maintain the (then still) comfortable
price level the oil & gas industry should have gradually lowered production, but it
didn't. The producers were enjoying the high price too much and everyone knew that
a reduction in his or her production would only support the price if everyone else did
the same. So no-one did anything, hoping someone else would. This Nash
Equilibrium lead to a steady increase in the imbalance between supply and demand,
until it reached close to 2 million barrels per day in the 4th quarter of 2014, causing
the price to collapse.

Unfortunat
ely, this
crash has
not broken
the market
free from
the Nash
Equilibriu
m. Rather,
it has
locked it
into
another
one.

It is well known that despite impressive improvements in efficiency over the last year,
a substantial part of the current tarsand and shale operations in North-America is
unprofitable in the current price environment of $40 to $50 per barrel. Producers in
these (and other) high-cost areas would actually make more money if they shut in
production, but only very few actually have. In fact, global liquids productions has
increased, from 92.5 million barrels per day during the 2nd quarter of 2014 to 96.3
million barrels per day in the 3rd quarter of 2015.
The reason for this surprising fact is that the oil & gas producers know that the first
one to take the rational step of reducing production will lose if all others don't follow
suit. Hence OPEC's decision not to reduce its production - why would it reduce in the
knowledge that those who do not reduce would then reap the benefit of a higher
prices?
The consequence of this new Nash Equilibrium in the global crude oil market is a
massive increase in inventories. According to the International Energy Agency the
global stockpile of crude oil now stands at almost 3 billion barrels. Around the world,
land storage sites are essentially full and producers and traders have turned to
storing excess crude in tankers, driving up the day rate of supertankers to around
$100,000 per day, its highest level since 2008.

This new Nash Equilibrium can end in only one way: another crude oil price crash.
So far, the high-cost producers in North-America have been enabled to continue
uneconomical production by banks providing credit on terms equal to, or even better
than those during the boom years. (Clearly, the banks are part of the current Nash
Equilibrium. Every one of the original lenders to the shale industry knows that it
would only be sensible to cut back lending, but he or she also know that whoever
cuts back credit first will lose because his borrowers will go bankrupt, unless all other
banks do the same at the same time.) In addition, private equity investors have
stepped in, hoping to snap up crude oil assets on the cheap and willing to finance
unprofitable operations until the oil price recovers.
Therefore, unless the price goes down further, shale production will not collapse any
time soon and the supply glut will remain. This effectively means that in the absence
of a sudden uptick in crude oil demand (which is highly unlikely, as the Chinese
economy is slowing and the country can not continue to build up strategic petroleum
reserves), the price will go down.
With land storage already full and floating storage increasingly uneconomical due to
the high day rates for supertankers, it is just a matter of time before the market
realizes it doesn't have to buy crude at oil $40 per barrel. Because producers are
getting ever closer to the situation where they simply have to sell their production, at
any price, due to a lack of other options. This will change market sentiment and drive
the crude oil price further down, even making $20 per barrel a distinct option.
In other words, the current Nash Equilibrium will be broken up by another price
crash, one that will really reset the industry back to normal and rebalance crude oil
supply and demand. Only from that point onward will the rule that the crude oil price
is determined by the cost of the marginal barrel apply again, which, as I explained in
'The trends that will keep the oil price below $60/B', I foresee to be around $60 per
barrel.
But we'll need to go down first, before we can start going up again.
View more quality content from
Andreas de Vries

10

Expecting The Return Of

High Oil Prices? Think
Again... Here's Why
Written by Alahdal A. Hussein
from Society of Petroleum Engineers (SPE)

It has been almost a year since oil prices hit new lows after OPEC's November 2014
decision not to cut production. Speculation by oil companies, industry analysts,
investors and financial experts that oil prices will rebound have not come true, and
prices continue to dip regardless of the few attempts of oil price recoveries.

Since the beginning of 2015, oil prices have seen a few modest recoveries that were
mostly due to falling rig counts, U.S. oil production decline, weakness in the U.S.
dollar or, lately, the escalating conflict in the Middle East. However, those recoveries
were short-lived.

A recent example of such recoveries in oil prices was the latest rally of early
October, when WTI jumped from mid-$40s per barrel to $50 per barrel following the
news of falling rig counts and the U.S. oil production decline. Many O&G companies
and analysts put their hope in this rally and saw it as the first signal for a long and
lasting recovery in oil prices. But, unfortunately, the rally did not last for long.

The following week, as the oil markets started to digest 'what happens next' and the
fact that the underlying fundamentals of supply and demand were unchanged due to
continuous growth of supply from other producers - mostly OPEC's members such
as Iraq, UAE, and Iran - oil prices retreated again. WTI dropped from $50 per barrel
back to $47 per barrel.

10

11

What the latest rally in oil prices meant

It is undoubtedly true that October's rally and how it ended was much of an eye
opener for many of those who were still hoping for a rebound. It made it clear that
'instead of hoping for a rebound, oil companies should learn how to make a living at
oil prices level of $40 per barrel or even less'.
Besides that, it is now clear that the issue is more about who will win the marketshare cold war, rather than who must balance the supply and demand. OPEC has
been always playing its role to balance supply and demand, but this time it chose to
pursue market-share. Therefore, supply and demand fundamentals are only being
used as a weapon in this market-share cold war.
October's rally also indicated that it will be unlikely to see high oil prices again as
'Lower for Longer' oil price strategy is the new normal in the oil and gas market.
The new normal: 'Lower for Longer' and why
It is now without doubt that OPEC's November meeting was a pivotal moment for the
oil and gas industry. A moment where we all look back and ask, could things go back
to the way they were before November 2014?
The answer to this question is definitely a big 'NO', and I believe by now, many of
those who were expecting things to get better and prices to increase to at least $70
per barrel have realized that oil prices are unlikely to go up to that level at least for
the short-term. And that means accepting the 'Lower for Longer' oil price strategy as
the new normal in the oil market.
OPEC's current strategy to pursue market-share over stabilizing the market is seen
as response to the threat posed by U.S. shale oil producers. By pursuing marketshare and keeping its production level sustained resulting in collapsing oil prices,
OPEC aims at squeezing high cost U.S. shale oil producers out of the market, and
therefore putting an end to the threat posed to its market share.
Besides that, the main reason why lower for longer oil price strategy is going to be
the new normal for at least the short-term is the fact that high oil prices is the main
reason for the current downturn.

11

12

How high oil prices led to the current downturn?

When higher oil prices were sustained for a long term, it provided an excellent
breeding season for few advanced technologies used to develop shale oil such as
hydraulic fracturing and horizontal drilling to nurture and flourish over the past years.

The use of such technologies increased the U.S. shale oil production to over 4.72
MMBD at the end of 2014 down from 1.24 million barrels daily (MMBD) back in 2007.
The new U.S. oil output supplied the domestic market and pushed out oil imports
from traditional suppliers such as Saudi Arabia, Nigeria and Algeria that suddenly
needed to find new market for its oil.

The oil production introduced by shale oil producers slightly glut the market at the
beginning, and the call was for OPEC to play its role to stabilize the market by
increasing/decreasing its production output. It seemed that U.S. shale producers
were certainly optimistic about OPEC's reaction. But this time, it was different. OPEC
was facing hard choices.

Playing its role to stabilize the market by reducing its oil production meant losing its
market-share for U.S. shale oil producers which OPEC cannot afford to do, because
the long term consequences for such decision meant losing its market-share and
influence on oil prices. As a result, OPEC decided to pursue market-share strategy
instead of stabilizing the market.

OPEC's decision marked the beginning of market-share cold war and drove oil prices
down to levels not seen since the depths of the 2009 recession. By following such a
strategy, OPEC aims to protect its market-share, force high-cost oil producers such
as shale oil, and deepwater out of the market, and let the market balance itself.

12

13

Why no increase in oil prices any time soon?

Looking back at what have been discussed above, it is crystal clear that the roots to
the current downturn lay mainly on the sustained high oil prices for a longer term
before November 2014. High oil prices means sustained and economical production
and development of shale oil not only in the United States, but also in China and
other counties as well, and this means OPEC was losing its influence and marketshare.
Therefore, it is expected that OPEC will stick firmly to its strategy leading to
sustained low oil prices for a long time. The result will be squeezing oil rivals such as
shale producers out of the market, reducing investment in technology and innovation
and hindering the development of new shale oil projects which will ultimately
decrease shale oil production and discourage any future investments in such
projects.
What makes the situation even more certain is the expected increase of Iranian oil
production after lifting the sanctions. Furthermore, Russia, Iraq, Libya, Kuwait and
UAE are working aggressively on increasing their oil outputs. On the other hand,
global oil demand is lagging behind due to slow economic activities. Therefore, lower
for longer oil prices are here to stay for quite some time but surely not for an
extended period of time.
We have learned from the history of oil and gas industry that neither higher nor lower
oil prices are sustainable over a long period of time. The current low oil prices will
discourage upstream activities such as exploration and production- affecting the
supply side of the equation and consequently leading to higher oil prices. But it is
hard to tell at present when- or how much- that increase in oil prices is going to be.

View more quality content from

Society of Petroleum Engineers (SPE)

13

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15

OPEC Can't Win

Written by Euan Mearns from Energy Matters
As the oil price war unfolds it becomes easier to understand the outcome. There is
ongoing speculation about the motives of the main players. Is it a battle between
OPEC and US shale? Or a battle by the USA and Saudi Arabia against Russia and
Iran? I lean quite strongly towards a market driven version of the former and believe
that OPEC (i.e. Saudi Arabia) cannot win against the USA. Low oil prices are a major
benefit to the US economy and US citizens, a disaster for OPEC and Saudi Arabia.
Figure 1 shows how halving oil prices slashes export revenues for the exporting
countries while halving the cost of oil imports to the USA.

Figure 1 Oil export and import figures based on BP 2014 for the year 2013. Values
based on constant $2014. The average oil price in 2014 was $110, shown in blue.
Had the oil price been $50 in that year, the value of oil exports to the exporting
countries would have halved (red). On the other hand, the cost of oil imports to the
USA would also have halved. One man's poison is another man's candy.

15

16

Methodology
The methodology employed is very simple and some may argue too simple, but it
serves to demonstrate a few points. I have used BP oil production and consumption
data, average annual oil price data and World Bank GDP data, all for 2013 to
calculate the value of production, exports / imports compared with GDP. Exports are
simply the difference between production and consumption. I'm aware of the
limitations here.
Figure 2 shows the value of oil production to the various economies expressed as %
of GDP.

Figure 2 The oil price averaged $110 in 2013. The value of production, therefore, is
barrels per day * 365 * 110. For Saudi Arabia 11.393 Mbpd * 365 * 110 = $457
billion. with GDP reported as $748 billion, oil production works out as 61% of GDP.
Consequences
The main point I want to make is that oil production is 2.4% of US GDP. The US has
the biggest oil industry in the world and yet it has rather small importance to the
economy as a whole. The fall in the value of oil production to $50 may turn out to be
catastrophic for some OPEC countries, it barely affects USA GDP at all and bestows

16

17

major benefits via lower energy costs and a positive impact on the trade balance.
The gigantic size of the US economy compared with the other players is shown in
Figure 3.
Figure 3 In
green is actual
GDP when oil
was $110 / bbl.
In blue is a
notional GDP if
oil had been $50
/ bbl. Its difficult
to see what is
going on with
the OPEC
states, so they
are reproduced
separately in
Figure 4.

Figure 4 The
same data as
shown in Figure
3, but for OPEC
countries only.
The drop from
$110 to $50 is
particularly
painful for the
Gulf States.
While they may
be the most
wealthy, they are
also being hit the
hardest. Kuwait
with a possible 39% drop in GDP, Saudi Arabia 33%. These numbers could be quite
far out but indicate the scale of the consequences (Figure 5).

17

18

Figure 5 Had
oil traded at
$50 in 2013,
this chart
illustrates the
drop in GDP
that oil
exporting
countries may
have
experienced.

To Sum Up
Cheap oil is a major benefit to the US economy. Cheap oil reduces the cost of US oil
imports and is good for the trade balance. The lost value of indigenous oil production
in the US is of little consequence to its gigantic economy. In summary, cheap oil is
really, really good for America and Americans.
In contrast, oil production is the major part of OPEC GDP, especially the Gulf states
that have rather undiversified economies. The drop to $50 is a disaster for them.
With WTI flirting with near term lows (on $40.73), the time of reckoning is nigh for the
oil price. Things could be about to become a lot worse. It is very difficult to
understand the OPEC strategy unless there is in fact a hidden political agenda. A
production cut of 2 Mbpd (shared with Russia) would see the price and all their
economies bounce. Sticking to the current course will see 2016 worse than 2015 for
oil producers while the consumers party.
Heads the USA wins. Tails Saudi Arabia loses.

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Energy Matters

18

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Oops! Low oil prices are

related to a debt bubble
Written by Gail Tverberg from Our Finite World
Why is the price of oil so low now? In fact, why are all commodity prices so low? I
see the problem as being an affordability issue that has been hidden by a growing
debt bubble. As this debt bubble has expanded, it has kept the sales prices of
commodities up with the cost of extraction (Figure 1), even though wages have not
been rising as fast as commodity prices since about the year 2000. Now many
countries are cutting back on the rate of debt growth because debt/GDP ratios are
becoming unreasonably high, and because the productivity of additional debt is
falling.
If wages are stagnating, and debt is not growing very rapidly, the price of
commodities tends to fall back to what is affordable by consumers. This is the
problem we are experiencing now (Figure 1).

Figure 1. Author's illustration of problem we are now encountering.

I will explain the situation more fully in the form of a presentation. It can be
downloaded in PDF form: Oops! The world economy depends on an energy-related
debt bubble. Let's start with the first slide, after the title slide.

20

21

Slide 2
Growth is incredibly important to the economy (Slide 2). If the economy is growing,
we keep needing to build more buildings, vehicles, and roads, leading to more jobs.
Existing businesses find demand for their products rising. Because of this rising
demand, profits of many businesses can be expected to rise over time, thanks to
economies of scale.
Something that is not as obvious is that a growing economy enables much greater
use of debt than would otherwise be the case. When an economy is growing, as
illustrated by the ever-increasing sizes of circles, it is possible to 'borrow from the
future.' This act of borrowing gives consumers the ability to buy more things now
than they would otherwise would be able to afford-more 'demand' in the language of
economists. Customers can thus afford cars and homes, and businesses can afford
factories. Companies issuing stock can expect that price of shares will most likely
rise in the future.
Without economic growth, it would be very hard to have the financial system that we
have today, with its stable banks, insurance companies, and pension plans. The
pattern of economic growth makes interest and dividend payments easier to make,

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22

and reduces the likelihood of debt default. It allows financial planners to set up
savings plans for retirement, and gives people confidence that the system will 'be
there' when it is needed. Without economic growth, debt is more of a last resortsomething that might land a person in debtors' prison if things go wrong.

Slide 3
It should be obvious that the economic growth story cannot be true indefinitely. We
would run short of resources, and population would grow too dense. Pollution,
including CO2 pollution, would become an increasing problem.

Slide 4

22

23

The question without an obvious answer is 'When does the endless economic growth
story become untrue?' If we listen to the television, the answer would seem to be
somewhere in the distant future, if a slowdown in economic growth happens at all.
Most of us who read financial newspapers are aware that more debt and lower
interest rates are the types of stimulus provided to the economy, to try to help it grow
faster. Our current 'run up' in debt seems to have started about the time of World
War II. This growing debt allows 'demand' for goods like houses, cars, and factories
to be higher. Because of this higher demand, commodity prices can be higher than
they otherwise would be.
Thus, if debt is growing quickly enough, it allows the sales price of energy products
and other commodities to stay as high as their cost of extraction. The problem is that
debt/GDP ratios can't rise endlessly. Once debt/GDP ratios stop rising quickly
enough, commodity prices are likely to fall. In fact, the run-up in debt is a bubble,
which is itself in danger of collapsing, because of too many debt defaults.

Slide 5

23

24

The economy is made up of many parts, including businesses and consumers. The
consumers have a second role as well-many of them are workers, and thus get their
wages from the system. Governments have many roles, including providing financial
systems, building roads, and providing laws and regulations. The economy gradually
grows and changes over time, as new businesses are added, and others leave, and
as laws change. Consumers make their decisions based on available products in the
marketplace and they amount they have to spend. Thus, the economy is a selforganized networked system-see my post Why Standard Economic Models Don't
Work-Our Economy is a Network.
One key feature of a self-organized networked system is that it tends to grow over
time, as more energy becomes available. As its grows, it changes in ways that make
it difficult to shrink back. For example, once cars became the predominant method of
transportation, cities changed in ways that made it difficult to go back to using horses
for transportation. There are now not enough horses available for this purpose, and
there are no facilities for 'parking' horses in cities when they are not needed. And, of
course, we don't have services in place for cleaning up the messes that horses
leave.

Slide 6

24

25

When businesses start, they need capital. Very often they sell shares of stock, and
they may get loans from banks. As companies grow and expand, they typically need
to buy more land, buildings and equipment. Very often loans are used for this
purpose.
As the economy grows, the amount of loans outstanding and the number of shares
of stock outstanding tends to grow.

Slide 7
Businesses compete by trying to make goods and services more efficiently than the
competition. Human labor tends to be expensive. For example, a sweater knit by
hand by someone earning $10 per hour will be very expensive; a sweater knit on a
machine will be much less expensive. If a company can add machines to leverage
human labor, the workers using those machines become more productive. Wages
rise, to reflect the greater productivity of workers, using the machines.
We often think of the technology behind the machines as being important, but
technology is only part of the story. Machines reflecting the latest in technology are

25

26

made using energy products (such as coal, diesel and electricity) and operated using
energy products. Without the availability of affordable energy products, ideas for
inventions would remain just that-simply ideas.
The other thing that is needed to make technology widely available is some form of
financing-debt or equity financing. So a three-way partnership is needed for
economic growth: (1) ideas for inventions, (2) inexpensive energy products and other
resources to make them happen, and (3) some sort of financing (debt/equity) for the
undertaking.
Workers play two roles in the economy; besides making products and services, they
are also consumers. If their wages are rising fast enough, thanks to growing
efficiency feeding back as higher wages, they can buy increasing amounts of goods
and services. The whole system tends to grow. I think of this as the normal 'growth
pump' in the economy.
If the 'worker' growth pump isn't working well enough, it can be supplemented for a
time by a 'more debt' growth pump. This is why debt-based stimulus tends to work,
at least for a while.

Slide 8

26

27

There are really two keys to economic growth-besides technology, which many
people assume is primary. One key is the rising availability of cheap energy. When
cheap energy is available, businesses find it affordable to add machines and
equipment such as trucks to allow workers to be more productive, and thus start the
economic growth cycle.
The other key is availability of debt, to finance the operation. Businesses use debt, in
combination with equity financing, to add new plants and equipment. Customers find
long-term debt helpful in financing big-ticket items such as homes and cars.
Governments use debt for many purposes, including 'stimulating the economy'-trying
to get economic growth to speed up.

Slide 9
Slide 9 illustrates how workers play a key role in the economy. If businesses can
create jobs with rising wages for workers, these workers can in turn use these rising
wages to buy an increasing quantity of goods and services.
It is the ability of workers to afford goods like homes, cars, motorcycles, and boats
that helps the economy to grow. It also helps to keep the price of commodities up,
because making these goods uses commodities like iron, steel, copper, oil, and coal.

27

28

Slide 10

In the 1900 to 1998 period, the price of electricity production fell (shown by the falling
purple, red, and green lines) as the production of electricity became more efficient.
At the same time, the economy used an increasing quantity of electricity (shown by
the rising black line). The reason that electricity use could grow was because
electricity became more affordable. This allowed businesses to use more of it to
leverage human labor. Consumers could use more electricity as well, so that they
could finish tasks at home more quickly, such as washing clothes, leaving more time
to work outside the home.

28

29

Slide 11
If we compare (1) the amount of energy consumed worldwide (all types added
together) with (2) the world GDP in inflation-adjusted dollars, we find a very high
correlation.

29

30

Slide 12
In Slide 12, GDP (represented by the top line on the chart-the sum of the red and the
blue areas) was growing very slowly back in the 1820 to 1870 period, at less than
1% per year. This growth rate increased to a little under 2% a year in the 1870 to
1900 and 1900 to 1950 periods. The big spurt in growth of nearly 5% per year came
in the 1950 to 1965 period. After that, the GDP growth rate has gradually slowed.

On Slide 12, the blue area represents the growth rate in energy products. We can
calculate this, based on the amount of energy products used. Growth in energy
usage (blue) tends to be close to the total GDP growth rate (sum of red and blue),
suggesting that most economic growth comes from increased energy use. The red
area, which corresponds to 'efficiency/technology,' is calculated by subtraction. The
period of time when the efficiency/technology portion was greatest was between
1975 and 1995. This was the period when we were making major changes in the
automobile fleet to make cars more fuel efficient, and we were converting home

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heating to more fuel-efficient heating, not using oil.

Slide 13
If we look at economic growth rates and the growth in energy use over shorter
periods, we see a similar pattern. The growth in GDP is a little higher than the growth
in energy consumption, similar to the pattern we saw on Slide 12.

If we look carefully at Slide 13, we see that changes in the growth rate for energy
(blue line) tends to happen first and is followed by changes in the GDP growth rate
(red line). This pattern of energy changes occurring first suggests that growth in the
use of energy is acause of economic growth. It also suggests that lack of growth in
the use of energy is a reason for world recessions. Recently, the rate of growth in the
world's consumption of energy has dropped (Slide 13), suggesting that the world
economy is heading into a new recession.
To read the rest of this article, please visit Gail Tverberg's website.

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33

Oil price forecasts based

on myths, not proper
analysis
Written by Paul Hodges from ICIS

Did your company or investment manager use $50/bbl as a forecast Scenario price
for oil this year? If not, why not? And has this question even been asked, as you
finalise forecasts for 2016?

In recent months, many readers have told me despairingly of their efforts to suggest
alternative Scenarios to last year's 'consensus' view that prices would always be
$100/bbl. They are even more despairing today, when they see the forecast for the
next few years - which almost always suggests prices will now rise steadily.
My suggestion is that you ask your company to evaluate the success of its forecasts
over the past 5 - 10 years:

Did it simply adopt the consensus view of $70/bbl in 2007, when budgeting for
2008?

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Did it include a Scenario based on the potential for a major financial crisis in
2008 and a price collapse?
More recently, did it forecast last year's collapse from $100/bbl?
And did it foresee the potential for a major slowdown in China to impact the
global economy?

If not, why not? And, even more importantly, what is it doing to improve the track
record for the future?
The problem is that very few companies do this type of routine evaluation. Yet
engineers routinely monitor whether projects are 'on time, on budget'; manufacturing
teams monitor product quality and safety records; customer services monitor
whether deliveries are 'on time, in full'. They know there can be no improvement
without measurement.
Obviously, I do have a stake in this debate. As readers will know, I routinely post a
review of the previous year's Budget Outlook before issuing the new one. I also
routinely publish the full record of Budget Outlooks since 2007, and the full record of
my New Year Outlooks since 2008.

This should be basic practice for everyone. Past performance may not ensure
success in the future, but it is the best guide that we have. This discipline was
certainly one reason why I was able to successfully forecast here, in the blog:

2007-8s final upward rush and subsequent collapse in oil prices, as well as
the potential for a major financial crisis - as highlighted in ICIS Chemical
Business in November 2008
Plus, of course, I have argued since August 2014 that a Great Unwinding of
policymaker stimulus is underway due to China's adoption of its New Normal
policies, and that oil prices would collapse to $50/bbl

My point is simply that it is nonsense for others to say 'nobody could have forecast
these developments'. And the world cannot progress unless we apply the basic
principles of measurement to such important areas.
One particular piece of current nonsense is summarised in the above chart. This is
the myth that the decline in the number of drilling rigs will have a major impact on US
oil production. As we reported in last month's pH Report:

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'The story has everything that is required in the era of Twitter and sound-bites: it
sounds logical, is easy to grasp, and needs no follow-up.
'The only problem is that it ignores the fact that oil rig productivity, like that of gas
rigs, doesn't stand still, as we discussed back in May. The number of gas rigs has
fallen from 1600 in 2008 to 200 today according to Baker Hughes (BH) data, yet US
Energy Information Administration's (EIA) data shows total US gas output has risen
by a third from 1.8Tcf to 2.5Tcf over the period. Gas rig productivity has thus risen
11-fold, and still seems to be on an upward path. Oil rig productivity appears to be
following the same pattern.
'As the chart shows (using BH oil rig count data and EIA oil output data), oil rig
productivity has already risen 4-fold over the past 4 years, with no doubt more to
come.
'The key is the adoption of new drilling techniques, imported from deep water
operations. It would be horrendously expensive to keep drilling new wells in 1000
metres of water. Instead, companies developed the new technique of horizontal
drilling which can increaseproduction by up to 20x compared to traditional horizontal
drilling. Three quarters of US rigs now drill horizontally, compared to only one quarter
in 2007.'
This type of analysis is not rocket science. It only needs access to the internet and a
calculator. Yet last Wednesday, a leading hedge fund told Reuters they were
mystified by the rise in oil rig production:
'The part of the report that continues to amaze is the domestic production number,
which showed a small rise, despite the ever-plunging rig count' .
Please, send a copy of this post to your CEO and senior management, and ask them
to review its argument. It is, after all, your salary and career prospects that are
affected when myths and opinion are mistaken for analysis.
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37

This Is The Only US

Shale Play Doing What
It's Supposed To
Written by Keith Schaefer from Oil & Gas Investments Bulletin

Oil bulls are hoping every shale play in the US pulls-'An Eagle Ford'
But it hasn't worked out that way-so far, the Eagle Ford is unique. What I mean by
that is..it's the only Big Shale Formation in the US where oil production really is
collapsing like The Market expected.
By contrast, stats from the North Dakota Oil Commission shows Bakken production
only showed its first Year-Over-Year decline in September-1.162 million b/d in Sept,
which was down from 1.188 million b/d in Aug.
Permian oil production is actually still growing.
The Eagle Ford is very different.
Production in the Eagle Ford peaked in March and has been dropping ever since.
The rate of that production fall isn't slowing.....it continues to accelerate.
The EIA data can be found in the Administration's monthly Drilling Productivity
Reports.
Here is the month on month production change that the DPR's have shown for the
Eagle Ford since the start of 2014:

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For the month of December alone the EIA believes that Eagle Ford production will
drop by 78,000 barrels per day.

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On a projected December 1 beginning production base of 1.356 million barrels that is

a pretty startling drop of 5.7% in just one month.
The DPR reports show that Eagle Ford production topped out at 1.726 million barrels
per day in March and will exit December 448,000 barrels per day lower at 1.278
million.
If the EIA's numbers are accurate this means that more than one quarter of the
Eagle Ford's production is gone in nine months!
Drilling Into The Decline Rates
Why is the Eagle Ford declining faster than the other plays? Is it the declining rig
count?
But digging into the EIA data shows the rig count decrease across the three major
shale plays is actually very similar.
The Permian rig count is down by 55% and the Bakken and Eagle Ford are both
down by a little more than 60%.
So it isn't the rig count. What is killing Eagle Ford production is its decline rate.
Existingproduction in the Eagle Ford is falling at a much faster rate than the other
plays according to the EIA.
No chart drives that point better than this one from the EIA's December DPR...

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The Permian's 2 million barrels of production at December 1 are expected to decline

by 75,000 barrels per day during the month.
Meanwhile the Eagle Ford's smaller 1.35 million barrels per day of December 1
production will decline by an incredible 150,000 barrels per day...
Talk about needing to run fast just to stand still.
The decline rate of existing production in the Eagle Ford is 75% higher than the
Bakken and almost triple the Permian.
Without a frantic rate of drilling new wells, it is no surprise that overall production in
the Eagle Ford has to decline.
Earlier this month at the Baird 2015 Industrial Conference Pioneer Resources
(NYSE:PXD)made the comment that they wouldn't be surprised if they were
completely out of the Eagle Ford within five years.
Instead Pioneer wants to focus on the Permian which according to the company 'is
the only American oil play that go grow over the longer term.'
You have to wonder how much the Eagle Ford's decline rates play a part in this line
of thinking.
I see a couple reasons why Eagle Ford production is decline faster than both the
Bakken and the Permian.
First, the Permian is not a pure horizontal or shale play. Before horizontal drilling
took off the region was already producing 900,000 barrels per day from conventional
wells. That base of production is very mature and declining very slowly. That masks
the true rate of decline of the Permian's horizontal production.
Second, part of the reason that the Eagle Ford is declining faster than the Bakken is
because it is a younger play. Bakken production started climbing several years
before the Eagle Ford did. Younger production means higher declines and heading
into this year the Eagle Ford had a huge surge of new production that is coming
down very quickly.

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Third, every play is different. In fact every well is different. With the high amount
ofcondensate that the Eagle Ford throws off it is quite likely that a typical Eagle Ford
horizontal well does decline faster than its Bakken and Permian counterparts.
How Much Is U.S. Production Declining Outside The Eagle Ford?
In their third quarter earnings release Core Labs (NYSE:CLB) gave an update on
where they see U.S. production exiting 2015 at. Since Core Labs has access to
better information than almost anyone, their view is at least worth a listen.
The Company continues to anticipate a 'V-shaped' worldwide activity recovery in
2016 with activity upticks starting in the second quarter......U.S. production continues
to fall from its peak in April 2015 and the Company now believes production could
fall by over 700,000 barrels per day by year end 2015.
If that 700,000 barrel decline is accurate and the EIA is right about the Eagle Ford
dropping 448,000 barrels it means that the Eagle Ford will be responsible for 65% of
the total decline.
If these numbers are close to being accurate the next question to ponder is how long
can this rate of decline continue? We know that over time the decline rates in
horizontal wells lessen. But we also know that the rig count is still dropping.
As per usual, oil market data provides as many questions as answers.
One thing that seems clear from the EIA data is that the Eagle Ford is the least
'sustainable' of the three major shale plays.
It may also be the key to an oil price recovery.

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41

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43

Latest US Jobs Report

Means Oil At $100 In
Early 2017
Written by John Richardson from ICIS
THE US economy is well and truly back is the conclusion you will reach if you read
just the front page newspaper articles following the release of last Friday's October
jobs report.
'Friday's numbers are a vindication of Fed chair Janet Yellen,' was, for example,
what the Financial Times wrote on the front page of its 7 November issue, after it
was announced that 271,000 new jobs had been created in October.
Not surprisingly, therefore, the US Federal Reserve has given a strong indication
that it might well raise interest rates at its 15-16 December meeting, which will be its
final meeting in 2015.
But the Fed is only talking about a small rate rise in December and gradual further
interest rate rises after that. This suggests a great deal of nervousness about the
underlying strength of the economy.
Incredibly, also, it has taken nearly seven years of the Fed benchmark borrowing
rate being close to zero to reach a point where Yellen and her colleagues seem to
feel that the US economy can withstand a moderate rate rise.
And as former US Assistant Secretary of the Treasury for Economic Policy Dr Craig
Paul Roberts very convincingly argues:

145,000 of the new jobs, or 54%, are assumptions based on the 'birth-death'
model. The model is built around a normally functioning economy. But we
know that over the past seven years, the economy hasn't been functioning
normally - hence, interest rates close to zero. Roberts therefore believes that
the Fed has overestimated the number of jobs from new business start-ups
and has underestimated losses from businesses shutting down. He therefore
calculates that only 126,000 new jobs were actually created in October.

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But for arguments sake, let's assume that the 271,000 jobs number is actually
real. 'According to the Bureau of Labor Statistics, all of the new jobs plus
some378,000went to those 55 years of age and older,' wrote Roberts.
But he added that males in the prime working age - 25 to 54 years of age lost 119,000 jobs
Roberts' conclusion is that full time jobs have been replaced with part time
jobs for retirees. He bases this on the fact that multiple job holders increased
by 109,000 in October, which indicates that people who lost full time jobs had
to take two or more part time jobs in order to pay their bills.

Newspaper headlines also made great play out of the drop in the percentage US
unemployment rate to 5% in October, half of its level during the Global Financial
Crisis.
Why is the 5% level so crucial? Because some people at the Fed, perhaps crucially
Yellen herself, believe that this is close to the 'natural level' of unemployment in the
US. Once you go below this level, labour markets tighten, wages start rising and you
need interest-rate rises. The Fed then hopes to stand back and pronounce that its
quantitative easing policies have been successful.
But here's the thing: As Edward Luce wrote in another FT article, which was
published after the release of the September jobs report:
The official jobless rate has dropped to 5.1%; yet, if the labour force were as big as it
was in 2008, the rate would be almost double that.
Real median household incomes remain stubbornly lower than they were in 2008. In
some sectors, such as manufacturing, both jobs and wages are declining. There is
little sign of America's widely forecast manufacturing renaissance.
Returning to the October job report and Luce's first point, the labour participation
rate has remained stuck at 62.4%, its lowest level since 1977.
The participation rate measures the number of people actually looking for work, and
so of course if so many people have decided to not to even bother looking for work,
the headline percentage unemployment rate will have to fall. This means that the
'natural level' of unemployment might now be a lot lower than 5%.

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This all comes down to the basic laws of supply and demand. People are not looking
for work because there is not enough demand to create enough work, and there is
not enough demand due to the fall in spending as the Babyboomers retire. And
because there is not enough demand to create enough work, middle class incomes
are stagnating.
What happens next then? If you are a chemicals company what should you plan for?
Here is one seven-stage scenario:
1. The Fed opts for a modest rate rise in December, and will very gradually
further raise interest rates after that.
2. These rate hikes won't make, simply cannot make, that much difference
because of demographics. The real US economy will continue to struggle.
3. Most policymakers, economists, analysts, and journalists etc. will still fail to
identify the underlying problem. It is that Western fertility rates in general have
been below replacement levels (2.1 babies/woman) for 45 years since 1970.
4. The consensus will instead blame the problem on the Fed's decision to everso slightly raise interest rates, especially if this decision is said to have also
inflicted 'collateral damage' on emerging markets.
5. So the clamour will grow for a fourth round of quantitative easing (QE4).
6. But no decision will be taken on QE4 because next year will see the latest US
presidential election cycle switch into full gear. QE4 will happen, therefore, but
not until after the new US president has been inaugurated in January 2017.
7. The launch of QE4 will push oil prices temporarily back to $100 a barrel as
speculative funds flow back into commodities in general and into stock
markets. This will further weaken a global that cannot afford $100 crude, and
so prices will soon retreat again.
Many other scenarios are of course possible. But none of the scenarios involve a
return to the Old Normal.

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46

LNG - the Coolest Player

in the European Gas
Game
Written by Patrik Farkas from DW Monday
History repeats itself. In January 1959 the first LNG vessel shipped out from Lake
Charles, Louisiana to deliver its trial cargo to Europe. Soon, another important LNG
shipment is going to leave the Gulf of Mexico. This time, the destination is Lithuania one of the first deliveries from Cheniere's Sabine Pass LNG export terminal will be
sent to Port of Klaip?da in January 2016.
Driven by significantly higher natural gas prices compared within Western-Europe,
Lithuania took the decision to reduce dependence on Russia by building an LNG
import terminal. The project was executed within three years and the Independence
FSRU (Floating Storage and Regasification Unit) started operations in December
2014. If planned gas infrastructure developments are delivered in the future,
Lithuania will be able to cover domestic natural gas demand from LNG and even
export gas to its neighbors. As a result, Gazprom has offered a gas price discount of
almost 20% to the country.
Other Central-Eastern European countries are seeking to diversify their gas import
sources through LNG. After a two-year project delay, the Polish LNG terminal is
scheduled to start its commercial operation in May 2016. The Croatian Government
has also announced the construction of an LNG import terminal as a strategic
investment project which has recently received the location permit on Krk Island. If
Hrvatska LNG passes the final investment decision next year, the plant could be
commissioned in 2019.
Currently, 26 LNG import terminals are in operation in the EU-28 countries, with
annual regasification capacity of 195bcm. An additional 23bcm/y of capacity is
currently under construction with 13bcm/y expected to come online this year with the
start of the Dunkerque LNG Terminal in France. Total European LNG import capacity
already exceeds recent Russian exports volumes. With extensive LNG export
infrastructure developments in North America and Australia, and slowing gas
demand growth in China and Japan, more LNG is anticipated to be available to
European gas markets, potentially reshaping the continent's natural gas landscape
significantly.
View more quality content from
DW Monday

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47

Exxon: We knew climate

change was a real threat
(but we didn't want you
to)
Written by Kurt Cobb from Resource Insights
One of the big complaints about climate change deniers is that they don't fund any
genuine primary scientific research into climate change.
We are used to deniers extracting out-of-context passages from existing legitimate
climate research and pretending those passages support the denialist position. But
wait... we now know, thanks to recent coverage by Inside Climate News and the Los
Angeles Times, that at least one climate change denier did fund a great deal of
legitimate climate research.
And, what did that research show? It showed that climate change is real, is caused
in great measure by human activities and has the potential to disrupt human society
significantly. To be fair, when Exxon Corp. (now Exxon Mobil Corp., the world's
largest publicly traded oil company) engaged in this research in the 1970s and
1980s, it was genuinely trying to understand the relationship between carbon dioxide
emissions and climate change. During that time Exxon scientists collaborated openly
with prominent academic and government researchers and were even praised for
their commitment and professionalism.
But, as we all know, that openness did not last. As the scientific findings became
more alarming, the company began to see the findings from climate research as a
threat to its business. Exxon launched a public relations offensive to dispute what
climate researchers around the world were discovering, an offensive that lasted until
2008 when the company announced that it would end its support for the vast network
of climate change denial organizations it had helped to build. (Whether the company
did, in fact, end that support is disputed.)
You can read all the gory and disturbing details concerning this turnabout at the sites
linked above. Some might consider this old news. Those who keep up on climate
news are certainly familiar with the large denialist apparatus of front groups, fake
think tanks and public relations firms supported by Exxon and others.

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What's new is the revelation about how deeply committed Exxon was to actual
legitimate scientific investigation and how much it did to further our understanding of
climate change--including creating some of the most sophisticated climate modeling
of the time. Those models are similar to models used by climate scientists today. But
the company now derides such models as 'useless.'
Given all this, it is hard to overstate how brazen and cynical Exxon's leaders
became. In the early 1990s, even while Exxon spokespersons and Exxon-funded
front groups were decrying the inadequacy of climate models and downplaying the
threat of climate change,the company was sponsoring a team of scientists to
evaluate how a warming planet might affect exploration opportunities in the arctic as
the sea ice melted. The prognosis looked good over the long term for turning arctic
prospects--then inaccessible and risky--into profitable operations once the ice began
to melt (as it has now started to do). The company was also interested in how
melting permafrost would affect its pipelines and processing facilities which might be
in danger of sinking into a landscape softened by warming.
But here's the real kicker: The team used climate models developed by Environment
Canada, the Canadian government's environmental agency, to create its positive
assessments about the eventual accessibility of underwater arctic oil and natural gas
deposits. So, while the company was disparaging climate models, it was
simultaneously salivating over the oil and gas profits that those very models
predicted a warming arctic would make possible from the company's arctic leases.
And, of course, the main ingredient for the warming represented in those models
was the very carbon dioxide produced when Exxon's oil and natural gas was burned
by its millions of customers.
Exxon has long used models to predict what it will find underground wherever it is
thinking about drilling. It uses them to manage its existing oil and natural gas
reservoirs. It uses models to calculate its reserves and implores its investors and the
U.S. Securities and Exchange Commission to believe the numbers its models spit
out. For this reason, it is completely obvious that Exxon has no genuine objection to
models of the physical world--except when those models might undermine the
company's profitability.
Based on the latest revelations, climate action group 350.org is calling for an
investigation by the U.S. Department of Justice. Just what crime Exxon perpetrated
is not specified. But, it's understandable that what the company did feels like a crime.
The closest analogy is the cover-up by tobacco companies of research they did into

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the harmful health effects of smoking, but which they lied about to the public for
many years. Those companies ended up getting sued by individuals, states and the
federal government for health costs associated with smoking. But the tobacco
companies are still in business and doing quite well.
I think those supporting an investigation of Exxon are hoping for criminal charges.
There is a feeling that the company perpetrated a fraud on the public, that it lied
about the dangers of its products while insisting on their safety. Fraud is indeed a
crime. However, people mostly end up getting sued for it. Only a few actually go to
jail.
It seems doubtful that such a prosecution could ever succeed. Exxon makes legal
products that work as advertised. And so far, it's not illegal to do things which change
the world's climate. It's true that the company has been trying to confuse
policymakers and the public about the nature of the scientific research on climate
change. But the First Amendment protects even people and companies who lie
about matters of public policy--so long as companies don't lie about their products to
the people who buy them.
Exxon never explicitly promised that burning oil and natural gas would not affect the
world's climate. The company merely adopted the legally safe position of saying that
the uncertainties surrounding climate change research were great. And, of course, it
funded front groups to make it seem as if this message of uncertainty was coming
from many places, not just one. But, none of this appears illegal, even if it is
unseemly.
If I worked in the higher echelons of Exxon Mobil today or at any time in the last
couple of decades, I'd be much more worried about being brought before some
future international court to answer for what are called 'crimes against humanity.' In
such a court, the protections afforded by U.S. law would be irrelevant. And, with the
damage inflicted by climate change, say, by 2030, the public appetite for someone to
blame might well be insatiable.

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Resource Insights

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