Thursday, December 29, 2016

The Mega Fractal Turns In The Markets I Wrote About In June Have Made Themselves Known

Back in June I posted "Fractal Condition of Several Key Markets At Mega Turn Points" where I submitted that there was about to be a big turn into either bull or bear mode (I was thinking bear at the time) and since then, these markets have indeed made a decisive turn. I have reposted the original article in black, and I have added in red what each of these has done since June.

Recently I wrote an article on gold's fractal dimension showing that it had built to a high level not seen for at least 10 years. Well you may be scratching your head asking "fractal what?" I briefly explained that it is a "high math" way of quantifying any moving object's reversion-to-mean force after it has been in a trendless state for awhile.

For something that can be charted, like a market, there are two dimensions. The fractal dimension at any point is a mathematical summation of something's behavior as either something that can be described with one dimension (a strong, straight-line trend) or by two dimensions (a meandering, chaotic range). Thus the dimension is calculated as being between 1.0 and 2.0 (between one and two dimensions).  We typically just take the decimal portion and refer to it like basis points.  So a fractal dimension of 1.35 is just called "35".  This "line vs chaos" thing in theory happens at all different time scales, minutes, years, what have you, and you have to divide all this rightly for it to mean anything in the scale that's significant to you.  The guiding mantra of all fractals is always "same thing, different scale". 

This also applies to the geometrical rescaling and repeating that markets tend to do.  Back in early February, I wrote an article, "Gold's Bull/Bear Status" on gold's apparent "new" bull market, which is likely just a repetition of a rescaled, typical, and oft repeated bull market fractal that is really all one bull market

Anyway, enough math.  After looking at gold, and seeing that it currently has a very unusual fractal condition, I looked at several other key markets and found that there is a similar fractal abnormality in them as well. First, let's look again at gold: (click on image to view)

As the graph shows, gold is currently at 55, highest in 10 plus years, presaging a very strong trend coming, either up or down.

Since June, gold has moved down from the top of the range shown, but the fractal dimension is still at 55. So gold is still moving in a range, undecided how to dissipate the 55.

Gold is linked to many other markets, so let's take a look at the US dollar with this measure:

"Historically unstable" would be a good description of the dollar's fractal behavior since the 2014 power move up and subsequent chaotic range. The peg-to-peg gyration from 30 to 60 is very unusual for a major index, especially a supposedly stable currency, even on the weekly scale as this fractal dimensioning is calculated.

Since June, the dollar quickly reversed this formation break back to the upside, reflated the fractal dimension back to 60, and the dollar has been on a tear since, dissipating its fractal dimension down to 45. 

Of course gold is also supposed to be an inverse play to the stock market, although I beg to differ with that take as there have been extended periods with both rising gold and stocks, with 2002 to 2007 being a prime example.  But historically, and especially lately, gold is inversely related.  So let's look at stocks via the Russell 2000, because it is a broad stock market and it is a leading group. Let's calculate some fractal dimensions:

Amazingly, we find that the stock market is also jam packed with the highest fractal energy level in over 10 years.  But just from this, we don't really know which way it wants to go, up or down, from looking at these graphs as they just show its fractal condition. 

Since June, the Russell has blitzed to the upside, deflating its dimension down to 52. This is still very high for a major index and suggests a lot more upside to come.

Is there something that we could check that could be more suggestive of the direction ? 

Consider copper.  "Every bull market has a copper top" is ancient wisdom, noting that copper puts in a top somewhere in the late stages of a bull.  And it is referred to as Dr. Copper because it has a PhD in economics.  It did indeed peak clear back in 2011 before the transports, European banks or any other leader.  Copper has put in attempts at bottoming ranges amidst a pronounced decline, and recently it has attracted attention to the $2.00 level as a major line in the sand.

There is the technical read where $2.00 is a Fibonacci level.  But then there is the basic fact that the world's biggest trafficker in dangerous derivatives, Deutsche Bank, is highly levered to Glencore, and Glencore is very highly levered to copper staying above $2.00 a pound.  An article, from Business Insider recently explained "Barclays: Glencore Is In Big Trouble If Copper Gets $0.30 Cheaper".  Copper was $2.34 at the time. The article states at the top:
Glencore is a strange hybrid company, both a commodities trader and a mining company, and it has a complicated balance sheet loaded up with different kinds of debt.  There are a lot of different ways to analyze the company but perhaps the best way to think of it is like a bank that's hitting a crisis, like Lehman Brothers ... if the price of copper falls below $2/lb, you begin to get some seriously sweaty palms in Glencore's finance department
If this level gives way, it will be a serious debt problem with the banking system.  And because $2.00 is also a psychological level, breached only in the March, 2009 and January, 2016 market debacles, it would also involve a confidence shock to all the other markets.  In fractal terms, this is how copper looks now:

Each of the ranges in the decline where the fractal dimension went to over 50 resulted in a sharp collapse downward.  The $2.00 per pound line in the sand is right at the red arrow I've drawn illustrating the current range.  And currently we have copper at a fractal dimension of 55, the highest of the entire decline, strongly suggesting another sharp drop, this time through the $2.00 barrier.  Of course, the direction could be up from here, but there is a very strong primary trend at work with copper, so the more likely outcome of the fractal situation is a continuation of this primary trend. It's showing no signs of reversal.

Since June, copper's dimension continued to build and slammed hard on 60 (the upper peg) and has since gone into a power climb with current dimension at 45 - still a lot of room to power climb.

Oil is in a similar but much less profound state of weakness.  It went to an extreme fractal dimension of 60 (monthly) in mid 2014 with oil seemingly stable at around $105.  The massive move to $45 in just 6 months that followed sent the fractal dimension to below 40 in a flash.  On the weekly scale, the fractal dimension went to 52 in mid 2015 with oil steady at $60, went back down to 30 as oil plummeted to $28, and is swiftly going back up as oil struggles in the $40s.  It is a similar plateau and plummet progression as copper, but not nearly as fractally strong, and with the primary down trend in question as oil is trading well above its 200 day moving average.

But there is yet another market index with a once-in-10 year fractal event going on where the direction is probably more clear.  Let's take a look at the VIX:

The fractal dimension reacted strongly to the 2008 event with a big build to 53, then a big dissipation clear down to 34.  It didn't seem to react as strongly to the 2011 Greece scare, as if it knew it was just a passing cry of "wolf".  But it has again gone to an extreme level, being violently pegged at 60 for some time now.  So there would seem to be an extremely large move coming. But if it were down, it would be to an absurd VIX level of around 10 or less. 

Not that this hasn't happened before.  We were cruising into 2007 up until March with the VIX at 10-12 before hardly anyone was worried about housing, or anything.  But in our day, this would imply that stock markets will sudden go to a PE of 30, or an unprecedented burst of earnings will suddenly materialize from a weak economy seemingly beyond the resuscitation of monetary policy, the rising debt defaults will suddenly stop from the mountain of shaky loans, interest rates will "normalize", the lion shall lie down with the lamb, and pigs will fly.

Since June, the VIX has stayed pegged about as low as it can go and its dimension is still pegged at 60.

It may not be just your imagination that the global economy, markets, and interest rates are going into some kind of twilight zone. The cold science of fractal analysis backs you up on that.

The collective fractal wisdom is saying buckle your seat belts, and the VIX is saying a big move will either be another big decline in stocks or a sudden trip to nirvana. I guess we could be going to nirvana, but until the evidence is convincing, it may be wise to make some preparation the other way.

Since June, we have gone to nirvana. How long will that last? I don't know, but there is a lot of fractal energy that says enjoy the ride!

If you would like more information on the fractal dimension in markets, you can read the works of Benoit Mandelbrot, who discovered and wrote about this phenomena in all areas of science. He coined the label "fractal" and founded the Chaos Theory approach to analyzing markets.  His book The (Mis)Behavior of Markets has been called "the deepest and most realistic finance book ever published".  There are a few product offerings that give you an FDI (fractal dimension index or indicator) along with the RSI and other technical indicators. One is from QUANTSHARE  Trading
Software.  If you are a programmer, there is code written for this calculation by AmiBroker and others.  You can also use someone's code at MetaStock with their Indicator Builder feature.

Friday, December 16, 2016

From The Makers Of Wal-Mart And Bank Of The Ozarks Comes Bear State Bank

What's up with these regional US banks? So many of them are growth stories nowadays with crazy stock climbs in a weak economy. And that was before the election. Since then, the small banks have been amazing - the best performing group .

Banks are certainly Trump stocks, but there was something cooking with them even before this year. As Thomas Michaud, CEO of the investment banking firm KBW said on CNBC's 12/21/15 interview, "there is a rise of regional champions" going on with merger activity among the well run regional banks looking to grow. Some of these growth stories have been stunning with stocks tripling or more despite junk debt and lack of economic growth.
There is your basic economic cycle. As rates rise, banks will benefit from a return to the classic business model of making profit from the yield curve between deposits and loans. But a big difference in this rate cycle could be our escape from the aberrant zero interest era. As explained in this article, the Fed is now paying interest to banks over the prevailing rate to keep the massive QE flood on banks' balance sheets and out of lending into the economy to prevent inflation from going out of control. The Fed is "bribing" banks to keep a lid on inflation.

This will be $24 billion yearly per 1/4 point rate increase. This was described as a problem back in 2013 as the commercial banks' reserves held at the Fed ballooned to over $2 trillion as noted in the Wikipedia account on this feature of the Fed:
As the economy began to show signs of recovery in 2013, the Fed began to worry about the public relations problem that paying dozens of billions of dollars in interest on excess reserves (IOER) would cause when interest rates rise. St. Louis Fed president James B. Bullard said, "paying them something of the order of $50 billion [is] more than the entire profits of the largest banks."
This fallout from the Fed's tom foolery with creating an artificial market in everything looks like a windfall "subsidy" for the banks. There is another megatrend that makes this development more significant - the drastic shrinkage in the number of banks as featured in a Wall Street Journal piece. Since 1985, the number of U.S. banks has shrunk from 18000 to around 6500 while squeezing deposit assets up from $3 trillion to about $10 trillion.

The weak banks being gobbled up by the strong is making the players left fewer and stronger. On top of that, not all commercial banks get this interest from the Fed, just the ones who are Fed member banks. You have to meet certain qualifications for that, and only about one out of three are member banks. This federally guaranteed largess, being funneled into select banks, is perhaps one reason why the fast growing "regional champions" are doing so great the last couple years. The Trump effect is looking to amplify all this. So we're seeing the post election jumps in these stocks.
I have been very negative on banks in some of my other writings. Have I changed my mind? Well, banks are like Italian families. Some are involved in the mafia and are neck deep in nefarious global doings. And some families just like toughening up their kids as they raise them, like Frank Barone of  Everybody Loves Raymond. They're all tough Italian families - but there is a huge difference in the mortality rate. It's the big global banks I am avoiding. There is a vast difference in the growing U.S. regionals run by tough, smart people, and the big banks drowning in derivatives and bad debt.

But do we want to buy banks into what appears to be a down debt cycle? The gloomy side of banking is centered around the commodity/junk debt problem that I wrote about in my 2015 article "The Debt Cycle And Rhymes of Lehman Brothers". In that article last year, I said of this gloom,"Personally I suspect this lopsided view of next year's stock market will be wrong" and I pointed out that "history has seen stock and debt markets act independently before, and next year [2016] may well be a case of that (hopefully) as was the year 1980." And I made this obsevation:
There we saw a nice climb for stocks even though we were entering the weak economy of '80-'82. The debt cycle was down as with any recession, and in fact snowballed into the Savings and Loan Crisis of the '80s that eventually saw one third of these banks go under! ... 1980 was an election year as is next year. To the extent you believe market forces are politically controlled, you have to put those forces all to the upside for 2016.
After the earthquake in Washington November 9, you must suspect, as in the early '80s, that we could see a down debt cycle with an up stock market, including the best run regional banks not being destroyed by debt.

Enter Bear State. It's a trick to find them before they have done big climbs and attracted attention. I offer Bear State Financial as such a find. It is a Fed member bank. Although it is obscure to say the least, it has started on a growth track being orchestrated by some most able growth people on the planet. It was formulated as a dramatic reorganization of a struggling bank, First Federal of Harrison, in 2011. A corporate raider restructure was done by one Rick Massey. As the Bear State Financial website describes it:
On May 3, 2011, Bear State Financial Holdings made a $46.3 million investment in the Company to recapitalize First Federal Bank. Company Chairman Richard N. Massey led the Bear State group, which brought a new management team to the Bank. In June 2014, First Federal Bancshares of Arkansas, Inc. changed its name to Bear State Financial, Inc. (NASDAQ:BSF). Bear State Financial is the parent company for Bear State Bank.
In the Form SC13D (Statement of beneficial ownership) filed May 11, 2011 in conjunction with this $46 million "investment" in First Federal, it's clear it was a one man takeover by Massey. The name officially changed from First Federal with ticker FFBH to Bear State Financial with ticker BSF in June, 2014. The name Bear State is for all the black bears in Arkansas.
So how has this heavy handed takeover worked out so far?


Not too bad. Overall, there seems to be a turn into fast growth taking hold.

These results, as nice as they are, may not be the star attraction here. It's the Board. The Board of Directors for Bear State is an intriguing mix of success and power with Little Rock's movers and shakers. The Stephens Group, a diversified investment banker, officed in Little Rock, is the largest brokerage outside of Wall Street, New York. It has had a strange, bipartisan habit of rubbing shoulders with presidential power ever since Jackson Stephens attended the US Naval Academy and became friends with Jimmy Carter. He later became financially involved with his administration. Then the "king maker" was a big backer of Reagan in the early '80s and has been given varying degrees of credit for installing Arkansas Governor Bill Clinton in the White House.
Jack Stephens epitomizes winning friends and influencing people. The football field at the US Naval Academy is named Jack Stephens Field to honor him. He underwrote the initial public offering for Wal-Mart Stores. Wal-Mart is now the largest company in the world by revenue. The Stephens Group also had a hand in building Tyson Foods and Alltel into giants. Alltel started in 1943 putting up telephone poles in Arkansas. By the mid 2000s, Alltel operated the largest network in the United States by area. Then Verizon gobbled them up.

Stephens and friends know growth. As the Wikipedia write up on him states it:
Jack began to grow Stephens by providing private equity to many young growing companies, much in the way of the British Merchant Bank investing model, predating by decades the private equity endeavors of Wall Street firms. Jack's acumen as an investor was combined in remarkable fashion with his ability to form enduring personal relationships with his partners. Several generations of companies and business leaders came to know Jack as not only a smart investment banker, but as a loyal and reliable friend as well. Jack's influence grew well beyond Arkansas to the boardrooms of corporate America and to the halls of Washington D.C.
What does this Arkansas power connection have to do with Bear State? Wal-Mart and Alltel are old news with this bunch, What they seem to be into now are regional banks. Many of the growth stories in the regional banks are launching from here including Home Bancshares, Inc. (NASDAQ:HOMB) of Conway and Bank of the Ozarks (NASDAQ:OZRK) of Little Rock. If you peek at what these two stocks have done the last 5 years, you see HOMB growing four fold and OZRK five fold.

Bank Director, the premier bankers' industry magazine, does a yearly ranking of banks by small, mid, and large size categories, and OZRK has held the number one ranking in the nation for the last four years running in its small, then mid size categories including its current number one rank in mid size. They rank the 300 best run banks out of about 6500 banks in the country. That's the top 1/2 of one % - it's an honor to even be in their ranking list.
In the SEC Prospectus filing for the 1997 IPO for Bank of the Ozarks, Stephens, Inc. is the chief underwriter. In this filing, it is amazing to read that the two main banks that came together to form Bank of the Ozarks were headquartered in Jasper, population 498, just a few miles south of Harrison, and Ozark, population 3525, just a few more miles south of Harrison. Wal-Mart's ground zero was actually this same Harrison.

After setting up shop in Rogers, AR, where I live, Wal-Mart's first store in 1962 labored as a local loner for almost 3 years. We didn't even think of it as a chain. Sam Walton himself described it in his book as an "experiment", trying his lower cost mass merchandising in a modest, unappealing building just to see if the concept itself would work. There's an antique mall in there today. I shop there.

They put gigantic "W A L - M A R T" letters on top - the first appearance of this name on a building on the planet. In 1965, when this store proved very popular and profitable, the Waltons began the real building and expansion blitz we know of today, opening over 20 stores between 1965 and 1967 - starting with store #2 in Harrison, population 13,000. The Rogers "store" was still in the flea market as the building spree blasted into the '70s. Stephens took the company public in 1970.

What is it with Harrison anyway? I go over there a lot, and it's beautiful, but it's a real cultural throwback. There's a joke that says if the world were to end, you'd want to be there, because it would end 30 years later. Why does the business elite of Little Rock like launching some of Wall Street's biggest growth behemoths from these backward hills? Is Harrison an alter ego of New York - the phantom Wall Street of the Ozarks?
Will The Phantom Strike Again with Bear State? Little Bear State is also from Harrison. Bear State could now almost be considered a branch of the Stephen's Group. For years before 2011, First Federal was thought of as a "Stephens controlled bank". And this piece from the Bear State website back in 2011 suggests a Stephens orchestrated rescue of First Federal in describing Bear's new board. Both Massey and Scott Ford had been key chiefs at Alltel, and Massey was Managing Director at Stephens for six years.

With Home Bancshares Inc. and Bank of the Ozarks, the role of Stephens was the public launch of those companies. With Bear State in 2011, there was no public launch, First Federal was already public. But Stephens supplied the board leadership that has essentially launched a new company. As promising as Bear State is, you see almost nothing being written about them. Bear State is already on a buying spree as detailed in this story published at Talk Business and Politics when they acquired Metropolitan National Bank last year. This was a quantum leap for Bear State as the MNB banks headquartered in Springfield, Mo. pushed total assets up by about a third, and breached the Missouri state line.
Already, a scant four years from reorganizing a failing bank, they are into the elite Banking Director list at #127 in the small category - a remarkable feat in and of itself. So could this tiny backwoods regional bank be another embryonic Stephens growth beast springing from the Arkansas Outback?  Watching the green Bear State signs popping up in front of banks around here is starting to remind me of the very early days of the Wal-Marts, taking first steps in and around Harrison and here in Rogers, then creeping over the state lines of Missouri and Oklahoma with zero national attention.

Tuesday, November 1, 2016

Swoon Factor At High Danger Level

In trying to anticipate any dangerous stock market collapses, I keep an eye on leading economic indicators, as I've written about before. But the truth is, no matter how much you study these things, the market has studied it more and will beat you to the punch about every time. I am a great believer in the efficient market theory, so I pay more attention to market behavior than anything else.

One such market behavior is breadth, what all the small stocks are doing that are not seen in the major averages we all look at. Smaller stocks seem to be more efficient in seeing things coming for whatever reasons. Maybe it's because there are more of them and they are less moved by en masse trading, ETFs and so on. So they discount information better as a group. Low breadth, when the smaller stocks are not doing as well as larger index stocks, happens often, but not always, in conjunction with major market declines:

This Business Insider chart from the article "The Stock Market's Breadth Is Unusually Shallow"  shows the red zone breadth levels occurring with the 2000 market top, the choppy, weak 2004 market, the 2007/2008 market top, the 2011 top, and it's showing up now. We are far in excess of the one standard deviation away from the 30 year average. But this condition also showed up several other times with nothing especially bad happening.

All the breadth calculations put moving averages, etc. into a formula and crank out a number. But another way to approach this is with the "eyeball" method. You can survey a set period of a stock's behavior, say 5 months, and classify it as normal or an abnormal swoon. This is somewhat subjective. But I did some surveying of the smaller stocks and used some rules for identifying an unusual swoon:

  • A steady change of slope of the 140 day ema from up to down
  • A persistent negative slope the whole period with widening divergence with the 200 ema
  • A change in trading behavior to high volume, sharp down moves below the 140 ema
  • A sudden large gap move down with no recovery breaking a normal pattern
  • A trading volume average of at least 2000 shares a day - a market participant
All this simply shows a profound weakening in a stock's condition. At any given time in the market, you will have a large population of stocks doing swoons, of course. But this population grows to a certain level just in front of rapid market declines, while the major indexes look fine.

I used this "swoon" consideration to look at small stocks in a steady, good market, mid 2005, and got a normal/swoon ratio of 5.6 showing the weakness level of my rules is a pretty small minority of stocks in a good market. Looking at a bad, but not catastrophic market, mid 2004, I get a normal/swoon ratio of 2.0 suggesting a non-precrash average of something like 4 normal to every swoon case.

To look at how this ratio foreshadows historic crashes, I look at the months just before the crash becomes evident, before there is anything looking scary. For the 2002 sharp crash, I viewed January to mid May when the market indexes looked fine. But the population of these breakdown cases amongst the small stocks was very elevated. You could tell something ugly was brewing by noting how frequently they were showing up. I got a 1.2 ratio there. This was after the recession was over. It was primarily a massive margin debt unwind, not a reaction to a recession.

Looking at 2008, I looked at mid year, while the major indexes looked very normal and get a 1.1 ratio. Looking at our present market, the Dow and Russell look nice. The economic indicators keep dancing between sluggish and pre-recession and have been for years. Since we are in an unprecedented period of weak but not recessionary numbers, I looked at 2014 to see if this was inducing any more swoon phenomena than normal. No, I get a 4.1 ratio there, perfectly normal. But looking at the previous 5 months this year, I am getting a 1.2 ratio - same as it was in front of the 2002 decline and about the same as it was in front of the 2008 decline. We now have the worst of both of these past two worlds - a market margin debt at record high levels and a brewing recession.

Does this mean the market must decline? No, these things can clear up and no one gets hurt. But until it does clear up. I, for one, am being very careful. It could be that we are morphing into a new no growth age for the global economy and this will dictate a vastly diminished population of the small stocks. There is a big difference in how levered small stocks are to economic growth vs the big stocks. If central banks are attempting to do away with economic cycles, and are accidentally shooting economic growth in the head in the process, then the huge population of small stocks will be whittled down over the years from here on. Maybe this is the beginning of that. The state of technical decay in nearly half the small stock world is an unstable condition and can't go on forever.

Sunday, October 9, 2016

What Hubbert Practitioners, Art Berman, and The EIA Agree On With Shale Oil

Oil Is Oil

A big problem with energy thinking today is the notion that "oil is oil" and it doesn't matter where it came from. Wrong! A major criticism you see of Hubbert is when they point to all the "oil" we've found (shale oil, tar sand, kindling wood) and throw it in the URR pot (Ultimate Recoverable Resource) and generate a production curve. This is not Hubbert's method at all, and when you see them doing this, you can ignore the whole analysis. It totally misses the vastly different set of recovery physics between conventional crude and shale, or anything else. Each set of physics demands its own Hubbert tabulation. His method can be done, for example, with the coal production of Australia, or any resource that has and will have fairly consistent recovery geophysics.

The shale oil of the US is ultra critical to oil prices and the world economy. A little considered fact with oil is that world conventional production has been declining since 2005 except for just two players:

Ken Deffeyes, using Hubbert knowledge he learned from him personally, wrote his book Beyond Oil: The View From Hubbert's Peak in 2005 where he said the peak is:
postulated as 24 November 2005 (`Thanksgiving' Day), after this date world oil will go into decline, slowly at first then more rapidly
This was for world conventional oil. Considering that the two players left out of the graph above are climbing almost entirely with shale (US) and bypassed oil (Russia) what you have shown is the world's conventional oil production. Deffeyes missed the peak by maybe a few days.

Isn't it ironic that these two big players, whose oil peaked over 30 years ago at the height of the cold war, are now both displaying a production resurgence that is changing perception of peak oil today. I discuss what's up with Russia here , which may have a lot to do with the cold war. But what about the amazing shale revolution of the US? It is very critical to the global picture, so it would behoove us to use the best projection tool there is to see about the future of shale. This method requires a few years of actual production data to make its projection. Now that we've had a few years of shale oil production, has anyone bothered to tabulate a true Hubbert curve for our shale oil ?

Yes. Tad Patzek has done a Hubbert curve on the two big shale oil plays of the US and published them earlier this year - "Is US Shale Oil Production Peaking?"

Who Is Tad Patzek?

Tad Patzek is Professor of Petroleum and Chemical Engineering at the Earth Sciences Division and Director of the Upstream Petroleum Engineering Center in KAUST, Saudi Arabia.  You can read his blog here.

He and Art Berman, a "good friend", collaborate to make Hubbert curves for both gas and oil in the shale fields. Berman supplies the data and Patzek does the rest. According to Wikipedia,
"The focus of his research is mathematical modeling of earth systems with an emphasis on multiphase fluid flow physics and rock mechanics [spending] years as a researcher at Shell Development under M. King Hubbert"
A fellow grasshopper of Hubbert, like Deffeyes, he generates curves per the methods used in his highly cited study  "A Global Coal Production Forecast With Multi-cycle Hubbert Analysis". If anyone on earth is qualified to make a Hubbert curve for Shale, it would be Patzek. Here is the Bakken:

And here is the Eagle Ford:

This is all very unsettling when you consider that the only thing propping us up from a return to Hubbert's curve for conventional, where we were driven to over $100 a barrel in 2012, is the current US shale oil boom we are enjoying. That's over 4 mb/d, and the two plays pictured above account for over 3 mb/d of that. Are we soon to lose our only prop saving us from peak net energy? This would have severe consequences on the price of oil out 5 years and beyond..

Patzek isn't the only one using Hubbert's method on US shale. David Archibald has done some curves that closely agree with the above in "The Imminent Peak In US Oil Production" posted over two years ago at Peak Oil Barrel, where the site's subtitle reads "The Reported Death Of Peak Oil Has Been Greatly Exaggerated".

The over-production problem I've discussed in other articles for the large conventional fields of Russia and Saudi Arabia may apply also to our shale oil when you consider that the shale drilling boom was fueled by free money and a massive debt frenzy. Instead of price wars or cold wars running the oil fields, we've had the bankers running our fields. The mechanics of shale over-production are different, but whatever they are, there has probably been a lot of it. A Bloomberg article "Refracing Is The New Fracking" points to one possible over-production mechanism, new fracking blasts before a well's first fracking production is over:
It’s easy for things to go wrong. If poorly executed, the maneuver could take oil from the producing zones of other wells, or worse yet, ruin a reservoir. Then there’s the concern that some industry analysts have that a refrack only accelerates the flow without increasing the actual total output over the life of the well. EOG is among the drillers that remain reluctant to start using the procedure.
Patzek views refracking as a poor substitute for making a good well to begin with:
As to the refracking the jury is out. Very poor wells may see some increase of production. Very long wells cannot be reentered towards the toe. Other wells may see the new fractures linking back to the old ones with no incremental benefit. I think that the technology of controlled refracking will improve, but I doubt if it will change the picture dramatically. The key is to make a good well first time around and improve how this well is hydrofractured. There is a lot of work done everywhere on this subject, including yours truly.
Arthur Berman is a consultant to several oil companies and provides guidance to capital formation and investment conferences. He is an energy contributor at Forbes and is interviewed often on CNN, CNBC, and other major media outlets. Does Berman buy this popular notion that we have many decades worth of shale oil to rely on? Well, he recently wrote an article titled, "Why Today's Shale Era Is The Retirement Party For Oil Production" wherein he states:
... looking at the Eagle Ford shale ... even the EIA shows Eagle Ford oil production peaking in 2016... Where do we get this decades of production? ... Eagle Ford isn’t going to stop in 2016; it will go on for many, many years, but at greatly reduced rates of production every year ... They look at the US tight oil plays and they see a couple of years, maybe five years before things start to fall off.
Rex Weyler, a director of Greenpeace said of shale:
In spite of huge shale and tar reserve discoveries, peak discoveries remain well behind us, in the 1960s. My father, a petroleum geologist his entire life (and still, in Houston, Kazakstan…), knew about shale and tar deposits when I was a teenager in the 1960s. He called them “the dregs.” These deposits are not really news within the oil industry. And they are the dregs because of high cost, low EROI and rapid depletion.
It is only prices around $100 that brings dreg oil out. Fracking was invented in 1947. It is less a technology revolution than a price revolution. Berman doesn't think the popular $60 figure for their profit point is right - more like $85-$95. He looks at free cash flow as a big measure of this. If you look at cash flow from operations on these companies, it's typically good if oil stays above $60. With free cash flow including a lot of future building cap-ex, Berman seems to be stretching present costs to cover typical future ambitions. He claims in the above article that, "these plays cannot survive on anything other than sustained $100, $90, $95 oil prices and that is the bottom line."

The profit points may be debatable, but the awestruck view of shale as new vistas of added oil supply seems like a pipe dream of either bad analysis or head-in-the-shale ignorance. Berman agrees:
... once your conventional production peaks, then you are going to be increasingly driven to more expensive, lower quality kinds of sources and that is exactly what we are seeing ...  Sure, we will find something more than what we have. Will we find the equal of what we found so far? Highly unlikely ...  I mean, these shale basins are not news ... The big companies have had teams of geologists and geophysicists and engineers studying them for decades ... so when the prices got high enough and the technology arrived ... companies knew exactly where to go.
If you look at the EIA total shale oil projection, you can see this "sweet spot first" effect evident in their production profile:

Here we see pretty much the same peak time frame for shale (yellow) as the Hubbert curves for the Eagle Ford and Bakken plays, the two sweetest of the sweet spots, with the super-fast ramp-ups in production. The giant, high quality Permian Basin is also contributing to this profile, but with a slower climb and a slower projected decline. The sharp climb pictured closely reflects what Eagle Ford/Bakken has done while the EIA sees the Permian and the sum of all the lesser plays coming on line hereafter plateauing a top and making for a much slower decline than just the two big play Hubbert curves. But they still see about the same overall top that the two big, explosive plays may produce by Hubbert linearization.

You have all these independent means of analysis in Tad Patzek,  Art Berman, and the EIA in close agreement. Patzek is using Hubbert's math method (with Berman's data) while Berman does meticulous well-by-well reserve data accounting. And they both agree on a shale oil production peak in 3 years or less. The EIA also is projecting this with a 2020 peak. If that's all true, in just 3 years, conventional will be declining along with shale oil. With these declines, the only meaningful prop keeping us above Hubbert's curve for conventional oil will then be buckling, and we will once more be in a losing battle with rising demand, as we were briefly before the shale sweet spots ignited in 2012. You will probably want to be long oil once this condition sets in, barring a really bad global economy.

Shale Oil outside the US

The EIA  says the US has 78 of world's 419 billion barrels of unproved technically recoverable reserves of shale oil. There is shale outside the US, but as explained in this study, "The Shale Oil Boom: A US Phenomenon" it is unlikely that the US shale explosion will be replicated elsewhere. The reason - logistics:

  •  The shale boom has depended on an exponential growth of wells drilled. Unlike conventional, shale oil requires punching holes in rock like crazy like a machine gun. No other country has anything like the drilling rigs of the US, where 60% of all the rigs in the world are. They simply don't have the tools or crews to make it happen. The study concluded that this is unlikely to change in this decade because of the time needed to build and man the right rigs and equipment.
  •  Also a problem is that the thousands of new wells a year will be impossible in the more populated areas like Europe due to environmental and other concerns.
  •  And nowhere but the US do you have the small independent oil companies that are needed to take on the fast moving, high risk business profile of shale. And in most other countries with shale, the property is state owned with issues unlike the private and freely sold property rights of the US.
  •  Also in other countries, they don't have the pipeline infrastructure or water supply needed by the water intensive shale business.
The study concluded:
For all these reasons. it is difficult to believe that a US style shale revolution may occur in any other part of the world in the foreseeable future.
The other shale plays in the world will be played - eventually. As oil stays high enough, these countries will deal with all the above logistic roadblocks, and this oil will find its way onto the market. If the "dreg" US shale card soon goes into a decline, there are other cards to play in global net energy supply. But how quickly can those cards be played?  It will likely be in small, erratic doses.

This is why it is so critical to build the natural gas bridge away from oil, as I and others have been writing about for 10 years now. Fracked natural gas has much different dynamics and will peak much later than oil, (around 2040 by Hubbert and other means) and is a much superior transportation fuel than refined oil. The Pickens Plan is needed more urgently now than ever.

Monday, September 26, 2016

Past Over-Production And A $100 Oil Norm For The Future

A Hubbert curve has proven to be about the most accurate way of estimating a production peak time frame for any resource extracted by a consistent method over the life of the resource. But there is one thing that rarely gets considered in Hubbert projections. In 1956, geologists ran the oil fields of the world. A conventional reservoir has an oil/water interface where pressurized water forces the oil up through the wells. Once the water migrates past this interface, as happens with faster rates of production, the drive mechanism for the reservoir is reduced. Oil gets stranded and can only be recovered by secondary methods at much lower net energy levels. Some water encroachment happens no matter what the recovery method over the life of the field, but geologists know just the right production rates to keep the drive at the optimal level through the field's life. Hubbert based his neat, symmetrical logistic curves on this in the peaceful 1950s.

But then we had geopolitical mayhem take over the oil fields. Saudi Arabia was the big swing producer (the Fed of oil) and, most of all, we had a cold war with oil financed expansion of the Soviet bloc, and an oil price war in the '80s and '90s between these two mega-players. It was a political soap opera, but suffice it to say that Russian centric geopoliticians began running the elephant oil fields of the earth. And they were not good geologists. This aspect of our present day energy markets is very rarely discussed or even considered. But its ramifications could be enormous. It is likely there was much over-production of the major fields with permanent reservoir damage.

No one can say just how much over-production and damage was done, and the secretive governments involved have never volunteered this information. The Wikipedia account for "Oil Reserves in Saudi Arabia" mentions Matt Simmons and his criticism of field management and noted:
"Simmons also argued that the Saudis may have irretrievably damaged their large oil fields by over-pumping salt water into the fields in an effort to maintain the fields' pressure and boost short-term oil extraction"
As I mentioned in this article, the decisive weapon deployed against Russia in the cold war was the Saudis' big production ramp and price war starting in the mid 1980s. There are those that claim this was in blatant partnership with Reagan, as this piece in the Telegraph details, with the main witness being none other than Michael Reagan, the president's son.

As for the massive Russian fields, well some say that, in the Soviet era, they were run as a military funding unit. They had no vibrant economy, so their massive oil fields were their prime treasury supply to build their empire, so they badly over-produced with poor technology. Russia is one of the most complicated oil cases on the planet, and opinions and future projections are all over the map.

But I want to present one scenario that would greatly alter oil price projections and energy investing out five years plus. I also should point out that over-production was not just a Russian thing, but they may be the biggest case of it. I should also point out how critical the Russian elephant fields are to the global production picture. The simple fact is that global crude has peaked and come off the plateau except for two players:

In the U.S. it is only the frantic shale boom diverging away from this peaking process. That's another story. As for Russia, it could be said that they are the most critical country in the world now for future oil pricing. This is because their production is over twice that of the U.S. shale and its future perhaps even shakier.

The following graph depicts the general effect of over-production:

The blue line is the kind of geologically sound curve Hubbert generated for the recovery of a large body of oil with just a little, maybe accidental over-production. The red line shows the effect of severe over-production, and has the effect of steepening the climb on the upside, but also steepening the decline rate an even greater amount after the peak with a greatly damaged field. 

As you can see from the graph, the price paid for all the added oil extracted pre-peak is a lot of oil that gets left in the damaged field. The peak time frame is about the same, thus Hubbert's peak time accuracy, and the total oil extracted is roughly the same. So how does our actual oil production history look so far?

This is a logistic fit of crude consumption done by Graham Zabel in 2007 and shows a couple interesting things. First, it's logistic, so it should be in accordance with Hubbert methods for peak projection. It is not Hubbert's method, but does show how well our production history so far is falling into line with typical, sound geology. It includes about 10 mb/d of the usual add-ons to conventional crude, but it does show the 2005 arrival at a bumpy plateau we've been on with conventional oil ever since.

Second, it shows us just where the over and under production areas are on the natural curve. From the late 1930s to the mid 1960s we had mild under-production, due in part to an economy emerging from the Depression. Then we had a booming economy and a historic surge in the principle use of oil, U.S. driving, amounting to over a doubling of miles driven from 1962 to 1977. This sent oil into mild over-production. Then a dramatic improvement in average gas mileage (and other oil uses) induced by the Arab oil shocks sent mileage up from 13 mpg in 1975 to 22 mpg in 1985. We also had a big slowing in the climb of miles driven. All this dipped the oil production curve back to mild under-production. Overall, as can be seen in the above chart, what was soundly produced and consumed followed market forces pretty closely.

So how did the dynamic duo of field mismanagement, Russia and Saudi Arabia, respond to all this?

Per this study by Political Economist, these two mega producers, making about 1/4th the world's supply, severely over-produced in response to the driving demand ups and downs, but the Soviet cold war financing over-production went on long after the driving demand dropped in the mid '70s. This went on until the Saudi ramp-up drove the Soviet oil industry to ruin in the '90s. Things have since settled back to typical Hubbert dynamics (red curves) as calculated here by Political Economist. But was there field damage?

I again refer you to the opinion of Matthew Simmons. He was an oil investment banker in the industry since 1973, was an oil advisor to the president and a member of the Council On Foreign Relations. He went through a mountain of SPE papers (Society of Petroleum Engineers) to write Twilight In The Desert in 2005. There was massive damage according to Simmons. He claims significant damage in Saudi Arabia, but also had this to say on Russia:
"The oligarchs who own and operate most of Russia's oilfields are aggressively tapping into the myriad pockets of bypassed oil ... This performance demonstrates the steps that can be taken to boost production after a field has been reduced to pockets of bypassed oil that water sweeps leave behind. These practices have accounted for most of Russia's surprising production rebound. But they are temporary, one-time remedies ... all oil fields have their rate sensitivities . Ignoring this concept and over-producing jeopardizes future production for any field, even in such prolific oil provinces as Western Siberia and Saudi Arabia." Twilight In The Desert, Matthew Simmons, p.307
One could look at the Hubbert curves above and say that Russia and Saudi Arabia aren't due to peak until clear out to beyond 2030. But there is serious doubt among Hubbert mathematicians whether the classic single curve is appropriate for these two cases. You could consider the curves shown above as "what should have been". Generating a Hubbert curve is based on the production physics staying about the same. When there are two vastly different ways of producing a large body of oil, like a country, sometimes a double curve is generated to better project the future. The very prolonged and severe over-production of the Soviet era could be considered a whole separate set of physics, and would justify a double math treatment for Russia, and by extension, to Saudi Arabia as well:

Sam Foucher, an oil analyst, presented the above in 2007 as his best Hubbert fit of what's to happen with Russian oil. I have added the data points through 2015. It has proven to be pretty accurate so far almost 10 years later. Russian production continued the rapid rise to just below the former peak and has been struggling to climb much higher in a similar plateau top as the '80s. If this projection plays out, it means Russian oil will soon turn into the same king of fast decline as the fast upside of the '60s and '70s and the fast decline of the '90s.

This view of Russia's oil future is from mathematicians viewing public data available on a secretive government from the outside. What do the Russian's themselves foresee? Russia projects their own oil future with a couple of Russian think tanks in "Global And Russian Energy Outlook to 2040". In that work, they conclude :
"Conventional oil (excluding NGL) production will drop to 3.1 billion tonnes by 2040 from the current 3.4 billion tonnes, and the long-discussed 'conventional oil peak' will occur in the period from 2015 to 2020. The drop in its extraction will be due to the gradual working-out of reserves of the largest existing fields." (p35) "Exports of petroleum products will peak in 2015 and will then gradually decrease ..."(p111)

Note they say here exports will peak in 2015 - that's the end of their contribution to the staving off of global decline for anyone living outside of Russia. This would leave just the U.S. shale prop in the global picture. Here is how the Russians see their crude in the years ahead:

"From old" means the oil they see coming from their existing aging elephant fields, so named because they can't be missed in exploration, and 99% of this oil globally has been found for over 30 years. This chart is based on two very optimistic items. First, it displays a 4.5% annual decline rate from the old fields, the "standard" rate applied to global post-peak fields. If these fields were greatly damaged as Simmons says, the decline rate will be much greater than that. Second, the blue parts of the bars are presenting the finding and exploitation of many more elephant equivalents. Good luck with that.

To give you an idea of how differing the explanations are on Russia, consider this fly in the ointment with the Simmons view above. A poster at The Oil Drum claims to have this simple explanation of the '90s rebound in Russian production:
About a month ago, I had the pleasure of spending 5 hours with the Chairman Emeritus of the most prestigious petroleum engineering consulting firm in the world as part of the SPE Distinguished Lecturer program. His firm has done reserve/ engineering studies in every major producing area of the world. He spent a lot of time in Russia over the past 12 years. He told me I wouldn't believe the principal reason for the Russian production increase from 1995 to 2005. They didn't have well tubing that had the tensile strength to run below 1,000'!!! As a result, the bottomhole pumps were set to 1,000' or shallower in all their wells. When they started tubing them deeper and pumping them down, here came the oil.
So this expert is saying the poor Soviet materials they had limited the wells to 1000' or less when clear back in the 1950s, average well depths were four times that. They were just scratching the surface in Russia!

But this explanation flies in the face of most expert opinion on Russia. It could be that they were just exploiting the top layer of oil fields and bungling that with over-production, putting a damaged cap on a lot of stranded oil to be recovered later with secondary recovery at lower production rates and low net energy levels. In my comments on the above cited article, I said this back in 2007:
Russia's very big part in the global peak can not be considered apart from the very large impact of the very large Soviet Union. The Russian production chart isn't a case of a single peak per Hubbert's theory, but what is going to be a twin peak ... One interesting article is this one written by an Air Force major in Air University Review in 1980. Way back then, he sounded just like Simmons today only talking about Soviet fields and predicting a production collapse by the mid '80s (which, in fact, did happen) ... He points out that Russia ambitiously directed over half of their oil exports to Eastern Europe and other parts of the expanding empire, and other geopolitical factors that led to serious overproduction where "...rewards for exceeding goals are given without regard to productivity over the long term ...The consequences are...overproduction of existing fields using low productivity techniques that reduce the total amount of recoverable oil." The major was thus accurately predicting the first Russian peak (a Twilight on the Tundra).
The Russian over-production was apparently bad enough to be a military cause for concern in 1980, just before the production collapse of the mid '80s, which was about it for the primary recovery of conventional crude according to Simmons. But as I said earlier, we mustn't just blame Russia for a possible field damaging production spree in years past. Any country with the elephants and an urgent need for oil revenue was about equally to blame:

Venezuela's chart looks even worse. In fact, the study by Political Economist cited in these charts looks at the top 11 mega producers, and all but Canada, US, China, and UAE have been severe over-producers. I'll give Iraq a pass on this since its erratic chart from political instability can't tell us much. Did everybody in the oil business over-produce. The study gives a chart for global production without these top 11:

Note that it is dropping off sharply from the 2005 peak.Clearly, not everybody over-produced. It was the large field owners that stepped in to the driving demand excess 45 years ago that were also playing all the political fun and games.  The geologists weren't in charge as they were elsewhere. The vast majority of the earth's fields were run sensibly. But here's the thing - The big 11 producers account for over 70% of the projected global peak production. They have done their deeds to the earth's elephant fields, the irreplaceable ones that have been mostly exploited. This soon may come back to haunt us.

Governments running oilfields is still a problem, as this article "Oil's Dark Secret" details. About 90% of the post-peak half is owned by state-run companies. Because they are not good at exploiting what they've got, "oil production will be even more concentrated in the hands of the national firms of Russia and the Persian Gulf."

All this is not good news for those of us stuck on the post-peak side of conventional oil's foreign affairs fun and games. Energy planners and forecasters tend toward an existing field post peak average decline rate of about 4%. But consider this. The Cantarell elephant field of Mexico, as recently as 2004, was the biggest producer in the world except for the Saudis' Ghawar field. It was over-produced in its later stages and has declined now to just 12% of its peak production, a 14% annual decline rate as opposed to the widely assumed 4% for existing production.

All fields behave differently, but if we are underestimating over-production damage to our elephants, we could all be in for a surprising oil production decline rate from damaged fields. Without the policies and infrastructure built needed to get us off the high net energy of conventional oil, with such things as The Pickens Plan, we may be left with a net energy crisis a few short years down the road.

This all sounds very gloomy. But there is a lot of high cost oil out there yet to be drawn into the market by high prices. We found that out when oil was at $105 and climbing in 2012, which drew a flash of American shale oil out of the rock. I'm writing an article on what's really out there in shale, and it shows that the U.S. shale experience is not easily replicated globally. But it will be replicated! Due to several factors, global shale oil will be slower to ponce on high oil, and may be more expensive. And I think oil will be cheap for a while before global shale supply is activated. But we are going toward a global secondary recovery cost norm (think bypassed oil, shale and other "dreg" oil). It's expensive but there is a lot of it. We think of the break-even cost for shale as about $60. But Art Berman believes that counting the typical total balance sheet tendencies of these aggressive companies, it's more like $100 for the "going concern" oil price. Oil at $200 will mean serious demand destruction and belated switch-over to natural gas. So I see oil modulated at $100 or a little more for a long time, if we can keep net energy from falling over the math cliff, as I discussed in this article- a big if.

We (Marketocracy) are publishing an article at Forbes online this week about an investing strategy for all this and a discussion of one stock in particular. The tentative article title is "Russia, Saudi Oilfield Mismanagement" in interview format with Ken Kam as the contributor. You can google to read it, probably later this week.

Friday, September 16, 2016

We Still Despatately Need a Natural Gas Bridge

[This is a republication of part of an article I wrote back in 2011, when oil was marching up to its highest average price ever in 2012. Now a shale oil blitz has taken everyone's mind off the need for anything but oil. But as I will show in a future article, this may not last very long. In the meantime, when we should be using the shale reprieve to help in a scramble to get our transportation switched over to natural gas, we are instead leaving the Natural Gas Act of 2011 dead in the Congress. This will come back to haunt us in the years ahead]

I have said in many past writings over the years that the US is the global village idiot when it comes to energy policy. I'd like to reiterate that here. But there seems to be a change happening in our Washington D.C. that is warming the heart of me, T. Boone Pickens, Jim Cramer, Harry Reid and a whole new army of nat gas fans.

I have described the danger of trying to safely get to a post carbon world without a carbon bridge. The problem with solar, hydrogen, ethanol, and wind is that they take about as much fossil fuel to make these forms of energy as the energy it gives us. They do not displace much fossil fuel if any. There are exceptions, like sugar ethanol; but until we have a good scientific handle on what is really worth a big infrastructure build, in net energy terms, we desperately need a good old fashioned high net energy bridge fuel - like natural gas.

Even before the fracing revolution of the last 5 years, there was a span of about 25 years between the Hubbert calculated peak production of conventional crude oil and the corresponding peak for conventional natural gas. As we pass the oil peak, and I'm referring to oil from conventional pressurized reservoirs which takes relatively little energy to retrieve, the still climbing nat gas curve starts to form a criss-cross where we embark on the "bridge" to a stable energy supply for the next couple decades. If you put all the forms of energy on a time-line, you see this bridge and its relation to the developing fuels of the future: (click to enlarge)

You basically have the huge separation by scale between the fossil fuels and the renewables. The fossil fuels are here and now while the renewables are a tiny fraction of our supply and aren't going to replace fossil fuels any time soon. This is why Washington's veto of anything with carbon in it is so dangerous. It prevents maybe a fraction of the CO2 that gets emitted by volcanoes and other natural sources, but surely cripples a massive share of our energy supply and keeps a post peak-oil bridge from being built for the civilized world.

As the chart shows, a twenty year bridge can be built on either coal or nat gas. Coal has two major problems. It is dirty, and it is of questionable net energy. You can burn it as has been done for hundreds of years with decent net energy, but poison our globe. Or you can go the CTL route (Coal-To-Liquids) and put coal derived fuel into your gas tank without having to burn it. The problem with this is that the EROEI (Energy Return On Energy Invested) calculations I've seen for this process are all over the map with most of them around 3.5 or so. This doesn't do much good in displacing crude - you need around 6 or higher, nat gas and oil are estimated at 8-11 currently. CTL certainly needs to be developed, as Sasol SSL and others are doing. But we know that nat gas is 30% cleaner than the oil we're using and we know that the shale gas net energy, at least for now, is good. The recent tech breakthrough in fracing, by the way, pushes the nat gas peaking curve much further out into the future.

The combination of peak oil and gas fracing has radically altered the oil and gas markets. Traditionally, one could judge valuations of the oil or gas price by just multiplying gas by 6. But the last 5 years has seen the end of this age:

We are now entering an era of troublesome oil prices and cheap nat gas. I still see arguments that gas must rise because it's so out of sync with oil. But that won't happen until a massive switchover of usage happens from oil to gas.

Which brings us to The Nat Gas Act of 2011. This bill was introduced into the House mid year and now has been sent to the Senate as of late November. It used to be mostly a Republican idea, but it is gathering strong bi-partisan support with Senate Majority Leader Harry Reid a key ring leader. This bill would give tax breaks to the purchase and usage of trucks designed to run on nat gas, and other gas infrastructure incentives. It's strengthening support is chronicled in DC Tripwire: NAT GAS Act: Is The Time Finally Right ?

Wednesday, August 17, 2016

Marion Hubbert and Boone Pickens On Oil's Mess

The price of oil is as difficult to predict as it is important to investors' economic outlook.  Books have been written on a correlation between climbs in oil and subsequent recessions so that all you had to do is look for a swift enough climb in oil to know that a recession was soon to follow.  But for every such analyst, there is one who points to weak oil as a sure sign of recession at hand.  Whatever your views, we all know oil is the 800 pound gorilla in the economic china shop.  So when accomplished oil price experts like Daniel Yergin and Boone Pickens speak, investors lean, hand cupped to ear, to listen.

Hubbert's Curve

In the early days of oil in 1956, a Shell geophysicist named Marion Hubbert, a much more obscure expert, developed a math model of oil production.  He was reviled as crazy, almost unpatriotic in the robust American oil business of the 1950s.  But his projection method called for a peak in US production in 1970, after which would be a permanent decline.  And that actually happened:

The red line is Hubbert's math projection made in 1956, and the green line is how it actually turned out.  The above Wikipedia chart is for the lower 48 and doesn't show the large contribution of Alaska in the '80s. But Alaska wasn't even a state in Hubbert's 1956 model.  His math was for conventional oil from naturally pressurized reservoirs (the only kind of oil they knew back then) and it has essentially proven to be correct.

But then, along came shale. This unconventional bonanza has blown the needle far away from Hubbert's curve of physics for conventional reservoirs.  Drilling horizontally in oil laden rock and propping open fissures with sand fracking is a totally different recovery with a whole new set of physics and planet of reserves. This departure from Hubbert's world can be seen very graphically in the US production history above. Two things happened to take us far away from the conventional curve, deepwater oil in the Gulf, which started in earnest in the mid '90s as the above chart shows, and the recent shale revolution, the radical explosion starting in 2009.

So, as Hubbert's projection for a global peak approached in the early 2000s, slightly fewer considered him a lunatic because his US prediction had been so accurate.  His global peak prediction was refined mathematically by Ken Deffeyes, a Shell associate of Hubbert's, as being 2005.  So how did Hubbert's global prediction turn out?  Well, that crazy man was right again:

The peak was 2005 right on the nose, just as Deffeyes pegged it in his 2005 book Beyond Oil
and in his 2001 book Hubbert's Peak: The Impending World Oil Shortage where, according to Amazon's review :
Deffeyes used a slightly more sophisticated version of the Hubbert method to make the global calculations. The numbers pointed to 2003 as the year of peak production, but because estimates of global reserves are inexact, Deffeyes settled on a range from 2004 to 2008
You see varying levels of this "conventional" oil from about 74 mb/d (EIA numbers) to around 84 mb/d depending on how many NGLs (natural gas liquids) and other things are included in "oil".  NGL is from gas production, so purists don't like lumping them in with crude production dynamics.

Here we see a rough breakdown of just what is propping us up from the disasters of peak oil. The two big props are the pale green one and the pink one - that is fracked gas liquids and shale oil (unconventional crude).  If it weren't for the gas shale fracking revolution that came along, natural gas production, along with the associated liquids, which get put into the "oil" totals, would have plummeted long ago.

This difference in conventional crude and total liquids is behind all the arguing over whether peak oil was right or wrong. "Peak total liquids" has not happened yet, and with shale, may not happen for a long time.  Peak conventional crude did happen, and it happened exactly as Hubbert and Deffeyes said. It is also what Boone Pickens has said.  Without the pink prop shown above, we would be put back on Hubbert's curve, and Pickens estimates something like $175 oil would result.  And without the natural gas shale fracking giving us the green prop, oil would probably be even higher, if the economy could stand it.

Boone Pickens On Peak Oil And The Saudis

The two vastly different types of oil source never gets explained very well, and few understand the difference or its immense implications.  This is very evident, for example, in the tempestuous Dec. 23, 2014 CNBC Squawk Box interview with Pickens, right after the sharp collapse in oil, where Joe Kernen calls anyone who still believes in peak oil a nut saying "that was a horrible call".  Pickens responded, "You need to go back and look at what happened to oil production without the United States."  Kernen then goes on about the Malthusian bet on world catastrophe.  Pickens responded, "Yeah, well that's all good bullshit and all  [this cracks Kernen up] 2005, you peaked.  Go back and look at it ... I'm the expert, not you ...what saved you was the shale."  The conversation meanders from there with Kernen complaining that "oil is oil", not understanding much about the oil business. Shale is as if we traveled to a whole new planet and began farming it and adding it to our earth oil that we've been poking a holes in underground balloons for.

Anyway, all this has abruptly propelled us far away from Hubbert's curve into a world now drowning in oil.

As if all this natural over supply against a weakening global economy wasn't enough of a price killer, we have the price war aspect of oil production as a nasty reality in our world today.  Saudi Arabia, thought of as the swing producer, operates mainly conventional fields with high EROI (net energy and ease of extraction) and they frown on significant competition.  They not only frown on it, they annihilate it.

Some say this is really what happened with the fall of the Soviet Union in the late 1980s.  Reagan's arms race was a real pain for the Soviet economy.  But as the article "It's Time To Drive Russia Bankrupt - Again" pointed out:
It wasn't Reagan's massive defense build-up, or his Star Wars program, that drove the Soviet Union to the wall; it was the decline in real oil prices caused by the Reagan/Volker/Greenspan strengthening of the US dollar.

The Saudis rubbed salt into those monetary wounds, because Russia was co-leader in the world's oil production at the time with poor quality fields nowhere near the Saudis' EROI and profit price.  The Saudis gunned production with their better fields to levels beyond prudent oil field physics and flooded the market with oil just below Russia's break-even price - and Russia suffered an economic collapse.  Thus we had the dramatic decline in prices going into the late '90s while Russia's inferior fields were being put out of business.

The Saudis have been aiming that same gunnery at their new enemy, the US shale producers now, as Boones Pickens has often pointed out. In a 4/28/16 article in The Tulsa World titled "T. Boone Pickens calls U.S. oil industry 'dead in the water'."  they said of Pickens:
Since 1980, he recalled in an interview, he has watched oil prices plunge five times worldwide. Four of those times, he said, Saudi Arabia stepped in to cut its oil production, balance the market and bring prices up again. The fifth time — this time — the Saudis kept pumping away, prices stayed low and U.S. companies let their drilling grind to a near-stop. Pickens doesn’t expect them to resume anytime soon ...
The Saudis could be waiting for the destruction of the shale industry before they bring prices back up again. Are they really that cut-throat?  Pickens certainly thinks so.  On the pending public offering of Saudi Aramco stock :
 “It’s a joke,” he said, because stockholders would own stakes in a company still very much subject to Saudi politics. “Who the hell would want to own Saudi Aramco?”
You could, however, make the case that it's mainly the shale explosion that is acting as the swing producer nowadays, not the Saudis. Take a look at this chart:

Here we see that total shale has added 5 mb/d to the world's production whereas the Saudis have been flat since mid 2011, and their market moving excess capacity is thought by Pickens to be only about 1-2 mb/d.  In a price war, are they fighting with a pea-shooter compared to the shale guns?

Well, fighting they are.  And they're putting up a pretty good scrap.

Pea-shooter or not, OPEC is the only one shooting any ammo in this war.  Their lifting costs are only about $15 a barrel, lower than anywhere.  The higher cost US and Russian producers are not trying to keep any lid on prices and aren't trying to drive anyone out of business.  But Aramco is a state run company, meaning that they run the government with their oil profit.  And they need about $80 oil or they must cut services, impose taxes, or dip into their cash reserves of $750 billion built from $100 oil.  In the current price melt, they are burning that reserve at $6 billion a month, a rate that will leave their peashooters empty soon.  So it's a rope-a-dope strategy by everyone against them, hoping they exhaust their arsenal soon and have to live with oil climbing over $60, limited only by real supply and demand in the US/Russia production onslaught.

The Saudis may soon become a more a victim of low oil than a victor.  As was pointed out in an article "Saudis Will Not Destroy The US Shale Industry" at The Telegraph, their temporary ploy can only force the shale properties and technology to change hands, not ever be destroyed.  For all the damage they inflicted on Russian oil in the '90s, Russia is now the world leader in production, outdoing the Saudis.

I have said all that to say this: the price of oil is not controlled by supply and demand equations you can tote up and say price must do this.  It is controlled by aberrant malinvestment cycles gone crazy, geopolitical price war machinations, surprise innovations, and about everything under the sun that any sane investor avoids.  For about 5 brief years from 2003 to 2007, oil pricing was between price wars, economic collapses, and surprise innovations; and Hubbert's curve took firm control as the peaking of conventional ran us way short of oil.  I was fascinated with Hubbert's theory and went long energy in those years.  But ever since it was de-Hubbertized in 2008, I have avoided the whole sector.

Oil simply has way too many layers of unpredictability in it now, many I haven't even mentioned - like Iraq's future flood of the only significant light, sweet fields left unexploited , and the very dangerous net energy problem with shale.  Boone Pickens has a history of making some very good calls on oil, but over the last couple years, he has been way wrong, calling for $80 in early 2015 by the end of that year, and missing big on the high side since then.  I'm not knocking Pickens.  I am a great fan of  US natural gas as a bridge fuel in trucking and the whole Pickens Energy Plan for America.  I was writing on this bridge fuel thing years before he went to Congress with his proposal.  He is on my short list of people I'd like to see as Secretary of Energy, president, or whatever position could enact The Plan.

But I think oil has gotten to be almost uninvestable, and even the best predictors are stumped.  We are in a transition zone.  On the other side will be a stable shale industry, in different hands, and it will be a good investing area again. We aren't there yet.

Adding to all the mess oil has gotten into is the whole banking aspect of it.  As we all know, the shale drillers have borrowed heavily in the NIRP free money years with oil above $55, putting their fortunes in the same boat with a great many banks.  Now with the oil oversupply keeping the price in the range where conventional oil profits but shale doesn't, the Saudis are again showing little mercy on their competition, and are thus at great odds with banking as well this time.  But this isn't 1988, and in this derivative crazed banking world we live in today, if they do to shale what they did to the USSR, we all could be in a heap of trouble.  The Saudis are probably aware that the shale debt craze has put $2 into the ground for every $1 of revenue, and they just have to keep oil below $60 until the shale companies fold up.

We are going to have banking troubles while bankruptcy courts redistribute the valuable shale properties, until the US shale is "restarted" after oil stays high for awhile.  In the above mentioned The Tulsa World article, Pickens was speaking at a gathering of supply-siders, including Art Laffer, Steve Forbes, Larry Kudlow, and some fund managers:
It’ll be hard to start the United States back up,” he said ... They pressed Pickens on how high prices would need to rise to bring U.S. oil rigs back online en masse; he said higher than $40 or $50 a barrel — probably closer to $60.
If we stay in a stable price war, with excess conventional capacity from the likes of the Saudis keeping the shale industry throttled, we will eventually be put back on Hubbert's curve where no excess capacity exists anymore from shale or anybody; and, as Pickens is predicting, prices will then ascend and slowly bring shale back.  This would likely be a gentle process of perhaps many years. We should be so lucky.  If the Saudis' price war and the banking problem induce shock into the financial system, a badly hurt global economy could have a not so gentle effect on oil.

All the aforementioned changing-of-hands of the valuable shale assets may provide some adventurous plays for the brave with some of the assumed prime beneficiaries of such a shuffle of the cards.  That would be the cash rich big oil companies looking to rebalance between conventional and shale assets.  The abrupt shale explosion has them way behind the curve on this.  Some companies to consider there are Exxon Mobil (XOM) Royal Dutch Shell (RDS/A) and ConocoPhillips (COP).  Conoco in particular is making a "massive wager" on US shale according to a Bloomberg release from a little over a year ago "ConocoPhillips Bets On Shale In Major US Spending Shift".  They are "pledging" to spend 50% more over the next three years, and much of that may be pennies on the dollar if the shale bust continues.

But I think such investment plays would have to be considered as much higher risk than what we normally think of with such names.  We have an unprecedented confluence of unstable, opposing mega forces acting on oil right now.  So my best investment advice with oil is - don't even go there.