Oil, gas, and the investment sinkhole problem

If we want to “grow” oil and gas production at all, businesses will need to keep investing increasing amounts of money (and energy) into oil and gas extraction. For this to happen, prices paid by consumers for oil and gas will need to continue to rise. In the US, there is a particular problem, because the selling price of natural gas is now far below what it costs shale gas producers to produce it–a price estimated to be $8 by Steve Kopits of Douglas Westwood. The Henry Hub spot natural gas price is now only $3.38.

Our Finite World

Gail Tverberg, an actuary with a background in math, analyzes energy and financial matters from a perspective that the world has limited resources. For more of Gail's posts, click here.

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  Graphic: Figure 1. Comparison of 2005 to 2011 percent change in real GDP vs percent change in oil consumption, both on a per capita basis. (GDP per capita on a PPP basis from World Bank, oil consumption from BP’s 2012 Statistical Review of World Energy.)
  (BP)

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  Graphic: Figure 2. Total primary energy consumed per capita, based on BP’s 2012 Statistical Review of World Energy data and population data from EIA.
  (BP/EIA)

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  Graphic: Figure 3. World oil supply with exponential trend lines fitted by author. Oil consumption data from BP 2012 Statistical Review of World Energy.
  (BP)

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  Graphic: Figure 4. Two views of future economic growth.

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The question now is whether oil and gas investment will keep rising fast enough to keep production rising.Barclays is forecasting only a 7% increase in worldwide oil and gas investment in 2013. According to the forecast, virtually none of the investment growth will come from North America, apparently because oil and gas prices are not currently high enough to justify the high-priced projects needed. The flat investment forecast by Barclays suggests a major disconnect between what the IEA is saying–that North America is on its way to becoming an energy exporter–and the actual actions of oil and gas companies based on current price levels. Of course, if oil and gas prices would go higher, more investment might be made–a point I made when writing about the IEA analysis.

What will the ultimate impact be on the economy?

I would argue that for most of the developed (OECD) countries, the ultimate impact will be  a long-term contraction of the economy, similar to that illustrated in Scenario 2 of Figure 4.

What happens is that as we increasingly reach limits, more and more investment capital (and physical use of oil) is allocated toward the investment sinkholes. This has a double  effect:

(1) The prices paid for resources that are subject in investment sinkholes need to continue to rise, in order to continue to attract enough investment capital. This is true both for goods that directly come from investment sinkholes (oil, gas and water) and from products that have a less direct connection, but depend on rising-cost inputs (such as food and electricity).

(2) Products outside of essential goods and services will increasingly be starved of investment capital and physical resources. This happens partly because of the greater investment needs in the sinkhole areas. Also, as consumers pay increasing amounts for essential goods and service because of (1), they cut back on the purchase of discretionary items, reducing demand for non-essentials.

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