Scraping The Bottom Of The Barrel

Scraping The Bottom Of The Barrel

By Gerald Harris

Wall Street is getting a lot of attention these days and understandably so. After all, investors are rattled. Historically, December has been a good month for stocks, but December of 2018 was the worst since the Great Depression. In fact, the entire 2018 was awful, the worst year in a decade. And when trading resumed in 2019, the downward trend continued. In this environment, who thinks about oil? But maybe we really should, because the events now unfolding could make this an even bigger story.

To be sure, those events are unfolding slowly. Nevertheless, some observers believe that by 2022, demand for oil will outpace supply by a wide margin. If this proves correct, the price of a barrel of crude will go higher – a lot higher.

Some believe a shortage of oil will develop even sooner than that. A report by the International Energy Agency concluded that there will be a significant increase in the price as soon as 2020.

Robert Johnston, CEO of Eurasia Group, one of the world’s largest political risk consulting firms, said the oil market is “fast approaching a supply gap that Saudi Arabia and US oil may not be able to fill.”

Eurasia Group estimates that a combination of shale and conventional sources will add seven million barrels of oil per day to the market by 2022; this certainly is a substantial amount. However, by that time, demand for oil will have grown by an additional 15 million barrels per day. In other words, there will be a significant shortfall of supply.

On The Lookout

According to Zero Hedge, if this potential shortage should materialize, to a great extent it will be due to “an oil investment drought marked by two years of consecutive decline, a statistic that has no precedent in the oil industry.”

In 2017, exploration companies found the least amount of oil since at least the 1940s, according to Rystad Energy, an oil- and gas-consulting firm. Less than 7 billion barrels were discovered in 2017, which is a relatively low number. Although the discoveries made by some companies have not been factored into this number, even when they are Rystad believes that they will increase the total amount of new oil by just 10 percent – at most. By comparison, 30 billion barrels were found in 2012.

The decline in new oil in 2017 was not a fluke. The amount of new barrels discovered have been falling every year since 2014. Perhaps more important is that there is less oil in the fields explorers are finding. According to Rystad, an average offshore discovery in 2017 contained about 100 million barrels of oil and equivalent, down from the average of 150 million barrels in 2012.

A Global Problem

Societe Generale’s Michael Haigh, global head of commodities, says that at the end of 2018 the level of oil inventories around the world were below their five-year average. According to Haigh, in 2018 there were 2 million barrels of oil a day in spare capacity globally, and while that may sound like a lot, it’s not.

“In an environment where growth in 2018 (approximated) 1.6 million barrels of oil per day and will be an estimated 1.3 million barrels in 2019, you are getting into a very sensitive area because inventories are very low and spare capacity is now declining.”

Meanwhile, in 2018, companies around the world have sold a record number of large crude tankers for scrap. Morgan Stanley estimates this will have important ramifications; specifically, the bank thinks it will lead to a shortage to the tune of 100 million barrels of transportation capacity by the first half of 2020.

“It prolongs the period of profitability after the (anticipated) turnaround,” said Fotis Giannakoulis, a New York-based shipping analyst at the bank. “The more you scrap, the more you bring the recovery forward and accelerate its speed. The market will strengthen with high scrapping even with the smallest growth in demand.”

Where Are The Reserves?

The last time oil and gas companies added as much to their reserves as they were producing was back in 2006. After that the numbers in reserves began declining. In 2012, only 50 percent of the reserves companies were using were being replaced. In 2017, just 11 percent of their reserves were replaced.

This doesn’t mean to suggest that the world is going to run out of oil any time soon. For one, major oil-producing companies have emergency reserves. Also, if the past is any guide, additional exploration will result in at least some new oil fields identified.

In fact, some important discoveries were made recently. In 2016, a field was discovered in Texas with an estimated 20 billion barrels of oil and 1.6 billion equivalent of natural gas. The US Geological Survey called this the largest continuous oil discovery in the US. In December 2018, an even bigger field was found; this one stretches from Texas into New Mexico and has an estimated 46.3 billion barrels of oil and 281 trillion cubic feet of natural gas. There have been other notable discoveries in Alaska, Mexico, and in Latin America.

Nevertheless, even while keeping these fields in mind, it’s important to note that a field – say with a billion barrels of oil –- is not as significant as it sounds because a billion barrels is enough to supply the world with oil for just 10 days. And even if dramatic new energy-producing technologies will be developed, oil will remain the premier source of energy for many years.

“Known reserves of oil are in decline and will continue to decline, except for fracking, but that bubble has popped so be careful,” billionaire investor Jim Rogers said recently. “Don’t sell your oil.”

Unless the supply/demand ratio improves quickly, the world may soon experience a serious supply shortage, one that could lead to much higher oil prices and much higher inflation. This also suggests that major oil-producing nations could gain much more political clout, possibly imposing their will on importing nations.

Oil-consuming nations have been lucky for a long time. Let’s hope that luck does not run out.


Gerald Harris is a financial and feature writer. Gerald can be reached at