The first peak oil recession: Interview with Steven Kopits
Steven Kopits, who runs the New York office of Douglas Westwood, was in Denver last week. He talked about his latest paper on peak oil and the economy with Steve Andrews and will share related remarks at the ASPO-USA conference next month. Steve popped a few questions:
Question: Tell us about your background.
Kopits: I’ve spent most of my career and as a strategic management consultant and investment banker. I’ve focused on the energy business for the last several years, and now I manage the New York office of Douglas-Westwood, a UK-based energy-business consultancy. We’re well known for our market research in the upstream oil and gas business. In the industry, we are considered the consultancy of record for our forecasts of offshore drilling and production, as well as for marine renewables like offshore wind. I am personally interested in macro oil markets and write frequently on issues related to peak oil.
Question: When did you learn about the peak oil story?
Kopits: I was preparing investor documentation—a prospectus for a public offering. As part of my work, I was looking at oil supply and demand issues, in particular as they related to China. When I ran the numbers, I found that projected demand turned out to be considerably greater than what the EIA was stating. Just for the sake of completeness, I thought to confirm that the oil supply was adequate to meet Chinese demand growth. Now you should keep in mind that, at the time, I thought peak oil was pure fantasy. But when I checked, supply growth promised to be much less than the EIA was indicating. I became concerned because I couldn’t find the resources on paper.
Question: Would it be fair to say that Douglas-Westwood has had a sober view of the long-term oil supply picture?
Kopits: That’s absolutely true. In fact, my views evolved as part of my relationship with the firm before I joined the company. In the past, we’ve also worked with Simmons & Co., for example, and consider them to be friends; philosophically speaking, we are in that camp. Our firm’s formal view is that we expect peak oil in the middle of the next decade. My personal view is that peak oil—at least in the sense of “practical peak oil”—is probably behind us already.
Question: Has the firm’s view of peak oil evolved much over the last three-to-five years?
Kopits: I think the supply story is proceeding more or less the way the firm had anticipated. There were no black swans in our forecast, at least in terms of the oil supply. Douglas-Westwood has been reasonably good at forecasting volumes going forward, and has been for some time. That’s part of the reason I joined the firm: they are good at what they do. The other reason, by the way, is because they’re great people. I am privileged to work for the company.
Question: What kind of feedback do you get when writing about the peak oil story?
Kopits: In general, the feedback has been very positive. I would point out, however, that we’re not vested in peak oil; we’re simply technical analysts. We analyze markets, and we report what the numbers say. When I write about peak oil, I just present charts and graphs and interpret them. Incidentally, what is interesting is the difference in feedback between Washington DC, New York and Houston regarding peak oil. When I’m on the east coast, I tend to use “peak oil” in quotes, and I am usually somewhat cautious speaking about the topic. In Houston, there’s no need to be shy. When I have mentioned peak oil to the managers for oil field services companies, they don’t flinch. They may qualify the phrase with “affordable peak oil” or “practical peak oil”, but our friends in Texas are the ones who have to find and produce oil on a daily basis, and they know it’s getting harder and harder all the time. Peak oil is not a theoretical concept in Houston; it’s a daily operating reality.
Question: But Daniel Yergin and Michael Lynch don’t seem to believe in peak oil.
Kopits: Douglas-Westwood’s perspective has differed from CERA’s for many years. Our firm’s view has held up; to date, CERA’s has not. Back in 2005, CERA predicted 101 million barrels a day of capacity by 2010; we’ll be lucky to see 90, maybe 89. On the other hand, we can’t discount the possibility that either technology will improve or that we will find oil that we did not anticipate. Look at how radically the natural gas picture has changed in the last two years—the outlook can change materially. Still, over the last five years, an investor or energy company would have received a more accurate view of the market using Douglas-Westwood forecasts.
Question: Your recent paper makes it sound as if we’ve been on an oil production plateau since late 2004.
Kopits: That’s correct. If I dispassionately just look at the numbers, the oil supply has not improved that much since the 4th quarter of 2004. And I don’t see anything on the horizon that makes it appear that we’re going to break out into a really new level of production that’s far different than what we have today. So if we’re talking about practical peak oil, my view is that it started in late 2004.
Question: What’s your sense of when we slip into decline on the back side of this plateau?
Kopits: It’s hard to say. From my perspective, the inception of decline is less important than the gap between supply and demand. If China weren’t growing so fast, peak oil could come and go without us noticing for some time. Now, even if the oil supply grows, it will not likely catch up with demand. So we can suffer the economic impacts of peak oil even with a modestly growing oil supply. Essentially, that’s the story of oil from late 2004 until mid 2008.
Question: What sort of decline rate to you anticipate, in 2012 or whenever it occurs?
Kopits: I don’t have an independent view on that. The IEA has pointed out that decline rates appear to have increased to 6-7%, and PFC has a very interesting chart on the increase in decline rates from offshore wells over time. By the way, these sorts of developments—secular increases in decline rates, for example—are one reason that I think peak oil is upon us already. Are they proof? No, but they are suggestive. And if you work in the industry, you keep running across similar charts, indicative of a system in trouble even if they are not conclusive. At the same time, you have to keep in mind that there are above-ground constraints on production which could influence aggregate decline rates. You have to consider, for example, whether the Saudis will increase production or if Iraq will get better at administrating its oil industry. There are a lot of things we don’t know at this point that will determine decline rates.
Question: Could you tell us about your views on the US oil price threshold for recessions?
Kopits: The US has experienced six recessions since 1972. At least five of these were associated with oil prices. In every case, when oil consumption in the US reached 4% percent of GDP, the US went into recession. Right now, 4% of GDP is $80 oil. So that’s my current view: If the oil price exceeds $80, then expect the US to fall back into recession.
Question: Can you comment on why, during an economic recovery, you see oil consumption growing faster in developing economies than in the OECD countries?
Kopits: Consumption will tend to grow faster in developing economies for two reasons. First, by their nature, developing economies should grow faster than mature ones, and this has been generally true of east Asia and strikingly so in the case of China. So faster economic growth means faster growth in demand for oil. Further, oil consumption growth follows an “S”-curve. At low levels of GDP, oil demand growth is quite slow. Once a country has reached middle class income levels, per capita oil consumption stabilizes. However, in the middle, as a country becomes middle class, oil demand growth can be explosive. Take South Korea, for example. South Korean per capita oil consumption peaked in 1996; however, in the previous 12 years, the country’s consumption increased nearly fourfold. China is now firmly on the S-curve. Based on South Korean experience, we would expect Chinese oil demand to stabilize at around 50 mbpd around 2032-2035.
But where is the oil going to come from? If you have a flat—or heaven help us, declining—supply of oil, then the emerging and fast-growing economies will have no choice but to start bidding away the oil from the advanced or slow-growing economies. That is consistent with what we’ve seen in the data starting in about 2006. For China to grow, it will have to take away the oil of Japan, the US and Europe, just as it has in the last three years.
If I run out the projections, this implies that US consumption is likely to drop by about one-third, from its peak at 21 mb/day before the recession, to about 14 mb/day in 2030. That will potentially be a long and painful adjustment.
Question: In the world of oil analytics, what rules does peak oil break?
Kopits: The primary thing that we have learned—or more precisely, re-learned—in the last year is that the global economy will not tolerate oil at any price. In the first half of last year, we had some prognostications of oil at $150, $200, even $500, and they were understandable because of the supply and demand dynamics at the time. But as we’ve seen since, once our oil consumption exceeds 4% of GDP in the US, we go into recession and we cut our oil consumption. The global economy cannot sustain oil at any price. Beyond a certain threshold, the result is likely to be stagflation or recession rather than perpetually increasing oil prices.
Question: Can Humpty-Dumpty put it together again, or are we in brand new terrain because of the peak oil plateau?
Kopits: I’m a supply pessimist because I think that’s what the data best supports right now. No, for oil, I don’t think we can put it back together. That means we have to look to next closest fuel supply, and that’s natural gas. I think we’ll see the migration of natural gas into traditional oil uses such as transportation. We’re not going to solve this overnight, but we need to progressively take pressure off the oil supply. If the price of oil is high, as I believe it will be, the market will drive buyers in the direction of natural gas.
Last question: Anything on your mind that I should have asked about?
Kopits: From a policy perspective, I think it’s important to understand that we are all in this together. Peak oil is not a U.S. problem, but a global problem. It is a problem for both the consumer and producer nations. Did Saudi Arabia enjoy this recession? Did Iran or Venezuela? What about China or Japan? Peak oil recessions—and I argue in an upcoming article that this is the first peak oil recession—are painful for everyone, and are worth avoiding or minimizing. To do so, we need to think about the issues together, constructively. Also, on the policy side, there are limits to what we can do with conservation; an over-aggressive conservation program is called a recession. So, we need to think about improving the transportation energy supply, and we need to act now. Time is short. Electric cars may be fine in 2020, but we need solutions that can be brought on line within the next 2-3 years, and from my perspective, that’s natural gas.
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