Has Peak Oil--As a Meme--"Tipped"? (Out of Futures Backwardation and into Contango)

Has Peak Oil, as a meme, "tipped"? Our latest oil price poll suggests that well over 70% of the sample (N>3000 now) thinks that oil will at least stay above $114 a barrel for the next two months--and almost half think it will hit $140 a barrel in that timeframe. Search volume on Google for the term is up dramatically in the past month, as is traffic at The Oil Drum. One indicator of a "tipping point" for acceptance of Peak Oil may be the state of backwardation in oil futures. I first raised this idea over 2 years ago, but recent market movements, coinciding with attention in the press, may be validating it: when the markets accept Peak Oil, we will see the end of backwardation in crude oil markets, and possibly even Contango. Here's what has happened over the past 6 weeks:

UPDATE: Graph updated with data as of 10:00am EST on May 19th to show significant contango

A few quick definitions: Backwardation is when prices in the future are lower than in the present. Contago is the reverse, where future prices are higher than in the present.

Normally, oil markets are in backwardation. It is conventional wisdom that oil markets will always return to backwardation for several reasons:

- The Hotelling Rule, e.g. the expectation that improved technology will lead to ever lower extraction costs (which, of course, Peak Oil theory rejects, and in fact argues for the opposite)
- The vicious cycle theory (.pdf): when backwardation reaches zero, there is no incentive to hold inventory of oil, which then causes inventory to decrease, which then causes spot prices to rise, resulting in increased backwardation
- There is no incentive to fix current prices at today's price, because the time-value-of-money would actually result in you paying more than today's price for oil (which only makes sense if you accept that Peak Oil will likely lead to dramatically higher prices in the future)
- Arbitrage (discussed below)

Is contango even possible in oil markets? The conventional wisdom is no, at least not over a sustained period of time. The theory behind this is that if oil is selling for more two years in the future than it is today, then producers will use arbitrage. They'll buy a front-month oil future, sell a distant-month oil future, pocket the difference, take delivery of the front month oil and store it for delivery at the later date. This prevents oil in the future for selling for any more than the cost of storage of oil until that date, and when time-value-of-money is accounted for, that usually requires that future oil sell for less than spot oil.

Contango could exist if a few circumstances were met: present rate of oil production would need to be effectively fixed, there would need to be a consensus that future rate of production will be lower and that demand will remain highly inelastic, and there must be some impediment to storing today's oil to sell in the future. If all three of these came to pass, then the oil markets could be in significant contango and arbitrage would not be able to remedy the situation. Of course, it seems unlikely that these things (specifically the inability to store oil) will come to pass unless through some kind of political or regulatory move, but it is possible.

Because backwardation is the norm, and contango seems unlikely, I think it is highly significant that oil has gone from very large backwardation to nearly zero backwardation over just the last 6 weeks. It seems consistent to me with an emergence of Peak Oil awareness in the markets that led the market to the rejection of every reason for "normal backwardation" listed above except arbitrage (which can only maintain backwardation equal to the difference between storage cost and time-value-of-money).

It's common for backwardation to decrease rapidly in an environment of declining spot prices, but to my knowledge there has never been a decrease in backwardation as dramatic as we've seen in the past weeks in an environment of rising spot prices. I think it's something that requires explanation, and a growing acceptance of peak oil by the markets seems like the most valid explanation. And for that reason, I think the recent decrease in backwardation is, itself, an indicator of exactly that dawning awareness...

Jeff - well done.

Actually, your graph cuts off in 2015. There are crude oil futures through Dec 2016, which actually ARE in contango vs current month (Dec 2016 closed Friday at 126.64 +$5.34 vs Jun 2008 which closed up $2.17 at $126.29.

Still cheaper than orange juice (but now more expensive than kool-aid).

Nate, Tradingcharts.com only carries the NYMEX Crude Oil (Light) contract out to December 2015. Can you give us the URL for whomever carries the December 2016 contract. Thanks,

Ron Patterson

Thanks Marvin, just noticed the last trade for the December 2016 contract was $130.35, up $3.71 on the day.

Ron Patterson

Kudos for a fantastic analysis.


You can get the full spread of quotes (out to Dec. 2016) direct from the NYMEX at:


At the morning, we are now in contango from Dec. 2011 on, with Dec. 2011 at $126.90, Dec. 2012 at 127.41, Dec. 2013 at 128.05, Dec. 2014 at 128.50, Dec. 2015 at $129.15, and Dec. 2016 at $127.40, and front month at $126.86.

Looks like I need to update the chart!


Thanks for the article especially the definitions. Can you (or anyone else) please explain how one would go about buying an option or where i can find this out, Oil Trading 101? For example:

Who or what are the counterparties = who are the trades done with? No point doing the trade if the counterparty cannot deliver.

I remember reading when $100 was first broken the trader bought the minimum quantity, 1,000 barrels? so presumably trades are in multiples of 1,000 barrels.

If I buy an option to purchase 1,000 barrels at $129.15 for Dec 2015 how much does this cost 1,000 x 129.15? Is a set percentage paid for the option and how much margin is required to guard against a falling price?

Is any acccount taken for inflation or a collapsing dollar? What would happen if oil were to be priced in gold or Ameros or Euros...

Does one have to take delivery of the oil or is there something similar to Contracts For Difference in the FX market where you just pay/receive the loss/profit?

Tony: I'd recommend talking to a full service commodities broker for advice on this--if you tell them how much money you want to invest, how much risk you're willing to accept, and where you think oil prices will be at X date in the future with what degree of confidence, they should be able to provide a good buy recommendation. In general, oil futures control 1000 barrels of oil, and require a margin (how much money you need to put up) of about $9000. Then, for every dollar it goes up (assuming you're long) you get $1000 deposited in your margin account at the end of the day, and every dollar it goes down you have to put $1000 into your margin account (if it falls below the maintenance requirement--about $7000). So, the problem with futures is that you can lose more than you put up in the first place. Options, on the other hand, can never lose more money than you paid to buy them (assuming you're the option holder, not the seller). So, for example, if you bought a December 2010 call option with a strike price of $150 for $3,000, and oil went to $200/barrel by the expiration date, then your option would be worth $50,000 at the expiration date. If oil was still at $130/barrel at the expiration date, your option would expire worthless. Generally you won't take delivery--you'll sell the option (or future) prior to that point. That's a very bare-bones, simplified explanation--there's lots more information available online, but I'd still recommend talking to a full-service broker until you feel confident enough in your understanding of how the markets work to trade on your own via an online broker.

Jeff, many thanks for your explanation.
I wasn't originally thinking about trading as never done anything with commodities was more interested in how it worked, but a call option might be a bit of fun instead of buying a red Ferrari:-)

If you're just interested in a wildly speculative "bet," then you can probably pick up a call option on December 2010 oil at a strike price of $250/barrel for under $5,000...

Therefore it will soon make sense to refine orange juice?

Only if you subsidize the sugar that would have to be added. Unfortunately, if energized OJ is used in a low compression engine, the sugar crystals tend to form scorch deposits around the exhaust valves, which in turn causes a loss of credibility compression.

I read this analysis over at The Daily Reckoning:-"Why the Oil Price Will Correct Itself"


Short quote from that article's conclusion:

"Some take measures to avoid using it. Some find substitutes. Some increase production. Markets still work, in other words. Every bubble eventually finds its pin. The day can't be too far off when the price of oil will fall back under $100."

That sounds like one part misunderstanding the root of the problem (he never mentions Peak Oil or any notion of supply constraints), one part faith ("Markets still work" . . . "can't be too far off"). Nor does he mention inelasticity of demand. As with most pundits, I'd say put your money where your mouth is--if an oil price correction "can't" be too far away, how many long-dated put options does the guy own?

He's not really a pundit. He spends lots of time talking about how the markets are not working. My take is that he focuses more on gold, currencies, and debt. If he looses any money betting against oil, he'll probably make it back in his own field, but I wouldn't expect him to be short, certainly not much. (I don't read his column much so feel free to correct me.) But I agree that he does not seem to be thinking about peak oil. I think there are many people who compare this time to the seventies, and expect it to pass.

Beware, the oil price can still fall but we use less if we are in a contracting economy.

Peak oil means less oil supplied/demanded each year post peak - when looked at from the 'less demanded' point of view implies ongoing world recession.

If no adequate alternatives can be found the cost of oil will rise as a percentage of income (GDP), but may fall in absolute terms if demand is less than possible supply - IMO what 'net export' oil market remains will still match supply and demand by price (unless there is a breakdown of law and order and the market is no longer 'free'.)

Post peak oil I don't think you can predict the 'net export' price any more than you can now (so the futures market is still gambling!)
You can expect just an undulating recession - the world economy always contracting, sometimes more than others - and not everywhere in the world will have less access to oil than it needs to expand their local economy - chose where you want to live with care.

Yes, but demand destruction may not occur as fast as crude depletion and hoarding, which could mean prices continue to increase in spite of reduced demand, resulting from dramatically reduced supply.

Demand is always destroyed by supply depletion.

Or are you suggesting that somehow we'll be able to consume some kind of a "virtual" oil?

Economics is such bull excrement. If I cannot buy something it does not mean I do not still want it, and it certainly doesn't mean I don't need it if it's central to my existence.

Demand destruction is a stupid term. It should pply only to wants, not needs. When it is needs, ability to buy is destroyed, not the need to. Flight to an alternative and/or getting fired/not eating, etc., is what it is.

We should be more careful about how we talk about things. Intellectual gymnastics should not be allowed to gloss over human misery.



luisdias, so you're saying then that if food became too expensive people would stop buying it? In what form would the sustinance come from for the nutrition your body craved in the face of starvation, resulting from the need to prove that demand is "always" destroyed by supply depletion? No, you'd be paying whatever the price was and be thankful as hell you had something to scarf down.

Very unfortunately, that is not always possible.
No doubt if you have the money, there is plenty of food in Haiti.
Unfortunately most simply have not got it, and so they eat mud biscuits.
For oil, at some point most will simply not be able to afford it, and that is why I think that oil prices at some point, perhaps $300-500/barrel, will simply not be able to buy the oil, and so price in my view is unlikely to rise above that.
The demand destruction will stabilise the price.

Cslater8, as Dave Mart says demand cannot exceed supply no matter what the price or whether you want or need it - hence several tens of thousands of people will die of starvation somewhere in the world today even though they may well have money in their pockets - there isn't always an adequate alternative.

If hoarding of oil starts in exporting countries in a big way (like the current hoarding of rice) the net export supply can be expected to fall away very rapidly.

Hoarding is normal human behaviour if is more profitable to act that way, and, at the current oil price acceleration it looks like it is more profitable even for oil companies like Exxon to keep the oil in the ground!

Nobody has any idea what the oil price will be that a poor impoverised OECD person can afford if there is a major resource constraint induced recession - but I suspect limited food (limited by the supply of phosporus and overpopulation) and clean water will take priority over everything else at some point.

So, eventually the price of oil may well be below the current one, people just won't have the money to buy it (as in most parts of the world already.) If you can't afford oil you won't be able to afford the alternatives like electric cars either IMO.

According to Picken on CNBC today oil prices will hit $150/barrel this year, and that can't be supported by the major importing nations, and will result in major depression until alternatives are found and used.
Higher prices in Europe in the past were a result of national taxation, and the money did not leave the economy.
IOW the effects I speculated on with oil at $3-500/barrel will actually hit at a lower price level, and next year.
He feels that not even $100/barrel is sustainable by importing economies, so even after demand destruction has reduced use below the 85 million barrels a day we can produce and prices drop, demand will not be stimulated.
It would just mean that oil exporting countries would have no incentive to hoard their asset as that too would be devaluing, but will not be able to afford so many imports as their impoverished customers will not be able to afford it.
This will further hit world economic demand.

Just means we are running out of sellers at the later dates..

As more and more energy companies become peak oil aware less want to be short 2016.. and lock in there price. More and more consumption companies and speculators want to be long, as they become Peak oil aware. Thus contango. NG has been in contango many times as has gold for years. There is no evidence that oil cannot be traded in contango. In fact if you look at gold and NG Contango is the normal state of affairs.

I agree that there's no evidence that oil cannot be traded in contango--today's prices are pretty clear on that. However, there are still powerful market forces that push back against contango. If a producer can sell oil for more in 2015, after accounting for cost of storage and time-value-of-money, than they can in the present, then they will do so.

This is true of any storable commodity. The big difference between oil and gold/natural gas, to the best of my knowledge, is cost of storage. I don't have good numbers for price of storage of gold off hand, but in many geological formations natural gas storage can be accomplished for very, very little and is routinely done on site (and there is a very large amount of NG storage available because it is a more seasonal commodity, at least in the US). For those who must store produced oil, as opposed to storing oil via shutting in production, the cost of storage is quite significant. I think this makes the shift to contango even more significant... does it suggest that those countries capable of shutting in production (e.g. OPEC) are doing so as they have lower cost of effective storage? Not sure...

But how can there be storage if it's taking everything possible to keep the markets supplied now?

Mac, there is always storage. Last week, in the US, it was 325.8 million barrels or 22 days supply. That is right in the middle of the five year average. There must be storage in case of any disruptions happened, hurricanes, war, etc. the refineries would not run out of oil.

This Week in Petroleum

Ron Patterson

I suspect some industrial consumers of oil are starting to store (hoard) the stuff, presumably as refined products.

They are now doing this, I'm guessing, not to turn a profit or save money later, but rather to hedge against the possibility of shortages. For many companies, the monetary value of any difference in prices (whether plus or minus) is trivial compared to the consequences of running short.

If many customers worldwide are doing even a little bit of hoarding, that could easily explain the recent rise in price. (Trading of futures, on the other hand, should not significantly alter the price of physical goods.)

I question any commodity storage figures going out 4 digits.

And 22 days supply is only based on stable pricing.

I posit that we are at MOL.

That inventories aren't keeping up and that is why we have backwardation.

Actuals are dictating the price.

Just an opinion of another oil user.

You're assuming that the goal of the market is to keep buyers supplied. This is incorrect--the goal is to make money. If sellers can make more money by selling their oil later as opposed to right now, they will do so, no matter how dire the present shortage.

This is one reason why unregulated markets should never be used for things like emergency medical care.

  • Q: What's the market price for a tracheotomy when you cannot breathe?
  • A: All of the money you have and all you will ever make (and probably all that of all those that care about you).

The goal of the market is to allocate scarce resources. It does so on based on price. If there are shortages, then the price will rise to communicate such shortages. At that time, the hoarder can quantify it is worth the current spot price or more or less. He can then make another decision to sell or hold.

So our current unregulated health care system functions why? What stops a doctor from charging one person their life savings to save their life? - Another doctor who does it for less...health care would take care of itself it was UNREGULATED and allowed to compete against each other. Instead you've got a few companies lobbying the $hit out of Congress to maintain status quo. For that you get stuck with whoever YOUR employer chooses, not you. Great system.


UNREGULATED health care - hmmmm. I don't know. I kinda like doctors who have to go to medical school, but thats just me.

Um, Cheapest form of storage is leaving it in the ground. It still seems to me the national oil companies are the only sentient energy institutions.

health care would take care of itself it was UNREGULATED and allowed to compete against each other ...

There are more logical errors (and ideological errors) in this than one has time to write about. Market forces don't work in the delivery of any essential services (I offer Enron as an example), least of all health care, because of infinite inelasticity, and not the least a social policy imperative supported by all reasonable people, that health care availability should not be dependent on your capacity to pay "market price".

A national insurance scheme is the best policy, and not that difficult to implement. Then you also have to regulate how often doctors should be able to upgrade the Porsche.

I wasn't clear, my mistake. Unregulated in the fact that anyone can claim to be a doctor is not what I meant. Unregulated in that you are not forced to use what your employer chooses for you. There is a third party making an individual's choice and we all complain because none of the choices seem palatable. So why are we asking for another third party to make that choice once again? You can't handle the freedom to make your own choice? I don't get it. Elaborate because I'm missing something. PM me if you so choose, but I seek the same goal its the means to that end up for discussion.

There is a lack of choice. You get to choose between possibly two providers selected by your income source. If instead, we would be able to shop against each other and get perhaps a corresponding tax break to offset the cost (dont like this either but I'm trying to compromise), we, the patient, would be at a net gain based on competition for our dollars.

This is basic competition and trying to institute some government program that wont work only serves to distort a free market more. When will people understand the totality of man's choices? We've seen how this has progressed and the solution every time is more government. Really? Thats what we need. We need more taken from us, to even things out. That's grand if we are lowering all of our standards in the process.


FYI, gold can be insured and stored quite cheaply say at around 0.2% of the cost per year. This is stored at a reputable bullion dealer vaults around the world in stable countries (so no need to hold it in your own country especially if they have a history of confiscating gold). This supposes you have bought the gold from the dealer.

Since one ounce of gold costs about eight barrels of oil it needs a somewhat smaller space to store and won't run all over the floor or catch fire:-)

The size of the storage required is what has always puzzled me about speculators driving up the price. Since one day's supply of 80 million barrels would more than circle the world standing up, to significantly affect the price huge amounts of storage would be required other than leaving it in the ground of course. So on this basis alone I can't see speculation as the culprit, maybe that's why it is a good target for politicians coz there's nobody to hit back:-)

Jeff, nice work.

I bought my first contract on 15 May 2004. It was a Dec 2008 for $29.50/bbl. I told the broker it would go to $80/bbl before it expired. He laughed.

Over the last 4 years, I have been waiting for two things to happen to indicate to me that people/investors/etc were becoming Peak Oil Aware: 1) When the price of the out most years rose above the preceding contract years, and 2) when the out years went contango.

Number 1 happened in Oct 2007, number 2 is happening today. All the out years are up $3+/bbl, while the front month is up ~$0.70/bbl. So 2011/2012 to 2016 are now higher than the front month.

Hmmm, if this sticks, then would oil producers want to cut production so they can produce more in the future at the higher prices?

"...if this sticks, then would oil producers want to cut production so they can produce more in the future at higher prices?"

That pretty much sums up the vicious cycle argument noted above: IF producers can get more money for a contract in the future (counting time-value-of-money and storage cost if they can't effectively shut in the oil) than they can now, then they should do so--and to the extent that they are corporations governed by US law, they have a fiduciary duty to their shareholders to do so.

The problem the, is that this would significantly reduce present inventories, and presumably cause the spot price to shoot up, erasing the contango. It will be interesting to see what happens.

The real issues, in my mind (and this also addresses Starvin Marven's comment above) are:

1. Can production be effectively shut in, or must it be produced and then stored. Many national oil companies may be able to merely shut in production, but domestically where a lease applies, or internationally with a PSA, there may be serious complications. Producing the oil and then storing it costs money and, presumably, would be reflected in a build-out of storage facilities or an increase in storage rates.

2. Diversification. In less geopolitically stable regions, producing the oil now and selling it now so it can go into your particular royal family's diversified overseas bank accounts has more value than the potential to sell that oil for more in the future, assuming you're still in charge...

Hello Jeff,

Regarding Step 2. Diversification....

Ye Olde Medieval King's Castle & Forest updated. IMO, I would expect their Sovereign Investment Funds [SIFs] to move into premium farmland, fertilizers, seed companies, grain elevators, purchasing water rights, building luxury Eco-Tech Bunkers, etc.

Storing energy in I-NPK is concentrated and cost effective. Recall the posting of 3 gallons of gasoline equivalent per 40 lb bag...and you cannot eat crude.

Imagine telling your postPeak peasantry, "Behave, or I won't sell you the farming inputs..."

Bob Shaw in Phx,Az Are Humans Smarter than Yeast?

I believe that most of the "sellers" of long-term future contracts are the producers. They will not stop producing today for many reasons, like: (1) send their employees home for 5 years; (2) politics; (3) violence perpertated by other humans; (4) most wells have royalty and joint interest owners who would all sue; (5) reserve and field management, (6) most leases are "held by production" so that if they do not produce for a certain period, they revert back to the landowner; (7)etc. The producers just sell their future production today on the NYMEX to lock in the higher future prices. The buyers of long-term futures are primarily users who are concerned that prices will be even higher, and some specs who are hoping for a profit. Thus, if PO is really beleived, the market should go into contango - but that also depends upon the pain if present shortages develop because some users would be willing to pay almost anything to keep their supply.
Which brings me around to rationing whenever peak oil is an accepted fact and there is not enough in the present to go around. The theory will be, that rationing makes sense while at the same time governments around the world will unite to find alternatives - kind of like the space station, etc.

Jeff - a very interesting article. Gas storage often involves producing gas then re-injecting into a reservoir. For oil I doubt this will ever happen. Tank farms are insignificant in the larger scheme. So the most sensible way of storing oil is to not produce it - leave it in the reservoir for a while longer. In Saudi Arabia its called reserve capacity. If other OPEC countries join this game then we are in for a roller coaster ride as production could be withheld.

In your point 2 I think you may overestimate the greed of some of the Islamic OPEC states - they have in fact over the years behaved with much greater consideration for resource conservation than has the OECD. When they realise that they can make a lot more today by producing less that's exactly what they will do.

It will be interesting to see how high 2016 oil goes now.

Ask me about the weather, and I talk about net oil exports, but IMO, the price of food & fuel is being set at the margin, as importers bid against each other for the volume of food & fuel that "escapes" into the export market.

Regarding oil, if we use $50 as the starting point, we have had the first doubling, to $100, and we are on our way to the next doubling, $200, followed by the third and fourth doublings, $400 and $800 . . .

WTI spot is up about $10 in 30 days.

We've just seen the first wave of oil prices
in the ag markets.

RoundUp is almost $100 the gallon.

We have to have record crops this year.

July 4 is the date to watch.


I think there's a direct link between Net Oil Exports and the shift to Contango. Any desire by oil producers to shut in production to meet long-dated demands would only exacerbate the Net Oil Export issue--yet another multiplier (on top of the existing fundamental basis for the dilemma, and the already existing exacerbation caused by geopolitical feedback loops).

Mention of net exports by Bill Paul, formerly with the WSJ:


(BTW, my net export stuff was based on Khebab's technical work, buildng on prior work by Simmons & Deffeyes, et al.)


I think we might start to have problems, i.e. a discontinuity in price rise, at around $300/bbl. My reasoning is two fold.

First, oil demand is insensitive to price. I read a while back that it is 25:1. It takes a 25% increase in price to reduce demand 1%. So, absent a supply constraint, if worldwide growth is expected to grow ~2%/yr, but of course there is a supply constraint, i.e.- ~0%/yr growth. So, in order to destroy the 2%/yr would-be growth, oil prices would need to rise a minimum of 50%/yr, minimum. So considering an oil price of $120/bbl (since the price has gone up so fast lately, we may be at a short-term high, ergo I backed off on the price) and a minimum 50%/yr increase, that will give a minimum oil price of:
summer 2008 = ~$120/bbl
summer 2009 = ~$180/bbl
summer 2010 = ~$270/bbl
summer 2011 = ~$450/bbl

Second, John Williams, at shadowstats, produced a graph last summer(?) that showed that the inflation adjusted high oil price was ~$200/bbl. Note, I am assuming that a new inflation adjusted all-time high would cause an actual decline in consumption. So, with (what he calculates and I think is) true inflation at ~12%/yr, that will give an inflation adjusted high oil price of:
summer 2007 = ~$200/bbl
summer 2008 = ~$225/bbl
summer 2009 = ~$250/bbl
summer 2010 = ~$280/bbl
summer 2011 = ~$315/bbl

These curves cross just below $300/bbl. So I am not looking for any serious repercusions until then and am investing accordingly. Anyway, just my 1.97 cents worth.


I don't think you hit the key issue, which I believe is percent of world GDP spent on oil. Toothpaste could go up 1000 fold without much consequence. Not sure of the current number but I think oil is about 3% of GDP at the moment. Another 4-fold rise brings this to 12% all of which has to come out of other consumption by consumers. And this does not include natural gas or coal increases. Clearly this size of increase will dramatically decrease living standard.

According to CIA The World Factbook World GDP (Purchasing Power Parity) was estimated to approx US$66 trillion in 2007.

An oil price of US$125/bbl and present consumption of 30 billion bbl a year totals approximately US$3,7 trillion or just below 6 % of World GDP presently being used. That is just oil (all liquids).

Throw in the other energy sources that are being affected by the rise in oil prices and the portion of the total World GDP presently paying all energy bills runs in the range of 12 – 15 %.

Quadruple the oil price and energy poverty immediately shows up at almost everyone’s doorstep.

If your numbers are correct, West Texas is wrong, oil will not go to $800/barrel. Demand destruction must happen.

I can't see oil at $800/barrel either.
Demand destruction will set in way before that, together with a depression, which will prevent people paying much over $3-400/barrel however much they might want to.
This will continue until substitution occurs on a large scale, and will also affect the oil producers as their output decreases, as they won't be able to increase prices fast enough to make up for their growing shortfalls in production.
This loss of earnings will further affect the ability to pay high oil prices, and put a lid on them.

Why $800? Before you started posting, $100 US was the invisible wall. Devalue the US dollar enough, and you could engineer $800 oil within a year, if that was your goal. All these discussions of future oil prices treat the US dollar as some sort of sacred constant, which is ridiculous.

Yeah, obviously the nominal numbers could got that way, but I was talking real values, as was West Texas in his $800/barrel oil predictions.

It will hit that eventually, if no complete collapse happens, but not before it is a much smaller part of the total economy and is only used for specialist tasks, in my view.

You people are forgetting that exporting countries pay less for their own oil than importing countries. The crude price is the "importing countries" price. Therefore, there are a lot of folks that are consuming a lot of juice without this kind of price hammer going down on them. How many? Don't know. But if the average price for all folks is to climb to 300$, for instance, if some only pay 50$, then there are those who will have to pay 500$...

And with a dollar burn up, it is possible that the US is the country that gets hit harsher.

Personally, I am preparing to retrofit my car with GPL and probably buy a scooter next year or something. In portugal I already pay 8.6 dollars per gallon of gasoline and it is getting heavier and heavier on the month's check!

I am well aware that people in oil producing countries pay far less for oil.
This entirely misses the point that if the rest of the world have not got $500 to pay for a barrel of oil, they won't pay it.

The point is, for an accurate measure of the percentage of GDP, you have to figure out at least the average price in the exporting/producing nations.



The easy way to do this is as follows:
What's the world average GDP per CAPITA? $10,000

Assuming 25% on taxes you have $7500 remaining
Assuming 25% for housing you have $5000 remaining
Assuming 25% for food etc you have $2500 remaining.

What is the total number of barrels of oil consumed annually per capita?
Well the answer to that is 80 mil x 365 / 6 billion = about 5.

So the top line the world average consumer can pay is $2500/5 = $500 per barrel.

Now you can do a more complicated version of this by region or with efficiency gains or whatever *(like marketing companies might do) if you like but in essence this is how to work out the price at which demand destruction happens.

$500 per barrel in today's dollars. That's the price.


Well put, and gives a good perspective.

So after they have spent US$500/bbl for their fair share, 5 bbl/a, of the global oil there is nothing left for clothing, downpayments on cars and furniture, health care, "stuff" the Wal-Mart version, and.......electricity. ;-)


So the average American consumes twice the oil of other people worldwide, does that mean that in this country, demand destruction would kick in at $250/barrel?

There are some countries (Venzuela, Libya, Iran to name a few) subsidizing their oil, but this is well below 10 % of present total global consumption.


Crude at US$800/bbl, gasoline and distillates would be in the area of US$20/gallon, and the exchange rate doesn’t matter as this will be the price at the pump facing American consumers.




The US consumes now approx 25 % of all the oil in the world.

It is hard to see that present US consumption levels would continue with US$20/gallon.
(That was in short the point I was trying to make.)

If the US$ should devalue to 1/5 or 1/6 of todays value, oil prices could no doubt become very high as expresssed in US$, question is what other economical effects would cascade from such a loss of dollar value?


According to Pickens today oil will hit $150/barrel this year, and that will be an unsustainable number, with recession the consequence until it is cut back - at $100/barrel oil the cost to the US economy would be $600bn, and he argues that even at that figure they would be bankrupt in ten years.
So it appears that if he is correct a world recession will knock prices back from $150/barrel, and continue until alternatives are found, assuming that the other importing countries can't sustain $150/barrel oil either.


I would tend to side with Pickens on this one. The math tells it all, US$150 througout the rest of 2008 is celarly not sustainable. This would cause oil prices to average approx. US$130/b, throughout 2008, which on average is some US$60/b above 2007 average oil price.

Further up in this thread I showed that an annual average increase of the oil price of approx
US$40/b would make world economical growth suffer big time.

Logics thus suggests that the oil price would come down later this year, but on the other hand .....most industrialised economies seems to be engineered for growth what matter the oil price.


He has given the end of this year/next year as the date for slump, because China, the second biggest importer, is not going to cut back until after the Olympics - I said that a week or so back!:-)
This should drive the US and the west into a second stage of the slump - my words, not his.
He did though say that what will stop the rise in oil prices is a world recession, which will come.

Dave, Pickens must be reading your posts!!

Crude oil is worth way more than $800 in the grand scheme of things, but we will never see close to that price. If supply demand is such that $800 is the clearing price (in todays dollars) rationing and nationalization of remaining oil companies will have happened well before that. At some point between $130 and $800 per barrel, the disparity between rich and poor will become so great that social unrest will necessitate public rationing, and negotiated supply contracts...e.g. people won't be able to 'buy' futures contracts anymore, etc. I don't know where that price is...200$? 300?, certainly before $800.

The one caveat is if we build out renewables to such an extent before steep depletion takes over and liquid fuels no longer are the predominant fuel of our society - then it could accelerate in price like a luxury, as opposed to a basic good. But this too is unlikely, as we need LONG lead times to accomplish this magnitude of infrastructure change.


In the grand scheme of things, I will absolutely agree with you. I think one of the reasons we are headed for such a mess is that oil in the first place was far too low priced.

I don’t know what would be the fair price of oil.

Assuming 1 liter of oil (that is 0,265 US gallons) contains 10 KWh of energy, and one man with hard labor can produce 0,7 kWh a day (doing a little overtime), then 1 barrel of oil contains the energy equivalent of 10 men doing hard physical work through a whole year.
(Geeeezzes I hope I got this right!!!)

Using a perspective as presented above a fair price of oil would be in the area of US$200 000/b (How many SUV’s does that buy?) using Western standards.


This will continue until substitution occurs on a large scale,

That could be a very, very long time. It will not be seemless nor smooth.

Assuming an annual World GDP growth of 4 % would translate into just above 2,5 trillion US$ (2007) (based upon CIA figures).

If oil prices and also all other energy prices rose in tandem this suggests that an annual oil price increase above US$40/bbl would absorb all the economical growth of the world that year (here assuming that approx 50 % of the increased energy prices is allocated to oil).

A row of annual price increases of US$40/bbl would then make economical growth difficult if possible. The present economical system survives on growth.

Obviously there is a roof on how much the annual oil price growth can be irrespective of the currency.


I would have thought we could do a better estimate than your off-the-shelf measure of price-insensitivity. Surely we can analyse the personal situation of major user-classes. At some price point many amricns are going to reason that it is no longer worth getting in their car to drive to the office, or their self-employed business model no longer makes sense (travelling salesman, plumber, cleaner, etc). And at such points the demand simply collapses (along, sadly, with much of the society that generated it). If someone could do the analysis of what that would imply I'd be most grateful to read it.
To get started, could anyone with US economy knowledge make an estimate of those demand threshold prices - I myself live on the far side of a pond so am not so well placed to do the dogwork (sorry for lame excuse).

What's the average US income per capita? Let's say it's $30K.
25% for taxes leaves $24K
25% for shelter leaves $12K
25% for food etc leaves $6K

So 6K divided by annual barrels per capita.

20 mil x 365 / 300 million = 24 barrels.

6K / 24 = $250.

Yikes. Looks like the US is more sensitive to oil price rises than the rest of the world.
I figure the world average user will feel pain at $500 using a similar calculation.
Given the Europeans are about twice as energy efficient with about the same income I'd figure their pain threshold is also a bit higher, though their tax burden is correspondingly higher.

So US feels pain at $250, EU somewhere between $250 and $500 and the rest of the world at $500.

This is a really simple back of the envelope calculation.
Can any of the geniuses on here point out the flaws?

The use of averages might be a flaw?

Only around one tenth of the world's population have a car, so the rest hardly use oil at all for personal transport.

What is the average income of a person who owns a car? ... and their oil consumption?

I would expect the USA to definitely be more at risk from a price rise - IMO, once you start down the route of a lifestyle based on oil it is difficult to stop or go back to how it was before.

Also I can't count!
1/4 of $30K is $7.5K not $6K.
So working it through gives $312 a barrel instead.
A little better but it still shows that the US is wasting oil compared to the world average.

They might be minor users compared to the US, but for the poor of the world their small kerosene purchases are far more vital than the use of a car for Americans.

Not to mention that the prices of fertiliser and food and virtually all goods will rise and be proportionately more expensive for the poor.

It is better to have a car you can give up so that you can still purchase food than to have to spend virtually all your income on essentials in the first place anyway you cut it.

Europe and Japan might possibly be more favourably placed than America initially, but in the longer term America has far greater energy resources than either.

I think the basic flaw is in the analysis.

If you assume a normally distributed population then the calculated number of $312/bbl ($250 in this post, corrected below) is not the beginning of the pain. It is the point at which 50% of the population has been forced to curtail demand. The US will feel the pain of reduced demand well before 50% of the population has to cut back.


I think that's a pretty fair assessment and it points to how to work out the numbers.
At what price does the bottom 5% drop out of the running?
The bottom 25%?

We already have a figure for the bottom 50% dropping out of the running based on this back of the envelope calculation and it's between $312 - $500.

This assumes absolutely no substitutes (i.e. people will bid as high as they can before affordability prices them out of the market rather than just substituting for something else).

I would hazard a guess and say that since substitutes do in fact exist the price rises may not be so dramatic.

Hi WT,

OK a doubling but over what time period? With inflation we know that it will double over time but are you saying over 12 months or ???

I wonder how this plays with the market contango that exisited from the ned of January 2005 to mid-July 2007? There was only a short pause at backwardation in October 2005.

Of course, if you go back to the beginning of the futures contract most of the period is dominated by backwardation with relatively short periods of contango.

I think the difference is in the shape of the backwardation/contango curve. Here's the curve for February, 2006:

Compare that to the shape of the contango curve at the top of this article. The 2006 curve, to my eyes, shows near-term contango due to the fear of short-term disruptions due to things like hurricanes, but long-term backwardation (at least when measured from the near-term contango peak) demonstrating a continued reliance on the "normal backwardation" factors listed above. I think that's the big "tipping point" of the current shape of the contango curve: an end of the belief that these "normal backwardation" factors remain valid...

I just checked out the 30 day MA for site visits to the Oil Drum on sitemeter...Interesting, it's gone up even quicker than the price of oil over the past month.
Roughly 18,000 to 22,000 IIRC.

Things just keep getting curioser and curioser.

Back when I was active in the oil and gas industry, we wanted to get the stuff out of the ground as quickly as possible, and all of our efforts were geared towards enhancing short-term production--drilling prospects with high production rates and quick payouts, better oil well stimulation, better lift systems, workovers--you name it.

However, I noticed some time back that the stock market valued the reserves of domestic oil and gas producing companies with a high reserve life index (RLI) at a greater price than those with a low RLI. This took conventional wisdom and turned it on its head. It means, in effect, that a well that produces 100,000 barrels of oil in 5 years is worth less than a well that produces 100,000 barrels in 15 years. I marked it all up to hype (all this hype and promotion of "resource plays" and "long-life reserves") and the ignorance of so many people investing in the industry who don't know what they are doing.

So the contango, which has existed in valuing oil and gas stocks for quite some time, has now infected the oil futures market as well.

Malaise is my reaction, for I am heavily invested in the oil and gas industry, I lived through the bust back in the 80's, and I'm too old to go back to work or start over again. But it is becoming rather obvious to me that either we are experiencing a complete paradigm change, or else something is very, very wrong.

Maybe both?

However, I noticed some time back that the stock market valued the reserves of domestic oil and gas producing companies with a high reserve life index (RLI) at a greater price than those with a low RLI. This took conventional wisdom and turned it on its head. It means, in effect, that a well that produces 100,000 barrels of oil in 5 years is worth less than a well that produces 100,000 barrels in 15 years.

That summarizes why there will be no all-out drilling frenzy. There are very powerful economic incentives to husband reserves.

The result will be an earlier but flatter peak. i.e. No sharp fall-off in global production for a long time.

IMO this could result in longer window of adaptation to alternative energy sources. Not a bad thing?

You apparently assume an unchanging landscape. People keep ignoring that before 2000 there were about 1.1 billion people living in "middle class" or "working class" levels of lifestyle. With China and India now we have an additional 2.4 billion that want that same level of life. We are about to triple the demand on everything related to middle class life. But what happens when that demand cannot be met?

Your assumption appears to be that a longer and flatter peak means a longer rational response from homo sapiens. But that's not a provable assertion at all. I expect the plateau to be a very geopolitically unstable period and political instability could do anything from hurt us all very badly to help us all incredibly. Remember that the combined consumption of China and India has already doubled over the last 5 years and will grow greatly yet again even if 500 million people just drive scooters (or Tata's Nano) instead of western cars. China+India consumption doubling while global production was roughly flat over the same 5 year period means higher prices. (It also means someone else had to do with less or even without.) And since China+India's consumption is not done growing, prices can only go up from here unless production explodes (which is not going to occur) or demand plummets (such as due to a severe recession or even depression).

Finally, two points - we appear to be at C&C peak and the statistical noise from January and February don't change my mind greatly on this. But we appear to still be in "peak lite" on all liquids - that is to say, that period of slowing production before all liquids hits its peak. So in a sense, the C&C focused people appear to be correct about the specifics of C&C peak plateau already being here while Robert Rapier's "peak lite" concept maps well to all liquids, which is more applicable to the world overall.

I have been wondering how long the 'lag time' would be 'Post Peak' and what indicators would be available in the MSM to indicate that the effects of availability and price had begun to hit the general market. Needless to say I had my head in my hands after reading this months DrumBeat.

Probably the most depressing series of articles I've ever read in an afternoon.

Just out of interest I stood and watched a short film being displayed on a giant screen in the city center on my walk to work this morning. It was beautifully made and showed a range of people of all ages and ethnicities with their heads in their hands, all having watched Chemtrail spraying going on above their heads. (It's every other day round here Bradford UK)

It reminded me that apathy is our real problem.
You can write about it, film it, show it in public and attempt to discuss it rationally but there
are two things you cannot do.
1) Get a straight answer as to what the hell is actually going on.
2) Stop it.

Nice article Jeff, as always. My question to you and the comments section is how this situation would change if margin requirements of futures contracts are raised?

Increasing margin requirements (which, interestingly, is one of the proposals of the Consumer First Energy Act of 2008 unveiled May 7th) would have three effects that I can think of:

First, to the extent that it turns the futures markets into very low leverage or cash markets, it would just push trading from futures to options (which don't operate on margin), and push those functions that can't be performed by options to overseas futures exchanges.

Second, to the extent that you need more cash now to control X amount of oil, it will increase the time-value-of-money input into financial (as opposed to physical) arbitrage operations. That would push back against contango a bit, but the only way I see it decreasing the spot price is if the "vicious cycle" theory is short-circuited to some degree by this.

Third, increasing margin requirements would make commodity derivatives less valuable as a hedging tool because of the lower leverage.

I think that only #2 has any potential for benefit, but that small potential is significantly outweighed by the negative effects of #1 and #3. Of course, I'm assuming that "increase margin requirements" is by a large amount--like up to 50% of underlying commodity value. What I would be in favor of is changing margin requirement from a fixed value to a floating value--say 10% of the value of the underlying commodity. I think that would maintain a desirable 10:1 leverage, and would allow people to more accurately calculate their risk exposure because the leverage of their contract wouldn't change over time. But that doesn't amount to a smack to the big bad speculator (which is the populist motivation behind the proposed legislation), so won't get anywhere...

Nymex has initial margin at $9788/contract, with maintenance margin at $7250/contract. If someone is trading oil with minimum margin, they could only take a $1633/contract loss, which is $1.63/bbl. Because of the volatility of oil, anyone trading at full margin will have a very large probability of receiving a margin call and most likely have their position closed out. IMO, one would be an idiot to trade oil on full margin.

For myself, my rule of thumb is to require a bare minimum of 25% margin and buy long term contracts. The purpose of trading/investing is not to lose money and let the long term trend increase the value of your positions. The long term contracts have less volatility than the short term contract (well, up until now they have), and as such have less of a percentage drawdown, i.e. capital preservation.

Since oil has gone up so fast lately, about a week ago, I partially hedged my long-term positions by shorting the Jun 08 contract. The short term contracts have a small bid-ask spread. Of course, in hindsight over the last week, I should not have partially hedged. I still think the near-term contract has a lot of resistance at $127-128/bbl, so I am maintaining the partial hedge expecting a $10-$15/bbl decline over the short term.

Wow did I digress a little. In a nutshell, use a bare minimum of 25% initial margin, better to use 35% initial margin. You will sleep easier during the short-term declines in price.


Did you consider the effect of eleveted inflation expectations on futures market?

I see the effect of peak dollars not peak oil.

The way to check: compare present backwardation-to-contango shift in oil to a food (eg wheat) a mineral (eg silver) and a currency (e.g ruble contracts).

we've had brief spurts of contango in oil the markets before.

why should this one be any different? i could be another brief spurt. or will this one stick around?

I think that backwardation & contango are inflation-expectation neutral, because that is already accounted for in the time-value-of-money input to arbitrage. If there is a growing expectation of increasing inflation, then that alone supports contango, but it also supports higher yields in other investments (in nominal dollar terms), so that counters contango. Plus, if you look at the Dollar Index,the Fed Funds Rate futures, etc. over the past 6 weeks where we have seen this dramatic shift from backwardation to contango, the movements in those markets don't support that the shift to contango is due to increased expectation of inflation. The recent oil rally has been interesting because (despite the press harping on "it's about the value of the dollar") it has actually occurred during a dollar rally.

The peak oil meme has definitely reached lift-off.

Some of the scenarios the EIA will be releasing in a matter of weeks show a near-term peak in conventional oil production. i.e. C & C production at only 60 million bpd in 2030.


That's a pretty interesting paper... One item that caught my eye, on p.11: "Short-term above ground factors like civil unrest and cyclical increases in factor costs are generally excluded"

I think that's a mistake, with potentially significant impacts. I think that civil unrest cannot be categorized as universally "short term" because it has the potential to become a positive feedback loop. Nigeria is a good example. I think it's also a mistake to characterize increases in factor costs as "cyclical" (and therefore implying that they're short term and will reverse) because I think it's just as likely that factor costs (esp. metals and energy required for manufacturing/fabrication) are largely rising because of energy scarcity in general--another feedback loop that, rather than going away, may only get worse.

I don't see either rising costs or civil unrest as feedback loops.

Civil unrest tends to get resolved and, even more importantly, has the effect of postponing production to the future when the oil will be needed more than it is needed today.

Regarding factor costs....they generally don't rise at nearly the rate oil does and yes, they fall.

The theory that civil unrest "tends to get resolved" isn't very convincing--particularly when the cause of the civil unrest I'm worried about (e.g. Nigeria, Iraq, Khuzestan, Bolivia) is partially the new phenomenon (meaning the relevance of historical tendencies is unknown) of increasing return on investment of attacks on oil due to the rising price of oil. That's a classic positive feedback loop.

Regarding factor costs, one graph showing a small fall in costs in one region is certainly not proof that they are cyclical (and will therefore always fall). On your graph, "cyclical" would suggest a fall back to "100." Rather, because energy price is, itself, a factor cost in energy production, it is axiomatic that this is a positive feedback loop. The only question for debate is whether this positive feedback loop will outweigh the Hotelling effect and those factors that are cyclical. On that point, anyone who claims to "know" the answer is relying on faith, not science--and that is precisely why I think it is a mistake to exclude rising factor costs on the assumption that they can be dismissed as merely cyclical--the facts don't support that conclusions (your graph above certainly doesn't), and the precautionary principle suggests that we at least consider two alternative scenarios, one with and one without perpetually rising factor costs, before we dismiss the notion entirely.

On that point, anyone who claims to "know" the answer is relying on faith, not science--and that is precisely why I think it is a mistake to exclude rising factor costs on the assumption that they can be dismissed as merely cyclical

Actually faith is unnecessary since we do have a social science that deals with this sort of thing: economics.

The rise in costs in not merely cyclical but, at the same time, the cyclical element is not small.

I think this second graph (deepwater rig rates) makes my point quite nicely: it doesn't support cyclicality of factor costs, but rather supports linear increase with minor cyclical perturbation. That certainly doesn't justify excluding them (just the opposite). And this is where the difference between faith-based economics and science-driven economics comes in: faith-based economics says that it MUST be cyclical, because it always has been in the past; science-driven economics realizes that, because initial conditions are not the same as in the past, there is a significant possibility that this time will not be cyclical. That's the key: no one can prove that this *will* be cyclical or not, but science-driven economics wouldn't exclude the data on the faith-based assumption that it will be cyclical. That's why I think it was a mistake to exclude it, and why I think it's hypocritical to argue that we don't need faith but can instead use science, when you're own argument (e.g. that "the cyclical element is not small") is faith based (or, to use a better term, "irrationally certain"). I agree that we don't need faith, but if we're going to claim to be scientific then we shouldn't go about excluding factors on the faith-based assumption that they're insignificant.

That's the key: no one can prove that this *will* be cyclical or not, but science-driven economics wouldn't exclude the data on the faith-based assumption that it will be cyclical.

There is tons of evidence that current price hikes are partially due to inflationary effects of the late cycle expansion.

Some of the key data can be found in the monthly PPI report which is quite detailed.

So, in the last 10 years oil has gone from $10 to $130 dollars , a 1200% increase. We can track with precision how much of that feeds through to higher prices. I don't think those "feed-back loops" will look nearly as scary as some think.

If you would like to track oilfield drilling and leasing, keep an eye on item 532412-2 in the PPI report.


EDIT: item 213111 might be even more germane.

Ase, I do not understand this at all. You posted a graph, presumably to show that deepwater rig day-rates are cyclical but in fact your chart really shows that they are not cyclical. At least not yet. Cyclical means going up then down again. According to your chart they only went up. Is this an attempt at humor? If so, you forgot to put a smiley face. ;-)

Ron Patterson

Hello Asebius,

From depleting memory: I think it was John Robb at GlobalGuerrillas that showed the 100,000:1 ERoEI cascading blowback return on attacking FF-infrastructure.

Civil unrest tends to get resolved ...

George, that is one of the more dubious statements I've seen you make. Can you posit a date or time-frame when the 'civil unrest' in the West Bank and Gaza will get resolved?

Any of these civil unrest spots have the spectre of increased population driving them, as well as the basic political/social/religious issues. If a situation is bad in a given part of the world (e.g.Nigeria), more people are certainly not going to make it better.

Unconventional liquids = fantasy liquids?

Natural gas plant liquids rising to 13 mmbpd by 2030 hahahahhaha.

CTL and GTL rising to 4.8 mmbpd by 2030 hahahahahhaha.

Biofuels (oil equivalent) rising to 4 mmbpd by 2030 - these guys have been on the juice.

All this requires vast amounts of nat gas to achieve that quite simply doesn't exist.

I imagine the effects of contango could be severe for firms like airlines who have previously been able to offset their fuel costs by hedging with futures?

Good point. I believe South-West airlines do this extensively, if I am thinking of the right company.
Another example would be Chrysler, which set up a recent deal to fix petrol prices on some models for three years.

Agreed, good point. The next logical question is: Why do we need a futures market if it provides no advantages to hedgers -- the ostensible beneficiaries? What is the social benefit of a futures market that doesn't do the intended job?

A similar problem is arising in agriculture, where margins have grown so large that many farmers can't afford to hedge.

While I agree that the Peak Oil cat is out of the bag -a new reality that could initiate autocatalytic 'human' responses to the idea of 'limits', the back months are VERY illiquid and this picture could change quickly with either intervention or economic change. The total open interest for the Dec 2016 contract equates to just over 3 million barrel of oil. Its up over $2 today on 76 contracts, which is 76,000 barrels of oil. In contrast, the front month has traded 194,000 contracts today, representing 194 million barrels of oil. So it is possible that one or several hedge funds/investors (Goldman/Barclays?) could spend a few million in margin to goose all the back months....I doubt this is what happened but am just pointing out with the illiquidity one can never be 'certain' of whats happening.

Imagine when Ghawar or Abqaiq waters out. That will not make the news for several months. But a few resevoir engineers tell their buddies who tell their uncle who knows someone at a hedge fund and in 3 weeks you see a $25 rise in the back months on oil.....hmmmmm....

Assuming that the US indeed has significant untapped oil reserves in ANWR and coastal areas, the delay in producing it has the marks of financial genius. It will probably go for 200x the price of price of the West Texas Intermediate that we were pumping prior to the US peak. Every day that goes by any in ground resources become more valuable....I guess it would be giving either environmentalists or politicians too much credit to have any guiding hand in this future wealth. We can only hope that it is NOT drilled out of the idiotic political attempt to reduce the pain at the pump.

Difficult to be sure today that massive demand destruction will not bring prices down in 2015 - after a peak at much higher prices before... The non-linearities of random walks, uups price movements, are difficult to forecast and are not reflected in the future price curve. Analysis shows that oil futures have no value in forecasting future oil (price).

It sounds like your analysis does not consider the value of the US dollar in 2015.

As of the close today, the June 2013 contract, and all contracts beyond are in contango.

NYMEX Crude Oil (Light)

Ron Patterson

I need some explanations, because I found this post confusing.

I do agree that arbitrage would prevent a contango situation, at least if we define contango
as a circumstance when after correcting for time value of money and storage costs,
you see long-term futures prices as higher than short-term futures prices.

So, net of these effects, the efficient markets theory precludes contango. However, I believe
that you are incorrect about some issues in your post:

The Hotelling rule, the way it is conventionally used, implies that the net price
(market price minus marginal extraction cost) RISES, not falls, at the rate of interest. Assuming
a constant marginal extraction cost, the gross (market) price (which is the one you have in mind)
in period t+1 will be equal to the gross price in period t PLUS the interest rate times the net price.
So, with constant marginal extraction costs, the Hotelling model assumes a rising market price.

Even with falling marginal cost, the Hotelling rule does not suggest anything a priori, because
the rate of decline of marginal extraction costs, as well as the functional form governing the
rate of change, would determine the outcome. In fact, as long as the product of the net price
and the interest rate is greater than the amount by which the marginal extraction cost declines,
the market should be in contango, after arbitrage has been taken into account.

Similarly, the time value of money implies that the long-term futures contract should sell at
a HIGHER price than a short-term contract. Since a futures contract doesn't tie up money
now (save for the margin account which earns interest), you can either sell oil at the spot rate,
invest the money at r% in a bank, and have S*(1+r) dollars at a future date, OR hold the oil
in the ground and sell it for F dollars. Given arbitrage, S*(1+r) = F, so with positive r, the
nominal price of the futures contract should be higher than the spot contract. If we make
the short-term futures contract our spot contract and the long-term futures contract to mean
the futures contract above, the same logic applies.

Am I missing something?


Just a quick explanation of my logic. If p(t) is the market price at time t and c(t) is the marginal cost at time t, the Hotelling rule says that p(t) - c(t) = [p(t+1) - c(t+1)]/(1+r) where r is the real interest rate.

So p(t)*(1+r) - c(t)*(1+r) = p(t+1) - c(t+1)

p(t) + r*p(t) - c(t) - r*c(t) = p(t+1) - c(t+1)

Assuming a constant marginal extraction cost [c(t) = c(t+1) = c], we have

p(t) + r*p(t) - c - r*c = p(t+1) - c

p(t+1) = p(t) + r*(p(t) - c)

If the resource rent is positive, then p(t+1) > p(t)


Assuming non-constant marginal extraction costs, the above equation does not simplify to c(t+1) = c(t) = c, so we have

p(t+1) - c(t+1) = p(t) + r*p(t) - c(t) - r*c(t)

p(t+1) = p(t) + r*p(t) - c(t) - r*c(t) + c(t+1)

p(t+1) = p(t) + r*[p(t) - c(t)] + [c(t+1) - c(t)]

So with declining marginal extraction costs [i.e. c(t+1) - c(t) < 0] we need to have
absolute value of [c(t+1) - c(t)] > r*[p(t) - c(t)]

Otherwise, even with declining extraction costs, the market will be in contango.

I don't think you're missing anything, I think I misspoke. I intended to point out other people's theories about the result of the failures of some of the preconditions of the Hotelling rule in application to an exhaustible resource: that oil is a purely competitive market (clearly not), that the amount of oil in the reservoir is known with certainty (again, false), and that the costs of extraction do not depend on the amount of oil remaining in the reservoir (true for only a portion of the production curve). When these preconditions are not met, some (like in article I linked) claim that technological advances will keep the price of extraction going down. I mistakenly labeled this theory as the Hotelling rule... so I think your implication is correct--that, absent the (erroneous, I'd argue, but widespread) assumptions about technology, prices should increase.

As for the TVM issue, I think it might depend on who is the primary driver of the price. If there is lots of demand for hedging future oil costs by consumers, then there will be lots of demand for long-dated futures contracts (presumably). That would lead to buyers being willing to pay whatever necessary to convince sellers (producers) to sell, and would argue for contango (as I think we're seeing now). Conversely, if there isn't much consumer demand to hedge, compared to the need of producers to lock in prices to justify the financing of a long-term project, then producers would be willing to sell long-dated futures at a discount (say company X needs to sell oil at $120/barrel over the next 5 years to justify a new project, it may be willing to sell futures at $122 or $123 when the spot price is $126). I think that was the dominant paradigm, until recently. So, I guess the crude way to characterize that is "time-value-of-money to whom?" A producer that has a lease but that can only raise money to finance production will have a different sense of that than a consumer who can afford oil at today's prices, but not at $200/barrel...

Makes sense now :-)

However, regarding the TVM perspective on the futures market, I would still argue that the demand for hedging is not essential - you may have speculators on both sides of the contract making the opposite bets. Also, with less liquidity, you get higher transaction costs, but the contracts should still be unbiased. With rational expectations [E(spot(t+1)|information(t)]=spot(t+1)+error(mean=0)], uncovered interest parity [i.e. spot(t)*(1+r)=expected_spot(t+1)] and covered interest parity [i.e. spot(t)*(1+r)=futures(t+1)], we get expected_spot(t+1)=futures(t+1), where futures(t+1) is a contract for t+1 arranged at t. This suggests that the futures contract should be priced as spot*(1+r), absent any additional information. So, contango ought to be the norm. But of course, markets are not efficient in reality - otherwise the mutual funds, hedge funds, etc. would cease to exist.

The other intangible thing here, and why Hotelling theory is ultimately wrong, is that people analyze all of this assuming that dollars (Euros, yen, etc.) are what people and countries will 'maximize' into the future. Once an understanding of multiple limits to growth reaches a tipping point (and I think we are years away from that), then people start to make decisions more based on fundamental tenets like food, water, national security, shelter, warmth, etc. Once that happens there will be an incredibly wide error band on oil production, and the limiting input will not be geology.

Although backwardation may be the more normal state, there are several instances when contango has appeared before. As the oil price fell the market was in contango for all of 1993. Again in 1998 during the Asian crisis the price of oil fell and we had contango for several months. After 9/11/2001 there was another few months of contango. In 2005 and 2006 the crude oil market was again in contango.

What is interesting now is not the fact we are in contango, but that it is happening in a strongly rising market. The last time that happened was actually in 2005, before the market plunged in 2006. Could it be that the futures market is actually predicting a fall in the front month price?

An interesting side affect of backwardation is that it gives you a positive roll return as you move from one contract to the next. This is easy money. As long as the curve stays in backwardation you can make one percent a month simply from rolling your contract. This is how oil exchange traded funds work, and it is also how a lot of new money has entered the market.

So what happens if we do get sustained contango? It will now cost you to roll onto the next contract. You have to be betting the oil price will increase beyond this loss if you want to make money from your ETF. Maybe this will see the start of some of the speculative money leave.

Interesting times.

[References: 1 2 3 4]

Natural gas back months were up over 5% today, even with 2008 NG down. 2012 and beyond were all up between 35 and 38 cents per mcf. This could be because nat gas is large input for oil production and followed on coattails of oil. Not only does the world discover peak oil, but it discovers systemic energy risk at same time...?

good grief, we've just gone contango for all 2 DAYS!! just 2 days!! i dont think the recent contango-ness is a sign that the investment community is now all of a sudden peak oil aware. in fact i'd say at least 2/3 is still asleep. all the engineers at my work still don't have a clue. abd u work at one of the greenest most liberal cities on the planet!

i am interpretting the market contango as a signal that for now our supplies are adequate.

I would say that far more than 2/3 are still asleep. Its the fast, smart 1/16 that are now aware, or at least more aware than they were.

The looming question is if drop in demand will offset drop in production in next few years. Lots of people expect a (small) increase in production but lots of people expected a drop in demand at $70 oil too...

Sorry for the off-subject comment, but have you noticed the latest in resource wars? Diesel vs Gasoline? It could end up being the USA vs Europe because of the difference in vehicular types or maybe it could end up in cooperation by exchange. Also the World seems to be moving more to diesel than to gasoline.

Apparently it takes different refinery configurations to produce different ratios of each and it's not a trivial modification. Maybe the experts can illuminate on this.

Looks like there's more of those nasty tar sands out there. This time in the Congo.


PO awareness hits National Geopgraphic Magazine, June 2008

Tapped Out

In 2000 a Saudi oil geologist named Sadad I. Al Husseini made a startling discovery. Husseini, then head of exploration and production for the state-owned oil company, Saudi Aramco, had long been skeptical of the oil industry's upbeat forecasts for future production. Since the mid-1990s he had been studying data from the 250 or so major oil fields that produce most of the world's oil. He looked at how much crude remained in each one and how rapidly it was being depleted, then added all the new fields that oil companies hoped to bring on line in coming decades. When he tallied the numbers, Husseini says he realized that many oil experts "were either misreading the global reserves and oil-production data or obfuscating it."

Related article on Siberian oil exploration in same edition.


Thanks for that analysis, Jeff!

Once the NYMEX oil futures market traders accept that peak oil has passed, a steep contango futures curve should become the norm.

My updated forecasts indicate Feb 2008 as the historic peak month for both crude oil and lease condensate (C&C) at 74.7 mbd (EIA) and total liquids at 87.3 mbd (IEA).

The forecast weighted average crude oil price is about $230/barrel in Dec 2012 which is over $100 greater than the future NYMEX Dec 2012 price of $127/barrel.

The forecast C&C chart below shows that, after the Feb 2008 peak, the C&C production rate will enter irreversible decline.

after X, the C&C production rate will enter irreversible decline.

I've noticed that time to time, you post a updated chart, always with that doom-porn scenario decorated with such fine graphics. One thing that would be funny would be to place those graphics side by side, or even superimpose them, it would be goddamn funny.

But, I understand that you wouldn't want to confront yourself with such humilliation.

Actually, forecasts of declining oil production do not necessarily qualify as "doomer porn". Other than that, what are you going on about this time?

They qualify because I recall that all of these graphs pointed out to an imminent "irreversible decline" of 3%. Yes, 3% starting today isn't exactly LATOC style, which goes more on the 12% line with sobering technical descriptions such as "TSHTF", but nevertheless it is doomer porn. Mathew Simmons and Laherre have stated several times that a plateau would be extended for at least 10 years, and that declines would be very smooth, as in 1-2%.

The comedic part is that such graphs have been done for years, and still they come back as if there were no past forecasts predicting exactly the same mistake, over and over.

Eventually, it is obvious that ace will be just right.

But so does broken clocks twice a day.

Mathew Simmons and Laherre have stated several times that a plateau would be extended for at least 10 years

On Jan 27, 2008, Matt Simmons presented the slide below which forecasts C&C production of 65 mbd by 2012 (slide 31). His forecast is not a 10 year plateau and is aligned with my slightly more optimistic forecast of 66 mbd for 2012.

My updated forecast below shows that the previous 2005 peak of 73.8 mbd might be surpassed by 2008 which is showing 74.3 mbd.

Colin Campbell, in his May 2008 newsletter, has also revised his peak total liquids forecast from 2010 to 2007. Campbell's forecast total liquids production is 75 mbd in 2015, down from 84 mbd in 2007, which is not a plateau but a decline of about 1.5%/yr.

Are you able to provide any recent 2008 references for Jean Laherrere's world oil forecasts to support your statements?

Ace's Prediction from August 2007

Ace's Prediction today

"Prediction is hard, especially about the future"

I think that chart from August 2007 assumed a stagnant price. That is the mistake many peak oilers make when trying to predict future production. You dont know what the price is gonna be, so you dont know exactly how much production there will be.

But it doesnt make much sense to nitpick the way you do. They are not that inaccurate. They're at least in the right ballpark. It's not like he hit a foul ball out of the park and through Yergin's windshield.

Oil prices have shot up by 50% since August 2007, yet production only went up by a couple percent. That is pretty gloomy. To me, that August 2007 chart was right on the money. It told me that the price of oil was going to go up. It told me that caps were going to be removed from wells. It told me that old pumps that hadnt been used in 30 years were going to be fired up again.

I guess all that chart told you was to mark a number on your calender so you can attack it six month later. Without stopping to consider what it took to make those predictions wrong by their measly 2%.

I wonder, if oil goes up 50% again, to $180, and production jumps another 2%, will you be here poking fun at the gloomers yet again?

Aug 07 pre-dates the wiki mega projects database. Once Ace got his hand on that data he revised his projection (shifted the plataue out a few months). Using the mega projects database he's been pretty acurate so far. And like you said, even his Aug 07 projections aren't off by that much.

The FT have an article linked from their main page that some people might be interested in:

Running on empty? Fears over oil supply move into the mainstream

Any chance of posting the text from the article?

CNBC just had Dr Robert Hirsch on. He was even allowed to say the phrase "Peak Oil" and given a few moments to explain his concerns. Joe Kiernan didn't even interrupt with some smarmy idiotic comment.

I was asked to vote twice in the latest poll so the number of voters may not be as large as 3000 owing to a bug?


As NG increases in price so will gasoline. It takes much gas to crack oil.

I've updated the chart to reflect today's (May 20th) increase in contango.

DEC 2016 closed up 9 bucks today, thats probably a record daily price move in oil, and it was the back end - so its not been widely reported on the bloomberg LP. Most unusually, this past three weeks, the back end has been rallying even though the front end is considered "high" due to perceived short term disruptions. Normally the curve compresses when the front end falls, but at generally higher prevailing prices than prior to the "disruption". Around 90,000 contracts were added to the existing 180,000 outstanding between DEC9 and DEC16. So decent volume in terms of the market normal activity, but tiny in real size (1 contract 1000 Barrels).

However the back end move will have major consequences - front end demand should be boosted by a desire to acquire physical because "hedging" forward is getting more expensive than current prices.

I think this move in the curve relates to news that will be forthcoming in JUNE. We shall see.

View www.nymex.com/lsco_fut_csf.aspx to monitor trading in all oil futures.

And regarding the opening brief on contango and storage - a restriction on storage is current availability of storage space - that is a real constraint, and is also influenced by the availability of oil tankers to move crude to storage tanks (again a real constraint). Note that the decline in Cantarell may be a cause of the sharp rise in tanker rates (i.e. US -West Africa), as the US pulls in crude from further-a-field. Naturally the further it goes, the higher the price, due to the higher transit risks.

"I think this move in the curve relates to news that will be forthcoming in JUNE. We shall see."

Okay, I guess I missed something. What is happening in JUNE?