Grantham: Lower oil price is new normal

From Jeremy Grantham:


The simplest argument for the oil price decline is for once correct. A wave of new U.S. fracking oil could be seen to be overtaking the modestly growing global oil demand.

It became clear that OPEC, mainly Saudi Arabia, must cut back production if the price were to stay around $100 a barrel, which many, including me, believe is necessary to justify continued heavy spending to find traditional oil.

The Saudis declined to pull back their production and the oil market entered into glut mode, in which storage is full and production continues above demand.

Under glut conditions, oil (and natural gas) is uniquely sensitive to declines toward marginal cost (ignoring sunk costs), which can approach a few dollars a barrel – the cost of just pumping the oil.

Oil demand is notoriously insensitive to price in the short term but cumulatively and substantially sensitive as a few years pass.

The Saudis are obviously expecting that these low prices will turn off U.S. fracking, and I’m sure they are right. Almost no new drilling programs will be initiated at current prices except by the financially desperate and the irrationally impatient, and in three years over 80% of all production from current wells will be gone!

Thus, in a few months (six to nine?) I believe oil supply is likely to drop to a new equilibrium, probably in the $30 to $50 per barrel range.

For the following few years, U.S. fracking costs will determine the global oil balance. At each level, as prices rise more, fracking production will gear up. U.S. fracking is unique in oil industry history in the speed with which it can turn on and off.

In five to eight years, depending on global GDP growth and how quickly prices recover, U.S. fracking production will start to peak out and the full cost of an incremental barrel of traditional oil will become, once again, the main input into price. This is believed to be about $80 today and rising. In five to eight years it is likely to be $100 to $150 in my opinion.

U.S. fracking reserves that are available up to $120 a barrel are probably only equal to about one year of current global demand. This is absolutely not another Saudi Arabia.

Saudi Arabia has probably made the wrong decision for two reasons:

First, unintended consequences: a price decline of this magnitude has generated a real increase in global risk. For example, an oil producing country under extreme financial pressure may make some rash move. Oil company bankruptcy might also destabilize the financial world. Perversely, the Saudis particularly value stability.

Second, the Saudis could probably have absorbed all U.S. fracking increases in output (from today’s four million barrels a day to seven or eight) and never have been worse off than producing half of their current production for twice the current price … not a bad deal.

Only if U.S. fracking reserves are cheaper to produce and much larger than generally thought would the Saudis be right. It is a possibility, but I believe it is not probable.

The arguments that this is a demand-driven bust do not seem to tally with the data, although longer term the lack of cheap oil will be a real threat if we have not pushed ahead with renewables.

Most likely though, beyond 10 years electric cars and alternative energy will begin to eat into potential oil demand, threatening longer-term oil prices.

Exactly right, though in my view the equilibrium price will be more like $50 than $30 for the next half decade.

Don’t miss the full report.


  1. The Saudis are doing China’s bidding now…not the USA’s.
    The Saudis and Russia have to suffer for a while in order to help China destabilise the U.S.
    Putin has said that Russia may have difficulties upwards of 2 years…but he is happy to play China’s game.
    The result of fracking companies going broke is the breakdown of the fracking bonds and the derivatives attached to them.
    And who would want to invest in them next time around?

    • Athalone, correct. Every time I fill the car now I save about $40.00. I wonder where that money went in the past.WW

      • I wonder if some of the big grocery houses will surprise on the upside here.

        A big slice of FMCG was always logistics – and they know they can squeeze their suppliers on price again?

  2. there is no such thing as equilibrium price of oil. Oil production and trade has nothing to do with market (and clearly not free market) forces, most of production is fully controlled by few governments under directives from USA. Even consumption is controlled to large degree by governments, bilateral agreements, special taxes and so on…

    Oil price in 3 months, 3 years or 30 years will be whatever few people in power decide it needs to be

  3. Wouldn’t be so bullish on electric cars. Good for buses and city run-abouts… just stating the fact that 97% of the global transportation industry is based on petroleum products – which is largely identical to that four decades ago. Battery power will make an impact in some small areas such as personal transportation (main via kinetic capture as oppose to battery transportation), but little in the areas of shipping, trains and flight – or developing nations.

    Furthermore, at these prices a lot of global oil production is in serious trouble – not from direct operating costs, but sustaining development for new production which is needed if supplies are to be maintained. Personally, on that front, I don’t even think $70boe is sufficient. But that is just my opinion.

    But if right, if prices don’t pick up then in four or five years time we will have the best part of a decade after that with prices in the vicinity of $90-100boe (in real terms).

    • weight insensitive commercial transportation means like ships and trains are much more suitable for battery powered technologies than small personal scale commuting. Adding one or a few carriages with batteries to a 100 carriages train makes almost no difference to weight or performance of a train. Every few hundreds or thousand km empty battery carriages can be quickly and easily replaced with full battery carriages.

      Even at present, this is much more economical way than diesel-electric or even electric overhead supply. Unless a rail-route is extremely busy it’s hard to justify overhead supply when compared to battery carriages.

      This is even more pronounced in case of large ships. Adding few hundred kilos of batteries for every container on a 10000 TEU ship would make no difference the performance or cost of transportation but would enable the ship to travel 10000km on pure electric. Batteries could be charged in ports during loading and unloading of cargo.

      The only current issue with this is that all the main battery technologies of today are very environmentally unfriendly. Reason is that these dirty technologies offer the best energy density storage. This doesn’t have to be the case in weight insensitive transportation modes like ships and trains. Using cheaper but heavier and less polluting batteries would not change much performance of the transportation.

      • Swiss company has bought the largest factory in the US (former cigarette factory) and is about to start manufacturing grid storage batteries – a product they have been working on in secret for almost two decades.

        Astonishing break throughs.

        Further, Samsung and two separate universities announced cheap, wholesale mass production of graphene supercapacitors last year which will be deployed over the next few years leading to almost unlimited battery storage from graphene.

        You could literally harvest the sunlight and have cargo ships with container sized batteries being transported all over the world to power grids.

        Future is here.

      • And when it comes to shipping an even more attractive option are the pebble bed reactors that china is building a factory to produce. Think a nuclear reactor the size of a shipping container which runs at maximum temperature in its idle state (ie is impossible to have a ‘melt down’). Change out the pebble fuel sources every few years and you have a virtually zero running cost power source (as long as you have an ample water supply).

    • LMFAO – probably the most ignorant comment Ive ever seen regarding the future of energy storage and transportation.

      Not just Tesla, but pretty much every single major car manufacturer has thrown their entier future behind electric cars. All of them.

      Volvo and VW are building competing recharging stations across the US and EU as I write to compete with Tesla.

      SolarCity is set to be the first of a series of mega-battery factories coming online this year not just from Elon but a slew of EU producers as well.

      All of this in the face of announcements from two universities and Samsung last year that they had all made breakthroughs allowing the cheap mass production of supercapacitors and graphene storage for batteries which are coming online over the next few years.

      So what ?

      Materials science is by far the most important field today not just in terms of relevance but breakthroughs. Graphene provides a super structure to build super strong, super light airframes around which double as batteries.

      As always Researchtime – as always.

      • We all need to hope fervently for real breakthroughs if we’re going to have any sort of decent future on this planet.

        We need:

        ► a way to drag CO2 from the air
        ► a way to increase the planet’s albedo without untoward effects (sulphates are one solution, but unintended consequences abound)
        ► a way to store CO2 in the ground (biochar is a maybe, lots of unresolved issues)
        ► a way to store energy from renewables (breakthroughs in battery tech)
        ► a smaller population globally (educate women, & invent better contraceptives)

      • a smaller population globally (educate women

        If you have 100% success wrt the last two words, everything else in your list will be a lot less needed, although you also need to educate men to allow the educated women self-determination.

        Without those two words, everything else is useless.

      • a smaller population globally (educate women, & invent better contraceptives)

        The problems rarely lie with the education of women and the efficacy of contraceptives.

        That should have read “give women cheap and easy access to contraceptives (including abortion) and ensure they have equality in law and the full support of the justice system”.

      • we do not need any geo-engineering that removes CO2 from the air and increases albedo or does anything because there is 100% chance that we will make things even worse. It never happened in history of human kind that a large engineering project didn’t make lasting bad consequences. What fool would think this time would be different.

        Our problems cannot be saved by technical solutions, technology is one of the the sources of of problems (it enables people to do more damage). The only way to save us on this planet is to reduce our ability to do something bad.

        Giving every bloody Costa Concordia captain a nuclear reactor can’t make things better in any way.

        We need to split countries and states into small local communities with direct democracy and make sure they do not cooperate on “defense” and large technical projects, make sure that no corporation has more than few hundreds employees and does not have more than 10% of market-share, no person have enough commercial or political power to significantly alter lives of large number of people (for worse or better – it doesn’t matter) …

      • @ r2m

        there are some of my own initial practical ideas , but based on some neoAristotelian (and some Communitarian) ideas.

        The current social and ecological conditions in the world are direct result of failed moral ideas (mainly Kantian, utilitarian, contractarian, emotivism) … not high CO2 levels, not even lack of democracy

        All of these failed rational morality ideas pushed our civilization into almost complete moral disarray that leads to our total social and even physical destruction.

        the only way to prevent social and ecological catastrophe is to treat the cause not the symptoms. Unfortunately all symptom treating solutions presented by both sides: contemporary conservatism (free market individualism) and modern liberalism (bureaucratic individualism) are destined to fail because these common problems cannot be solved in an individualist society by pursuing individual happiness neglecting (even not understanding) common good.

        Even more unfortunately, all the bureaucratic socialist ideas that promised solutions (mainly Marxism) failed miserably as well.

        CO2 emission, pollution, neocolonialism, poverty … are just consequences of our (global) failed morality. No fix that offers charity, lower CO2 emission, or recycling will change situations significantly. What needs to be changed is our perception of us, others and common good.

    • Wouldn’t be so bullish on electric cars.

      Electric cars are a drop-in replacement for most people today. Their numbers are only going to increase.

      In twenty years I doubt there will be many petrol(-only)-driven vehicles on the road outside of niches like driving enthusiasts.

  4. The U.S. is not growing, as can be shown by the fact that Electrical Power Consumption has not equalled its August 2008 all time high.
    In late 2009 it had reduced by 4.73% and is still 2.75%
    below the Aug 2008 all time high.
    Is it any wonder that petrol usage is also down during a depression?

  5. Oil is just one piece of the puzzle. Heinberg explains the oil situation best of all:
    Download/Listen (30 minutes)

    Bigger picture:

    William Catton Jr., author of the seminal volume about our human destiny, Overshoot: The Ecological Basis of Revolutionary Change, died last month at age 88.

    Catton believed that industrial civilization had sown the seeds of its own demise and that humanity’s seeming dominance of the biosphere is only a prelude to decline. His work foreshadowed later works such as Joseph Tainter’s The Collapse of Complex Societies, Richard Heinberg’s The Party’s Over: Oil, War and the Fate of Industrial Societies, and Jared Diamond’s Collapse: How Societies Choose to Fail or Survive.

    In Overshoot Catton wrote: "We must learn to relate personally to what may be called ‘the ecological facts of life.’ We must see that those facts are affecting our lives far more importantly and permanently than the events that make the headlines." He published those words in 1980, and now, it seems, at least some of those facts have made their way into the headlines in the form of climate change, soil erosion, fisheries collapse, species extinction, constrained supplies of energy and other critical resources, and myriad other problems that are now all too obvious.

    But, even today, few people see the world as Catton did. Few realize how serious these problems are and how their consequences are unfolding right before us. Few understand what he called "the tragic story of human success," tragic because that success as it is currently defined cannot be maintained and must necessarily unwind into decline owing to the laws of physics and the realities of biology. We can adjust to these realities or they will adjust us to them.

  6. The US Rig count has dropped about 20% already.

    The new price wn’t be normal in 2 years time as production from fracked wells falls from existing levels (it runs off quite quickly about 80% in 3 years).

    The Saudi’s and others will then get a 3 year super profit after prices rise and US Bankers will be very cautious about lending to frackers who haven’t sold forward at the high prices for most of their production.

    Given the exchange rates and oil prices, the big countercyclical investment is Gazprom.

    • Gazprom, Rosneft and a host of other Russian companies are offering the potential for huge returns. If i had deep pockets that is where i would invest. The US can try to hold Russia down all it likes, it won’t work.

  7. Gee really like Grantham he puts forth such rational arguments/analysis. I can’t beleive these prices at the bowser atm even with a low AUD.