Thursday, April 4, 2013

5 Reasons Why Oil Companies Get Away With Overblown Field Estimates

We’ve all seen the big headlines over the few past few years proclaiming various new oil fields. These stories often go on to claim how the Age of Oilquarius is now upon us and we will swim and bathe in seas of energy until the sun explodes and the universe ends. We are often showered with numbers and statistics that upon closer inspection don’t mean anything useful at all.
Case in point is the announcement earlier this year that a large oil field had been discovered in the Australian outback. Check out these three headlines and bylines below:
Trillions of dollars worth of oil found in Australian outback 
Up to 233 billion barrels of oil has been discovered in the Australian outback that could be worth trillions of dollars, in a find that could turn the region into a new Saudi Arabia.
$20 trillion shale oil find surrounding Coober Pedy 'can fuel Australia' 
  • Coober Pedy has between 3.5 billion and 233 billion barrels of oil
  • Australia could change from oil importer to exporter
  • Boom and bust: How mining has shaped Australia's history
Oil discovery in Australia’s outback could ‘transform world’s oil industry’
Pretty heady stuff. The first headline goes straight for the Benjamins, mentioning an undefined ‘trillions of dollars’ and then follows up with the astronomical number of 233 billion barrels. It ends with the George Clooney of the oil world, the country that everyone wants to be, Saudi Arabia. Where do I sign up?
The second headline also carries the money line and adds that holy grail in energy circles of ‘ENERGY INDEPENDENCE.’ The headline asks us to dream of the Australian oil utopia where true blue Ozzies no longer have to buy oil from those troublesome Arabs. Neither does anyone else because Australia is now a net oil exporter! Hooray! Unfortunately they also mention that pesky detail that Coober Pedy has somewhere between 3.5 billion and 233 billion barrels of oil. One of those numbers is quite a bit bigger than the other one (we will revisit this later).
Finally we have the slightly more sober ‘transform world’s oil industry’ which isn’t really that much more sober when you consider that the revenue for Conoco Phillips is larger than the GDP of Pakistan, the revenue for Chevron is larger than the GDP of the Czech Republic and the revenue for Exxon Mobil is larger than the GDP of Thailand, i.e when we we talk about transforming the world’s oil industry we are talking about some major world changing activities.
So I hear you ask: why are these headlines so fantastic? The first reason is just one word. Hype.
1. Hype
Hype is what marketers do to sell people things they don’t really want or need. The above headlines are the news story equivalent of a store proclaiming ‘up to 70% off selected items.’ Never mind that once your in the store you find you don’t actually want any of those luckily selected 70% off items: half the battle is already won. You are already in the shop and that greatly increases the likelihood of you buying something else .
Like stores, oil companies want people to buy their product. Although in the case of oil exploration companies initially the product they are selling is an investment with the potential to have a large pay off down the line. Of course the larger they can hype the market the more people will be interested and more likely to invest. A few might be turned off by deeper reading into the flaky numbers but there are more than enough people out there with wads of cash who are willing to take a gamble. Hence the company attracts investors and the board of directors live sweet for a couple of years on the investment capital until the next big find.
2. Most people don’t understand basic mathematics
The second reason why oil companies get away with overblown estimates is because most people don’t understand basic mathematics.
Taking the example above the Coober Pedy could hold somewhere between 3.5 billion and 233 billion barrels. Most people don’t stop and think about how huge the difference in those numbers actually is. If we converted that to a salary of $3,500 and compared it to $233,000 we see very easily how the former wouldn’t last more than a few months while latter would provide a wealth of excess. Another way of thinking about it is that 233 billion is over 6550 percent larger than 3.5 billion.
Scientifically the confidence intervals would be so wide as to be absolutely meaningless. But most people don’t get this and so oil companies continue to pedal this hogwash.
3. The bystander effect
It’s basic human nature to avoid a problem until it starts affecting you personally. It is also basic human nature to avoid a problem if everyone else is also avoiding the problem. The is called the bystander effect or Genovese syndrome. For example an accident with a crowd standing around: because the majority of bystanders are doing nothing about it, the less likely it is for anyone individual to break the mold and help those involved in the accident. This is occurs because as the number of bystanders increases an individual is less likely to notice the situation, interpret it as a problem and less likely to assume responsibility for taking action.
In the realm of energy activism there are only a small number of people willing to risk their careers and reputations in calling for an end to the status quo. The majority of people don’t even notice our addiction to oil  let alone see it as a problem. Therefore the oil companies throw around any numbers they like and barely anyone not already interested in energy takes any notice.
4. Keeping business as usual
Given that we live in an age of sound bites and miniscule attention spans what we read in the form of headlines is incredibly powerful. This creates problems when those headlines aren’t entirely truthful and we can’t even have a frank and open discussion about our energy future because “everything’s fine, they keep finding big ones everywhere.”
If we look at the figures above comparing oil company profits to countries GDP’s we can see that oil companies are doing pretty darn well for themselves. They don’t want anything to change that could threaten their profit margin. They have a vested interest in keeping business as usual.
There is a concerted effort to downplay the occurrence of peak oil and to reinforce that there is plenty of affordable oil left in the world. Because if people really start getting spooked en mass then governments could be forced into seriously looking into alternative energy, the last thing  any oil company really wants.
By reporting overblown field estimates oil companies keep people passive and unconcerned about their future. This means oil companies can get on with making as much money as they possibly can while cheap oil is still relatively accessible.
5. Warding off effective action on climate change
There is a wealth of evidence that oil companies have invested huge amounts of money in disinformation campaigns to confuse the public about climate change. By downplaying climate change and continuing to attract investment with overblown field estimates oil companies can continue with the most environmentally damaging industry on earth.
Overblown field estimates keep investors away from alternative energy projects and keep governments away from effective climate change policy as they vie for petro dollars.
In these tough financial times governments are jumping over each other to look attractive towards oil companies. Oil companies promise huge financial benefits for the relaxation of pesky environmental laws and the increase in penalties for protesting against oil companies. 
So next time you see an article proclaiming a huge amount of oil or gas in an area, stop for a second and think about how those companies might be benefitting from such positive press. Because more than likely the truth might be buried a little more deeply than the provocative headline.

Friday, March 22, 2013

Energy Literacy 101 – 40 Terms To Help You Become An Energy Expert

The energy industry is full of industry specific jargon that can make it difficult for an outsider to understand exactly what they are reading. Have you ever wondered exactly what the difference is between tight oil, shale oil and oil shale? Read on for those terms and more explained in a succinct, easy to digest form.

API gravity - The American Petroleum Institute gravity is a measure of how heavy or light a petroleum liquid is compared to water.

Barrel of oil (bbl) – A unit of volume for oil that equates to 42 US gallons or 159 litres. 

Barrel of oil equivalent (BOE) – A unit equivalent to the amount of energy found in a barrel of crude oil. This is approximately 5.8 million British Thermal Units (MBtus) or 1,700 kilowatt hours (kWh).

Brent oil – A light, sweet crude oil sourced from fifteen fields in the North Sea. Brent is the traditional benchmark of global supply and demand for oil.  

British Thermal Units (BTU) – The amount of heat energy needed to raise the temperature of one pound of water by one degree Fahrenheit. This is the standard measurement used to state the amount of energy that a fuel has as well as the amount of output of any heat generating device.

Conventional oil – Oil produced by a traditional well requiring a relatively low energy input. Conventional oil flows through a well without stimulation and through a pipeline without processing or dilution.

Crude oil – Synonymous with petroleum.

Development Well - A well drilled in a proven producing area for the production of oil or gas. 

Downstream – The sector of the oil and gas industry that is involved with the refining of crude oil and the processing and purifying of raw natural gas as well as the marketing of the products derived from fossil fuels.

Economically recoverable reserves - The volume of petroleum which is recoverable using current exploration and production technology while still being economically viable. Synonymous with proved reserves.

EIA – United States Energy Information Administration. They provide official energy statistics from the U.S. Government.

Exploratory Well – A well drilled in an unproven area that an oil or gas company hopes will be successful.

Fracking – Short for hydraulic fracturing, the process of injecting a high pressure mixture of sand, water and chemicals into rock formations in an effort to increase the flow of oil and gas by creating and widening cracks in the rock.

Futures – A financial contract that obligates the buyer to purchase an asset (or the seller to sell an asset) such as oil at a predetermined future date and price.

IEA – International Energy Agency. Implements an international program of energy cooperation among 28 member countries. Established in 1974 in the wake of the 1973 oil crisis.

Light oil- Refers to the ability of the oil to flow freely which makes it easier to transport and refine.

Natural Gas Liquids (NGL) - Components of natural gas that are artificially separated from the gas state in the form of liquids. Natural gas liquids as classified based on their vapour pressure:
Low = condensate
Intermediate = natural gas
High = liquefied petroleum gas

Oil in place - The total estimated amount of oil in an oil reservoir, including both producible and non-producible oil.

Oil shale – Any fine-grained sedimentary rock that contains solid organic matter (kerogen) and yields significant quantities of oil when heated.

Oil sands - Sand and rock material which contains crude bitumen (a heavy, viscous form of crude oil).

OPEC – Organization of the Petroleum Exporting Countries. An intergovernmental organization originally formed in 1960 by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela to coordinate and unify petroleum policies amongst member countries.

Peak oil – The point at which the maximum amount of oil possible is produced after which oil production enters terminal decline. While proven for individual wells and countries it has yet to be conclusively proven on a global scale.

PlayA group of oil or gas fields or prospects in the same geographical area that display similar geological properties. 

Possible reserves -– Reserves which cannot be regarded as “probable” and are estimated to have a significant but less than 50 percent chance of being technically and economically recoverable. Referred to as P10 or P20 reserves

Petroleum – Synonymous with crude oil. 

Proved reserves - The volume of petroleum which is recoverable using current exploration and production technology while still being economically viable. Synonymous with proved reserves. Referred to as P90 reserves.

Probable reserves – Reserves which are estimated to have a better than 50% chance of being technically and economically producible. Referred to as P50 reserves.

Liquefied Natural Gas (LNG)A natural gas consisting mainly of methane (CH4) that has been converted to a liquid form for ease of transport or storage.  

ReservesThe producible fraction of oil that can be brought to the surface due to reservoir characteristics and limitations in petroleum extraction technologies.

Shale Oil – An unconventional oil produced from oil shale in an energy intensive process.

Sour oil - Oil that has a relatively high sulphur content, typically over 0.42 percent. 

Sweet oil – Oil that has a low sulphur content, typically lower than 0.42 percent. This oil sells at a premium to sour oil as it easier to process into high quality products.

Tight oil – Light crude oil contained in petroleum-bearing formations of relatively low porosity and permeability. Commonly extracted by using hydraulic fracturing.  It should not be confused with shale oil as it differs by the API gravity and viscosity of the fluids, as well as the method of extraction.

Tar sands - Synonymous with oil sands but typically not used by the oil industry due to the negative connotations of the word “tar.” More commonly used by environmental groups.

Technically recoverable reserves - The volume of petroleum which is recoverable using current exploration and production technology without regard to cost, which is a proportion of the estimated in-place resource.

Upstream - The sector of the oil and gas industry responsible for exploration, drilling of exploratory wells, and subsequently drilling and operating the wells that recover and bring the crude oil and/or raw natural gas to the surface.

Unconventional oilOil that is produced by techniques other than traditional oil well extraction. The primary sources of unconventional oil are oil sands, oil shale and tight sands.

Undulating plateau - A phase where oil production and consumption cycle around the horizontal over a period of time. This appears to have been the state of the global oil supply since 2005.

URR – Ultimately recoverable resource. An estimate of the total amount of oil that will ever be recovered and produced. It is a subjective estimate based on only partial information.

WTI West Texas Oil is lighter and sweeter than Brent and sourced from around North America. It is priced from the trading hub of Cushing, Oklahoma.

Wednesday, February 20, 2013

Oil Consumption & GDP Growth

The economy is getter better, isn’t it? It seems that no matter how hard the New Zealand government tries to convince us there are a range of statistics released from it’s own departments that pour cold water on the notion of any kind of strong economic recovery. Unemployment hitting the highest rate in 12 years is just one of those statistics. 

So what does this really mean for the future?

Chris Martenson from Peak Prosperity recently wrote a great article called The Real Reason the Economy Is Broken (and Will Stay That Way). He referenced Gail Tverberg’s work on investment sinkholes and the link between oil consumption and GDP.

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

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

Martenson explains:

Oil and GDP are highly correlated and always have been.  The general observation is that growth in GDP is usually higher than growth in oil consumption - as growth in oil consumption powers economic growth.  Without growth in oil consumption, GDP growth doesn't advance.

So if we run some similar numbers for New Zealand how do we fare, given our high oil consumption per capita (38th in the world) and reliance on primary industries as the basis of our economy?

imageFigure 2: Comparison of 2005 to 2011 percent change in real GDP vs percent change in daily oil consumption, both on a per capita basis. (GDP per capita on a PPP basis from World Bank, oil consumption from BP’s 2012 Statistical Review of World Energy, NZ population data from Statistics New Zealand.)


Back in 2009, in a piece entitled Oil - The Coming Supply Crunch (Part I), I calculated that every 1% increase in global GDP was associated with a 0.25% increase in oil consumption in other words, a roughly 4:1 ratio.

Based on Figure 2 the ratio for New Zealand over this period is a 0.6% increase in GDP associated with a 0.25% increase in oil consumption which falls well below the global average.

That being said, compared to the Eurozone and the United States the New Zealand economy hasn’t fared too badly. While there has still been economic contraction and rising unemployment we are still a lot better off than our foreign neighbours. Figure 2 shows that GDP per capita rose just shy of 19 percent  over the 2005-2011 period while oil consumption has risen just under eight percent. One of the New Zealand’s economies saving graces has been the 2008 free trade deal with China. Exports to China rose $1.5 billion (37 percent) in 2010. 


Figure 3: New Zealand GDP per capita vs. daily consumption of oil per capita. (GDP per capita on a PPP basis from World Bank, oil consumption from BP’s 2012 Statistical Review of World Energy, NZ population data from Statistics New Zealand.)

Figure 3 shows we have seen GDP per capita rising steadily for the last 30 years with a flattening off after the global financial crisis. Over this period we also see the consumption of oil per capita peak during the consumerist decade of the 80s and then more or less decline.


Since 2007, something quite remarkable has happened in the world of oil, and that has been a decline in the consumption of oil in the U.S. and Europe -- with China and India pretty much making up the difference for everything that the West didn't consume.

New Zealand’s oil consumption per capita has actually increased from 2007, most probably due to growth in fossil fuel reliant primary industries.  But before that period GDP steadily grew while oil consumption steadily fell. How do we reconcile that with Chris Martenson’s view that “without growth in oil consumption, GDP growth doesn't advance.”?

As with most things economic it’s not quite that simple. Gail Tverberg explains further:

In Figure 1, we see that for several groupings, the increase (or decrease) in oil consumption tends to correlate with the increase (or decrease) in GDP. The usual pattern is that GDP growth is a little greater than oil consumption growth. This happens because of changes of various sorts: (a) Increasing substitution of other energy sources for oil, (b) Increased efficiency in using oil, and (c) A changing GDP mix away from producing goods, and toward producing services, leading to a proportionately lower need for oil and other energy products.

The situation is strikingly different for Saudi Arabia, however. A huge increase in oil consumption (Figure 1)…does not seem to result in a corresponding rise in GDP.

New Zealand matches up with both (a) and (b) causing per capita oil consumption to decrease. However given our export based economy, (c) does not ring true at all. Most of our economic growth has come from an intensification of farming practices (mainly dairy), more efficient forestry practices and a large increase in crude oil exports. This coupled with new markets such as China has been a great benefit to New Zealand.

The trouble is when we are so reliant on other countries economies being strong we are incredibly vulnerable when they weaken. There is already murmurs that the commodity boom in Australia is on shaky ground and that the aging population of China spells real trouble when a huge proportion of the population can’t work and needs to be supported. If we want to know how New Zealand economy will do in the future these are the two key countries to watch.

So while we might be doing ok for now, unless our current trading partners perform miracles and stay strong for the foreseeable future don’t expect the New Zealand economy to get much better than this.

Thursday, August 30, 2012

Don't Worry, There's Plenty of Oil

Reposted from Energy Bulletin. By Richard Heinberg. 

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In recent months we've seen a spate of articles, reports, and op-eds claiming that peak oil is a worry of the past thanks to so-called "new technologies" that can tap massive amounts of previously inaccessible stores of "unconventional" oil. "Don't worry, drive on," we're told.

But as Post Carbon Institute Senior Fellow Richard Heinberg asks in this short video, what's really new here? "What's new is high oil prices and … the economy hates high oil prices."


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We can fall for the oil industry hype and keep ourselves chained to a resource that's depleting and comes with ever increasing economic and environmental costs, or we can recognize that the days of cheap and abundant oil (not to mention coal and natural gas) are over.

Unfortunately, the mainstream media and politicians on both sides of the aisle are parroting the hype, claiming — in Obama's case — that unconventional oil can play a key role in an "all of the above" energy strategy and — in Romney's — that increased production of tight oil and tar sands can make North America energy independent by the end of his second term.

We need your help: Please share this video and help bring a dose of reality to the energy conversation.

The Script

Our civilization runs on oil.

It’s the cheapest, most energy-dense and portable fuel we've ever found. Nature required tens of millions of years to make petroleum, and we've used up the best of it in less than two hundred.

A little over a decade ago, eminent petroleum geologists calculated that global oil production would soon hit a “peak” and begin to decline, no longer meeting ever-rising demand. But oil industry spokesmen countered with the message, "Don't worry, there's plenty of oil!" and assured us that everything would be just fine.

So what actually happened? World crude oil production flat-lined in 2005, and oil prices went crazy. Wars erupted in the oil-rich parts of the world, and the global economy went into a tailspin. The term "Peak Oil" entered the lexicon.

The oil industry is now staging another PR counter-offensive. They're telling us that applying "new" technologies like hydrofracking to low-porosity rocks makes lots of lower quality, unconventional oil available. They argue we just need to drill more to produce more. Problem solved!

But wait. What's actually new here? Most of this technology has been around since the 1980s. The unconventional resources have been known to geologists for decades. What's new is high oil prices.

It’s high oil prices that make unconventional oil worth producing in the first place. It takes lots of money and energy, not to mention water, to frack low-porosity rocks. And the environmental risks are staggering.

How does the economy handle high oil prices? Well, it turns out the economy hates high oil prices and responds by going into recession. Which makes energy prices volatile, rendering the industry subject to booms and busts.

So, what’s the bottom line here?

Yes, there's still oil in the ground. We just can't afford it. In broad terms, the peak oil analysts were right. But the fossil fuel industry is winning the PR battle.

What really matters, though, is not who wins the debate, but how we prepare for the inevitable. We’ve got to wean ourselves off our high-energy lifestyle.

We'd be foolish to wait for events to settle the debate once and for all. Let's say goodbye to oil. It's saying goodbye to us.


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Wednesday, August 22, 2012

Mind the Gap: The Difference Between Brent and WTI

There is much talk in the media about “oil prices” especially when it begins to hurt consumers at the fuel pump. Prices are sometimes referred to as  Brent crude or West Texas Intermediate (WTI) or sometimes just as oil. So what does this all mean and what are the differences?

Brent crude is sweet light oil sourced from fifteen fields in the North Sea. “Sweet” refers to the sulphur content. The lower the sulphur content the easier it is to refine. “Light” refers to the ability of the oil to flow freely which makes it easier to transport and refine. In comparison oil from the Alberta tar sands is considered to be heavy as it is transported as diluted bitumen (dilbit) and is much more difficult to refine.  WTI is lighter and sweeter than Brent with a sulphur content of 0.24% compared to 0.37%. WTI is sourced from around North America and priced from the trading hub of Cushing, Oklahoma.


Figure 1: Monthly ratio of the nominal price of Crude Oil (petroleum); Dated Brent divided by the price of West Texas Intermediate. From Indexmundi.

Historically Brent prices lagged behind WTI until Brent began selling for more than WTI in the early 2000s for the first time. Since then Brent has gradually pulled away from WTI and was trading at a US$17.81 premium at the time of writing.

Goldman Sachs expects WTI to close the gap with Brent in the near future as shipments into Cushing slow, decreasing supply. This does not bode well for global oil prices with Goldman Sachs also predicting that Brent will reach US$120 in the next three months due to field maintenance in the North Sea and European market optimism.

Traditionally WTI has been used as the international benchmark for oil prices but over the last few years Brent has overtaken WTI in importance. This is backed by a 2007 report from the now defunct Lehman Brothers that WTI was no longer a gauge for the international oil market. As Cushing is landlocked it is restricted by pipeline capacity which has led to an supply glut over the past few years. WTI is not traded in any significant quantity outside North America.

Steve Austin at “Brent is the real international benchmark.Two-thirds of the oil consumed in the US is Brent, and two-thirds of international crude is priced to it. Still the media and market persist in quoting WTI, rather. This is a US singularity, like the non-adoption of the metric system.”

Figure 2: Oil production from the North Sea, based on EIA data. From Our Finite World.

North Sea oil production peaked in 1999. Even with record high oil prices since 2007 production has not been turned around. Oil companies have been in dispute with the British government over tax rates since 2011, responding by cutting production by 18% which lead to a £2.3bn drop in tax revenues. Since a government u-turn on the tax arrangement, investment in the North Sea is expected to increase from £8.5bn last year to £11.5bn this year.

This decreased output from the North Sea has raised grumblings that Brent is no longer a true indicator of global supply and demand either. But there is currently no viable alternative and so it looks as though Brent is set to stay as the global benchmark for sometime to come.

Saturday, August 18, 2012

Running on Empty: Big Airlines in Big Trouble

I have a joke with a friend of mine that airline pilots are nothing but glorified bus drivers. As cynical as this may be, for the majority of us with regular jobs who fly economy air travel is increasingly becoming like its land-based cousin: cramped, overcrowded and at times downright unpleasant.

Most people living in our modern industrial society take air travel for granted. We think very little about hopping on a plane and travelling around the world for little more than a couple of weeks wages. As jet fuel prices bounce along with the price of crude however many airlines are increasingly struggling to break even. Fuel prices now account for 35 percent of operating costs compared to 15 percent a decade ago. Air travel has always been a fickle business, earning an average net profit of one to two percent, compared with an average of over five percent for U.S. industry as a whole. Research from the 1980s found that some carriers would have zero profitability if they had lost just one out of ten business passengers. 

So how does the future look for the airline industry? If recent trends are anything to go by, not good. Not good at all.

Plane Trends

Airlines have increasingly been moving towards smaller aircraft despite the popularity of the “Superjumbo” Airbus A380 since its release in 2007. Airbus has sold 253 A380s while Boeing has orders for 106 747-8s with the large majority of these being used for cargo operations. Richard Aboulafia from Teal Group,  an Aerospace and Defense Market Analysis company believes that smaller, sleeker aircraft are the future of international air travel ““The market for large aircraft in general is disappearing fast. Most of the 747-8 planes are cargo. There’s just a limited market.”

Packed Like Sardines

In an effort to increase profits from each flight a number of airline companies are trying to fit more passengers onto each plane. The sale of an extra one or two seats can mean the difference between breaking even and a loss. While standing room only flights appear to be nothing other than a cheap marketing ploy companies have reduced the seat width in order to fit an extra seat in each row.

Air New Zealand recently replaced its older 747s with a significantly narrower 777-300ER. To accommodate the same 3-4-3 seat configuration the new seats are one inch narrower and the aisle has decreased in size as well. Air New Zealand was named the most innovative airline in the world last year and so it is likely that other airline companies will follow suit.

In 2010 an Italian company, Avio Interiors,  introduced the world to its “Skyrider” saddle-style seat. Intended for up to four hour long flights the passenger sits at an angle with 23 inches of legroom (compared with 30 inches on a standard configuration) allowing more passengers per flight. Two years later no airlines have yet committed to the Skyrider seating but as fuel prices continue to rise one has to wonder how long it will take before it is seriously considered.  

At the other end of the spectrum some airlines have introduced what has colloquially been termed “chub class.” In an effort to accommodate the expanding waistline of Western flyers  Airbus is increasing the size of aisle seats to 20 inches wide on its A320 jets while decreasing middle and window seats by one inch. The premium wide seat will be sold at for an extra US$10.

Weight Reduction

Scoot Airlines, based out of Singapore has recently removed television monitors from airplane seats replacing them with Apple iPads. The television monitors and associated electronics are reported to weigh two metric tonnes.  According to Bloomberg this has enabled the airline to add 40 percent more seating while decreasing the weight of a fully loaded flight by seven percent. 

Extra Charges Everywhere

Traditionally the most successful airlines traded on glamour and providing a service experience. Recent trends however show that airlines are increasingly moving towards a no-frills approach in an effort to cut expenses. To do this airlines are  imposing costs on everything possible under the thin veil of “increased consumer choice.” Changes seen over the last few years include the removal of a complimentary item of check-in luggage, the removal of complimentary meals and extra charges for window seats and seats towards the front of the plane. The iPads on Scoot flights mentioned above will cost US$17 to hire for the flight.

Recommendations from a 2005 study suggest that a low-cost strategy should no longer be considered an exception but should rather become the norm for the airline industry. We can see this recommendation playing out today with the stripping of services from flights shifting to an almost purely user pays model.

Case Study: The Air New Zealand Situation

A good example of this new user pays model is Air New Zealand. In 2010 they changed to single class short haul flights with radically rebundled fares. Travellers can now choose from one of four options beginning with a seat, one 7kg carry-on bag, tea, coffee and water and access to some entertainment options but no new release entertainment. At the other end they have the ‘Works Deluxe’ which allows two priority bags, a carry-on bag, meal and drinks, a seat request, a guaranteed empty seat next to the passenger, premium check in, lounge access and better entertainment options.

Being the most innovative airline company does not necessarily make you the most profitable. Air New Zealand announced a 71 percent earning slump in February 2012. As part of its recovery plan the company announced it was cutting 441 jobs. The airline blamed a decrease in passenger numbers as well as as fuel costs NZ$173 million more than forecast. This is despite the airline enjoying “a solid performance from the domestic network including benefits from the Rugby World Cup and improved market share on the Tasman” according to Air New Zealand chairman, John Palmer.

The outgoing chief executive Rob Fyfe says the price of jet fuel has doubled over the last three years and due to the weak global economy it has been difficult to pass on the higher costs to passengers.The inflation adjusted average price of jet fuel was US$3.04 per gallon for the six months to December 31st. Going off jet fuel prices alone it is unlikely the airline will see much of a turn around in profitability for 2012. In the first six months of 2012  the average price barely moved, up US$0.04 to $US3.08.

The full year earnings are not released until the end of August but the few media releases coming out of Air New Zealand the last few months are beginning to sound increasingly desperate. On 19th July 2012 Fyfe and Palmer called for an “urgent review” of New Zealand tourism. Palmer told Parliament's finance and expenditure committee that despite operational improvements (newspeak for job cuts), Air New Zealand's financial performance was not healthy and decreased expenditure was yet to be reflected in its currently "disappointing" share price.

Air New Zealand is looking to focus on its domestic, Australian and Pacific service as these have been the most economically sustainable. According to Fyfe, "An aircraft flying to London and back, a 777-300, it costs $1.25 million to get that aircraft to London and back and over 50% of the cost of fuel, a 737 flying to Auckland - Wellington about 23% of the cost is fuel."

The Global Situation

Globally the situation does not look much better. Some Middle Eastern airlines and Asian carriers are still recording strong growth but they are the exception. The International Air Transport Association (IATA)  revised the Middle Eastern profit forecast in March 2012 from USD300 million to USD500 million assuming jet fuel prices stay stable.  A spike in oil prices could however could turn the forecast profit into a USD200 million loss for the region’s airlines. According to the IATA  average oil prices could reach as high as US$135 per barrel this year in the unlikely event of Iran closing the Strait of Hormuz. Oil prices this high would create a US$5.3billion loss for the global aviation industry.   

U.S. airline profits have historically followed a cyclical profit-loss pattern of three to five years since U.S. deregulation in 1978. Profit margins have always been thin, sitting at 1.6% during the 1980s and only 1.0% for the period between 1990 and 2000. The early 2000s however saw economic downturn accompanied by huge industry-wide losses of $7 billion in 2001, $7.5 billion in 2002, and $5.3 billion in 2003. The impact of 9/11 and the associated changes to the way airlines run as well as the Dot-com crash cannot be denied either. Between 2000 and 2005 the industry plunged into record operating losses of $40 billion in total.

Figure 1: World economic growth and airline profit margins: 1970 to 2011. Source: IATA Financial Monitor for Jan/Feb-2012 released on 01-Mar-2012, sourcing IATA, ICAO & Haver.

Figure 1 clearly illustrates the cyclical nature of the airline industry. Whenever world GDP growth drops below two percent this is reflected by the net post-tax profit margin turning negative.

The director general and CEO of IATA, Tony Tyler, has cautioned that global GDP is not expected to pass two percent in 2012. “The risk of a worsening Eurozone crisis has been replaced by an equally toxic risk – rising oil prices. Already the damage is being felt with a downgrade in industry profits to $3.0 billion… With GDP growth projections now at will not take much of a shock to push the industry into the red for 2012,” Mr Tyler said.  

Rising fuel costs have taken a massive chunk out of the airline industries profit margins. The cost of jet fuel closely maps that of crude oil prices. This means that when prices are high at the local pump the airline companies are also hurting.

The IATA has forecast the airline 2012 fuel bill is expected to be $US213 billion, equivalent to 34 percent of total operating costs. The IATA fuel price average for 2012 is currently $US128.6 per barrel which is estimated to add an extra $US31billion onto the forecast 2012 jet fuel bill.

These IATA forecasts illustrate the fragility of the airline industry. Profitability is an elusive prospect for the industry with the IATA commenting  that  “the best collective margin of the last decade of 2.9% (2007 and 2010) does not cover the cost of capital”. Cargo traffic around the globe declined 1.9 percent in May 2012 compared to May last year. Cargo traffic generated US$66 billion in 2010 but has declined every month since May 2011. “Business and consumer confidence are falling,” Tyler said. “And we are seeing the first signs of that in slowing demand and softer load factors. This does not bode well for industry profitability.”

Dirty Air

If airlines are struggling this much with the current economic conditions it is almost certain that a globally unified approach to carbon taxing would cripple the industry. A report from 2008 found that airlines were emitting 20 percent more carbon dioxide than previously estimated. This could grow to 1.5 billion tons a year by 2025, far more that the worst cast IPCC predictions. As a comparison the entire European Union currently emits 3.1 billion tons of CO2 annually. This emission prediction does assume that oil prices will stay relatively low and that economic growth gets back on track, two assumptions that are looking increasingly unlikely.

Travel While You Can

Environmental concerns aside if you want to travel anywhere in the next five years now is the time to do it. The global economy is extremely fragile at the moment. Petroleum deliveries are at their lowest point since September 2008, with the weakest July demand since 2005 and yet Brent crude prices are still sitting above $US116 per barrel. This is not to mention the impending US “fiscal cliff” where $600bn in tax increases and spending cuts come into effect on January 1, 2013. Unless the US Congress  comes to some kind of agreement on raising the debt ceiling again by the end of this year GDP growth could be reduced by four percent, plunging the US into recession. Europe is cannot escape its current quaqmire without huge upheaval and there is now talk that France will be the next to crumble leaving Germany on its own. China’s growth has slowed to a three year low of 7.6 per cent with little sign of recovery in the next few months.  

This is all bad news for airlines that are already combatting high fuel prices. I expect to see a number of big name airlines fold or amalgamate in the next two years as financiers can no longer afford to prop up an industry that is hemorrhaging with no relief in sight. This could mean a reduced number of flights, less options of places to travel and skyrocketing ticket prices. While mother nature might thank us for the reduction in emissions the airline industry is running on empty. 

Monday, August 13, 2012

Update - The New Paradigm: Volatile Oil Markets

It was kindly pointed out to me last week by erich, a commenter on my article at Energy Bulletin that the data set I had used had not been adjusted for inflation. I had originally argued that it shouldn’t make much difference. I thought that as I was dealing with the price changes within a year and as the ANOVA treats each year as a separate group the effect of inflation would be negligible. However after thinking about it for a while I decided it would be worthwhile to run the inflation adjusted numbers to remove any doubt on the conclusions I had drawn from the original data set. Using this consumer price index (CPI) information I adjusted my original data set to 2010 dollars and reran the ANOVA.

Figure 1: Statistically significant Bonferroni-Holm test results looking at the difference between years in the monthly change in price for crude oil (US dollars per barrel), simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh, August 1982-June 2012. Data from

Figure 1 shows there were less results rejecting the null hypothesis, 32 compared to 59 in the unadjusted data which goes to prove erich’s point that at least some of the effect I was seeing was due to inflation. I feel somewhat vindicated at the same time that my original conclusions still stand. As erich said in his comments after I shared the new results “Adjusting prices for inflation makes your analysis and conclusions more robust and defensible” and so I thank erich for first raising the issue in a polite and encouraging manner.

I also tracked down some more oil price data sets that I hadn’t come across before and I was excited to see if my hypothesis, that oil volatility has significantly increased since conventional oil production plateaued in 2005, could be replicated.

This morning I came across an article on the 2012 United States Presidential “Energy Election” at a blog called Con Carlitos, written by Calvin Sloan. He had an interesting footnote which explained something I had not quite grasped and I will quote here in full:

As noted by Steve Austin at “Brent is the real international benchmark.Two-thirds of the oil consumed in the US is Brent, and two-thirds of international crude is priced to it. (Brent crude is sourced from fifteen oil fields in the North Sea.) Still the media and market persist in quoting WTI, rather. This is a US singularity, like the non-adoption of the metric system.”

Due to this I decided to look specifically at Brent crude prices as the strongest conclusions can be made from that data. I looked at both monthly and weekly Brent Crude prices between May 1987 and June 2012. Using average annual CPI data from the U.S. Bureau of Labor Statistics I adjusted the monthly and weekly Brent crude prices to 2012 dollars .

The monthly data returned only four results rejecting the null hypothesis. 2008 was significantly different to 1993, 1994 and 1995 and 2011 was significantly different to 1995. I was surprised this result was so low and intrigued to see if the weekly data was any different.

Brent May 1987 June 2012 volatility

Figure 2: Statistically significant Bonferroni-Holm test results for weekly Brent crude prices May 1987 to June 2012.

It would appear from Figure 2 that the monthly effect was largely masking the difference in Brent price volatility between years. When looked at on a weekly level we see that 76% of the statistically significant results occur after the 2005 production plateau.

It can be concluded  that while oil prices may be highly volatile on a week to week basis the effect is reduced on a monthly basis. We can also conclude that post 2005 we have seen a marked increase in weekly oil price volatility. The first six months of 2012 data is the fourth (equal with 2010) most volatile year for oil prices in the last twenty-five years behind only 2011, 2009 and 2008. The data from July and August  2012 was not included in this data set but it is my guess they would push 2012 further up the ranks. It is even possible by the end of the year that 2012 could be the second most volatile year after 2008. I for one will be watching oil prices over the next few months with great interest to see if the great yo-yoing continues.

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