As I explained yesterday in The oil market falls into line, perfectly, the oil futures market is doing some decidedly weird things, at least measured by historical standards. Beyond the rapid run up in price–including a $4+ jump just yesterday–there’s this issue of the market being in a state of “continuous contango”, meaning that as you go further into the future the price of oil in various contracts rises.

The conventional wisdom is that contango can’t last with a non-perishable commodity like oil, since doing so would indicate that traders couldn’t simply delay selling it until the price rose, which would push up current prices (less is being consumed now) and bring them down in the future (when that supply becomes available). Checking the NYMEX oil prices just now, I see that while the market is generally still clearly in contango out to the furthest contract, dated December 2016, the pattern is no longer perfect, and a few very minor dips have shown up in the prices.

So, what’s going on here?

After having a little time to do some more reading and just sit and think about it, I’m convinced that we’re seeing a confluence of two factors, one “news” (at least to commodity traders who were behind the curve on peak oil), one not.

Factor 1: Surprise! Peak oil isn’t a myth!

The news is that peak oil is looking a lot more like a mainstream concept and an imminent phenomenon. No, the oil traders haven’t suddenly started flocking to this site or others talking about peak oil, but they very likely are aware of the stunning news that will be published by the IEA in November, according to The Wall Street Journal:

The world’s premier energy monitor is preparing a sharp downward revision of its oil-supply forecast, a shift that reflects deepening pessimism over whether oil companies can keep abreast of booming demand.

The Paris-based International Energy Agency is in the middle of its first attempt to comprehensively assess the condition of the world’s top 400 oil fields. Its findings won’t be released until November, but the bottom line is already clear: Future crude supplies could be far tighter than previously thought.

…

For several years, the IEA has predicted that supplies of crude and other liquid fuels will arc gently upward to keep pace with rising demand, topping 116 million barrels a day by 2030, up from around 87 million barrels a day currently. Now, the agency is worried that aging oil fields and diminished investment mean that companies could struggle to surpass 100 million barrels a day over the next two decades.

The decision to rigorously survey supply — instead of just demand, as in the past — reflects an increasing fear within the agency and elsewhere that oil-producing regions aren’t on track to meet future needs.

“The oil investments required may be much, much higher than what people assume,” said Fatih Birol, the IEA’s chief economist and the leader of the study, in an interview with The Wall Street Journal. “This is a dangerous situation.”

…

But the direction of the IEA’s work echoes the gathering supply-side gloom articulated by some Big Oil executives in recent months. A growing number of people in the industry are endorsing a version of the “peak-oil” theory: that oil production will plateau in coming years, as suppliers fail to replace depleted fields with enough fresh ones to boost overall output. All of that has prompted numerous upward revisions to long-term oil-price forecasts on Wall Street.

…

The IEA’s study marks a big change in the agency’s efforts to peer into the future. In the past, the IEA focused mainly on assessing future demand, and then looked at how much non-OPEC countries were likely to produce to meet that demand. Any gap, it was assumed, would then be met by big OPEC producers such as Saudi Arabia, Iran or Kuwait.

But the IEA’s pessimism over future supplies has been building for some time. Last summer, the agency warned that OPEC’s spare capacity could shrink “to minimal levels by 2012.” In November, it said its analysis of projects known to be in the works suggested that the world could face a shortfall by 2015 of as much as 12.5 million barrels a day, unless there was a sharp drop in expected demand. The current IEA work aims to tally the range of investments and projects under way to boost production from the fields in question to get a clearer sense of what to expect in production flows.

Think about this for a moment and you’ll probably agree that this is an enormous conceptual leap, the economic equivalent of Walter and Luis Alvarez figuring out that the dinosaurs were wiped out by a big rock falling out of the sky. It’s a true paradigm shift, and it raises some very uncomfortable questions.

Factor 2: No place for our stuff

As for the other factor, let me being with a snippet from one of Jeff Vail’s posts on The Oil Drum:

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.

My contention is that there simply is no way to store enough oil to bring down future prices, if you assume that the IEA reassessment is accurate, which means that from the perspective of today’s traders, all of Jeff’s conditions are met. We’re on a production plateau; there is now a consensus that the future rate of production will be lower, at least relative to demand, which is what really matters; and we can’t store the oil.

Why can’t we store oil? We do it all the time, right? The problem is that we can’t store enough of it to make a difference over a period of years.

Assume, for example, that to loosen up the markets and drop the price substantially you have to come up with another 1 million barrels of oil per day. (We’re currently consuming about 85 million barrels/day, worldwide.) That means that over the 8.5-year period covered by the NYMEX contracts, you would need to store just over 3.1 billion barrels of oil, or all the world’s oil production for 36 consecutive days. That’s a lot of oil.

How much do we store now? The IEA’s figures for the OECD countries[1] show that in February 2008 their combined stockpiles of crude oil, NGL, and refinery feedstocks were 2.3 billion barrels. (See Table 9.2 of this spreadsheet (1MB XLS file).)

So, where would we put 1.35 times as much unrefined oil as the entire 30-nation OECD currently stores? We can’t put that 3.1 billion barrels on supertankers, as that would take a fleet of about 1,000 ships, assuming they’re all the largest ones currently in existence, with a capacity of 3.1 million barrels each, of which we currently have four.

The entire US SPR (strategic petroleum reserve), which is the largest such reserve in the world and stores oil in underground salt domes, is “only” 700 million barrels, just 23% of our target 3.1 billion barrels.

You can come up with your own scenarios about how long it would take to build up that large an oil stockpile, and how insane the market would go if we tried.

Conclusion

I’m convinced that we’re seeing an awakening of the broader market to the breadth and depth of our worldwide oil mess. A crucial segment of the economy, the money people, are finally figuring out that those of us who have been obsessed with this topic for years weren’t all crazy. My guess is that there was no single event that triggered their change of mind, but a rising tide of information and opinion gently lifting their conceptual boat: We’ve had numerous statements in recent months from oil companies about the difficulty of meeting future demand, plus a growing list of ever more dire predictions from the investment and securities firms. But the news that the IEA is doing their own megafields project, ala Chirs Skrebowski’s (which is the most reliable methodology, in my opinion, and concludes we’re headed for a 2011/2012 peak), and that it will show a dramatically lower peak probably contributed the last ripple needed. (And I have to wonder about the IEA leaking this news six months in advance of the report’s official release. That’s as transparent an attempt to soften the blow of bad news as one could imagine. Even with continual leaks, I expect to see a knee jerk reaction when the final report is released.)

The market likely will oscillate between contango and backwardation, with few eyebrow-raising events like the continuous contango we saw two days ago. But barring any unforeseen surprise, like a dramatic drop in worldwide oil demand or someone discovering how to turn sea water into regular unleaded at $1/gallon, we’ll see continued “high” and generally rising prices, even without any other factors, like a new war or terrorist attack, launching the market into low-Earth orbit.

In short, during the last 48 hours the energy world dramatically changed shape, with vast implications for almost everything we do in our daily lives.

[1] The OECD countries are: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States