Escolar Documentos
Profissional Documentos
Cultura Documentos
Adam Marmaras
Chief Executive Officer
Issue 32 November 2014
OilVoice
Acorn House
381 Midsummer Blvd
Milton Keynes
MK9 3HP
Tel: +44 208 123 2237
Email: press@oilvoice.com
Skype: oilvoicetalk
Editor
James Allen
Email: james@oilvoice.com
Director of Sales
Mark Phillips
Email: sales@oilvoice.com
Chief Executive Officer
Adam Marmaras
Email: adam@oilvoice.com
Social Network
Adam Marmaras
CEO
OilVoice
Google+
Linked In
Read on your iPad
You can open PDF documents, such
as a PDF attached to an email, with
iBooks.
Contents
Featured Authors
The biographies of this months featured authors
Oil decline: Price makes the story
by Kurt Cobb
Why it's different this time
by Keith Schaefer
Why oil exports are not like ice cream
by Loren Steffy
Oil & Gas M&A in upstream sector falls to $34.5 billion in Q3 2014
by Mark Young
De-marginalising small oil fields
by Edward Marriott
Should we be in the Arctic?
by David Bamford
Tech Talk - Pessimistic Talk in a time of surplus
by David Summers
Nanotechnology hits the oilpatch
by Keith Schaefer
WSJ gets it wrong on 'Why Peak Oil Predictions Haven't Come True'
by Gail Tverberg
World War III: It's here and energy is largely behind it
by Kurt Cobb
Eight pieces of our oil price predicament
by Gail Tverberg
3
5
9
11
14
19
29
31
33
36
43
46
Featured Authors
Keith Schaefer
Oil & Gas Investments Bulletin
Keith Schaefer is the editor and publisher of the Oil & Gas Investments
Bulletin.
Loren Steffy
30 Point Strategies
A senior writer for 30 Point Strategies and a writer-at-large for Texas Monthly.
Loren worked in daily journalism for 26 years, most recently as an awardwinning business columnist for the Houston Chronicle, and before that, as a
senior writer at Bloomberg News.
Edward Marriott
ABT Oil & Gas and RMRI
ABT Oil and Gas (ABTOG) is creating a new marginal field sector within the
oil and gas upstream market: the economic development of small or stranded
hydrocarbon accumulations.
RMRI is an independent, risk management consultancy delivering bespoke
decision making support for over 20 years.
Mark Young
Evaluate Energy
Mark Young is an analyst at Evaluate Energy.
David Summers
Bit Tooth Energy
While one of the founders of The Oil Drum, back in 2005, he now also writes
separately at Bit Tooth Energy.
Kurt Cobb
Resource Insights
Kurt Cobb is an author, speaker, and columnist focusing on energy and the
environment. He is a regular contributor to the Energy Voices section of The
Christian Science Monitor and author of the peak-oil-themed novel Prelude.
Gail Tverberg
Our Finite World
Gail the Actuarys real name is Gail Tverberg. She has an M. S. from the
University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty
Actuarial Society and a Member of the American Academy of Actuaries.
David Bamford
Petromall
David Bamford is a past head of exploration and head of geophysics at BP,
and a founder shareholder of Finding Petroleum.
These answers, of course, aren't really news. They are more like axioms.
The answers for the recent swoon in the oil price include:
1. Oil is purchased in dollars and the dollar has been rising which puts
2.
3.
4.
5.
benefit of making much American tight oil production uneconomic, thus discouraging
new drilling.
The Saudis know something very important about the U.S. tight oil drillers. Most of
them are independents who are loaded with debt and don't have the financial
wherewithal to weather a period of sustained prices below their cost of production.
They will quickly reduce their drilling to only those prospects which seem as if they
might be profitable at these new lower prices.
That will pave the way for sustained higher world prices later as growth in U.S. oil
production comes to a halt. After the damage is done, the Saudis will try to bring the
price back up.
It's always possible that the Saudi strategy will fail because what's really happening
may be the first stages of a colossal economic and financial crash that will take the
world economy into prolonged recession. That would bring the price of oil down to
levels not seen in a decade where they might stay for a considerable period.
I'm not predicting that. And, in fact, none of what I've written may have any validity.
Even though the Saudis have publicly stated that they are defending their market
share, they may not be telling us exactly what their aims are. Saudi acquiescence to
lower oil prices may simply be having consequences the Saudis don't intend, but
can't avoid.
In truth, the whole issue of oil prices is too complex and too lacking in transparency
to be discussed intelligently when it comes to short-term price movements. I am
reminded of the tale of the blind men and the elephant of which the last stanza of a
poetic version is quoted above.
But, as I say, price makes the story.
together
further
10
But there really are a couple things different about the North American oilpatch now
than at any other severe oil price downturn:
1. Everybody has LOTS of land and drilling inventoryliterally years, and sometimes
even decades of low-risk drilling.
This means a couple things.
a) E&P budgets no longer have to spend 40% of cash flows on high priced land
grabs, which they have been doing for 10 years now. So thats a 25-40% increase in
cash flows that can start happening if times get tough.
I wrote a story on this earlier this year, based on a report by US brokerage firm
Raymond James, which you can read HERE. http://oilandgasinvestments.com/2014/oil-and-gas-financial/free-cash-flow-should-energize-your-oiland-gas-portfolio/
b) And its not just that producers have lots of landtheir drilling inventory is
expandingfor free, due to downspacing. Think of the space between wells in a
big field. The industry is moving from four wells a square mile to eightand in some
cases 16 or even up to 32!
Thats because the industry is finding they can frack wells much closer together than
ever before thought possible without impacting the flow rate of other nearby wells.
On an NPV basis, the wells you arent going to drill for 20 years become
meaninglessand a potential source of cash for producers in a free market.
2. Improvements in drilling and fracking continue to improve returns.
a) In fracking, there was a step change in the summer of 2013 as EOG and
Whitingtwo large independent producers in the USstarted using smaller, more
tightly spaced fracks. In essence, they used short wide fracks instead of long skinny
fracksand production increased dramatically. The entire industry is now moving in
this direction.
b) In drilling, a recent improvement is extra-long horizontal drillingup to 2 miles
that are improving rates by 50-100% with only a 20% increase in costs.
c) The industry is moving to big pad drill sites where multiple wells can be drilled
from the same place, in a circular or fan formation out from the well. This is reducing
drilling costs.
And the last point isthe Market always pays up for certainty/visibility of cash flows.
Economics are obviously important, but so is long term stable cash flowno matter
how big or small it is.
For the first time ever, the North American oil industry has a high certainty of how
much oil they can produce for the next 20-30 yearsjust insert a specific oil price.
11
Every other time that OPEC has squabbled and sent prices down, the US and
Canada were chasing conventional oil pools with short reserve lifesbut not this
time.
Thats not good for everybody, but it is for the low cost producers.
Look at the stock charts of Canadian natural gas producers Peyto Explorations
(PEY-TSX) and Tourmaline (TOU-TSX)production grew and so did the stock price,
in a very low gas price environment. But the stock didnt move up until the
commodity price bottomed in April 2012.
The negative side of this argument however, is that the Saudis need to see oil under
$60/barrel to really inflict pain on North American producers.
And until the oil price finds a bottom, none of these arguments are going to matter.
12
about as much oil as we produce. Thats a huge change from five years ago, but it
means we still need imports to meet our energy needs. That perspective gets lost
when you see congressmen like Texas Republican Randy Weber invoking the
slogan for Blue Bell Ice Cream in discussing crude exports. Weber told Reuters that
his view is:
Lets use all we can and sell the rest. I am a free market kind of guy. A rising tide
raises all ships.
He may be a free market guy, but hes clearly not a numbers guy. To use all we can
and sell the rest would mean we would have to double our already high domestic
production. We would have to be producing oil at a far greater rate than this country
has ever seen. Webers comments are the sort that encourage public
misunderstanding of exactly what our increased oil production can and cant do.
The discussion of ending the crude ban is being driven by producers, particularly in
the Midwest, who arent able to get the highest price for their oil because there isnt
enough refining capacity to handle it. That isnt because we have more oil than we
need, its because after years of reliance on imports many U.S. refineries arent
calibrated to handle the grade of crude being produced in regions such as the North
Dakotas Bakken Shale. Weber whose district includes Port Arthur, Texas, home
to Shells huge Motiva refinery ought to understand this.
Crude oil is not like ice cream. Lifting the ban on exports may have its benefits. It
may, for example, help shield world crude prices from the effects of geopolitical
upheaval in the Middle East. But it will not replace our imports.
Congress should revisit the crude export ban, but it needs to understand the issue
before it does. A far better explanation for lifting the ban comes from Webers fellow
Texas Republican Michael McCaul, who told Reuters:
The decades old ban on crude oil exports is no longer justified given the current
market conditions. Lifting the ban will also give America a new foreign policy tool to
provide greater stability in the world oil market.
In other words, exporting crude may give us more leverage in influencing prices in
the global oil market, and that could be important given that the U.S. is still the
worlds largest oil consumer, but make no mistake: every barrel we export is one
more were going to have to import.
neosgeo.com
14
15
many cases of companies with a diverse variety of assets trying to streamline their
property holdings to give a more specific area of focus and as a result many North
American assets have been made available for purchase. This stands in stark
contrast to a few years ago where companies looked to hoard as much shale and
unconventional acreage as possible across every play they could find. With the
increasing gas prices and the approaching reality of North American gas exports,
gas assets are also becoming more and more marketable. As for deal value drying
upoutside of North America, it is very hard to pinpoint any specific factors that would
drive down activity. The number of deals announced outside of North America has
been reasonably consistent over the last few quarters, so this points to the lack of
big deals being the main contributor of the low deal value. In Q3 2014, there were
only 2 deals announced outside of North America with a value of more than US$500
million, one of those happening on the very last day. In Q1 and Q2 2014, there were
8 and 12 such deals respectively.
US Permian Basin High Demand in Q3 2014
Whilst Q3 2014 seems to have been a quiet period for global E&P M&A activity, the
US Permian basin has seen a hectic few months in contrast. Acquisitions in the
Permian basin made up nearly half of the total E&P deal value in the US and just
under a third of total E&P deal value worldwide at around US$11.2 billion. M&A
activity in the Permian Basin has been on the rise since Q1 2014.
Encana Speeds Up Move to Oil Production with Biggest Deal of the Quarter
In late September, Encana, Canadas biggest gas producer, signed the largest deal
of the quarter in agreeing to acquire Texas-based Athlon Energy Inc. for around
US$5.93 billion in cash. Once the assumed debt of US$1.15 billion as well as
Athlons cash position of around US$243 million is taken into consideration, the deal
represents a total outlay by Encana of US$6.84 billion.
The deal marks Encanas entry into the Permian basin, which seems to be the most
sought after resource play in North America right now. It is typically oil rich from
shale and other tight, unconventional formations. Encanas acquisition of Athlon is a
huge step for the company in quickly realising its goal to become a more oil weighted
16
company. Of all the companies listed on the TSX, Encana is the biggest gas
producer but only ranks as the 11thbiggest oil producer. Encanas board has been
seeking to rectify that in recent times, solely focusing efforts on its North American
unconventional resource plays. The multi-billion dollar spin-off of PrairieSky Royalty
Ltd., which closed in September, was part of this strategy and helped leave the
Canadian company with ownership positions in the following shale plays:
Encanas positions in the plays listed above gives them a large amount of current
natural gas production, but any oil is mainly prospective, future production. The
position in the Permian basin (roughly 140,000 acres) will add to this, but does give
Encana some immediate oil production (the 30,000 boe/d acquired was made up of
80% oil, 20% natural gas) to bolster its figures. The future potential of the asset and
Encanas plans to quickly expand the oil portion of its portfolio will explain the
relatively high prices paid per boe/d of production and per boe of 1P reserves ($223k
and $38.69 respectively).
All Permian Basin Deals in Q3 2014
17
18
Notes:
1) In the Bakken, company guidance for the year 2014 gave an average well cost
estimate of US$8.9 million, and Eagle Ford wells averaged at a cost of US$7.2
million.
19
De-marginalising small
oil fields
Written by Edward Marriott from ABT Oil & Gas and RMRI
In the run up to the Scottish referendum there was heated political debate over
whether 15 billion, 24 billion or even more barrels of oil equivalent (boe) could still be
extracted from the North Sea. It served only to highlight the wide-ranging uncertainty
surrounding the total figure.
Yet one assertion can be made with much more confidence. Whatever the
extractable total turns out to be, over five billion barrels of oil equivalent contained in
some 303 already known, but undeveloped fields across the UKCS could make a
considerable contribution towards reaching that total. These are confirmed,
appraised discoveries recorded in the IHS EDIN database used by RMRI in research
for ABT Oil and Gas.
Their numbers include accumulations of all types and sizes in a range of water
depths, and they have all at some stage been dismissed by the oil industry as having
little or no commercial interest. Many were thoroughly appraised prior to rejection,
then were plugged and abandoned or suspended while the license holders moved
on to seek richer prizes. These are the marginal fields, so called because they
inhabit an uncertain economic margin created by oil price, development costs and
the fiscal regime.
The two principle reasons for the marginalisation of fields are their technical difficulty
or their size. Either combines with their location to determine whether they are
economically viable or not, since proximity to existing facilities enables projects
which would otherwise prove too costly for development.
Isolated small fields are particularly interesting because they often contain
conventionally recoverable, oil-rich reserves. From the IHS EDIN database, RMRI
has identified 105 such fields, in UKCS waters, each containing between 3 and 30
million boe, with a collective reserve of 1.25 billion boe. Their limited output and short
productive lives do not justify the capital or operating expense of conventional
production methods, especially from a unit cost perspective. In a University of
20
Aberdeen Occasional Paper, Professor Alexander Kemp and Linda Stephen stress
that field lifetime costs for small fields can 'become very high on a boe basis.' [1]
This steep unit cost as field size diminishes can be demonstrated by charting the
capital expenditure (CAPEX) and operating expenditure (OPEX) across a range of
reserve sizes. The costs are based upon an RMRI analysis of conventional facilities
with liquid processing capacities similar to the two production systems available to
ABT Oil and Gas, which are discussed in greater detail later in this article. Adjusting
the OPEX according to size of project, Chart 1 plots the unit cost per boe,
highlighting, the point at which fields lose viability and the impact of oil price
movements upon this. The precarious nature of marginal field economics can clearly
be seen.
The chart makes obvious the parabolic increase of cost per boe as field size
diminishes, with exponential increase at the lowest end. It also demonstrates the
extreme vulnerability of small fields to any fall in oil price.
A bench mark total field cost of $1280 million (800 million) including CAPEX and
OPEX, using a ratio of 5:3 is based upon a 10 million boe field from which other field
costs are extrapolated. OPEX is adjusted for differences in field size on a per million
boe basis by simple addition or subtraction for fields larger or smaller than bench
mark size. The GB pound/dollar conversion factor is set at 1.6 and the base oil price
at $90
21
After the spectacular fall from $140/boe to $40/boe within six months during the
recession, prices have recovered to between $90 and $100/boe and have fairly
settled for the past three or four years.[2] Nevertheless, within this period, there have
been frequent fluctuations of around $20/boe, creating a zone of extreme
uncertainty, plotted on the chart as a spread of $10 above and below the 90 base
price.
At $90 per boe, fields containing 19 million boe break even, putting 83 fields this size
and smaller within the UKCS below economic recovery, with a loss of 747.7 million
boe[3]. Costs, however, must be considerably lower than break-even to achieve the
hurdle rate for a project to be considered commercially viable and sanctioned. As
such, in this model, fields containing up to 25 million boe, the average size of recent
discoveries, remain at high risk. A rise in oil price to $100 drops the viable field size
to 15.5 million boe, but it will attract investment only if a sustained rise is anticipated;
a circumstance not expected by the oil futures market according to both US Energy
Information Administration and the CME Group. This makes the prospect of a
massive oil price rise giving economic certainty to small marginal fields a highly
unlikely.
Price increases, then, cannot be relied upon to transform marginal field
development. The macro-economic and geo-political influences that determine oil
price cannot be controlled by operators, investors or even government. Besides this,
when oil prices more than doubled between 2003 and 2013, any positive impact
upon small field economics was limited by a massive fivefold increase in costs over
the same period.[4]
22
Cost increases, if anything, pose a greater threat to small field development than
falls in oil price. Chart 2 shows that a cost rise of 11.1% (equivalent to a $10 price
reduction) takes fields containing less than 30 million boe into the high risk zone,
making their commercial viability uncertain. Such an increase, or even larger, is
highly probable in a maturing region where rising costs are endemic. As with price,
macro-economic factors, such as international demand for labour and equipment,
can influence costs, but three main causes - depletion of major reserves, the age of
facilities and systemic problems of the region's fundamental development pattern are local to the UKCS. They have meant:
The last two points signal a major underlying problem: the accelerating effect of
increased costs, especially operating costs, against declining production. This drives
cost per boe ever higher and the situation has the potential to spiral. In its 2014
Activity Survey, Oil and Gas UK, says: ...in the space of 12 months, around 300
million boe of reserves are no longer considered recoverable as a result of operating
cost increases that are shortening the economic life of fields.'[5] Each boe of lost
production increases the recovery cost of all remaining barrels, further threatening
overall economic recovery of reserves. According to Oil and Gas UK, 'This relentless
rise in costs is unsustainable...' A stark symptom of the problem was highlighted by
Scotland's Independent Expert Commission on Oil and Gas, who pointed out that
'the number of people needed to produce a barrel of oil (rose) from 18 in 2006 to 45
in 2012.'[6]
The pattern of rising costs associated with established means of production makes
the future look bleak for small fields. Chart 1 above indicated that fields with reserves
below 19 million boe could be permanently lost, and fields containing up to 25 million
boe could be considered too high risk for development. However, unlike oil prices,
with innovation and new technology it is possible that costs can be controlled by
industry and government at a local level. Chart 3 below demonstrates the impact of
cost reduction.
23
24
systems designed to exploit huge fields. Extending this to include smaller and more
marginal fields has, so far, been the favoured method small field exploitation.
According to James Harpin, more than half of the small fields developed in the UK
North Sea between 2000 and 2010 'depended upon subsea infrastructure tieback to
host processing and export facilities'.[7] For fields within reach of suitable platforms
this has proved cost effective and will, according to Sir Ian Wood, be further enabled
by the cluster development advocated in his UKCS Maximising Recovery Review.[8]
If, however small fields can be developed only through linkage to existing
infrastructure, as Sir Ian Wood implies when he says, tieback enables small fields to
be developed which would have been uneconomic on a stand-alone basis[9] then the
numbers exploited will be severely limited. Since tieback costs increase with
distance, it will confine small marginal field development, and much exploration
activity, to the catchment areas of existing facilities. Extending beyond this will
require an additional complex network of subsea facilities, pipelines and intermediate
host platforms, with obvious future decommissioning cost implications.
More crucially, small projects, already economically vulnerable, would continue to be
linked to an increasingly costly ageing infrastructure, including major platforms
whose primary fields are severely depleted and whose own future is insecure. Many
production facilities require increased throughput from satellite fields to remain
economic so, unless several robust projects are within geographical reach, the
security of the host, and therefore all its dependent fields, will be dictated by its
economically weakest satellites.
These problems of existing infrastructure network must inevitably be passed on to
third parties seeking to link into that network. For example, even if owners of fixed
installations are reluctant to inflate tariffs, the higher expenditure or looming
decommissioning costs encountered by many will force a lease rate increase.
Floating Production storage and Offloading (FPSO) vessels provide a means of
sidestepping these difficulties. However they were designed for medium to large
accumulations, have 24/7 crewing requirements and a high front-end CAPEX which
is reflected in lease rates. In addition, with some 20 - 23 FPSOs operational in UK
waters,[10] coverage and availability is limited and any increase in demand is likely to
have a high impact upon costs.
Licence holders of marginal fields, typically small operators for whom these
25
These examples indicate the hurdles which must be overcome if the potential
contribution of marginal fields to the economic recovery of the UKCS is to be
maximized. Part of the remedy is highlighted in Scotland's Independent Expert
Commission on Oil and Gas when it stresses the requirement for smaller specialist
companies in the region, and the need to attract 'agile, entrepreneurial, and therefore
often smaller players'.[11]
This aptly describes British company ABT Oil and Gas (ABTOG). The company has
long recognised the need for a new sector within the upstream oil and gas industry,
focussed upon the economic extraction of small or stranded fields. As a result
ABTOG are creating the next evolution in offshore oil production: buoyant solutions
which can unlock the potential of such accumulations. Central to this is the need to
drive down costs and, at the same time free small operators from dependency upon
existing infrastructure. Through innovative production and storage systems,
ABTOGs buoyant solutions provide the appropriate means to deliver these two
crucial elements.
Having identified appropriate solutions, ABTOG worked with its partners to develop
two stand-alone production systems both of which secure dramatic reductions in
both CAPEX and OPEX; a taut-tethered Production Buoy and, along with GMC Ltd.,
a solution specifically cost-effective for the North Sea, which they call the SelfInstalling Floating Tower (SIFT). The potential impact of the SIFT on small field
26
For an initial 10 million boe project, use of the SIFT reduces field-life cost by around
60% of the cost of a comparable established production system. Including generic
CAPEX and abandonment costs of $350 million (220 million), and an OPEX around
$130 million (80million), total cost for a field of this size is $480million (300
million). This brings the break-even field size to below 5 million boe, and reduces risk
for fields containing about 5.25 million boe.
Both the SIFT and the buoy utilise innovative adaptations of proven technology
enabling dramatic cost reductions through lower construction costs than alternatives.
They contain all the equipment needed for processing up to 20,000 barrels of fluid
per day, adapted for use in low-cost buoyant housing structures. OPEX is held down
to a minimum as normally-unmanned operation cuts back crewing costs. There is
also capacity for integral storage in the cellular legs of the SIFT, or in a separate
seabed tank for the buoy, so tanker offloading avoids the high delivery tariffs of
existing pipelines and infrastructure.
Most importantly, the buoyant nature of these systems, linked with ease of
installation, simple decommissioning and low-cost refitting and transportation, means
27
that they can be redeployed possibly several times over during their 25-year
design life. Costs are almost halved to around $288 million dollars (180million) for
subsequent deployments, reducing the viable field size by another 2 million boe as
shown in Chart 5.
From this it is clear that the SIFT renders fields containing 5 million barrels
economically viable during its first deployment, and pushes this figure to below 3
million for second and subsequent deployments. Further than this, the tightening
curve of the cost parabola's 'elbow' means the lower 'arm' falls quickly away from the
high risk zone, reducing the overall economic vulnerability of all fields containing
above 3 million boe. Though real field conditions and project parameters will vary,
this gives an indication of the cost reductions that can be achieved using ABTOGs
solutions. Further reductions might come from:
With these advantages, the solutions offered by ABTOG have more to offer than a
means to exploit known small accumulations. Sir Ian Wood complains that, There
has not been a significant (multi hundred million) discovery for five years. This
makes the need for solutions to the recovery of small marginal fields even more
28
imperative. With the average size of discoveries now around 25 million boe, a way of
developing smaller finds is crucial. Apart from the revenue that such discoveries will
provide, if exploration continues to be severely curtailed through fear of subeconomic finds, as the Wood Review suggests, then new discoveries will become
fewer and some huge, but as yet unsuspected, accumulation might never come to
light. There is therefore an urgent need to revitalise exploration by providing the
means to transform small, isolated discoveries into economic finds.
Even without new discoveries, identified small fields alone could produce a post-tax
profit of 22 billion and boost tax revenue by 19 billion. Further than this, all fields
decline and at some point all fields will become marginalised, making their existing
facilities uneconomic and decommissioning inevitable. When this happens, ABTOG's
solutions could sustain hydrocarbon production from isolated locations throughout
the region long after its fixed structures have been decommissioned and cut up for
scrap.
Now that the custodian of the UKCS is decided, the UK government must put aside
arguments about the size of the regions hydrocarbon potential and focus on how it
can maximise the economic recovery of offshore reserves. Regardless of how much
oil remains in the maturing North Sea, small and stranded fields must be transformed
from marginal assets to become a key component of the nations energy security
and economic prosperity for decades to come.
[1]
Prospects for Activity in the UK Continental Shelf after Recent Tax Changes: The
2012 Perspective. Professor Alexander G Kemp and Linda Stephen
[2]
Macrotrends
[3]
Of 105 fields identified from IHS EDIN database
[4]
The UKCS Maximising Recovery Review, February 2014, Sir Ian Wood.
[5]
Oil & Gas UK: Activity Survey 2014
[6]
Scotland's Independent Expert Commission on Oil and Gas: Managing the Total
Value Added.
[7]
Measuring the impact of aging infrastructure in the UK North Sea, James Harpin
IHS
[8]
See Footnote 5
[9]
Ibid
[10]
Culled from information listed on fpso.net; fpso.com and A Barrel Full.
[11]
See Footnote 5
29
Should we be in the
Arctic?
Written by David Bamford from PetroMall
The sanctions-driven freeze on US and European involvement in the Russian Arctic
gives us time to consider a fundamental question:
Should we be exploring in the Arctic at all?
On the one hand, as an explorer I am aware of, even excited by, USGS notions that
the Arctic may contain say 100 bn boe waiting to be discovered. Some would say
theres more even than that. On the other hand, there are (at least) three notions we
should consider:
1. As I understand it, the ExxonMobil/Rosneft budget for drilling just two
exploration wells in the Kara Sea was ~$700m. Does this mean that the
discovery and adequate appraisal of a potentially commercial petroleum
accumulation would cost $1.5 2bn?
2. At the moment (*as far as I can tell) there is no development technology that
will lead to economic production from an Arctic oil field.
3. If an oil spill enters an area of ice, it is not evident (*to me) that our industry
has the technology to clean it up.
Now I know that some people take a stance against Arctic exploration, development
and production on environmental and moral grounds. And that of course is their right.
However, it occurs to me that the costs of finding, appraising, developing and
producing a barrel of oil in the Arctic are going to run ahead of the oil price curve for
the foreseeable future, if not indefinitely, and for this reason we might be better
devoting our attention to other provinces. I would imagine that if you are an investor
sitting say in New York, Houston or Dallas, the US onshore looks a way, way more
attractive proposition than the Arctic anywhere.
* I have qualified my comments because of course it is perfectly possible that
somewhere in Houston, say at EPR Co or BP, there are folk who know perfectly well
how to do this. If so, I have not met them and their light is, right now, hidden under
the proverbial bushel!
Contact us today:
Website: www.neftex.com
Email: enquiries@neftex.com
Tel: +44 (0)1235 442699
Facebook: www.facebook.com/neftex
Neftex 97 Jubilee Avenue OX14 4RW UK
Now Explore
3318_13_Generic ad re-size Geo Arabia (207mm x 291mm).indd 1
21/05/2014 12:38
31
32
Libya and Iraq will progress. Similarly it is hard to see how relations with Iran will
change, potentially easing sanctions and allowing them to sell more product into the
global market would upset the current balance in trade, and could, in the short-term,
increase the glut and lower prices.
But supplies from those outside the cartel and the Americas are continuing to
decline. That is not going to change. The rates may fluctuate a little (though the
current drop in prices is not going to encourage large scale investment in declining
fields) but the overall trend is steadily downward. And it is within that picture that
potential changes in the production from the three LII countries have to be placed.
Figure 2. Recent oil production from Libya and the price of Brent Crude (EIA)
Pre-conflict Libya was producing over 1.6 mbd, it recovered to 1.4 and is now
struggling at around 0.8 mbd. But the prospects for the levels of peace required to
sustain even that level do not seem promising. The conflict is worsening and seen as
spiraling out of control.
Moving East to Iraq, despite the use of air power, the situation in the North is not
33
improving, although the Kurds have now a pipeline to carry oil up into Turkey that is
not controlled by the Islamic State. While it is still a matter of debate how much oil
they will be able to sell, they hope that, by the end of next year they may be able to
pump as much as 1 mbd, up from the initial 0.1 mbd when the pipeline went on line.
At the same time, in the South, the oil fields lie some distance from the conflict, and
there seems little threat, at the moment, to the plans to increase production, and
move the majority of the oil to the coast for export. It is, therefore possible to foresee
an increase in Iraqi production of perhaps a million barrels a day in the next couple
of years. Is it likely? It is hard to say. Factional fighting is always hard to predict, and
the willingness of those involved to use explosives makes it even more of a problem
to predict what will occur, given the vulnerability of pipelines to attack.
Predicting how Iran will change is similarly conflicted, in that it is hard to predict the
behavior of those who control the country, and in turn impact oil exports.
But putting this within the context of OPEC, I suspect that overall production will not
fall much outside of the current volumes that the MOMR are predicting which is
sensibly overall stable output over the next year or so. And if that is the case, then I
would, as mentioned last time, expect to see that the global surplus of oil supply over
demand will gradually disappear over the next year, with the impact becoming
evident once we reach the summer of 2016. It would be nice to be wrong, but I think
it unlikely.
Nanotechnology hits
the oilpatch
Written by Keith Schaefer from Oil & Gas Investments Bulletin
Dropping energy pricesfor both oil and natural gashas investors and analysts
checking to see what the break-even price is for oil production in each play in North
America.
This is a moving target, and its going lower all the time.
34
And Im going to tell you The Next Phase of increasing profitabilityi.e. lower breakeven costsfor the industry.
Now, the #1 reason is for lower break-even costs is better fracking techniques. The
industry has not yet found the upper limits of how much oil or gas they can get out
from under a square mile patch of land.
Improvements or increased efficiencies arent happening every year; theyre not
happening every quarter, they are happening every MONTHas this graph
illustrates:
35
So while commodity prices are dropping a lotcash flows wont be going down by
the same amount. (And in Canada, energy prices have barely budged when you
count the lower Canadian dollar.)
So whats the next Big Thing in fracking that will increase productivity and lower
costs? Nanotechnology. This means being able to engineer systems at the
molecular level. And oil and gas is all about the molecules.
Ive discovered a company that has proven nanotechnology in the oilpatch. They are
able to use a chemistry that has smaller molecules than their competitors. The
smaller molecules can be pushed farther up the fracks, and open more area for oil
and gas to be released.
They recently tested 12 wells with one of the largest independent producers in the
United Statesa $40 billion company. Six wells used this new technology, and six
did not. Thats a big deal, because trust me, producers dont like testing new
technology. Adoption rates are slow.
But the results were fantasticall six of the wells using nanotechnology showed
better flow rates18%-33% betterfor the same cost as using regular fracking
technology.
I think it has the potential to be the next killer app in the Shale Revolution. This
company already has positive cash flow, and it trades under $10/share.
The oilpatch is a tight-fisted industry. But best practices spreads like wildfire across
a play. When they can buy a superior product for the same price (which actually
gives better than industry margins to this nanotech supplier), they will buy it.
What I like most about this story is that this the ground floor for this opportunity
they have just started selling it. And they are already making expansion plans at their
manufacturing facility for it.
As industry revenues get squeezed with lower commodity prices, they are jumping
for a proven product that improves productivity and reduces costs. Get to know this
company before it issues its next operational updateclick here.
36
37
financial system, and the world economy would grow forever. There was not even a
need for resources!
Peak Oilers Involvement
The Peak Oilers walked into a situation with this wrong world view, and started trying
to fix pieces of it. One piece that was clearly wrong as the relationship between
resources and the economy. Resources, especially energy resources, are needed to
make any of the goods and services we buy. If those resources started reaching
diminishing returns, it would be harder for the economy to grow. The economy might
even shrink. Dr. Charles Hall, recently retired professor from SUNY-ESF, came up
with one measure of diminishing returnsfalling Energy Returned on Energy Invested
(EROEI).
How would shrinkage occur? For this, Peak Oilers turned to the work of M. King
Hubbert, who worked in an area of geology. He wrote about how supply of a
resource might be expected to decline with diminishing returns.
Hubbert was not concerned about what effect diminishing returns would have on the
economypresumably because that was not his area of specialization. He avoided
the issue by only modeling the special case where no economic impact could be
expectedthe special case where a perfect substitute could be found and be put in
place, in advance of the decline caused by diminishing returns.
Figure 1. Figure from Hubberts 1956 paper, Nuclear Energy and the Fossil Fuels.
In the example shown above, Hubbert assumes cheap nuclear would take over,
before the decline in fossil fuels started. Hubbert even talked about making cheap
liquid fuels using the very abundant nuclear resources, so that the system could
continue as before.
In this special case, Hubbert suggested that the decline in resources might follow a
symmetric curve, slowly declining in a pattern similar to its original rise in
38
consumption, since this is the pattern that often occurs in extracting a resource in
nature. Many Peak Oilers seem to believe that this pattern will happen in the more
general case, where no perfect substitute is available, as well. A perfect substitute
would need to be cheap, abundant, and involve essentially no cost of transition.
In the special case Hubbert modeled, Hubbert indicated that production would start
to decline when approximately 50% of reserves had been exhausted. Peak Oilers
often used this approach or variations on it (so called Hubbert Linearization), to
forecast future production, and to determine dates when oil production would peak.
Of course, as technology improved, additional oil became accessible, raising
reserves. Also, as prices rose, resources that had never been economically
extractible became extractible. Production continued beyond forecast peak dates,
again and again.
Peak Oilers got at least part of the story rightthe fact that we are in fact reaching
diminishing returns with respect to oil. For this they should be commended. What
they didnt figure out is, however, is (1) how the energy-economy system really
works, and (2) which pieces of the system can be expected to break first. This issue
is not really the Peak Oilers faultit is the result of starting with a very bad model of
the economy and not understanding which pieces of that model needed to be fixed.
How the Economic System Really Works
We are dealing with a networked economy, one that is self-organized over time. I
would represent it as a hollow network, built up of businesses, consumers, and
governments.
39
An important part of the economy is the financial system. It connects one part of the
system with another and almost magically signals when shortages are occurring, so
that more of a missing product can be made, or substitutes can be developed.
Debt is part of the system as well. With increasing debt, it is possible to make use of
profits that will be earned in the future, or income that will be earned in the future, to
fund current investments (such as factories) and current purchases (such as cars,
homes, and advanced education). This approach works fine if an economy is
growing sufficiently. The additional demand created through the use of debt tends to
raise the prices of commodities like oil, metals, and water, giving an economic
incentive for companies to extract these items and use them in products they make.
The economy really cant shrink to any significant extent, for several reasons:
1. With rising population, there is a need for more goods and services. There is
also a need for more jobs. A growing networked economy provides increasing
numbers of both jobs and goods and services. A shrinking economy leads to
lay-offs and fewer goods and services produced. It looks like recession.
2. The networked economy automatically deletes obsolete products and reoptimizes to produce the goods needed now. For example, buggy whip
manufacturers are pretty rare today. Thus, we cant quickly go back to using
horse and buggy, even if should we want to, if oil becomes scarce. There
arent enough horses and buggies, and there arent enough services for
cleaning up horse manure.
3. The use of debt for financing depends on ever-rising future output. If the
economy does shrink, or even stops growing as quickly as in the past, there
tends to be a problem with debt defaults.
4. If debt does start shrinking, prices of commodities like oil, gold, and even food
tend to drop (similar to the situation we are seeing now). These lower prices
discourage investment in creating these commodities. Ultimately, they lead to
lower production and job layoffs. If deflation occurs, debt can become very
difficult to repay.
Under what conditions can the economy grow? Clearly adding more people to the
economy adds to growth. This can be done by through adding more babies who live
to maturity. It can also be done by globalizationadding groups of people who had
previously only made goods and services for each other in limited quantity. As these
groups get connected to the wider economy, their older, simpler ways of doing things
tend to be replaced by more productive activities (involving more technology and
more use of energy) and greater international trade. Of course, at some point, the
number of new people who can be connected to the global economy gets to be
pretty small. Growth in the world economy lessens, simply because of lessened
ability to add underdeveloped countries to the networked economy.
Besides adding more people, it is also possible to make individual citizens better off
by making workers more efficient at producing goods and services. Most people
think of greater productivity as happening through technological changes, but to me,
it really represents a combination of technological changes, plus a combination of
inexpensive resources of various kinds. This combination often includes low-cost
fossil fuels; abundant, cheap water supply; fertile soil; and easy to extract metal ores.
40
Having these available makes possible the development of new tools (like new
agricultural equipment, sewing machines, and vehicles), so that workers can become
more productive.
Diminishing returns are what tend to mess up this per capita growth. With
diminishing returns, fossil fuels become more expensive to extract. Water often
needs to be obtained by desalination, or by much deeper wells. Soil needs more
amendments, to be as fertile as in the past. Metal ores contain less and less ore, so
more extraneous material needs to be extracted with the metal, and separated out. If
population grows as well, there is a need for more agricultural output per acre,
leading to a need for more technologically advanced techniques. Working around
diminishing returns tends to make many kinds of goods and services more
expensive, relative to wages.
Rising commodity prices would not be a problem, if wages would rise at the same
time as the price of goods and services. The problem, though, is that in some sense
diminishing returns makes workers less efficient. This happens because of the need
to work around problems (such as digging deeper wells and removing more
extraneous material from ores). For many years, technological changes may offset
the effects of diminishing returns, but at some point, technological gains can no
longer keep up. When this happens, instead of wages rising, they tend to stagnate,
or even decline. Figure 3 shows that per capita wages have tended to grow in the
United States when oil was below about $40 or $50 barrel, but have tended to
stagnate when prices are above that level.
Figure 3. Average wages in 2012$ compared to Brent oil price, also in 2012$.
Average wages are total wages based on BEA data adjusted by the CPI-Urban,
divided total population. Thus, they reflect changes in the proportion of population
employed as well as wage levels.
What Effects Should We Be Expecting from Diminishing Returns With Respect
to Oil Supply?
There are several expected effects of diminishing returns:
1. Rising cost of extraction for oil and for other commodities subject to
diminishing returns.
41
Figure 4. Shape of typical Secular Cycle, based on work of Peter Turchin and
Sergey Nefedov in Secular Cycles.
42
In my view, the date of the drop in oil supply will be determined by what appear to
on-lookers to be financial problems. One possible cause is that the oil price will be
too low for producers (a condition that is occurring now). Governments will find it
unpopular to raise oil prices, but at the same time, will be powerless to stop the
adverse impacts the fall in price has on world oil supply.
Falling oil prices have especially adverse effects on oil exporters, because they
depend on revenues from oil to fund their programs. We are already seeing this now,
with the increased warfare in the Middle East, Russias increased belligerence, and
the problems of Venezuela. These issues will tend to reduce globalization, leading to
less world growth, and a greater tendency for the world economy to shrink.
Unfortunately, there are no obvious ways of fixing our problems. High-priced
substitutes for oil (that is, substitutes costing more than $40 or $50 barrel) are likely
to have as adverse an impact on the economy as high-priced oil. The idea that
energy prices can rise and the economy can adapt to them is based on wishful
thinking.
Our networked economy cannot shrink; it tends to break instead. Even wellintentioned attempts to reduce oil usage are likely to backfire because they tend to
reduce oil prices and have other unintended effects. Furthermore, a use of oil that
one person would consider frivolous (such as a vacation in Greece) represents a
needed job to another person.
Should Peak Oilers Be Blamed for Missing the Real Oil Limits Story?
No! Peak oilers have made an important contribution, in calling the general problem
of diminishing returns in oil supply to our attention. One of their big difficulties was
that they started out working with a story of the economy that was very distorted.
They understood how to fix parts of the story, but fixing the whole story was beyond
their ability. The following chart shows a summary of some ways their views and my
views differ:
43
One of the areas that Peak Oilers tended to miss was the fact that an oil substitute
needs to be a perfect substitutethat is, be available in huge quantity, cheaply,
without major substitution costsin order not to adversely affect the economy and in
order to permit the slow decline rate suggested by Hubberts models. Otherwise, the
problems with diminishing returns remain, leading to declining wages and rising
costs of making goods and services.
One temptation for Peak Oilers has been to jump on the academic bandwagon,
looking for substitutes for oil. As long as Peak Oilers dont make too many demands
on substitutesonly EROEI comparisonswind and solar PV look like they have
promise. But once a person realizes that our true need is to keep a networked
economy growing, it becomes clear that such solutions are woefully inadequate.
We need a way of overcoming diminishing returns to keep the whole system
operating. In other words, we need a way to make wages rise and the price of
finished goods fall relative to wages; there is no chance that wind and solar PV are
going to do this for us. We have a much more basic problem than new renewables
can solve. If we cant figure out a solution, our economy is likely to reach what looks
like financial collapse in the near term. Of course, the real reason is diminishing
returns from oil, and from other resources as well.
44
45
be affected if the conflict heats up. Again, we are back to concern about the flow of
resources by countries not directly a party to the dispute--yet.
Traditional diplomacy among great powers does not seem to have been effective at
resolving these conflicts. And, traditional military operations seem less than effective
as well. Kurds in Syria report that U.S. airstrikes against ISIS are not working. This
conflict and others like it which are characterized by poorly defined boundaries,
shifting participants and unclear goals are confounding major powers and wreaking
havoc on countries where these conflicts rage.
One of the most obvious strategies for responding to these conflicts--deep, rapid and
permanent reductions in fossil fuel energy consumption through efficiency measures,
conservation, and expansion of renewable energy--does not seem to be a prominent
part of the policy mix. Such a reduction would not necessarily cause these conflicts
to disappear; but they might become far less dangerous since the major powers
would be less interested in them and thus less likely to make a miscalculation that
would lead to a larger global conflict.
That is the danger that lies in my version of World War III--that it could morph into
the kind of global conflict that risks nuclear confrontation between major powers--not
because those powers would seek such an obviously insane outcome, but because
they might miscalculate and by mistake push the conflict in this terrible direction.
It is not clear how this danger can be avoided given the current trajectory of world
energy use. And, it is not clear how to get the world's leaders to focus on the obvious
need to reduce not only fossil fuel energy use, but use of all the world's
nonrenewable resources in order to forestall conflict.* That humans can have good
lives without perpetual growth in the consumption of resources is simply not a
possibility in the minds of most world leaders. And that means we should prepare for
a very long World War III.
46
47
back on discretionary expenditures in order to afford oil products. This will lead to
layoffs in discretionary sectors. See my post Ten Reasons Why High Oil Prices are a
Problem.
If the compromise price is too low for producers, a disproportionate share of oil
producers will stop producing oil. This decline in production will not happen
immediately; instead it will happen over a period of years. Without enough oil, many
consumers will not be able to commute to work, businesses wont be able to
transport goods, farmers wont be able to produce food, and governments wont be
able to repair roads. The danger is that some kind of discontinuity will occurriots,
overthrown governments, or even collapse.
2. We think of inadequate supply being the number one problem with oil, and
at times it may be. But at other times inadequate demand (really inadequate
affordability) may be the number one issue.
Back in the 2005 to 2008 period, as oil prices were increasing rapidly, supply was
the major issue. With higher prices came the possibility of higher supply.
As we are seeing now, low prices can be a problem too. Low prices come from lack
of affordability. For example, if many young people are without jobs, we can expect
that the number of cars bought by young people and the number of miles driven by
young people will be down. If countries are entering into recession, the buying of oil
is likely to be down, because fewer goods are being manufactured and fewer
services are being rendered.
In many ways, low prices caused by un-affordability are more dangerous than high
prices. Low prices can lead to collapses of oil exporters. The Soviet Union was an oil
exporter that collapsed when oil prices were down. High prices for oil usually come
with economic growth (at least initially). We associate many good things with
economic growthplentiful jobs, rising home prices, and solvent banks.
3. Too much oil in too short a time can be disruptive.
US oil supply (broadly defined, including ethanol, LNG, etc.) increased by 1.2 million
barrels per day in 2013, and is forecast by the EIA to increase by close to 1.5 million
barrels a day in 2014. If the issue at hand were short supply, this big increase would
be welcomed. But worldwide, oil consumption is forecast to increase by only 700,000
barrels per day in 2014, according to the IEA.
Dumping more oil onto the world market than it needs is likely to contribute to falling
prices. (It is the excess quantity that leads to lower world oil prices; the drop in price
doesnt say anything at all about the cost of production of the additional oil.) There is
no sign of a recent US slowdown in production either. Figure 2 shows a chart of
crude oil production from the EIA website.
48
Figure 2. US weekly crude oil production through October 10, as graphed by the US
Energy Information Administration.
4. The balance between supply and demand is being affected by many issues,
simultaneously.
One big issue on the demand (or affordability) side of the balance is the question of
whether the growth of the world economy is slowing. Long term, we would expect
diminishing returns (and thus higher cost of oil extraction) to push the world economy
toward slower economic growth, as it takes more resources to produce a barrel of
oil, leaving fewer resources for other purposes. The effect is providing a long-term
downward push on the price on demand, and thus on price.
In the short term, though, governments can make oil products more affordable by
ramping up debt availability. Conversely, the lack of debt availability can be expected
to bring prices down. The big drop in oil prices in 2008 (Figure 3) seems to be at
least partly debt-related. See my article, Oil Supply Limits and the Continuing
Financial Crisis. Oil prices were brought back up to a more normal level by ramping
up debtincreased governmental debt in the US, increased debt of many kinds in
China, and Quantitative Easing, starting for the US in November 2008.
Figure 3. Oil price based on EIA data with oval pointing out the drop in oil prices,
with a drop in credit outstanding.
49
In recent months, oil prices have been falling. This drop in oil prices seems to
coincide with a number of cutbacks in debt. The recent drop in oil prices took place
after the United States began scaling back its monthly buying of securities under
Quantitative Easing. Also, Chinas debt level seems to be slowing. Furthermore, the
growth in the US budget deficit has also slowed. See my recent post, WSJ Gets it
Wrong on Why Peak Oil Predictions Havent Come True.
Another issue affecting the demand side is changes in taxes and in subsidies. A
change toward more taxes such as carbon taxes, or even more taxes in general,
such as the Japans recent increase in sales tax, tends to reduce demand, and thus
give a push toward lower world oil prices. (Of course, in the area with the carbon tax,
the oil price with the tax is likely to be higher, but the oil price elsewhere around the
world will tend to decrease to compensate.)
Many governments of emerging market countries give subsidies to oil products. As
these subsidies are lessened (for example in India and in Brazil) the effect is to raise
local prices, thus reducing local oil demand. The effect on world oil prices is to lower
them slightly, because of the lower demand from the countries with the reduced
subsidies.
The items mentioned above all relate to demand. There are several items that affect
the supply side of the balance between supply and demand.
With respect to supply, we think first of the normal decline in oil supply that takes
place as oil fields become exhausted. New fields can be brought on line, but usually
at higher cost (because of diminishing returns). The higher cost of extraction gives a
long-term upward push on prices, whether or not customers can afford these prices.
This conflict between higher extraction costs and affordability is the fundamental
conflict we face. It is also the reason that a lot of folks are expecting (erroneously, in
my view) a long-term rise in oil prices.
Businesses of course see the decline in oil from existing fields, and add new
production where they can. Examples include United States shale operations,
Canadian oil sands, and Iraq. This new production tends to be expensive production,
when all costs are included. For example, Carbon Tracker estimates that most new
oil sands projects require a price of $95 barrel to be sanctioned. Iraq needs to build
out its infrastructure and secure peace in its country to greatly ramp up production.
These indirect costs lead to a high per-barrel cost of oil for Iraq, even if direct costs
are not high.
In the supply-demand balance, there is also the issue of oil supply that is temporarily
off line, that operators would like to get back on line. Libya is one obvious example.
Its production was as much as 1.8 million barrels a day in 2010. Libya is now
producing 800,000 barrels a day, but was producing only 215,000 barrels a day in
April. The rapid addition of Libyas oil to the market adds to pricing disruption. Iran is
another country with production it would like to get back on line.
50
5. Even what seems like low oil prices today (say, $85 for Brent, $80 for WTI)
may not be enough to fix the worlds economic growth problems.
High oil prices are terrible for economies of oil importing countries. How much lower
do they really need to be to fix the problem? Past history suggests that prices may
need to be below the $40 to $50 barrel range for a reasonable level of job growth to
again occur in countries that use a lot of oil in their energy mix, such as the United
States, Europe, and Japan.
Figure 4. Average wages in 2012$ compared to Brent oil price, also in 2012$.
Average wages are total wages based on BEA data adjusted by the CPI-Urban,
divided total population. Thus, they reflect changes in the proportion of population
employed as well as wage levels.
Thus, it appears that we can have oil prices that do a lot of damage to oil producers
(say $80 to $85 per barrel), without really fixing the worlds low wage and low
economic growth problem. This does not bode well for fixing our problem with prices
that are too low for oil producers, but still too high for customers.
6. Saudi Arabia, and in fact nearly all oil exporters, need todays level of
exports plus high prices, to maintain their economies.
We tend to think of oil price problems from the point of view of importers of oil. In
fact, oil exporters tend to be even more affected by changes in oil markets, because
their economies are so oil-centered. Oil exporters need both an adequate quantity of
oil exports and adequate prices for their exports. The reason adequate prices are
needed is because most of the sales price of oil that is not required for investment in
oil production is taken by the government as taxes. These taxes are used for a
variety of purposes, including food subsidies and new desalination plants.
A couple of recent examples of countries with collapsing oil exports are Egypt and
Syria. (In Figures 5 and 6, exports are the difference between production and
consumption.)
51
Figure 5. Egypts oil production and consumption, based on BPs 2013 Statistical
Review of World Energy data.
Figure 6. Syrias oil production and consumption, based on data of the US Energy
Information Administration.
Saudi Arabia has had flat exports in recent years (green line in Figure 7). Saudi
Arabias situation is better than, say, Egypts situation (Figure 5), but its consumption
continues to rise. It needs to keep adding production of natural gas liquids, just to
stay even.
Figure 7. Saudi oil production, consumption and exports based on EIA data.
52
As indicated previously, Saudi Arabia and other exporting countries depend on tax
revenues to balance their budgets. Figure 8 shows one estimate of required oil
prices for OPEC countries to balance their budgets in 2014, assuming that the
quantity of exported oil is pretty much unchanged from 2013.
53
Many people have convinced themselves that high oil prices will help make this
transition possible, but I dont see this as happening. High prices for any kind of fuel
can be expected to lead to economic contraction. If transition costs are high as well,
this will make the situation worse.
The easiest way to reduce consumption of oil is by laying off workers, because
making and transporting goods requires oil, and because commuting usually
requires oil. As a result, the biggest effect of a cutback on oil production is likely to
be huge job layoffs, far worse than in the Great Recession.
8. The cutback in oil supply due to low prices is likely to occur in unexpected
ways.
When oil prices drop, most production will continue as usual for a time because wells
that have already been put in place tend to produce oil for a time, with little added
investment.
When oil production does stop, it wont necessarily be from high-cost production,
because relative to current market prices, a very large share of production is highcost. What will tend to happen is that production that has already been started will
continue, but production that is still in the pipeline will wither away. This means that
the drop in production may be delayed for as much as a year or even two. When it
does happen, it may be severe.
It is not clear exactly how oil from shale formations will fare. Producers have leased
quite a bit of land, and in some cases have done imaging studies on the land. Thus,
these producers have quite a bit of land available on which a share of the costs has
been prepaid. Because of this prepaid nature of costs, some shale production may
be able to continue, even if prices are too low to justify new investments in shale
development. The question then will be whether on a going-forward basis, the
operations are profitable enough to continue.
Prices for new oil development have been too low for many oil producers for many
months. The cutback in investment for new production has already started taking
place, as described in my post, Beginning of the End? Oil Companies Cut Back on
Spending. It is quite possible that we are now reaching peak oil, but from a different
direction than most had expectedfrom a situation where oil prices are too low for
producers, rather than being (vastly) too high for consumers.
The lack of investment that is already occurring is buried deeply within the financial
statements of individual companies, so most people are not aware of it. Dividends
remain high to confuse the situation. By the time oil supply starts dropping, the
situation may be badly out of hand and largely unfixable because of damage to the
economy.
One big problem is that our networked economy (Figure 1) is quite inflexible. It
doesnt shrink well. Even a small amount of shrinkage looks like a major recession. If
there is significant shrinkage, there is danger of collapse. We havent set up a new
type of economy that uses less oil. We also dont have an easy way of going
54
backward to a prior economy, such as one that uses horses for transport. It looks like
we are headed for interesting times.
Leaders in the
world of natural
resource location
Globe
Regional Reports
Commissions
Data