The Death of Cheap Oil The Rude Awakening
Baltimore, Maryland
Thursday, December 14, 2006 - The big "what if?" of Peak Oil - Can we afford to be wrong?
- Tracking supply, demand and price of the world's premier old energy,
- Squiggly lines for energy investors, America's axis of ruin, Mr. And Mrs. Pitt/Smith and plenty more…
Eric Fry, reporting from Baltimore, Maryland… Here at the Rude Awakening, we don't spend a whole lot of time thinking about "what is." Instead, we like to think about "what if?" What if the rallying stock market is due for sharp selloff? And what if the dollar's slump worsens? And what if the current lull in the housing market is not the beginning of a rebound, but just a brief pause before prices some more? And what if the globe really is getting warmer? And what if Brad Pitt and Angelina Jolie had never worked together on Mr. and Mrs. Smith? And, lastly, what if the world's supply of easy-to-find crude oil really is running low? Last month, Dan Amoss, the editor of Strategic Investment, attended a conference that examined the phenomenon known as "Peak Oil" - the idea that the world is fast-approaching its peak production of crude oil. Your editors here at the Rude Awakening do not know if the world is approaching its all-time peak production of crude oil. But what if it is? Dan Amoss addresses this essential question in the column below…. --- Energy Special ---
Countdown to a Full-on Oil War Prepare Your Portfolio for $150 Crude Before Spring 2007 Ninety years ago, a single assassin's bullet triggered the First World War. Now today, another assassination has marked the beginning of an even bigger event - a chain of events that could push oil prices higher than ever before. Discover the proof…and arm yourself with the facts you need to invest and protect your wealth in the troubles ahead. But don't wait. Events are moving quickly - and you need to be ready now for your chance at big profits by spring 2007. ---------------------------- The Death of Cheap Oil
By Dan Amoss "Oil demand is too young, supply is too old," according to oil industry expert, Matt Simmons. Most of the presenter's at last month's ASPO-USA conference agreed with Simmons assessment. ASPO stands for the "Association for the Study of Peak Oil and Gas." The conference brought together some of the world's top minds in the fields of both conventional and alternative energies. A great amount of research was presented and many platforms were proposed, but one key conclusion was communicated by several speakers: there are no "silver bullets" for the world's long-term oil and natural gas supply challenges. An audience of 450 listened intently as Matt Simmons, a top global oil industry expert, mentioned two key technologies that greatly expanded the capabilities and the reach of oil and gas explorers: 3-D seismic and deepwater drilling. The problem is they've already existed for decades. Through his 37 years of experience in energy sector investment banking, Simmons has lived through several booms and busts, witnessing the evolution of oil field technology from the front lines. So his view that "the technology pipeline is nearly empty" does not bode well for those waiting on a great free-market solution to the ever-present challenge of depletion. Most oil field innovations of the last 40 years sought to accelerate oil production rates. That's because one of the highest priorities of corporate executive teams is to maximize the internal rates of return for their companies' expansion projects. The best way to achieve this goal is to shorten the "payback" period of prospective projects: Profits generated next year are far more valuable than profits generated 10 years down the road. Technologies that advance future production include multilateral well-bores, sub-sea satellite tieback fields, and tertiary recovery methods like water flooding. To quote Simmons from his presentation, the downside of these technologies… is that they brought production to "just in time," maximized internal rates of return. It avoided the need to properly define reservoir sizes through added appraisal wells that were "cored" and flow-tested, which led to a lot of overbooking of what we thought were proven reserves because we didn't have enough data over the last 15 years to know the difference…the reality of future oil field R&D is that there are very few breakthrough ideas on the drawing board. The major oil companies basically backed out of this area and shut down their labs, assuming the oil service companies would take over their responsibility. The oil service companies effectively quit because they never got paid any premium [for their research efforts]. In another part of Simmons' presentation, he laid out the primary thesis behind a long-term upward trend in necessary drilling activity (emphasis added): An uncomfortable fact is that too many regions are now in decline. Modern oil field production programs were all aimed at maximizing "net present value," which is basically "get it out of the ground as quickly as you can." This tactic has accelerated field decline profiles. Once declines begin, the number of wells drilled needs to accelerate, which is why we've used up the entire population of high-quality drilling rigs. They are all now at work. 
The number of wells drilled has indeed accelerated in mature basins including the U.S., where peak oil was reached on a local scale in the early 1970s (see chart). Oil production in the U.S. has become more and more drilling-intensive ever since. This leads right into the key conclusion in Simmons' presentation: "The nub of the problem is what I would call a clash of ages: Demand is too young, and supply is too old." Most everyone is familiar with the "demand is too young" part of his conclusion. Even though the price of crude oil has tripled over the last four years, global demand continues to boom. The robust economies of China, India and other developing countries have become robust consumers of oil. For energy investors, the "supply is too old" part of Simmons' conclusion is very important to consider. At the conference and in public interviews, he repeatedly refers to the rusted state of the global oil infrastructure. Specifically, dangerous over-reliance on very mature super-giant fields and the old age of the global drilling rig fleet put future oil consumers in a precarious position. In its 2006 Global Upstream Performance Review, John S. Herold, a leading oil and gas industry research and consulting firm, concludes that capital intensity is gradually rising. The study includes data from over 200 publicly traded oil and gas companies from around the world. One of its recurring themes - one should not assume that more dollars invested in the oil patch automatically leads to growth in production.
To quote from the study: Reserve replacement costs surged by 73% as increased capital spending did not translate into incremental reserve additions. A 36% increase in finding and development expenditures generated just an 8% increase in reserve additions via the drill bit for the over 200 companies in this study…Proved reserves worldwide were up by 2% in 2005, to 257.7 billion boe. Arthur Smith, chairman of John S. Herold, included the graph entitled Global Upstream Performance Review Activity (see graph below) in his presentation at the October 2006 ASPO-USA conference. The total number of exploration and development wells drilled has grown from about 33,000 in 2002 to about 50,000 in 2005, yet as the bars in the graph show, reserve additions per well have trended down, from 450,000 barrels to 300,000 barrels. After Peak Oil, this trend is likely to accelerate, increasing the demand for available rigs and hastening the depreciation of the drilling rig fleet. This confirms that the trend of declining U.S. oil well productivity (see graph below) is being felt in basins around the world. 
This adds to the investment appeal of drilling equipment companies. In the December issue of Strategic Investment, I examine a company with a dominant position in the business of supplying and refurbishing the global drilling rig fleet. This company has great earnings visibility, tremendous operating leverage, and is on the right side of a multiyear investment trend that will work directly in its favor. Check in tomorrow for a few more thoughts on the world's dwindling supplies of hydro-carbons… Joel's Note: In addition to drilling for profits on Wall Street, Dan has been busy getting his teeth into some other, rather unsavory, research. This one isn't for everybody but if you are more the "what if" kind of investor than the "what is" type, you'll want to have a look here… America's Axis of Ruin --- Special Report --- Washington's Dirty Secrets Threaten Your Income, Investments, and Security The secrets and lies are finally revealed! The U.S. debt is 10 times higher than you've been told…and you're stuck holding the tab. Washington's secret money-laundering scheme has put your money at risk. But these five potentially lucrative solutions will pump wealth back into your pocket when the secrets and lies finally explode. For the details, click here… | 
