It may be blasphemous to ponder in a region that produces a good deal of the
world’s hydrocarbon-based energy, but what if Peak Oil has already occurred?
“My opinion is that it’s increasingly likely that we actually set an all-time
record in May 2005 of 74,252,000 barrels per day,” states Matt Simmons,
founder and chairman of the world’s largest energy investment banking
company, Simmons & Co. International.
“And for the first three months of 2007,” Simmons continues, “we were almost
a million barrels per day behind that, and we’re dropping fast. If that
record still holds a year from now, I’ll bet someone ten-to-one that we set
peak oil in May 2005 and it’s now past tense.”
Not one to shy away from a bet, Bud Conrad, chief economist at Casey Energy
Speculator and fellow Peak Oil enthusiast, plotted the following slightly
more inclusive chart to give us an idea of where we stand today.
As the graph clearly illustrates, world production has been on a rather
unimpressive plateau for the past couple of years. Part of this stagnation in
global output growth stems from the coughing, spluttering “chokepoints” that
we read about in the news every other day.
Just this past weekend we saw crude shoot up about four bucks on the back of
threats made by Venezuela’s head honcho, Hugo Chavez, that he may sever
export lines to the thirsty U.S. Then there was a decline in production in
Nigeria…troubles in the North Sea…ongoing issues in Iran…the “problem
with Putin”…the list goes on.
The thumbscrews are tightening for net oil importers. As we explained in
yesterday’s Rude, “The American SUV driver was a tad sluggish in his gait
this morning. Once again his pocketbook has been pinched. The hefty drive
from his suburban McMansion to work in the city and the heating in his
Connecticut vacation home just became a little more expensive.”
But the issues that face net-importing nations around the world may soon be
felt by the net-exporting nations too. Oil, as a finite commodity, will one
day dry up. The impetus for economies with a heavy oil hand to diversify,
therefore, is rather serious.
Consider that Abu Dhabi, capital of the UAE and one of the Middle East’s
largest crude exporters, has just pumped $15 billion into their Masdar Green
City initiative and one begins to understand just how seriously even the
crude rich nations are taking the issue of ultimate depletion.
In the following column, Bud sits down with Matt Simmons to root out some of
the grim realities emerging at the tail end of our petroleum age. This may
hurt a little…but we hope it also helps.
Empty Holes and Black Swans
Bud Conrad interviews Matt Simmons
Bud Conrad (BC): Let’s jump right into it. The Peak Oil issue certainly looks
ominous, and should be scary to more people than it seems to be.
Matt Simmons (MS): It ought to be. I don’t know if you read the National
Petroleum Council study that was released just last year…
BC: The IEA report too!
[Ed. Note: Matt Simmons is referring to the National Petroleum Council report
“Facing the Hard Truths about Energy,” released in, 2007, which was roundly
criticized as glossing over all the hard truths and replacing them with the
delusions of a Pollyanna mentality.
Bud is referring to the IEA mid-term report that came out around the same
time, claiming that oil demand will outstrip production causing a supply
crunch starting in 2010 that will worsen until 2012. The graph below shows
the IEA conclusions, with increasing demand growth represented by lines, and
diminishing supply growth represented by bars.)
MS: The IEA thing, basically, was good news. That’s the first huge change in
the mood of the IEA of finally being realistic that we have some unbelievable
problems. But you know what the major oil companies got wrong in this NPC
study? They basically didn’t understand that the peak oil people were talking
about flow rates. They thought we were talking about the ultimate resource
base, which is the funniest concept in the world.
BC: Let’s discuss that for clarification. We know that flow rates are what we
measure to understand whether we’re at peak or not. In M. King Hubbert’s
work, peak oil is calculated using the total resource base, but your point is
that we may still have oil that we’re just not able to produce in an economic
way.
MS: If it’s in the ground and you can barely get it out, it’s as irrelevant
as me looking out over Penobscot Bay and saying “There’s a vast amount of
hydrates about a thousand miles from here, a thousand feet underwater.” Well,
so what? That’s not useful energy.
BC: If it takes more energy to dig up that last barrel of oil than it
produces, then there’s no sense in trying.
MS: And another important concept is that if you’re lucky enough to find a
highly pressurized field and it turns out to be condensate, which is
sometimes called natural motor gasoline, you can literally bypass the
refinery - because it’s been baked in the ground - and put it right in your
car. It doesn’t run perfectly, but it runs. With the heavy oil out of Canada,
you have to expend energy to make it ooze out of the ground, and once it’s
oozed out of the ground, you still have totally unusable oil.
BC: You still have to go through a fairly hefty process…
MS: …of upgrading, and then finally diluting it with high-quality oil
before it can flow. So one is total junk oil, and the other is the Rolls
Royce of petroleum.
BC: The world needs to understand that we’ve been using up the Rolls Royces
first because they’re more available. The harder-to-find and harder-to-refine
stuff is what’s left. I think that’s misunderstood.
MS: Oh, it’s totally misunderstood. Sour, heavy oil is really not worth very
much.
BC: We’re probably in more serious a situation than most people would
realize, and it’s no better with natural gas. Switching gears for a moment,
do you think the rise of LNG will be enough to keep up with declines in
natural gas discovery and subsequently in natural gas production?
MS: Well, first of all, the problem with LNG is that if we try to develop a
spot market out of LNG, the odds of it ending in bankruptcy are about 90%.
BC: Who goes bankrupt?
MS: All the players. The cost to produce and distribute LNG is so high that
to make LNG work in any sort of financial reality, you would need a 25- or
30-year guaranteed supply. And then you can amortize it over 25 or 30 years.
If you’re going on a spot supply, you’ve got to write it off over 10 years
and then you’ll need $40 per million BTU to make the economics work. The
other thing is that about 35% of the hydrocarbon value gets chewed up in the
process of cryogenically freezing natural gas, transporting it, and then re-
gassing it.
BC: In your opinion then, LNG is not an economically viable solution. We
won’t do it.
MS: We shouldn’t do it. But it turns out that high-quality natural gas –
sweet, high-quality natural gas – is just like sweet oil. It’s basically in
decline.
BC: And therefore also harder to find, despite our original hope of about a
decade ago. Clean energy was going to fix everything through natural gas for
electricity and everything else.
MS: Yes, and using natural gas for electricity turned out to be an
unbelievably stupid decision. Using electricity for heat was equally stupid.
Natural gas should be refined to one use and one use only, and that’s
creating instantaneous and high-efficiency heat.
BC: In one of your presentations, you have a very memorable clip of a ration
book from World War II. Are we headed towards rationing and if so, between
here and there, what are your estimates on what the price of energy might do,
especially if we’re hit by any ugly political events?
MS: I try to stay agnostic about political events because they’re
unpredictable. If you took a blackboard and filled it up with every political
event that could impact the supply of energy, not a single one of them is
positive. All political events are just unforeseen black swans.
Bud Conrad (BC): I’ve read “Twilight in the Desert,” and I’m interested in
your view of the overall Middle East reserves, particularly what happened in
the mid-’80s when most of the countries in the Middle East magically doubled
their reserves…
Matt Simmons (MS): At the very least…
(Ed Note: Here’s a graph that shows the sudden jump in reserve numbers that
occurred in the Middle East)
BC: OK, depending on the country, there were a huge amount of paper increases
in apparent reserves. What are your thoughts on Saudi Arabia and what’s going
on in the Middle East?
MS: Well, I can tell you an awful lot of anecdotes that I’ve heard. It’s been
two years since “Twilight in the Desert” came out, and I have so much more
information that I’ve been able to gather in feedback from people within
Saudi Aramco who, I’m told, learned an awful lot by quietly, secretly reading
the book, which is sort of…
BC: (laughing) Saudi Aramco learns from you!
MS: Well, they had been so secretive over the years. If you think Saudi
Arabia’s a secretive place, within Saudi Aramco, it was even more secretive.
And one of the first times that I got a glimpse of this was when I was a
keynote speaker, this must have been six years ago or eight years ago now, at
the bi-annual SPE global conference for coil tubing. This guy comes up to me
afterwards and he’s an American. I saw his card and he’s from Saudi Aramco.
So I said “Oh, do you live over there?” and he said “Yeah, I just flew over
for the coil tubing conference.”
I asked him what he knew about Safaniya. He replied, “You know what – I’ve
never heard anything about it. I’ve been there 18 years. I know where the
field is, that’s about it. Where did you get that data? You never hear field
data in Saudi Arabia!”
So I said, “What do you do at Saudi Aramco?”
He said “I’m a production manager at Ghawar.”
I said “Gosh, Ghawar is the largest oil field in the world.”
He nodded, “Yep.”
“How big is Ghawar?”
“God, I couldn’t tell you that, I’d be sacked.”
I said, “Okay. Now if you walked from north to south and east to west, how
big is it?”
He said, “Oh, it’s about 145 miles long and 20-25 miles wide at its widest
point, but don’t ever quote me on that. I could lose my job.”
And I’ve just talked about the dimensions! (laughter) Any map shows this.
BC: Unbelievable.
MS: I thought “Good lord, if they’re that secretive within Saudi Aramco that
this guy who is senior enough to be going to Houston for the coil tubing
conference, and has been there 18 years, doesn’t dare tell me.
It took about three months after the book came out before I started getting
feedback from within the system, and then there were these Saudi Aramco guys
saying “God, what a fabulous book. We had all told ourselves that this stupid
guy in Houston was writing this stupid book that Saudi Arabia no longer has
any oil through total incompetence and how these camel jockeys screwed up the
world’s biggest oil fields, and it made us madder than hell.” And, of course,
the book didn’t say anything like that.
BC: You’re saying we don’t know what the reserve numbers are, and that we
need more people to honestly tell us. This is a world resource and we
shouldn’t be risking humanity’s future without knowing what’s going on.
MS: Absolutely.
BC: If you’re looking at investments, what draws your interest?
MS: Our firm has daily recommendations, and I basically stay totally out of
that. I tend to buy a stock and then hold it for five or ten years, unless I
think that I’ve made a mistake. And I tend to think more about which sectors
to avoid or be interested in to look at.
One of the things that really amazes me about the stock market and their
love/hate relationship with energy is that of the current weighting of
institutional investors in the market, the S&P weighting of energy is about
9%. Institutional ownership comprises about half of that. What’s interesting
is that about two-thirds of the ownership is in the major oil companies,
which is the one group that I would avoid like the plague. So the market is
invested in the wrong area – the major oil companies.
BC: They haven’t been able to keep up their reserves.
MS: Yeah, and they can’t. Their decline rates are so high and they operate
such old, mature basins that they can’t drill enough wells, and they don’t
have places to drill wells, and they don’t have a sustainable strategy. So,
in that respect, the oil service companies are the savior of all the
problems.
BC: Specifically?
MS: The service industry is Schlumberger (NYSE: SLB), Baker Hughes (NYSE:
BHI), Transocean (NYSE: RIG) and others. There’s about 150 of them and, like
in any sector, some of them are very poorly run companies, and some of them
are outstandingly well run. What I really think is going to be the most
active area is West Africa, or Libya, or that region. You can sort of name
your scenario, and then you can pick the handful of service companies to give
you good exposure.
In the E & P business, you get companies like Chesapeake (NYSE: CHK), for
instance, who have an unbelievably high talent, quality senior management,
and they basically figured out a decade ago that the only way you grow
production is by monopolizing drilling rigs and drilling like crazy. And so
they’ve had double-digit production growth in their natural gas while almost
every one of their peer group is in decline. I guess that’s one thing that I
would observe in forty years of energy investment banking is that management
matters.
BC: Thank you for taking the time to speak with us.
MS: My pleasure.