Saudi America? – The U.S. Oil Boom in Perspective

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saudi-americaIs America really the new Saudi Arabia of oil, or did the recent surge in U.S. production obscure the risks still posed by America’s profound dependence on oil? With a dramatic drop in prices sending shockwaves throughout the oil industry, and dampening the early euphoria about a shale oil revolution, do we need to re-think what the recent U.S. oil boom really means for America’s energy security? What factors have fundamentally changed and what realities remain essentially the same?

On today’s show, we’ll examine these and other critical questions about the outlook for oil and the implications for America’s future.

Guests:

 

Key Questions:

  • Overall: How has the recent boom in U.S. oil production altered America’s long-term energy security outlook? What has and has not fundamentally changed? What have we learned from the fallout over low oil prices?
  • Costs: How are costs to develop oil in the United States changing? Do low prices mean that oil is getting cheaper?  How do costs in the United States compare with Saudi Arabia and other oil-exporting countries?
  • Supply: How long is the current U.S. oil boom likely to last? How do U.S. reserves and supply capacity compare to Saudi Arabia and other countries?  How will the interplay of price and cost shape U.S. oil production? (do prices need to keep rising?)
  • Demand: How might demand trends affect America’s energy security? Can/will the United States be self-sufficient in oil–for how long? Are consumption patterns fundamentally changing, or is it due to slower economic growth?

 

Transcript:

Jan Mueller:

This is the Energy Exchange, conversations about how energy connects to the economy, national security and sustainability, helping you to understand a changing world. Thanks for joining us. I’m Jan Mueller. On today’s show, Saudi America? Is America really the new Saudi Arabia of oil or has a recent surge in US production obscured the risks still posed by America’s profound dependence on oil?

With a dramatic drop in prices sending shock waves throughout the oil industry and dampening the early euphoria about a shale oil revolution, do we need to rethink what a recent US oil boom really means for America’s energy security? What factors have fundamentally changed and what realities remain essentially the same? On today show, we’ll examine these and other critical questions. About the outlook for oil and implications for America’s future.

With us to help address these questions we have 3 outstanding guests and I’m very pleased to have on the show today. John Staub is the team lead for exploration and production analysis with the Energy Information Administration at the US Department of Energy. Tad Patzek is the director of the Upstream Petroleum Engineering Research Center at the King Abdullah University of Science and Technology in Saudi Arabia and previously a professor and chair of the department of Petroleum and Geosystems Engineering at the University of Texas, and Art Berman who is a consulting petroleum geologist with Labyrinth Services in Houston and a frequent commenter on oil and gas issues, a contributor to Forbes and many other publications.

Gentlemen thanks for joining us today. If we could, let’s start with an overview about how the United States is really different than Saudi Arabia and the Middle East. Tad, given your unique perspective and having spent a lot of time and done a lot of work in the United States and now stationed in Saudi Arabia, how are things looking from where you are?

Tad Patzek:

They certainly look differently than how they looked let’s say a year and a half ago when I was in Austin. You gain a new perspective. Let me talk briefly about how Saudi Arabia is different from the United States. Saudi Arabia is essentially different from the United States in that Saudi Arabia is a very large oil producer and a very large oil exporter and it actually does not import pretty much anything in terms of petroleum products and petroleum.

Saudi Arabia has been producing plus minus 10 million barrels of oil per day—of oil and lease condensate, I want to be very cautious here—and it consumes about 3 million barrels of oil per day right now in 2015. Its consumption has been growing on average about 20 percent per year in recent years. It has some signs of slowing down, but it’s still a very high rate of growth. In Saudi Arabia, most of electricity is in fact produced by using oil-powered power stations.

A rough estimate of how much oil is used to generate about 300 billion kilowatt hours of electricity in Saudi Arabia—that estimate is about 1.5 million barrels of oil per day, so that’s a fixed cost. Also, Saudi Arabia uses up about 3 cubic kilometers of water per year, out of which I estimate 1.8 cubic kilometer comes from water desalination. Water desalination is powered by oil so again that’s a fixed cost for Saudi Arabia.

There is loose talk in the US about the United States being the next Saudi Arabia. That is absolutely a false statement. While US has produced nine and a half million barrels of oil and lease condensate per day in 2015, US also imported 7.3 million barrels of oil per day from various sources—most importantly from Canada. Imports from Saudi Arabia are not very big in the US—in fact just a small fraction of imports. By volume, crude oil imports were 78 percent of domestic crude oil production and we must not forget this because the numbers I just mentioned are obfuscated in various ways.

For example, by saying there is availability of crude oil and production and petroleum products which was about 19 million barrels per day in 2015. That’s a very high number. Out of those 19.4 million barrels per day of petroleum and products, imports were 9.4 million barrels per day. Which means that about 2.1 million barrels of products were imported. At the same time the US exported 4.4 million barrels of products per day and a small volume of oil about half a million barrels per day.

I threw a lot of numbers and probably most listeners will forget them immediately so let me recap. The United States imports 78 percent of its own domestic crude oil and lease condensate production. Saudi Arabia produces 100 percent and then exports 65 percent of that production. That’s a fundamental and inescapable difference which is now obfuscated and confused in the United States. Having said that, Saudi Arabia will be consuming more and more oil internally because of the growing population.

Which means that unless strict controls are taken internally and nuclear power is introduced as a source of electricity, Saudi Arabia would be able to export less and less as time goes on. The last point I would like to make which becomes clear if you do a certain type of analysis of production, which I will not name after King Hubbert, but essentially these are Gaussian [curves] that result from production from many wells on many fields, you will see that the recent increase of production in the US is actually defined by a cycle by a Hubbert or Gaussian curve, which is a very steep and very narrow.

That means that the rate went up almost vertically, but it will come down almost vertically, unless there is incredible and continued influx of money and resources so that the drilling can be continued at the current rate which I doubt it will be, but I let others speak to that.

Jan Mueller:

 Tad, thanks very much and that’s a great overview. The first question is, supply is one side of the equation, but demand is the other and even though we export, technically export certain products, we are a big consumer so we’re really not in that same position as Saudi Arabia. Then the big question becomes…

Tad Patzek:

 Yes, but we’re also a big importer. We must not forget that. You cannot be a swing producer if you import so much oil. What are you going to swing? What you’ve imported?

Jan Mueller:

Understood. I’m trying to reiterate your point, but then the thing that people are still hopeful about is that at least the share of our own domestic consumption that we’ve been able to produce ourselves has gone up dramatically and then the big question becomes how long can we sustain that? Especially given what’s going on with capital investment and prices and a pretty uncertain future.

John Staub, what is EIA thinking, you guys have come out with the Annual Energy Outlook every year. You’ll be coming up with a new one in June or so if I’m not mistaken and you’ve been incorporating some these new changes, but what do we know from your existing analysis that you have out there as far as what’s going on with US oil production and in particular shale?

John Staub:

Thank you Jan. One thing to note, a different way to look at US production is to first think about US consumption. In 2015, the US was consuming about 19 million barrels a day of total liquids. This includes crude oil, refined products, biofuels et cetera and of that volume, US was producing 9.3 million barrels a day and this year in April of 2016, we reached almost 9.7 million barrels a day of production.

A significant portion of US production of total consumption is coming from domestic production of liquids when you add on refinery gain and biofuels. Our net imports of total liquids in 2015 was actually about 22 percent of total consumption. We actually are at a very low point in terms of imports, but when you look at the absolute numbers that hides what’s actually happening in the US oil industry or oil market, is that the US is becoming more interdependent with the global market.

 

We are importing volumes of crude oil that we actually convert into refined products and are exporting more of those refined products. Now, with the removal of restrictions on crude oil exports, we’re having some exports of volumes. There’s an economic benefit for trading of those products, but we see with these low prices, there’s a slowdown in crude oil production in the US from April 2015 a high of 9.7 million barrels a day. We’ve declined down to about 9.1 million.

We’re declining roughly at about 80,000 to 100,000 barrels a day a month over month at this point from our analysis. In our short term outlook, we have production declining down to about 8.2 million barrels a day in the second half of 2017 and then we have prices beginning to recover and that starts bringing production back up slowly.

Jan Mueller:

That’s the story to date. What’s going to come of this shake-up, if you will, in the industry? Low prices, they’re going to coming back up from below $30 per barrel to around 40 today. Art, what’s you’re your perspective from down there in Texas, what’s been going on in the oil patch with all this … Low prices and projects being put on hold or cancelled, and financing rethought.

Art Berman:

It’s a fascinating situation Jan. One that I don’t think anybody would have or can predict, certainly not me. I am frankly stunned by the amount of capital that has flown into E&P in the United States, mostly tight oil production so far in 2016. If you would have asked me in December, I would have said or … I think the funding is going to be severely restricted with all of the distress.

With potential bankruptcy and problems with high yield corporate bond markets et cetera, but the reality is, is that mostly through share offering, something like $10 billion has come into the aid of US exploration and production companies so far this year, which far exceeds last year at this time, which was higher than any year, I think, subsequent to 2010, right after the recovery in oil prices, after the financial crisis.

From my perspective down here in Texas, the industry is in considerable disarray and yet there seems to be an almost limitless access to capital from around the world to continue to fund whatever operations are going on. On the one hand, I read a lot of opinions saying that, if oil prices get back maybe just a bit higher than they are right now, say to $45 a barrel, that all of these companies are going to go right back to producing great guns again as they did about a year ago, when we had an oil price increase up to about $60 per barrel.

At the same time talking with people in the field, listening to discussions by the likes of the head of Schlumberger and Halliburton, that seems less likely than it was a year ago. Rigs have been lay down. Crews have been let go. A lot of these service companies are really running on skeletal kinds of support.

I think the likelihood of just going back to drilling as if nothing ever happened is improbable. A lot of the money that’s flowing in right now, I think is being used to pay down debt and to pay for overhead, not so much to new drilling. I think the EIA forecast for basically losing another 90,000 barrels of oil between of production, crude oil between now and September or so of 2016 is quite probable and realistic.

It’s going to be an important component of where prices can go. I’ll just finish this comment with the observation that … One of the things we learned from the price rally back in March through June of 2015, when as I said prices got up to $60 a barrel is that, it appears that increase of only about $15 a barrel had a profound effect on demand. Part of what cratered that price rally and there were many factors, but part of it is that apparently there was actual demand destruction from that relatively high, percentage wise, it was a very high percentage, but $15 a barrel increase.

When I hear people speculate about the possibility of oil prices going back to $60 or $70, I don’t think anybody at this moment has the ability to say what’s going to happen, but that very recent analog tells me that the demand is very much range bound within certain prices and that demand will go up at very low prices and it will also be kept down… at least that’s what the analogy tell me.

In summary, the oil business is in a bigger mess than certainly the public perception that there’s always … We’re always finding ways to drive cost down to 0. Of course, production has been resilient. I don’t think anybody can dispute that, but I think the reality of it is that things are looking really quite grim. More and more layoffs. We will undoubtedly get into a discussion of what true costs and the cost of technology actually is, but I’m not nearly as optimistic and that’s why I think the EIA forecast is quite reasonable. That we’re going to see a lot more decline in coming months.

Jan Mueller:

I do very much want to get into the question of cost and technology, but I think that given all the disarray as you describe it, people are losing money, but as many of us learned in ECON 101, there’s the point which you may be losing money, but it’s not actually the same point at which you close your doors. We’ve seen rigs count decline and we’ve seen people losing jobs and people are certainly losing money, but it’s been disproportional … The decline in actual production has been softer than some of that activity would suggest and is it because a very much smaller part of the capacity of the industry is producing most of the oil? Is that important to understand?

Tad Patzek:

Again, it’s a very difficult question Jan. I would just refer to my own work … Things that I have calculated myself so I’ll tell you this. There’s obviously a cause and effect between the price of oil and the number of rigs and the number of wells drilled and those numbers have subsided. The production in all major shale, gas shale and oil shale has turned around, peaked and is now declining. In fact, as I wrote in my blog in my last two posts, all of the major shale areas in the US have seen a peak of production.

Again, by using the statistical model that essentially sums up weakly correlated or uncorrelated variables, which is wells production and there are thousands and tens of thousands of wells per play, so that’s a very good sample. There’s a very robust inference that can be made out this, which is the global production rate and the ultimate recovery, regardless of the fancy economics and the fine tuning of the analysis at the end. That picture shows me that the production will keep on declining now very rapidly in the foreseeable future, unless we reinstate a massive drilling and tracking program in the United States, but the having said that, the hurt is not limited to the United States or it’s not limited to Texas, everybody is hurting. Saudi Arabia is hurting. Saudi Aramco is hurting even though their oil production costs are very, very low compared to most of the American production costs.

The cost cutting measures are everywhere. The service companies are essentially scalped and driven to skeletal crews everywhere and nothing will come back so very quickly around the world, but especially in the United States where the relative effort to bring the production up is much, much, much higher than the same Saudi Arabia.

John Staub:

I guess Jan. I’ve seen a number of reports about what it costs to produce oil and there is general agreement in terms of the distributional costs for the large producers around the world. There’s for example there is a report that CNN money carried of analysis done by Rystad Energy. They said that the average costs of operational expenses for oil production in the US was about $15 a barrel and of the top 20 producers in the world, the top 17 producers were under $15, so from a short term perspective, the cost for producing oil is still significantly below what the traded Brent or WTI prices are.

Jan Mueller:

Right. But going back to ECON 101 and it’s about the marginal cost in price. I think the question EIA’s data shows or projection shows, they wouldn’t disagree with Tads characterization that we may be at or near a peak, but the decline much more gradual and still in the 8, 9 million barrels a day range well into the future and that though depends and maybe it might be useful John to talk a little bit about how EIA constructs its projections, because it is contingent on demand and price that might support that supply.

It doesn’t say that these millions of barrels will come out of the ground because they’re there. That the economy and the industry, based on a return on investment, will bring them forth. Then we can talk about given all our investment, whether or not this is what’s possible. Could you talk through that a little bit?

John Staub:

Sure. I’d be happy to. We do analysis of the global market in terms of resources and distributions of the costs to producing resources around the world and demand factors, so looking at the economic growth, policy, deployment, trends in development across merging markets and from that analysis we produce our 3 oil price cases for the Annual Energy Outlook.

These are meant to be long term market equilibrium scenarios. The reference case we have for oil prices, for example in the year 2015 rising to around $80 by 2021 and then steadily increasing to about $140 by 2040 in real terms. Those prices then are an input into the modeling system that’s used to produce the long term outlook. The resources within the US are responding to those prices.

Similarly, on the demand side of the various sectors of energy consumption in the US are responding to the market prices that they’re seeing, so then that’s producing the balances that we have for oil production and for all the other types of oil energy production in the annual energy outlook.

Jan Mueller:

It’s not just prices at which it makes sense to break even. You can make some money at a certain price, it’s also that it’s going to bring forth an investment. I’m wondering what … you’ve done a lot of work looking at how some of the financing for how this all works. The EIA, the reference case is 70, a range of 70 to $140 a barrel. You’ve got a lower price scenario below that and you’ve cut some things even higher than that. No one is here to predict oil prices. If we could do that we’d all be doing something else right now, but just to understand that what really has to happen for the industry to maintain the level investment that Tad is cautioning about.

Art Berman:

There’s a few things that are important to understand. The first is that low prices are not all bad. Service costs are radically lower right now than they’ve been really any time in the last 10 or 20 years in real dollar terms. An awful lot of the much touted efficiency gains and the costs savings that we hear about so regularly are really just reduced costs of oil field services, including drilling costs.

Just to give you a real life example, I’m in the oil business. I’m not a pundit and I’m not a journalist. I’m not an analyst. I’m a petroleum geologist and I drill wells. My clients drill wells. We just finished drilling 2 wells that will be originally got bids for the drilling rigs and they were here in Texas, we got bids of around $28,000 a day. These are top shelf, high horse power, diesel rigs and this was … its estimates came in the latter part of 2014. By the time we signed the contracts in the spring of 2015, those costs had come down to about $16,500 per day.

There’s been a tremendous reduction in the cost of doing business and that being on the high cost of doing business when oils prices were $100 was crippling, killing an awful lot of the major oil producers. That’s something that doesn’t get talked about a lot. There is a weird upside to lower oil prices. The flip side of that or at least correlated to that is that much is made of technology and drilling efficiency.

I’m certainly not going to dispute that goes on, but I think it’s a factor of diminishing returns that you don’t continue to increase drilling productivity and efficiency at 15 percent forever. I think a lot of that has worked out of the system. I think that’s an important piece of this. The bigger factor though and John is correct I think in saying that $12 or $15 per barrel of oil equivalent is roughly the variable operating costs that these companies have, but I think when we read about break even prices and there’s so much of that, then it must confuse the heck out of almost anyone who tries to understand it, that there really is an awful lot of costs like drilling the wells, the major capital expenditures that you just can’t factor out and you can’t ignore that.

I don’t want to get into a specific discussion, but just so listeners are clear in the work that I have done and have collaborated with others on, the idea that anybody or any company that is can break even on anything less than just $50 a barrel of oil is just way beyond any kind of reality check that we can do. That’s, so we talk about $12 to $15 to just pay operating expenses, but of course to actually justify the full expenditure we need more than 3 times that much.

If you look at just the financial statements of these companies and most of them have now reported for a full year 2015. It’s just a disaster. It’s an absolute disaster. The debt ratio, it’s the debt to cash from operation ratios of most of these companies that I follow both in the tidal oil and shale gas sphere. The average for these companies is well above the threshold for banks to technically to be able to call the loans because they’re too risky. The kind of capital expenditure to cash flow ratio it’s on average of well over 2:1. This is a very precarious industry that we’re in and so then the question is, why does money keep flowing to it and I think it’s pretty straightforward and that is that we live in a post 2008 financial crisis world, where interest rates have been artificially kept at pretty near zero.

Those with money, just demand a better yield than they can possibly get in conventional passive investments, which is to say, treasury bonds and savings accounts and certificates of deposit. While I’m sure most of these investors would love to find a better place to put their money than US exploration and production, they just can’t turn away from the yields that they’re getting on corporate bonds and preferred shares. They’re getting 7 or 8 percent and so the question is, at what point is there a negative payback and that will ultimately be if it comes and I don’t know that it will. That will be the point of crisis.

Now I was on a panel up at the University of Texas a few weeks ago for their UT Energy Week and the other 3 members of the panel were, energy economists and hedge fund managers and CFOs of E&P companies and those guys, not me, they were all in full agreement that if only 30 percent of US oil companies go bankrupt in 2016, that would be good news. I’ll leave my comments there.

Jan Mueller:

Okay. I think you all have painted the picture,  set the stage and laid out the landscape pretty well. We’re going to take a short break and when we come back, we can dig into the details of what will have to happen to keep the oil boom that United States has benefited from these last several years going and what could change some of the projections and scenarios that we’re seeing. We’ll be right back.

Jan Mueller:

We’re back, talking with John Staub, of the US Department Energy’s, Energy Information Administration. Ted Patzek, with the King Abdullah University of Science and Technology in Saudi Arabia and Art Berman with Labyrinth Consulting Services, a petroleum geologist based in Houston. Before the break, we were talking about all the upheaval that’s been going on in the US and global oil industry.

Those are obviously important to a lot of people, a lot of dollars invested, but from a broader public interest question is, what the longer term trend might look like once we get back to normal, what might normal look like and where we might be in terms of supply, cost, price. Again, we’re not trying to compete in our predictions, but just understand the factors that are going to shape the future. One of which is that Saudi Arabia, despite the fact that we’re currently producing comparable volumes of oil, seems to have a lot more oil in the ground and of a conventional sort.

There is not any shale production happening in Saudi Arabia currently. That’s a big question, whether or not our shale development experience can be exported elsewhere, but John, what does EIA think about in terms of looking longer term, beyond these ups and downs in price and investment and financing and everything that Art talked about earlier?

John Staub:

Certainly, the Saudi Arabia reserve numbers are 260-some billion barrels that are frequently discussed. The thing to note is that those are more akin to 2P reserves. Whereas the US reserves, which are around 33 billion barrels are 1P reserves, which require a higher level of certainty in the investment and in the infrastructure that will be used to produce those reserves. It’s not an apples to apples discussion when we talk about reserves in those regards. If you look at other resources that the US has, in terms of unproved resources, there’s roughly an additional 225 billion barrels of those unproved resources.

There’s a significant volume of resources in the US, compared to the annual production, which is more in the order of about 2.5 billion barrels currently. I think it’s important to, as you were saying, that we’re in the midst of some market fluctuations right now and there’s a fair amount of uncertainty in where prices are going, but when you look at the longer term, the annual growth and demand globally for liquids includes crude oil and natural gas plant liquids and biofuels.

That’s roughly 1.2 million barrels a day and we see a demand by 2040 globally growing to about 120 million barrels give or take, depending upon price scenarios and other policy type assumptions.

Jan Mueller:

Demand is growing globally, but I think EIA still has domestic consumption and demand for oil pretty much staying about where it is and at the same time, our economy growing. Is that a rough …?

John Staub:

Correct, yeah. We stay in the 18 to 19 million barrel a day demand level for liquids.

Jan Mueller:

We never become energy independent under any scenario really? Or to use a more accurate term, energy self-sufficient. We may be exporting, we may be more interconnected with the global market and we may be exporting more finished products, but in terms of volumes, is that a fair assessment that we’re this … What we started talking about is how our consumption is so high and we’re not really going to be exporting in a net sense.

John Staub:

Right, in our reference case we continue to be a net importer. We do have a high oil and gas resource and technology case and in that case, we do have, I forget exactly what the numbers are in terms of net imports, but they are actually net exporting in that a situation.

Tad Patzek:

Net imports are 2.7 billion barrels per year in 2015. Okay, I’m thinking hard how to convey to the listeners, the mind boggling complex of the oil supply, oil demand around the world, the state of the global economy, climate change, political tensions, which are occurring now everywhere in the US, in Europe, rise of nationalism and violent tendencies in so many countries. Just to try to make sense out of this is almost impossible.

In addition, the system which we are operating right now, it has absolutely unbelievable complexity, which I don’t think anybody can grasp anymore. Including people like me, who have worked in the industry for 30 years, have been reservoir engineers, researchers in academia and have been working with the industry for so many years and have been doing analysis of production and mechanisms of production for decades.

We can talk about economics, we can talk about many things, but let me just give you a simple example that I find actually instructive. In early 2011, I analyzed production from the Barnett Shale based on the data from Texas Railroad Commission, through October of 2010. I made a prediction using my usual approach. The prediction was, 26, the ultimate production of about 26 TCF trillion of standard cubic feet, for the current development in the Barnett.

In the subsequent 4 years, many people discarded or disregarded that prediction and because everybody knew that the Barnett shale has to produce more with the improvement of technology and more people drilling wells and everything going up and up. I revisited the Barnett just 2 months ago and to my surprise, I found out that that prediction I made in very early of 2011 and I showed it to the advisory board of the College of Engineering, at the University Of Texas in Austin and was published, that that prediction was spot on.

In the end, when everything was said and done and the situation in the world changed several times, the Barnett shale produced what I thought it would produce and was much less than other people thought. I would say that I would warn anyone including myself because I doubt my own results just as much as I doubt everybody else’s results from predicting the future as one of ever increasing supply and demand.

My own take on the future is that in fact, even though the population of the earth is increasing dramatically, the demand will actually stagnate sooner rather than later and so will the supply of oil. I think people will go to other resources, I think people will be using a lot more photovoltaics and wind, which will be playing an increasing auxiliary role in supplying energy.

I think in many countries there will be an increase of electrification by using nuclear energy as bad as it sounds to many people, but I would warn that right now when I’m sitting here in the Middle East, I’m watching what’s happening around me in Asia and Africa in the Middle East that the global economy and the global system is incredibly fragile and it takes just one major upheaval to dismantle many of the assumptions we have had and we’ve been taking for granted.

I would like to issue a little bit of caution about us issuing a longer term prediction other than the future will be certainly different than what you think it will be and that climate change and the deterioration of global economy, will be 2 big variables or wild cards in this equation.

John Staub:

I think though when companies are making these long term investments, they can’t avoid thinking about what’s going to happen 25 years from now and so we need to and that’s part of EIAs a mandate is to think about the long term and think about how the economics of the global market function and from our analysis, the resources are much larger than people often think.

It’s one of these things where it’s easier to study the things you know because there is more data related to them, but as we’ve found with shale, there’s often a lot of opportunity there in a place where there is not a lot of data. For example I think you are saying that in your analysis, the Barnett produces 26 trillion cubic feet over the life of that play in our …

Tad Patzek:

Yes. In the current cycle with the current generation of wells however many permits about 20,000, there is a potential to increase the Barnett Shale production and that’s because it’s a very unique in all American Shales that it has a system of conjugate natural factors which can be opened during hydro- factoring and in fact is productivity is higher than and the rate of decline of Barnett wells is lower than in most other shales.

John Staub:

Right and we have about 52 trillion cubic feet being produced from the Barnett from when it began producing in 1990 through 2040 and we build in technology changes over time too of about 1 percent per year.

Tad Patzek:

So let me give another example. I just revisited the North Sea production in Norway, which is an almost picture perfect analysis of summing up all the correlated variables to give a Gaussian [curve] which is mostly production in Norway. I’ve looked at the developments in Norway after 2007 over the last 8 years and there was a very considerable investment of course over the last 8 years and those investments, wonderful as they have been, yielded marginal improvements, but they were barely able to slow down the rate of decline.

I guess what I’m trying to say without sounding too cautious or too pessimistic because I don’t want to give that impression, that with the technology of which I am aware and I have Norwegian friends with Statoil and some of them will be visiting me here next week. With the beautiful organization, beautiful know how, deep technical knowledge, wonderful technology, Statoil was able to produce about 1.4 plus 2.5 billion barrels of oil more.

Which is very respectable, but the fundamental cycle produced 25.5 billion barrels. We have increased production, but by doing many, many things to different projects, but those increases are let’s say 3 out of 25 or 9 out of 100 or 12 out of 100. 12 percent increase, great, but it’s not or never will be 50 percent or more over the lifetime of the project.

Jan Mueller:

Tad, you noted how complex all these interactions are and your cautions about too much faith in assumptions about demand and growth, but if I could just focus on one thing about what you’re saying especially when you started about the Barnett or the North Sea or really anywhere else is that these applications of technology may be changing the shape of the production and the timing, maybe it even moves consumption and production up, but it doesn’t get you, necessarily get you more resource at the end.

Maybe we should be thinking about how to make these things last longer as opposed to how quickly we can get them out of the ground. I would invite everyone’s comments on that, but I’d like to know if that’s a vaguely fair assessment.

Art Berman:

In United States we seem to be rushing to produce our national resources as quickly as is seemingly possible regardless of what kinds of economic returns we might get for our investors and certainly with very little thought I believe, to what benefits there are for the society in general and so we are currently, we’ve lifted the crude oil export ban after 40 years and taking the example of the North Sea for instance, here in the united kingdom was a great exporter of oil and natural gas for many, many years and today they find themselves in the unfortunate position of having to pay whatever premium is required to supply their basic needs.

The United States just started exporting liquefied natural gas in February, first cargo has left Cheniere facilities in Louisiana and yet we have a natural gas forecast from EIA that says we should be moving into a supply deficit of natural gas later on this year. Now supply deficit doesn’t mean we’re out of gas, but these are the kinds of things that I wonder about where we’re currently producing tremendous volumes of both crude oil and natural gas into priced environments in which nobody can make any money.

I’ll be happy to back that statement up, just as a stalking horse, let’s just say that these $1.75 per MCF gas and roughly $30 or so dollars less that the well had for crude oil, everybody’s losing money and so we’re producing incredible volumes and we’re exporting volumes into a market that doesn’t return even our basic investments and so where does the public end up on all this assuming that they even care?

Tad Patzek:

Art, that is actually a very good point. I thought about it a lot and I’m thinking about it even more. If you are in the kingdom, the kingdom of Saudi Arabia as I am, it’s much easier to have long range planning and coordination of production, facility, build up, drilling programs and what have you and the research. In fact Saudi Aramco right now in Dhahran has the largest and probably the strongest research center in the oil industry around the world.

That ability to plan, to coordinate, to keep production level as Saudi Arabia has for decades, is in fact absolutely unachievable in the private equity market driven by private people, many, many companies, each one optimizing their own profits while the overall good of the country is generally forgotten. In fact, it was John Von Neumann in 45 who published a book on Game Theory, where he proved mathematically that whenever there’s 2 or more players in a game, the overall optimization of some … One target function that would satisfy all players is impossible.

That is, you cannot … Even if in the case of a single company, a simple example you want to maximize your profit and minimize risks to the environment or risks of loss of life at the same time. That is actually an impossible task and mathematically, it’s inconsistent. We make those mental jumps and arrive at judgment that what’s good for company A is in fact must be good for the country and it isn’t in fact, not by a long stretch.

The example of Great Britain and Margaret Thatcher was when Britain was exporting natural gas and oil when it both cost almost nothing because she was such a strong believer in free market. She was ousted right at the time when both prices went up. I think it was in 2012, Great Britain founded itself in a position where the reserves of natural gas to run for heating in homes in March of 2012, I believe was 3 days away from exhaustion because Great Britain right now is importing most of its natural gas.

It’s very easy to turn from a position of a major exporter to become in a matter of years and major import depending on the whims of the market and the suppliers. Again, I would issue this warning that, this is a big game in which not everybody not everybody will come out unscathed.

Jan Mueller:

The United States actually had that experience of going rapidly from being an exporter or to an importer back around the 1970s. We were on a long slow decline before the shale boom began. I guess John Staub, EIA does not make policy, but you do analyze scenarios. I’m wondering, this idea of whether production increases in the short term. What it means for the long term in terms of investments of technology and money–whether there’s either a point of diminishing returns or maybe we need to apply that technology in a measured way as opposed to an all at once way for … and you can at least compare the alternatives of different approaches.

John Staub:

Right. EIA is certainly not a policy organization, but we do analysis of the implications of policy on the energy market. I think back to 2003, when natural gas prices were upwards of $13 per million BTU and now we’re talking about prices under $2 per million BTU. The question for the consumer is, which is a better environment to be using energy and spending money on energy.

We’re always going to have market fluctuations in the long term that those will occur and that it’s part of how the market sends signals and balances changes in consumption and production of resources. It’s just part of the market.

Jan Mueller:

How about the question about technology and costs? Technology in some ways can bring costs down, but in some ways it doesn’t and cost have gone down because the price has gone down. It’s a dynamic situation, but how do technology and costs fit in your models … You talked about where average cost is now, but where does EIA think costs are going or at least what are different scenarios for … What’s the interplay of technology and cost?

John Staub:

Right. We just last week released a report that we commissioned looking at the upstream cost. Both the cost of drilling and completing and then also some information about the broader cost of producing oil and gas. Costs were essentially bid up, leading up into 2012 as shale, tight oil and shale gas were really ramped up partly driven by more complex and deeper and longer wells and completion techniques, but partly driven by just the expansion of interest and using that equipment to develop resources.

Since 2012 through 2015, costs across 5 key regions in the US like the Bakken, the Eagle Ford, the Marcellus, parts of the Permian, costs fell between 25 percent and 30 percent from 2012 to 2015. Some of that was due to the price drop, but some of that was due to better and more efficient use of equipment and technology. We’ve looked at how technology improvement happens over time and from a very aggregate level, if you look at proved plus unproved resources in the US from 1900 through 2015, generally have been increasing at about 3 percent per year.

From 2005 through 2015, that growth rate … the average growth rate is more on the order of 5 percent to 6 percent. There’s a lot of improvement that’s happening partly because of where the market prices are and that creates incentives to develop new technologies, but also borrowing technologies from other industries. Whether it’s controlled technologies from cell phone technologies for directional drilling or computing power that allows for improved seismic studies or better types of alloys that are able to handle high pressures and temperatures.

It’s an ongoing process and where there’s an economic incentive to make profits, we see improvements in technology.

Jan Mueller:

I think there’s obviously been huge benefits through the application of this technology. Whether it’s been new technology or technology that’s been around for a while that finally got cost effective to apply, but if we could, I think we should take another short break. In the final segment, we can talk about this issue of where technology and costs fits in the broader economy. There have been incredible benefits from all this activity, but there are limits as well.

Can we continue to increase? Or can we continue to tread water and sustain the levels that we’ve been seeing for a long time or are we ultimately going to have to deal with figuring out what to do when things are going back downhill? We’ll be right back.

Jan Mueller:

We’re back again, talking with Tad Patzek of the King Abdullah University of Science and Technology in Saudi Arabia. Art Berman, with Labyrinth Consulting Services in Houston and John Staub, with the Energy Information Administration with the US Department of Energy.

Before our second break, we were getting into how technology has done amazing things in general, but in the energy world and in oil and gas in particular, but it’s not necessarily a magic cure. All this stuff does cost money and there are still issues of geology, where it’s getting more difficult [to produce oil]. There are less high quality resources to go after.

At the same time in our last podcast, none other than Scott Tinker also at the University of Texas and the State of Texas geologist. Some of his colleagues in this movie called Switch talked about how great the oil and gas have been in terms of an energy source and the primary driver of economic activity. Even though the stuff is getting harder, all things considered, given what it does for us, that it’s beneficial to produce and we’ll continue to produce it when there’s demand.  But there are lots of question marks about what’s going on in the global economy.

John Staub, if you would, what about the economic benefits? Economics are very much part of your model. Obviously your whole model is based on an economic demand for this great stuff you call oil?

John Staub:

Scott [Tinker] and Steve [Koonin] in your previous podcast discussed the energy density of oil and how it allows for very efficient fueling of transportation options and so, because we don’t use oil for just using oil. We don’t produce oil just to produce oil. We produce oil and gas for heating our homes cooling them in the summer time, transportation, keeping food safe to eat.

While you know we’re not finding more large reservoirs like Ghawar, there are many resources that we’re discovering how to produce at still a very competitive price relative to other energy options. We continue to spend on the order of 4 percent to 5 percent of our GDP on these types of energy sources for transportation. It continues to be valuable and relatively affordable compared to other options.

Jan Mueller:

Art and Tad in your long careers, you’ve seen how oil is getting [harder to produce] … we’ve moved from conventional to unconventional and all this technology. What is your perspective on how … what this means for … what those changes mean for the broader society and in the global economy?

Art Berman:

I think that John makes a very good point. I won’t refute it that we’re as long as we’re able to produce crude oil and natural gas at a profit that we’re going to continue and we should continue to do it, but I want to create some context that so much of what we hear is how the wonders of the miracles of technology keep making all of the stuff cost less than, I think the impression that a lot of the audiences that I speak to have is that it’s almost free because of the wonders of technology.

I was speaking with the board of directors of a municipal power company in the east coast last week. I went through a calculation with them. A lot of their, get most of their gas comes from the Marcellus Shale and it’s in my view by far the best Shale gas play certainly that that’s ever been discovered from a geological standpoint, in terms of estimated ultimate per well recoveries, commercial break-even kinds of considerations.

Here’s the reality, that with all of the improvements in deficiency and technology. We’re still stuck with the reality that each well completed cost $7.5 million. Every month for the last 6 months. 180 new wells about have been added. You do the simple arithmetic there. That means that we’re spending $1.3 billion a month on completing new wells in the Marcellus Shale.

Now, it doesn’t take very many months for that had to become, well, $1.3 billion is a heck of a lot of money and maybe leave it there. We’re getting the cost down. Everything keeps getting better, but we’re spending 1.3 billion dollars on one play every month to add production and production is not increasing at the rate that it once was.

In fact we’re making 13 or 14 BCF a day from Pennsylvania Marcellus and that’s huge, but that rate of growth is declining. I think that’s the context that the oil companies around the world have increased their capital expenditures over the last decade tremendously, over the decade before and yet the incremental improvement or increase in oil production and gas production has not been so great on a global basis.

On the one hand, I want to acknowledge and even celebrate our ability to continue to find and produce more and more oil and meet the needs of the world, which is as an industry that’s one of our responsibilities. At the same time, I think Tad’s point is well taken and that is that the overall efficiency of doing that may not … it’s we’re reaching … we may be reaching a point of diminishing returns.

Tad Patzek:

Actually, both John and Art made very important and very good arguments and I agree with both. In fact, I would like to add that oil and natural gas are the mathematical equal to blood of all societies on the planet. You can actually show it that the consumption of oil and gas per capita per day or per year is akin to basal rate of metabolism of all mammals for all countries. That said, the Democratic Republic of Congo or Burundi are the microshrews and Qatar and Abu Dhabi or the blue fin whales, but the scaling of the standard of living with consumption of oil and natural gas, is just like the standard … the scaling of how a body functions with the blood flow.

From this, it follows that all societies on the planet will suffer greatly if that flow of petroleum blood and natural gas blood were diminished. That’s the concern that I have is that we have to make a certain preparations for the day when these flows will be diminished especially internationallly. Individual countries may keep up the internal production and satisfying their internal needs, but the overall amount of petroleum around the world may actually stagnate or even decline in the next decade or so.

That’s probably the biggest point I would like to make to the audience that oil is so valuable, let’s not waste it. That’s also very difficult for individual people to implement in their private lives. That’s pretty much my take on this issue.

John Staub:

I would caution though in terms of thinking about how demand is going to change over the long term because just in the last year, information in terms of research on semi-autonomous vehicles and autonomous vehicles suggests that there may be opportunities to significantly reduce consumption. In the not very distant future.

Tad Patzek:

Sure, but at the same time the number of cars or automobiles around the world I think is reaching or has exceeded 1.5 billion cars and that alone, since petroleum supplies most of all transportation fuels to speak of around the globe, that results in an increase of demand which is continuing with other minerals, regardless of all other uses of petroleum around the world.

I don’t think we will exhaust the subject during this program, but hopefully the listeners have maybe a glimpse of the scale of this industry, which is probably the largest industry on the planet, of its importance to the world being of all developing and developed societies and of the consequences that will occur if there is under investment in new petroleum projects or maintaining production from the existing petroleum projects.

To Art’s point and to reiterate my point about Norway, there has been a very rapid decrease of investment from let’s say $600 billion in 2014 around the world, to something like $250 billion, I may be off, but in the latter part of 2015 and now. That lack of investment will be translated into fewer projects getting started and fewer projects being maintained in the next few years. That’s something that we also need to be cognizant of.

Jan Mueller:

John, EIA has for most fuels including renewables pretty much either maintaining or a slight increase in some sectors through to 2040. I guess I’m wondering, even if we were able to achieve that and with a lot of investment and dollars, is it possible that the economic benefits of all that [energy production] may diminish over time. They’ll still be significant and we have this [seesawing] economy, but I guess in terms of the growth, the GDP projections forward, is there a way of even considering that in your model?

I don’t know if we have to look at the  globe versus just what’s going on in the United States, but what kind of economic questions do you guys ask yourselves when you’re basically making those longer term economic growth projections?

John Staub:

Our models have macro-economic feedback built into them and the reality is, is that, the amount that we spend on energy is quite small share of our macro-economic activity in the US. While the numbers that Art was talking about just a few minutes ago sound large, the US economy, our GDP in 2015 was roughly over $18 trillion. The individual wells sounds expensive, when you add up a lot of wells, that sounds expensive, but it’s actually quite small.

Right now what the market is telling producers is that, there has been too much investment in oil and gas, production needs to slow down to raise prices. It will possibly create a period of time of under-investment that will push prices higher than they would have been if there had been a more closely matched level of the investment to global growth. The market works fairly well, but it’s not perfect in terms of how it judges how quickly demand is growing or slowing, in any given time period.

Jan Mueller:

I think this issue of energy in the economy, not just oil. We already had one show on oil in the global economy and it seems that there needs to be a lot more discussion about it. Obviously, it’s been important in our economic history. There are researchers that point to what you say John, about the percentage of oil that accounts for GDP.

At the same time, this is a point that Stephen Brown of the University of Nevada made, the capital stock of the world’s economy is also highly dependent on energy, especially oil, and so the productivity of that capital stock is reduced. It’s an ongoing question that we hope to shed some light on with this show and we will bring more people with the energy expertise that you guys bring, but also economics and other perspectives about what’s going on in United States and around the world.

But we’re close to the end of our time so I’d just like to invite all of you to make some closing remarks. Let’s start with Art.

Art Berman:

Thanks Jan and I agree, this has been a fascinating discussion, some really different perspectives. Where I stand on assessing, moving forward in the United States particularly, with energy and with oil and gas in particular, is that, we constantly hear how things are getting better and companies are getting more flexible and adapting, adjusting to this low cost environment. At the same time, it seems that we’re really eager to believe that we’re moving back toward normal.

We’re going to get back to oil and gas prices where more companies can actually make some money. I don’t want to be pessimistic about it, but I think it’s important that people who are not deeply involved in the industry or in the analysis of the industry, understand that this is a moment of crisis in oil and gas production. Both in the United States and around the world. While it may be true that the amount of GDP that’s invested in energy is a relatively small or manageable of total US or total global GDP.

Sitting here in Texas today, I can assure you from the number of the, adjacent to my building, it’s one measure. That there has been a market effect on at least the Texas economy, in terms of the reduction in spending. That spills over into all of the correlative or collateral economies that you drive down into south Texas, in the Eagle Ford area or over to the Permian Basin and people that run hotels and car washes and gas stations and restaurants, they’re all feeling the result of diminished investment as well.

Energy is a core aspect of the economy. Maybe THE core aspect of the economy and I think it’s a mistake to understate the level of emergency that currently exists in energy exploration and production. I think it’s important to understand what returning to normal may mean. I’ve described how the US and global energy businesses, is in a situation of considerable distress right now and we may have entered a period of rising oil prices that will get us somewhat closer to normal.

I want to say that I think it’s unlikely that those oil prices will return anywhere close to the very high $100 a barrel oil prices that we experienced consistently, from late 2010 until near the end of 2014. Probably, that’s a very good thing for the world economy and for consumers in general that, it may be nice to talk about getting back to $100 oil for those of us in the business, but that had some rather negative effects on consumers and on the global economy. No one knows where we’re going.

Hopefully, prices will stabilize somewhere in the middle between where they have been and where they were, so that companies can go back to making a little bit of money and re-hiring people that they’ve been forced to let go. At the same time, what we’re going through right now will be a long term and rather structural adjustment.

Jan Mueller:

Thanks very much Art. Tad Patzek, you’re in Saudi Arabia. The Saudi economy as well as the Saudi government budget is obviously in a little bit of turmoil with these low oil prices, but what’s your perspective on where energy fits in the economy?

Tad Patzek:

Energy, actually it’s not energy, it’s power. It’s energy per unit time. One of the big misnomers that we use as mental shortcuts is that we say energy when we talk about power. If we were talking about energy, it would be the same thing to drive a little scooter and a BMW 700, but it’s not, because the latter has more power. Power that is generated by petroleum natural gas around the world, literally powers the global economy. That global economy builds on top of that base, the foundation.

Incredibly complex structures which are called hedge funds and stock markets and mutual insurance and hedging and betting and what have you. The illusion that all of these activities create, is that they are so very important. They may be very important, in fact, in many cases they provide the lubricant which actually makes the economy move and flow smoothly, but without the power at the base of that huge infrastructure, the infrastructure will simply fall apart.

As a petroleum engineer and as somebody who works on better technology to be applied in Saudi Arabia and elsewhere in the Middle East and the world and working day and night in fact, I want everybody to understand how important petroleum is to the well-being of the world and how dangerous it is to have an attitude that suddenly, the renewables will supplant and displace both oil and natural gas from the economies of most countries.

I think that the responsible people need to focus on the role of petroleum and natural gas and the power they bring to the global economy. How to use the benefit, that incredible benefit that accrues from them to develop better sources of renewal energy, which are inevitably subsidized by the infrastructure that is based on crude oil and natural gas. In a way, most of us are like fish who live in water, but we don’t know or we forget that our noses are wet. We can talk all we want about how irrelevant water is for us, but we are still fish and without water we die. On that happy note I would like to end. Thank you very much.

Jan Mueller:

Thank you very much Tad. John Staub, you have the last word.

John Staub:

I think it’s important to realize that or remember that the oil and natural gas industry is a cyclical business and the low prices that we’re seeing currently are part of that cycle and they will go back up again and they’ll go back down again and continue cycles at various intervals. It’s also important to remember that the reason why we produce oil and gas is because of the value that it brings to our lives and we can’t talk about oil and gas without talking about the resources that are in the ground.

The technology that lets us reach those resources and extract them and the marketplace value that those resources provide to us. We can’t talk about oil and gas without talking about all 3 of those pieces. Thank you.

Jan Mueller:

John, I think that’s well said and I think in general we agree with all that and the finer points and I think was a really rich discussion today. I would just like to point out that the Energy Information Administration produces an amazing wealth of information of which the work of ourselves as well as the other guests on the show would not be possible without it, so thanks very much for taking time today.

Tad Patzek:

I want to thank EIA and thank you thank you again for providing all the data. Especially now being abroad and looking in other countries and the quality of reporting on the energy issues, the United States … I just told my students this the other day. The United States has an unparalleled quality of providing information about energy around the world and no other country perhaps, but a few, Norway, Germany come even close. Thank you very much.

Art Berman:

I find myself very often assailed with questions from my audience about don’t you think there is manipulation going on with the information and you know we can’t trust this forecast from EIA etc. What I always tell them is look, a forecast is just a forecast and it’s going to be wrong no matter what, but I’m sure glad somebody does it and I completely agree with Tad that so much of the work that I do and therefore the living I earn is based on the high quality of information from EIA. So I don’t want this to turn into a mutual admiration society, but I really do appreciate the work you guys do.

John Staub:

Thank you Tad and Art and Jan. It’s been a pleasure.

Art Berman:

Likewise.

Jan Mueller:

We’ve been talking with John Staub, the team lead for exploration and production analysis at the Energy Information Administration at the US Department of Energy, and Tad Patzek, the director of the Upstream Petroleum Engineering Research Center at the King Abdullah University of Science and Technology, and previously a professor with the Department of Petroleum and Geosystems Engineering at the University of Texas, and Art Berman, a consulting petroleum geologist with Labyrinth Services and you’ll find Art’s comments on oil and gas issues and their connection to the wider society in Forbes and many other publications. Gentlemen, thanks very much for joining us today on The Energy Xchange.

2 Comments

  1. I think it is concerning when future scenarios of continued oil production growth (i.e. avoiding peak oil) are predicated on future $140/bbl of oil. How will the future global economy grow and create demand to maintain such a high price, particularly when it has failed to do so at lower oil prices in recent years? This seems to me a critical point.

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