Oil Painting By Numbers
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First, it has been decided that "demand destruction" is the only immediate
way to mitigate a collapse that is coming sooner than almost anyone
expected. The US, with 5% of the world's population is using more than 25%
of the world's energy yet has become (by design) an economic basket case,
ripe for a liquidation sale. The American people are becoming -- to quote
Kissinger -- "useless eaters". China's (now confirmed) pending re-evaluation
of the Yuan will only hasten this demise.
Oil production numbers are dismal to say the least. Is it possible that
Russia has declined to commit increased oil production to either Japan or
China because it can't? Absolutely! We already know that Russia is teetering
on the brink of its own decline. The problems are worse with respect to
natural gas. Just two days ago Britain received its first-ever LNG tanker
import marking the final death knell for the North Sea gas fields. The US
congress has just approved a federal override for governors and local
jurisdictions on the placement of LNG regasification terminals in the US.
The hand might have been forced sooner than planned. Either US demand must
be curtailed (and quickly) or else there will be no way to keep itchy
fingers off of nuclear buttons around the world. We are at the point where
one nation's full supply is another nation's starvation and collapse.
Suddenly the massive realignment of Eurasian powers with China and Russia
over the weekend, marching to a new NWO manifesto excluding the US makes
good sense. Watch closely what happens when Russian and Chinese leaders meet
in Kazakhstan next week.
In the meantime the Bush administration becomes increasingly weakened and
ineffective by the Rove/Plame scandal and other problems. This becomes a
perfect excuse (out) to explain why the administration will be unable to
cope with the collapse that is coming. "The Bush administration, hobbled by
recent scandals, has proved incapable of dealing with these crises on
Capitol Hill" CNN will say. The people will scream, "It's time for a
change!"
"Meet the new boss..." Isn't it strange that best friends GHWB and Bill
Clinton just conveniently went boating in Maine? It is the perfect set up
for Hillary in 2008 and also a convenient way to explain the collapse of the
American economy.
We have very little time and all FTW subscribers are encouraged to start
planning for a winter that may include inflation, blackouts, fuel shortages,
and even possibly rationing. - MCR
Oil Painting By Numbers
Eric Sprott, CA & Sasha Solunac, CFA
Sprott Asset Management
July 5th, 2005
http://321energy.com/editorials/sprott/sprott070505.html
In accordance with Title 17 U.S.C. Section 107, this material is distributed
without profit to those who have expressed a prior interest in receiving the
included information for research and educational purposes.
At the risk of sounding like a broken record (or a scratched CD as the case
may be), in this Markets at a Glance we will once again revisit one of our
favourite topics: Oil. We don't mean to be long in the tooth on this
subject, for, as our readers are well aware, we've already written about
Hubbert's Peak and Peak Oil on quite a few occasions since our first article
on oil in April, 2004. This time around we won't bore you with the theories
and hypotheses, and the whys and wherefores, of imminently declining global
oil production. Nor will we mention the world's ultimate demise when it
finally realizes that there just isn't enough of the stuff to go around
anymore. Verily, our views in this regard are already well known to those
who read our articles.
Rather, we will merely be connecting the dots (painting by numbers if you
will) on a canvas of interesting data points that have come to light
recently. Truth be told, the dynamics in the oil market are changing so
rapidly that it is a topic worthy of frequent visitation. The problem, as we
see it, is one of mathematics - the numbers just aren't adding up. Global
oil demand is expected to increase by 1.8 million barrels per day this year
(according to the IEA), and yet everywhere we look we see evidence that
production is falling short of expectations. Countries that were supposed to
grow production and be the "saviours" (Russia, Mexico, and perhaps even
Saudi Arabia) are showing signs of peaking production, and countries that
are already in decline are declining more rapidly that expected (U.K.,
Norway, and Indonesia). More and more experts (executives of oilfield
services companies like Schlumberger and Baker Hughes for example) are now
saying publicly that the average decline rate of the world's oil wells is
8%! - a shockingly high hurdle to overcome with new production.
The implication of an 8% decline rate is that 6.7 million barrels per day of
new production must be found every year just to break even (let alone meet
growing demand). Although data on decline rates is difficult to come by, we
suspect that 10 years ago nobody was using decline rates greater than 5%
(we've even seen ranges as low as 1-3%). Let's be conservative and assume
5%. That means in 1995, when oil production was 71 million barrels per day,
the world needed to find 3.5 million barrels per day in order to break even
on production. To overcome today's decline rates means that we have to find
over 3 million barrels per day more of new oil than we did 10 years ago.
Based on recent evidence, that just ain't happening. Furthermore, 10 years
ago it was known that OPEC could increase production by 10 million barrels
per day over the next decade, and Russia by 3 million. (That's how we got
from 71 million barrels per day to 84 million.) The rest of the world
(non-OPEC/Russia) has merely flatlined. If OPEC and Russia flatline today,
then global oil production is sure to go down.
As a side note, the decline rates being experienced in the natural gas
industry are even more onerous. First Energy revealed that Canadian natural
gas production is expected to rise by a measly 0.1% this year, even though
exploration and development costs are up 25%. So 25% more money has to be
spent in order to find 0.1% more natural gas. As one can see, the supply
side of the natural gas market is having problems of its own.
So far this year the supply side of the oil equation has been anything but
encouraging to those who believe that plentiful oil will be with us for
decades to come. On the contrary, with each passing day we are becoming
increasingly convinced that a "supply shock" is just on the horizon, and it
will likely manifest itself before the year is out. This year, 2005, may
well turn out to be the peak year for global oil production. In the
seasonally strong fourth quarter, demand is expected to be 86.5 million
barrels per day - that's 4 million barrels per day higher than current
demand in the second quarter. Where this extra production is supposed to
come from is leaving many of us scratching our heads. Be that as it may, the
moment of reckoning is quickly approaching.
So why are things looking so bleak for oil supply? For one thing, it is
becoming increasingly apparent that North Sea oil production is now falling
off a cliff. In a report released this week, it was revealed that Britain
had the steepest decline in oil production of any oil-producing nation last
year, falling by 10% or 230,000 barrels per day. Norway (the other major
North Sea oil producer) in the first four months of the year saw its oil
production similarly fall 10% compared to last year. Even more disturbingly,
the month of May alone saw a drop of 40,000 barrels per day versus April. If
such a month-over-month rate of decline continues then Norway will lose at
least 400,000 barrels per day of production this year alone.
The heyday of North Sea oil production is clearly a thing of the past. It is
worth noting that at its peak in 1999, the North Sea accounted for 9% of
world oil production. Since that time it has lost one million barrels per
day of oil production, with the most precipitous declines occurring in the
last 12 months. The news coming out of Mexico isn't helping matters either.
Until recently, Mexico has been a bright spot on the oil scene, having
achieved consistent production increases over the past decade from 2.6
million barrels per day in 1995 to 3.4 million barrels per day last year.
However, production figures coming in for this year show that Mexico may
already have peaked. Production so far this year is coming in slightly down
year-over-year, after only a marginal increase (12,000 barrels per day) last
year. Mexico's largest oilfield is Cantarell, a giant that produces 2
million barrels per day and accounts for over half of Mexican production.
Late last year, the CEO of Mexico's state-owned oil company warned that
Cantarell may start to go into decline as early as the middle of this year,
and once it does the decline rate will be 10%-15% per year! That amounts to
another 200,000-300,000 barrels per day of oil production per year falling
by the wayside.
Meanwhile, the Russian Economy Minister said this week that Russian oil
production will only grow 3.5% this year - half the average growth rate
experienced in the last five years. Even 3.5% seems optimistic to us given
that in the first five months production was up only 3.2%, and that was an
easy compare (Russian production was still ramping up at the start of last
year). However, if one were to look at the monthly chart of Russian oil
production it is definitely starting to look "peakish".
Production has been flat to slightly down since October 2004 after ramping
up considerably in the five years before then. Be that as it may, even if
Russia were to realize the 3.5% growth that they claim, it would amount to a
mere 300,000 barrels per day over what they produced last year. To put that
in perspective, that's an amount equivalent to Cantarell's (potential)
decline, and is still less than half of what North Sea oil production is
losing every year. In short, nowhere near enough to make up for the decline
rates we mentioned earlier.
Have the OPEC countries been picking up the slack? Hardly. OPEC ministers
are saying publicly that many member countries such as Iran, Venezuela, and
Indonesia are failing to meet production targets. (Indonesia is now a net
importer of oil. so much for the E in OPEC). The Iranian oil minister even
went as far as to say, "OPEC members are already pumping at full capacity
and can do nothing about prices." Recall that it is OPEC (along with Russia)
that has been responsible for the majority of the world's oil production
growth over the past decade. The rest of the world as a whole has remained
more or less flat over that time. If OPEC and Russia are indeed running
their wells flat out, then it's game over. There is no excess capacity
anywhere in the world.
The problem is that we are reliant on a handful of gigantic (and aging)
oilfields for the vast majority of our oil supply - oilfields that have been
in production for decades and may have been "overproduced" in order to keep
up with growing demand. As these fields go, so does global oil production -
they are that large. Nothing found since can hold a candle to these
goliaths. Nowhere is this more apparent than in the Middle East, especially
Saudi Arabia which is the largest OPEC producer by far. 90% of the oil that
Saudi Arabia has ever produced has come from five giant oilfields, some of
which (like Ghawar) are over 50 years old. The two largest, Ghawar and
Safaniya, have accounted for 75% of all Saudi oil production ever, and
Ghawar today at five million barrels per day still accounts for almost 60%
of Saudi production. To put the size and relevance of Ghawar in perspective,
in the last 25 years the number of oilfields discovered in the world that
are producing over 250,000 barrels per day can be counted on one hand. Hot
off the presses is a new book by Matt Simmons, Chairman and CEO of Simmons &
Company International and a leading proponent of the Peak Oil hypothesis.
The book is titled Twilight in the Desert - The Coming Saudi Oil Shock and
the World Economy. Simmons has been an oil industry analyst for over 30
years and for this book has poured over 235 technical papers written by
engineers and scientists familiar with the key Saudi oilfields. He does a
field by field assessment of 12 oilfields and concludes that Saudi Arabian
oil production is at or very near its peak sustainable volume, and will
likely go into decline in the very near future. The biggest problem is with
Ghawar. This mammoth oilfield has been producing oil at prolific levels for
the past 25 years, and it may have been irrevocably damaged by efforts to
maintain its production through massive water injection. Simmons calls this
"overproducing" - a term that is common in the oil industry and implies two
things: (1) less oil being ultimately recoverable from the oilfield, and (2)
a precipitous decline in production once damage from all the water injection
fails to maintain pressure. Saudi Aramco (the state-owned oil company)
started injecting water into Ghawar since the early 1960's, but it found
itself having to inject more and more water over time to maintain production
levels. The amount of water injected started in the tens of thousands of
barrels per day and steadily grew to 12 million barrels per day by 1998.
Today, Simmons suspects that the Saudis are injecting 15 to 18 million
barrels of water per day into Ghawar - three times the quantity of oil that
is being produced. Simmons believes Saudi oil production can collapse at any
time. The proof will be in the pudding. If the Saudi's are unable to
increase oil production, this will become most clear in the fourth quarter
when OPEC is scheduled to increase production to 30.5 - 31 million barrels
per day from the 28 mbpd it produces currently.
So the prospects for global oil supply look tenuous at best, but let's not
forget the demand side of the equation. Many interesting data points can be
found here too. Chinese car sales in the month of May were up 24%
year-over-year, and are expected to be up at least 15% for the year as a
whole. Similarly, car sales in India were up 20% in the month of May. To put
a historical perspective on what this means for oil demand, back in the
1950's and 60's when automobiles started to become ubiquitous in the Western
world, oil demand grew from 10 million barrels per day in 1950 to 50 million
barrels per day by 1970. Clearly, there won't be enough oil to go around for
this kind of automobile demand in developing countries as well.
Although the world for the most part is still in denial when it comes to the
pending oil crisis, the markets haven't been oblivious to these
developments. Even though we are seasonally in a low demand period, the
price of oil is quickly approaching $60 as we speak - an all-time high and
an increase of $12 in the past month alone. The futures price of oil is now
in contango (future price higher than spot) until 2007 and, early last week
before the run-up in the spot price, was in contango all the way to December
2011 (the longest contract available). A contango in the oil market was
practically unheard of as recently as the beginning of this year. However,
the way events are unfolding, posterity may well show that buying a 2011
barrel of oil for $55 today was the bargain of the century!
How high can oil go? In a crisis the sky's the limit. Even the threat of a
shortage can send the price parabolic. Back in 1970 when US oil production
unexpectedly peaked (nobody believed Hubbert back then), the price of oil
shot up from $1 per barrel in 1970 to $12 per barrel by 1973. (This all
happened before the Arab oil embargo.) There wasn't a de facto shortage of
oil back then, as the Middle East was able to pick up the slack in US
production. Unfortunately, there is nobody left to pick up the slack today.
All the data points are confirming that we have a problem in oil, and by
inference the entire energy sector. It is the biggest problem the world
faces today.