Heavy Oil Becomes More Appealing As Light, Sweet Crude Runs Out

When most people think of oil, they think of light, sweet crude that comes up out of little holes in the ground. You describe oil by its API gravity. For example, oil like Brent crude or West Texas Intermediate has an API gravity of 38-40. The oil that Col. Drake pulled from the ground at Titusville, Pa., in 1859 had API gravity near 60. These types of oil are relatively easy to pump from a reservoir, lift to the surface and transport via pipeline to the refinery.

The Shift to Heavy Oil, with an “Energy Microsoft” at the Forefront

But a significant portion of the world’s oil is much lower quality than the light, sweet stuff. Indeed, most oil that’s found in nature is a heavy, viscous hydrocarbon with the consistency of cold molasses. This heavy oil – defined as API gravity 22.3 or less – is difficult and costly to produce and refine. That’s why people have pumped and burned the light, sweet oil for the past 150 years. Throughout its history, the oil industry has usually bypassed the heavier oil fractions. Why go to the trouble and expense, right?

But now conventional oil resources are drying up. The reasons have to do with geology, politics, macroeconomics and the investment cycle. Boiled down, it’s the Peak Oil argument, which focuses on the worldwide decline in output of light, easy-to-get oil. And Peak Oil is a serious matter. As light oil gets scarce, however, a lot of new heavy oil plays are coming out of the industrial shadows.

Indeed, with the breakout of heavy oil into the marketplace, the world energy business is about to change dramatically. It’s kind of like what we saw with the computer revolution that began about 30 years ago. Big, heavy mainframes gave way to small-scale, distributed and personalized computing power. At the heart of the revolution was the operating system, much of which wound up coming from Microsoft.

Today, the energy industry is on the cusp of a revolution equally profound. And in the forefront of that change is the company that I’ll describe in this issue of Energy and Scarcity Investor. This visionary firm is sort of an “Energy Microsoft.”

How Much Heavy Oil Is Out There? A Lot!

First, let’s define a few terms and look at some numbers. According to oil service giant Schlumberger, only about 30% of the total world oil resource is the conventional, light, sweet crude (technically, API gravity 22.3 and above). Heavy oil (API 22.3 and below), by comparison, makes up about 15% of the world’s oil resource. Extra-heavy oil (API gravity less than 10) makes up 25% of the world’s oil resource. And nearly 30% of the world’s oil resource is in the form of tar sands and bitumen (with API gravities in the low single digits – it doesn’t flow at all).

Schlumberger estimates that there are between 6-9 TRILLION barrels of heavy oil in the world. Big numbers, right? Especially since the current total world demand for oil is in the range of 30 billion barrels per year. With heavy oils, we’re talking about 200-300 years’ worth of potential supply. (That’s at current rates of use. If we can get it all. Which we can’t. So it won’t happen. But it illustrates the point.)

Where is all of this heavy oil? Here are the nations with the largest estimated deposits:

This list goes on to include other nations with significant heavy oil deposits, such as Brazil, Saudi Arabia and Indonesia. Further down the list of countries holding sizeable heavy oil resources are Australia, South Africa, Nigeria, Libya, Argentina, Peru and Vietnam.

So you can see that heavy oil (and extra-heavy oil, tar sand and bitumen) is a vast and underutilized energy resource. Of course, keep in mind that nowhere near all of this resource is recoverable under even the best scenarios. But the point is that heavy oils, of all types, constitute immense energy potential – many decades worth of supply. And it’s all but certain that, as conventional oil becomes scarcer and more expensive to extract, the world’s energy industry will turn to heavy oils. It’s already happening.

Early and Current Efforts with Heavy Oil

Looking back in history, people and nations used heavy oils when necessity demanded. During World War II, Italy supplied its military (and the military of Germany) with oil products from a modest-sized heavy oil deposit in Albania. The Soviets, desperate for oil products, utilized several heavy oil deposits in south-central Russia. The Japanese exploited heavy oil deposits in Japan, Indochina and Indonesia.

Today, the energy industry has an array of projects that exploit heavy oils. Chevron, for example, lifts about 80,000 barrels per day of heavy oil from its large complex (of 8,000 wells!) at Kern River, California. Venezuela’s national oil company PDVSA produces about 400,000-500,000 barrels of heavy oil per day from projects in the Orinoco region. Offshore Brazil, Petrobras has a deep-water project targeted at a string of heavy oil deposits. And BP has several billion barrels of heavy oil resources located under the Arctic tundra near the conventional oil fields of Prudhoe Bay, Alaska.

When it comes to tar sands and bitumen, the massive developments in western Canada offer a $500 billion example. The Canadian tar sands projects currently yield nearly 2 million barrels of oil per day out of bitumen, strip-mined from the near-surface prairies of Alberta.

Next week, I’ll be in Denver for the American Association of Petroleum Geologists (AAPG) convention. I’ve been a member of AAPG for 30 years, and it’s been a source of great professional education and growth for me. I’ll attend the exhibits and talks and meet with several energy companies to get the latest insight into what’s going on out in the field. I’m even scheduled to be a judge on some of the programs for geothermal and heavy oil. All that, and I’m visiting with some hard rock miners while I’m in the area.

Naturally, I’ll look for great investment ideas and keep you posted.

Until we meet again,
Byron King

June 3, 2009

The Daily Reckoning