Oil Booms and Busts

The Daily Reckoning PRESENTS: Over the past 25 years, the “growth” in oil reserves estimated to be in existing oil fields has actually exceeded the additions to reserves from new discoveries. The implication is that the existing oil fields of the world are as important, and maybe even more important, than the prospective new discoveries out in wildcat country. Byron King explores…

OIL BOOMS AND BUSTS

It is easy to live your life and not think too far upstream as to where it all comes from. For example, when you go to the supermarket, you buy produce. Do you really think about the truck driver who delivered the produce? Or the rail cars or transport ships that brought that produce to your region of the country? Or the processing centers that packed and shipped the produce? Or the pickers in the field who lifted the produce off the ground and put it on the flatbed tucks that hauled it to the processing center? Or the farmer who planted the field? Or the water engineer who maintained the irrigation system? Or the people at the seed bank who developed the seeds that the farmer planted and the water engineer made sure received the irrigation? You get the picture, I am sure. We live in a world of complex social and economic relationships.

It is the same thing with oil and gas. When you go to the gas station to fill the tank of your car, do you really think about how it all happens? Do you mentally picture the tanker trucks, the storage terminals, the long-distance pipelines, the refineries, the gathering system that brought the oil ashore or the tankers that hauled the oil from some overseas loading terminal? Do you have a mental image of some oil well somewhere, lifting oil from the depths of the Earth? Do you appreciate that some geologist came up with a prospect and laid his or her reputation on the line to convince a financial backer to fund the drilling of an oil well? The crust of the Earth is, I assure you, pockmarked with the dry holes of failed oil exploration efforts. Like many things in this world, it only looks easy.

In my opinion, admittedly biased by my own background, what makes the oil and gas systems of the world work are, at root, the geologists who have the knowledge to tell the drillers and everybody elsewhere to make the hole. And this is not to slight the engineers, the technical staff and everybody else who is part of the industry, to include the fry cook in the kitchen trailer and the guys who sign the checks down at the bank. Everybody has to work together and respect the contribution that every other soul makes to the whole. It gets back to that “division of labor” thing. It is just to say that finding and extracting oil and gas is not an “easy” thing to do in that “division,” and a lot of people who thought otherwise have lost their shirts.

Recently, I attended the American Association of Petroleum Geologists (AAPG) convention in Long Beach, California. As I walked among the poster presentations and sat in on the technical discussions, I was struck by the high scientific quality of the work coming out of what you might call the “nontraditional” locales. There were geologists from Russia, China, Indonesia, Nigeria, Egypt, Algeria, Brazil, Mexico, Venezuela and many more nations of the world. Really, it seemed to me that every one of them had one or more areas of technical competence in which he or she was building a true reputation. This has a lot of implications for both the present and the future, but what it says in a big way is that knowledge and technical competence in the field of geoscience is not solely resident in the United States or Western Europe. The oil industry is truly a “global” industry, for as much as that expression is overused.

AAPG has about 30,000 members now, about half the number that it had back in the early 1980s. This is another way of saying that things were booming in the oil biz back then. But many people who worked in the geology business were laid off during the mid- to late-1980s and throughout the 1990s, due to what we look back and call the “oil bust.” From its high price of about $50 per barrel back in 1980 (using the dollars of that era, and it would be over $100 per barrel today in our inflated U.S. bucks), oil crashed in price to near $5 per barrel by the mid-1980s, a 90% fall in price.

With that fall in price came massive layoffs in the industry. The layoffs totaled well over 1 million jobs in all (geologists, engineers, support staff and many other job classifications, according to the U.S. Department of Labor). This number of layoffs actually exceeds the combined job losses of the U.S. steel and auto industries over the past 25 years. So the long-term crash of the U.S. oil patch claimed and ended many promising careers. This matters quite a bit right now because, as the oil industry is booming again, there is a severe shortage of skilled personnel.

Costs for everything in and around the oil patch are rising. Many projects are on hold due simply to the fact that there are not enough experienced personnel available to do the work. The only way for a person to get experience in the oil industry is to work in the oil industry, but the ranks are missing an entire generation that either was laid off in the 1980s and 1990s or was never hired in the first place. It will take many more years to rebuild the critical cadre of human skills that the world’s energy industry will need over the next decades. By some counts, well over 50% of the world’s skilled geoscience work force will be retiring in the next 15 years. And the age cadre just behind these retirees is missing, for reasons that I explained above. Who will be left to do the work? The younger folks, by default, but there are not nearly enough of them out there.

Let’s discuss that oil bust. There were a lot of reasons for that oil price crash of the 1980s. Among them were that the high oil prices of the late 1970s, caused by the loss of oil output from Iran after the fall of the Shah and the Iranian Revolution, led to a worldwide recession. The recession reduced demand for oil and allowed prices to fall. Also, a number of then new oil provinces of the world were coming on line, and oil output grew rapidly from nontraditional locales such as Alaska, the North Sea and Mexico. And one critical reason for the fall in the price of oil was purely geopolitical, in that the Saudis maximized oil production to drive the price down and hurt the economic interests of the Soviet Union, which had invaded Afghanistan in 1979. By reducing the price of oil, the Saudis indirectly deprived the Soviets of a key source of hard currency, from the sale of Soviet oil for U.S. dollars. As the Mogambo Guru likes to say, “Everything is connected to everything else.”

But as I mentioned above, the falling price of oil severely harmed the world oil patch. Only the “best” prospects were drilled, and the low-cost oil was extracted and sold at relatively low prices (in retrospect, the prices were ridiculously low). The more high-priced oil was uneconomic to extract, and hundreds of thousands of oil wells across the world, particularly in the United States and Canada, were plugged and abandoned. Perhaps it made economic sense to plug the marginal wells when oil was selling for $10 or $15 per barrel. But today, when oil is selling for $60 or more per barrel, don’t we wish that we still had many of these old wells, even producing just a few barrels per day? And many elements of the vendor base went out of business as well. From drilling companies to equipment makers to service providers, there was a severe contraction within the oil and gas industry. But with oil appearing “cheap” based on its nominal price, no one was calculating the long-term price to be paid. The bill, however, is now coming due.

Over the past 25 years, the “growth” in oil reserves estimated to be in existing oil fields has actually exceeded the additions to reserves from new discoveries. The implication is that the existing oil fields of the world are as important, and maybe even more important, than the prospective new discoveries out in wildcat country. The challenge for the industry is to recover more of the oil that is down in the reservoir, but which has traditionally been too expensive, or beyond the technical means to recover.

Briefly, by “growth,” I mean the tendency for the estimates of the resource base to increase over time, and with those estimates, the “reserve” estimate increases as well. That is, when a well is first drilled, there is an estimate of how much oil in place (OIP) is down there. This estimate for OIP may or may not be highly accurate, but it is based on the best knowledge when the well is drilled. Over time, however, the well develops a production history, and each well is cumulated to obtain production statistics for a given field or set of fields. Hence the OIP reserve estimates become more and more refined over time, as actual oil is extracted and lifted to the surface.

Looking at the broad picture, out of about 35,000 known oil fields across the Earth, only about 11% are currently subject to “enhanced oil recovery” (EOR) methods, which tend to increase recovery of OIP, sometimes by quite a bit. Some estimates place more than 50% of the world’s oil fields as candidates for EOR applications, which could lead to dramatically higher reserve estimates, or “reserve growth,” in the future. But are there enough experienced personnel to do the work? Is the vendor base sufficient to supply the equipment and services? Will world oil supply remain stable over a long enough period of time to allow these scenarios to play out, and the “old” oil fields and their OIP to be accessed?

Until we meet again…

Byron W. King
for The Daily Reckoning
April 17, 2007

P.S. These are all critical questions. And aside from the very real importance of these questions to global oil supply, these questions have great bearing on the kinds of investments we pursue from our perspective at Outstanding Investments. We do, however, think we’ve come across some very interesting energy investments.

Editor’s Note: Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments.

Black Tuesday?

This is the dreaded day for most Americans – except if you are one of those goody-two-shoe, non-procrastinators out there. That’s right. Tax Day. Dun dun dunnnnn…

But there’s a different reason we are referring to today as ‘Black Tuesday’: The British pound has topped $2 for the first time in 15 years.

The last time this happened was in September of 1992, when currency speculators (particularly George Soros) pushed the pound off of the European Exchange Rate Mechanism. Mr. Soros did pretty well…making over a $1 billion on this speculation. Not too shabby…

The U.K. Treasury estimated the cost of what was dubbed ‘Black Wednesday,’ at 3.4 billion pounds. And in the months following that day, the pound fell significantly.

MarketWatch reports that today, the pound climbed up to $2.0074 before eventually settling at $2.0049 on inflation reports. According to Martin Slaney, analyst at Global Forex Trading, “Inflation figures came in significantly higher than virtually everyone in the market was expecting, and a push through $2 was inevitable after figures like this. A [interest rate] rise at the May meeting is now a certainty, and some are factoring in a half-point rise.”

Experts are saying that the pound could still have a ways to go – some are even predicting that it could rise to $2.10 by the end of the year.

So, what does our currency counselor, EverBank’s Chuck Butler, think about all of this? Well – he’s not surprised:

“You know, a couple of years ago, I was receiving hate mail daily. Some awful things were said to me, about me, and so on… All because the dollar had taken a technical, or mid-weak dollar trend, pause. Today, I feel vindicated. I said two years ago that the pound sterling would get to 2… And today, it’s there!”

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Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“I see that February had three fewer days than January, which posted a $59 billion deficit. That’s a $1.9 billion (and change) a-day ticket. So if we just add three more days of $1.9 billion to February to even it out, we see the trade deficit actually widened to $64 billion! Aye, yi, yi! But, hey, don’t let the facts get in the way of a ‘feel good’ story by the media!”

For the rest of this story, see today’s issue of The Daily Pfennig

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Short Fuse, back in Los Angeles…

*** As we’ve mentioned in these pages before, there is a commodity that is often overlooked by investors: Water. Well, we’re willing to bet that those days are coming to an end, as crumbling water infrastructure opens up opportunities for water companies worldwide to step up to the plate.

In the United States alone, there are 70,000 miles of aging pipeline and pumping stations – all of which are in dire need of updates and repairs.

And this isn’t just affecting the United States anymore…the world population has tripled over the last century, and world water use is up six-fold. And since the water infrastructure has not kept up with demand, water shortages have been plaguing cities in China, Saudi Arabia and Algeria.

In fact, an article in today’s LA Times points out that, “‘Western Algeria had running water only one day out of every 18 at the peak of the crisis, in 2002. The rationing also affected Algiers,’ said Christopher Gasson, publisher of Global Water Intelligence. ‘At that point, water became a political priority, and the government is now investing heavily in desalination,’ he said.”

“The emerging water crisis gets more and more attention with each passing month,” says our resident ‘blue gold’ expert, Chris Mayer. “It is hard to ignore the billions of dollars needed to fix the world’s water infrastructure – things like replacing leaking water and wastewater pipes. Plus, there are major health consequences. Millions get sick or die from waterborne illnesses. This affects the U.S., too. Last year, for example, was the worst year for sewage spills in U.S. history. The cause: Old leaking pipes. Expect things to get worse before they get better.

“For investors, though, there are several ways to play it.”

Fortune magazine recently said, “Water promises to be to the 21st century what oil was to the 20th century: The precious commodity that determines the wealth of nations.” Find out how you can profit – before the rest of the world catches on.

*** Now, over to Bill in Argentina:

On Friday, we saddled up after breakfast to visit ‘The Fortress.’

Francisco explained: “It is an Inca ruin up in the hills. It’s called the Fortress because it must have been a place where the Indians defended themselves. You’ll see.”

We left the ranch house in single file…mounted on sturdy mixed breed horses – mostly Peruvians crossed with Arabians. There were not enough horses for everyone, so Edward rode a mule, which turned out to be the best animal for the ride. It was slow, but more sure-footed and calm on the rocky, crooked paths that led up to the Fortress.

We rode up over the little mountain behind the house, and then followed a track along the edge of the hill, looking down onto a thin strip of grass along a stream below. There were a few twisted algarrobos (carob trees) and molle pepper tress…all looked as though they were hundreds of years old. There were also a few willows here and there, known locally as ‘sauces.’

The horses walked…until there was a wider, smoother stretch of trail. Then, they broke into a fast trot until the rocks stopped them again.

“You know, a group of 4×4 land rovers driven by Germans are supposed to come through here,” we told Francisco. “They’re taking a group on a ten-day tour of the Andes just to prove their cars can take the punishment of these roads.”

“Well, if they go slow enough, they can make it through here. Another group…I think they were from Toyota…did this same road three years ago. They took a group of new Toyota Land Cruisers through here. But if I had a new Toyota Land Cruiser this is the last place I’d want to take it.”

After about an hour, we rounded a hill and saw a green valley in the distance.

“That’s where we’re going,” said Jorge.

“Down into that valley?” we asked.

“No, look…above the valley on the other side. You see that hill that looks white? That’s the Fortress. We’ll go down into the valley and then up the other side. When we can’t go any further on horseback, we’ll go on foot.”

The valley itself held our attention for a long moment. It was an oasis of green, between very dry hills of brown and red, with a rock cliff on the east side, next to where the little creek flowed through.

Perched on the edge of the green valley floor was an old adobe house…well, we presume it was a house. We could look inside through the open door. Actually, we saw no door, but there must have been something to close out the cold night air.

Between the adobe walls were strung dried out, uneven poles, covered with twigs and straw…and the whole lot was topped with sun-hardened mud. It looked more like it might have been a storage building for Navajos, with a blue bicycle leaning against the mud wall.

Except for the bicycle, the place looked as it probably did four hundred years ago, when the Spanish first arrived in the valley. The floors were of dirt. The ceiling was blacked by pitch from an open fire. We wondered what would happen if you put a match to it. Apparently, no one ever did.

We half expected to see an Indian come out and chuck a spear at us. On our way here we had seen a naked woman walking along the side of the road, her hair sticking out wildly…her body the color of the adobe mud. For an instant, we thought she was a beast -a form of pre-human that had somehow survived in the Andes. Then, we saw her face…twitching…as if she was having a conversation with an invisible friend. We realized then that she was not only human…but as mad as the rest of us.

But there was no sign of life from the adobe house, neither human, nor animal.

We remembered another old woman, living in a similar hovel on the other side of the ranch. The last time we visited she was dying. We asked Jorge.

“Ursula…yes…” Jorge pointed to the south. “We all thought she was dead. But Felipe’s wife, Marcella, is her daughter. And Marcella is my aunt – so Ursula my great aunt too. Well, Marcella was looking after her, because she was sick. And she’s 90 years old, at least, so we figured she was a goner. But she’s still living. She’s lived up there all her life. You saw it; you can only get there on horseback. She’s never seen a doctor, because the doctors won’t go up there and she won’t come down. But she’s still doing fine.”

Below the adobe were rich fields of autumn corn and hay…and a small vegetable garden surrounded with a thicket of broken limbs and thorny bushes. In one field, two horses grazed. Otherwise, we saw no animals.

We continued our ride…pushing the horses upward through rocky switchbacks…much further than we thought they could go. The horses stumbled and slid on the rocks. They sweated and breathed heavily…but they kept moving upwards…towards the Fortress. Finally, they could go no further.

“We have to go the rest of the way on foot,” Jorge announced.

More to come…

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