The Alchemist of the Oil Patch
The Daily Reckoning PRESENTS: Opinions differ about future capabilities of oilfield technology…and while both sides have valid points, Dan Amoss feels that it’s important to remain focused on progress underway at major projects and depletion of large existing fields, and not argue about potential resources thirty years into the future. Read on…
THE ALCHEMIST OF THE OIL PATCH
Since the advent of the oil business, scientists and engineers have developed a series of very remarkable technologies. Oilfield technology tends to compound at a steady rate, extending the boundary of what was long considered the absolute limit of exploration and production. Oil and gas resources once thought completely out of reach have now arrived in the fuel tanks and furnaces of consumers around the world.
Opinions differ about future capabilities of oilfield technology. Some argue that technology will allow us to unlock trillions of barrels worth of oil out of unconventional and not-yet-discovered resources. Others argue that every technology in use today was developed twenty or thirty years ago; not only that, but growing service industry bottlenecks could halt several desperately needed development projects in their tracks. While both sides in this debate have valid points, I think it’s important to remain focused on progress underway at major projects and depletion of large existing fields, and not argue about potential resources thirty years into the future.
Resource owners usually want to produce a hydrocarbon reservoir as fast safety and engineering limits allow, so it makes sense that most oilfield technology was developed to accelerate the process. The concept of “time value of money” doesn’t end on Wall Street; it extends to the oil patch. Producers are under pressure to satisfy the demands of employees, bankers, tax collectors, and shareholders so the sooner oil and gas arrives, the better.
This picture of working to beat the clock not only applies for newer discoveries, it also applies for projects that strive to extend the lives of older fields. Oilfield equipment and services have become very expensive and are likely to become even more expensive in the coming years. The free market is the driving force behind oilfield technologies. If there’s thought to be a few million more barrels of oil left in an old well, an operator will go ahead with an enhanced oilfield recovery project if the return on investment is high enough. But if oil and gas prices fall and service prices remain high over the course of this project, it can lose a lot of money. So timing is of the essence.
Low-viscosity, or “sticky,” heavy crude and sour crude with high levels of impurities like sulfur require extra steps in both wellhead processing and refining. The initial step in crude oil refining really occurs at the “wellhead,” or the site where it’s first pulled from the ground.
The trend toward heavier, sourer crude oil will directly benefit manufacturers of specialized wellhead equipment. These lower grades of crude make up a steadily rising share of global oil production because just as you’d expect, the sweetest, lowest-hanging fruit in the oil patch tends to be picked and consumed first.
More barrels of crude will require upgrading, particularly the abundant, yet barely accessible heavy crude from sources like the Orinoco belt in Venezuela. Technology is what the Venezuelans, the Russians, and the Saudis need, and they will pay up for it. Some of the biggest wealth-creating companies of the next generation will be those that can unlock the value these politically unstable resources – without committing billions in capital to projects that can be seized overnight.
Odds are, the next few years will look like the last few – a period of growing resource nationalization not unlike hoarding. Leaders of countries sitting on vast reserves are taking actions in the best interest of their people (or their personal Swiss bank account) and telling major oil companies to “get out.”
Most of their remaining reserves are difficult to produce, so Vladimir Putin and Hugo Chavez wouldn’t have kicked the big oil companies out if they hadn’t planned on granting major development projects to big service companies like Schlumberger, Baker Hughes, and Halliburton. Yet despite having access to the best oilfield technology in the world, most big projects still suffer from bottlenecks, delays, and cost overruns. This phenomenon is widespread enough that it supports the core ideas behind the Peak Oil theory – most notably that the “easy oil” has already been consumed.
Chris Skrebowski, editor of Petroleum Review, became a leading Peak Oil theory proponent after initially setting out to prove that it was nothing more than worrywarts seeking to make headlines. With decades of international oilfield consulting and research experience, he ran the numbers and concluded that data on both historical production and future projects was not precise enough to assume ample oil supply as far as the eye can see.
So Skrebowski started a “megapprojects” database to track the projects widely expected to satisfy growing demand. He’s noticed an undeniable trend of delayed startups and shortages of everything from drilling rigs to qualified personnel. Assuming that the current backlog of projects proceeds without a hitch, he expects that “24.8 [million barrels per day] of new capacity [is] due to come onstream between January 2007 and December 2012.”
An extra 24.8 million barrels per day of new capacity may sound like plenty for the world’s 2012 production needs. After all, it represents a little over 4% annual growth over the next 6 years. But this ignores depletion of the existing base, the elephant in the room that most Peak Oil critics either overlook or avoid. Skrebowski warns that the data behind the existing base, especially from national oil companies like Saudi Aramco, is not transparent enough for us to make happy assumptions about long-term supply. If average global depletion is running a little over 4% per year – a fair estimate – the world is likely to have the same oil production capacity in 2012 as it has today.
Skrebowski draws two conclusions from his latest megaprojects analysis. “First, data on production, project performance, and depletion rates is wholly unsatisfactory, particularly for the OPEC producers. Second, the large volumes of new capacity being added between 2007 and 2012 may not translate into the sort of increased production flows the world economy needs to underpin economic growth.”
Dan Amoss, CFA
for The Daily Reckoning
April 12, 2007
Editor’s Note: Dan Amoss, CFA is managing editor for Strategic Investment and a contributing editor for Whiskey & Gunpowder. Dan joined Agora Financial from Investment Counselors of Maryland, investment advisor for one of the top small-cap value mutual funds over the past 15 years.
Dan brings to Strategic Investment the unique experience of an institutional background and a drive to seek out the most attractive investments within favored “big picture” trends. He develops investment ideas for SI readers with a global network of geopolitical and macroeconomic analysts. Dan holds the Chartered Financial Analyst designation, a professional designation widely recognized within the investment community.
Doubts crossed our mind as we drove the last hour. We had been traveling since Saturday. It was now 11 PM on Monday night and we still hadn’t reached our destination. We were getting close; we had made the turn into the estancia, but that was 15 minutes ago. We were still going uphill and down…around hairpin turns…still racing along the dusty road.
“Why couldn’t we just stay at a nice hotel for our vacation?” Elizabeth had asked, adding, “Like other people?”
“Why?” we repeated, merely to give ourselves a little time to think of a good reply. “Why?” we said again, because we couldn’t think of a good answer. Then, seeing no way out, “Because this is more interesting,” we responded.
What was more interesting about it was, so far, expressing itself in hardship. After our unexpected layover in Brazil we finally arrived in Buenos Aires, barely in time to change airports. Then, we had trouble getting out of the place.
Our plane was delayed. Then, it was mysteriously unlisted. Then, an announcement said to “Ask Agent.” And then finally, all of a sudden, the plane was boarding. But by the time we got to Salta, it was 6PM…and raining. We would have to drive over one of the worst roads in Christendom in the dark…and in the rain.
“I’m closing my eyes,” said Elizabeth.
“You don’t have to; you can’t see anything anyway.”
We had hoped that in the last 12 months the road would have improved. What made it so dangerous a year ago, according to the road signs, was that there were teams of workers trying to fix it. Today, it appeared to us that they should have left it alone. It was still washed out in places…with turns so tight that a hairpin would get a backache on them.
But after five hours, we were finally arriving.
“You have to be pretty robust to be a part of this family,” we remarked.
“Yes, but I don’t think even we are robust enough for this.”
As you know, dear reader, our family seems to have lost track of who we are and where we belong. We have been away from our Maryland home for more than a decade. When we visit, we feel a bit like strangers…like we no longer belong there. But then, where do we belong? Maybe down here. So we are trying it out.
Argentina has always been a refuge for lost souls…war criminals…and crooks on the lam. Maybe it will work for us too.
There is always a natural rivalry between doing things in an easy, familiar and safe manner, and taking a chance on something new. This rivalry exists in everything – marriage…career…investments. A man marries the girl next door and he knows what he is getting. He speaks her language. He knows the family, the class, the caste…everything.
On the other hand, marrying a gypsy girl he met last week on the street in a foreign city is another thing altogether. He doesn’t know what he is in for. Maybe something better…maybe not. In any case, the excitement of it carries him along for a while. After that, anything can happen.
Some people prefer to put their money into mutual funds recommended by their local banker, too – easy, familiar, and safe…more or less. Others prefer to take chances in the hopes of getting something better.
And here we are at the end of the road…on the far fringe of civilization. Why are we here? We are taking a chance…it is as if we were marrying a gypsy girl; we don’t know exactly what we are getting ourselves in for, but we are still hoping for something special.
Now, for the news:
Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…
“The Fed is in a pickle here, and they know it, even though the minutes didn’t indicate it. Or, maybe they dont know it, and they are clueless. OK, I’ll put my money on the latter!”
For the rest of this story, and for more insights into the world currency markets, see today’s issue of The Daily Pfennig
And more views:
*** A note from Strategic Investment’s Dan Amoss, CFA:
“The conflict between religious conservatives and moderates in Saudi Arabia is at constant risk of escalation. An article in yesterday’s Wall Street Journal includes a few chilling quotes from a Saudi religious leader:
“‘A young imam from a large Riyadh mosque illustrates this mindset. ‘We are waiting for the time to attack,’ the imam says, in the course of a long interview. ‘Youth feel happy when the Taliban takes a town or when a helicopter comes down, killing Americans in Iraq. It is a very dangerous situation for the U.S. in the whole Muslim world.’…
“‘Arabic regimes are corrupted and can’t fight the U.S. So Arab people have to help their brothers. I tell you, the U.S. could not stand one day in Iraq if the Saudi rulers called for jihad there.’
“‘As for American ideals, the imam is dismissive. ‘Your leaders want to bring your freedom to Islamic society,’ he says. ‘We don’t want freedom. The difference between Muslims and the West is we are controlled by God’s laws, which don’t change for 1,400 years. Your laws change with your leaders.'”
“This mindset is likely to grow in popularity as millions of disillusioned, underemployed youths take sides in the struggle for the future of Saudi Arabia. Risks are growing, so we just published a free special report on how geopolitics and geology can combine to make things much worse for Middle East stability – and stability in the oil markets.
More from Dan, below…
*** And some Commodities 101 from Kevin Kerr:
“Like stocks, commodity prices don’t always go down or up. But the one thing you can practically guarantee about the commodities market is that somewhere prices are on the move,” he writes. “And predicting these prices is where fundamentals and technicals come in.”
“Technicals versus fundamentals, which is better? This is an ongoing argument among traders, but actually they’re both necessary. I use both technicals and fundamentals, and I firmly believe it’s vital to have a well-rounded knowledge of both in order to be a successful trader.
“The trick is to know when to rely more on one or the other, or sometimes even neither, and just go with your intuition – your gut – sometimes, for some of us, this is the best indicator of all. Certain commodities, such as crude oil, tend to make use of the fundamentals; others, such as financials, rely more heavily on technicals.
As I talk about different commodities in my just-released book, I’ll show you how these two methods can be used to build your own trading system around these markets and make solid profits.