ALCHEMIST OF THE OIL PATCH
by Dan Amoss, CFA
Editor, The Daily Reckoning
April 15, 2007
Daily Reckoning PRESENTS:
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.
"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�"
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 as 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
P.S. Investors who hold gold will be very reluctant to sell it when dollar holders around the world anticipate the endgame of paper monetary systems. For its holders, gold will serve as a solid bridge on the journey from this monetary system to the next. Steady accumulation of gold-related investments remains a prudent strategy, and this month, I have a new gold stock to recommend to my Strategic Investment subscribers. See here for the full story:
© 2007 Dan Amoss
The Daily Reckoning Archives
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.