"Proof Positive Peak Oil is Here" by Bill Powers. FSO Editorial 07/31/2009

FSO Editorials

PROOF POSITIVE PEAK OIL IS HERE
by Bill Powers
Editor, Powers Energy Investor
July 31, 2009

While being a bull on the oil market has been tough for much of the last year, I maintain that we are in a secular bull market in oil due in large part to one of the most significant economic events of the 21st century – the peaking of worldwide oil production. According to the US Energy Information Agency (the statistical division of the US Department of Energy), the summit of worldwide oil production occurred in May 2005. While the event received only mild concern then, the news has been more recently overshadowed by the fall in real estate prices, the near collapse of the banking system and the most severe economic contraction since the Great Depression.

Peak oil would be irrelevant if not for our continued and extreme thirst for it. Dr. Colin Campbell, petroleum geologist, is credited with quantifying that we find one barrel of oil for every four we consume and that the discovery of new oil reserves peaked in the 1960’s (The World Oil Supply). Published in 1995, Dr. Campbell’s work could not have anticipated the expanding consumption required to catapult the economies in developing China or India. Nor did it contemplate our current worldwide economic slowdown.

What Dr. Campbell’s work does shed light on is this: we are on an oil usage treadmill that is unsustainable. In 2008, while the world did consume .6% less oil than it did in 2007, it consumed 21% more than it did in 1995 when Dr. Campbell’s research was released (Source: BP.com historical statistic review from governmental and public sources). In light of this information, the importance of peaking worldwide oil production is difficult to overstate. Despite all the rhetoric with respect to alternative energy sources, oil literally makes the world go around and will continue to do so for the foreseeable future.

In up coming issues of the Powers Energy Investor, I will analyze some of the largest oil-producing countries to examine where they fall on the Peak Oil spectrum. This month, I will examine the most explored and drilled petroleum-producing region in the world – the United States. I believe the US provides many insights into oil production profiles for other countries as they become more mature.

Before getting started, I would like to clarify what I mean when I refer to “oil” in the context of Peak Oil. I will use the definition used by both the US Energy Information Agency and the International Energy Agency. They consider “oil production” to be crude oil production plus lease condensates but not natural gas liquids.

US Oil Production: The Prototype

While every oil field and oil producing country is different, depletion studies have shown that most fields will reach production peaks once half of their reserves have been produced. As noted in Issue 1, much of the work on oil depletion was pioneered by M. King Hubbert who developed “Hubbert’s Peak” and quantified the theory that once half a field’s reserves have been produced, the field will go into an irreversible decline along a bell shaped curve.

The graph below poignantly depicts worldwide oil production for non-Opec and Non-Former Soviet Union producers. While the chart reflects less than half of the world’s production, the consistency of the production pattern, regardless of size or location, is compelling.

With Hubbert’s theory of oil depletion in mind, an evaluation of US production data provides its own convincing downward curve after it’s peak in 1971. As Hubbert predicted, the below table shows that the US appears to be in permanent and irreversible decline:

US Oil Production

Year	Oil Production (mmbpd)*
1970	9.63
1975	8.37
1980	8.59
1985	8.97
1990	7.35
1995	6.56
2000	5.82
2005	5.17
2008	4.95

Source: US Energy Information Agency
*mmbpd = million barrels per day

While Hubbert’s theory and the US production experience alone make the fundamental case for a higher oil prices, many market observers remain unconvinced. They argue that new technology and the development of deepwater fields will allow production to remain at current levels or higher. Not surprisingly, I disagree. Technology has not saved the US from experiencing declining oil production and it will not save other countries.

Let’s examine the two major producing offshore basins in the US where modern oilfield technology is being most heavily applied -- the Gulf of Mexico and the North Slope of Alaska. Since offshore exploration in the US has been the beneficiary of many of the major breakthroughs in technology that have occurred over the last 50 years, these two major offshore areas should provide a model for other offshore areas such as Brazil and West Africa. Below are tables containing snapshots of the production histories of federal leases in the Gulf of Mexico and the North Slope of Alaska:

Gulf of Mexico Oil Production
from Federal Leases

Year	Oil Production (mmbpd)*
1997	1.13
1998	1.23
1999	1.35
2000	1.43
2001	1.53
2002	1.55
2003	1.55
2004	1.45
2005	1.28
2006	1.29
2007	1.27
2008	1.16

Source: ibid.
*mmbpd = million barrels per day

Alaskan North Slope Oil Production

Year	Oil Production (mmbpd)*
1981	1.52
1985	1.77
1990	1.74
1995	1.44
2000	.942
2005	.845
2008	.671

Source: ibid.
*mmbpd = million barrels per day

These areas, which were once thought to be inexhaustible, are clearly showing signs of old age. Given that the technology applied to these older areas is now being implemented in emerging offshore basins, I expect these new basins to age with a vengeance.

The most important technological breakthrough over the last half century that has accelerated the development of offshore production has been the 3D seismic survey. With the ability to drag very high resolution seismic equipment behind a ship in virtually any depth of water and at a fraction of the cost of seismic acquisition on land, the Gulf of Mexico and the North Slope of Alaska are some of the world’s most seismically defined oil producing provinces. The application of 3D technology and emerging 4D technology, along with advances in micro processing capabilities to compile results, has helped offshore producing companies more rapidly delineate emerging offshore basins and find the last remaining prospects in an existing area. While the Gulf of Mexico took more than 40 years to reach its production peak and Alaska a much shorter period, I expect offshore Brazil and West Africa to peak within the next five years.

Much of my pessimism regarding the ability of these two promising areas to grow production stems from the incredible decline curves of offshore basins. Since the rate at which an oil pool is depleted depends, in large part on the down hole pressure of the zone being produced, one can see how having a discovery sit in very porous rock under several thousand feet of seabed can create some incredible down hole pressures as well as some incredible decline curves.

In examining the production profiles of Brazil and Angola, one should notice the steep inclines in production over the last few years. Since much of this incremental production for these two countries came from deepwater wells, it can be expected that the down slope will be equally as steep if not worse:

Angolan Oil Production

Year	Angolan Oil Production (mmbpd)*
1990	.475
1995	.646
2000	.746
2005	1.25
2008	1.98

Source: ibid.
*mmbpd = million barrels per day

Brazilian Oil Production

Year	Brazilian Oil Production (mmbpd)*
1990	.631
1995	.695
2000	1.26
2005	1.63
2008	1.81

Source: ibid.
*mmbpd = million barrels per day

Technology has also radically changed the production profiles of onshore producing basins. Secondary and tertiary oil recovery techniques have greatly increased the percentage of oil recovered and economic life of many fields. Since many of these techniques were developed by US-based service companies and first used on mature domestic fields, looking at the production history of the State of Texas will provide insight into the limits of enhanced recovery techniques. Texas has a long history of oil production dating all the way back to the Spindletop discovery in East Texas in 1901.

Texas Oil Production

Year	Texas Oil Production (mmbpd)*
1985	2.38
1990	1.85
1995	1.53
2000	1.21
2005	1.06
2008	1.07

Source: ibid.
*mmbpd = million barrels per day

Today, the Permian Basin in the western part of the State and other areas make Texas one of the largest concentrations of water flood and tertiary projects anywhere in the world.

Many oil fields go through three distinct phases of life. The first stage is primary production which is when a well is able to produce with only the reservoir pressure pushing oil to the well bore. The second phase, water flooding, involves drilling water injection wells around the edge of a field in an effort to push the remaining oil towards the producing wellbores located in the center of a producing field. The final stage of a field’s life is tertiary recovery. This is when a chemical agent (the most popular chemical mixture is alkaline surfactant polymer) or carbon dioxide is injected to mix with the remaining oil after a field has been water flooded.

While water flooding and tertiary recovery are proven and reliable technologies, they are expensive and provide only incremental recovery of original-oil-in-place. For example, water flooding and tertiary recovery techniques may improve recovery for a field from 25% of original-oil-in-place on primary recovery to 45% after tertiary recovery. While this improvement in recovery is worth pursuing at times of high oil prices, the higher operating costs and significant capital investments needed for water flooding and tertiary projects make only large fields worth pursuing.

The country that is most likely to experience a production decline curve similar to that of the State of Texas is Russia. Russia is home to many enormous fields and the country has done an excellent job of rehabilitating old fields during the decade that followed the ruble collapse in 1998. However, the next frontier for Russia will be the application of increasingly advanced recovery techniques to increase recovery factors in its existing producing basins.

Russian Oil Production

Year	Russian Oil Production (mmbpd)*
1998	5.85
1999	6.07
2000	6.47
2001	6.91
2002	7.40
2003	8.13
2004	8.80
2005	9.04
2006	9.24
2007	9.43
2008	9.35

Source: ibid.
*mmbpd = million barrels per day

With the big drop in oil prices last year and the flattening of production growth in Russia over the last few years, it is unlikely the country will be able to keep production above 9 million barrels a day for much longer. While secondary and tertiary projects are very proven technologies, they have long lead times. It usually takes 9 to 18 months before the programs produce meaningful increases in production.

It is clear that the Russian oil miracle of the last decade is coming to an end. Stay tuned to see if the country is able to make the necessary investment to keep production from quickly retreating to previous levels.

The final area where advances in oilfield technology are boosting production is in the production of unconventional oil resources. Oil production from shale formations has grown significantly over the last few years, however it still remains a small fraction of overall US production. The Bakken Shale in the Williston Basin of North Dakota, Montana and southeast Saskatchewan is the clear leader in oil production from shale. Oil production from North Dakota has exploded in recent years as a direct result of the Bakken.

North Dakota Oil Production

Year	North Dakota Oil Production
2000	89,000
2001	86,000
2002	84,000
2003	80,000
2004	85,000
2005	97,000
2006	109,000
2007	123,000
2008	169,000

Source: ibid.

Many of the advances in drilling technology, such as long length horizontal drilling and multi-stage fracturing that allowed for the tremendous growth of natural gas production from shales, are now being applied to oil production. The other area where oil production from shale is emerging is from the Barnett Shale in the Fort Worth Basin. While the Barnett is nowhere near as prolific for oil production as the Bakken, the delineation of its potential is still in the early stages.

Given that the extraction of oil from shale through other methods, such as mining, has yet to reach commercial viability in the US despite the billions spent, the elusive potential of oil shale mining will likely continue for some time. While there are known shale oil deposits scattered around the world, only a few small-scale operations, such as those in Estonia and China, currently exist. It will take at least several more years and billions of dollars of research before any significant commercial shale oil mining projects are brought into production. For readers interested in a more in depth look at the colorful history of the oil shale mining industry, I suggest reading “Shale Oil – The Elusive Energy” by Walter Youngquist which can be found at the following URL: http://hubbert.mines.edu/news/Youngquist_98-4.pdf

Oil production from bitumen (oil sands) is the world’s largest source of unconventional production. While there are known bitumen deposits outside of Canada’s Athabasca Basin (which produces approximately 1.2 mmbpd), currently none are in production outside of Canada. Due to the large costs associated with development, as well as higher operating costs associated with bitumen projects, it is unclear how rapidly Canada’s bitumen industry will expand. Until crude oil trades well north of $70 a barrel for at least six months and the credit markets thaw further, it is unlikely we will see more than a very measured pace of development in the Athabasca Basin.

For oil bears who believe worldwide production will continue advancing into the foreseeable future, I am curious where they think it will come from? Existing fields? With US oil production in a terminal decline despite continued technological advances and huge sums of money being spent on exploration, it is quite reasonable to expect similar peaking and significant downward production trends for fields in other countries. Not an optimistic sign of things to come for oil supply, but a tremendous opportunity for those looking to invest in the sector.

The Powers Energy Investor provides readers with both a unique perspective on the energy world as well as investment ideas that will not be found anywhere else. Please visit our website at www.powersenergyinvestor.com for more information.

Contact Information