Matthew R. Simmon
Chairman, Simmons & Company, Int'l & Author, Twilight in the Desert
"Critique of the CERA Report"
Transcription of Audio Interview, November 25, 2006
JIM: Last week the oil markets received a bombshell: peak oil theory falls down according to the CERA folks; and we will not reach peak oil until the year 2030; and the world’s reserves are estimated somewhere in the neighborhood of 4.8 trillion and growing.
To challenge those assumptions joining me on the program is Matt Simmons.
Matt, I want to get to this figure here, where they talk about one of the first assumptions of the CERA report is that we do not get to peak oil until 2030. Let’s talk about that one first.
MATTHEW R. SIMMONS: It’s interesting. First of all, I’m so glad you didn’t call me yesterday, because I’ve been out of the country and I saw when I was pulling up my Blackberry about 20 different people sending me saying, “did you see this press release?� And until last night, I hadn’t had a chance to read the � I’ve got it right now in front of me � 12 or 13 page report.
Now I have read it, and I’m a lot more comfortable talking about it.
The first thing I found a little bit strange is that they basically say the global resource base is 4.82 trillion barrels and likely to grow. And I thought, why would you ever say �4.82’ ? Why wouldn’t you say �4.5 to 5’ ?
But by doing the 4.82, they create the illusion that there’s a precision there that they have that is far beyond anybody’s ability to grasp. They talk about �yet to discover’ oil that they have a specific number for. And I just think people shouldn’t basically do these sort of reports, and claim to be so precise, without a huge caveat saying, “by the way, this is just our own hunch.� [6:55]
JIM: And shouldn’t it be more realistic to give like a range instead of 4.5 to 4.8?
MATT: At least �4.8’ is better than �4.82.’
JIM: They’re talking about cumulative production of over a trillion. Then they get the Middle East reserves. And we all know from 1985 to almost 1990 Middle East reserves grew by over 300 billion that nobody can account for.
MATT: Then even worse, that number stayed static for 17 years � that didn’t grow � and people started thinking it was a conservative number. [7:29]
JIM: The other thing here is they’ve got enhanced oil recovery � now, granted, with technology oil companies have been able to get more oil out of the ground from existing wells. But the thing that struck me was that despite the fact that they’ve been able to replace their reserves from existing wells, production has not gone up in the United States; it hasn’t gone up in the North Sea; it hasn’t gone up in the North Slopes of Alaska. Production keeps falling.
MATT: Yes. What I think the reserve appreciation thing is all about now, is once you’ve declined to a pretty low level, and as long as the price is high enough, there are a lot of techniques � some of which we had 30 years ago � that you can do to keep 10% going for a far longer period of time. But you’ve already gone from 100 all the way down to 10% before you start doing those. So I call it �managing the tail.’ [8:21]
JIM: The other thing that struck me here, for example, extra-heavy oil: 440 billion; oil shale: 704 [billion]. You get to the tar sands and you get to oil shale � that’s a mining operation; that’s much different from pulling oil out of Ghawar.
MATT: There’s a huge difference between oil sands, which is a mining operation; tar sands which is a mining having injections with steam.
And oil shale might, or might not, some day be commercial. But as of today, it’s commercial in the most limited sense of the word. So to actually kind of lump that altogether is casually, flippantly dangerous � or naive.[9:01]
JIM: What about the exploration potential where they have 758 billion? I mean where does that number come from?
MATT: Once in a while I like to speculate my net worth by 2030. Luckily, I’ve never had the audacity to go into a bank and say, “how would like to make me a loan against my estimated net worth in 2030?�
For a subject so serious, I actually shouldn’t be flippant about it. But when I read the report last night, I really thought, you know, I just don’t understand where these guys are coming from. And it’s basically laden with “we’re the experts.� [9:41]
JIM: When it came out last week, it was all over the financial channels.
MATT: I gather.
JIM: Oil got hammered. And here we are, we know that, for example, they issued a similar report in the year 2000 when we had a ton of natural gas and we know that natural gas production has peaked in Canada, here in the United States, and a lot of it � the so-called stranded � has yet to be proved it actually exists.
MATT: Yes. Back in 1998, 1999 and 2000, the National Petroleum Council was feverishly working on a massive report for our government on taking a very careful look at the reliability of our natural gas base, as we’ve accidentally turned the whole energy future of the United States, and the whole growth of our power sector, into the hands of the natural gas industry. And of the 150 people working on this, I was known as by far as the most negative because I had some grave concerns � and a growing number of operators in the industry had grave concerns � that the decline rates in natural gas were so high now that it was really unlikely to see the supply grow by even 10%, let alone grow by 35% in a decade.
And as the controversy grew of the reliability of that report, CERA defended stoutly that we had unbelievable amount of growth. I was on several programs with CERA people who said, “Matt is wrong, he is dead wrong, and I’ll prove it to you.� What they did is show a PowerPoint, and they showed the supply story. Well, had they been right, supply would have basically been about 30% higher today than it actually is. And it turned out our supply of natural gas in the United States hit a secondary peak, far below the first peak in 1973, in 2002. And it’s down about 10% since then. And had it not been for the Barnett Shale, and some associated gas coming from deep-water, it would probably be now off 18%.
And about 3 years after, CERA came out with a report saying, “aha, we’ve just discovered that natural gas supply is basically shaky.� But there was never a mea culpa saying, “I’m sorry that we basically dumped all over the naysayers.� And I think that they’re doing exactly the same thing on oil. I just don’t understand where they’re coming from. But of course, we’re all entitled to our opinions, and I’m sure they feel just as strongly that they know a lot more than I do � as I [feel I] know more than they do. [12:00]
JIM: They are also going to follow this up with a new one called The Dawn of a New Age, which is going to give the signpost to look for as we approach the plateau. But they are saying that plateau is decades away.
MATT: There’s a very interesting number that I’m watching like a hawk. The Department of Energy’s Energy Information Administration � the EIA � publish monthly global oil supply numbers. This is crude oil only. And it takes about 6 months before the adjustments level out � it’s not perfect data but it’s the best we’ve got. And then it looks to me like we start falling further and further away from the all time crude oil record hit in December 2005 � to put it just barely across 70 million barrels a day. That might actually be what we look back on and say, “well, that’s the year that peak oil in the world actually peaked.� So the idea that we have until 2030, I think has a credibility of about 1%.
Anything can happen. We can discover a new Prudhoe Bay tomorrow. But if we did, it would take a decade � and Prudhoe Bay being the largest oil field in North America, basically peaked at 1.5 million barrels a day and it stayed there for 11 years, and now it’s down to 400,000 barrels a day. Even a Prudhoe Bay would basically be a drop in the bucket. You’d actually have to have about 15 of them. [13:17]
JIM: The other thing that strikes me too and you see this every single week in the oil markets that they wait for the inventory numbers. Let’s just assume that these inventory levels � which nobody is taking with a dipstick � are true. The thing that strikes me is if 5 years ago we were consuming 10,000 barrels a day, and 5 years later we’re consuming 20,000 barrels a day � those inventory numbers would be more relevant if they talk about days supply versus the inventory numbers themselves.
MATT: You’re absolutely right. And it’s actually even more complicated because now we have all these complicated boutique grades that you can’t basically blend. So they all have to basically�it’s a little bit like going into a grocery store about 40 years ago when we had homogenized milk, and milk that wasn’t homogenized that had a big slug of cream on the top. And so you only had to have a limited number of bottles of each. Today, you go into a grocery store and you’ve got about 17 grades of milk, so your inventory requirements have gone way up. And that’s exactly what’s happened in our gasoline supply; and it’s also happening in our diesel supply now that we’ve just introduced this ultra-fine, less than 15 ppm Sulfur diesel.
And one of the reasons we had this big bulge in the Spring and Summer in gasoline first, and then diesel second, is that we were having to build up a brand new grade while we were still using an obsolete grade. And now we’re basically liquidating the obsolete grade so fast � in the last 6 weeks we’ve never had a bigger finished product draw. So as I looked at the numbers that came out a week ago tomorrow from the EIA, our gasoline stocks are basically back to kind of right on top of the 5 year lows. But since demand is at a record high we’ve never had less gasoline stocks than the United States on a day’s usage, and we’re going into Thanksgiving weekend. [15:10]
JIM: Another figure I found rather striking and hearing the economists talking on Wall Street, they’re talking about if the US economy slows down � as it did in the third quarter where we had 1.6% GDP growth � if we slow down, and we’re the big economic engine, the rest of the world slows down, therefore there’s going to be less demand for oil. But this is the first time I’ve seen in the last 5 years, we have really not had any demand destruction despite rising prices.
MATT: No, we’ve had none. What we are now starting to see, both in the United States and on a global basis, is the rapid growth in demand is ending because it can’t be supplied. The United States, there were 3 months in 2006 we crossed 21 million barrels a day. My guess is that’s probably the last time that will ever happen, because we just literally can’t supply it. And what’s going to be very complicated is figuring out the difference between looking at how demand growth is slowing down as if it’s demand destruction, versus, a supply constraint.
The same thing happened in natural gas. When natural gas supply couldn’t grow, then obviously use couldn’t grow. And for a long time people said, “well, that’s because the price is so high.� And then the price collapsed; it didn’t decrease demand either. Demand can theoretically be anything, but use always has to equal supply plus what you can liquidate from inventory. And my guess is we have liquidated our usable inventory down to as close to a just-in-time supply as you can get. We have a very tight market and it’s likely to get a lot tighter before we’ll ever see it loosen up. [16:43]
JIM: Why do you think we’ve had this disconnect then in the energy markets because certainly you see it in the PE multiples on the oil stocks despite record profits; you’ve seen it in the price of natural gas which got hammered this Summer when we didn’t have bad hurricanes; you’ve seen it recently in the months of September and October with the price of oil coming down. And yet as the markets get tighter and tighter we’re acting like there’s this glut of oil that exists somewhere that nobody knows about.
MATT: It has a lot of precedent to it. If you go back a year ago, once the hurricanes had quieted down and it was clear that we basically didn’t have massive shortages, oil prices briefly crossed $70 a barrel, and they fell all the way back to the mid-50s. And as they were falling, the optimists were saying, “I told you so, that we were headed back to low prices here: here we come $27 oil.� They were just unbelievably shrill, and then lo and behold, a few months later we were back over 60, and a few months later we were back over 70.
And I remember the surprise of arriving out of contact in Italy for about 5 days and arriving in Ireland to give a talk at the University of Limerick, and they said, “well, what do you think of $75 oil?� I said, “$75 oil! When did that happen.� � “Today!� And that was the middle of April.
So if you go back and you look at the astonishing climb from $10 a barrel back at the end of 1998, all the way up to $78 a barrel after the Prudhoe Bay pipeline disaster was announced � all along the way you have a sharp spike up, and then it kind of runs out of steam and it starts collapsing, and then it kind of settles, and then some other event heads it back up again. And all we’re doing basically is setting new floors. So I think what we’ve now pretty effectively done is tested the 60 floor, and said, “Ok, the next time we have an event then the question is can we break the $80 ceiling?� I’ve never been one to even try to imagine you can speculate the future movement of prices, but I think the reality is there is nothing out there that is likely to bring on a significant amount of new supply between now and 2012 and 2013. And that’s a long period of time to go where all your risk is downside risk on supply. [18:56]
JIM: The thing that I find more astonishing, obviously supply has to grow to provide for it, yet the greatest source of new supply is going to be new discoveries, and discoveries peaked over 30 years ago.
MATT: Yes. It’s been a long time since we’ve actually had a new virgin area discovered. In fact, the irony is the last 3 great areas to be discovered all happened between 67 and 69. They were Western Siberia, the North Slope and finally the North Sea. Now, in the meantime, we have perfected the technology starting in the early 70s to basically go extend abilities in the ocean to produce oil beyond about 200 feet; and that ultimately led to the creation of deep-water, which was the last big supply growth. But if you look at the deep-water production which is on now, and the steep decline curves that happen in all of these deep-water fields after about 3 or 4 years of production, my guess is that we are probably now seeing deep-water production nearing its peak.
And then if we were lucky enough, let’s say basically Congress in the United States came to their senses and said, “isn’t it important for the future of our economy to get rid of all of our drilling bans, and start on a desperate search to see what we might have in 90% of our outer Continental shelf that’s never seen a drill bit,� and we found another North Sea. It took 30 years to build a North Sea up from zero to 6.1 million barrels a day, and in 7 years it’s down 50%. So I think we’ve sort of run out the clock to introduce some form of viable new supply that could allow demand to continue their rapid path that’s it’s grown over the last 20 years. [20:53]
JIM: In one of your recent speeches you gave at the ASPO conference in Boston in October, you talked about these discoveries and you also talked about how you became really a data researcher looking into the data. Why do you think others are not doing the same thing you’re doing? In other words, where does CERA get these numbers? Where do these optimists get these numbers, because obviously they’re not looking at the same data you’re looking at?
MATT: What I find interesting about the last 2 or 3 years of CERA reports is they all basically say “based on a detailed field by field study,� and I don’t know where they’re getting the data. In the Summer, they came up with an unbelievably bullish report on the growth of oil supplies through I think 2013 or 2015, and they said it was based on 367 specific fields. I would be incredibly surprised if there are over 100 specific fields that are basically on the blackboard to develop that actually now have a name; and anything that doesn’t have a name is just a prospect of what you hope will be a field. I hate to say� but they probably do have some proprietary [data]base, but then they don’t want to share it with anybody.
Most of the other guys that I run into that we argue about this all the time are laden with theories, but what they’re really devoid of is any specifics on facts, and I guess it’s only because I am sort of a data nut that I happen to have just a ton of facts � a lot of the facts aren’t perfect data but they’re a lot better than no data. [22:08]
JIM: The thing that we’re focused on right now is global warming which is caused, according to some experts, by the burning of fossil fuels. But if fossil fuel consumption is about ready to peak with peak oil, it seems to me the problem begins to solve itself.
MATT: If in fact that’s the cause of global warming or climate change as I like to say. Again, that’s an area I read with interest but I say, “that’s someone else’s issue.� But ironically in a very insidious �for all the wrong reasons’, we do start to change significantly the CO2 emissions, other than the fact that it’s going to be very encouraging to try to make up the gap in some of this stuff in the use of coal. And there’s no question the use of coal creates unbelievably greater volumes of CO2 and other bad emissions than the use of natural gas or crude oil. [22:59]
JIM: The thing that strikes me, if you were to summarize this, looking at where we are today: we know that energy demand growth has been relentless � especially in Asia and India and emerging markets, and the United States; we’ve got declining new discoveries; we have growing regions now in productivity decline � just look at Mexico, and even Kuwait; lack of spare capacity which proves itself every time we have a disruption whether it’s a terrorist event or an act of nature; we have maturing strategic assets. The energy infrastructure itself needs to be rebuilt � it’s in disrepair; and today, you have a lack of people � I mean who wanted to become a petroleum geologist and work in the oil business in the 80s and 90s; we have a shortage of rigs; new projects � a shortage of those. It’s like you point out in several of your speeches, there is really a disconnect between the data and conventional energy wisdom. I mean today we’re looking at prices of oil below $60 a barrel. In my mind they shouldn’t be below 60.
MATT: No, and we’re giving the stuff away. How the disconnect happens I don’t have any idea � except for the fact that for the last 50 years, we all lived under the illusion that the Middle East was laden with so much oil that had almost no cost to it, that basically it was going to be a permanent ceiling on keeping the price of oil permanently low. And then I come along and stumble on to some databases of real research papers, and discover that was a myth too.
It hasn’t been the first time, I liken back to the irony that all of us in our 50s and 60s and 70s kind of grew up under the illusion of the Cold War, and the illusion that the USSR was an economic superpower at least equal to us � maybe even stronger � and it took the wall coming down for all of a sudden everyone to realize, “oh no, they’re actually a Third World country.� It’s amazing what the human mind has the ability to do to pretend and imagine. I guess it isn’t human nature to basically just search for data first. I think you kind of have to have some sort of a whacky analyst bent, and I think luckily I just became that. But it does give you a very different look at the world when you actually start out with real data. And the reality of things like the drilling rig scarcity and the people scarcity and the project scarcity � to start to say where are these optimists coming from? Oil field technology is a painfully slow process, and the blackboard for new technology today is as empty as it’s ever been in the last 40 years. There’s nothing being worked on. [25:38]
JIM: Given that, do you see any change? � I know we have this Congressional report that’s supposed to come out I think the end of this month when they’re looking into peak oil.
MATT: The GAO report. And then the National Petroleum Council has a massive effort going on that they tackled only because Secretary Bodman sent a letter last Fall saying, “I would really like a comprehensive study about peak oil,� � that will be coming out sort of mid-way next year. And I think in both cases, who knows what the GAO report will say but I know when they spent an afternoon in my office about 5 months ago, they were asking all the right questions. We’re slowly but surely getting smarter about the issue. And I think it’s interesting to see how many people used to read an executive summary of a CERA report and would say, “Well, that must gospel,� are now saying, “where are those people coming from?� [26:25]
JIM: Do you think there’s any chance in the new Congress that begins in January that energy policy will change, or we’ll get serious about this issue?
MATT: No. I’m kind of resigned unfortunately to a belief that we’ve gone so long, and it’s so controversial, and it didn’t matter who controlled the Congress that until we have a crisis we’re not going to do anything. We’re going to have to have an energy 9/11. [26:48]
JIM: We’ve been fortunate in the sense that if you take a look at the last 2 or 3 Winters, we’ve been able to avoid one of those 9/11s. I can’t imagine what would happen if we had 3 weeks of continuous cold front on the East coast where we were drawing down natural gas storage that the reality of natural gas would present itself.
MATT: I’ll tell you what NEP Pool � the New England Power Pool � [said when they] issued a warning a year ago last October, is that a 10 day to 2 week cold snap in the Northeast would likely induce a blackout because none of the utilities which are very reliant on natural gas had any supply contracts. And if the cold snap hits the Northeast it’s likely to hit further South, and it’ll be used up before it gets to New England. If we ever had a one week to 10 day blackout in frigid weather, I can’t imagine the impact that would have on human health. I think we all forget you take an elderly person or a person who just doesn’t have a very strong body, and leave them in a room that’s 40 degrees, for a day or two � and it’s just like floating in water, you get hypothermia just as effectively. And with a big area wide blackout, how we would evacuate New England would be one of the real crisis stories of the history of the United States. The fact that we were basically spared by the bell of warm weather, and then we basically casually used that opportunity to kind of get mad at people that warned that we had a problem is really amazing � and very discouraging. [28:18]
JIM: And when you see other countries that are building nuclear power plants or doing something serious about it, drilling as much as they can � look what China is doing in its efforts to acquire energy resources around the globe.
MATT: Yup, you look at the seriousness that the European Union is now taking when all of a sudden it has now dawned on them that Gazprom had nearly all of their fields in permanent decline, and yet Europe had blissfully relied on the next 20 years of their natural gas coming from Western Siberia because they had contracted for it. And now there’s a genuine panic among the serious energy planners saying how fast can we build nuclear plants. And what we don’t know about nuclear plants is first of all how energy much you consume in building a nuclear plant because it’s a massive use of concrete and steel; and secondly, our reliability of proven, usable enrichment-grade uranium is skimpy as can be. [29:09]
JIM: And that’s the other problem, too, because aren’t we running large supply deficits in uranium?
MATT: Well, we basically worked off about a decade and a half overhang of weapon-grade nuclear waste which could be processed into usable atomic energy; and which is the reason why uranium prices have soared so much in the last couple of years. [29:29]
JIM: Now, one of the popular theories that you have going around in the financial world right now, the only reason that we have oil prices at $60 or uranium at $60 is hedge funds.
MATT: We do a lot of business with hedge funds, and yeah, I think hedge fund managers drive cars, but I don’t think hedge funds actually consume oil. [29:51]
JIM: They don’t consume it, but if they buy it, or if they’re going into the futures market like that one hedge fund in natural gas � the theory is because they’re buying it they’re driving the price up. But really the demand for it � other than these hedge funds � isn’t as strong as the price would relate.
MATT: The thing about energy contracts is it’s a zero-sum game. For every buyer there has to be a seller. [30:14]
JIM: I would suspect since a lot of this takes place in the paper markets, people are just trading energy contracts, I would suspect if these guys went and started to try to take delivery on natural gas and oil it would be a different picture.
MATT: No, I don’t think from the best knowledge that I’ve tried to get in this area and having from time to time having invested pretty actively in NYMEX contracts, there’s no evidence that even 1% of the open interest ever hangs around at closing to take delivery. [30:46]
JIM: And so really what you have is just financial speculation and because of that, it’s really distorting.
MATT: Yes, it creates the illusion of a price signal because we tore up contracts, and natural gas and oil prices have no idea of where they should be until the Nymex closes and then de facto that becomes the cash market because the traders know best.
JIM: Energy was hot until up about the end of August, the hurricane season was benign and so natural gas went down and oil went down � yet you have companies today that are selling at 6 times earnings, 7 times earnings. Matt, if you were investing in this area today, what areas would you be looking at?
MATT: First of all, because I’m the Chairman of an investment banking firm that deals only in energy we don’t ever trade energy stocks, so the things that I invest in I look at as a private placement, and some of my holdings have gone back for 10 or 15 years. And I think the well managed service companies, they don’t have an exploration risk. You get a global play. I think the big challenge for the service industry is by and large their asset base is just as old and rusty as the rest of the system. So there has to be a lot of cash flow spent in replacing the asset base and it’s going to be tough hanging on to good people.
I think energy is going to be a lot safer place to invest in than a lot of other parts of the economy, but I also think that there’s no safe harbor. And the idea that you can just throw darts at the energy business and pick a winner if prices double from here or go up 50%, even 25% - it takes some sound knowledge to make sure you’re investing in the right type of energy stock.
And I guess I’d have to say if you wanted to basically ask where is the lowest risk? � It’s probably infrastructure rebuilders, probably not the highest net return either. But if we don’t rebuild our oil and gas infrastructure to the extent of at least 50% being replaced over the next 50 years then we’re going to have the indignity of supply being down and deliverability being way further reduced than supply � just because you can’t get it any place. And I literally see a 2 or 3 or 5 trillion dollar investment program rebuilding the energy infrastructure, and obviously that kind of spending creates a strong market for blue collar workers, and an enormous amount of wealth for somebody. [33:06]
JIM: This reminds me of back in the 50s with Sputnik. One day we said, “holy cow, the Russians are putting people in space,� and we woke and then began this serious effort with engineering and R&D. It seems that we have to do almost the same thing here.
MATT: What we have to do is have the Sputnik event though. And unfortunately, I think that with all the unbelievable, overwhelming amount of data that I look at � CERA could be right, there might be a 1% chance of being right, but � the data so heavily argues that we should be preparing for supply to shrink. But I guess until we have a shock, we’re not going to actually look up in the heavens and say, “oh my God, that’s not a shooting star, that’s Sputnik.� [33:53]
JIM: And yet a lot of this infrastructure that you’re talking about � whether it’s adding to drill rigs, repairing them, making platforms in the gulf of Mexico that can withstand heavier weather, rebuilding our rail system � these are projects that you’re not going to do this in a couple of years. They take time, so�
MATT: Oh no, they take a decade.
JIM: And yet that’s something we should be doing now. So it seems like to me the sooner the Sputnik event occurs the better off we’re all going to be rather than looking at the CERA report and saying, “that’s great, I don’t have to worry about that for another couple of decades.�
MATT: You’ve expressed my sentiments a lot more eloquently and gently than I would have. [34:33]
JIM: Well, listen, I know you’re just back from a vacation. I wanted to talk to you and get your take on the CERA report � this was only supposed to be 10 or 15 minutes but as always Matt, you’re very gracious with your time, and I want to thank you for joining us here on the Financial Sense Newshour.
MATT: You’re very welcome. You ask some excellent questions, and I think you’re looking at exactly the right issues. I applaud you.
JIM: Well, thanks Matt, and all the best to you.
And remember, you can get Matt’s book, Twilight in the Desert, now out in paperback.
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