From an email from www.elder.com (Dr Alexander Elder) "For...

From an email from www.elder.com (Dr Alexander Elder)

"For months I have been writing about Hubbert’s Peak, and today I want to share with you a very informative email from Lew – a reader and an aspiring trader who is professionally involved in the oil industry.

The concept of Hubbert’s Peak is that in order to pump oil you first have to discover it. The rate of oil discovery worldwide has been in a nosedive for several years and almost as much oil is being pumped as is being discovered. The demand for oil is about to outstrip the supply – something from which you as a trader can draw useful conclusions. Please read Lew’s ‘A View from the Oil Pump’ below."

-A VIEW FROM THE OIL PUMP
By Lew W.

I have worked in the oil industry for 25 years, 95% of my time outside the USA. My professional specialty is ultra-deep- water, cutting edge oil and gas drilling technology. As I try to demystify the oil market and comment on Hubbert’s Peak, I want to remind you that I am not trying to provide you with a specific advice. My goal is to outline the pathways for your own considerations. Several industries are interlinked – nuclear, coal, oil/gas, and solar. Let us review them one by one.

OIL & GAS
Most of the land has been explored; deep water represents the remaining opportunity to find oil. Deepwater drilling was created by the USA during 1940-1980. By 1980 we had perfected the offshore rig design, and almost all CEOs of offshore drilling contractors were visionaries who had grown up working on rigs. These visionaries knew some facts most of the public is still unaware of today.

You will note that I use the word “extraction” instead of production. “Production” implies that all it takes to get more oil is build another “production” facility. This is a flawed belief, hence “extraction.” For long term stability, discovery must equal or exceed extraction.


Despite constantly expanding searches, the last super giant oil field was discovered in 1967. The largest oil reservoir in the world, Saudi’s Ghawar field, has been draining since 1951 and is showing signs of decline. The 4 largest fields in the world, all at least 50 years old, provide 12% of world oil supply.
All the super giant and giant fields were in full extraction by 1981, except reserves in Iran and FSU countries surrounding the Caspian Sea, where the political situation prevented access.
Offshore and onshore fields discovered since 1970 are much smaller. Today, an offshore field makes headlines if it is 1% of the size of Ghawar.
In 1981 extraction of oil exceeded discovery of new oil for the first time, a trend that has accelerated for 24 years.


In the early 1980s, the US Gov’t asked the Saudis to ramp up extraction and use the money to help fund covert activities in Afghanistan. The Saudi were able to drill hundreds of wells in their super giant fields, allowing extraction to exceed consumption, though this rapidly drained the giant fields. This surge of Saudi production caused the price of oil to collapse by 1984, destroying the market for offshore drilling. For all practical purposes, by 1985 the US offshore oil drilling industry was dead. A significant factor in the tight oil market today is that from 1982 until 1992, very few oil wells were drilled. When the drilling industry recovered somewhat in the 1990s, the majority of wells were for development of fields discovered in the 1970s, not looking for new oil,

Meanwhile, cheap oil spurred world oil consumption, and the oil cushion began to disappear. Today, the cushion is essentially gone, and all of the giant fields are experiencing extraction declines. Other reservoirs must be developed and new ones found.

Stories of Hubbert’s Peak become popular when oil prices spike. There is actually plenty of oil. We are not in any near or long term danger of running out of oil. However, it will get more expensive as time passes, and it may become VERY expensive in the short term, because we have to make up for years without drilling activity.

In the offshore drilling industry we know several facts:


Oil is found almost everywhere. The world’s largest science project, the Ocean Drilling Program (ODP) has drilled the world’s oceans continuously since 1965. The ODP has found hydrocarbon traces nearly everywhere that sediments are deposited.
While hydrocarbons are common, oil/gas fields are rare. Hydrocarbons are the lightest thing found underground, so they migrate. Hydrocarbons are not found in economic quantities unless there is a “trap” of some sort – an impermeable rock formation shaped like an upside down cup.
As rare as geological traps are, oil reservoirs even more rare. To form a reservoir, the occurrence of a trap must be combined with a porous “sponge-like” rock under the trap so the oil has somewhere to pool, and so that the pool can be drained.
As rare as geological traps with reservoir rocks are, large reservoirs are even more rare.


You can see where this is going. Oil is common, oil reservoirs are rare, and giant oil reservoirs are extremely rare. So, we are not running out of oil, but we stopped discovering cheap oil 40 years ago. With current economics, an oil reservoir in deep water must have about a billion barrels (bbl) of oil to be worth extracting, unless it occurs close to other reservoirs, so that extraction facilities can be shared. About 100 deepwater rigs are currently drilling. About half the fleet is engaged in development work – drilling wells to develop existing fields. The other half is looking for new oil. For discovery to equal consumption all 50 rigs must find 2 large offshore fields, of a billion bbls each, every year. The current success rate is less than half what is needed.

From a discovery point of view, many more offshore wells need to be drilled than we are drilling now. As a trader, watch the construction of offshore rigs. At present, there is little or no construction, but a building boom should start by Q1 2006. Rigs take 2-3 years from purchase order to drilling. Oil takes another 5-10 years from discovery to extraction. Rig count will have little to do with oil supplies in the near term, but will affect the longer term.

The war on Iraq and conflicts over oil in Central Asia will determine the near term price of oil. The remaining giant fields in these areas contain enough cheap oil to hold down oil prices for another 10 years. These fields are land-locked in politically unstable areas. Governments tend to view oil as a strategic resource, and have been maneuvering to gain control of this oil, and prevent others from gaining control, since 1900. Political unrest in Georgia, Chechnya, Iran, Afghanistan, Pakistan, and countries around the eastern Caspian Sea all relate to oil supplies and pipeline routes. For an overview of this conflict read “The New Great Game” by Lutz Kleveman.

Essentially, the situation there is that the US, Russia, China, and several minor players are contesting for oil and oil revenues. The US wants to build a pipeline either through Chechnya & Georgia, or Afghanistan. The Russians want the oil to flow through their pipelines so they can charge transport fees. The Chinese want to build a pipeline to the east, which won’t pass through Russian or US controlled territory. Continued squabbles may prevent this oil from coming online. If the major governments change to peaceful free market tactics, this oil has a good chance to reach the market in sufficient quantities to reduce oil prices for another decade. All solutions EXCEPT a direct pipeline to China would require fleets of tankers for one leg, at high economic cost and environmental risk. Allowing China to buy all of the Central Asian oil would reduce Chinese pressure on world oil prices. However, logic seems to become rare when oil is at stake.

OIL SANDS
There is a lot of talk about the Canadian oil sands but while the quantity of oil is large, the quality is very low, extraction costs are high, and massive quantities of natural gas are required. Oil sands are not likely to contribute significantly for another 5 years, but in 10 years oil sands may represent 1% of the market.

OIL SHALES
These don’t really contain oil, but a close cousin which is relatively expensive to convert. This resource is unlikely to ever contribute to energy needs.

HYDRATES
There are immense hydrate reserves all around the world. The Japanese are currently working hard to figure out how to develop this resource. The quantities are ample, but extraction and distribution costs are high, so hydrates will only be a contributor at $45/bbl or higher. Oil companies are aware of deepwater hydrates and future deepwater drilling budgets may explore this vast resource.

COAL
The demand is strong. In the last few years, coal companies have combined into a few major suppliers. Rising gas prices have driven power plants to switch to coal. US coal exports have soared as other countries want our clean burning coal. All of these forces have combined to boost coal revenues. At present, there is more demand than supply. Coal mines add large per-unit capacity, so coal companies are hesitant to build more without contracts to support extraction long enough to pay off the mine. Coal company profits seem likely to be a sustained trend, especially if the coal companies can figure out how to balance exports and domestic markets. Several of these companies, ACI and BTU in particular, have had solid years and look likely to have a good 12-24 months ahead.

NUCLEAR
There has recently been an increased interest in nuclear power. The major manufacturers have released new designs which are supposedly cleaner, cheaper, and safer. Nuclear has its own “Hubbert’s Peak” and other problems – just like with oil, all the cheap and easy uranium has been found. There is plenty of uranium available, but the price is going up fast. Another factor that gets little discussion is the relationship between oil and uranium. It takes massive quantities of oil to mine uranium. A friend once argued that the only reason nuclear was economically viable was subsidies from the US Government. If US nuclear weapon production were to slow down, nuclear energy might be un-economic.

WIND
Wind power is booming in the USA, but is no threat to oil or coal in the short term. It is twice as expensive as coal per-kW. This gap will tighten as technology matures.

SOLAR
Current solar thermal power generation is cheaper than coal. However, the company owning the technology is holding it real close, so growth is unlikely to have any effect for another decade or longer. Direct solar conversion is currently not competitive.

HYDROGEN
This is not a viable source of energy. It requires more energy to make than it releases when burned. The only reasonably economic source of hydrogen is natural gas, which is in short supply, has tripled in price in the last three years, and looks likely to go even higher. Hydrogen is similar to Star Wars in that it is technically impossible and incredibly expensive but promoted by the government anyway.

FUSION
The secret of fusion had been solved. Two universities are perfecting the process, one in the USA and one in Europe. Physicists thought of achieving a sustained fusion reaction using ultrasonic energy focused on a glass of heavy water (deuterium). A few months ago fusion using this technique was successfully achieved in a lab. This is exciting because instead of futuristic magnetic bottles and high temperature plasmas it uses a glass of water and well known relatively low technology sound equipment. There are a number of details to be worked out, but physicists estimate that in 10 to 20 years we will have commercial fusion reactors using deuterium for fuel. Deuterium has an essentially unlimited and relatively cheap supply, obtained by simply centrifuging sea water. US university science R&D funds are at risk, but the Europeans are expanding their efforts.

SUMMARY
From a trader’s point of view, the cost of oil is going to remain high, with fluctuations. The indicators to watch are:

1. Availability of Iraqi, Iranian and central Asian supplies
2. Offshore exploration budgets of major and minor oil companies
3. Rig construction and offshore drilling rig utilization rates
4. War, which always drives prices up"

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Hubbert's Peak reference - http://www.geocities.com/lclane2/hubbertspeak.html

beautiful~