WHAT KANGAROO COURT CREATED

OUR OIL AND GAS MARKETS?

GEOPOLITICS MARKETS ECONOMY

SUPPLY
DEMAND

Australian American Chamber of Commerce Houston

January 29, 2009
Houston, TX
By:
Matthew R. Simmons, Chairman
Simmons & Company International
The Turmoil In Global Oil And Gas Markets
Is Ridiculous

■ Market structure for how we run world’s most important

business must have been
created by a kangaroo court
in the Billabong.
■ USSR’s central planning did
a better job than the “free
market” system did for oil
and gas.
■ We now have a turbulent market for oil, and worse for
gas.
■ Left unchanged, it could destroy the global economy.
 Chaos In Current Energy Markets Is
Serious And Getting Worse

■ But, it all did not have to happen this way.

■ The flashing signs of trouble ahead began two decades

ago.

■ But, few wanted to listen to the “naysayers” and many

wanted to hear from the optimists.

■ So, the kangaroo court ruled in favor if the optimists.

■ Let’s go back to a year ago and see what happened.

 2008: Oil’s Annus Horribilis

■ 2008 started out so “bright” for “1992 is not a year

oil markets:
– Rigs were fully employed
– Oil price was high but not
exorbitant
– Oil regions were booming
■ But, then came “volatility”:
– Prices spiked from $96 to $147
on which I shall look
back with undiluted
pleasure. In the words
of one of my more
sympathetic
correspondents, it has
turned out to be an 'Annus Horribilis'. I
suspect that I am not alone in thinking it
so. Indeed, I suspect that there are very
few people or institutions unaffected by
these last months of worldwide turmoil
and uncertainty.”

by early July (+53%)

– Prices took a breather through mid-September
– Then, prices plunged 74% in next 3 months
 The Big Question As
2008 Came Crashing To An End

■ Why did prices spike so high?

■ Why did oil prices then crash?
■ Many pundits answered by
observing:
– Prices spiked because
of speculation
– Prices collapsed because:
 Speculators went AWOL
 Oil demand began to
plunge
 Oil gluts quickly emerged
The Spike And The Collapse Were Asymmetric

■ The “spike” topped off a 15 fold ?

increase from under $10 in
1998 to $147 in 2008.
■ The 3 month plunge took oil
prices back to where they were
in November 2003.
■ Were both anomalies?
Will we ever know?
“January 2009 Was Not A Good Month”

■ Oil price collapse came to an end.

■ But, price volatility continued to create chaos.
■ And, almost all major supply advances slowed or were
stopped.
■ North American rig count plunged.
■ Rumors of oil glut grew.
■ Rumors of vast amounts of oil stored on tankers grew
rapidly.
■ And, reported oil inventories stayed tight in many key
regions.
 What Is A Fair Price For Oil?

■ Oil prices will stay at $5 for a

decade or two. Maybe oil is so
(The Economist cover story March, 1999) plentiful that it
has no fair price!
■ “$27 oil price is fair.”
(British Petroleum’s Lord Browne – October, 2004)
Multiple Quiz
■ “$30 - $45 oil price is fair.”
(Shell’s John Huffmeister – January 6, 2008)  Fools Gold?
 Just another commodity?
 World’s most precious
■ “$75 oil price is fair.” natural resource?
(King Abdullah of Saudi Aramco – December 2008)
 Nothing Goes Straight Up!

■ Oil price 15 fold rise had many 2008

retractions.
■ But each dip soon became a new
high.
■ These are “normal
prices.”
■ When inflation adjusted
(CPI) the picture
altered.

1990
Why Did Prices Rise 15 Fold In A Decade?

■ 1997 – 2007 fundamentals changed:

– Demand grew by 12.7 MMB/D
– Crude oil production grew by
7.3 MMB/D
– Gap was filled by:
 Increased natural gas liquids
 “Other liquids”
 Refinery processing gains
 Occasional stock liquidation

■ OECD total petroleum stocks:

12/1997: 2,615 million (56 days’ use)
12/2007: 2,566 million (52 days’ use)
■ Along the way, speculators often shorted oil contracts.
Why Did Crude Supply Not Keep Pace
With Demand Growth?

■ E&P spending grew from less than $100 billion to

$400 billion in the decade.
■ By 2008, every quality drilling rig (and other oil service
assets) were employed.
■ Technology gains allowed deepwater/ultra deepwater
exploration.
■ Seismic advances and reservoir simulation modeling
allowed greater amounts of trapped oil to be drained.

But, all this still created “flattening” of

crude oil supply in last few years.
 Did Oil Field Technology Not Work?

■ If so many new wells were

drilled and so much money
spent, was it wasted?
■ No. These projects were
critical to offset accelerating
decline rates from mature
fields.
■ The big problem:
– All new discoveries were either small or in deepwater
– All peak fast and decline fast
 Long-Term Supply Trend Got
Uglier By The Year
■ >800 super-giant, giant and large
oil fields comprise 58% of world’s
crude supply.

■ Other 42% comes from ≈70,000

small to tiny fields (average field
production 440 bbls/day).

■ Foundations of world’s oil supply

comes from 356 super-giant oil
fields. Almost all are “mature”
and past peak.

■ IEA’s WEO 2008 Supply Outlook

laid bare some ugly facts.
“The Era Of Cheap Oil Is Over”
(IEA November 14, 2008)
 Has Crude Oil Now Peaked?

■ Hard data argues that

sustained peak supply
reached in 2005.
■ Too many key producing
countries are now in
irreversible production
decline.
■ Only a handful of key
producers have some growth
left:
– Angola
– Brazil
– Sudan (?)
Source: EIA Monthly Energy Report – March 2008
– Canada’s heavy oil (?)
 Detailed Peek Into
Why Crude Oil Peaked In 2005
■ When only 9 key producing countries show any significant growth, bad sign.
■ When rest of world collectively falls by almost 5 MMB/D, terrible sign!
Major Increased Crude 2005 2008 Change
------------- MMB/Day -------------

Russia* 9,185 9,520 335

Azerbaijan 454 895 441
Kazakhstan 1,266 1,412 146
China* 3,617 3,810 193
Brazil 1,634 1,822 188
Iraq 1,992 2,374 382
Kuwait* 2,133 2,314 181
Angola 1,228 1,847 619
Sudan 305 480 175
Total 21,814 24,474 2,660
Rest of world crude 51,033 46,396 (4,637)
Net change 72,847 70,870 (1,977)

*Now in decline, too.

Source: Highly regarded confidential supply model.
 A New Look At
Best-In-Class Supply Model
2005 2008
Non- Non-
Conventional Conventional Conventional Conventional
-------------------------- MMB/Day -------------------------
USA 5,877 2,219 4,946 2,579
Canada 1,358 1,698 1,409 1,832
Mexico 3,333 429 2,804 368
UK 1,600 240 1,304 222
Norway 2,506 463 1,941 530
Other Europe 743 58 635 84
Australia 452 89 472 77
New Zealand, Japan 25 28 69 31
Russia* 9,185 443 9,520 471
Other FSO* 2,162 2,753
E. Europe 158 123
China* 3,617 3,810
Other Asia 2,658 2,636
Brazil* 1,634 356 1,822 448
Other LA 2,273 1,738
Non OPEC, Middle East 1,845 1,611
Non OPEC, Africa, Middle East 3,682 2,593
OPEC Crude 20,702 20,587
Other OPEC 9,037 4,628 10,097 4,959
72,847 10,651 70,870 11,601

Source: Highly regarded confidential supply model.

Between 2005 And 2008, A Lot Happened

■ All world’s drilling rigs were finally at work.

■ Prices went up at furious pace.
■ Technology advanced ways to bring out more oil flows.
■ E&P spending soared.
■ But, this did not impact rising decline rates for almost
all important key oil fields.
■ And, it did not find any easily producible high quality
crude oil.
 Supply Growth Coming From
Junk Crude (Crud)
■ In 2005, world’s NGL, bitumen, syncrudes and “other
supply” totaled 10,651 MMB/D.
■ By 2008, these tough to
process non-conventional
crudes grew to 11,598 MMB/D.
■ These slivers of junk crude are
hard to grow and harder to
refine into light finished
products.
■ They are easy to turn into asphalt!
The Supply Picture Is Not Pretty
(And Explains $147 Oil)
■ There are no bright spots on supply horizon.
■ There are many flashing red lights indicating
“all is not well”:
– Civil unrest in key oil producing
regions
– Fragile aging infrastructure
– Accelerating decline rates due to oil field
technology

■ Visible oil stocks keep getting “too tight.”

■ These all explain why oil prices rose 15 fold.
What Explains The Crude Oil Price Collapse?

Crude Oil Price History Jun – Dec 2008

■ Media and pundits say: $160

– Speculators left the game $140

that created spike $120

– Unraveling economy killed $100

off demand $80

– Gluts are now endemic: $60

 Tank farms brimming with oil $40

 Super-tankers now floating $20
oil gluts
$0

■ But, none of these “facts” 7/1/08 8/1/08 9/1/08

Source: Bloomberg
10/1/08 11/1/08 12/1/08

can be proven.
■ Only clear fact: “Crude oil fell 74% in 12 weeks”
(September 22nd – December 22nd).
 Are We Missing “The Black Swan?”

■ Credit default swap

3,500 40
Glencoore SR CDS 5 yr (USD)

index soared as crude 3,000

WTI (USD/bbl)
60

oil plunged. 2,500

USD/BBL (Inverted Axis)

80

■ Credit freeze began 2,000

USD
100
when oil collapsed. 1,500

120
■ This had to hurt traders’ 1,000

ability to own oil contracts. 500

140

■ If any traders ever had 0 160

to liquidate contracts,
this would cause oil prices to temporarily fall.
■ Glencore (aka Marc Rich & Co AG) Energy Trading Credit
default swaps illustrate the squeeze.
 Are Current Oil Prices Now “Fair?”

■ NO! They are dangerously low.

■ Middle East producers now facing
deficit spending.
■ Key projects have been
postponed or cancelled.
■ Drilling rigs are being laid down.
■ New rigs are facing credit
problems with shipyards.
■ Industry economics do not work
at current prices.
 What Do We Need Oil Prices To Be?

■ $100 - $147 oil prices did not increase crude supply.

■ It did not alleviate rig and people shortages.

■ It did not stimulate rebuilding a rapidly aging

infrastructure.

■ It also did not cause catastrophic economic damage.

■ It began creating booming prosperity across the oil

world.
 Is There An Oil Price That Begins
To Cut This Gordian Knot?

■ There is no hard data to

shed light on this.
■ $150 oil with a permanent
floor might help for a while.
■ But, this does not:
– “Find more” oil
– Quickly build additional new
drilling rigs
– Recruit and train oil workforce
 When Do Oil Prices Get So High
They Really Hurt Economies?

■ Through 2007 - 1st half 2008, many key consuming

regions paid retail prices for gasoline at $8 to $11 per
gallon.

■ This translates to $378 - $462/bbl for oil and no

economic pain was evident.

■ How the wellhead revenue for high oil prices gets

reinvested is key to insure high prices help, not hurt,
global economies.
 Natural Gas Supply
In Worse Shape Than Crude Oil
■ Conventional North American gas
peaked decades ago:
– USA’s conventional dry gas peaked at
63 bcf/day in 1973
– Its output by 2008 shrank to under
30 bcf/day
■ Growing percentage of global gas
tainted with sulfur and other toxic
gases and metals.
■ Growing amount of gas is “wet gas”
coming from gas caps of old oil fields.
■ Most global proven gas reserves have
never properly been discovered.
 Natural Gas Production
Decline Rates Are Amazing
■ Since natural gas is a vapor, it can be produced at extremely high
rates, but once it declines, rates can range from 30% - 65% per
annum.
■ Tight rock gas can
be fractured or acidized
to create high flow rates
for short periods.
■ Shale gas resource
base is abundant, but:
– It is very energy intensive to get out of ground
– Its decline rates vary by type of shale
– Individual well flows are small
 U.S. Natural Gas Prices
Fell Further Than Crude Oil

■ By early 2008, gas analysts began predicting a coming

glut of shale gas. This created
heavy pressure on gas prices.
■ By end of year, natural gas
prices were back to $3.50 to
$5.00 range (BOE equivalent
of $21 - $30 oil).
■ Gas rig count began to plunge.
■ Shale gas needs high prices to be economically viable.
Russian Gas Crisis Almost Froze Europe

■ On January 1, 2009 a bitter

Arctic blast froze Russia.
■ Putin had a tough decision as
high amount of their gas was
committed to Europe (at high
prices).
■ Russia did not have enough
gas for peak winter in Russia
and Europe, let alone Ukraine. Source: CBCNews.ca – January 9, 2009

■ So, they closed their taps and Europe almost froze.

■ This problem was not political. It was mature Siberian giant gas
fields in steep decline.
 Russia’s “Big Three” Problems
Will Never Get Better
■ Russia’s three top gas fields produce 65% – 70% of its gas.
■ All have peaked. 410

■ Urengoy is the “Ghawar” of 360

310
global gas:
260
Zapolyarnoye
– It peaked in the mid-1990s at
210
305 bcm/year Yamburg
160
– By 2000, Urengoy’s production Urengoy
110
was 145 bcm/year
60
– By 2015, production is estimated
10
to fall to 70 bcm/year 1999 2000 2001 2002 2003 2004 2010 2015 2020

■ Yamburg’s decline is close behind.

■ Zapolyarnoye came on stream one year ago and is just starting to
decline.
 Gas To Liquids (GTL)
Is Outrageously Expensive
■ Shell’s Pearl GTL project is world’s
most costly new energy project:
– Construction is ≈50% complete
– Cost estimates range from
$15 - $30 billion
– It consumed 100,000 tons of piping
steel, 100,000 tons of structural
steel and 100,000 tons of steel
equipment
■ It will produce 140,000 barrels per
day of distillate plus high volume of
sulfur and some condensate.
■ Its gas reserves are tough to
produce.
 Global Refinery Squeeze
Is Another Bottleneck
■ Most of world’s key refineries are extremely old and not suited to
convert heavy crude into light finished products.
■ Nameplate capacity is misleading as 10% – 15% of refineries need to
be shut down at unspecified times.
■ Only a fraction of global
refineries are “new.”
■ Average age of USA
refinery complex is over 80
years.
■ Refineries wear out (and
explode when run at full
capacity).
 High Prices Do Not Address
Oil Industry’s Twin Cancers
■ Two “issues” threaten oil industry’s sustainability.
■ Both took decades to
develop into twin cancers.
■ Neither has any clear,
quick resolution.
■ Both could take decades
to redress.

The “Issues”
■ People Crisis
■ Rust
 Unresolved People Crisis
Will Cripple Global Industry

■ High percentage of current employee base of global oil industry will retire in next
5 – 7 years.
■ This crisis touches every aspect of the industry:
– Rig hands
– Geologists
– Engineers of all disciplines
– Welders
– Manufacturing workers
– Executives across the face of industry
■ How quickly can industry recruit and train millions of employees?
 “Rust” Is A More Serious Twin Disease

■ “Rust” is code word for aging oil

delivery system.
■ It is all built of steel, which begins
to rust on day one.
■ “Rust never sleeps” is timeless
maritime phrase.
■ High percentage of “delivery
system” from well bores,
gathering system, tank farms,
pipelines, tankers, refineries, rigs, other oil service assets and
service stations tanks, etc., etc. beyond original design life.
■ The Band-aid Era is over.
■ The era to rebuild the entire infrastructure has to begin ASAP.
Conquering Rust Will Be World’s Largest
And Most Complex “Project”

■ Replacing even 80% of global delivery system of oil will be

more costly and complex than fighting WWII or Marshall
Plan.
■ Total cost might exceed $100 trillion.
■ Manpower needs could exceed 500,000 to 1 million
engineers, construction workers, etc.
■ Could the world run out of iron ore and steel in getting the
task done?
 Oil Prices Need To “Snap Back” Fast

■ The longer current prices stay

low, the higher the odds rise
the industry will destroy itself.
■ Industry leaders/stakeholders
need to re-examine how little
is known about what sets oil
prices, the aging of industry
key assets and the reality that
oil has peaked.
■ Someone needs to abolish
Source: Upstream – November 28, 2008
current extreme volatility
before it destroys the industry.
 Natural Gas Prices Should
Scale At BTU Premium To Oil
■ Natural gas is world’s only source of instant heat.
■ In the winter, heat is a gift of God.
■ In severe cold, lack of heat quickly
leads to hypothermia, which kills
quickly.
■ Gas is scarce and should
command a BTU premium to oil.
■ Post-Katrina, we briefly had close to BTU parity:
– $12.65 natural gas ≈$76 oil
 2009 Will Be Year Of Extreme Challenge

■ If industry leadership keeps heads buried

in sand, they deserve the blame for
anguish this is causing.
■ New Obama Administration needs
to get quickly educated on these
key issues.
■ Easiest way to crush any economic
recovery is to end up with oil shortage and
sky-rocketing oil prices.
■ Natural gas might be worse shape than oil.
■ 2009 needs to be “Year of Enlightenment.”
 What To Watch For As 2009 Unfolds

■ Watch how fast rigs working

slow down.
■ Watch oil stocks getting tight.
■ Watch production starting to
decline as drilling stops.
■ Watch OPEC cut too deeply
into tight market.
■ Watch the horror of layoffs ending a nascent recruiting era.
■ Watch for sharp rebound in oil and gas prices when supply
drops outstrip demand.
 Does The Oil Business
Have To Be “Boom And Bust?”

■ Is the industry fated to lurch between

feast and famine?
■ With cost of new oil and gas projects
so high, can anyone survive this
volatility?
■ When reality sets in that oil supply
really peaked, can this usher in a
Brave New World in oil?
■ Or, does this exacerbate vicious
volatility?
■ Is this oil industry still sustainable?

Not on its current course.

 Can The World Adjust
To Having Less Oil To Use?
■ Not on present global blueprint.
■ We are heavily embedded in an
oil powered economy.
■ Mobility, agriculture, distribution of
food, etc., all depend on plentiful
and reliable oil supplies.
■ 90% of world population just
starting down path America and
Europe began after WWII.
■ We have a brief window to
change current path.
■ Otherwise, future could be crazy.
Source: Oil & Gas Middle East , April 2008
 SIMMONS & COMPANY
INTERNATIONAL

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to the
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