Global Oil Supply:From Peak to Plateau

Despite persistent weakness in North American natural gas prices, the recent slump in worldwide crude prices and geopolitical crises across many regions, delegates to the inaugural Oil & Gas Supply/Demand Symposium held in New York in late June were generally sanguine about oil and gas investment.

To be sure, the bears warned that booming oil demand from the developing world is beginning to slow. Even so, “this is a good time for market entry,” said Steven Kopits, New York director at global energy business analysts Douglas-Westwood. “For both oil and gas, there are good entry points out there.”

Kopits said “the fundamentals worldwide support an oil price of $105 a barrel. It is true that at the moment the price for oil is rising more slowly than are exploration and production costs, but there is lots of latent demand.

“If you can produce oil at $100 per barrel, the demand looks effectively infinite.”

Douglas-Westwood’s thesis is that industrialized countries have lower carrying prices for oil than do developing nations. Kopits pegged the U.S. carrying cost at $95 a barrel, but China’s cost is about $115. When prices crest the carrying capacity of industrial countries, consumption falls, with volume ceded to emerging economies. Indeed, advancedeconomy consumers—not oil producers—have been providing 85% of the increased oil consumption of emerging economies since the start of the Great Recession, said Kopits.

“The U.S. is fundamentally energy-starved,” he said. “Even allowing for the effects of the recession, demand should be 22 million barrels a day, but it is only at 18.4, down 16% from trend projection. The much-touted U.S. energy self-sufficiency is really just the U.S. being bid out of international markets. It’s really just the continuation of a process that began in 2005, and we don’t see the fundamental trend reversing any time soon.”

Edward Morse, managing director and global head of commodities research at Citigroup Global Markets, is among those doubting the developing world can extend the energy-consumption growth of recent years. “Long-term, the outlook for oil is bearish,” he said. “There is already an incredible slowdown in the Chinese economy. That is a very powerful story.”

Overall energy demand in the Chinese economy is decelerating faster than central government policy can respond, Morse said,

“but there will be aggressive moves once the leadership changes again.”

At the same time, he added, “North America is the new Mideast. It is the fastest-growing supply center in the world.”

North Dakota’s surge to second place in domestic production has gotten a lot of attention, but the No. 1 ranking is just as big a story. “Texas will add 500,000 barrels a day of production this year and is likely to do so again every 12 months for the next few years,” he said.

Similar factors are at work in Louisiana and offshore. “We are already seeing dislocation in relative crude prices,” Morse said. “Domestic production has backed out Louisiana Light Sweet imports to the U.S. Heavy crudes could be next, but global heavies need the U.S., because this is about the only place with sufficient upgrader capacity.”

A surge from Mexico is next, said Morse. “We are going to see some big surprises in Mexico. Once the election is over and the new government gets settled, we are going to see some big announcements in the Gulf of Mexico and in Pemex growth projections. It is not unlikely that Mexico will add significantly to its reserves and its production.”

Even with North American supply growth and reduced demand from China and emerging nations, “the key macroeconomic risk in the oil markets today is Saudi overproduction,” especially in reaction to an event such as a strike on Iran, Morse said. “The last time we saw demand collapse, in 1997-1998, the price of oil fell from $30 a barrel to $10, or two-thirds.”

Several speakers questioned the value of associated liquids that have been juicing production logs and balance sheets.

According to Mark Lewis, managing director and global head of energy research at Deutsche Bank, an alarmingly large portion of the overall global increase in liquids production has been driven by natural gas liquids (NGLs). “Real crude has almost been flat,” he said.

The problem is that crude is counted as providing 6.3 gigajoules of energy per barrel, while NGLs are rated at 4.6. “The net increase in actual energy to the world has been only 1.3%,” Lewis said. “At the same time, we averaged more than $100 a barrel for crude last year, the first time ever that the yearly average was in the triple digits. The macro situation is looking worse by the moment.”

An oil plateau?

Ray Leonard, president and chief executive officer of Houston-based Hyperdynamics Corp., said discussions of “peak oil” have given way to the idea of an oil plateau. “Conventional oil production passed new discoveries around 1985, and peaked in 2005,” he said. “The gap has been filled with production from the deep water and unconventional resources.”

OPEC holds 73% of the conventional reserves in the world, but produces 40% of the actual supply; Russia and the former Soviet Union hold 13% of the reserves, but produce 20%; and the rest of the world holds just 14% of conventional reserves, but produces 40% of present supply. “That situation is clearly not sustainable,” he said.

In the near term, among OPEC nations, Persian Gulf production is “rock solid, but non-Gulf OPEC conventional production is declining; deepwater non-Gulf OPEC, notably Angola and Nigeria, is increasing,” he said. “We are now in the golden age of deep water. Peak discovery is upon us. Between 2006 and 2010, half of all the discoveries in the world were in deep water. Peak production is likely by 2020, at about 11 million barrels a day.”

A significant problem with deepwater exploration “is that on land, well workover is cheap,” he said. “In the far offshore, it is prohibitively expensive. So we see rapid decline and rapid abandonment.”

By the time the golden age of deep water is past, the golden age of unconventional gas and oil will be in full flower. “It will take at least another 10 years for shale oil to be a major source worldwide,” he said. “But we have to bear in mind a 75% decline curve.

“Shale oil just passed 1 million barrels a day and will be double that by 2015. I expect it will level off at 3 million barrels a day.”

Jason Stevens, director of energy equity research at Morningstar, expects a tighter time frame, saying tight-oil production will reach 3 million barrels a day by 2015. “We understand that our forecast is higher than that of the EIA (Energy Information Administration), but we believe that the number of emerging tight basins, from the Utica in Ohio and the Cline in the Permian Basin to the Austin Chalk, Tuscaloosa Marine and Brown Dense, will have the potential to be very prolific once producers figure them out.”

Morningstar also expects oil prices to stay relatively high versus natural gas prices, supporting continued exploration and development of unconventional resources . “Shale gas collapsed the price of gas in North America,” said Stevens, “but that was a regional market. Oil is a global market, and shale oil will not collapse the price of oil. Rather, it may widen WTI-Brent differentials.”

Beyond the vast latent demand potential in the global market, “tight oil is constrained by the availability and prices of oilfield services prior to production, and then take-away capacity in most basins after production begins,” said Stevens. He added that the bulk of investment today, even in historic oil regions like West Texas, is for transportation for oil and gas and for gas processing.

The age of plateau oil is also the age of price-sensitive oil. “All the cheap, easy oil is gone,” said Leonard. “The only question is how do we deal with that reality? What are we willing to pay for? Generally, $70 to $90 is the transition range. Below $90 a barrel some production becomes marginal. Below $80 you start to see a decrease in production. And $70 is the floor.”

Tancred C. M. Lidderdale, head of short-term forecasting for the EIA, was forthright about “the reality of uncertainty. Pay attention …to the story behind the forecast.”

Under new chief administrator Adam Sieminski, formerly of Deutsche Bank, the EIA has begun to publish a price uncertainty chart showing the relationship between how commodity and financial markets view oil and gas. Also, the EIA will begin adding Brent prices to its calculations.

Morningstar, Douglas-Westwood, and Ravenna Capital Management sponsored the symposium (see oilwildcards.com? ).