Oil – The Next Revolution

EXECUTIVE SUMMARY (Excerpt of the full text)

Contrary to what most people believe, oil supply capacity is growing worldwide at such an unprecedented level that it might outpace consumption. This could lead to a glut of overproduction and a steep dip in oil prices.

Based on original, bottom-up, field-by-field analysis of most oil exploration and development projects in the world, this paper suggests that an unrestricted, additional production (the level of production targeted by each single project, according to its schedule, unadjusted for risk) of more than 49 million barrels per day of oil (crude oil and natural gas liquids, or NGLs) is targeted for 2020, the equivalent of more than half the current world production capacity of 93 mbd.

After adjusting this substantial figure considering the risk factors affecting the actual accomplishment of the projects on a country-by-country basis, the additional production that could come by 2020 is about 29 mbd. Factoring in depletion rates of currently producing oilfields and their “reserve growth” (the estimated increases in crude oil, natural gas, and natural gas liquids that could be added to existing reserves through extension, revision, improved recovery efficiency, and the discovery of new pools or reservoirs), the net additional production capacity by 2020 could be 17.6 mbd, yielding a world oil production capacity of 110.6 mbd by that date. This would represent the most significant increase in any decade since the 1980s…. the economic prerequisite for this new production to develop is a long-term price of oil of $70 per barrel. Indeed, at current costs, less than 20 percent of the new production seems  profitable at prices lower than this level.

Matthew Simmons, energy investment banking CEO who made world headlines with his definitive work, Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, was wrong. Peak oil is not coming, nor is it on the near-term horizon. The gist of Simmon’s exhaustive and indisputable research was that about 40% of global oil production came from less than a hundred “super-giant” oil fields, all of which had been discovered over thirty years ago and were already in a state of advanced age. He accurately argued that these venerable oil fields – the crux of seventy years of the global energy economy – were about to reach peak production and that no technology, however advanced it could be, would do anything more than slightly delay or ameliorate the production decline. Simmons over-reached, however, by arguing that unconventional production would never be sufficient to counteract the decline in production from the great super-giant oil fields. As can be seen below, Simmons was right, when he wrote in 2005, that conventional oil production was about to peak (conventional production peaked in 2006), but since then unconventional production has taken up the slack and then some.

The revolutionary changes occurring right now in the industry, spurred by George P. Mitchell’s discovery of how to use horizontal hydraulic fracturing techniques to profitably exploit tight oil shales are one of the most important and least foreseen factors currently at work in the American economy. However, as I have previously reported on, the benefits of this revolution in the energy markets are poised to be poorly distributed and otherwise impeded by an insufficient energy infrastructure. Pipeline bottlenecks have gotten so out of hand that Bakken oil is now being barged down the Missisippi. The national energy infrastructure is in the sorry state that it is because, as recently as ten years ago, no one anticipated the U.S. to become a resurgent oil power. In natural gas especially, every analyst was expecting (accurately) significant depletion of the nation’s conventional production, increasing the nation’s reliance on imports. $100 billion was invested in various LNG import facilities that are now largely redundant. Cheniere Energy is one of the firms that was founded in anticipation of increasing American LNG imports, and invested billions of dollars in building an import terminal that is now operating well below capacity.

As of right now, the U.S. has almost no operational capacity to export natural gas, aside from a relatively small Chevron-managed Alaskan facility that exports almost all of its product to Japan. This is an unusually extreme infrastructure failure due to, 1) the sheer profitability of successfully engaging in LNG exports, and 2) the thousands of buy-side and sell-side counterparties who would be willing to pay top dollar, right now, for the ability to export American natural gas if the capacity existed.

Cheniere Energy (ticker symbol:NYSE, AMEX: CQP) is the only U.S. company that will in the short to medium medium term have the ability to export natural gas to the rest of the world, where prices can from $14-$22 per mbtu. In the near future, I’ll be writing an article on Cheniere as an investment thesis.

In the meantime, I would suggest that you read the full text of the Harvard Kennedy School’s excellent piece of research, Oil – The Next Revolution, written by Leonardo Maugerie, a former ENI SVP and one of the world’s greatest authorities on the direction of the energy markets.