Oil Price in the Market - The actual state of Supply and Demand

8/14/2019 Oil Price in the Market - The actual state of Supply and Demand

1/44

WHAT KANGAROO COURT CREATEDOUR OIL AND GAS MARKETS?

Australian American Chamber of Commerce HoustonJanuary 29, 2009

Houston, TXBy:

Matthew R. Simmons, ChairmanSimmons & Company International

GEOPOLITICS MARKETS ECONOMY

DEMANDSUPPLY


2/44

The Turmoil In Global Oil And Gas MarketsIs Ridiculous

Market structure for how we run worlds most importantbusiness must have beencreated by a kangaroo courtin the Billabong.

USSRs central planning dida better job than the freemarket system did for oiland gas.

We now have a turbulent market for oil, and worse forgas.

Left unchanged, it could destroy the global economy.


3/44

Chaos In Current Energy Markets IsSerious And Getting Worse

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

The flashing signs of trouble ahead began two decadesago.

But, few wanted to listen to the naysayers and manywanted to hear from the optimists.

So, the kangaroo court ruled in favor if the optimists. Lets go back to a year ago and see what happened.


4/44

2008: Oils Annus Horribilis

2008 started out so bright for 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

by early July (+53%) Prices took a breather through mid-September Then, prices plunged 74% in next 3 months

1992 is not a year 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.


5/44

The Big Question As2008 Came Crashing To An End

Why did prices spike so high?

Why did oil prices then crash?

Many pundits answered byobserving: Prices spiked because

of speculation Prices collapsed because:

Speculators went AWOLOil demand began toplungeOil gluts quickly emerged


6/44

The Spike And The Collapse Were Asymmetric

The spike topped off a 15 foldincrease from under $10 in1998 to $147 in 2008.

The 3 month plunge took oilprices back to where they werein November 2003.

Were both anomalies?Will we ever know?

?


7/44

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.


8/44

What Is A Fair Price For Oil?

Oil prices will stay at $5 for adecade or two.(The Economist cover story March, 1999)

$27 oil price is fair.(British Petroleums Lord Browne October, 2004)

$30 - $45 oil price is fair.(Shells John Huffmeister January 6, 2008)

$75 oil price is fair.(King Abdullah of Saudi Aramco December 2008)

Maybe oil is soplentiful that it

has no fair price!

Multiple Quiz

Fools Gold?Just another commodity?Worlds most preciousnatural resource?


9/44

Nothing Goes Straight Up!

Oil price 15 fold rise had manyretractions.

But each dip soon became a new

high. These are normal

prices.

When inflation adjusted(CPI) the picturealtered.

1990

2008


10/44

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 liquidsOther liquidsRefinery processing gainsOccasional 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.


11/44

Why Did Crude Supply Not Keep PaceWith 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 modelingallowed greater amounts of trapped oil to be drained.

But, all this still created flattening of crude oil supply in last few years.


12/44

Did Oil Field Technology Not Work?

If so many new wells weredrilled and so much moneyspent, was it wasted?

No. These projects werecritical to offset acceleratingdecline rates from maturefields.

The big problem: All new discoveries were either small or in deepwater All peak fast and decline fast


13/44

Long-Term Supply Trend GotUglier By The Year

>800 super-giant, giant and largeoil fields comprise 58% of worldscrude supply.

Other 42% comes from 70,000small to tiny fields (average fieldproduction 440 bbls/day).

Foundations of worlds oil supplycomes from 356 super-giant oilfields. Almost all are matureand past peak.

IEAs WEO 2008 Supply Outlooklaid bare some ugly facts.


14/44

The Era Of Cheap Oil Is Over(IEA November 14, 2008)


15/44

Has Crude Oil Now Peaked?

Hard data argues thatsustained peak supplyreached in 2005.

Too many key producing

countries are now inirreversible productiondecline.

Only a handful of keyproducers have some growth

left: Angola Brazil Sudan (?) Canadas heavy oil (?) Source: EIA Monthly Energy Report March 2008


16/44

Detailed Peek IntoWhy 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!

*Now in decline, too.

Source: Highly regarded confidential supply model.

Major Increased Crude 2005 2008 Change

Russia* 9,185 9,520 335Azerbaijan 454 895 441Kazakhstan 1,266 1,412 146China* 3,617 3,810 193Brazil 1,634 1,822 188Iraq 1,992 2,374 382Kuwait* 2,133 2,314 181Angola 1,228 1,847 619Sudan 305 480 175Total 21,814 24,474 2,660Rest of world crude 51,033 46,396 (4,637)Net change 72,847 70,870 (1,977)

------------- MMB/Day -------------


17/44

A New Look AtBest-In-Class Supply Model

Source: Highly regarded confidential supply model.

ConventionalNon-

Conventional ConventionalNon-

Conventional

USA 5,877 2,219 4,946 2,579Canada 1,358 1,698 1,409 1,832Mexico 3,333 429 2,804 368

UK 1,600 240 1,304 222Norway 2,506 463 1,941 530Other Europe 743 58 635 84Australia 452 89 472 77New Zealand, Japan 25 28 69 31Russia* 9,185 443 9,520 471Other FSO* 2,162 2,753E. Europe 158 123China* 3,617 3,810Other Asia 2,658 2,636Brazil* 1,634 356 1,822 448Other LA 2,273 1,738Non OPEC, Middle East 1,845 1,611Non OPEC, Africa, Middle East 3,682 2,593OPEC Crude 20,702 20,587Other OPEC 9,037 4,628 10,097 4,959

72,847 10,651 70,870 11,601

2005 2008

-------------------------- MMB/Day -------------------------


18/44

Between 2005 And 2008, A Lot Happened

All worlds 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 almostall important key oil fields.

And, it did not find any easily producible high qualitycrude oil.


19/44

Supply Growth Coming FromJunk Crude (Crud)

In 2005, worlds NGL, bitumen, syncrudes and other supply totaled 10,651 MMB/D.

By 2008, these tough to

process non-conventionalcrudes grew to 11,598 MMB/D.

These slivers of junk crude arehard to grow and harder to

refine into light finishedproducts.

They are easy to turn into asphalt!


20/44

The Supply Picture Is Not Pretty(And Explains $147 Oil)

There are no bright spots on supply horizon.

There are many flashing red lights indicatingall is not well:

Civil unrest in key oil producingregions 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.


21/44

What Explains The Crude Oil Price Collapse?

Media and pundits say: Speculators left the game

that created spike Unraveling economy killed

off demand Gluts are now endemic:

Tank farms brimming with oilSuper-tankers now floatingoil gluts

But, none of these factscan be proven.

Only clear fact: Crude oil fell 74% in 12 weeks(September 22 nd December 22 nd).

$0

$20

$40

$60

$80

$100

$120

$140

$160

7/1/08 8/1/08 9/1/08 10/1/08 11/1/08 12/1/08Source: Bloomberg

Crude Oil Price History Jun Dec 2008


22/44

Are We Missing The Black Swan?

Credit default swapindex soared as crudeoil plunged.

Credit freeze beganwhen oil collapsed.

This had to hurt tradersability to own oil contracts.

If any traders ever hadto liquidate contracts,this would cause oil prices to temporarily fall.

Glencore (aka Marc Rich & Co AG) Energy Trading Credit

default swaps illustrate the squeeze.

40

60

80

100

120

140

1600

500

1,000

1,500

2,000

2,500

3,000

3,500

U S D / B B L ( I n v e r t e

d A x

i s )

U S D

Glencoore SR CDS 5 yr (USD)

WTI (USD/bbl)


23/44

Are Current Oil Prices Now Fair?

NO! They are dangerously low.

Middle East producers now facingdeficit spending.

Key projects have beenpostponed or cancelled.

Drilling rigs are being laid down.

New rigs are facing creditproblems with shipyards.

Industry economics do not workat current prices.


24/44


25/44

Is There An Oil Price That BeginsTo Cut This Gordian Knot?

There is no hard data toshed light on this.

$150 oil with a permanentfloor might help for a while.

But, this does not: Find more oil Quickly build additional new

drilling rigs Recruit and train oil workforce


26/44

When Do Oil Prices Get So HighThey Really Hurt Economies?

Through 2007 - 1 st half 2008, many key consumingregions paid retail prices for gasoline at $8 to $11 pergallon.

This translates to $378 - $462/bbl for oil and noeconomic pain was evident.

How the wellhead revenue for high oil prices gets

reinvested is key to insure high prices help, not hurt,global economies.


27/44

Natural Gas SupplyIn Worse Shape Than Crude Oil

Conventional North American gaspeaked decades ago: USAs 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 toxicgases and metals.

Growing amount of gas is wet gascoming from gas caps of old oil fields.

Most global proven gas reserves havenever properly been discovered.


28/44

Natural Gas ProductionDecline Rates Are Amazing

Since natural gas is a vapor, it can be produced at extremely highrates, but once it declines, rates can range from 30% - 65% perannum.

Tight rock gas can

be fractured or acidizedto create high flow ratesfor short periods.

Shale gas resourcebase 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


29/44

U.S. Natural Gas PricesFell Further Than Crude Oil

By early 2008, gas analysts began predicting a comingglut of shale gas. This createdheavy pressure on gas prices.

By end of year, natural gasprices were back to $3.50 to$5.00 range (BOE equivalentof $21 - $30 oil).

Gas rig count began to plunge.

Shale gas needs high prices to be economically viable.


30/44

Russian Gas Crisis Almost Froze Europe

On January 1, 2009 a bitterArctic blast froze Russia.

Putin had a tough decision ashigh amount of their gas wascommitted to Europe (at highprices).

Russia did not have enoughgas for peak winter in Russia

and Europe, let alone Ukraine. So, they closed their taps and Europe almost froze.

This problem was not political. It was mature Siberian giant gasfields in steep decline.

Source: CBCNews.ca January 9, 2009


31/44

Russias Big Three ProblemsWill Never Get Better

Russias three top gas fields produce 65% 70% of its gas. All have peaked. Urengoy is the Ghawar of

global gas:

It peaked in the mid-1990s at305 bcm/year

By 2000, Urengoys productionwas 145 bcm/year

By 2015, production is estimated

to fall to 70 bcm/year Yamburgs decline is close behind. Zapolyarnoye came on stream one year ago and is just starting to

decline.

10

60

110

160

210

260

310

360

410

1999 2000 2001 2002 2003 2004 2010 2015 2020

Zapolyarnoye

Yamburg

Urengoy


32/44

Gas To Liquids (GTL)Is Outrageously Expensive

Shells Pearl GTL project is worldsmost costly new energy project: Construction is 50% complete Cost estimates range from

$15 - $30 billion It consumed 100,000 tons of pipingsteel, 100,000 tons of structuralsteel and 100,000 tons of steelequipment

It will produce 140,000 barrels perday of distillate plus high volume ofsulfur and some condensate .

Its gas reserves are tough toproduce.
http://www.hydrocarbons-technology.com/projects/pearl/


33/44

Global Refinery SqueezeIs Another Bottleneck

Most of worlds key refineries are extremely old and not suited toconvert heavy crude into light finished products.

Nameplate capacity is misleading as 10% 15% of refineries need tobe shut down at unspecified times.

Only a fraction of globalrefineries are new.

Average age of USArefinery complex is over 80years.

Refineries wear out (andexplode when run at fullcapacity).

h dd


34/44

High Prices Do Not AddressOil Industrys Twin Cancers

Two issues threaten oil industrys sustainability.

Both took decades todevelop into twin cancers.

Neither has any clear,quick resolution.

Both could take decades

to redress.

The Issues

People Crisis

Rust

l d l


35/44

Unresolved People CrisisWill Cripple Global Industry

High percentage of current employee base of global oil industry will retire in next5 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?


36/44

Rust Is A More Serious Twin Disease

Rust is code word for aging oildelivery system.

It is all built of steel, which beginsto rust on day one.

Rust never sleeps is timelessmaritime phrase. High percentage of delivery

system from well bores,gathering system, tank farms,pipelines, tankers, refineries, rigs, other oil service assets andservice 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.

C i R Will B W ld L


37/44

Conquering Rust Will Be Worlds LargestAnd Most Complex Project

Replacing even 80% of global delivery system of oil will bemore costly and complex than fighting WWII or MarshallPlan.

Total cost might exceed $100 trillion.

Manpower needs could exceed 500,000 to 1 millionengineers, construction workers, etc.

Could the world run out of iron ore and steel in getting thetask done?


38/44

Oil Prices Need To Snap Back Fast

The longer current prices staylow, the higher the odds risethe industry will destroy itself.

Industry leaders/stakeholdersneed to re-examine how littleis known about what sets oilprices, the aging of industrykey assets and the reality that

oil has peaked. Someone needs to abolish

current extreme volatilitybefore it destroys the industry.

Source: Upstream November 28, 2008

N l G P i Sh ld


39/44

Natural Gas Prices ShouldScale At BTU Premium To Oil

Natural gas is worlds only source of instant heat.

In the winter, heat is a gift of God.

In severe cold, lack of heat quicklyleads to hypothermia, which killsquickly.

Gas is scarce and shouldcommand a BTU premium to oil.

Post-Katrina, we briefly had close to BTU parity: $12.65 natural gas $76 oil


40/44

2009 Will Be Year Of Extreme Challenge

If industry leadership keeps heads buriedin sand, they deserve the blame foranguish this is causing.

New Obama Administration needsto get quickly educated on thesekey issues.

Easiest way to crush any economicrecovery is to end up with oil shortage andsky-rocketing oil prices.

Natural gas might be worse shape than oil.

2009 needs to be Year of Enlightenment.


41/44

What To Watch For As 2009 Unfolds

Watch how fast rigs workingslow down.

Watch oil stocks getting tight.

Watch production starting todecline as drilling stops.

Watch OPEC cut too deeplyinto tight market.

Watch the horror of layoffs ending a nascent recruiting era.

Watch for sharp rebound in oil and gas prices when supplydrops outstrip demand.

D Th Oil B i


42/44

Does The Oil BusinessHave To Be Boom And Bust?

Is the industry fated to lurch betweenfeast and famine?

With cost of new oil and gas projectsso high, can anyone survive thisvolatility?

When reality sets in that oil supplyreally peaked, can this usher in aBrave New World in oil?

Or, does this exacerbate viciousvolatility?

Is this oil industry still sustainable?

Not on its current course.

C Th W ld Adj t


43/44

Can The World AdjustTo Having Less Oil To Use?

Not on present global blueprint.

We are heavily embedded in anoil powered economy.

Mobility, agriculture, distribution offood, etc., all depend on plentifuland reliable oil supplies.

90% of world population juststarting down path America andEurope began after WWII.

We have a brief window tochange current path.

Otherwise, future could be crazy.Source: Oil & Gas Middle East , April 2008


44/44

S IMMONS & C OMPANY

INTERNATIONAL

Investment Bankersto the EnergyIndustry

Documents

Oil Price in the Market - The actual state of Supply and Demand