Thursday, May 22, 2008

Oil Primer

Oil Primer

Recently – in the news there is much speculation as to WHY oil prices are so high. Everything from OPEC is to blame to speculators driving up the price. People didn’t care about oil prices or how HIGH they went, until it hit them at the gas pumps.

NOW people need answers and the complexity of how commodities, futures, extraction rates – are too boring or dry for most people to comprehend. They need to point a finger at somebody or a group of people.Politicians and the media will look at everything except the math – in order to make sense of something. It is easier to believe in a conspiracy or hate a group of people – then it is to swallow the math.

Since Hubbert (a geologist predicted the U.S. peak – extraction vs. consumption in 70s), which lead to an oil crisis in this country – other economist, energy traders, geologist, and government agencies have be preparing themselves for the eventual peak.There are some facts about oil - which we ALL need to understand before we start making accusations as to OPEC or Speculators that are driving the price.

1. Extraction Rate (currently aprox. 85 million barrels per day) –Maximum is aprox. 90 million barrels per day

Oil is extracted via pressure.When more oil comes out of the ground – the pressure drops. Water and Gasses are FORCED into the ground to build that pressure back up to extract the oil. All oil wells have a MAXIUM extraction rate.
This is simple physics – you just can’t add more holes in the ground to get it out any faster. You also can only increase the pressure to a certain PSI to maintain maximum extraction. Currently the world is running at 95% of maximum extraction on proven reserves.

2. Consumption Rate (currently aprox. 87 million barrels per day)

Global Demand is 2% per year (compounding)The US has remained relatively flat on oil consumption over the last 3 years. The US makes up about 20% of the entire world’s oil consumption, but is rapidly losing ground to the emerging markets. Global consumption is accelerating – China is increasing at a rate of 5-7% per year.
The US Energy Information Administration (EIA) annual report stated that current demand growth shows as 37% increase from 2007 to 2030 to 118 million barrels per day. Most of the demand will come from emerging markets with China and India at the top. World population growth is expected to be double in 2030 of that in 1980.

3. Reserves

Many people think reserves mean some large tank somewhere with gas in it. Actual reserves are just where the oil is underground. Reserves fall into two categories – proven and unproven. Proven means that we know with a fairly high degree of likelihood as to the amount of oil in the ground and with current technology are able to extract it, unproven fall into two sub-categories (possible and probable) – with different degrees of likelihood. All PROVEN reserves have been found in the world over a couple of decades ago. Only unproven reserves have recently been discovered and either the technology to extract it is either not available or too costly. Currently oil is being extracted from proven reserves at 95-98% of their maximum extraction rate.
SPR – the Strategic Petroleum Reserves are underground caves in the Gulf of Mexico that can store up to 800 million barrels of oil. Currently it has about 700 million barrels. These caves are located near refineries in Texas and Louisiana. The SPR has enough oil to last the U.S. 50-60 days.

At the beginning of May, Congress voted to HALT oil shipments (70,000 barrels per day) to the SPR to FREE up supply. Several countries have SPRs – but collectively they are a fraction of what the monthly global consumption rate is.

4. Reserve LIFE – how much oil based on CURRENT extractions.

This becomes rather skeptical – because we must rely on the country telling us the TRUTH as to their PROVEN oil reserves. .

However – these numbers are extremely suspect as OPEC continues to RAISE the amount of proven oil reserves. Recently it has been revealed; via classified documents that Kuwait has overstated their proven reserves by as much as 50%. Mexico, Russia, and the US are at 10-20 years of oil in their production reserves.
Regardless – if we hold these reserves to be accurate – then most oil fields look to have about 75-100 years left

5. OIL is not GAS The U.S. has a refinery capacity issues

We can only refine the oil at a certain rate – just like extraction. This has traditionally been a bottle neck in this country and we have not built any NEW refineries in the last 20 years. It takes time to convert oil into the other products we need. Remember the SPR is OIL – not GAS!


Time to start focusing on the BIG PICTURE and stop worrying about the minutia and blame game!Like will all commodities – the basic math is about supply vs. demand, nothing more, and nothing less. Oil is a soft commodity – meaning that once it is used you can NOT reuse it or resell it. It is also a depleting commodity – with a finite supply. These two facts are inescapable.

Additionally – regardless of media stories – if we just stick to what we ACTUALLY know – we can draw some simple deductions from the above information.

1. Extra SuppliesThe SPR only has enough oil to last us 50-60 days in a crisis.

There are NO secret warehouses of gas. That means the global pretty much consumes what it extracts on a daily basis (give-or-take a few thousand barrels). It’s sort of like living pay-check to pay-check. You might be up this month, but next month you could be short. Extra supplies can be used up in a couple of days. So what we have today may NOT be here tomorrow. Any talk about extra supplies is fairly silly – when it is obvious (even with the SPR being utilized) we would be out of oil in a few weeks. You also might hear a story about a couple of tankers hording oil, or a warehouse with oil – compared to the daily consumption rates of oil – even in this country – that tanker or warehouse would be dry in a day.

2. Consumption

We continue to ignore what happens in the Global world until it hits us in the pocket book. Rogers, Buffet, Ross, Pickens, and other billionaire investors have been talking about China and the Bull Run in commodities for the last 5 years. They have already been on the train and making billions.
However, we lazy Americans hear the sound-bite and change the channel. For most of us are NOT investors in commodities. We don’t care. But WAIT it is now affecting me at the gas tank. Now we take notice.
China has been growing at an accelerated rate for the last 5 years. Same is true with India and other emerging markets. These countries have been slowly shifting from exporters of raw materials to importers. Cement, Steel, Copper, and OIL – more recently soft commodities (like Rice, Wheat, etc.) they are booming populations, booming manufacturing, booming cities. It is not stopping. They have taken first manufacturing jobs from the U.S., then service jobs, and now commodities. It is not going to stop.
We cannot argue that the math of global consumption WILL and HAS eventually out-paced extraction rates. Even the EIA has predicted a doubling of global population growth by 2030. That population growth is NOT happening in the U.S. it is happening in China and elsewhere. Same is true with consumption – while ours has been flat – theirs is growing at 5-7%.

No one denies (for the most part) including the U.S. government and several oil producing nations that oil is a finite resource, that it can only be extracted at a certain rate, and that we will eventually hit maximum extraction. The debate is WHEN it will happen. Information from the top geologist and scientist and oil experts were pooled for a paper (Hirsch Report) for the U.S. Energy department in 2006 to predict when maximum extraction would happen. They run from 2006 – 2020. Most of the predictions were for 2010.

4. The U.S. Government KNOWS
The U.S. Government had the Energy Agency investigate the oil concern – including the above mention predictions for peak oil (extraction vs. consumption). The government is VERY concern – and the document prepared for the government clearly states the concern in the opening remarks.

Hirsch Report

The peaking of world oil production presents the U.S. and the world with an unprecedented risk management problem. As peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented. Viable mitigation options exist on both the supply and demand sides, but to have substantial impact, they must be initiated more than a decade in advance of peaking.Important observations and conclusions from this study are as follows:
1. When world oil peaking will occur is not known with certainty. A fundamental problem in predicting oil peaking is the poor quality of and possible political biases in world oil reserves data. Some experts believe peaking may occur soon. This study indicates that “soon” is within 20 years.
2. The problems associated with world oil production peaking will not be temporary, and past “energy crisis” experience will provide relatively little guidance. The challenge of oil peaking deserves immediate, serious attention, if risks are to be fully understood and mitigation begun on a timely basis.
3. Oil peaking will create a severe liquid fuels problem for the transportation sector, not an “energy crisis” in the usual sense that term has been used.
4. Peaking will result in dramatically higher oil prices, which will cause protracted economic hardship in the United States and the world. However, the problems are not insoluble. Timely, aggressive mitigation initiatives addressing both the supply and the demand sides of the issue will be required.
5. In the developed nations, the problems will be especially serious. In the developing nations peaking problems have the potential to be much worse.

6. Mitigation will require a minimum of a decade of intense, expensive effort, because the scale of liquid fuels mitigation is inherently extremely large.

7. While greater end-use efficiency is essential, increased efficiency alone will be neither sufficient nor timely enough to solve the problem. Production of large amounts of substitute liquid fuels will be required. A number of commercial or near-commercial substitute fuel production technologies are currently available for deployment, so the production of vast amounts of substitute liquid fuels is feasible with existing technology.

8. Intervention by governments will be required, because the economic and social implications of oil peaking would otherwise be chaotic. The experiences of the 1970s and 1980s offer important guides as to government actions that are desirable and those that are undesirable, but the process will not be easy.


We can certainly continue to be whipsawed by the media or a politician during the election year. We can easily blame OPEC or speculators. We can easily jump when an analyst tells of their predictions. We can easily read TOO much into this story or that. We can easily look to conspiracies. We can easily fall prey to many things to explain the higher prices of gas. But we can NOT explain away the simple facts of supply and demand – it is just math.

This was coming – we all knew it – so did the government (Hirsch Report). We have entered a new era.

While Pickens is making billions on the current rise in crude prices, he just bought a 1,000 wind turbines from GE and is building the largest wind farm in the U.S., he is also investor in natural gas, coal, and solar. He sees the writing on the wall – he is not trying to drive prices higher in some conspiracy – he KNOWS that we are already at maximum extraction and is already making his NEXT investments in energy (Wind, Solar, Gas, Coal) – why does he make billions – because he puts his money where his mouth is and is also the EARLIER pioneer or adopter in new business.

Pickens is the premier oil man and when you see the guy that made BILLIONS in oil now investing 100s of millions in Coal, Wind, Natural Gas, and Solar - he is looking out 1 year, 5 years, 10 years and saying we are being FORCED to find alternative energy because we can NOT keep up with consumption. It’s time to stop focusing on the minutia and blame game and start looking at the BIG PICTURE – Supply and Demand.Oil prices are high and they should and may come down – but that doesn’t change that there is some real concerns about Supply vs. Demand.

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