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HOW TO CURB OIL PRICES NOW!
Energy Policy Recommendations to Reduce Oil Prices
and Enhance Domestic Energy Security
with
Background Information on
Global Oil Supply and Demand
By,
G. Warfield Hobbs
New Canaan, Connecticut
June 30, 2008
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Geologists, Geophysicists and Engineers
Energy and Mineral Advisors Since 1982
181 MARIOMI ROAD NEW CANAAN, CONNECTICUT USA 06840
PHONE: (203) 972-1130 FAX: (203) 972-6899
www.ammoniteresources.com
June 30, 2008
To:
The White House
United States House of Representatives
United States Senate
U.S. Department of Energy
Obama Campaign
McCain Campaign
Editor, Wall Street Journal
Editor, New York Times
Editor, Washington Post
Editor, Chicago Tribune
Editor, Los Angeles Times
Editor, USA Today
CNN News
NBC News
Fox News
CBS News
ABC News
From: G. Warfield “Skip” Hobbs
Re:
HOW TO CURB OIL PRICES NOW!
The time has come to stop the political posturing, and implement a national energy policy that
effectively does something to bring down oil prices, and enhance domestic energy security – and
quickly. $140/barrel oil - even $100/barrel, is going to strangle the United States and global
economies. We must finally admit that there is an energy crisis, and that its harmful impact will be
felt in every community and home across that land if we do not act quickly and resolutely. As a
prominent professional petroleum geologist, an energy consumer, a New Englander, and a
committed conservationist here are my policy recommendations:
1. The President should issue an emergency presidential order that institutes a 55 mph national
speed limit. This would immediately cut demand for transportation fuels and significantly
reduce the price at the gas pump. Fully 65% of crude oil in the United States is refined as
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motor gasoline and distillate (diesel) fuels. Getting from “A” to “B” might take a bit longer,
but it will surely cost less, and be better for the economy when gas prices retreat.
2. Congress should raise the margin requirement for commodity trades to 50%, and phase out
over an 18 month period trading by companies that do not physically take possession of
crude oil, natural gas and refined products. This would immediately curb speculators and
significantly reduce commodity prices.
3. Federal excise taxes on gasoline and diesel should be raised 10 cents per gallon, effective
immediately, rising to 25 cents/gallon in 12 months. This would curb consumption, and the
incremental funds should be dedicated to improving public transportation and for alternate
energy research. Fuel prices in Europe are more than twice those in the USA - the difference
being mostly taxes. European economies have not crashed as a result of high transportation
fuel taxes.
4. Automobile and truck mileage standards mandated in the 2007 energy bill
should be “fast forwarded” for implementation by 2015. General Motors and Ford will be
out of business and Toyota will rule if this is not done. Consumers want fuel efficient
vehicles in the face of $4.00/gal gas and $5.00/gal diesel. Conservation is a critical
component to reducing energy demand.
5. Global oil trade is denominated in United States Dollars. The precipitous decline of the US
Dollar against the Euro, British Pound and other currencies is a significant factor in rising
oil prices. The Federal Reserve must immediately institute monetary policies that strengthen
the dollar. This will lower global oil prices, and reduce the balance of trade deficit.
6. The President should sign an Executive Order that lifts the moratorium on drilling in federal
waters on the Atlantic and Pacific continental shelves, and in the Eastern Gulf of Mexico. In
May 2007, the Department of the Interior Minerals Management Service estimated a mean
technically recoverable resource 17.8 billion barrels oil and 76.47 trillion cubic feet of gas in
these areas. This would demonstrate to global oil producers that the USA is serious about
increasing its own domestic supply. This perception will help lower oil and natural gas
futures. Offshore petroleum exploration and production can be conducted in an
environmentally responsible manner with significant economic benefit to all stakeholders, as
evidenced by production operations in the harsh operating environments of the North Sea of
Europe and in the Atlantic offshore Eastern Canada. Hurricane Katrina devastated the
petroleum industry in the Gulf of Mexico, yet there were no serious oil spills due to modern
oil well technology. Activity will be tens to hundreds of miles offshore, well out of sight of
land. It is the incremental barrel of supply that sets the commodity price. An additional 1+
million barrels equivalent (oil and natural gas) of new oil production per day is likely
achievable over the next five to seven years, if we start today. The Canadians are producing
over 500 million cubic feet of gas a day offshore Nova Scotia, and exporting about 400
million cubic feet per day to New England – enough to heat over a million homes. These
same producing formations extend into the USA North Atlantic OCS.
7. Congress should immediately authorize exploration in the Arctic National Wildlife Refuge
(ANWR) of Alaska. ANWR encompasses an area of 19 million acres – about the size of the
state of South Carolina, of which 1.5 million acres on the coastal plain – designated the
“1002 Area” are highly prospective for oil and natural gas. The United States Geological
Survey (Open File Report 98-34) estimated a potential economically recoverable resource of
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4.2-11.8 billion barrels, with a mean expected resource of 7.7 billion barrels (this was when
oil was less than $20/barrel). This magnitude of reserves would support oil production at a
rate of 1 million barrels per day for over 20 years. This is a huge incremental oil supply
which would significantly moderate commodity prices, and reduce U.S.A. foreign exchange
losses for imported oil. The caribou will not mind the activity. Despite public perception to
the contrary, the North Slope caribou population has more than doubled since oil production
began over 30 years ago at Prudhoe Bay. The reason - caribou do not mind the exploration
activity, and come into the production areas to calve on well pads and road beds out of the
bogs and away from bugs, and where the wolves, their principal predators, fear to tread.
8. The United States is well-endowed with coal resources. Every effort should be made to:
enhance clean coal technology; restore “Futuregen” financing; facilitate power plant flue gas
capture for carbon sequestration in underground reservoirs and for enhanced oil, as well as,
enhanced recovery of natural gas from coal seams; and facilitate coal to liquids and syngas
technology. Congress should provide increased R&D spending for the DOE in these areas,
and provide additional tax credits to energy companies as incentives to implement these
technologies. The “stick” to encourage the transition to clean coal technology would be to
impose heavy fines on coal-fired power plants that do not reduce their emissions by 50%
over the next 5 years, and by 75% over the next 10 years.
9. The construction of new nuclear power plants should be facilitated by “fast tracking” the
permitting process. Once the technology has been approved, it should not have to be reapproved for every plant built on the same design. The U.S.A. has abundant uranium
resources, and despite public perception to the contrary, nuclear energy is safe, and there are
no CO2 emissions. The Nuclear Waste Repository at Yucca Mountain must also be
approved. The delay and outrageous cost of this project is a national disgrace!
10. Significant new tax credits should be extended to home owners and businesses that improve
energy efficiency (building insulation, new light bulbs, appliances and boilers, et cetera),
and for the installation of alternate energy sources. This will cut petroleum and total energy
demand.
11. There should be a federal mandate for every municipality to implement by 2010
comprehensive recycling of plastic, used tires, metals, glass and paper. This would reduce
the demand for mining and/or harvesting basic raw materials, and reduce the energy needed
to convert raw materials into finished commodities. Conversion of aluminum soda pop cans
into aluminum ingots, or scrap iron into new iron products, requires vastly less energy than
processing aluminum and iron ore into the finished metal. Plastics are a by-product of
petroleum. Synthetic “fleece” winter clothing, for example, is made from recycled plastic
bottles. Recycled tires, made largely from petroleum by-products, are a high BTU fuel
source themselves when finely ground. The area needed for waste landfills will also be
reduced through recycling.
12. A series of Department of Energy public service announcements should be prepared for
broadcast on national and local TV that shows consumers how they can reduce their energy
use (and fuel and electric bills) by using public transportation, planning their driving needs
more efficiently, turning out the lights, better insulating their homes, and learning to live
with cooler homes in the winter (wear a sweater!) and warmer homes in summer (the air
conditioner thermostat does not have to be set at 68 degrees – you can survive quite
comfortably at 75 degrees!).
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Implementation of these energy policy recommendations will quickly bring down oil prices –
and the price of gasoline at the pump, enhance energy security, reduce the very significant
balance of trade deficit caused by the importation of 60% of the nation’s crude and refined
products; and importantly, improve air and water quality. Everyone wins!
There are naturally other view points. The opinions of everyone must be heard, and the
interests of all stakeholders balanced. However, time is of the essence, and we cannot let any
one interest group hold up implementation of these legislative recommendations through
protracted hearings and litigation.
BACKGROUND DISCUSSION
Relatively cheap energy and abundant natural resources, combined with American ingenuity
and a strong work ethic, are responsible for the historically robust American economy, and our
comfortable standard of living. However, the age of cheap petroleum is now over, as domestic
oil and gas reserves have been depleted, and the developing world has finally entered the
Consumer Age. Americans now have serious global competition for international petroleum
resources. Chinese, Russian, Indian, Brazilian, Middle Eastern and other consumers demand the
comfortable housing, quality foods, electric appliances, automobiles and modern infrastructure
that Americans take for granted. We are not going to experience “cheap” petroleum-based
energy again.
Supply vs. Demand
The United States, with slightly less than 5% of the world’s population consumes almost 21
million barrels (MMBO) of oil per day, or about 25% of global crude oil and condensate
production of about 85 million barrels/day. China, as the second largest petroleum consumer
behind the United States, presently consumes about 7.5 million barrels oil per day. Demand in
China has been growing at a rate of 7-10% annually. The graph below shows that the per capita
consumption of oil in the U.S.A. is about 24 barrels/year, while Indian and Chinese
consumption, representing about 36% of the world population, is less than 2 barrels/year.
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Energy Consumption as an
Indicator of the Wealth of Nations
$30 ,000
United
States
$25 ,000
Per capita income
Canada
France
Germany
United Kingd om
$20 ,000
Japan
Italy
$15 ,000
Saudi Arabia
$10 ,000
Indonesia
Mexico
Brazil
The world’s
15 larges t
economi es
Russia
$5,000
China
India
0
0
5
10
15
20
25
30
Per capita oil consumption (bbl/yr)
As developing countries enter the “Consumer Age” and move from left to right up the
consumption curve, global demand will increase. Projections by the U.S. Energy Information
Agency (EIA) show global oil demand rising to over 100 MMBO per day over the next ten
years as indicated in the figure below. The U.S. will be – and already is, competing with the
developing economies for this incremental supply.
According to EIA statistics global crude production reached 83.12 MMBO per day in 2004,
but appears to have reached a plateau of 84.6 MMBO per day for the past three years. Global
demand continues to rise, but global production is static.
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Domestic U.S.A. demand for oil and natural gas is projected to continue to increase by the
EIA as shown below, despite the growth in non-hydro renewable energy.
USA PROJECTIONS
Source: EIA 2007
As demand rises, however, domestic production is declining. The graph below show how
U.S. oil production has declined from a peak in the early 1970’s, bumped up with the discovery
of oil on the North Slope of Alaska, and then has declined precipitously since the mid-1980’s as
Alaskan and “Lower 48” fields are depleted.
USA CRUDE PRODUCTION 1954-2006
Source: EIA 2007
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Domestic natural gas production remains strong, due to the drilling of tens of thousands of new
gas wells in unconventional onshore coal seam, shale, and low permeability sandstone
reservoirs. New discoveries in the ultra-deep waters (>5,000 ft) of the Gulf of Mexico have also
provided important new incremental oil and gas production. However, these deep water
exploratory wells cost from $50 -$100 million each, and discoveries take years to appraise and
develop. New gas production has offset step declines in the conventional gas reservoirs of the
Gulf Coast, as shown in the graph below. However these new wells also decline rapidly, and to
meet future natural gas demand, new areas must be opened for leasing and drilling, and new
LNG import facilities must be approved and constructed to make up the shortfall in domestic
production.
Imported Oil
The United States presently imports 60% of its crude oil and refined petroleum supplies to
make up the deficit between domestic production and demand. The latest EIA projections
shown below (June 2008) forecast a decrease in imports to between 45% (high price) and 54%
(reference case). Imports will remain the same in a “low price” scenario. Prior to the relatively
new introduction of ethanol fuel additives, imports were projected by EIA to increase over the
next decade to 70%.
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The projected decrease in imports is based on the assumption that biofuel production will
increase dramatically as mandated by the 2007 Energy Act. I personally believe this is grossly
over-stated because public reaction to the significant rise in food prices, and the negative
environmental impact (fertilizer and soil run-off into water courses and loss of wildlife habitat)
that are resulting from corn and soy bean based biofuel production, as well as high farm fuel
costs, will curtail biofuel production. Non-food crop, cellulose based ethanol production is a
better alternative!
Price Forecasts
When supply cannot keep up with demand, prices rise – a fundamental economic principal.
The graph below shows how NYMEX light crude oil prices have surged 600% from $20/barrel
in 1999 to over $130/barrel in 2008. Notice how prices began to take off when the apparent 84
MMBO/day supply plateau was reached in 2004.
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NYMEX LIGHT CRUDE PRICES 2000-2008
The collective “wisdom” of the commodities markets is that oil prices are going to remain high
in the foreseeable future, as indicated below. Note how the forward price expectation has nearly
doubled since 2006.
Source: John S. Herold, Inc. June 23, 2008
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In addition to the simple economic consequences of supply and demand affecting prices, the
decline in the value of the U.S. Dollar against the Euro, British Pound and other currencies, has
had a significant impact. International oil prices are denominated in U.S. Dollars, and as the
Dollar declines in value, the price of oil goes up. The chart below demonstrates what has
happened since 2002 when the Euro could be purchased for less than one Dollar.
Source: Raymond James, Energy Stat of the Week, Equity Research, June 16, 2008
War and political turmoil in the Middle East, guerilla attacks in Nigeria, and threats from
Venezuela to cut exports to the US, have added a “political risk” premium to oil prices. This is
probably on the order of $10-$20 per barrel. A loss of just 200,000 BOPD from an attack in
Nigeria, for example, will cause a temporary price spike of several dollars. Because of the
political risk, companies are not, or cannot, making investments in exploration and
infrastructure in areas where there is turmoil or lack of access.
Weather is now another factor that adds to price volatility. Hurricane Katrina knocked
800,000 BOPD of production offline resulting in immediate price increases. Now even the
threat of a tropical storm will cause temporary price spikes of several dollars per barrel. This is
symptomatic of the very delicate balance between supply and demand, and the minimal amount
of “spare” production capacity.
As reported by the New York Times on June 24th, speculators have apparently increased their
share of oil futures contracts on the NYMEX to 71 percent this year, from 37 percent in 2000.
One can intuitively conclude that speculators trading on the global commodity exchanges have
probably inflated prices, and have certainly increased price “volatility”, but it is difficult to
quantify the impact of speculation. If speculation were to be curbed, it is likely that prices
would drop significantly. This happened when “speculators” abandoned zinc and nickel base
metal trading in 2007.
Oil is not the only commodity whose price has gone through the roof due to limited supplies
and surging demand. As the chart below demonstrates, prices for coal, metals, cement,
construction aggregate, lumber, grains, vegetable oils, and fertilizers have also sky-rocked.
Welcome to the global Consumer Age! Beware….inflation ahead.
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Source: Scotiabank, June 2008
Are We Running out of Oil?
Demand is exceeding deliverable supply, and petroleum prices have doubled over the past
year. Does this mean we are running out of oil? The quick answer is no - not yet, but the ability
to produce, refine and distribute product has not kept up with global demand.
The world has produced and consumed about 1 trillion barrels of crude oil since Col. Drake
drilled his well in Pennsylvania in 1859. Remaining global “proved” reserves – those quantities
of oil known with reasonable certainty to be recoverable with current technology and pricing,
are estimated at 1.3 trillion barrels as shown below. Proved U.S.A. reserves as of January 1,
2007 were 21.7 billion barrels, representing only 1.6% of global reserves. The world consumes
about 31 billion barrels per year, so 1.3 trillion barrels is a 42 year global supply at current
demand.
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According to a study by the United States Geological Survey (USGS) there is a global total
of 2.8 trillion barrels oil equivalent (gas and oil) known petroleum resources, which includes
proven and unproven reserves as shown below. These resources will eventually be moved into
the proven category with further development and new technologies. Note the location of these
resources. The quirks of geology demand that the United States, as the world’s largest
petroleum consumer, maintain good relations with the Middle East and countries of the Former
Soviet Union if we wish to have access to their oil and natural gas supplies. More than one half
of the North American resource is represented by the Canadian oil sands. However, there is
significant environmental pressure on the oil sands industry as it is a major emitter of
greenhouse gases, and has a huge impact on regional water supplies, and the local aborigine
population. Future oil sands production will likely be limited to less than 2 – 2.5 MMBO per
day for these reasons.
Source: USGS Open File Report 97-463
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New oil discoveries are becoming smaller and less frequent as global exploration matures Brazil’s deep water Tupi Field, a 7 Billion BO discovery, is an exception, but demonstrates that
large oilfields can still be discovered. This means that a large portion of future incremental
production must come from fields that have already been discovered and developed. The
average recovery of oil in place from a reservoir is only 34% due to the physics of the rock
material and the fluids in the reservoir. By increasing recovery factors by only an additional 3%,
an additional 200 billion barrels of crude oil would be recovered. If total recovery factors were
increased to 45%, an additional 1 trillion barrels of oil would be added to global supply (Source:
AAPG Hedberg Conference 11 / 06). Increasing recovery factors requires increased R&D
funding! Only the very largest international oil companies can afford this cost. DOE funding
should focus on enhanced oil recovery technologies to assist the smaller oilfield operator.
Estimates of undiscovered oil and gas reserves in unexplored areas are made by geologists
and engineers using limited well data, and by regional analogs. Newscasters are now citing the
billions of barrels of oil and trillions of cubic feet of natural gas in ANWR and the Atlantic
Continental Shelf, as if these potential reserves are there for the taking. The public must
appreciate that these are not readily accessible “proved” reserves. They are in fact merely
potential volumes estimated by a complex probability methodology that takes into account a
broad range of likely values (for example, a probability of 10%-mean-90%) for regional rock
volume, ratio of sand-shale-limestone; depth of burial; organic content and thermal maturity of
the organic matter – (i.e. has the rock been “cooked” sufficiently to generate oil); potential
reservoir thickness and reservoir porosity; potential field size; and the geological history of the
basin. The presence of these potential petroleum resources can only be confirmed by actual
drilling.
In its 2000 World Petroleum Assessment, the USGS estimated a probalistic mean of
undiscovered resources of 724 billion barrels oil and 5,196 trillion cubic feet of natural gas.
At the current 31 billion barrels per year rate of consumption, that is another 23 years of
potential global supply.
Oil from oil shales in the Rocky Mountain states is often cited as a future source of domestic
petroleum. Shell Oil Company, for example, has developed a new “in situ” thermal process for
recovering shale oil; however, their pilot project is still in the early stages. There are trillions of
barrels of hydrocarbons locked up in “oil” shales, but the capital, and more importantly, the
environmental cost, to recover the organic “kerogen” and convert it to petroleum in meaningful
volumes, is prohibitive in my opinion.
Natural gas hydrates – a methane ice found below the permafrost in Alaska and on the deep
continental shelves, is another potential source of energy for the United States. There is actually
more energy locked up in global methane hydrates than all global conventional petroleum
resources. However, more research is needed before this resource can become commercial – if
ever, in meaningful volumes. The USGS has been conducting research on gas hydrates in
Alaska, and with a consortium of international organizations in the Canadian Arctic – funding
for this work should be continued!
Before I end this section, I want to clarify a popular misconception. Politicians and
newspaper reporters often cite potential reserves as representing only “so many months of
production”. For example, opponents of drilling in ANWR, with mean potential oil reserves of
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7.6 billion barrels, have said that it is “not worth destroying the Arctic for less than one year’s
worth of production.” The same applies to the Atlantic Continental Shelf, where there may be a
potential 4+ billion barrels. This assumes that domestic supply would come from no other
sources, which is absurd. In reality, these areas would be producing significant “incremental”
oil and gas supplies for more than 20 years, and providing jobs, royalties, corporate and
personal income taxes to the U.S. Treasury and bordering states, and reducing our dependence
on foreign oil. Incremental production of 1 million barrels per day at $100/barrel, would reduce
the balance of trade deficit by $36.5 billion per year. That is not chicken feed!
Alternate Energy/Renewable Energy
Alternate energy is seen as the panacea to the nation’s energy needs. However, it is not a
near-term solution to high petroleum prices. Wind power, for example, doubled last year, but it
is only a tiny fraction of total domestic energy supply. The EIA chart reproduced below shows
where our energy comes from.
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Wind, solar, geothermal, waste and biofuels accounted for 27% of the 7% slice of total
energy supply represented by “renewable energy”. That is slightly less than 2% of total energy
supply. Hydropower and wood make up the balance of renewable energy. It is unlikely that any
major new hydro-electric plants will be built on the nation’s river systems; although tidal power
is a promising new technology. The public simply does not appreciate the scale of alternate
energy vis-à-vis total supply. Fossil fuels contribute 85% of total energy supply, and this is not
going to change much through 2030. Nevertheless, it is critical that the U.S.A. move full speed
ahead in developing alternate energy sources (and nuclear) to reduce petroleum imports, and
meet supply requirements at the end of the 21st Century. Each barrel oil energy equivalent
produced by domestic U.S.A. alternate and/or renewable energy sources, is one less barrel of
imported oil!
Peak Oil
“Peak Oil” is a controversial topic within the petroleum industry among company CEO’s
and petroleum geologists and engineers. Some claim that we have already reached “peak oil”
production capacity, as evidenced by the 84.6 MMBO/day production plateau of the past three
years. The graph below is a compilation by the late Dr. John Edwards, University of Colorado at
Boulder, of energy forecasts from a number of international sources. It is a very interesting
graph, particularly when considers the impact of its message on the lives of our grandchildren
and great grandchildren.
Source: the late Dr. John D. Edwards, University of Colorado, Boulder, CO
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Dr. Edwards concluded that “peak oil” would probably occur around 2030. This might
happen 10 years earlier or later, depending on the state of the global economy. Note that by
2100, fully 40% of global energy will have to come from renewable or entirely new energy
sources. This means that we better get moving now to build out the infrastructure to deliver
these new energy sources to the consumer. Note also, that the traditional fossil fuels – oil,
natural gas and coal, will continue to play an important role through the end of this century.
My personal view is consistent with that of Dr. Edwards and the USGS, that there are
abundant remaining global oil and gas resources, and that we have not reached “peak” oil due to
depletion. There are still huge potential conventional petroleum resources in the United States
and on our continental shelves- if we have the political will to find and exploit these resources.
New technologies will allow us to increase recovery factors from mature fields and
unconventional hydrocarbon resources. The root cause of tight supply and the consequent rise in
commodity prices is insufficient capital investment in new infrastructure to produce, process,
refine and deliver crude and refined produced to the global consumer. Lack of access
(geopolitics) to areas of known major hydrocarbon deposits, such as Iraq, Iran, Russia, and even
the North Slope of Alaska, is another major factor. The decline in the value of the United States
Dollar and commodity speculation are also contributing factors. Many trillions of dollars of
new capital investment are required, but until there is geopolitical “peace” in the World, this
investment will not be made in the amounts required, and supply and demand will remain out of
balance. Oil prices will remain high as the developing economies move up the consumer curve
without major new investment, or significant conservation and development of alternate energy
sources on the part of the world’s developed economies.
Petroleum Investment
Petroleum exploration, development and production is a high risk, capital intensive business.
There is no other industry where a company may spend up to $100 million to see if a geologist’s
interpretation is correct – and 70% of the time it’s not; and if successful, then abandoning the
wildcat well by filling the borehole with cement. Future appraisal drilling, project design,
regulatory approval, and then field development, costs many tens of million of dollars onshore,
and hundreds of millions to several billions of dollars in deep water, harsh environments. The
time line from initial geological studies and leasing to first production in remote areas is
typically five to ten years. As a consequence, cash flow is negative for a very long time before
any revenues are received.
John S. Herold, Inc., Norwalk, CT and Houston, TX, tracks the performance of 228 public
companies – all the majors, and most of the independent public companies. The three graphs
which follow show: a) the amount of money invested in 2006 (the latest year for which data are
available); b) where the capital is being invested; and c) the cumulative 5-year return on capital
invested. These are very instructive charts.
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WHERE DOES THE MONEY GO?
$401 Billion Upstream Capital
Invested in 2006
(Vs. $ 276 B in 2005)
EXPLORATION IS ONLY 13%!
Source: J.S. Herold 2007 Global Upstream Performance Review
study of 228 largest E&P companies
WHERE IS THE CAPITAL EXPENDED?
Source: J.S. Herold 2007 Global Upstream Performance Review
study of 228 largest E&P companies
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WHERE IS THE MONEY BEING MADE?
Source: J.S. Herold 2007 Global Upstream Performance Review
study of 228 largest E&P companies
Oil companies are being criticized for their “excessive profits”. As the “Where is the Money
Being Made?” chart demonstrates, the 5-year cumulative return in the United States and Canada
is only 14-15%. In a 2005 study made by PriceWaterhouse Coopers LLP of company earnings,
oil industry earnings were only 8%, well below that of many industries, as shown on the chart
below.
How Do Oil Industry Earnings Compare to
Other Industries?
18.5
18.0
Pharmaceuticals & Biotechnology
Banks
Semiconductors & Semiconductor Equip.
Diversified Financials
Household & Personal Products
Consumer Services
Software & Services
Telecommunication Services
Food, Beverage & Tobacco
Oil & Natural Gas
Real Estate
Capital Goods
All Industries
Technology Hardware & Equipment
Utilities
Consumer Durables & Apparel
Media
Commercial Services & Supplies
Materials
Retailing
Health-Care Equipment & Services
Insurance
Food & Staples Retailing
Transportation
11.4
14.1
13.4
10.1
9.9
9.1
8.5
8.2
8.0
7.1
6.8
6.6
6.5
5.9
5.4
5.0
4.8
3.5
3.5
2.8
2.5
0.2
0.0
5.0
Source: Company filings as reported by Oil Daily for the oil and gas
industry, and by Pricewaterhouse Coopers LLP from data compiled by
Standard and Poor’s Compustat for all other industries
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3rd Quarter of 2005
10.0
15.0
Cents per dollar of sales
20.0
The macroeconomics of the oil industry have changed dramatically over the past two years.
Oil and natural gas prices have doubled. Investment in 2007 and 2008 will be even higher than
in 2006, as the cost of oilfield goods and services has also doubled. There is a shortage of deep
water drilling rigs. A heavy-duty offshore rig, for example, for service offshore Europe, Africa
or Canada, now costs $350,000 - $500,000/day for the rig rental, and about the same amount for
the ancillary offshore supply boats, helicopters and other contract services. Daily rig fuel costs
are about $24,000. A typical exploratory well may take two months to drill, test and complete
and cost from $25-50 million, and much more in ultra-deep water.
The oil companies are an easy target to “bash”, because they touch every one on a daily
basis, and their revenues are large in absolute dollar amounts. However, in terms of earnings
and return on capital employed, the oil companies have historically been in the middle of the
pack. Our economy has prospered because the oil companies have historically been successful
in finding and delivering “cheap” energy. Exxon’s profit of $40.6 billion in 2007 is enormous
because Exxon is huge and produces more oil than any other non-government owned company.
The company’s 31.8% return on capital employed in 2007 is indeed much more than most
companies can even dream of, but this is an anomaly due to the huge run up in oil prices. Exxon
did invest $20.8 billion in capital and exploration in 2007.
The majority of the several thousand oil and gas companies that operate in the United States
are in fact small “independents”, many are publicly owned, but many more are private. The
majority of exploratory wells are drilled by the independents.
If the country hopes to increase domestic oil and gas production to reduce our dependence
on imported oil, then Congress must pass legislation that facilitates exploration and production,
and funds new technologies for enhanced oil recovery. It must not punish successful public
companies and their stockholders. The large international oil companies are able to self-fund
their activities because of the profits they make. Restoration of “Windfall Profit” taxes will only
help to reduce domestic supply. Smaller companies are constantly issuing new equity and
incurring debt to meet their capital needs. The smallest independents always seem to be starved
for exploration financing. Restoration of the tax deductibility of intangible drilling costs by
private investors in limited partnerships, would result in a drilling revival by the smaller
independent. Elimination of this tax deduction in the 1986 Tax Reform Act, was the death knell
for many small operators. There were over 4,000 drilling rigs at work in the U.S. in the early
1980’s, many funded through tax partnerships – now there are almost 1,900 rigs in operation;
and that is up from a low of less than 1000 rigs in the late 1980’s-1990’s.
“Big Oil”
As the chart below indicates, global “proved” reserves are not controlled by big international
oil companies – they are controlled by state-owned and/or controlled companies (NOC’s) like
Saudi Aramco and the National Iranian Oil Company. Less than 25% of global reserves are
accessible to the publicly traded international oil companies (IOC’s). ExxonMobil, for example,
the largest non-government owned oil company, produced 2.6 MMBO/day in 2007,
representing about 3% of total global production of 85 MMBO, and had proved oil reserves of
7.7 billion barrels, representing only one-half percent of global proved reserves of 1.3 trillion
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barrels. By comparison, Saudi Aramco produced produces about 10 MMBO per day of crude oil
and condensate – or nearly 12% of global supply. If Exxon made $40 billion in 2007, imagine
the global wealth transfer to the state oil companies!
Control of Proven Oil
Reserves
Neg
otia
ted
nds
Rou
Bid
Source: AAPG after PFC Energy
CONCLUSIONS
The emerging economies of the world have entered the Consumer Age, and are successfully
competing with the developed economies for traditional sources of crude oil supply.
Global oil production has not been able to keep up with rising demand. This is a function of
many factors, including:
•
•
•
•
•
•
Depletion and natural decline of 4-6% in mature producing oil fields.
Known and easily accessible petroleum producing basins have been thoroughly
explored, and new discoveries are limited.
Frontier exploration areas in ultra-deep waters and in hostile operating environments
such as the North Atlantic, South Atlantic, Barents Sea, and Arctic oceans are very
expensive and have long lead times for development.
Limited access – over 90% of the remaining oil reserves are controlled by national oil
companies or companies that are government controlled – not “Big Oil”.
Political turmoil in Iraq and Iran – countries with huge remaining oil and gas reserves.
Insufficient investment in the massive and capital intensive infrastructure required to
produce, refine and distribute petroleum products to the global consumer.
Static supply with limited global “excess capacity” in the face of rising demand, has led to a
600% increase in crude oil prices since 2000. The decline in the value of the United States
Dollar and commodity speculation are also contributing factors in the rise in oil prices. Many
trillions of dollars of new capital investment are required, but until there is geopolitical “peace”
in the World, and access to prospective oil producing regions, this investment will not be made
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in the amounts required, and supply and demand will remain out of balance. High commodity
prices can be expected to continue in the interim.
There are significant remaining global petroleum resources, sufficient to supply the world’s
economies well into the 21st Century. However, the USA has only a small fraction of these
remaining reserves, and will continue to depend on foreign oil imports to meet demand. The
United States can reduce imports through conservation, increased alternate energy, and by
increasing domestic supply, but the incremental supply will not offset the need for significant
future imports of foreign oil. Even with some dramatic technological breakthrough, it will take a
generation to build the infrastructure required to deliver significant new energy supplies to
consumers. Politicians are fond of stating “we must reduce our dependence on foreign oil”, this
is true, but the reality is that we will require significant volumes of imported oil to power our
economy for at least another generation. The U.S. simply cannot drill its way to energy
independence. A multi-faced approach is required.
So what can we do before high oil prices significantly impair the economy? By artificially
cutting demand, we can reverse the recent upward trend of oil prices. As the consumer of 25%
of the world’s petroleum, whatever action the United States takes significantly impacts the
global balance of supply and demand. Implementing a 55 mph speed limit would have an
overnight effect on demand and price. Imposition of a 50% margin call on commodity trades,
and phasing out the ability to trade unless one takes physical possession of crude and refined
products, would also immediately reduce prices. Fiscal policy that strengthens the U.S. Dollar
will lower global oil prices. Longer term, demand can be reduced in meaningful volumes by
promoting conservation, alternate energy sources, clean coal technologies, nuclear power, and
by recycling of products made from petrochemicals. Supply can be increased significantly by
allowing exploration in Alaska and on the Atlantic and Pacific continental shelves, and onshore
in many areas presently closed to exploration. Research must be funded to enhance recovery of
the original oil in place in mature oil fields, and to extract more oil and natural gas from
unconventional reservoirs. These steps will enhance supply and energy security, create jobs,
moderate prices, and improve the national economy.
It is the incremental barrel of supply, or incremental barrel equivalent achieved from
conservation and alternate energy sources, that moderates commodity prices. It is possible to
reduce oil prices and increase supply, but the nation must put partisanship aside, and have the
collective political will to implement an effective energy policy. Let’s do it, and now!
*****
Note: This report may be copied and distributed by anyone who wishes to do so. In fact, I
encourage readers to send this analysis to their friends and policy makers at the state and
federal level.
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About the Author
G. Warfield “Skip” Hobbs is Managing Partner of Ammonite Resources Company, an
international petroleum geotechnical, economic and business consulting firm that Hobbs
founded in 1982 in New Canaan, CT. He began his career in 1970 as an exploration geologist
with Texaco, and worked in Ecuador, the United Kingdom, Indonesia and Portugal. In 1977 he
returned to the United States, and worked as a senior staff geologist for international ventures at
the headquarters of Amerada Hess in New York. Skip holds a B.S. degree in Geology from Yale
College, and a M.S. Degree in Petroleum Geology from the Royal School of Mines, Imperial
College, London. He is a past national officer of the American Association of Petroleum
Geologists, and served from 2004-2007 on the Executive Committee of the American
Geological Institute, a Washington-based organization that represents over 120,000 members in
44 professional geoscience societies. Skip currently serves as the USA director of the Burgess
Shale Geoscience Foundation, Field, British Columbia. He is a member of the Canadian Society
of Petroleum Geologists, and a Fellow of the Geological Society of London. Hobbs is also a
trustee of the New Canaan Nature Center, a not-for-profit organization that provides educational
naturalist and environmental awareness programs to over 100 primary and middle schools in
Fairfield County, Connecticut and Westchester County, New York. He writes and lectures
regularly on domestic and international petroleum and energy issues. When he is not working on
geological and energy matters, Skip don’s his “farmer’s hat” and raises Scottish Highland cattle,
fruit and vegetables with his wife and sons, for family and friends, at a family farm in
Massachusetts.
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