A little knowledge is a dangerous thing, and that’s what I have when it comes to the oil business. I can neither read a seismic survey nor explain the best method to drill for gas in a fractured reservoir. That said, for more than twenty years, I have been involved with oil and gas companies, read their financial statements, listened to their traders, and studied their results. I have visited oil fields in Kuwait and Texas, and refineries in a far-flung Russian province. In Riga, the Latvian capital, I even went to an old U-boat pen that the government wanted to convert into a storage terminal (for oil, I was told, not U-boats).
In this time, I have formed a few conclusions about the petroleum industry, along these lines: a lot of people in the so-called upstream side of the business (that is, those companies exploring for new oil and gas) tend to have the personalities of riverboat gamblers, if not the matching pearl-lined vests. Rarely do they see an underground prospect that does not contain the reserves of the next Saudi Arabia. On the downstream side—that making its money in the chain between refining and service stations—location and borrowed money rule the balance sheet. The companies that do well are those with the lowest debt-to-equity ratios and the best locations. An inefficient refinery in Rotterdam with little debt will last longer than a modern but debt-laden plant in Belarus, because it is closer to the consumer markets of Western Europe. The same is true of gas stations or pipelines.
I thought of my petroleum clichés recently in England when I met a series of people connected to different segments of the oil and gas business. At times, or so it seemed, everyone at the table was $50 million short and looking for ways to drill into the proven reserves of Middle East money. In general at oil exploration meetings, one group shows up with a dream, and the other party supplies the money, although everyone at the table tends to have divining rods, if not conical hats.
During some of the meetings, I found my mind wandering to the larger questions: Is the North Sea running on empty? Did the recent spike in oil prices mark the beginning of petroleum’s end or for the next fifty years, as prices increase, will the world’s proven energy reserves also move up? Is it necessary for countries to be energy independent? To what extent should the struggle against terrorism be known as The Oil Wars?
Whither the North Sea?
A lot of the discussions in England touched on the future of the North Sea, which, in terms of global production, once represented about 10 percent of global oil production (now it’s below 5 %). At one meeting, I met a geologist who was present at the creation of the offshore oil industry. I asked him if North Sea oil was in decline and, if so, how long would it take to run dry.
He said he expected such established fields as Norway’s Brent to last until around 2024. But then he made the trenchant remark that the only way to run out of oil—in the North Sea or anywhere else—“is to stop looking for it.” He spoke of new technologies, available only in the last three years, which would allow geologists to estimate the hydrocarbons in fields adjacent to those pumped dry. He thought that giant new fields (known in the trade as “elephants”) might be found 30,000 feet under the seabed. But the only way to verify such possibilities is to drill into them, and drilling to 10,000 meters presents a host of technological and legal challenges. Technologically, the deeper you go, the more expensive a well costs; legally, it is not clear who owns the rights to petroleum assets potentially below existing but shallower oil fields.
Another problem in the North Sea is that while its oil is depleting, it is also short of rigs. With the boom in petroleum prices, day rates of deep-sea oil rigs have skyrocketed, which means that even if you want to search North Sea acreage for new reserves, the cost of employing a rig is more than $300,000 a day, making it the province of the multinationals. As a result of the rig shortage and day rates, smaller companies, some with so-called “promote licenses,” risk losing their grubstake claims if within two years they cannot develop their chosen fields. Only those companies in the North Sea with access to rigs will make money there.
Given such platform demand and short supply, you might think it better to own shares in a rig outfit than those of an oil exploration company, especially a small one. But the problem with that strategy is one of price. For example, shares in a leading North Sea rig company, Transocean Inc., trade at 47 times earnings, which indicate for its shareholders the well has already come in—even if for the exploring company it may be a dry hole.
Is the Oil Tank Half Empty or Half Full?
In the circles of geological and petroleum sciences, there is a lively debate as to if and when the world, in general, has or will have depleted more than half of its petroleum reserves. Some scientists argue that the hydrocarbon bell-curve will keep moving to the right, as new technology allows companies to find more oil and, as the price of oil increases, its extraction becomes more economically efficient. Nevertheless, one report I have read claims global oil production will peak before 2010. Meanwhile alchemists employed by the U.S. Department of Energy keep stirring their vats to prove that oil production will only peak long into the future, presumably after the last barrels have been extracted from the last deposits of molten lead. But whenever the oil wave crests, the reality is that most of the easy money has been made from Western reservoirs, and that increasingly the world’s petroleum spigots will be turned in countries where despotism, or at least some form of Islamic fundamentalism, may have a hand on the tap.
The problem for the Western democracies is that the bell curve has certainly sounded on their domestic oil production. You can argue with the finer points in the data, but essentially oil production in the North Sea peaked around year 2000 while in the US the high-oil mark came around 1971. Based on current rates of exploitation, the oil fields in the North Sea, and in East Texas and the Gulf of Mexico, will run dry a lot sooner than the wells in places like Iran, Iraq, and Saudi Arabia. At present neither the U.S. nor any European country appears on the list of countries with large proven oil reserves. Saudi Arabia tops the chart with some 261 billions barrels of proven reserves. Others include Iran with 125 billion barrels, Venezuela with 77 billion, and Russia with 60 billion. With nearly all the countries on this list, is it surprising that, in the last thirty years, the US has fought either a hot or cold war?
In terms of proven oil reserves, the United States, with 22 billion barrels, ranks ahead of Qatar, but behind China, in 13th place on the world’s reserves table. At the same time, the U.S. consumes more barrels of oil a day than are used by the next six countries combined, and those economies include Japan, China, Germany, Russia, South Korea, and Brazil. Recent statistics have tried to downplay the importance of oil in western economies, arguing that its price hikes are less inflationary than they were in the 1970s and 80s—when energy costs were more significant in the consumer price index. But domestic U.S. oil production only fulfills about 40 percent of the country’s consumption demands, which may explain why Washington is always preaching from The Democratic Book of Virtue to countries like Venezuela, Iran, and Nigeria but is strangely silent to genocide in places like oil-dry Rwanda.
Declarations of Energy Independence?
In addition to being a political resource—something largely traded by state oil companies, or oil companies that run states—petroleum has qualities of an aesthetic commodity. North Sea oil evokes the same virtues of energy independence as does the gas extracted in Oklahoma or the power generated by the windmills in Holland. By contrast, Nigerian oil is synonymous with African corruption, and purchasing barrels of Iranian crude implies sympathy for a nuclear devil. Although many countries—including the U.S.—take the measure of their national security as a ratio between homegrown and imported oil, there are only small degrees of difference (most having to do with sulfur content) between, for example, Libyan crude and that bubbling to the ground in Titusville, Pennsylvania. Thus does it matter what countries, or which governments, own an oil field? In the era of naval historian Alfred Mahan’s imperial fleets, countries wanted to control the sea-lanes to keep markets stocked and the empire running. But, in the 21st century, should we care whether the oil turning over the engine of an SUV comes from Alberta’s tar sands or Iranian mullahs?
Keep in mind that there is little price differential between high-test fermented in the Gulf of Mexico or that drilled along Colonel Muammar al-Qaddafi’s Line of Death. Once a barrel of oil reaches the high seas, it becomes a commodity as fungible as coffee, sugar or cocoa: something difficult to trace to its wellhead, especially if it is blended. The recent report on the UN Oil-for-Food Program in Iraq, undertaken by His Moral Conscience, Paul Volker, makes it clear that the international community was tilting at oilrigs when it thought it could control the distribution of Saddam Hussein’s Iraqi petroleum. Once the crude passed the Straits of Hormuz, it was anybody’s game. Ironically, to line his pockets and palaces, Saddam flooded the oil market as best he could, helping to lower world petroleum prices, while the American invasion has mostly crippled Iraq’s output, thus pushing prices skyward. Instead of declaring a war on terror, the Bush administration might just as well have asked the Texas Railroad Commission to draw up the by-laws of a new Greater Economic Co-Prosperity Sphere. When OPEC rallies its faithful, are American oilmen on their feet or knees?
Filling Up al-Qaida?
A few years ago, I read a doomsday scenario by the former National Security expert on terrorism, Richard Clarke, who wrote a celebrated book about September 11th. In the conclusion he imagines fundamentalist control of Pakistan, instability in Afghanistan, Iranian Shiite control of southern Iraq, and a revolutionary al-Qaida-like government in Saudi Arabia. It is not an impossible scenario to imagine, given the inequality that divides many of the Middle Eastern sheikdoms from their impoverished citizens, among whom al-Qaida has a niche market.
For the U.S. and its industrial partners, the question is whether radical or fundamentalist Muslim Middle East would cut off oil shipments to the West. They might try, but somehow I doubt they would succeed, if for no other reason than that cheating on OPEC quotas is one of the great petroleum sports. (Right up there with embargo busting and pretending that high-test or STP does anything for your engine.) Whether the West would want to transfer billions of dollars of its wealth, in exchange for oil, to its sworn enemies is a more difficult question. I would say we should not, but then I tend to be a Luddite, and would develop an Interstate bicycle highway and bring back the Twentieth Century Limited.
You can’t have a nation of single-passenger commuters and a Route 66 mentality in the White House, and then have any illusions about energy independence. Anyone who has spent time on the highways of America knows that the U.S. is a gas-guzzling republic, hostage to the fortunes of oil-producing entities. For some years, the words “fill her up” have been a muezzin’s call to the faithful. I wish it were otherwise, but you don’t win the Great Game by ripping up train tracks or driving Hummers to the mall.
