Oil Basics and The Limits to Economic Growth - Art Berman

LabyrinthConsultingServices,Inc. artberman.com

Oil Basics and The Limits to Economic Growth

Art Berman Labyrinth Consulting Services, Inc.

Reality 101 Honors Seminar University of Minnesota October 31, 2016


OilDominatesWorldPrimaryEnergyConsumption2015

• Fossilenergy—oil,coalandnaturalgas—dominateworldprimaryenergy(86%)• Oildominatesfossilenergy(38%).• Renewableenergyis3%ofprimaryenergy.• Theworldwillcontinuetodependonoilandotherfossilenergyforsometimeregardlessofclimateconcernsandadvancesinrenewabletechnology.

Oil33%

Natural Gas24%

Coal29%

Nuclear4%

Hydro7%

Source:BP&LabyrinthConsultingServices,Inc.


WhatIsOil?

• Anorganiccompoundofhydrogenandcarbon.• Itisanaturallyoccurringsubstancethathasbeenabundantandrelativelycheapforthelast150years.• ItiscalledcrudeoilifitisdarkandviscouswithanAPIgravity<35(SGoil/SGwater)• ItiscalledcondensateifitisclearandvolatilewithanAPIgravity>35.• Oilisstoredinrocksbelowtheearth’ssurfaceandisproducedbydrillingwells.


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HowOilIsFormed

• Oilisformedfromtheremainsoforganicmatterfromplantsandanimalsthatlivedintheoceanmillionsofyearsago.• Phytoplankton(algae)andothermicroscopicanimalsarethemajorsourcesofcommercialoil.• Organicmatterwasburiedundersedimentbroughtfromnearbyshorelines.• Itcan’tdecaytoomuch—itmustkeepitscarbon.


HowOilIsFormed

• Organicmatterandsedimentsaccumulateinmarinebasinsthatsubsideovergeologictimetoformdepositionalbasins.• Heatandpressurefromburialtransformedtheorganicmatterintothermallymatureorganicmatter(kerogen)andeventually,intooil.•Mostofthematurationprocessoccursbetween50to100degreesC.• Athighertemperaturesthehydrocarbonconvertstomethanegas.


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TheTotalPetroleumSystem

Source RockMigration RouteReservoir RockSeal RockTrap

Elements

PreservationGenerationMigrationAccumulation

Processes

24803

Petroleum System ElementsPetroleum System Elements

120° F120° F

350° F350° FGenerationGeneration

MigrationMigration

Seal RockSeal Rock

Reservoir RockReservoir Rock

OilOilWaterWater

Gas CapGas Cap

EntrapmentEntrapment

• Thetotalpetroleumsystemconsistsofalltheelementsandprocessesfromsourcerockdepositiontooilaccumulation.• Oilisgeneratedinthesourcerock.• Itisexpelledbyexpansionandmigratesverticallyalongfracturesystemsandfaults.• Afterencounteringareservoirorcarrierbedwithporosityandpermeability,itmigrateslaterallyuntilitistrapped.• Eachelementofthepetroleumsystemcanbeevaluatedqualitativelytodetermineprojectrisk.


TheTotalPetroleumSystem

• Oilinthereservoirrockmigratesupwardbybuoyancyabovegroundwater.•Migrationstopswhenabarrierortrapisencountered.• Thiscanbeananticlinalorbuoyancytrap,afaulttraporanaturalstratigraphictrap.• Theverticalcomponentoftheaccumulationiscalledaseal.• Fluidssegregateintheaccumulationaccordingtobuoyancy.• Oilislighterthanwaterandgasislighterthanoil.• Anticlinalorstructuraltrapsarethemostcommonforconventionaloilaccumulations.


HowOilIsStoredandMovesThroughRocks

• Reservoirrocksconsistofmatrixgrainsandporespace.• Fluidresidesintheporespacesandcanmoveiftheporesarewellconnected.• Althoughitmaynotseemlogicalthatfluidcanmovethrougharock,itisimportanttoconsidertheconsiderablepressureatdepth.• Averagepressuresareabout0.5psi/ft soat10,000ft.,pressuresmaybe5000psi.• Thisisapproximatelytheforceneededtoputthespaceshuttleintoorbit.


Depletion:MuchReservoirEnergyComesFromDissolvedGas

•Whenawellisopened,itisapressuresink—anescapepathforhighpressuredfluidsinthereservoir.• Gasdissolvedintheoilexpandstoseveralhundredtimesitsreservoirvolumepushingtheliquidsupthewellbore.• Thismeansthatmaximumdrivepressureexistsatthemomentthewellisfirstopenedanddecreasesthereafter.• Oncemostofthedissolvedgashasbeenproduced,thereservoirpressureapproacheszeroandproductionstops.• Thisiscalleddepletion.


Depletion:OilRecoveryInSolutionGasDriveReservoirs

• Solutiongasreservoirstypicallyrecoverbetween5and25%oforiginaloilinplaceand60to80%originalgasinplace.• Fieldshavegeographiclimitsbasedontheextentofthetrap.• Fieldproductionwillincreaseuntilalllocationsaredrilledandthenproductionwilldecline.


ConventionalOilandTightOil

• Conventionaloilplaysinvolvedrillingreservoirrockswithverticalwells.• AfterallthecommerciallyattractiveconventionalfieldsintheU.S.werediscoveredandwereindepletion,unconventionalplaysweretheonlyoption.• Tightoilplays(fracking)involvedrillingthesourcerockwithhorizontalwells.• Tightoilhorizontalwellscost2-3timesmoretodrillandcompletethanconventionalverticalwells.• Thereisconsiderablefanfareaboutthenewvolumesofoilbutlittlediscussionaboutthecostofthetechnologyanditseffectonthepriceofoil.


DeepWaterandOilSandPlays• Unconventionalplaysincludetightoil,deepwaterandoilsandplays.• Deep-waterplaysinvolveconventionalreservoirsbutinthousandsoffeetofwater,relianceofunconventionaltechnology,greatcostandrisk.• Oilsandsarebasicallyaminingoperation.

DeepWaterPlays

OilSandPlays


PeakOil

• TheobservationofPeakOil:onceconventionalproductionpeaks,supplywillbecomeincreasinglydependentonmoreexpensive,lowerqualitysourcesofoil.

• …Likeshale,deep-water,andtarsands.• ItlookslikePeakOilisbatting1000!• Manypeoplemis-understandandthinkthatPeakOilmeansthatwearerunning

outofoil.• Thatiswrong.Peakoilisaboutrunningoutofaffordableoil.

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MillionsofBarrelsofCrudeO

ilPerDay

U.S.Conventional&UnconventionalOilProduction

Conventional Oil(45%)

Unconventional OilTight+Deepwater(55%)

Source:EIA,DrillingInfo &LabyrinthConsultingServices,Inc.

Peak10 mmbopdNov.1970

Peak9.6 mmbopdApr.2015


WhereIsTheRemainingOil?

• Nearlyhalfoftheworld’sprovenreservesareintheMiddleEast.• Only14%areinNorthAmerica.• U.S.importshavedeclinedsincetheadventofunconventionaloil.• TheU.S.stillimports52%ofitscrudeoil(7.9millionbarrelsperday2016average).• ThatmeansthattheU.S.willbecomeincreasinglydependentonforeignoil.• Thehypeaboutenergyindependenceisabsurd.

3%

8%

9%

14%

19%

47%

AsiaPacific

Africa

Europe&Eurasia

NorthAmerica

S.&Cent.America

MiddleEast

ProvenOilReserves

Source:BP&LabyrinthConsultingServices,Inc.Source:BP


TheDifferenceBetweenOilandLiquids

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MillionsofBarrelsPerD

ay

Oilvs.Liquids

Oil

NaturalGasLiquids

BiofuelsRefineryGain

Source:EIA &LabyrinthConsultingServices,Inc.

• Crudeoilrepresentsabout80%ofwhatisoftencalled“oil.”• Therestofwhatarecalled“liquids”areacombinationofotherthingssomeof

whichdonotevencomefrompetroleum.• Thebiggestcomponentisnaturalgasliquids—compoundslikeethane,butaneand

propane—thatcomefromprocessingnaturalgas.Theycontain~65%oftheenergycontentofcrudeoiland~45%ofthevaluebutarecountedasbarrels.

• Biofuelscomefromplantmateriallikecornandsugarcanethatisprocessedintoflammablealcoholsliketheethanolandisaddedtogasoline.

• Refinerygainisthevolumetricincreasethatresultsfromrefiningcrudeoilintoproductsthathavealowerspecificgravity.


ConventionalandUnconventionalOil

• Conventionaloilrepresentsabout85%oftotalproductiontoday.• EIAforecaststhatheavyoilwillremainabout3%oftotalproductionwhiletightoil

willdoublefromabout5%to10%ofworldproductionby2040.• DespiteincreasesinunconventionalandNGLproduction,theoverallpercentageof

conventionaloilisforecasttoremainfairlyconstantatabout85%forthenext25years.

• Theuncertaintyintheseforecastsisthatworldliquidsproductionwillincreasefrom93.5mmbpd in2016to118mmbpd in2040.

• Ifnot,thepercentageofunconventionaloilandNGLswillbehigher.

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ay

Oilvs.Liquids

Oil

NaturalGasLiquids

BiofuelsRefineryGain

Source:EIA &LabyrinthConsultingServices,Inc.0

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MillionsofBarrelsofLiquidsPerD

ay

WorldConventional&TightOilProduction

ConventionalOil

Source:EIA &LabyrinthConsultingServices,Inc.

Tight Oil

Heavy Oil


ConflictingViewsofTheFutureofOilSupplyandDemand

• Mainstreamoilproductionforecastsmakeademandassumption:ifyoubuildit,theywillcome.• Ifdemandisthere,supplywillcome.• Thismodelhasnorelationtosupplybutassumesthathighpriceswillresultinanylevelof

productionneeded.• Theproblem—otherthantheobvioussupplycomponent—isthatthissameassumptionhasresulted

inbothoilbubblesinwhichhighpricescrippledtheworldeconomy…anddemanddestructionprolongedthesupplyforawhile.

• Thegreatfearamongdemand-sideadvocatesisthatpeakdemandisaroundthecorner.• MorepessimisticPeakOilforecastsalsohavebeenconsistentlywrong.• Thebottomline:allforecastsarewrongbutmainstreamforecastsaredisconnectedwitheconomic

reality.PeakOilforecastsunder-estimatetheroleofmonetarypolicyandcapitalmarketstosubsidizesupply

• Theworldafterthe2008FinancialCollapseisdifferentandmustbeconsideredinanyforecast.


NetEnergy&EnergyDensity

The Landscape of Energy

2

The Landscape of Energy

Our global system of energy production and con-sumption faces systemic challenges that have been

centuries in the making—and that no one technology or fantastic new resource will solve. As the figures on the following pages illustrate, we face major obstacles to continuing our recent energy bonanza through the twenty-first century and beyond.

The global economy requires a massive, uninterrupted flow of energy every single day, the vast majority in the form of fossil fuels. These nonrenewable energy resources are constantly depleting, so we must continu-ally find and successfully exploit new sources so that tomorrow we can meet the same demand as we did

today—plus additional resources for the world’s grow-ing population and economies.

But the transition to new sources will be far from seam-less: The physical infrastructure of modern society is designed to run primarily on cheap, powerful conven-tional fossil fuels. Unconventional fossil fuels come with greater economic and environmental costs, significantly reducing their energy benefit, while renewables fall short at matching many of the characteristics we so value in fossil fuels.

An analysis of the available energy resources shows that there are no easy answers.

101% 100%

92%

76%

65% 65% 60%

36% 35%

24%

0.1% 0.1% 0%

20%

40%

60%

80%

100%

120%

Diesel Crude Oil Gasoline Anthracite Coalfor

Electric

Power

Ethanol LNG Wood Lignite CNG Methane Natural Gas

Percento

fCrudeOilEnergyContentPerLiter

EnergyContentofVariousFuelsComparedToCrudeOil

Source: EIA&LabyrinthConsulting Services,Inc.

• Notallenergysourcesareequal.• Promotersofalternativeenergysourcesemphasizecostcompetitivenessbutother

factorsareimportant:netenergy,energydensity,carbonintensity,intermittencyandbreadthofuse.

• Netenergy:howmuchenergygoesintogettingenergyout.• Oilandcoalwinonnetenergybutunconventionaloilhaslowernetenergyandcoal

hashighcarbonintensity.• Renewableenergywinsoncarbonintensitybutloseonintermittency,energy

densityandbreadthofuseparticularlyfortransport.• Energytransitionsarecomplex,costlyandtakedecades.


• Theoilshocksofthe1970sandearly1980sbroughthighoilpricesthatledtomassiveinvestmentinoilexplorationandproduction.

• ThatresultedinmajordiscoveriesintheNorthSea,MexicoandSiberiathatgreatlyover-suppliedthemarket.

• Highoilpricescauseddemanddestructionandover-supplythatbursttheoilbubble.Oilpricesdidnotrecoverforalmost25years.

• Oilsupplyflattenedafter2005andpricesincreasedleadingtorenewedE&Pover-investment.• Debt-fueledeconomicexpansioninChinaandzero-interestratesafterthe2008FinancialCollapse

resultedinthe2nd oilbubble.• Thistime,over-supplywascausedbyexpensiveunconventionaloilandthebubbleburstinmid-2014.

The2014OilPriceCollapse:TwoOil-PriceBubblesSince1970

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CPIA

djustedWTIPrices(July2016DollarsPerBarrel)

CPI

Oil Shocks-->

Massive E&PInvestment(North

Sea,Mexico,Siberia)

Over-Supply, DemandDestruction&PriceDeflation

Debt-FueledEconomicExpansion&Rapid

GrowthinChina&EastAsia

MassiveE&PInvestment(Shale, DeepWater,Heavy

Oil)

Over-Supply, DemandDestruction&Price

Deflation

Sept2016

TwoMajorOilBubblesSince1970:BothCollapsedBecauseofOver-Supply,DemandDestruction&PriceDeflation

Source:EIA, U.S.Bureau ofLaborStatistics &LabyrinthConsulting Services,Inc.

Avg1986-2004 $34/barrel Avg2005-2015 $86/barrel

All PricesinConstant August2016Dollars


EconomicGrowthandTheRealCostofOil

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CPIA

djustedWTIPrices(July2016DollarsPerBarrel)

CPI

Oil Shocks-->

Massive E&PInvestment(NorthSea,Mexico,Siberia)

Over-Supply, DemandDestruction&PriceDeflation

Debt-FueledEconomicExpansion&Rapid

GrowthinChina&EastAsia

MassiveE&PInvestment(Shale, DeepWater,Heavy

Oil)

Over-Supply, DemandDestruction&Price

Deflation

Oct2016

TwoMajorOilBubblesSince1970:BothCollapsedBecauseofOver-Supply,DemandDestruction&PriceDeflation

Source:EIA, U.S.Bureau ofLaborStatistics &LabyrinthConsulting Services,Inc.


All PricesinConstant September2016Dollars

CurrentlyLowOilPrices40%HigherThan1986-

2004Average

• U.S.GDPincreaseswhenoilpricesarelowandisflatwhenoilpricesarehigh.• 1986-2004wasatimeofgreatexpansionoftheAmericaneconomy.• Theaveragerealpriceofoilsince2005is2.5timeshigherthanintheperiod

1986-2004.Thisreflectstheincreasedcostoftechnologyforunconventionaloil.• Evenattoday’sdepressedoilprices,therealpriceofoil--$48perbarrel—is40%

higherthanthein1986-2004of$34perbarrel.• Economistsandpoliticianscannotunderstandwhytheeconomywon’tgrowbut

neverconsidertheunderlyingcostofenergy.

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016$/Ba

rrel)

ChartTitleAug2016

U.S.GDPIncreasesWhenOilPricesAreLowandIsFlatWhenOilPricesAreHigh

OilPrice

GDP

GDP 5YrMovingAvg

Source:WorldBank,EIA,U.S.Bureau ofLabor Statistics&Labyrinth Consulting Services,Inc.


GDP&Oil PricesInConstantAugust 2016Dollars


WhyisOilSuchABigDeal?

• Energyistheeconomyandoilisthemasterenergyresource.• Theglobaleconomyrequiresmassivesurplusenergytoextractnaturalresources,movethemtobe

manufacturedintoproductsandtransportthemtobesoldaroundtheworld.• Thatglobaleconomydevelopedwhenoilpricesaveraged$34perbarrel.• Whenoilpricesincreasedtomorethan$85perbarrelafter2005,economicgrowthcouldnotcontinue.• Nobusinesscanwithstanda2.5-foldincreaseinunderlyingcostandmakeaprofit.• Althoughoilpricesarelowersincethepricecollapsein2014,theyarestill40%higherthaninthe1990s.• Theaveragebreak-evenpriceforOPEC,tightoil,oilsandsanddeep-waterplaysis$82perbarrel.That

meansthatproductioncostshavenotdecreasedandthatoilisbeingproducedwellbelowitsreplacementcost.

• Economicgrowthisunlikelyattheseunderlyingenergycosts.

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rabia

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AGE

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ater

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pTightO

il

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ianTightO

il

SpraberryTightO

il

ExistingOilSands

BoneSpringTightO

il

Kuwait

Break-EvenPrice(DollarsPerBarrel)

Projected2016Break-EvenOilPricesforOPEC*&UnconventionalPlays

Source: IMF,RystadEnergy,Suncor, Cenovus,COS&Labyrinth Consulting Services,Inc.

*IMF estimatethat includes revenuetobalance fiscal budgets ofOPECcountries

Average Break-EvenPriceTodayis$82/Barrel


ConcludingObservations• Energyistheeconomyandoilisthemasterenergyresource.• Oilwillcontinuetodominatetheworldenergylandscapefordecadesbecausenootherenergy

sourcecanmeetglobalneeds.• Unconventionaloildoesnotofferameaningfullong-rangealternative.• Whileincreaseduseofrenewableenergyisinevitableanddesirable,itisnotasatisfactory

substituteforoil.• Atransitionawayfromanoil-weightedenergysupplywillbecomplex,costlyandlengthydespite

supportingargumentsorpreferences.• Thereisnoclearwayforwardthatincludessustainingcurrentlevelsofenergyuse.• Thebestpathforwardistostoplookingforimprobablesolutionsthatallowustolivelikeenergy

isstillcheap,andfindwaystolivebetterwithless.

Oil Basics and The Limits to Economic Growth - Art Berman

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