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Primer on Oil Equilibrium

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#1 Russ Winter

Russ Winter

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Posted 17 June 2012 - 11:05 PM

“Complexity is not free, and it is all reducible to energy.” – Joseph TainterThis post is not an immediate actionable, but preparation and background for future actionables.Regardless of whether there is peak oil or not, almost all the marginal global oil available to maintain supplies comes from expensive offshore deepwater projects and North American onshore unconventional plays.  Some 12% of global oil production comes from deepwater versus 3% a decade ago.   Offshore conventional production from sources like the Middle East, North Sea, Mexico and the Gulf of Mexico have been barely able to stay flat lined, and only then through constantly increasing costs. The second chart shows the location of deepwater oil reserves.Posted ImagePosted ImageThe next chart shows where most of the new deepwater production has come from, namely Brazil. Production in 2011 ran at about 2.8 billion barrels/day, and Petrobras has plans to spend nearly a quarter trillion through 2016 to crank this up to 5.7 billion.  This article from Econ Matters goes into more detail about the costs and challenges of Brazil’s critical effort to execute this plan.   These projects are very difficult; for instance in April Exxon and its partners Hess (HES) and Petrobras (PBR) abandoned their exploration effort in the once hyped Santos Basin, epicenter of Brazil’s offshore oil boom. This was XON’s sole effort in Brazil.Brazil needs high and stable prices to have any chance to pull this off.   The second chart shows the equipment that Brazil will need to round up for this project.  Once again, we have the extremely expensive Tainter complexity theory at work and  a plunge in oil from here would be highly disruptive.Posted ImagePosted ImageLower prices would also be highly destabilizing to almost all the oil exporters. These countries have budgeted for and in some cases have bought off their population following Arab Spring.  Nobody cares about Russia, and at sub 100 the natives get restless in Nigeria.   But once the price gets near $90, western petro-client states, the UAE and Oman are impacted.  At about $80 Brent Sea the alarm bells go off for Qatar and Saudi Arabia.  Petrodollars from these suppliers are part of the US Treasury debt recycling scheme as well.Posted ImageOther oil price reference points:-Total SA (TOT) Chief Executive Christophe de Margerie sees $100 oil as necessary for major long term projects.- The breakeven point for most oil operations in Alberta’s Athabasca oilsands basin is roughly $60 per barrel.Citi report: Current shale oil economics are in the $50-80/bbl range — costs in the Bakken are running just over $60/bbl on average. US shale project have high up- front capital costs.The bottom line is that the global economy is already in recession mode.  Saudi Arabia and the US have produced a bit extra, and Iran is increasingly perceived (incorrectly in my view) to be a geopolitical non-factor.   Yet the Brent Sea price is still at $97.  Only a massive economic collapse would knock prices down to levels where the UAE and Saudi Arabia howl and Brazil needs to defer.  Therefore I will treat a break from here as unsustainable. Citi has a report on Long Term Prices of Oil and uses 75-80 as equilibrium price,  kind of optimistically low.Citi also has a detailed reference report on North American Petroleum Production called Energy 2020, that I will utilize. This discusses the potential for about a 3 million b/pd increase over the next five years in US production primarily from high cost development of shale oil (also referred to as tight oil and gas or liquids) and GoM deepwater (now that post BP-Machando moratorium have ended).  Of course natural gas is also produced as a by product of liquids-rich plays.    Because of decades of geological data the US has advantages developing unconventional onshore oil and gas. However for the foreseeable future US shale oil and gas is mostly landlocked, and western Canadian product is stranded, thus requiring infrastructure investments that are often tarnished by politics (such as Keystone).Once again this demonstrates classic Tainter complexity theory (Collapse of Complex Societies):  expense and difficulties stand out when one does a dispassionate through reading of the Citi piece  (which I would highly recommend).   Most of the firms involved in the primary tight oil and gas plays like Bakken and Eagle Ford are dependent on bank credit lines,  and I believe the fate of CHK holds the key there.I prefer the energy service pick and shovel providers and infrastructure firms anyway,  and right now see GoM and international as the best bets. As the last chart shows, the rig fleet is old. The bottom line is that in the US, a trillion dollars will need to be thrown at getting this challenge to pay-off. This in a casino based country  dominated by corruption and expediency.   This should get interesting, and can’t just be ignored.Posted ImagePosted Image

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