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Can shale oil & gas bring the U.S. energy independence? Is there any oil offshore East Africa?

Edition Eight - November 2012


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OilVoice Magazine | NOVEMBER 2012

Adam Marmaras Manager, Technical Director Issue 8 – November 2012 OilVoice Acorn House 381 Midsummer Blvd Milton Keynes MK9 3HP Tel: +44 208 123 2237 Email: press@oilvoice.com Skype: oilvoicetalk Editor James Allen Email: james@oilvoice.com Manager, Technical Director Adam Marmaras Email: adam@oilvoice.com

Welcome to the eighth edition of the OilVoice Magazine. Each month we put together the best content the industry has to offer, and offer it free for you to read. Last month we achieved a record number of downloads for the magazine, and our readership numbers on issu and scribd continue to climb. We use those services as an alternative way to read the magazine and reach new audiences. The 'page turning' feature of issu is particularly impressive. Take a look if you haven't already.

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OilVoice Magazine | NOVEMBER 2012

Contents Featured Authors Biographies of this months featured authors

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Oil use to continue despite efforts to be green by Larry Wall

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Argentina: Unconventional potential beneath its feet by Richard Ethrington

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Is there any oil offshore East Africa? by David Bamford

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Why natural gas isn't likely to be the world's energy savior by Gail Tverberg

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Last chance for the oil boomers by Andrew McKillop

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Recent Company Profiles The most recent companies added to the OilVoice directory

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The journey of the price of natural gas from 'zero' to dirt cheap by Wolf Richter

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An economic theory of limited oil supply by Gail Tverberg

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Can shale oil & gas bring the U.S. energy independence? by Keith Schaefer

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How 'hot' is the Barents Sea? by David Bamford

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OilVoice Magazine | NOVEMBER 2012

Featured Authors Andrew MacKillop OilVoice Contributor Andrew MacKillop is an energy and natural resource sector professional with over 30 years experience in more than 12 countries.

Keith Schaefer Oil & Gas Investments Bulletin Keith Schaefer, editor and publisher of the Oil & Gas Investments Bulletin.

David Bamford Finding Petroleum David Bamford is non-executive director of Tullow Oil, and a past head of exploration, West Africa and geophysics with BP.

Gail Tverberg Our Finite World Gail Tverber has an M. S. from the University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty Actuarial Society and a member of the American Academy of Actuaries.

Larry Wall HubPages Larry Wall is a long-time observer of the oil and gas industry as a result of his 16 years newspaper reporter career.

Richard Etherington Finding Petroleum Richard Etherington, 24, works as a freelance journalist. Richard, a BA Hons Political Science graduate, is also a fully trained sub-editor and reporter. He is a former equities reporter and columnist, who specialised in small cap drilling and mining companies – during which time he built up an impressive portfolio of industry contacts.


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OilVoice Magazine | NOVEMBER 2012

Wolf Richter Testosterone Pit Wolf Richter has over twenty years of C-level operations and finance experience, including turnaround situations and start-ups. He went to school and worked for two decades in Texas and Oklahoma, with an interlude in France, and then headed east to New York City, Brussels, Tokyo, and finally San Francisco, where he currently lives.

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OilVoice Magazine | NOVEMBER 2012

Oil use to continue despite efforts to be green Written by Larry Wall from Larry Wall The famous Muppet, Kermit the Frog sings a song about 'It's not easy being green.' Those that are pushing a green fuel economy probably often feel that it is not easy to be an advocate for green fuels. They want fuels that will provide the services we need, transportation and electricity, and they want to do it without having any harmful impacts on the environment. Most would agree that is a very worthy goal. However, one very important point is often overlooked, or if not overlooked is not given the attention that it deserves. If we eliminated the use of oil as a fuel source (we will skip natural gas for the moment, since it almost has reached the status of being green), there are issues that still need to be addressed. Few people realize how important oil is not only to the economy, but to our very civilization. In south Louisiana, there is an expression about pigs. The story goes that when you butcher a big, 'you use everything but the squeal.' The same is true for oil. Virtually, every molecule from a barrel of oil is used to make something else. Certainly, gasoline, diesel, and aviation fuel are at the top of the list, and those are the fuels that many in the green movement would like to eliminate. If you were to do that, a fair portion of that barrel of oil, the portion that produces chemical feed stocks, refinery gas and the ingredients that help make asphalt, which is used to paved streets around the world. Trying to list everything that is made from oil would take up an enormous amount of space and range from medications and heart valves to tennis shoes and basketballs. Furthermore, there are things like food preservatives, lubricants of all kinds, rubber tires and as already stated the list goes on and on with new uses being found all the time. However, suppose we eliminate the use of gasoline, diesel and aviation fuel in the next 10 years. What is going to be done about replacing the building block for all the other products? Granted, some research has been done, but nothing has come to the forefront as being able to be broken down and reassembled to produce all the products we need.


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Therefore, assuming that oil will still be needed to produce the plastic that makes up a large part of most automobiles, computers and telephones, what are we going to do with the oil that we once used for fuel? There are certain physical limitations on how you can rearrange the hydrocarbon molecule. Less fuel could be produced, and more feedstock produced, but then that is just moving the dependence on oil from the fuel side, to the chemical side. Regardless, of the primary product, we will still have to produce oil, meaning wells will have to be drilled. Produced water and other waste will have to be handled in a responsible manner. Refineries will be needed to make these products and at the end of the day, there is going to be a fair amount of gasoline, diesel and aviation fuel left. Now, you cannot really just dispose of it, and only so much can be stored, so what are we going to do? Let me take you back in time for a few minutes to when Jimmy Carter was President of the United States and the world was going through one of its many energy crises. The United States Congress enacted the fuel use act, which prohibited the building of new electrical plants that run on natural gas. The belief was that the world was running out of natural gas, so we had better switch to something else. It was an emotional response to an issue that was not fully investigated or evaluated. The result is that in Louisiana, a major produce of oil and natural gas, the birthplace of offshore oil and gas exploration, had a utility plant built near the middle of the state that runs on coal. Louisiana is not a coal producing state. To fuel this plant, there are two trains that go back and forth every day to the Wyoming-Montana area to collect and deliver coal to this plant. In all likelihood the trains are running on diesel fuel. When oil was discovered, its uses became known on a gradual basis. First, it was used to replace whale oil, thus it was one of the first efforts aimed at saving the whales. From illumination then to heating and later transportation and finally to the building block discoveries, the increasing use of oil has been taken one step at a time. Therefore, any move to green fuels is going to have to take baby steps and recognize that the elimination of oil as a fuel source is not going to happen overnight, if it ever happens. In the United States, more and more oil and natural gas is being found in shale formations. Oil and gas discoveries are being made around the world. Thanks to the technology that allows the transportation of liquefied natural gas, that fuel can now be sold on the international market, when at one time, it was considered to be a domestic fuel limited to a contagious geographic area. Will there ever be a replacement for oil? I do not think there will be a total replacement. It is a natural resource that needs to be utilized. Environmental impacts have to be considered along with the economic benefits it brings many countries and many individuals.


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Our fuel choices may be based on geography. Electric cars may be practical in large urban areas, where the average driver only goes a few miles. In rural area, gasoline or natural gas will most likely be the fuel of choice. Airplanes are probably going to depend on aviation fuel for a long time and new uses for chemical feed stocks are being found all the time. Therefore, it is not practical to think that the production, and the refining of oil are going to be eliminated in the United States, the United Kingdom or any other place in the world. It may play a smaller roll one day or a different roll, but it is going to be a part of our lives for decades, if not centuries to come. Being green may be fashionable and may be worthwhile, but again as Kermit the Frog noted, 'It's not easy being green.' (Larry Wall is a former newspaper reporter and worked as Director of Public Affairs for the Louisiana Mid-Continent Oil and Gas Association, which is the oldest and largest trade group in Louisiana representing all aspects of the oil and gas industry. Today, Mr. Wall is an observer of the oil and gas industry and a free-lance writer. You can view other works by Mr. Wall at http://larrywall.hubpages.com)

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Argentina: Unconventional potential beneath its feet Written by Richard Ethrington from Finding Petroleum Could Argentina become a bona fide unconventional oil hub? It certainly has the potential to live up to this title; whether this potential is


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OilVoice Magazine | NOVEMBER 2012

realised, however, remains to be seen. According to the US Energy Information Administration's (EIA) 2011 Annual Energy Outlook, published in April of last year, Argentina is sat on something of an uncoventionals goldmine. The South American nation boasts the third-highest geological potential for natural gas and oil trapped underground - the EIA puts Argentina's shale gas reserves at around 774 trillion cubic feet (tcf), which is equivalent to 60 times greater than the country's current conventional reserves. Only China and the US are sat upon more of these types of hydrocarbons. The shale gas reserves can be found spread across four basins with the largest of them, the NeuquĂŠn province basin, attracting the most investor and media attention. The NeuquĂŠn basin is home to the Vaca Muerta and Los Molles formations which have the strongest potential at the time of writing. Early estimates indicate estimate that there are 170 tcf of recoverable gas at Vaca Muerta and between 130 and 192 tcf in Los Molles. YPF's five-year plan proposes the creation of 132 new mine shafts over 40 square kilometres at Vaca Muerta. Earlier this year, Spanish major Repsol went as far to suggest that the same basin could do as much as to double Argentina's production within a decade, although such progress would require an estimated US$25 billion per year of investment over the ten year period. The challenge, of course, has not be finding such reserves but getting to them. This is the problem facing recently re-nationalised Argentine oil major YPF, which saw 51% of its shares taken away from Spanish oil major Repsol and placed into the hands of the Argentine state back in May of this year. Argentina's emergence as a net importer of fuel since 2010 saw YPF expropriated under strict instructions to reverse plummeting oil and gas production levels in proven reserves. A lack of investment both internally and from overseas waved goodbye to Argentina's status as a self-sufficient energy nation. However, given the unconventionals potential beneath its feet, Argentina is in a position to regain this status once more - even at a time when consumption levels are increasing simultaneously. In sum, Argentina's shale plays are something of a potential game changer. When it comes to Argentina and energy, however, nothing is ever so straightforward. YPF may be willing to bet big on the successful development of the country's significant shale reserves, but there are significant hurdles that it will need to overcome first before its mammoth US$37.2 billion investment plan to boost productivity can begin to bear fruit. This is certainly not an environment where there is reward without risk. First and foremost, a high level of investment is required - the lion's share of which will need to come from abroad. And secondly, the potential environmental impacts of drilling for unconventionals are far reaching, as the process of extraction requires using potentially damaging chemicals substances as well large sums of water and energy by a process of hydraulic fracturing, or as it is more commonly known 'fracking'. Fracking involves drilling holes vertically to depths than can reach up to thousands of metres, as well as horizontally up to 1,000 metres along the shale formation. In sum, the challenge lies in taking advantage of the vast shale opportunity while mitigating the potentially damaging environmental impact. However, there is no secret formula for making this happen.


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OilVoice Magazine | NOVEMBER 2012

So, what does YPF plan to do about it? The state-controlled firm is planning to first raise, and then spend big bucks. Rumour has it that YPF is looking to monetise its interest in unconventional plays via striking up partnerships with cash-rich overseas players. And there has long been a list of interested parties, led by energy hungry China at the top of it. China is no stranger to Argentina in this respect. Indeed, the Asian nation has made ties with Buenos Aires before, as it looks to secure its energy future: most recently, China Petrochemical spent US$2.45 billion for US-based Occidental Petroleum's unit in Argentina back in 2010. The deal followed in the footsteps of CNOOC's US$3.1 billion purchase of a 50% holding in Argentina-based Bridas Energy Holdings. A string of North American firms including Chevron, ExxonMobil and Apache have also shown an interest in getting involved. Once the money has been successfully raised, YPF plans to go to work by testing unconventional extraction techniques in Argentine next year. The firm plans to invest US$1.3 billion in 2013 to get the process stated. If successful, YPF will then bring out the chequebook once more to invest an additional US$12 billion in unconventional resources between the close of 2013 and 2017. In theory, this heightened level of investment in unconventional energy plays will in turn lead to an increase in output levels. Even further down the line, Argentina could potentially add unconventional oil and gas to its lists of major exports - alongside beef and soybean, of course. But that is not all. The development of the industry could bring in much needed investment to Argentina, which stands to benefit via the creation of new jobs (primarily via the expansion of the oil refinery in La Plata and investment into a petrochemical complex in BahĂ­a Blanca), an increase in tax revenue and greater long-term energy security - the last of which the county had long taken pride in until its recent reversal in fortunes. All this, however, is dependent upon things going according to plan. One major stumbling block hanging over the industry's development is Argentina's unpredictable energy policies. The business environment in Argentine is something which has been deteriorating for overseas players for some time now, with the expropriation of YPF serving as the most high-profile indicator of Buenos Aires' intentions. Such moves have been further compounded by strict currency controls and prohibitive import restrictions, which would prevent the very sort of high-tech exploration and production companies that Argentina is attempting to attract from going about their normal business - at least in a profitable way anyway. To be sure, such developments could prove a major impediment to attracting the foreign money needed for the projects to go ahead.

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OilVoice Magazine | NOVEMBER 2012

Is there any oil offshore East Africa? Written by David Bamford from Finding Petroleum

Huge amounts of gas have been discovered offshore East Africa, mainly in Mozambique, then Tanzania; and this month there was a modest gas discovery offshore Kenya. We will wait to see if and when this gas can be moved economically to market, given the plentiful amounts of gas being found globally and the potential for shale gas to be exported as LNG from the USA. Imminent high value is more likely to result from the discovery of commercial volumes of oil offshore - but where? This article updates an earlier one in Geoexpro. Needless to say, the emergence of East Africa as a petroleum province has been spotted by the media, especially the UK press where a headline such as 'Improved technology helps to oil the wheels for East Africa' (The Times, 7th January 2012) is but one of many. As a recent Finding Petroleum Forum revealed, it is certainly true that improved technology has had an impact, whether satellite imagery, aero-magnetics, gravity gradiometry or plate tectonic modelling, but where the oil is - and whether the gas that has been discovered is commercial - requires more careful thought. I am grateful to Alastair Bee at Richmond Energy Partners, Chris Matchette-Downes at MDOil and Oswald Clint & Robert West at Bernstein Research for helping me summarise the current status. If we go back let's say 10 years, East Africa was completely disregarded by petroleum explorers. Only a handful of wells had been drilled and there wasn't very much data but source rocks were generally believed to be absent or poor; the prevailing view was that there would only be small amounts of gas, if anything.


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OilVoice Magazine | NOVEMBER 2012

Actually, this was based on 'Myths, Myopia, Misinformation' as pointed out by Chris Matchette-Downes in 2005(1). In particular, he identified evidence for contiguous source rocks, for example in the Early and Mid-Jurassic, which could be in the oil window offshore. And of course, persistent seeps were known both offshore and in the lakes of the East African Rift System. Since 2008, there has been significantly more exploration activity and whilst new well results are being announced all the time, the essence is still the same: Oil has been discovered onshore in the Albertine Graben of Uganda (and very recently in Kenya) - see the Finding Petroleum presentation by Shane Cowley of Tullow Oil(2). Large amounts of gas have been discovered offshore - in both Mocambique and Tanzania - but no oil as yet. The gas volumes discovered in both Mocambique and Tanzania are significant and as a distant observer one's immediate response is to think that they are both candidates for LNG schemes. However, as Monica Enfield of Energy Intelligence pointed out in her Finding Petroleum presentation(2), this perspective ignores the focus both host governments will have on domestic issues such as creating a local market and providing employment in the relatively short term. As Bernstein Research has noted, a combination of successes - for example shale gas onshore in the USA, conventional gas in the Eastern Mediterranean and on the NW Shelf of Australia - have led to there being a large number of global LNG opportunities, for gas to move to either Europe or SE Asia, which may mean that somewhat more costly East African LNG will have to wait its turn in the queue. Whilst the Majors may be content to 'bank' gas for the longer term, ready for the day the price rises and it is needed, as pointed out above this may not at all be in line with the hopes and expectations of the governments of Tanzania and Mocambique. The attraction of offshore oil would be that the global price is probably going to remain high and that a discovery of a few hundred million barrels can be developed fairly rapidly with an FPSO and shuttle tankerage (indeed many tankers pass this way as they go around the Cape of Good Hope!).


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So where might there be oil offshore? Explorers now have vast amounts of data - from satellites, airborne surveys, field geologists, seabed cores, national repositories, the huge number of wells drilled (over 200,000 'wild cats' alone since 1965), publications - to sift through to identify basins and plays which might work or, in the question I have just posed, might work in a particular way. The ability of explorers to spot the next big play depends on their ability to deal with this veritable Niagara Falls of data, to solve what some have referred to as the 'Big Data'(3) problem - or opportunity, perhaps? Deploying a deep understanding of plate tectonics and chrono-stratigraphy understanding what gets deposited where and when - is the key process by which this is achieved, whereby opportunity is accessed. What has been proposed so far offshore is that the youngest source rock is an Early/Mid-Jurassic marine shale and so one model is that this may have been buried under more sediment than previously anticipated and is now in the gas window. However, this source rock has not been sampled and an alternative explanation is that the gas derives from an area of this source rock that has had high terrigenous input and so is gas prone. 1. East Africa Petroleum Conference, 2005 2. Finding Petroleum Forum, 17th April 2012 3. http://www.findingpetroleum.com/video/385.aspx

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OilVoice Magazine | NOVEMBER 2012

Why natural gas isn't likely to be the world's energy savior Written by Gail Tverberg from Our Finite World

We keep hearing about the many benefits of natural gas–how burning it releases less CO2 than oil or coal, and how it burns with few impurities, so does not have the pollution problems of coal. We also hear about the possibilities of releasing huge amounts of new natural gas supplies, through the fracking of shale gas. Reported reserves for natural gas also seem to be quite high, especially in the Middle East and the Former Soviet Union. But I think that people who are counting on natural gas to solve the world’s energy problems are “counting their chickens before they are hatched”. Natural gas is a fuel that requires a lot of infrastructure in order for anything to “happen”. As a result, it needs a lot of up-front investment, and several years time delay. It also needs changes on the consumption side (requiring further investment) that will allow this natural gas to be used. If the cost is higher than competing fuels, this becomes a problem as well. In many ways, natural gas consumption is captive to other things that are happening in the economy: an economy that is industrializing rapidly will easily be able to consume more natural gas, but an economy in decline will find it hard to scrape together funds for new ways of doing what was done previously, now with natural gas. Increased use of renewables seems to call for additional use of natural gas for balancing, but even this is not certain, because in many parts of the world, natural gas is a high-priced imported fuel. Political instability, often linked to high oil and food prices, creates a poor atmosphere for new Liquefied Natural Gas (LNG) facilities, no matter how attractive the pricing may seem to be. In the US, we have already “hit the wall” on how much natural gas can be absorbed into the system or used to offset imports. US natural gas production has been flat since November 2011, based on EIA data (Figure 1, below).


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Figure 1. US Dry Natural Gas Production, based on data of the US Energy Information Administration. Even with this level of production, and a large shift in electricity production from coal to natural gas, natural gas is still on the edge of “maxing out� its storage system before winter hits (Figure 2, below).

Figure 2. US natural gas in storage, compared to five-year average. Figure prepared by US Energy Information Administration, Weekly Natural Gas Storage Report as of October 5, 2012.


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World Natural Gas Production The past isn’t the future, but it does give a little bit of understanding regarding what the underlying trends are.

Figure 3. World natural gas production, based on BP’s 2012 Statistical Review of World Energy data. World natural gas production/consumption (Figure 3) has been increasing, recently averaging about 2.7% a year. If we compare natural gas to other energy sources, it has been second to coal in terms of the amount by which it has contributed to the total increase in world energy supplies in the last five years (Figure 4). This comparison is made by converting all amounts to “barrels of oil equivalent”, and computing the increase between 2006 and 2011.

Figure 4. Increase in energy supplied for the year 2011, compared to the year 2006, for various fuels, based on BP’s 2012 Statistical Review of World Energy data.


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In order for natural gas to be an energy savior for the world, natural gas consumption would need to increase far more than 2.7% per year, and outdistance the increase in coal consumption each year. While a modest increase from past patterns is quite possible, I don’t expect a miracle from natural gas. Natural Gas: What Has Changed? The basic thing that has changed is that fracking now permits extraction of shale gas (in addition to other types of gas), if other conditions are met as well: 1. Selling price is high enough (probably higher than for other types of natural gas produced) 2. Water is available for fracking 3. Governments permit fracking 4. Infrastructure is available to handle the fracked gas Even before the discovery of shale gas, reported world natural gas reserves were quite high relative to natural gas production (63.6 times 2011 production, according to BP). Reserves might theoretically be even higher, with additional shale gas discoveries. In addition, the use of Liquified Natural Gas (LNG) for export is also increasing, making it possible to ship previously “stranded” natural gas, such as that in Alaska. This further increases the amount of natural gas available to world markets. What Stands in the Way of Greater Natural Gas Usage? 1. Price competition from coal. One major use for natural gas is making electricity. If locally produced coal is available, it likely will produce electricity more cheaply than natural gas. The reason shale gas recently could be sold for electricity production in the United States is because the selling price for natural gas dropped below the equivalent price for coal. The “catch” was that shale gas producers were losing money at this price (and have since dropped back their production). If the natural gas price increases enough for shale gas to be profitable, electricity production will again move back toward coal. Many other parts of the world also have coal available, acting as a cap on the amount of fracked natural gas likely to be produced. A carbon tax might change this within an individual country, but those without such a tax will continue to prefer the lower-price product. 2. Growing internal natural gas use cuts into exports. This is basically the Exportland model issue, raised by Jeffrey Brown with respect to oil, but for natural gas. If we look at Africa’s natural gas production, consumption, and exports, this is what we see:


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OilVoice Magazine | NOVEMBER 2012

Figure 5. Africa natural gas production, consumption, and exports, based on BP’s 2012 Statistical Review of World Energy. In Africa, (mostly northern Africa, which exports to Europe and Israel), consumption has been rising fast enough that exports have leveled off and show signs of declining. 3. Political instability. Often, countries with large natural gas resources are ones with large oil resources as well. If oil production starts to drop off, and as a result oil export revenue drops off, a country is likely to experience political instability. A good example of this is Egypt.

Figure 6. Egypt’s oil production and consumption, based on BP’s 2012 Statistical Review of World Energy. No matter how much natural gas Egypt may have, it would not make sense for a company to put in an LNG train or more pipeline export capability, because the political situation is not stable enough. Egypt needs oil exports to fund its social programs. The smaller funding amount available from natural gas exports is not enough to make up that gap, so it is hard to see natural gas making up the gap, even if it were available in significant quantity.


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Iran is a country with large natural gas reserves. It is reportedly looking into extracting natural gas for export. Again, we have a political stability issue. Here we have an international sanctions issue as well. 4. “Need the natural gas for myself later” view. A country (such as Egypt or the United States or Britain) that has been “burned” by declining oil production may think twice about exporting natural gas. Even if the country doesn’t need it now, there is a possibility that vehicles using natural gas could be implemented later, in their own country, thus helping to alleviate the oil shortage. Also, there are risks and costs involved with fracking, that they may not choose to incur, if the benefit is to go to exporters. 5. Cost of investment for additional natural gas consumption. In order to use more natural gas, considerable investment is needed. New pipelines likely need to be added. Homeowners and businesses may need to purchase gas-fired furnaces to raise demand. If it is decided to use natural gas vehicles, there is a need for the new vehicles themselves, plus service stations and people trained to fix the new vehicles. Additional natural gas storage may be needed as well. Additional industrial production is difficult to add, unless wages are low enough that the product being sold will be competitive on the world market. Existing “pushes” toward better insulation have the effect of reducing the amount of natural gas used for heating homes and businesses, so work in the opposite direction. So do new techniques for making nitrogen-based fertilizer using coal, rather than using natural gas. 6. Touchy balance between supply and consumption. If additional production is added, but additional uses are not, we have already seen what happens in the United States. Storage facilities get overly full, the price of natural gas drops to unacceptably low levels, and operators scramble to cut back production. The required balance between production and consumption is very “touchy”. It can be thrown off by only a few percent change in production or consumption. Thus an unusually warm winter, as the United States experienced last year, played a role in the overly full storage problem. A ramp up of production of only a few percent can also cause an out of balance situation. Unless a developer has multiple buyers for its gas, or a “take or pay” long-term contract, it risks the possibility that the gas that is has developed will not be wanted at an adequate price. 7. Huge upfront investment requirements. There are multiple requirements for investing in new shale gas developments. Each individual well costs literally millions of dollars to drill and frack. The cost will not be paid back for several years (or perhaps ever, if the selling price is not high enough), so debt financing is generally needed. If fracking is done, a good supply of water is needed. This is likely to be a problem in dry countries such as China. There is a need for trained personnel, drilling rigs of the right type, and adequate pipelines to put the new gas into. While these things are available in the United States, it likely will take years to develop adequate supplies of them elsewhere. All of the legislation that regulates drilling and enables pipeline building, needs to be in place as well. Laws need to be friendly to


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fracking, as well. Growth in Exports to Date Exports grew as a percentage of natural gas use through about 2007 or 2008.

Figure 7. World natural gas exports as percentage of total natural gas produced, by year, based on EIA data (older years) and BP’s 2102 Statistical Review of World Energy for 2010 and 2011. In recent years, natural gas exports have fallen slightly as a percentage of total gas extracted. Thus, if world natural gas supplies have risen by an average of 2.7% per year for the past five years, exports available for import have risen a little less rapidly than the 2.7% per year increase. A major ramp-up in export capability would be needed to change this trend. While we hear a lot about the rise in exports using LNG, its use does not seem to be adding to the overall percentage of natural gas exported. Instead, there has been a shift in the type of export capacity being added. There are still a few pipelines being added (such as the Nord Stream pipline, from Russia to Germany), but these are increasingly the exception. The Shale Gas Pricing Debate Exactly what price is needed for shale gas to be profitable is subject to debate. Shale gas requires the payment of huge up-front costs. Once they are drilled and “fracked,” they will produce for a long period. Company models assume that they will last as long as 40 years, but geologist Arthur Berman of The Oil Drum claims substantial numbers are closed down in as few as six years, because they are not producing enough natural gas to justify their ongoing costs. There is also a question as to whether the best locations are drilled first.


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Logically a person would expect shale-gas to be quite a bit more expensive to produce than other natural gas because it is trapped in much smaller pores, and much more force is required to extracted it. In terms of the resource triangle that I sometimes show (Figure 8, below), it epitomizes the low quality, hard to extract resource near the bottom of the triangle that is available in abundance. We usually start at the top of the resource triangle, and extract the easiest and cheapest to extract first.

Figure 8. Author’s illustration of impacts of declining resource quality. Berman claims that prices $8.68 or higher per million Btu are needed for profitability of Haynesville Shale, and nearly as high prices are needed to justify drilling other US shale plays. The current US price is about $3.50 per million Btu, so to be profitable, the price would need to be more than double the current US price. Prices for natural gas in Europe are much higher, averaging $11.08 per million Btu in September 2012, but shale gas extraction costs may be higher there as well. The US Energy Information Administration admits it doesn’t know how the economics will work out, and gives a range of projected prices. It is clear from the actions of the natural gas industry that current prices are a problem. According to Baker Hughes, the number of drilling rigs engaged in natural gas drilling has dropped from 936 one year ago to 422, for the week ended October 12, 2012. Backup for Renewables One area where natural gas excels is as a back up for intermittent renewable energy, since it can ramp up and down quickly. So this is one area where a person might expect growth. Such a possibility is not certain, though: 1. How much will intermittent renewables continue to ramp up? Governments are


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getting poorer, and have less funds available to subsidize them. They do not compete well on when they go head to head with fossil fuels, nuclear, and hydroelectric. 2. When intermittent renewables are subsidized with feed in tariffs, and requirements that wind power be given priority over fossil fuels, it can provide such an unlevel playing field that it is difficult for natural gas to be profitable. This is especially the case in locations where natural gas is already higher-priced than coal. The Societal “Recipe” Problem Our economy is built of many interdependent parts. Each business is added, taking into account what businesses already are in place, and what laws are in effect. Because of the way the economy currently operates, it uses a certain proportion of oil, a certain proportion of natural gas, and more or less fixed proportions of other types of energy. The number of people employed tends to vary, too, with the size of the economy, with a larger economy demanding more employees. Proportions of businesses and energy use can of course change over time. In fact, there is some flexibility built in. In particular, in the US, we have a surplus of natural gas electricity generating units, installed in the hope that they would be used more than they really are, and the energy traded long distance. But there is less flexibility elsewhere. The cars most people drive use gasoline, and the only way to cut back is to drive less. Our furnaces use a particular fuel, and apart from adjusting the temperature setting, or adding insulation, it is hard to make a change in this. We only make major changes when it comes time to sell a car, replace a furnace, or add a new factory. In my view, the major issue the world has been dealing with in recent years is an inadequate supply of cheap oil. High priced oil tends to constrict the economy, because it causes consumers to cut back on discretionary spending. People in discretionary industries are laid off, and they tend to also spend less, and sometimes default on their loans. Governments find themselves in financial difficulty when they collect fewer taxes and need to pay out more in benefits. While this issue is still a problem in the US, the government has been able to cover up this effect up in several ways (ultra low interest rates, a huge amount of deficit spending, and “quantitive easing”). The effect is still there, and pushing us toward the “fiscal cliff.” The one sure way to ramp up natural gas usage is for the economy as a whole to grow. If this happens, natural gas usage will grow for two reasons: (1) The larger economy will use more gas, and (2) the growth in the economy will add more opportunities for new businesses, and these new businesses will have the opportunity to utilize more natural gas, if the price is competitive. I have compared the situation with respect to limited oil supply as being similar to that of a baker, who is trying to bake a batch of cookies that calls for two cups of flour, but who has only one cup of flour. The baker is able to make only half a batch. Half of the other ingredients will go unused as well, because the batch is small. To me, discovering that we have more natural gas than we had before, is analogous


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to the baker discovering that instead of having a dozen eggs in his refrigerator, there are actually two dozen in his refrigerator. In fact, he finds he can even go and buy more eggs, if he is willing to pay double the price he is accustomed to paying. But the eggs really do not fix the missing cup of flour problem, unless someone can find a way to change eggs into flour very cheaply. Basic Energy Types To me, the most basic forms of energy resources are (1) coal and (2) oil. Both can be transported easily, if it is possible to extract them. Natural gas is very much harder to transport and store, so it is in many ways less useful. It can be made work in combination with oil and coal, because the use of coal and oil make it possible to build pipelines and make devices to provide compression to the gas. With coal and oil, it is also possible to make and maintain electric transmission lines to transport electricity made with natural gas. I sometimes talk about renewable energy being a “fossil fuel extender,” because they hopefully make fossil fuels “go farther”. In some ways, I think natural gas is an extender for oil and coal. It is hard to imagine a society powered only by natural gas, because of the difficulties in using it, and the major changes required to use it exclusively. In the earliest days, natural gas was simply a “waste product” of oil extraction. It was “flared” to get rid of it. In many parts of the world, natural gas is still flared, because the effort it takes to collect it, transport it, and make it into a useful product is still too high. The hope that natural gas will be the world’s energy savior depends on our ability to make this former waste product into a product that will replace oil and coal. But unless we can put together an economy that needs and uses it, most of it probably will be left in the ground. The supposedly very high reserves will do us no good.

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Health, Safety, Environment and Risk Management RPS Energy is a global multi-disciplinary consultancy, providing integrated technical, commercial and project management support services in the fields of geoscience, engineering and HS&E.

Contact James Blanchard T +44 (0) 20 7280 3200 E BlanchardJ@rpsgroup.com

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OilVoice Magazine | NOVEMBER 2012

Last chance for the oil boomers Written by Andrew McKillop from OilVoice SERIAL TRADING Oil traders have now likely entered the Home Run to the nowhere of a massive crash in prices. Of course given a turbo punch on the downhill ride, prices can implode to one-half present levels near $90 for WTI and an unreal or frankly fantastic $115 for Brent. The oil traders want it, and can deliver it in quick time when they forget about the Goldman (Sachs) dream price of $130 oil. As my analysis of the "right price for oil" is around $75, getting back up to that price range, after the crash, might also be quite rapid. Great volatility, wonderful see-saws and therefore great times coming, for traders! At present the crash forecast is "downside nonsense" talk, to be sure. Tired of those tiring fundamentals - like supply, stocks, demand and nonoil energy costs and prices which only point downwards for oil - traders still locked-on to the fantasy of oil at $115 a barrel have now mass migrated to the fantasy land of geopolitical risk. This by its nature - unknown - is the best possible thing for shifting prices, because "markets hate uncertainty". Markets perhaps, but certainly not oil market operators. Geopolitical threat to oil is a traditional offering from the always-excited pack of analysts and thinkers who work the lodes of War on Terror, the Clash of Civilizations, Israel and the Arab World, and related potboilers. When the geopolitical threat disappears or was shown to have never existed the result is always downside: prices always fall after a geopolitical risk prime boost implodes. By definition these boosts are a blip - unless we go back to the Oil Shocks of 40 years ago. The first and most dramatic of these in 1973-1974, delivered an overall 350% rise in oil prices. The first stage of the round of oil price hikes raised prices by 70% to $5.11 per barrel. The final price after the series of hikes raising prices by 350% was around $12 a barrel (no missing zeros). Another important detail was that almost zero percent of world oil was traded until the late 1980s. The biggest threat to world oil, meaning sky high prices, is called Wall Street. SERIAL TALKING Moving up in the gunsights and talktime of oil talking heads, we now have the Syrian war threat to the entire Middle East, starting with Turkey. After all, Syria has chemical weapons, which crowds out the reality that NATO-member Turkey could take out almost zero oil producing Syria in a few days. Oil boomers therefore need to claim that by osmosis or other magic means, the Syrian war can threaten Saudi Arabia. We can ask: and why not further afield?


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Adding more depth and richer spin, the boomers tell us Syrian-linked Hezbollah will mount suicide attacks on Israel, if the el-Assad regime totters much more than at present. And then so what, concerning oil? Would Israel mount retaliation attacks on sunna ruled Saudi Arabia, if Lebanese majority shia Hezbollah attacked Israel? More likely, Saudi Arabia would pay Israel to take out the Hezbollah, and if Israel thought that was a little too risky, Turkey could be paid to take them out. The big one is of course Iran, making it obligatory for the oil boomer fraternity to talkin the Iranian crisis - so old it essentially dates back to 1979 and nothing whatsoever to do with Israel-Palestine sparring, which goes back even further. It can however still yield a couple of tens of cents extra on a traded barrel of paper oil: Oil this week got a small boost when it was reported that Israeli prime minister Benjamin Netanyahu had called for early elections. While the main reason given by Netanyahu for disbanding his right-wing government was budget deficit and austerity spending cut wrangling within his own party, the oil boomers vastly preferred to see it as Netanyahu solidifying his power before calling a referendum on war with Iran. After this, if he won it, Israel could or might bomb Iran after a certain period of time, if the US and other allies approved, or possibly even if they didn't, and of course if Israel's air force wants to run a certain suicide mission. Russia could or might not approve of the proposal, we could easily surmise although that would be great for the oil boomers because they will tell us Russia would certainly cut-off of oil supply to Israel's allies, every drop would be shut off, even if those allies didn't approve of Israel's hypothetical war plans against Iran! Almost cut and dried, therefore, that Israel will bomb Iran. Just a question of weeks you know. Reports that Iran is only months away from having a nuclear weapon can be checked for their lengthening and antique status, and who cooked them up, but when the oil boomers need more ammunition, these reports will circulate. Curiously enough, any country with even one single major civil nuclear reactor has - stationed on its own soil - the equivalent of up to 100 Hiroshima-sized atomic weapons. This is far from being a self-defence weapon, let alone an arm of attack but oil boomers do not see things that way. Civil nuclear reactors only provide the deadly plutonium and U238 needed to make bombs. Netanyahu's political pitch, apart from austerity business, is that Iran bombing talk can possibly tip the balance in coming elections, to his advantage, the exact opposite of the boomers' claim that he wants to win the election handily to get a mandate to bomb Iran. Due to the key role Iran hysteria plays in talking up oil prices, deep analysis of Israeli politics now crowds into oil trading. The spin takes two tracks: the next Israeli elections are unavoidable because of the nation's deepeening economic crisis, unpopular austerity programme and ballooning budget deficit - but the main media focus of the election campaign is Iran. This is helped by Netanyahu's Likud party having two main rivals both headed by former Israel Defence Force chiefs of staff: Kadima led by Shaul Mofaz and Atzmaut led by Ehud Barak. Each leader pitches to the voting public and media, but the most essential fact is that


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Netanyahu has moved mountains and molehills to get the Iran nuclear issue into Israeli and world media, totally supplanting the Palestinian issue which nobody talks about nowadays. When or if needed and the same way oil prices see-saw, the two issues can be switched around again. Between times and as all Israeli political leaders know, like their opposite numbers outside Israel, the public including voters, also called couched potatoes have to be kept amused and distracted. SERIAL LYING Staying briefly with Israel, its New Normal status in a world facing its worst ever economic crisis is shown by a host of factors - including the status of Only Possible PM for Netanyahu. As France's switchover from only possible Sarkozy to president Hollande has shown, or Spain's switchover from Jose Zapatero to Mariano Rajoy has shown, the newcomers are totally unprepared for running the economic crisis show - let alone handle the geopolitical side dishes and designer wars in the New Colonies of the Lost Imperium. If Netanyahu's government falls, Israel's economic crisis will deepen, the problem being that the crisis will deepen anyway. Turkey's military responds to shelling from Syria like it should, while fundamentalist sunna rebels funded by Saudi Arabia and Qatar fight it out with el-Assad's forces, implying an interesting state of new border play when or if the rebels win, take power, and lay down Shariah law in New Syria. But future oil production and export supply capacity from New Syria is unlikely to change in any major way, either up or rather slightly down. Conversely, moving on to Serial Liars, the International Energy Agency says that Iraqi oil production could hit 6.1 million barrels a day by 2020 and 8.3 Mbd by 2035, compared with a little more than 3 Mbd now, making Iraq the second-biggest world exporter, pushing Russia into third place. By osmosis or serial exaggeration, Iran can be expected or supposed to be capable of producing at least as much new oil: say 16 Mbd for Iraq and New Iran combined. All that is needed is to liberate Iran. Finding the imaginary oil resources to jack up oil output by that amount, is only a minor problem for the wordsmiths and spin doctors. The pure schizophrenia of this Fantasy Oil track, for the price boomers is clear to anybody outside their talk circus. Taking only Iraq, if it doubles its export supply of oil by 2020, oil prices can only fall due to New Iraq becoming a mega exporter into a flat-line market for oil.. Since 2007, world oil demand growth has given every impression of being dead: whatever high oil price artistes need, it is not extra supply. Whether or not Turkey takes out the el-Assad regime, which we could hope it does, whether Israel revotes Netanyahu, which we could hope it doesnt, the present geopolitical risk talk of the oil boomers is tacky at best, and usually simple lying.

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OilVoice Magazine | NOVEMBER 2012

Recent Company Profiles The OilVoice database has a diverse selection of company profiles, covering new start-up companies through to multi-national groups. Each of these profiles feature key data that allows users to focus on specific information or a full company report that can be accessed online or printed and reviewed later. Start your search today! Hallin Marine

IndianOil

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By combining experience, expertise and a wide-range of assets Hallin designs and delivers tailor-made, professional, safe and cost effective solutions to clients in the oil, gas and renewable energy sectors world-wide.

IndianOil is the highest ranked Indian company in the latest Fortune ‘Global 500’ listings, ranked at the 83rd position. IndianOil's vision is driven by a group of dynamic leaders who have made it a name to reckon with.

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Visit IndianOil’s OilVoice profile

Green Plains Renewable Energy

Hydrocarb Corporation

Ethanol

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Green Plains Renewable Energy, Inc. (Nasdaq:GPRE) is North America's fourth largest ethanol producer. The Company markets and distributes approximately one billion gallons of renewable motor fuel on an annual basis.

Hydrocarb Corporation is a privately held energy exploration and production company targeting major under-explored oil and gas projects in emerging, highly prospective regions of the world. With headquarters in Houston, Texas we maintain offices in Abu Dhabi, UAE and Windhoek, Namibia.

Visit Green Plains Renewable's OilVoice profile Visit Hydrocarb Corporation's OilVoice profile

Bumi Armada Transport

Intelligent Energy Electricity and Gas

Bumi Armada Berhad is the largest owner and operator of offshore support vessels in Malaysia and is an established and trusted service partner in the oil and gas industry. Visit Leland Bumi Armada's OilVoice profile

CEC North Star Energy Oil & Gas

CEC North Star Energy Ltd ("CEC") is a privately held emerging oil and gas development company targeting oil opportunities in the Carbonate Triangle in Alberta, Canada. Visit CEC North Star Energy's OilVoice profile

Intelligent Energy is a leading clean power systems company focused on a cleaner, lower carbon and more efficient energy future. Intelligent Energy is a global company located in the UK, and the US, with offices in Japan and India. Visit Intelligent Energy's OilVoice profile


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OilVoice Magazine | NOVEMBER 2012

The journey of the price of natural gas from 'zero' to dirt cheap Written by Wolf Richter from Testosterone Pit On March 14, I shredded the natural gas components of the government’s Blueprint, a document that spelled out its energy policy, because it relied on the existence of dirt-cheap natural gas from the “shale gas revolution.” While the combination of horizontal drilling and hydraulic fracturing (fracking) opened up huge resources in the US, and natural gas (NG) production jumped as a consequence, it also pushed prices far below the cost of production, for far too long. A disaster for an entire industry. An opportunity for its customers. But it cannot last. Back when the Blueprint was released, NG was truly dirt cheap: $2.28 per million Btu (MMBtu) at the Henry Hub. Storage levels were 48% above the five-year average, after a warm winter had curtailed the use of NG for heating. There was talk that the price would go to zero, as storage levels would reach capacity in the fall, and excess production would have to be flared. Producers cut back on drilling, and by midMarch, Baker Hughes’ rig count had plunged to 670 from 936 in October last year. It was a catastrophic scenario. And the price kept dropping. It was wreaking havoc in the industry—yet production continued to rise. When NG hit about $1.90 per MMBtu at the Henry Hub on April 19, a decade low, its path to zero seemed assured. Lacking liquefied natural gas export terminals, the US couldn’t even sell its excess production to the energy-starved Japanese who had to pay around $17 per MMBtu on the world markets. By May, billions in write-offs were pummeling the industry. Chesapeake and other producers were dumping assets to stay afloat. The rig count dropped to 600. Shale gas production was an uneconomic activity at these prices—though by May 23, it had climbed to $2.73 per MMBtu, up 44% from the April low. The economics of horizontal fracking are horrid. With all wells, production drops over time. But instead of years for traditional wells, decline rates for shale gas wells are measured in months. After a year, production may be down by 80%, after a year and a half by 90%. High production early in the lifecycle allows drillers to show a big upfront profit. Initially, decline rates are obscured by production from new wells. But the more wells they have, the more they have to drill to hide the drop-off in production of older wells! What caught up with them was reality. And they responded by switching to drilling for oil and gaseous liquids, which fetched higher prices,


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because they had to survive, and producing dry NG wasn’t a survivable activity. But the benefits of dirt-cheap NG were spreading across the country: households and companies benefited from lower energy bills. Power generators profited from their strategy, launched in the 1990s, of investing in highly efficient natural gas combined-cycle (NGCC) turbines. The building boom of NGCC plants nearly doubled natural gas-fired capacity, at the expense of coal-fired plants—which are being retired at a breath-taking pace [Natural Gas Is Pushing Coal Over The Cliff]. And companies that manufacture plastics, fertilizers, and chemicals from NG are building plants in the US where they can buy their raw material for a fraction of the cost elsewhere in the world. By June 20, excess inventory levels were plummeting. It had become clear: storage levels would not reach capacity, and NG would not drop to zero. Speculating in NG entered the sweet spot: the price was still way below the cost of production, but the threat of zero had been taken off the table. Timing remained uncertain, but sooner or later the price would have to self-correct, and by nature, it would over-correct. The rig count had fallen to 562—but production was still rising. The price dropped to $2.53 MMBtu at the Henry Hub. Nothing is ever easy. And in the industry, capital destruction continued [Natural Gas: Where Endless Money Went to Die]. So, when will production finally decline? With drilling activities slowing, production should follow, the theory goes. But there’s a laundry list of reason why it hasn’t happened: producers are now only drilling their most productive wells; drilling technologies have become more efficient, such as pad drilling; finished wells that had been shut in due to pipeline constraints or collapsing local prices, including over 1,000 wells in northern Pennsylvania, are coming on line; dry gas production as a byproduct from the booming oil and gaseous liquids plays is surging; etc. The EIA’s Monthly Supply and Disposition Balance for July, the latest available, shows that production of dry NG through July was still 6% higher than last year! From April through July, production was up 4.2% over prior year. For data since July, we have to look at the EIA’s weekly figures (available only in percentages), and they’re tapering off: the last week that production was over 3% higher than the same week in 2011 was the week of August 15, at 3.4%. Since then, the differential hovered been between 1% and 2%. Last week, it dropped to 0.6%. So production is still higher than it was at the same time last year (but barely), even as the rig count dropped to 427. Waiting for production to decline is like waiting for Godot. But demand for dry gas is ballooning. From April through July, which excluded the effects of the warm winter, demand was up a stunning 9.6%. The EIA’s weekly yearover-year demand numbers are volatile, but since late August, the low point was the week of September 12 with a 6.2% increase in total demand over the same week last year; four weeks in that period saw double-digit increases, with the week of October 3 jumping by 18.7%. This surge in demand has performed what in March would have been considered a miracle: it cut the amount of NG in storage from 48% above the five-year average to 7.1%. Inventory levels now feather the upper limit of the five-year range.


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At its current price—recently $3.43 per MMBtu, up 80% from the April low—NG is stilldirt cheap, and therefore, demand from power generators and industrial users will continue to be strong. When the heating season kicks off in earnest, weather will be the primary factor for a few months, and cold waves, or the lack thereof, might distract from the surging demand for power generation and industrial use that will gradually put pressure on storage levels even if production refuses to decline. The protests and attacks against American embassies have devastated public support for a military presence in the Middle East, writes Chriss Street. And to facilitate a Middle East withdrawal, the public will soon demand a crash program to exploit domestic energy resources. With big opportunities. Read.... The Coming American Energy Independence.

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An economic theory of limited oil supply Written by Gail Tverberg from Our Finite World

We seem to hear two versions of the story of limited oil supply: 1. The economists’ view, saying that the issue is a simple problem of supply and demand. Substitution, higher prices, demand destruction, greater efficiency, and increased production of oil at higher prices will save the day. 2. A version of Hubbert’s peak oil theory, saying that world oil production will rise and at some point reach a plateau and begin to decline, because of geological depletion. The common belief is that the rate of decline will be determined by geological considerations, and will roughly match the rate at which production increased.


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In my view, neither of these views is correct. My view is a third view: 3. An adequate supply of cheap ($20 or $30 barrel) oil is no longer available, because most of the “easy to extract” oil is gone. The cost of extracting oil keeps rising, but the ability of oil-importing economies to pay for this oil does not. There are no good low-cost substitutes for oil, so substitution is very limited and will continue to be very limited. The big oil-importing economies are already finding themselves in poor financial condition, as higher oil prices lead to cutbacks in discretionary spending and layoffs in discretionary industries. The government is caught up in this, as layoffs lead to more need for stimulus funds and for payments to unemployed workers, at the same time that tax revenue is reduced. There can be a temporary drop in oil prices (as there was in late 2008), as recession worsens, but eventually demand rises again, oil prices rise again, and the pattern of layoffs and increased governments financial problems occurs again. Without substitutes at a price that the economy can afford, economies will adapt to lower amounts of oil they can afford by worsening recession, debt defaults, and reduced international trade. There may be tendency for international alliances (such as the Euro) to fall apart, for countries to break into smaller units (Catalonia secede from Spain, or countries break up the way the Soviet Union and Yugoslavia did). At some point, probably not too many years in the future, the amount of oil extracted from the ground will drop, reflecting a combination of geological and economic factors. The fall may very well be quite steep. While we can’t expect to extract more than geology will allow, there is nothing to say that political and economic factors will allow extraction of this amount. If civil war breaks out in an oil producer, production may drop quickly. Or if oil prices drop because of severe recession, drilling of new fields and wells may drop off quickly, leading to lower production as existing wells deplete, and not enough new supply as added. There may also be disruption in international sales of oil. What the Economists’ View Misses The economists’ view misses the fact that it is external energy that makes the economy operate the way it does. (See my earlier posts, here, here and here.) If energy products are higher priced, energy importers can afford less of them, and there is a tendency of their economies to shrink back to what their economies can


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afford—fewer employed workers and fewer government programs. I talk about the connection between employed workers and energy consumption in The Close Tie Between Energy Consumption, Employment and Recession.

Figure 1. World GDP, oil consumption and energy consumption growth rates, based on data of USDA, Angus Maddison, and BP’s 2012 Statistical Review of World Energy data. As the growth rate in energy supplies decreases (oil by itself, or in total), the economy tends to shrink back. Initially (in the 1970s and 1980s), the economy shrinking back looked like it was slowing down – no longer undertaking big new initiatives like interstate highway systems and major electrical grid expansions, and adding new initiatives for taking care of the poor. Then the economy shrinking back morphed into a bigger emphasis on debt financing; less concern about keeping up infrastructure the way it had in the past; and switching from manufacturing of goods to production of services, to keep energy needs lower. Another way of keeping down energy use was by keeping wages down. Since wages translate to purchase of things that energy can make, lower wages allow an economy to “get by” with less energy consumption. In the US, the quest for lower wages has manifested itself in many ways—the failure of men’s median wages to rise after the mid 1970s, the increasing use of women (at lower average wages) in the workforce, and later outsourcing of jobs to countries overseas with lower wages


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(and thus less energy consumption by workers).

Figure 2. Per capita oil consumption in countries with recent bank bailouts, based on data of the US Energy Information Administration. Eventually, the economy shrinking back has become more disruptive. It looks more like recession, with job layoffs, debt defaults, and serious government funding problems. Governments find themselves going deeper and deeper into debt, as tax revenue lags, and there is more need for stimulus funding and benefits for unemployed workers. In such an atmosphere, government stability is at risk. This seems to be where quite a few of the European countries are right now. The United States is not far away either, with many of its problems hidden by deficit spending, “quantitative easing,” ultra low interest rates, and the fiscal cliff. The Myth of Substitution A big part of the economists’ problem in figuring out the problem with limited cheap oil supply is their assumption that energy is not very important. It doesn’t cost very much, so why worry about it? Certainly, there should be substitutes. For example, if we can’t afford to make goods, we should be able to switch to the production of services, since these don’t require as much energy to produce. This might be a method of substitution.


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But think about this. In our own life, our own energy comes from food. If someone told you that we were having a problem with food supply, but the economists said not to worry, we would find a substitute, how convinced would you be that economists really knew what they were talking about? Do you feel less hungry after a haircut, or a trip to get a loan at a bank (two standard types of services)? Perhaps they were underestimating the importance of food. Something like that happens with other forms of energy as well. It is virtually impossible to substitute away. There is a little substitution over time of one form of energy for another, just as there is substitution of wheat for corn. But in general, each type of energy has its own uses, and it is hard to substitute one type for another. A car runs on gasoline. It is possible to substitute up to 10% or 15% corn ethanol in the gasoline, but unless significant changes are made, it is not possible to run the car on natural gas or on coal. A big part of economists’ problem with overestimating the role of substitution is their missing the adverse impact of high oil prices (or other high energy prices) on the economy. As I have explained previously, when oil prices rise, both the cost of food and cost of commuting tend to rise. Workers cut back on discretionary spending, so as to have enough money for commuting and food expenses, leading to layoffs in discretionary industries. Housing prices stagnate or drop, as people cut back their expectations of moving to a higher priced home. Governments find themselves in increasingly poor financial condition, trying to fix these problems, with lagging tax revenue. All of this creates substantial economic problems, which cannot be overlooked. The comment a person often hears is, “As soon as the price of oil rises high enough, _______ will substitute for it.” This doesn’t work for a couple of reasons: (1) By the time the price rises that high, the economy will be “in the tank” anyhow; a high-priced substitute doesn’t fix the problem. (See my post High-Priced Fuel Syndrome) (2) Substitutes generally use oil in their production, either directly or indirectly, so when the price of oil rises, the price of the substitutes tends to rise as well, although probably not as much as the oil price rise. Substitution to date is not taking place very quickly. On a worldwide basis, 87% of current energy use comes from fossil fuels, based on BP’s 2012 Statistical Review of World Energy Data. The remainder is divided as follows, in the year 2011:


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Nuclear amounted to 5% of the total;

Hydroelectric amounted to 6% of the total, and Renewables (including wind, solar, biofuels, wood, waste, geothermal, and others) come to a total of 2% of world energy supply.

There has been some substitution away from oil for a long time, because oil is high priced. Often, this occurs through electrification of various processes. The electricity used in this process is today mostly from natural gas and coal, with lesser amounts from nuclear, hydroelectric, and other renewables. The speed with which substitution of electricity for oil is taking place varies, with stationary applications working best, and transportation being slow to change. According to the US Energy Information Administration, in 2011, only 0.3% of US transportation fuel was electricity. The rest of transportation was divided as follows: Oil, 92.7%; Biofuels, 4.3%; Natural Gas, 2.7%. Another application which is a significant user of oil, but for which little substitution toward electricity is readily available, is in food production. Oil is used in operating farm machinery, in making herbicides and insecticides, and in transporting food to market. This is a reason why many people are interested in local food production, using techniques that use less oil. What the Peak Oilers Missed If a person goes back and looks at M. King Hubbert’s 1956 paper, Nuclear Energy and the Fossil Fuels, they will discover that Hubbert talks about a very optimistic scenario: the use of nuclear energy rising, before the use of oil and other fossil fuels begins to decline. See my post, Will the decline in world oil supply be fast or slow?

Figure 3. Figure from Hubbert’s 1956 paper, Nuclear Energy and the Fossil Fuels.


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Elaborating further on this idea, Hubbert, in his 1962 paper, Energy Resources – A Report to the Committee on Natural Resources, writes about the possibility of having so much cheap energy that it would be possible to essentially reverse combustion– combine lots of energy, plus carbon dioxide and water, to produce new types of fuel plus water. If we could do this, we could solve many of the world’s problems–fix our high CO2 levels, produce lots of fuel for our current vehicles, and even desalinate water, without fossil fuels. The problem that arises if we don’t have such a substitute for fossil fuels is a severe one. How do we keep our current economy operating, if oil prices, or fossil fuels in general, become high priced, and start interfering with the economy? At some point, the interference will become so great that recession will set in, in many major oil importing nations. Oil prices will drop, and oil producers will not be able to extract oil at those prices. There may be major financial impacts as well—governments dropping out of the Euro, the US government facing a financial cliff, and other countries (Japan, Britain, and China, for example) facing difficulties as well. In my view, the shape of down slope in oil production is likely to be steeper than the pattern by which oil supply increases. Geology determines the maximum amount of extraction, but it doesn’t determine how much will actually be extracted. Economic conditions need to be right for the extractions to take place. Low oil prices by themselves could cause political upheaval in some oil exporting nations. If there are huge international trade problems, this could reduce demand as well. Why International Trade Can Be Expected to Contract Huge economic growth since World War II has been enabled by increased international cooperation and increased globalization. It is now possible to make many high-tech goods using trained specialists who travel around the world and raw materials imported from countries that will put up with high levels of pollution. These high-tech goods can be very cheap, if they are assembled in a country such as China with cheap labor. Once countries start operating in a mode of “not enough energy to go around,” the model of global cooperation starts disintegrating. If unemployment becomes an increasing problem, then countries are no longer be willing to let in cheap labor from lesser-developed countries. We can see this happening in the United States, with respect to workers from Mexico. If oil is becoming a problem, we will see more spats, of the type recently occurring between Japan and China, leading to lower trade. There may even be more resource wars. Large countries encountering financial problems will see individual units wanting to go their own way, with the parts that are doing better economically wanting to disassociate themselves from the have-nots.


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OilVoice Magazine | NOVEMBER 2012

Figure 4. Oil as a percent of total 2006 energy consumption for European countries, based on BP’s 2012 Statistical Review of World Energy High oil prices are likely to lead to more defaults on loans. In fact, Figure 4 shows that the countries most at risk of defaulting tend to be the ones that imported the largest percent of their energy from oil in 2006, before the recent crisis begin. As the world encounters more and more loan defaults, this too can be expected to erode interest in foreign trade. Such trade will likely not disappear, but may be carried on to a greater degree between trusted partners, or on more of a barter basis. For example, a certain quantity of oil may be traded for goods that the oil-producing country can use. Businesses, Governments and Consumers form a Networked System The way the world operates today, each business is added to the existing web of governments, businesses and consumers that exists today. Some businesses succeed, while others fail. Success or failure depends the laws that are in effect, the resources that are available, what competition there is, and the purchasing power of customers.


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OilVoice Magazine | NOVEMBER 2012

If energy is in short supply, more and more governments and businesses will fail, and increasing numbers of consumers will find themselves without jobs in the traditional economy. Banks may be overwhelmed by debt defaults. At some point, supply chains will become so disrupted that it will be hard for anything other than small local businesses to succeed. This will correspond to what Joseph Tainter talks about as moving to a state of lower complexity. We don’t know exactly when or how this will happen, but it appears that we are already moving in this direction. The next years seem likely to be challenging ones!

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Can shale oil & gas bring the U.S. energy independence? Written by Keith Schaefer from Oil & Gas Investments Bulletin

Can shale oil and gas carry the U.S. to energy independence? The short answer is no, says Credit Suisse (CS) in a September 7 report, but North America as a whole could be energy self-sufficient. CS hangs their thesis on 4 key pegs: 1. Flow rates from oil wells about 25% higher than now, based on future technology advances 2. More wells that are on average 39% closer together than they are now (the industry calls this “downspacing”) 3. $95/barrel Brent pricing


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OilVoice Magazine | NOVEMBER 2012

4. Increased use of natural gas in the economy The barriers to continental self-sufficiency are: 1. Fast declining production in shale wells 2. Oil below $75/barrel 3. Enough money to build pipelines and refineries CS says US oil production will peak out at 10 million barrels of oil per day (bopd) by around 2022—a double from 2008’s 5 million. 2011 oil production in the US was 5.7 million bopd. EIA stats show petroleum consumption has fallen steadily for seven years, and in 2011 was 18.8 million bopd—the same as 1997 and 2 million bopd below the peak in 2005. Once you include 3 million barrels of US liquids production (natural gas liquids like propane, butane, condensate and biofuels), overall production was still less than 9 million boepd—not even half of the country’s total demand of 19.2 million barrels of oil equivalent per day (boepd). Canada and Mexico are comparatively small consumers, using only 4.4 million bopd, with combined overall oil and liquids production of 6.6 million boepd of oil and NGLs. All these numbers show that overall, the U.S. is falling short by 10.7 million boepd itself, and North America as a whole comes up around 8.8 million boepd shy of total demand. That means energy independence would have the US producing and refining 10.7 million boepd more than it does now. That’s a (very) tall order. CS expects U.S. oil and liquids production to rise from the current 8.7 million boepd to around 15 million boepd by 2022, while demand will slump closer to 18 million boepd. A modest jump in Canadian output paired with continuing low demand will help bridge the shrinking supply gap, moving North America closer to energy independence. And that assumes a steady decline from Mexico. The crux of the report’s predictions lies in the Americans’ ability to tap their massive unconventional oil resources. The first key to this prospective boom is the initial production (IP) rates for the country’s major shale oil fields – the amount produced at each well over the first 30 days. (The industry shows this number in print as the “IP30” rate.) These numbers are often the most important, since the greatest output comes in the first few months before declining rapidly. CS estimates IP30 rates for each of the major shale plays using production numbers at the end of the fourth quarter of 2011. Some of these assumptions are set far above what actual production numbers are


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today. For example, actual output in the Utica shale and Mississipian formation was close to nil—so almost no data on which to guesstimate the future. But CS expects wells to eventually reach around 600 and 400 boepd, respectively, as the plays mature. Other young plays that lack any production data like the Brown Dense limestone and the Woodford shale are projected to top 300 boepd based on the limited data of those regions. The biggest producers – the Granite Wash and Eagle Ford shale – are already close to their CS assumptions. On the whole, CS estimates average a 21%-25% bump over actual output numbers from last year. Only the Granite Wash and Cana Woodford oil plays are projected above the CS exploration and production team’s numbers. The report backs up its optimistic IP30 rates with strong early numbers in some of the developing unconventional plays. Over three years, IP30 rates in the welldeveloped Barnett formation more than doubled. But in the Bakken and Marcellus shale plays, IP rates tripled in 13 months and nine months, respectively. The Eagle Ford is the only exception, and those numbers are skewed somewhat by an early focus on natural gas over liquids. A large part of rising IP rates is the assumption that oil and gas companies will eventually learn the nuances of each region. But CS also notes the increased use of pad drilling—where four wells can be drilled from one, two-acre pad—should keep more oil rigs online for longer during the first 30 days, as they don’t need to be moved around as much from well to well. Pad drilling will also play a role in lowering the spacing between unconventional oil wells. CS projects the U.S. will need to increase its total oil wells by 27% in order to prevent a decline within the next four years. In order to meet the report’s production numbers, the country would have to increase the number of new wells being drilled each year by 39% through 2022. These estimates are all a bit voodoo—they depend on tight spacing and a lot higher flow rates than now. However, CS says recent experiments in downspacing in the Eagle Ford shale play should help boost production. The big question when you downsize your wells is—are you just cannibalizing existing production from existing wells or are you able to recover more oil overall (the Recovery Factor) by draining parts of the reservoir that you wouldn’t have gotten otherwise. If it’s the former, the impacts on the US production outlook would be dramatic. The biggest question mark for me, however, is what will the decline rates on shale oil


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be long term? Right now CS suggests average decline rates in the Bakken and Eagle Ford—the two largest shale oil plays right now—are 60% in Year 1, 30% in Year 2 and falling close to 15% in Year 5. CS puts its estimate for the average terminal decline rate – beyond 20 years – of unconventional US oil resources at 8%. But the Bakken and Eagle Ford shale plays have only been drilled hard for the past 3-4 years. So long term decline rates—which CS thinks will average out at 4% for the Bakken and 6% for Eagle Ford over the life of the well—is an educated guess. CS estimates expected ultimate recovery per well for the Bakken of nearly 900,000 boepd and 600,000 boepd for the Eagle Ford shale. Less developed projects like the Permian Horizontal, Woodford shale and Granite Wash are all expected to reach near 500,000 boepd, despite a small sample size. If declines are steeper than they project, then these wells will get shut-in sooner and produce less than CS suggests. Though they didn’t talk about waterflooding, which will likely GREATLY increase overall reserves in US tight oil plays. Read all about that here in my story onwaterfloods. CS estimates that the oil industry will need Brent prices of at least $95 per barrel to justify investment through 2014. After that, investment costs will drop low enough that shale fields would eventually draw interest even at benchmark prices of almost $75 per barrel. The CS analysis is most sensitive to a change in rig counts. A drop to $80 per barrel within the next year would result in 180 fewer rigs operating within the country and $60 billion less in total investments by 2014. Oil production in this scenario would reach only 8 million bopd. The report says that massive infrastructure spending (pipelines, refineries, etc.) is a key to energy independence—and notes that oil companies have already proven unwilling to invest in new infrastructure at prices as high as $90 per barrel, despite most wells remaining profitable. A lack of infrastructure spending—specifically pipelines to take crude oil out of the Cushing Oklahoma hub, and to get Bakken and Canadian oil to the east and west coasts—have caused a $15/barrel discount in North American crude prices to the rest of the world. This is huge lost revenue for US and Canadian oil producers. Pipelines such as the Seaway pipeline and the proposed Keystone XL should add between 950,000 and 1.25 million bopd of capacity away from Cushing OK, to the Gulf Coast. But Bakken oil will continue to rely on rail and barge transportation, and both the Keystone XL and the Flanagan South pipelines that would service the region are yet to be approved. CS also gives some consideration to possible regulatory restrictions, primarily in terms of water restrictions. Several states have already considered limiting water use in the energy sector to prevent the decline of local agriculture industries, while


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concerns about water safety have spurred most of the objections to the use of fracking in the U.S. US energy independence is a hot topic spurred by the rapid rise in shale oil production—The Shale Revolution. While it’s hard for anybody to guesstimate what such a dynamic industry will be doing 10 years from now, Credit Suisse data suggests that will remain an elusive goal.

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OilVoice Magazine | NOVEMBER 2012

How 'hot' is the Barents Sea? Written by David Bamford from Finding Petroleum Is the Barents Sea a 'Hot Spot', enjoying a renaissance? In the search for oil can explorers finally unlock its secrets or will it disappoint us once more? There's no doubt there's lots of gas - but what does Gazprom's apparent decision to put the development of the giant gas Shtokman field 'on ice' mean for the potential of more Arctic gas? Several recent oil and gas discoveries in the Western Barents Sea are now triggering an increased interest in this huge, largely unexplored petroleum province far beyond the Arctic Circle. First, Statoil announced an oil and gas discovery with well 7220/8-1 - Skrugard - on April Fool's Day, in the Bjørnøyrenna Basin. It contains at least 250 MMboe, maybe up to 500 MMboe, within Jurassic sandstones. A 33m gas column and a 90m oil column were encountered (GEO ExPro Vol. 8, No. 3). Later, during late spring, Total drilled 7225/3-1 - Norvarg - far north on the Bjarmeland Platform. The well proved gas in three different layers within the Triassic. It has not been finished yet, but rumours say it may be a significant discovery. Then Lundin Norway made another gas discovery in July with well 7120/2-3S Skalle - further to the south, on the southern flank of the Loppa High, and only 25 km north of the producing Snøhvit field, in the Hammerfest Basin. The well proved gas in three separate zones with a total column of 95m in Jurassic and Cretaceous sandstones. The gas field Snøhvit has been producing since 2007 (1 Bboe recoverable gas and condensate), while the oil field Goliat (220 MMboe) is under development and is expected to start flowing in 2013. 'This follows 30 years of meagre results with only two commercial discoveries, in spite of close to 90 exploration and appraisal wells and hydrocarbons shows all around,' says Bengt Larssen, President, Exploration with Aker Geo.

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OilVoice Magazine | November 2012