Behind The Oil & Gas Abundance Narrative: The True Status of Crude Oil

For those that are time challenged, go straight to the takeaways.

Every other day we are bombarded by wonderful news of shale gas abundance brought on by the technology revolution of hydraulic fracturing (fracking). The mainstream airwaves and headlines are also filled with news of oil abundance brought on by tight (shale) oil. The U.S. is on the verge of energy independence and to become the largest oil producer in the world. The worldwide oil production is growing by leaps and bounds in the past few years.

Check out these headlines:

U.S. Will Meet Energy Needs by 2020: Citi Researcher (link: Forbes)

US Is on Fast-Track to Energy Independence: Study (CNBC)

Double clicking on one of these typical headlines – this one from The New York Times – this is what you will see:

Surge Seen in U.S. Oil Output, Lowering Gasoline Prices

HOUSTON — Domestic oil production will continue to soar for years to come, the Energy Department predicted on Monday, scaling to levels not seen in nearly half a century by 2016.

The annual outlook by the department’s Energy Information Administration was cited by experts as confirmation that the United States was well on its way — far faster than anticipated even a year ago — to achieving virtual energy independence.

The report predicted that the increase in United States production would contribute to a decline in the world oil benchmark price over the next few years to $92 a barrel in 2017 from a 2012 average of $112 a barrel, which should translate into lower prices at the pump for consumers.

It projected that domestic oil production would increase by an average of 800,000 barrels a day annually through 2016, nearly reaching the 1970 historic high of 9.6 million barrels a day . The increase in domestic oil production should bring the imported share of oil supplies down to 25 percent in 2016 from the current 37 percent. Just a few years ago, the country imported half of its oil supplies.

To be fair, one cannot really accuse a storyline such as the one above of lying. The only problem is if you would look beyond the headline or dig deeper than what is presented, as we shall do in this article, you would quickly realize that the facts presented only represent half the picture, and come up with a very different conclusion.

Before diving into the details it would be instructive to set the overall context so we are aware of where this discussion on U.S. tight oil fits in the overall scheme of things as it relates to global crude oil production and consumption.

By the numbers – world crude oil & U.S. tight oil

Here are some stats and charts to help you set the context:

World crude oil production:

  • Total crude oil production (including lease condensate) in 2013: 76.1 million barrels per day (mbpd)
  • Total liquids production in 2013: 87.9 mbpd (see explanation on the difference between liquids and crude oil below)
  • The top two crude oil producers are Russia (10.7 mbpd) and Saudi Arabia (9.6 mbpd), according to IEA.

U.S. tight oil production:

  • Tight oil production in the U.S. averaged 3.22 mbpd in the fourth quarter of 2013. Combined with crude oil produced from conventional oil wells, the U.S. crude production was 7.84 mbpd.
  • The U.S. produces just more than 10% of the world’s total crude oil production in 2013.
  • In 2013 tight oil production in the U.S. represents 4.3% of the world’s total crude oil production.
  • In February 2014, 63% of U.S. tight oil production came from two basins: the Eagle Ford in South Texas (1.21 mbpd or 36% of the total tight oil production), and the Bakken Shale in North Dakota and Montana (0.94 mbpd or 28% of total).

US tight oil production as percentage of world total

Source: EIA

Rest of world tight oil production

  • Tight oil production in the U.S. represents 91% of all North American tight oil production. Canada makes up the remaining 9%.
  • Of the 3.52 mbpd of Canada’s total crude oil production in 2013, about 10% (0.34 mbpd) comes from tight oil extracted from the western provinces of Alberta, Manitoba and Saskatchewan.
  • The U.S., Canada and, to a much smaller extent, Russia, are the only major producers of tight oil in the world. Outside of the U.S., less than 1% of crude oil production comes from tight oil.

North American tight oil production Source: EIA

Worldwide oil production growth – the fine print

Every day now we are told that worldwide oil production is growing by leaps and bounds. How true is that statement and is that cause for exuberance?

Well, It depends on how you count.

If you look beyond the headline and dig a little deeper, the most common set of data you would be presented in support of the claim would resemble something like the following chart with the global total oil production showing slow but steady growth since 2000. Leaps and bounds might be a bit of a hyperbole, but steady growth nonetheless.

Total global liquids production Date source: EIA

However, it gets interesting when you try to break down what exactly that aggregate number is. This benchmark number reported officially and broadly referenced by the industry is used to represent crude oil production . In recently years, however, the industry and officialdom started reporting on a slightly different number (total liquids production ) and used that as the benchmark headline number instead. This new benchmark includes not only crude oil proper but also other oil type liquids.

 

The highly followed benchmark got unceremoniously switched to something else in recent years.

 

This Resource Insights article gives a good explanation of what the new oil liquids components are and how they are not substitutes for oil. Here’s a summary:

  • Crude oil and lease condensate (C+LC) – crude oil and lease condensate (Petrowiki) are the two components conventionally known as crude oil before other liquids are included to be collectively called oil liquids.
  • Natural gas plant liquids (NGPL) – NGPL are hydrocarbons other than methane that are separated from raw natural gas at a processing plant. They include:
    • Ethane – feedstock for the production of ethylene by the petrochemical industry
    • Propane – used mainly for heating
    • Butane – fuel for butane lighters and propellant in aerosol sprays
    • Pentane – for industrial and laboratory uses
  • Biofuels – it is not an energy source so much as an energy carrier. There is also a limit of ethanol which can be added to the fuel mix, not to mention the fact that it takes more energy to produce than it provides.
  • Refinery gain – the total volume of crude oil increases once it is separated into its various fractions. This is not a source of oil so much as a consequence of spending energy to refine it.

What is this semantic nitpicking all about and what is the harm done by lumping these similar liquid types into the mix, you wonder?

Well, the problem with this is threefold, the least of which is that by changing the definition you are no longer comparing apples to oranges, especially if the quantities of the other components being included are not insignificant.

The next serious issue is that lumping the data together obfuscates the true state of the important components and takes away our ability to monitor it easily. Regardless of whether you are a believer of climate change or agree with fossil fuel use or not, everyone would agree that crude oil is absolutely critical to our society and our economic activities.

The diagram on primary energy consumption by section below drives home the above point.

Transportation, which includes the movement of foods, raw materials, finished products and people, in other words, all human activities in the physical click-click-bang-bang world on this planet, run practically exclusively on petroleum derived liquid fuels (93%) . Add to this the fact that there is little to no substitute for petrochemical products, you would conclude pretty quickly that petroleum is a pretty darn critical commodity and energy source, at least until an alternative can be found. (For a primer on the various refined products derived from petroleum, click here ).

Ethane and other NGPL cannot be used to power vehicles, just like one cannot shove a pile of coal into the gas tank of a vehicle and expect it to drive. When we talk about running out of oil, we are talking about running out of petroleum from which transportation fuels are made. We are not talking about running out of propane for our BBQs. So NGPL is irrelevant in this regard.

So it stands to reason that something as critical as the commodity from which transportation fuels are derived should be closely monitored and the data which facilitates such monitoring should be in plain sight and clear of unnecessary noise.

primary energy consumption by source and sector Source: EIA

The last issue with the change in headline benchmark is that by presenting and reporting aggregate numbers to mainstream media and the public who are uninterested in or incapable of digesting anything more than headlines and sound bites, critical information gets masked, alarming trends becomes less apparent, and important issues do not get debated and dealt with the way they deserve.

Having the above said, if we go back to the old benchmark and only look at crude oil and lease condensate, the chart below is what you would see. In essence, global crude oil and lease condensate production has been more or less flat since 2005, between 72 – 76 mbpd.

global crude + LC production Data source: EIA

But wait, there is more. If you further divide global C+LC production into North America and the rest of the world, a much more concerning picture emerges.

First the good news chart. North America C+LC production has been ‘growing by leaps and bounds’ in the past two to three years, thanks largely to the increase in production from U.S. tight oil and, to a lesser extent, Canadian tar sands.

(Click to see larger image)

Crude & lease condensate production North America Source: EIA

Now the not too good news. Outside the U.S., C+LC production from the rest of the world has been flat to slightly declining since 2005. In fact, there is strong evidence that global peak of C+LC production might have already been reached in 2005. In other words, minus U.S. tight oil, peak crude oil production might already be in the rear view mirror .

Keep in mind the world minus the U.S. accounts for 90% of the total global C+LC production.

Global crude production less US World minus U.S. crude oil production. Source: EIA

Situation with conventional oil

Conventional oil is the type of crude oil which has been extracted by humans for the longest time – by pumping it out from wells from underground reservoirs under normal pressure and temperature. Getting the oil out of the ground is relatively easy and inexpensive. In other words, this is the ‘easy oil’ which the world has enjoyed for the past decades.

Where are we today with the ‘easy oil’?

Most of the oil producing countries in the world have already passed their production peaks or have reached a plateau in their production . According to EIA data, of the 42 largest oil producing countries (30 non-OPEC, 12 OPEC producers) representing 98% of all oil production, 30 have either plateaued or passed their peaks (see country list here).

Existing conventional oil fields are also depleting on average between 4 to 6% every year (see analysis here). That means new oil fields, conventional or otherwise, will need to be discovered to replace what is consumed. And how are we doing in that department? Well, not too good either, I’m afraid. In fact, peak discoveries – the most amount of new oil discovered in any particular year – happened in the early 1960s. Right now the world is using up on average four barrels of oil for every new barrel it discovers . Yup, we are digging into our savings.

Tight oil to the rescue?

Quick answer: no.

First of all, let’s remind ourselves of the context again. We are really talking about 5% of total global crude oil production here which tight oil represents. So one way or another, it is not going to alter the big picture by a significant amount even if tight oil manages to do magic here.

Tight oil faces many of the same geological and economic challenges as shale gas (see Deconstructing the 100 years natural gas abundance narrative). These challenges put a severe limit on how much production can grow and how sustainable the rate of production will be.

Before going into details about the unique challenges of tight oil, let’s revisit the earlier statement from the mainstream article.

Again, per the New York Times:

HOUSTON — Domestic oil production will continue to soar for years to come, the Energy Department predicted on Monday, scaling to levels not seen in nearly half a century by 2016.

…… and

It projected that domestic oil production would increase by an average of 800,000 barrels a day annually through 2016, nearly reaching the 1970 historic high of 9.6 million barrels a day . The increase in domestic oil production should bring the imported share of oil supplies down to 25 percent in 2016 from the current 37 percent. Just a few years ago, the country imported half of its oil supplies.

Now try to image if one puts in front of you a chart showing U.S. tight oil production based on NYT’s assessment above. Can you visualize what that chart might look like? I bet your mental chart would probably have an ever rising line from the left to the right end of the chart.

Below is the actual chart presented in the same EIA report from which the NYT assessments were based. Assuming whoever wrote the article did not copy and paste from some other sources, you have to wonder if that person actually read the chart further down the EIA report. The first two blue dots on the left of the chart were actual data. The blue line was based on their revised outlook which is higher than their 2013 outlook. But otherwise the blue and orange lines pretty much trace out the same shape.

EIA US crude production prediction Source: EIA Annual Energy Outlook (AEO) 2014 Early Release Overview

Looking at the actual chart, even a grade 9 math drop-out in less than 30 seconds would come up with the following observations:

  • Production rising through 2016, as observed by the article (true enough)
  • Production plateau between 2016 and 2020
  • One-way decline starting 2020

Sorry, NYT, your statements are less than half truths; they’re about one third correct.

Now what about this statement from the same article:

The annual outlook by the department’s Energy Information Administration was cited by experts as confirmation that the United States was well on its way — far faster than anticipated even a year ago — to achieving virtual energy independence.

Let’s put that assessment against a couple of other charts in the same EIA report from which the observation was presumed to have been made.

(Click to see larger image)

US petroleum supply 1970-2040 Source: EIA Annual Energy Outlook 2014 Early Release Overview

The chart on the left shows U.S. oil consumption against domestic supply since 1970. Since the U.S. consumes more oil than it produces itself, the consumption line is naturally above the supply line. The gap between the two lines represents the net imports of oil into the country. The widest gap (i.e. most net imports) occurred in 2005 when the U.S. imported 60% of the oil it needed. In 2012, that import amount narrowed to 40%. The same AEO report predicts that at the peak of tight oil production around 2016 the net import will narrow to about 25%. Once the production peak is past beyond 2020, the import gap will again widen to 32%.

The chart on the right shows a more detailed breakdown of supply sources. The blue area on the top represents the amount of oil imports needed to meet demand. Again, natural gas plant liquids and other liquids are included in both charts, so the demand for crude oil is understated.

Even if you believe the EIA projections which are subject to regular revisions, more often than not, to the downside (Monterey 96% downgrade, remember?), ‘virtual energy independence’ in light of a 25% import gap even at the peak of tight oil production sounds quite farfetched. I sat in on a bunch of physics lectures during university, so by that same line of logic I guess that makes me a ‘virtual physicist’.

The US consumed 18.9 million barrels a day of petroleum products during 2013, 6.2 million barrels of which (32.8%) came from imports. The U.S. will likely continue to be a major crude oil importer .

Decline rate and the drilling treadmill

Once on a drilling treadmill, it is like trying to go up a down escalator. It becomes harder and harder to maintain the current rate of production, let alone expanding it.

Shale/tight oil is facing the same problem as shale gas in that the decline rate of the wells is simply atrocious. Available data to date pegs the three year decline rates of the Eagle Ford and Bakken fields, two of the largest tight oil plays in the U.S., at 91% and 86%, respectively, as the charts below illustrate.

(Click to see larger image)
Bakken and Eagle Ford production decline curves

Source: David Hughes , Sustainability Research

As production from legacy (existing) wells declines, more and more wells need to be drilled in order to maintain the same level of production before an increase can be contemplated. Recent snapshots of production data taken from Eagle Ford truly help visualize the dynamics of a drilling treadmill, as illustrated by SRSrocco Report below.

The set of charts are snapshots of legacy production change taken in Nov 2013 through Jan 2014 showing decline rates are increasing from month to month.

(Click to see larger image)

Eagle Ford legacy production change
Eagle Ford indicated oil production change

Source: SRSroccoreport

The set of charts on the right drives home what a drilling treadmill looks like. For the month of Nov 2013, a new addition of 105,000 barrels per day were brought online on top of an existing base production of 1,069,000 bpd (9.8% increase) from the previous month. Over the same period, legacy production decreased by 83,000 bpd, bringing the net increase for the month to only 33,000 bpd. The months of Dec 2013 and Jan 2014 pretty much paint a very similar picture.

The situation in the Bakken play does not paint a more optimistic picture, either. Notice the steady increase in the number of additional wells needed in order to bring on progressive 200,000 bpd increments of  production, likely attributable to (a) need to offset decline in existing wells, and (b) deteriorating well qualities as the sweet spots are drilled and the low hanging fruits are harder to come by.
Bakken oil production & total wells

Source: Oxfordenergy.org

The seemingly explosive increase in aggregate production from all tight oil fields in the past several years masks a very worrying reality. The jump in production was the result of drilling a massive number of wells against a backdrop of some brutal decline rates of existing wells. In effect, the higher one’s production, the more number of wells one needs to drill to maintain that production rate. At some point,  we are going to run into physical limits of the real world – spots to drill, pipeline infrastructure and drilling machines just to name a few .

The high depletion rates also guarantee that production will fall off a cliff as soon as we slow the pace of drilling.

Marginal cost of production

The vast majority of oil and gas companies require an oil price of over $100 per barrel to achieve positive cash flow under current capital expenditures and dividend program.

Lumped into the mainstream and industry narrative of the ‘dawn of oil and gas abundance’ is the nirvana of cheap oil once again thanks to the growth of tight oil and gas by ‘leaps and bounds’.

Again, per the NYT:

The report predicted that the increase in United States production would contribute to a decline in the world oil benchmark price over the next few years to $92 a barrel in 2017 from a 2012 average of $112 a barrel , which should translate into lower prices at the pump for consumers.

The above statement would have you think that these new barrels of oil would be easy and cheap to pump out. In reality, tight oil, deep sea oil, tar sand and pretty much the majority of new oil discoveries for that matter, are neither cheap nor easy to produce.

Take a look at the two charts below.

E&P capex cost per barrel of oil

Source: Steven Kopits

The chart above shows the aggregate exploration and production (E&P) capital expenditures (capex) by the oil majors. E&P capex pertains to the upstream cost of looking for new oil fields and bringing these new fields into production. The growth in E&P costs (0.9% compound annually) from 1985 to 1999 had been relatively manageable. However, notice that the turn of the century has seen a dramatic rise in E&P costs to 10.9% compound annually from 2000 through 2013.

The chart below, which plots the total capex against the oil production of some of the oil majors, points to an even more worrying trend – Not only has capex cost soared more than 5 times from $50 billion to $262 billion in 12 years through 2012, the oil production, the fruit of such upstream spending, had actually declined.

capex vs oil production

 Source: Steven Kopits

 

What does that tell you? The additional barrel of oil is increasingly difficult to find and more costly to produce. How expensive is that marginal barrel to produce and are the oil companies drowning in profit from those newfound barrels as a lot of people seem to suggest?

The chart below shows the oil price required by oil companies to be free cash flow after capex and dividends. Here are the highlights from the same report:

  • The vast majority of oil and gas companies require oil price of over $100 per barrel to achieve positive cash flow under current capex and dividend program. [i.e. oil companies need $100 per barrel or more in order to generate enough revenue to pay for capex, operational costs and give dividends to shareholders]
  • Nearly half of the industry needs more than $120 per barrel. The 4th quartile, where most of the U.S. E&Ps cluster, needs $130 per barrel or more.

(Click to see larger image)

Free cash flow breakeven oil price

Source: Steven Kopits, Douglas-Westwood

 

Challenges faced by the oil majors

New fields are not worth pursuing at $110 per barrel as the oil companies’ marginal cost is higher than that.

Put yourself in the shoes of a major oil company executive and imagine the challenges you are facing.

  • You need to maintain a positive outlook for the company in order to support the company’s stock price, mainly by:
    • Increasing or at least maintaining production.
    • Increasing or at least maintaining oil and gas reserves lest your company would be viewed as a self-liquidating enterprise.
  • E&P cost is growing at an alarming rate. You are spending more but producing less.
  • Oil price is capped by the limited ability of the global economies to absorb high oil price without going into recession.
  • You need to generate and maintain healthy free cash flow (your oil revenue minus capex and dividends to shareholders).

As you can see, the oil companies are getting boxed in by rapidly rising production costs and capped oil price. What should you do as the company’s executive in order to preserve shareholders’ values? Well, you rein in costs and apply capital discipline by getting rid of investments that do not meet return on investment criteria.

In fact, that is exactly what is happening across the oil majors in 2014, as one after another the oil majors are announcing capex cuts and, for some of them, also along with asset write-downs.

To wit:

  • Shell to cut capex spending by 20% while divesting $15 billion of assets in 2014/15 (Reuters)
  • Exxon to cut capex spending by more than 6% in 2014 (24/7Wallst)
  • Hess to spend 15% less on capex from 2013 (Reuters)
  • BG Group to slash capex by up to 34% from 2013 level through 2016 and write off $2.4 billion in assets (Bloomberg)
  • French Total to cut spending even though outputs were stalling (Rigzone)

By virtue of their actions, the oil companies are virtually throwing in the towel and adjusting to the new reality:

  • At $110 per barrel, the world, especially the developed world, is barely pulling itself out of recession. What would the world economy be like at $130?
  • With less upstream E&P spending, it is a virtual certainty that production will fall in the future (remember, legacy conventional oil wells depletes by 4 – 6% a year, much higher for tight oil).
  • New fields are not worth pursuing at $110 per barrel as the oil companies’ marginal cost or production is higher than that. They’d rather cut cost and raise dividends to the shareholders while waiting for oil price to go higher.
  • Bottom line: even if there is abundant oil, and that’s a big if, the oil will stay in the ground at $110.

Takeaway points

To summarize:

  • The oil and gas abundance narrative touted by mainstream media and the industry are half truths at best. You need to dig deeper to remove the obfuscation and reveal the facts.
  • Crude oil is and remains the most critical resource to the world’s economy until an alternative is found. Data pertaining to this critical resource should be monitored in isolation, and not lumped into and reported together with other liquids.
  •  Conventional oil discoveries peaked decades ago and peak production very likely has already passed in 2005. Conventional oil production drops 4 to 6% a year on average.
  • Tight oil represents a tiny sliver (5%) of the global oil production. One way or another it won’t be a deciding factor when it comes to future oil production. The high depletion rate of tight oil wells will guarantee the production boom will be short lived, to be measured in years and not decades.
  • Oil at $110 a barrel is not economically viable for most oil companies to go out and find those extra barrels. Cutbacks in spending will mean more production cuts in future years.

 

Sources and further reading:

 

Tight oil Shale gas

This article is part of the Tight oil Shale gas in-depth topic. Get a crash course and read the latest developments on this topic.

GO

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes:

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>