January 1999 Vol. 220 No. 1  Offshore

Robert E. Snyder,  Editor

Oil and gas prices: What else is important?

After studying the volumes of material published in November and early December on the oil / gas industry’s problems stemming from the $10+ per bbl drop in crude oil price, I think a quote from one of the presenters at Arthur Andersen’s 19th Annual Energy Symposium held in Houston, December 8 and 9, sums up the problem and the solution in just these few words, "The best cure for low oil and gas prices is low oil and gas prices."

Economics 101 tells us that supply / demand problems tend to take care of themselves when an increase in demand for cheaper products erases the supply excess. In our case, its more likely that the supply "bubble" will be erased to more closely match even a reduced demand growth. For oil, this is not going to happen in a year or two because of OPEC’s surplus capacity and because that crude oil can be shipped to anywhere in the world. For gas, transportation is more difficult, thus, supply / demand varies by geographic location.

Crude supply / demand. Matthew Simmons of Simmons & Company International, continues to assert that world crude prices are set in the pits of the commodity markets, or the NYMEX, which is influenced, rightly or wrongly, by the latest reports on Middle East activity, crude inventory levels, political events, etc. These traders, who actually sell only about 5% of the paper crude they buy, are not perceptive in guessing crude prices, they actually control them.

The world demand for crude is highly influenced by Asia. When I first traveled in Indonesia in the 1970s, I was shocked to see a society in which people dreamed of owning a bicycle. As Asian economies grew, these dreams advanced to bicycles with gasoline engines, and now automobiles. Should a significant percentage of the billions of people there realize their dreams, the world could not supply their energy needs.

Two specific countries with problems were noted by Jim Placke of Cambridge Energy Research Institute, at the Arthur Andersen Conference: China, which is facing a major devaluation problem, and Japan, which is key to Asia’s recovery. Reportedly, some corrective measures are being applied in each area. The close tie of energy use to gross national product and stock markets in Asia is noted in the Editorial page in this issue.

Placke also discussed the failure of OPEC to act to trim its excess supply despite two meetings. One problem he noted was competition between Saudi Arabia, Venezuela and Mexico for the U.S. export market. Saudi Arabia sees a great need to increase its U.S. supply for strategic reasons, i.e., if the U.S. is dependent on Saudi crude, it’s going to protect the source. Another meeting is scheduled for March, but there is not strong hope for meaningful supply constraints. Nor is there much hope the U.S. government will see a potential problem with imported energy exceeding 60% of U.S. demand; and there is no prospect for a meaningful energy policy that addresses this concern.

Depletion: It’s inevitable. Everyone who has ever completed an oil or gas well knows that after initial flush production, its all downhill. And any developing field or area will follow a bell-shaped curve which peaks, then declines. For example, King Hubbert, in 1956, predicted the U.S. oil peak in 1969 with an accuracy of ± one year. L. F. Ivanhoe has extended such an analysis to the world (see World Oil, October 1995) and that curve peak is expected before 2010, even with the huge Middle East reserves.

More relevant to the immediate problem, Simmons & Co. is studying depletion and its potential effects on the oil / gas industry and will publish reports on selected areas. The first such study, "Depletion: The forgotten factor in the supply demand equation: Gulf of Mexico analysis," came out in November, along with a companion study, "Depletion: Implications for the Gulf of Mexico jackup rig market." Such studies are difficult to do, incidently, and the U.S. Gulf, with government data available on the Outer Continental Shelf, may be one of the more feasible. It is probably impossible to do on a worldwide basis.

Simmons’ basic conclusions are that the average decline rate for GOM oil production is now 26% per year, and average natural gas depletion is 38% per year. The 38% is a composite of a 20% depletion until the mid-’80s and an increase since then to nearly 50% per year, i.e., newer wells in this area deplete faster.

The report further classifies depletion as "gross" or "net"; the former being the rate with no further drilling activity; the latter with on-going and future drilling. As an example, it illustrates Alaska’s Prudhoe Bay field, for which, oil wells drilled prior to 1989 are depleting at 18% per year. However, considering on-going drilling since 1989, overall depletion is 10% per year, which is a lot for a field starting with 1.5 MMbopd. In this case, arresting the decline has required an intensive drilling / gas injection program.

The report emphasizes GOM gas because the area produces 14 Bcfd, 27% of total U.S. gas production. It is noted that when this depletion loss cannot be made up from traditional areas, it will have to be replaced with expensive deepwater GOM gas, or imports from Western Canada, which are not all that easy to come by. The analysis shows that, in 1999, the GOM will lose about 4.1 Bcfd to depletion, and to replace this will require the drilling of nearly 1,000 successful oil / gas wells with an average peak per-well rate of 6.0 MMcfd. That number will increase to 1,161 in 2001.

The companion report translates this gas depletion effect to the GOM rig market, specifically jackups, since the bulk of gas drilling / production is from shelf areas. The conclusion is that the 1,000 to 1,200 wells per year through 2002 will increase jackup utilization to 80% next year and to 95% by 2002.

What does all of this mean? A consensus derived from sitting through several conference sessions is that our problem will take the better part of this year to correct, but that the fundamentals for stable-to-improved oil / gas prices are in place. The addition of motors to bicycles needs to resume in Asia to help worldwide oil demand. And gas demand, insulated from OPEC as it is, will be the center of attention in more than one area. If you are advising your kids on an education, get them into NYMEX trading. It rules.

Copyright © 1999 World Oil
Copyright © 1999 Gulf Publishing Company