Running on empty
The leading energy analysts who foretold Enron's demise have an alarming
new claim: The world's major oil companies are almost tapped out.
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By Robert Bryce
March 15, 2005 | Four years ago, the analysts at John S. Herold Inc. were
the first to call bullshit on Enron. On Feb. 21, 2001, three Herold
analysts issued a report that said Enron's profit margins were shriveling,
the company had too few hard assets, and its stock price was way too high.
Less than ten months later, Enron filed for bankruptcy.
Today, the analysts at Herold -- a research-only firm that issues
valuations on several hundred publicly traded energy companies -- are
making predictions even bolder than their call on Enron. They have begun
estimating when each of the world's biggest energy companies will peak in
its ability to produce oil and gas. Herold's work shows that the best minds
in the energy industry are accepting the reality that the globe is reaching
(or has already reached) the limit of its own ability to produce ever
increasing amounts of oil.
Many analysts have estimated when the earth will reach its peak oil
production. Others have done estimates on when individual countries will
hit their peaks. Herold is the first Wall Street firm to predict when
specific energy companies will hit their peaks.
Since last fall, Herold has done peak estimates on about two dozen oil
companies. Herold believes that the French oil company, Total S.A., will
reach its peak production in 2007. Herold expects 2008 to be critical, with
Exxon Mobil Corp., ConocoPhillips Co., BP, Royal Dutch/Shell Group, and the
Italian producer, Eni S.p.A., all hitting their peaks. In 2009, Herold
expects ChevronTexaco Corp. to peak. In Herold's view, each of the world's
seven largest publicly traded oil companies will begin seeing production
declines within the next 48 months or so.
Executive vice president Richard Gordon, who heads Herold's global
strategies team, says the firm's goal in doing peak-production estimates
for individual oil companies is simple: "If the dinosaurs are going
extinct, we are trying to figure out which ones are going to go extinct the
Herold's projections have enormous ramifications both for stockholders in
the major oil companies and for every energy consumer on the globe. If
Herold is correct, and the world's biggest oil companies cannot increase
their production in the coming years, then several things appear certain:
# Oil prices -- which are already at record levels -- will continue rising
as demand outstrips supply. In a few years, gasoline prices of $2 per
gallon could seem like a bargain.
# State-owned oil companies like Mexico's Pemex, Venezuela's PDVSA
(Petroléos de Venezuela) and Saudi Arabia's Saudi Aramco may be unable to
increase their production enough to meet burgeoning global demand.
# The producers who belong to the Organization of the Petroleum Exporting
Countries, and Saudi Arabia in particular, may have even more leverage over
the global oil market in the coming years.
# The United States will be ever more reliant on oil imported from
countries filled with people who don't like George W. Bush or his policies.
While Herold's projections provide ammunition to the growing chorus of
analysts who believe peak oil is imminent, they are not being welcomed by
the oil companies. Last month, when I asked ChevronTexaco's chairman and
CEO, David J. O'Reilly, to respond to Herold's projection that his company
would reach its peak production in 2009, he replied snappishly, "I'm not
going to comment on that."
A spokesman for Royal Dutch/Shell in London was similarly coy, saying in an
e-mail that the company had "no comment" on Herold's projection. However,
the company's spokesman, Simon Buerk, pointed to a September 2004 report
published by Shell that predicts the company will be producing the
equivalent of 4.5 million barrels of oil per day by 2014, not the 4 million
barrels per day that Herold foresees for that time frame.
Charley Maxwell, an analyst at Weeden & Co., a Connecticut brokerage, says
oil industry officials are loath to discuss Herold's projections because
doing so would "circumscribe their future prospects and the future growth
of their stock, and executives have no interest in doing that since so much
of their compensation is tied to their stock options." Maxwell, one of the
most respected stock pickers in the energy business, believes the non-OPEC
oil producers will hit their peak oil production in the next five years.
And he applauds Herold's research, saying that no other reputable firm "has
been willing to make this type of prediction."
Another energy industry veteran, John Olson, co-manager of Houston Energy
Partners, an energy hedge fund, agrees. Olson believes that Herold's
predictions about peak production are "very significant. It is perhaps the
first cannon ball over the bow of a big tanker."
But Herold has its critics. Brian J. Jennings, the chief financial officer
of Oklahoma City's Devon Energy Corp., which Herold believes will hit its
peak in 2009, says that Herold's analysis is "a truncated look at the
company. It assumes that nothing we are going to do over the next five
years will increase our production." Jennings says Devon expects to
increase its oil production by 25 percent over the next five years -- and
that figure does not include fields that the company is developing in the
Gulf of Mexico.
Of course, scientists, pundits and oil men have been predicting that the
world will run out of oil ever since the gusher blew at Spindletop in Texas
in 1901. Despite those predictions, the last century has been one of
unbroken increases in supply. Each year, the oil industry has produced more
oil than it did the year before. Today, the industry is producing about 83
million barrels of oil per day. New oil fields in the deep-water Gulf of
Mexico, in the Caspian Sea and in Saudi Arabia will soon begin pumping oil
onto the global market. Plus, huge deposits of oil are available in the
Canadian tar sands and American oil shale.
But turning tar sands and shale into motor fuel is a very expensive
proposition. And those new, unconventional oil sources may be insufficient
to replace the decline in production from existing fields, which deplete by
about 6 percent per year. Further, they may be too small to quench the
demand from the developing world -- China in particular. Last month, at a
conference in Houston, Zhu Yu, the president of China's Sinopec Economics
and Development Research Institute, said that between January and September
of 2004, motor fuel use in his country soared by 20 percent. Yu also
predicted that China's oil consumption will double over the next 15 years
to more than 10 million barrels of oil per day. Meanwhile, the Energy
Information Administration expects India's oil consumption to increase by
nearly 30 percent over the next five years.
The oil industry has plenty of other reasons to be nervous. The royal
rulers of Saudi Arabia, the world's biggest producer, appear vulnerable to
terrorist attacks and civil unrest. The Saudi government's biggest enemy,
Osama bin Laden, has focused his ire on both the Saudi royals and the oil
infrastructure in the Persian Gulf. And his loyalists are eager to attack
both of those targets.
In Iraq, insurgents are continually attacking that country's oil
infrastructure -- thereby crippling the war-torn nation's economy and its
future prospects. In Venezuela, which has the biggest oil deposits in the
Western hemisphere, president Hugo Chavez has threatened to cut off the
flow of oil to the United States if the Bush administration continues its
efforts to undermine his government. In Russia, president Vladimir Putin's
brazen, state-sponsored theft of Yukos, one of that country's biggest oil
companies -- and his jailing of the company's CEO, Mikhail Khordokovsky --
is likely to slow investment in Russian oil fields for years.
Furthermore, spare oil-production capacity has largely disappeared. Oil
producers are running their wells at maximum capacity. Indonesia, a member
of OPEC, cannot meet its OPEC quota of 1.4 million barrels per day. In
February, Indonesia was able to produce only 942,000 barrels per day, its
lowest level of production in 34 years. And last week, Algeria's energy
minister, Chakib Khelil, said that OPEC "does not have the production
capacity to increase its quotas."
All of these factors are sending oil prices to record highs. Monday's NYMEX
closing price for light sweet crude was $54.95 per barrel. Last week, the
Department of Energy issued a report saying that it expects prices to stay
near or above $50 per barrel for the rest of this year. That's a big change
for an agency that has always been conservative in its price projects. At
about this same time last year, the agency was predicting that oil would
cost about $29 per barrel throughout 2005.
Whatever price projections are used, it's increasingly clear that the era
of cheap oil is over and that oil companies are having a harder time
finding new oil to replace the oil they're pumping. In short, it appears
that the late M. King Hubbert, a geophysicist who worked for Shell in
Houston, is being proved right. In the 1950s, Hubbert used mathematical
models to predict that American oil production would peak in the early
1970s. That's exactly what happened. Now, Hubbert's theories are being
tested on a global scale.
Herold's owner and CEO, Art Smith, is a believer in Hubbert's work. Smith
and his fellow analysts at Herold have been building their peak production
databases since 1996. About 10 months ago, Herold began publishing what it
calls "strategic evaluations" of specific companies, which include graphics
showing when that company will reach its peak production. Herold does not
do geologic analysis. Instead, its analysts mine the company's filings with
the Securities and Exchange Commission. It also looks at the oil properties
that the company has acquired or sold, along with new projects being
drilled, and older oil fields in the company's portfolio. "We look at this
data, put it into a financial model, and start asking questions," says
Herold analyst Gordon.
Herold isn't the only Wall Street firm considering the issue of peak oil.
In early December, Deutsche Bank issued a report that predicted global oil
production will peak in 2014. The Deutsche Bank report also stresses
political instability and China's surging demand. Those factors, Deutsche
Bank believes, "could trigger a shortage shock leading to a price crisis."
And while many analysts in Houston are convinced a peak in global
production is in the offing, there are others who believe that today's high
prices will trigger a surge in new oil production. David Pursell, a partner
at Pickering Energy Partners, a Houston brokerage, says with oil at $50 per
barrel, "a whole lot of oil fields that used to be woefully uneconomic
suddenly become profitable and that means that any peak projections get
delayed." Although Pursell is not ready to agree with Herold's projections
about individual energy companies, he -- along with virtually everyone else
in the oil industry -- agrees that the era of cheap energy is over and that
America must begin adapting to the new geopolitical realities that come
with that fact. Alas, it appears the Bush administration hasn't made that
Last week, President Bush gave a speech on energy policy in Columbus, Ohio,
in which he encouraged Congress to pass an energy bill. Once again, he
touted his plan to drill for oil in the Arctic National Wildlife Refuge, a
move he said would "eventually reduce our dependence on foreign oil by up
to a million barrels of oil a day." The key word here is "eventually." Even
if approvals for drilling ANWR were granted immediately, the first oil from
the refuge would not reach the continental United States for years.
Furthermore, as the New York Times reported last month, it appears that the
major oil companies may have cooled in their desire to drill in the refuge.
During his speech, Bush also talked about efficiency measures that could
save homeowners electricity. But during his 4,600-word, 35-minute-long
speech, Bush uttered the words "hybrid vehicle" exactly one time.
It's astonishing that Bush, the former Texas oil man, still doesn't
understand the fundamental problem of America's imported oil addiction. Nor
does he appear to grasp the threat that is posed by the possibility of peak
The majority of the oil that the United States imports from places like
Saudi Arabia and Venezuela is used as motor fuel in automobiles. Yet the
president conflated the idea that burning more coal and building more
nuclear power plants will somehow allow America to reduce its oil imports.
In his speech, Bush refused to discuss the obvious: We cannot cut our oil
imports (read: gasoline addiction) without dramatic changes to our auto
fleet. At some point, the United States will have to force the automakers
to build more efficient automobiles. And a key part of that efficiency
changeover will mean replacing increasing numbers of America's 200 million
cars and trucks with hybrid vehicles.
Even some of Washington's most hawkish neoconservatives are embracing the
idea of high-mileage hybrid vehicles. Former CIA director James Woolsey, a
key backer of the war in Iraq, is driving a Toyota Prius. Woolsey, along
with neocons like Frank Gaffney have begun preaching the Greens' gospel of
energy efficiency. The neocons haven't joined the Sierra Club. Instead,
they're arguing that energy conservation is simply smart strategy when
dealing with the Muslim extremists who reside in the oil-rich countries of
the Persian Gulf. But so far, the neocons haven't been able to get Bush's ear.
Remarkably, when it comes to thinking about peak oil and what it means for
the future of America, Wall Street analysts and neocons are taking the
lead, while the former oil man from Midland keeps his head up his tailpipe.