March 9, 2007

By Chris Nelder

“The worst thing that could happen is to confuse ourselves and the public with too much spin about unlimited energy supplies at cheap prices, alternative fuels on a global scale, or energy independence in a matter of years. That kind of thinking simply dilutes our focus, defers the tough solutions that are needed today, and sets us all up for more future shocks and economic disruptions.”

— Sadad al Husseini, former head of exploration and production for Saudi Aramco, in a January, 2007 interview with the Journal of Petroleum Technology

When confronted with the indisputable reality of the peaking and decline of the world’s top-producing oil fields, the cornucopian camp points to new projects as the cavalry that will ride in and save the day. High crude prices, they argue, will make formerly marginal oil projects profitable and encourage the development of new oil fields.

But given recent events, it seems their faith in the Invisible Hand is ill-placed.

Let’s take a look at some of them.

First, the Kashagan oil field in Kazakhstan. Situated on the western coast of the Caspian Sea, it’s the largest new oil field discovery in over 30 years, with a potential production of 1.5 million b/d. That would make it one of the top four most productive oil fields in the world. (Only three of the world’s 4,000 oil fields produce more than 1.5 mbpd, and all of them are either in decline or suspected of being in decline.)

Consequently, production from Kashagan has been eagerly anticipated by cornucopians, who expected it to make up for the depletion of the world’s mature fields.

But two weeks ago, the Italian oil group operating the field, Eni, announced that the startup cost of the project is going to be almost double the initial estimate, at $19 billion vs. $10.3 billion. And that’s just to get the initial phase of the project going through 2011, when it will produce 300,000 bpd.

It’s also going to take about three years longer than previously anticipated, beginning production around 2010, and won’t hit its 1.5 mbpd peak production until 2019!

Since it appears that we’re already at the peak of global production, that means the Kashagan cavalry will show up just in time to clear the bodies off the battlefield.

Just two days earlier, ExxonMobil announced that the costs of its much-anticipated, $15 billion liquefied natural gas (LNG) project in Qatar were running out of control, and so it decided to scrap the project altogether.

“Right now, everyone around us is postponing and delaying projects,” Qatari Oil Minister al-Attiyah said.

Oops, there goes another company of horsemen.

This is a severe blow to the cornucopians, who have predicted a massive expansion of the liquefied natural gas industry. One week ago, PricewaterhouseCoopers released a report saying that LNG will deliver 31% of global gas by 2010, a doubling of the production level in 2005. About two thirds of that production was to come from Qatar.

Exxon’s announcement that they were scrapping the Qatar project was on February 21, a week before the PricewaterhouseCoopers report was released. Presumably the report was nearly done by that time. I wonder if anybody considered revising it, or if they just decided to let the optimistic story stand and hope that nobody would notice.

Across the Caspian Sea from Kashagan, on the northeastern edge, is another highly anticipated oil project on Russia’s Sakhalin Island. Royal Dutch Shell’s Sakhalin II field is the world’s largest combined oil and natural gas project and Russia’s first LNG plant–a very, very big deal.

But, in what has become a well-worn ruse in the ongoing play of Russia renationalizing her resources, the project was accused of environmental negligence and threatened with lawsuits until Shell was forced into minority role, with Russia back in control.

Among the shady shenanigans and nasty allegations surrounding the project is the revelation that Shell executives had known for some time about the ballooning projected costs of the project, but kept the information secret. When the project was taken over by the Russian government, they dropped that poison pill, revealing that the costs were actually going to double: not $10 billion but $20 billion. Putin was reportedly furious.

The cost overrun is definitely going to slow things down in Sahkalin.

Meanwhile, in Nigeria, our number-five top source of oil imports, the militant group MEND issued a press release saying that Italians and Nigerian officials had paid a $1 million bribe in order to secure the release of captured oil workers. One of the hostages escaped and MEND broke off negotiations with the Italians, saying they would keep the remaining hostages until May.

Violence and killings have ratcheted up ever since, and the Italians are now telling their 600+ nationals in Nigeria to get out of dangerous areas.

On the whole, at least 50 foreigners have been kidnapped in Nigeria over the last two months, thousands of foreign oil workers have left the country, and oil production in the swamps is down 20%.

Attacks on the pipelines, and attempts to siphon fuel from punctured pipelines, have also led to the deaths of thousands of locals when the pipelines exploded.

Due to the danger and uncertainty, major oil companies have announced that they will postpone planned projects in the Nigerian swamps, including LNG plants worth about $20 billion. Those plants have been highly anticipated as critical sources of future imports for the U.S. and the U.K.

And in Ghana, a natural gas supply line currently under construction to bring Nigerian gas to African energy generation plants is delayed because the Niger Delta militants keep vandalizing the pipeline.

Chalk up another company of horsemen that won’t be riding to the rescue.

In addition to its losses in Kashagan and Nigeria, Eni lost production last year in Venezuela as Chavez seized their Dacion field. They have now asked the World Bank to arbitrate the dispute with Venezuela. (I wonder how far they’ll get, with Paul Wolfowitz, architect of the Iraq war and a bitter antagonist of Chavez, heading up the Bank?)

It’s tough to be an oil company out on the frontier of development. Very tough.

A few days ago, Venezuela made another unpleasant announcement to the six foreign oil companies that are being forced out of their investments there under Chavez’s renationalization program. Instead of being compensated in dollars, they will be paid in vouchers that will give them reduced equity stakes in future oil projects. Ouch.

Back in December, Occidental Petroleum announced it was going home after a long legal battle with the native people of northern Peru. For 30 years, Oxy failed to clean up their chemical waste from drilling operations there, leading to numerous health problems for the locals. Oxy has also been forced out of a $60 million investment in Colombia, where residents have struggled to stop the oil developments for over a decade, engaging in demonstrations, threatening mass suicide, and even being gunned down by paramilitary forces allegedly hired by Oxy.

In short: The people down south want a safe and clean environment as much as anybody else, and they don’t see the need to sacrifice that in order to satisfy our need for oil imports.

Turning to Iraq, a senior oil ministry official recently said that the country is losing up to 400,000 b/d of production due to attacks on the oil infrastructure, most of them targeting pipelines. In 2006, there was an attack about once every other day.

Pipelines are notoriously difficult to protect, and with the country verging on civil war and U.S. forces unable to secure even Baghdad, hopes for restoring the oil infrastructure in Iraq are fading fast.

So much for their being able to finance their own reconstruction, too.

As we have noted before , in some cases the price of oil itself is stifling oil projects. For example, at Shell’s Alberta oil sands project, the cost of producing a barrel of oil, after a planned 100,000 b/d expansion, will be six times higher than the cost when the project first started! That announcement last year had investors fleeing for the exits, and mercilessly took down the stocks of the companies involved . . . no doubt slowing those projects down as well.

The overriding theme should be clear:

• Cost overruns are the norm, not the exception, and projects are running over budget by two times or more.
• Foreign oil companies are taking some serious hits in their far-flung projects, and are adopting defensive postures. They will not be rushing out to the frontiers of Africa and the Caspian to develop the world’s last major sources of untapped oil and natural gas any time soon.
• The fossil fuel cavalry, if it ever leaves home at all, won’t be arriving in time to delay the peak or avert shortfalls.

Last week, legendary Texas oil man and oil market prophet T. Boone Pickens confirmed that we’re at the global peak of oil production: “If I’m right, we’re already at the peak,” he said. “The price will have to go up.”

Need another reason to believe him? Pickens’s bets on the oil market have netted him 800% returns since 2001.

A technical analysis last week by Stuart Staniford of The Oil Drum supports the notion that we’re at the peak, concluding that Saudi oil production went into decline at the rate of 8% a year in 2006. If Saudi Arabia is in decline, then by definition the world is in decline. An 8% decline rate there cannot be made up elsewhere.

So where does all this bad news for fossil fuels leave us?

You already know the answer: renewables.

They don’t need to be deployed in remote and dangerous parts of the world. They require no blood to protect, and do not bring disease and death to local populations. They emit no greenhouse gasses. And when the cost of oil projects spirals out of control like this, they start to look downright cheap, especially if you can think beyond next quarter’s balance sheet and see these trends extending a decade or two into the future.

I don’t believe the Street has priced in just how expensive the future of oil production is going to be, or how cheap renewables will be by comparison in a very short while.

But that’s what we’re here for: to give you the heads-up so you can get in on the ground floor and make a killing.

Until next time,

–Chris