Oil Basics and The Limits to Economic Growth Art Berman Labyrinth - - PowerPoint PPT Presentation

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Oil Basics and The Limits to Economic Growth

Art Berman Labyrinth Consulting Services, Inc. Reality 101 Honors Seminar University of Minnesota October 31, 2016

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Oil Dominates World Primary Energy Consumption 2015

• Fossil energy—oil, coal and natural

gas—dominate world primary energy (86%)

• Oil dominates fossil energy (38%).
• Renewable energy is 3% of primary

energy.

• The world will continue to depend on
• il and other fossil energy for some

time regardless of climate concerns and advances in renewable technology.

Oil 33% Natural Gas 24% Coal 29% Nuclear 4% Hydro 7%

Source: BP & Labyrinth Consulting Services, Inc.

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What Is Oil?

• An organic compound of hydrogen, carbon and oxygen.
• It is a naturally occurring substance that has been abundant and relatively cheap for

the last 150 years.

• It is called crude oil if it is dark and viscous with an API gravity < 35 (SG oil/SG water)
• It is called condensate if it is clear and volatile with an API gravity >35.
• Oil is stored in rocks below the earth’s surface and is produced by drilling wells.

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How Oil Is Formed

• Oil is formed from the remains of
• rganic matter from plants and animals

that lived in the ocean millions of years ago.

• Phytoplankton (algae) and other

microscopic animals are the major sources of commercial oil.

• Organic matter was buried under

sediment brought from nearby shorelines.

• It can’t decay too much—it must keep

its carbon.

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How Oil Is Formed

• Organic matter and sediments

accumulate in marine basins that subside

• ver geologic time to form depositional

basins.

• Heat and pressure from burial

transformed the organic matter into thermally mature organic matter (kerogen) and eventually, into oil.

• Most of the maturation process occurs

between 50 to 100 degrees C.

• At higher temperatures the hydrocarbon

converts to methane gas.

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The Total Petroleum System Source Rock Migration Route Reservoir Rock Seal Rock Trap Elements Preservation Generation Migration Accumulation Processes

24803

Petroleum System Elements Petroleum System Elements

120° F 120° F 350° F 350° F

Generation Generation Migration Migration

Seal Rock Seal Rock Reservoir Rock Reservoir Rock Oil Oil Water Water Gas Cap Gas Cap

Entrapment Entrapment

• The total petroleum system

consists of all the elements and processes from source rock deposition to oil accumulation.

• Oil is generated in the source

rock.

• It is expelled by expansion and

migrates vertically along fracture systems and faults.

• After encountering a reservoir
• r carrier bed with porosity and

permeability, it migrates laterally until it is trapped.

• Each element of the petroleum

system can be evaluated qualitatively to determine project risk.

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The Total Petroleum System

• Oil in the reservoir rock

migrates upward by buoyancy above ground water.

• Migration stops when a barrier
• r trap is encountered.
• This can be an anticlinal or

buoyancy trap, a fault trap or a natural stratigraphic trap.

• The vertical component of the

accumulation is called a seal.

• Fluids segregate in the

accumulation according to buoyancy.

• Oil is lighter than water and gas

is lighter than oil.

• Anticlinal or structural traps are

the most common for conventional oil accumulations.

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How Oil Is Stored and Moves Through Rocks

• Reservoir rocks consist of

matrix grains and pore space.

• Fluid resides in the pore

spaces and can move if the pores are well connected.

• Although it may not seem

logical that fluid can move through a rock, it is important to consider the considerable pressure at depth.

• Average pressures are

about 0.5 psi/ft so at 10,000 ft., pressures may be 5000 psi.

• This is approximately the

force needed to put the space shuttle into orbit.

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Depletion: Much Reservoir Energy Comes From Dissolved Gas

• When a well is opened, it is a pressure sink—an

escape path for high pressured fluids in the reservoir.

• Gas dissolved in the oil expands to several

hundred times its reservoir volume pushing the liquids up the well bore.

• This means that maximum drive pressure exists at

the moment the well is first opened and decreases thereafter.

• Once most of the dissolved gas has been

produced, the reservoir pressure approaches zero and production stops.

• This is called depletion.

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Depletion: Oil Recovery In Solution Gas Drive Reservoirs

• Solution gas reservoirs typically recover between 5 and 25% of original oil in

place and 60 to 80% original gas in place.

• Fields have geographic limits based on the extent of the trap.
• Field production will increase until all locations are drilled and then production

will decline.

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Conventional Oil and Tight Oil

• Conventional oil plays involve drilling reservoir rocks with vertical wells.
• After all the commercially attractive conventional fields in the U.S. were

discovered and were in depletion, unconventional plays were the only option.

• Tight oil plays (fracking) involve drilling the source rock with horizontal wells.
• Tight oil horizontal wells cost 2-3 times more to drill and complete than

conventional vertical wells.

• There is considerable fanfare about the new volumes of oil but little discussion

about the cost of the technology and its effect on the price of oil.

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Deep Water and Oil Sand Plays

• Unconventional plays include tight oil, deep water and oil sand plays.
• Deep-water plays involve conventional reservoirs but in thousands of feet of

water, reliance of unconventional technology, great cost and risk.

• Oil sands are basically a mining operation.

Deep Water Plays Oil Sand Plays

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Peak Oil

• The observation of Peak Oil: once conventional production peaks, supply will

become increasingly dependent on more expensive, lower quality sources of oil.

• …Like shale, deep-water, and tar sands.
• It looks like Peak Oil is batting 1000!
• Many people mis-understand and think that Peak Oil means that we are running
• ut of oil.
• That is wrong. Peak oil is about running out of affordable oil.

2 4 6 8 10 12 Feb-60 May-61 Aug-62 Nov-63 Feb-65 May-66 Aug-67 Nov-68 Feb-70 May-71 Aug-72 Nov-73 Feb-75 May-76 Aug-77 Nov-78 Feb-80 May-81 Aug-82 Nov-83 Feb-85 May-86 Aug-87 Nov-88 Feb-90 May-91 Aug-92 Nov-93 Feb-95 May-96 Aug-97 Nov-98 Feb-00 May-01 Aug-02 Nov-03 Feb-05 May-06 Aug-07 Nov-08 Feb-10 May-11 Aug-12 Nov-13 Feb-15 May-16

Millions of Barrels of Crude Oil Per Day

U.S. Conventional & Unconventional Oil Production

Conventional Oil (45%) Unconventional Oil Tight + Deepwater (55%)

Source: EIA, Drilling Info & Labyrinth Consulting Services, Inc.

Peak 10 mmbopd

• Nov. 1970

Peak 9.6 mmbopd

• Apr. 2015

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Where Is The Remaining Oil?

• Nearly half of the world’s proven reserves are in the Middle East.
• Only 14% are in North America.
• U.S. imports have declined since the advent of unconventional oil.
• The U.S. still imports 52% of its crude oil (7.9 million barrels per day 2016 average).
• That means that the U.S. will become increasingly dependent on foreign oil.
• The hype about energy independence is absurd.

3% 8% 9% 14% 19% 47% Asia Pacific Africa Europe & Eurasia North America

• S. & Cent. America

Middle East

Proven Oil Reserves

Source: BP & Labyrinth Consulting Services, Inc.

Source: BP

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The Difference Between Oil and Liquids

20 40 60 80 100 120 140 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 Millions of Barrels Per Day

Oil vs. Liquids Oil Natural Gas Liquids Biofuels Refinery Gain

Source: EIA & Labyrinth Consulting Services, Inc.

• Crude oil represents about 80% of what is often called “oil.”
• The rest of what are called “liquids” are a combination of other things some of

which do not even come from petroleum.

• The biggest component is natural gas liquids—compounds like ethane, butane and

propane—that come from processing natural gas. They contain ~65% of the energy content of crude oil and ~45% of the value but are counted as barrels.

• Biofuels come from plant material like corn and sugar cane that is processed into

flammable alcohols like the ethanol and is added to gasoline.

• Refinery gain is the volumetric increase that results from refining crude oil into

products that have a lower specific gravity.

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Conventional and Unconventional Oil

• Conventional oil represents about 85% of total production today.
• EIA forecasts that heavy oil will remain about 3% of total production while tight oil

will double from about 5% to 10% of world production by 2040.

• Despite increases in unconventional and NGL production, the overall percentage of

conventional oil is forecast to remain fairly constant at about 85% for the next 25 years.

• The uncertainty in these forecasts is that world liquids production will increase from

93.5 mmbpd in 2016 to 118 mmbpd in 2040.

• If not, the percentage of unconventional oil and NGLs will be higher.

20 40 60 80 100 120 140 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 Millions of Barrels Per Day

Oil vs. Liquids Oil Natural Gas Liquids Biofuels Refinery Gain

Source: EIA & Labyrinth Consulting Services, Inc.

20 40 60 80 100 120 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 Millions of Barrels of Liquids Per Day

World Conventional & Tight Oil Production ConventionalOil

Source: EIA & Labyrinth Consulting Services, Inc.

Tight Oil Heavy Oil

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Conflicting Views of The Future of Oil Supply and Demand

• Mainstream oil production forecasts make a demand assumption: if you build it, they will come.
• If demand is there, supply will come.
• This model has no relation to supply but assumes that high prices will result in any level of

production needed.

• The problem—other than the obvious supply component—is that this same assumption has resulted

in both oil bubbles in which high prices crippled the world economy…and demand destruction prolonged the supply for awhile.

• The great fear among demand-side advocates is that peak demand is around the corner.
• More pessimistic Peak Oil forecasts also have been consistently wrong.
• The bottom line: all forecasts are wrong but mainstream forecasts are disconnected with economic
• reality. Peak Oil forecasts under-estimate the role of monetary policy and capital markets to

subsidize supply

• The world after the 2008 Financial Collapse is different and must be considered in any forecast.

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Net Energy & Energy Density

101% 100% 92% 76% 65% 65% 60% 36% 35% 24% 0.1% 0.1% 0% 20% 40% 60% 80% 100% 120% Diesel Crude Oil Gasoline Anthracite Coal for Electric Power Ethanol LNG Wood Lignite CNG Methane Natural Gas Percent of Crude Oil Energy Content Per Liter

Energy Content of Various Fuels Compared To Crude Oil

Source: EIA & Labyrinth Consulting Services, Inc.

• Not all energy sources are equal.
• Promoters of alternative energy sources emphasize cost competitiveness but other

factors are important: net energy, energy density, carbon intensity, intermittency and breadth of use.

• Net energy: how much energy goes into getting energy out.
• Oil and coal win on net energy but unconventional oil has lower net energy and coal

has high carbon intensity.

• Renewable energy wins on carbon intensity but lose on intermittency, energy

density and breadth of use particularly for transport.

• Energy transitions are complex, costly and take decades.

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• The oil shocks of the 1970s and early 1980s brought high oil prices that led to massive investment in oil

exploration and production.

• That resulted in major discoveries in the North Sea, Mexico and Siberia that greatly over-supplied the

market.

• High oil prices caused demand destruction and over-supply that burst the oil bubble. Oil prices did not

recover for almost 25 years.

• Oil supply flattened after 2005 and prices increased leading to renewed E&P over-investment.
• Debt-fueled economic expansion in China and zero-interest rates after the 2008 Financial Collapse

resulted in the 2nd oil bubble.

• This time, over-supply was caused by expensive unconventional oil and the bubble burst in mid-2014.

The 2014 Oil Price Collapse: Two Oil-Price Bubbles Since 1970

$0 $20 $40 $60 $80 $100 $120 $140 $160

Jan-70 Feb-71 Mar-72 Apr-73 May-74 Jun-75 Jul-76 Aug-77 Sep-78 Oct-79 Nov-80 Dec-81 Jan-83 Feb-84 Mar-85 Apr-86 May-87 Jun-88 Jul-89 Aug-90 Sep-91 Oct-92 Nov-93 Dec-94 Jan-96 Feb-97 Mar-98 Apr-99 May-00 Jun-01 Jul-02 Aug-03 Sep-04 Oct-05 Nov-06 Dec-07 Jan-09 Feb-10 Mar-11 Apr-12 May-13 Jun-14 Jul-15

CPI Adjusted WTI Prices (July 2016 Dollars Per Barrel)

CPI Oil Shocks

• ->

Massive E&P Investment (North Sea, Mexico, Siberia) Over-Supply, Demand Destruction & Price Deflation Debt-Fueled Economic Expansion & Rapid Growth in China & East Asia Massive E&P Investment (Shale, Deep Water, Heavy Oil) Over-Supply, Demand Destruction & Price Deflation

Sept 2016 Two Major Oil Bubbles Since 1970: Both Collapsed Because of Over-Supply, Demand Destruction & Price Deflation

Source: EIA, U.S. Bureau of Labor Statistics & Labyrinth Consulting Services, Inc.

Avg 1986-2004 $34/barrel Avg 2005-2015 $86/barrel All Prices in Constant August 2016 Dollars

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Economic Growth and The Real Cost of Oil

$0 $20 $40 $60 $80 $100 $120 $140 $160

Jan-70 Feb-71 Mar-72 Apr-73 May-74 Jun-75 Jul-76 Aug-77 Sep-78 Oct-79 Nov-80 Dec-81 Jan-83 Feb-84 Mar-85 Apr-86 May-87 Jun-88 Jul-89 Aug-90 Sep-91 Oct-92 Nov-93 Dec-94 Jan-96 Feb-97 Mar-98 Apr-99 May-00 Jun-01 Jul-02 Aug-03 Sep-04 Oct-05 Nov-06 Dec-07 Jan-09 Feb-10 Mar-11 Apr-12 May-13 Jun-14 Jul-15 Aug-16

CPI Adjusted WTI Prices (July 2016 Dollars Per Barrel)

CPI Oil Shocks

• ->

Massive E&P Investment (North Sea, Mexico, Siberia) Over-Supply, Demand Destruction & Price Deflation Debt-Fueled Economic Expansion & Rapid Growth in China & East Asia Massive E&P Investment (Shale, Deep Water, Heavy Oil) Over-Supply, Demand Destruction & Price Deflation

Oct 2016 Two Major Oil Bubbles Since 1970: Both Collapsed Because of Over-Supply, Demand Destruction & Price Deflation

Source: EIA,U.S. Bureau of Labor Statistics & Labyrinth Consulting Services, Inc.

Avg 1986-2004 $34/barrel Avg 2005-2015 $86/barrel All Prices in Constant September 2016 Dollars Currently Low Oil Prices 40% Higher Than 1986- 2004 Average

• U.S. GDP increases when oil prices are low and is flat when oil prices are high.
• 1986-2004 was a time of great expansion of the American economy.
• The average real price of oil since 2005 is 2.5 times higher than in the period

1986-2004. This reflects the increased cost of technology for unconventional oil.

• Even at today’s depressed oil prices, the real price of oil--$48 per barrel—is 40%

higher than the in 1986-2004 of $34 per barrel.

• Economists and politicians cannot understand why the economy won’t grow but

never consider the underlying cost of energy.

$0 $2 $4 $6 $8 $10 $12 $14 $16 $18 $20 $0 $20 $40 $60 $80 $100 $120

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

U.S. GDP (July 2016 $Trillions) CPI-Adjusted WTI Price (August 2016 $/Barrel)

Chart Title

Aug 2016 U.S. GDP Increases When Oil Prices Are Low and Is Flat When Oil Prices Are High

Oil Price GDP GDP 5 Yr Moving Avg

Source: World Bank ,EIA, U.S. Bureau of Labor Statistics & Labyrinth Consulting Services, Inc.

Avg 1986-2004 $34/barrel Avg 2005-2015 $86/barrel GDP & Oil Prices In Constant August 2016 Dollars

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Why is Oil Such A Big Deal?

• Energy is the economy and oil is the master energy resource.
• The global economy requires massive surplus energy to extract natural resources, move them to be

manufactured into products and transport them to be sold around the world.

• That global economy developed when oil prices averaged $34 per barrel.
• When oil prices increased to more than $85 per barrel after 2005, economic growth could not continue.
• No business can withstand a 2.5-fold increase in underlying cost and make a profit.
• Although oil prices are lower since the price collapse in 2014, they are still 40% higher than in the 1990s.
• The average break-even price for OPEC, tight oil, oil sands and deep-water plays is $82 per barrel. That

means that production costs have not decreased and that oil is being produced well below its replacement cost.

• Economic growth is unlikely at these underlying energy costs.

$137 $119 $115 $110 $97 $95 $94 $90 $89 $86 $82 $77 $75 $70 $69 $67 $65 $61 $55 $50 $49 $49

$0 $20 $40 $60 $80 $100 $120 $140 $160

Yemen Iran Algeria Bahrain Libya Oman OPEC Average New Oil Sands Qatar Saudi Arabia AVERAGE Deepwater Wolfcamp Tight Oil UAE Iraq Eagle Ford Tight Oil Bakken Tight Oil Permian Tight Oil Spraberry Tight Oil Existing Oil Sands Bone Spring Tight Oil Kuwait

Break-Even Price (Dollars Per Barrel)

Projected 2016 Break-Even Oil Prices for OPEC* & Unconventional Plays

Source: IMF, Rystad Energy, Suncor, Cenovus, COS & Labyrinth Consulting Services, Inc. *IMF estimate that includes revenue to balance fiscal budgets of OPEC countries

Average Break-Even Price Today is $82/Barrel

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Concluding Observations

• Energy is the economy and oil is the master energy resource.
• Oil will continue to dominate the world energy landscape for decades because no other energy

source can meet global needs.

• Unconventional oil does not offer a meaningful long-range alternative.
• While increased use of renewable energy is inevitable and desirable, it is not a satisfactory

substitute for oil.

• A transition away from an oil-weighted energy supply will be complex, costly and lengthy despite

supporting arguments or preferences.

• There is no clear way forward that includes sustaining current levels of energy use.
• The best path forward is to stop looking for improbable solutions that allow us to live like energy

is still cheap, and find ways to live better with less.