Saudi Arabian oil production, OPEC cuts and IEA estimates

It appears that the world economy has started into a slightly more significant phase of growth, at least according to Saudi Arabia. When the recession hit, in order to control prices and maintain at least a semblance of their income, the nations of OPEC instituted a cut in supplies, initially of just over 2 mbd and then, last December again, to a total of 4.2 mbd, that ate up what would have been a global surplus of oil. In that way prices could be brought back to the $65 to $80 dollar range that OPEC prefers.

Over the past few months, as the economy has improved, and oil prices began to move up again, so there has been a gradual slippage in the rigidity with which the supply was curtailed. In the first half of the year, overall the EIA estimated that OPEC was supplying some 28.7 mbd, which it reported as being some 2.6 mbd less than a year earlier. Of those sticking to the OPEC targets, Saudi Arabia has been the most rigorous. Given that it also supplies the greatest amount of crude of the OPEC nations, this also, more than other nation’s restrictions meant that the world supply could be set in balance with the perceived demand, and price controls could be maintained.

In June OPEC reiterated their position that supplies would be restricted, despite future price rises, until the existing global surplus was drawn down. However there was a report, in April, that part of the reason for Saudi’s adherence to policy might have been caused by an inability to sell more than 7.89 mbd.

The question of Saudi capabilities has been a topic of conversation ever since Matt Simmons wrote “ Twilight in the Desert,” yet if one looks at the EIA figures for crude production, Saudi Arabia had a peak in production of 9.7 mbd in July 2008, but had cut back production this year to an average (over the first seven months of the year) of 8.2 mbd, although by July they had increased back to 8.58 mbd, from a low of 8.086 mbd in February. However part of this increase is due to an increase in internal consumption, shown by the relative plot from Energy Export Databrowser. (which includes more than just the crude and distillate that the EIA counts).

Saudi Arabian oil production (Energy Export Databrowser)

The kingdom is uncomfortably aware of this burgeoning demand, and is already seeking ways to provide internal power by other means . Part of the problem has been that they have relied on natural gas to provide much of their internal power, but have discovered that in cutting back on oil production, they have also restricted the amount of natural gas produced. Which might explain their recent request that nations of the world might have to pay extra even when they don’t buy as much oil as they used to.

But those days, already seem to have passed and now, perhaps in order not to let prices start to rise too much, as the global economy appears to be regenerating and demand grows, Saudi Arabia has recognized that it can continue to increase the amount that it itself supplies, without threatening the overall price levels that have now been reached.

The amounts being made available do not fully relax the cuts that Saudi has made in production but nevertheless the removal of some restriction recognizes the change.

one Asian customer expected to receive full contracted volume for the first time in a year . . . . other lifters of crude from the world's biggest oil exporter expected steady supplies for December compared with November and most were still receiving much less than maximum levels.
"It's between 5 and 10 percent more," one source said, with reference to supplies to global firms for December compared with November.
"But we're still nowhere near the level at which we were."

So far OPEC is producing within the constraints that keep market price stable, with varying degrees of compliance to the overall target. However global demand can be anticipated to continue to grow as the effect on demand from the recession fade. China, for example, has just signaled its intent to buy around 1 mbd from Saudi Arabia next year.

The question will then come, as the available spare capacity in OPEC starts to diminish, how quickly will this impact overall price levels. One can envisage there being enough oil still in the pot that supply can meet demand through next year, but prices may rise a little in that time frame.

What happens beyond that? Well that’s where it gets interesting, and the reports that Western estimates of reserves may have been overinflated due to political pressure don’t help build confidence that all we will need to do is tighten our belts a little. And unfortunately that realization may arrive just in time for the next Presidential election.

However the IEA World Energy Outlook (WEO) is due out tomorrow, and it will be interesting to see what the actual predictions are that the IEA (a recently more cautious Agency than the EIA) are actually producing. There have already been stories, which I commented on last week that the IEA were cutting their projections of demand. The question then arises as to how they will address the potential of OPEC to meet even that limited demand.

Oh, and one last thing, I just got around to checking on what was happening with the Arthur Berman situation, and I may be one of the last to find out that the World Oil Editor was fired over the same situation. Boy! Somebody must have trod on some sensitive corns.

Arthur Berman leaves World Oil magazine

This is just a short note, since Tuesday's tend to be my busiest days in class, but I could not help but put up the news best reported by quoting from Arthur Berman's Petroleum Truth Report

In an act of extraordinary courage, a top Petrohawk executive threatened to cancel his free subscription to World Oil if the magazine continued to publish my column. Today, John Royall, President and CEO for Gulf Publishing, cancelled my November column.

I have accordingly resigned as contributing editor.

For those of you who do not understand the import of this, Arthur Berman has been writing for some time about the credibility of long-term natural gas well production claims from the gas shales around the United States.

There has been a considerable hype about these shales (hence the tech series that I am starting to post on Sundays) and the wealth of natural gas that they are adding to the nations reserves. However, through examination of some of the records Arthur has shown that the performance of individual wells is not holding up to the original promise.

For example the industry relies on a decline model for well production that, over time, allows one to make a certain prediction for the recovery of natural gas from that well. Thus, for the sake of example, integrating over time the amount of gas might suggest that a field might ultimately yield 2.5 billion cubic feet of natural gas.

However, by examining records that show that the declines rates are much faster than predicted (see my post on his paper at ASPO) he has shown that the reserve from these wells might come in at only half, or less, that predicted.

Given that the wells are extremely expensive (at around $8 million or so) Arthur calculates that the industry needs a price of $9 /kcf to make a profit on a well with about 2.5 bcf in reserve. What he is seeing is that with the more rapid decline rates that are being experienced in the Barnett and Haynesville, and the current drop in natural gas prices, that neither of these conditions is being fulfilled. Thus he is strongly questioning the financial underpinning to the health of those that are heavily engaged in these gas plays.

Of these, Chesapeake and Petrohawk are the largest, though I have largely confined most of my posts to Chesapeake, since it was their testimony before Congress that suggested that they could operate with a price of $4/kcf. Obviously Petrohawk feels threatened by his commentary, and has acted accordingly. It is disturbing that World Oil seems to have folded so easily to that pressure.

An interesting, and worrying talk at ASPO

Unfortunately I have had to miss the ASPO Meeting in Denver this week, and so cannot provide the daily reports that I have written in the past. But I notice that at least one of the talks has already caught a significant amount of press, and that is the one by Arthur Berman on the gas production from shale deposits such as the Barnett, Haynesville and Marcellus.

There has been a considerable hype in the press about the value of the gas from these shales, and the ability that they provide to bring in an “Age of Natural Gas”. Commenting on the situation last year, the CEO of Chesapeake noted

"the U.S. today consumes about 63 billion cubic feet of natural gas per day - in energy BTU equivalency terms, that’s 10.5 million barrels of oil per day, or about half of the amount of oil that the U.S. consumes each day. Of that 63 bcf per day of natural gas consumption, we import about 1 bcf in the form of liquefied natural gas, or LNG, and we import about 8 bcf per day from Canada. This means that we are about 98.5% self-reliant on natural gas supply from North America and about 86% self-reliant on natural gas supply from the U.S. Contrast that with oil, where we are only about 41% North American self-reliant and only about 27% self-reliant from U.S. sources."

This picture of a large supply of natural gas has been strengthened by the increase in production from a number of the gas shale fields, at the same time that the recession hit, and as a result there has been more gas available than needed, and the price has dropped considerably as a result. This, in turn, has led to a considerable reduction in the number of rigs that have been drilling new wells.

Natural gas has been steadily increasing its share of electricity generation, rising to over 20% of the market, on its way to 25%. Natural gas is favored because of its reduced carbon footprint over coal, and it has historically been used since it is somewhat easier to start and stop gas turbines than it is coal-fired power. Thus natural gas is seen as a favored backup to the installation of wind farms, where the vagaries of the wind are backed by the ability to use natural gas when needed.

There are, however, considerable concerns about the ability of wells in the gas shale to produce to the targets that are being set up. I first noted Arthur Berman’s concern about this back in 2007 when I drew attention to a piece he had written in World Oil, where he noted the short life of most of the gas-producing wells; the very high costs for the wells and technology required to create them and, as a result, that only 28% of them return a reasonable profit. (Unfortunately the article itself is now behind a paywall).

Since then I returned to the topic at Bit Tooth showing, among other data, the very high decline rate (now 60%) of many of the gas wells in Texas (where the Barnett shale is) that Swindell has reported.

First year decline rates of Texas natural gas wells (after Swindell)

There is further disquieting news that is now coming out of the Barnett field. The Ft Worth Weekly has just reported that many of those who expected to make substantial amounts of bonus money from drilling companies using their leases have had the agreements withdrawn and lost their money.

In April 2008, the Southeast Arlington Communities of Texas (SEACTX) negotiated a deal with XTO Energy that would bring in bonus money of $26,517 per acre and a royalty rate of 26.5 percent - among the highest in the Barnett Shale play. When leaders of SEACTX, representing about 7,000 property owners with about 5,000 acres, did the math, they figured that more than $100 million in upfront bonuses would be coming into their community of mostly modest to middle-class neighborhoods. . . . . . . . . . Well, that was then and this is now, when natural gas prices have fallen to less than half what they were in early 2008. And as anyone who has been following the Barnett Shale saga knows, drilling companies pulled out of those deals and others in mid-October of last year. Some property owners, whose bonus checks were processed prior to the cancellation, got paid. Tolli Thomas, a spokeswoman for SWFA, estimated that 4,000 to 5,000 people in her area got the money promised to them - and the other 20,000 or so did not.

Prices for drilling these wells run on the order of $5 million apiece, and Chesapeake has, in the past, noted that it takes $4.00/kcf to bring in enough money to cover those costs – with a good well. (Note that this is the Henry Hub price, consumers should add about $3 to this to get the residential price). Those numbers are considerably higher than the ones that Mr Berman used with his calculation two years ago that only 28% of the wells will be financially remunerative.

He recently (April 2009) expressed similar concerns about the Haynesville wells – though his production decline numbers are stunningly higher – as much as 20-30% in a month, for an annual decline rate of 80-90%. The costs that he cites are up at the $7.5 to $9.5 million range for the wells, with a net final cost that the producer has to pay in the region of $7.25/kcf. He therefore concludes that the breakeven point for wells in the Haynesville lies at a price of around $9/kcf Henry Hub; with a minimum reserve of some 2.5 Bcf. He upgraded that opinion in June expressing a concern, that I echo, with the availability of natural gas from a variety of sources (including the Rocky Mountain Express and increased LNG shipments) which will make it difficult to sell gas from formations such as the Haynesville, at a profit.

In his most recent post on the subject some of the possible reasons for the rapid decline (which fall a little along the same explanation as I gave on chalk collapse) which are as follows:

An abnormally high-pressure gradient (0.7-0.9 psi/ft) distinguishes the Haynesville from other shale plays. It may also explain the extremely high decline rates, as pressure depletion transfers stress to the rock and allows proppant-filled and open fractures to compress, thereby reducing the effective reservoir permeability.

Unfortunately for the hopes of a new age for gas, in preparation for a meeting on the Haynesville production last week, he had calculated the numbers for some 67 wells in the Haynesville and was still coming up with decline rates of 25% a month.

He also noted

The average EUR in our study is 1.72 Bcf/well, compared to the 6.5-7.5 Bcf/well reported by many operators. Only two wells of the 67 evaluated have an EUR greater than 6.0 Bcf. At the same time, seven wells have already produced more than 2 Bcf and one has exceeded 4 Bcf.

Petrohawk has the best well performance with an average EUR of 3.4 Bcf/ well (19 wells evaluated). Chesapeake has the most wells on production (29 wells evaluated) but we project an average EUR of only 1.2 Bcf/well.

It sounds as though I missed a really interesting and valuable talk – just have to wait for the DVD’s to come out, I guess!! But in the meantime I have added his site to my recommended reading list, over on the right.

I'm also going to have to reorder some of the technical talks on Sundays so that I can more fully explain his concern about the Haynesville shale.