SOLVING OUR ENERGY CRISIS (not)

Mark Jones jones118 at SPAMlineone.net
Sun May 13 14:28:14 MDT 2001


SOLVING OUR ENERGY CRISIS:
The Important Role Which The Offshore Oil & Gas Industry Must Play

OFFSHORE TECHNOLOGY CONFERENCE 2001
Houston, Texas
April 30, 2001

By: Matthew R. Simmons
President
SIMMONS & COMPANY INTERNATIONAL


I first attended the Offshore Technology Conference (OTC) in 1970, which was the
last year it was still held in our downtown Albert Thomas Convention Hall. As I
vaguely recall, there were several hundred exhibitors and almost 5,000 attendees.
While the general oil and gas business was in the doldrums, offshore oil and gas
activity was exciting and growing at a rapid pace. Our offshore industry was so
young and the challenges were many.

The offshore world and the OTC would change rapidly over the next few years. In
1971, the OTC moved to the Astro Arena and then spread to both the Astro Arena and
the Astrodome itself. Two years later, the energy crisis of 1973 removed the last
vestiges of the energy doldrums. This crisis became the fuel that propelled the
offshore energy world into its greatest era of growth.

By the 1982 OTC, the event had mushroomed into the largest international energy
forum in the world and was one of the largest industrial events ever held. Why?
Because rapid advances in offshore oil and gas brought on the extra energy supplies
to break the back of the shortages and tight capacity that led to both oil shocks in
the 1970’s.

As I recall, the 1982 OTC shattered any former attendance record with over 105,000
attendees. There was a waiting list for exhibitors in line to display their wares.
Bevies of beautiful women were hired to pin ribbons on attendees. At the end of each
day, you would see men staggering out of the Astrodome looking like highly decorated
World War II generals!!

The 1982 OTC also became the high-water mark for the offshore business. Within
months after this carnival ended, the industry nose-dived off a steep cliff. At the
industry’s nadir, the OTC was only being held every other year and even then
attendance, in the full program years, was down to the mid-ten thousand range.
Because its former glitter and stunning growth in attendance epitomized the success
that offshore arenas enjoyed for the decade of the seventies, the forum became
almost a sad reminder, for many of the loyal attendees, of the glory days which the
industry once enjoyed. And its meager attendance was symptomatic of how depressed
things were throughout the energy business, including the once booming offshore
industry.

By the start of 2000, most OTC attendees had almost forgotten the old “Glory Days”,
or perhaps the carnival spirit that the OTC’s of the late 1970’s and early 1980’s
came to represent. Instead, the forum, whose attendance never rebounded to even half
of its peak boom years, matured into what its founders always hoped it would be: a
serious educational forum to discuss the leading challenges and technical
breakthroughs for offshore energy development.

In spite of all the ups and downs the energy business experienced over the past 30
years, the OTC, as a proxy for the role the offshore played, is still the most
important energy industry conference held in the world. And the technology gains
made over this same era rivaled or exceeded the advances made in space over the same
time span.

Today, on the 32nd annual Offshore Technology Conference, the world once again faces
a serious energy crisis. The new crisis will likely be far worse than the two oil
shocks of 1973 and 1979. Once again, the offshore oil and gas industry will be
challenged to respond and help solve this crisis before it threatens to destroy our
economies.

What I hope to do this afternoon during my allotted time, is to discuss how this
energy crisis erupted on the world, why it is such a serious energy crisis, how it
gets solved, and outline the important, if not critical role the offshore oil and
gas industry has to play to insure resolution of this crisis.

The term “crisis” has many definitions. In the energy business, it is a word often
used when energy prices rise to levels that annoy energy consumers. In the spring of
1973, the Oil & Gas Journal had several articles about the “energy crisis” but all
this term really referred to was that motor gasoline had risen from $.25 per gallon
to over $.40 per gallon. Ironically, the true energy crisis was still six months
away. But the accurate definition of a true crisis is when a problem or a series of
problems turn from being troublesome to extremely severe. (Or as some would say,
when a problem suddenly becomes terminal.)

There are many today, even within the energy industry, who argue we do not have an
energy crisis. But, because they are part of the industry does not mean they are
right.

According to our history books, most observers doubted the U.S. really had a crisis
between the North and the South even after Fort Sumter officially began the civil
war. And many pundits in both Europe and America passionately denied a political
crisis existed even as Germany finally invaded Poland.

Why I believe the world now faces a genuine energy crisis is that we have
accidentally used up virtually all spare capacity to increase energy demand. And we
let this happen not just in oil, or natural gas but in all three of our basic forms
of energy: oil, natural gas and electricity. That they all reached this point
virtually simultaneously was coincidental. But this convergence created a perfect
energy storm.

Running out of spare energy capacity does not mean the world has run out of energy.
This would be impossible as the world uses over 180 million barrels a day in oil
equivalent terms. But being out of spare capacity means that every 1% growth in
worldwide energy demand requires the addition of 1.8 million barrels a day
equivalent of new energy capacity and it takes the better part of five to ten years
to get even this marginal amount of brand new capacity built.

This capacity limit is not in every single part of the world and in every energy
form. But it is also far wider spread than just California or the USA. There are
still limited slivers of spare energy capacity here and there. But the slivers are
few and slim. Moreover, another year’s growth in energy demand will effectively
eradicate almost all the slight cushion the world still enjoys.

This lack of spare capacity is most evident in North American natural gas. Despite
record levels of gas rigs furiously drilling to bring on more supplies, the North
American gas supply base refuses to grow. Even record levels of new gas well
completions can no longer overcome the decline curves in the producing basins
throughout North America.

Outside North America, there has never been any excess capacity for natural gas. We
have always had large quantities of stranded gas and lots of gas resource potential,
but every molecule that can be physically delivered to natural gas consumers is
being delivered and consumed.

In our electricity grid, for decades the U.S. maintained a spare capacity cushion
close to 20% as an almost legally mandated reserve for sudden changes in demand.
This was necessary since we need generating capacity sufficient to meet not a year’s
average demand or the peak needs in a given month, but literally, the peak demand in
the highest demand minute of a year. Most of the rest of the world has never had
this luxury which is why blackouts are some common in so many parts of the world.

To assure the U.S. maintained this spare cushion of electricity reserve, America
added another 10% to its base of power plants, the generators of kilowatts, every
five years until the decade of the 1990’s began. Then, the pace of added power
plants fell to 4% from 1990 to 1994 and then to less than 2% from 1995 through the
end of 1999. But electricity demand continued to soar, which accidentally gobbled up
virtually all of America’s spare reserve margin. So now, America faces the risk of
either rolling brown-outs or blackouts if weather is too hot or too cold, or if the
economy enjoys one more spurt.

If the lack of spare energy capacity were only limited to natural gas and
electricity, it would be bad enough. But the energy problem also extends to oil,
though many still deny or ignore this fact.

For years, OPEC maintained massive spare energy capacity. The exact amount of spare
cushion will never be known as we never had a fire drill to test the excess cushion.
But it served as a giant insurance policy for some unplanned event that kept daily
oil supply constrained. At its peak, the world’s spare daily oil production was
probably around 20 million barrels a day.

By the time of Desert Storm, “behind the wellhead valve” spare capacity had shrunk
to less than 6 million barrels a day but this was sufficient to keep the oil system
flowing even with the production from Iraq and Kuwait removed from the market.

Today, this cushion is almost gone. And it might be totally over. No one still
presumes there is any substantial shut-in oil supply outside the Kingdom of Saudi
Arabia. Saudi’s oil minister has publicly warned that it has 1.8 million barrels per
day of spare capacity but he has also added an important few choice words: “This 1.8
million barrels a day can be brought on in around 90 days.”

It does not take 90 days to turn on a well head valve. And any event that takes 90
days might take far longer or not even work.

Even if Saudi had close to 2 million barrels per day of spare capacity that can be
brought on overnight, the world is now out of spare tanker capacity, spare refinery
capacity in most parts of the world, spare pipeline capacity and spare tank farm
capacity.

Every aspect of our spare cushion was eroded by soaring demand and an
under-investment in additional supply.

Today, with no spare energy cushion, the slightest bad news can tip the world into
energy shortages. It has already happened in California’s use of electricity and
natural gas. It happened with heating oil in parts of the Northeast in the winter of
2000/2001 and in parts of the Midwest for motor gasoline last summer.

Over the course of the last two years, we let the stocks of spare supplies for
natural gas in North America fall to their lowest levels ever and let the spare
stock of motor gasoline fall to over 11 million barrels less than record low levels
a year ago.

How serious is this energy crisis? Henry Kissinger described the Oil Shock of 1973
as the worst threat to our economy since World War II. That shock only involved oil
and lasted for less than 90 days. Re-building a safe cushion of spare energy
capacity will take at least a decade. In the meantime, we face a meltdown of our
economy if anything goes wrong.

How important is offshore oil and gas to solving this energy crisis? The answer is
simple. Unless we suddenly discover vast amounts of new oil and gas onshore,
something that has not occurred for almost 30 years, added supplies of both oil and
gas from the offshore is the world’s ONLY solution. But even all the offshore oil
and gas that is now being planned will be insufficient to solve our energy woes. We
also need to return to more nuclear energy and coal. The world no longer has the
luxury of betting on any single energy source. Every energy form needs to be
expanded, as some will not be as effective as others.

How much more energy capacity does the world need to add? The easy answer is as much
as we can build. But adding new capacity takes a while. It takes around a decade to
add even 10%. If we added three times this amount, the time line is probably about
the same. If the world only added 10%, it would take a decade to accomplish and then
we only buy three of four years of growth before once again being short. So my
advice would be to expand the world’s energy capacity by 30% so we finally re-create
a cushion of spare margin once more. When this feat has been accomplished, we should
never again let this insurance policy lapse.

If this is all we do, the investment is wasted. The present energy infrastructure
that allows the world to use over 180 million barrels of energy per day is old and
decaying. Therefore, while we add 30%, we also need to rebuild or totally refurbish
the entire existing energy base, brick by brick. This means rebuilding or totally
refurbishing all our pipelines, our tankers, our refineries, tank farms, power
plants, rigs, supply boats etc. The list is almost endless. Delivering 180 million
barrels of oil equivalent in energy each day is not a simple task.

How much will all this cost? The answer is unknown since no blueprints have been
drawn and until this is done cost estimates are simply guesses. But, the feat will
be extremely expensive. In fact, it might easily be the most expensive investment
the world has ever made, surpassing even the cost to re-build Europe after World War
II. I have taken a rough guess at the cost to rebuild and expand some very obvious
parts of the energy system and can quickly get the cost to numbers exceeding $5
trillion with vast chunks of this badly needed expansion still to be added to the
total bill.

How did we get into such an energy mess? The answer to this is also easy. It was a
culmination of 30 years of energy mistakes, beginning with a misunderstanding of
what caused the two painful energy shocks of the 1970’s. Neither of these energy
shocks were caused by geo-political events in the Middle East. They occurred because
we let energy demand use up all the excess capacity so demand then edged ahead of
supply.

The world then failed to see the slowdown and ultimate drop in energy demand while
supply additions finally became too much as the decade of the 1980’s began. In
correcting this mistake, we literally crushed the infrastructure required to drill
and complete wells and tore down the plants built to add more things like drilling
rigs.

The world then “enjoyed” almost 20 years of flat energy prices. Over time, these
flat prices, which were really price declines in inflation adjusted terms, began to
seem normal. But the entire energy complex spent 20 years doing virtually no real
expansion and continually downsized, desperately struggling to become small enough
to cope with prices that were simply too low. They were far less than the
replacement cost of any aspect of our energy complex. But, too few industry
spokesmen ever did the real math. Instead we all fell in line and preached that
energy prices would stay low forever. Since the thesis was wrong, it was inevitable
that this bubble would finally burst. Now it has happened.

As the world begins to build its way out of this energy crisis, a huge burden will
fall on the offshore oil and gas side of the energy complex. As robust as the
offshore sector appears, from a quick glance at all the startling technology
advances which are being showcased at this year’s OTC, the offshore part of the
energy complex is actually very fragile and the bulk of its asset base remarkably
antiquated and worn.

The offshore drilling fleet, along with the tanker fleet and supply boat system now
has an average age close to 20 to 35 years, with only a fraction of these assets
under ten years old. No one has ever done a real audit of the offshore industry’s
human resource base but some anecdotal evidence argues that perhaps half of all the
people now working in all aspects of offshore energy will retire over the course of
the next decade. There are no plans in place to recruit replacements for this
skilled workforce, let alone plans to recruit the added 30% to bring on the badly
needed new capacity.

In the meantime, the world’s offshore supplies are now not the young resources they
were in the OTC’s glory days. Much of this base is now getting quite “long in the
tooth.” Let me focus on the U.K. part of the North Sea to highlight how vulnerable
much of our offshore supplies have now become. I picked the U.K. sector since it
represents one of the single biggest fresh offshore oil and gas supplies over the
past 30 years. And the North Sea region is the only part of the world where
production statistics are available on a field by field basis.

U.K. oil production grew from almost nothing 30 years ago to a plateau of 2.7
million barrels per day in the mid-1990’s. Over the last five years, one forecast
after another predicted that U.K. oil production would finally exceed 3 million
barrels a day. In 1995, many long-term forecasts estimated that this production
might get to as high as 3.5 million barrels a day by the start of the 21st Century.

In reality, U.K. production flattened out in the 2.5 million barrel a day range and
has remained around 2.20 to 2.3 million barrels a day for the past year. If you take
the U.K. government Brown Book numbers as a guide, 1995 UKCS production was 2.4
million barrels a day. 89 individual fields contributed to this total. By 1999,
production from these 89 fields had fallen to 1.445 million barrels a day.
Fortunately, another 58 new fields were brought on stream since then but only held
production flat. However, their average production is only 19,000 barrels per day
per new field.

In 1995, the top 11 producing fields accounted for 52% of U.K. production. But this
1.245 million barrels a day base fell to only 355,000 barrels per day by 1999 and is
far lower today.

Over the past six months, U.K. production from over 120 individual fields has kept
the production base around 2.3 million barrels a day, but only 3 fields now produce
in excess of 100,000 barrels per day, and average only 106,000 barrels per day. Gone
are the days of fields like Brent and Forties which produced close to 500,000
barrels per day. In their place are lots of small fields that peak fast and decline
even faster.

The Forties field still generates vast quantities of production, but most of this
volume is water. In fact, water produced by the Forties field totals almost 17
million gallons per day. This is almost equivalent to the amount of water used per
day in Houston, American’s fourth largest city. Like the Gulf of Mexico, most new
North Sea fields are simply tiny additions and it takes a steadily increasing number
being developed to keep the production base flat.

In 1990, almost 350 wells were drilled in the U.K. sector. Exploration and appraisal
wells made up two-thirds of this total. By 1998, before activity declined due to the
price collapse of oil, the U.K. sector was drilling a record levels of wells, but
development wells were making up 75% of the base, with only 25% of the wells being
exploratory or appraisal wells.

The dilemma this poses is acute. Until a vastly expanded offshore rig fleet is
created, the U.K. sector will ultimately fade away if exploration and appraisal
drilling remain so low. But if the current rig fleet suddenly shifts back to doing
65% E&A wells, the production base will collapse as it is being propped up by this
high level of development and workover wells.

The U.K. sector of the North Sea is not unique. It is probably a great proxy for
almost all the offshore today. The other areas simply lack the excellent data to
track what is really going on.

There is a growing body of evidence that the world might never experience the luxury
of giant oil and gas fields that climb to over 1 million barrels a day, and then
continue to produce at this level for years as the giant field is being choked back.
In 1973, over 30% of the world’s production base came from such giant fields.

In 1978, Mexico’s Cantarell field began production. This was the last new field that
ever generated over 1 million barrels a day. Over a decade later, the Cusiana field
was discovered in Columbia. For several years, it was thought to be as big as Alaska
’s Prudhoe Bay. But this proved vastly over optimistic as this giant field finally
peaked at just over 400,000 barrels a day and is estimated to drop to around 270,000
barrels a day by the end of 2001.

Saudi Arabia’s Shayba field, the only new field to begin production in the Middle
East in decades, is now reaching peak production but its system is only designed to
produce 500,000 barrels per day and it cost about $3 billion and took over three
years to bring this field on-stream.

In a 25-year period, Cantarell, Shayba and Cusiana became the world’s three top
producing new fields. Cantarell is still a giant field, but Pemex just spent $10.5
billion propping up what would soon become a rapidly falling production base. There
are no fields now on the drawing board through 2005 that appear likely to produce in
excess of 250,000 barrels per day and only a handful are estimated to exceed 200,000
barrels per day.

This does not mean that the world has run out of oil but it does suggest that giant
fields, in terms of daily production capacity, are a thing of the past. And if the
world needs to rely on scores of smaller fields coming on stream each year to merely
keep current production of oil and gas flat, let alone grow to meet rising worldwide
GDP, we need a far larger asset base in rigs, boats, FPSO’s, etc., or these
production increases will never happen.

These are the challenges facing every attendee of this year’s OTC. We are about to
enter an energy war and the energy industry is as ill equipped to wage it, as the
free-world countries were to wage World War II at the end of 1939. Like our defense
plant explosions that occurred as the 1940’s began, the energy industry is about to
get a similar call to action.

The world now has a serious energy crisis on its doorstep. It is incumbent on the
energy industry to grasp the severity of this crisis and begin planning how we solve
the problem. Otherwise, we can easily destroy our economies which will re-create
spare energy capacity but it will also spell the end of future economic growth and
prosperity we all cherish so dearly.

It is hard to imagine what an OTC forum will look like as this group meets in 2010.
It could be as dramatically different as the OTC of 1981 was compared to the first
OTC held in this facility in 1971, 30 years ago. If the change is not so great, it
might imply that the energy crisis was not solved. Such a scenario would be a sad
situation for our world.

I am honored to speak about these genuine challenges and risks. I am a great
believer in the industry’s ingenuity to rise to these challenges. Getting the job
done will challenge each and every participant here today.

Thank you for your attention to such serious issues.






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