Arthur Berman: Why The Price Of Oil Must Rise
Geologist Arthur Berman explains why today's low oil prices are not here to stay, something investors and consumers alike should be very aware of. The crazy-low prices we're currently experiencing are due to an oversupply created by geopolitics and (historic) easy credit, not by sustainable economics.
And when the worm turns, we are more likely than not to experience a sudden supply shortfall, jolting prices viciously higher. This will be a situation not soon resolved, as the lag time for new production to come on-line will be much longer than the world wants:
The same things that always drive prices in the end it’s always about fundamentals. The markets are peculiar and they change every day. But the fundamentals of supply and demand at some point markets come back to those and have to adjust accordingly. Not on a daily basis, maybe not even on a monthly basis. But eventually they get it right. So this oil price collapse is really straight forward as far as I can tell, and it has to do with cheap stupid money because of artificially low interest rates that resulted in over-investment in oil -- as well as lots of other commodities that are not in my area of specialty, but that’s what I see. And over-investment led to over-production and eventually over-production swamped the market with too much supply and the price has to go down until we work our way through the excess supply.
Now the wrinkle in all of this is that because the supply excess/surplus was generated by debt and a lot of correlative instruments, the problem is that the companies and the countries that are doing all this over-production need to keep generating cash flow so they can service the debt, which means they have to continue producing pretty much at the highest levels they possibly can which doesn’t really allow very much room for reducing the surplus. So that’s piece number one and then there’s the demand side. So the thing that drove all of this over investment and over production were high prices. And after a while people get tired of high prices and we see a phenomenon called demand destruction or you know as Jamie Galbraith calls it the choke chain effect. You know your dog runs out on a leash, eventually you know it stops and he chokes and so we’re dealing with that. People have changed their behavior because of high prices and then we add to the fact that people just change their behavior. I mean young people aren’t driving as much as they used to, they spend their time in a – you know on a smart phone more than they do in a car. We’ve got climate change issues. There’s considerable momentum toward cutting back on fossil fuels. Add it all together, demand is down, supply is up, it’s a bad situation...
We started this conversation with your important observation that we’re only talking about a million or million and a half barrels a day of oversupply. So we could go from over-supply to deficit pretty quickly, because we’re not investing in finding that additional couple of million barrels a day that we need to be discovering. So we’re deferring major, major investments. We’re not just deferring exploration; we’re deferring development of proven reserves. Capital cuts across the world represent 20 billion barrels of development of known proven reserves. And so we will get to a point, and we will, we most certainly will, where suddenly everybody wakes up and says “Oh my God we don’t have enough oil! We’re now half million barrels a day low." And what will happen? The price will shoot up. That’s the way commodity markets work. And everybody will say “Whoopee! Let’s get back to drilling big time." Well there’s a big lag. There’s a huge time lag between when the price responds and people actually get around to drilling and they actually start bringing the oil onto the market and it becomes available as supply, because they’ve been asleep at the wheel for you know for how many months or years. And so you know you can’t just turn a valve and all of a sudden everything is okay again
Click the play button below to listen to Chris' interview with Arthur Berman (56m:07s)
Chris Martenson: Welcome to this Peak Prosperity podcast, I am your host Chris Martenson. Last week saw oil close at a weekly low, below the emergency "the world is falling apart" lows of 2009 and back to levels not seen since 2004. Now as you know, energy is the master resource and so we have to wonder, deeply, about what this plunge in oil prices is really telling us. Separating the signal from the noise is essential but never more so than when you’re talking about the master resource. Oil is the master resource as far as I’m concerned economically.
Now does all of this oil price plunge mean that peak oil is wrong? Does it mean that oil companies have figured out how to produce oil profitably at one-third the oil price from a year ago? Does it mean that demand is falling off a cliff or that supplies are skyrocketing? To help us make sense of all of this by far is my favorite oil analyst and energy specialist out there, Arthur Berman, who is a geological consultant with 37 years of experience in petroleum exploration and production, with 20 of those at Amoco—now a part of BP. He has published more than 100 articles on geology, technology and the petroleum industry during the past five years. Publication topics include: Petroleum exploration, oil and gas price trends and cycles, petroleum play evaluation, sequence stratigraphy, coastal subsidence, earthquakes, Tsunami’s and petroleum geopolitics. He has published more than 20 articles and reports on shale plays, including the Barnett, Haynesville, Fayetteville, Marcellus, Bakken and Eagle Ford shales—all ones that we cover here at Peak Prosperity pretty routinely.
During the past four years he’s made more than 50 presentations to energy sector boards of directors and executive committees, financial analyst conferences, oil and gas association meetings and engineering and geological society meetings. Listen, Art’s been out there attempting to tell the tale that something needs to be examined a little more closely when it comes to oil, particularly shale oil. We’re talking to a true oil expert on this subject. Welcome Art, it’s great to have you back.
Arthur Berman: Thanks Chris; thanks for having me back.
Chris Martenson: Well let’s start right at the top. The collapse in oil prices. What’s driving that in your mind?
Arthur Berman: The same things that always drive prices; in the end it’s always about fundamentals. The markets are peculiar and they change every day. But the fundamentals of supply and demand—at some point markets come back to those and have to adjust accordingly. Not on a daily basis, maybe not even on a monthly basis. But eventually they get it right. So this oil price collapse is real straight forward as far as I can tell, and has to do with cheap stupid money because of artificially low interest rates that resulted in over investment in oil as well as lots of other commodities that are not in my area of specialty, but that’s what I see. Over investment led to over production and eventually over production swamped the market with too much supply and the price has to go down until we work our way through the excess supply.
Now the wrinkle in all of this is that because the supply excess, or surplus, was generated by debt and a lot of correlative instruments, the problem is that the companies and the countries that are doing all this over production need to keep generating cash flows so they can service the debt, which means they have to continue producing pretty much at the highest levels they possibly can, which doesn’t really allow very much room for reducing the surplus. So that’s piece number one.
Then there’s the demand side. The thing that drove all of this over investment and over production were high prices. After a while, people get tired of high prices and we see a phenomenon called "demand destruction," or as Jamie Galbraith calls it, "the choke chain effect." You know, your dog runs out on a leash and eventually it stops and he chokes. So we’re dealing with that. People have changed their behavior because of high prices. Then we add to that the fact that people just change their behavior. I mean, young people aren’t driving as much as they used to, they spend their time on a smart phone more than they do in a car. We’ve got climate change issues. There’s considerable momentum toward cutting back on fossil fuels. Add it all together: demand is down, supply is up; it’s a bad situation.
Chris Martenson: Now, this over supply has been with us for a little while. Help people understand this because it’s not a huge amount. The world does burn, of total liquids—I’m rounding here—90 million barrels a day. How much are we actually over-supplied on a daily basis right now?
Arthur Berman: Right, well okay so there’s a distinction that has to be made between oil and liquids. So when we’re talking about the world, we’re generally talking about liquids. That means crude oil plus a lot of other stuff—refined products, natural gas liquids, bio-fuels, you name it. So the number you cited, which is 90-94 million barrels a day, that’s total liquids, okay? That includes gasoline and jet fuel and all that stuff. The crude oil piece of that is somewhat less. It’s around 73-74 million barrels a day. So that’s the context.
So let’s talk about liquids. We’re over supplied in liquids by approximately a million and a half barrels per day. Now, like you say, that doesn’t seem like a lot or huge amount as percentage—and it’s not—but in all commodity markets, certainly in the oil market, which is my expertise, it doesn’t take a whole lot before it drives the price down. A glut or a shortage can be a whole lot less than a million and a half barrels a day. And in fact a million and a half barrels a day is pretty high by historical over supply standards and it’s completely anomalous in terms of length of time that it’s lasted. We had over supply spikes of a month or two or three months several times in the past decade or two, but they adjusted out pretty quickly. That's because, first, they were usually related to some anomaly—either a supply interruption or the end of a supply interruption—and they occurred during periods when there was more geopolitical risk in the world. In other words, there were civil wars going on in places like Libya or whatever that could quickly reduce the overall supply and therefore bring down the surplus. What’s happened here in the last three or four years certainly is despite all of the turmoil in the world— the world hasn’t gotten any safer, but for whatever reason, coincidence, we just haven’t had any significant supply interruptions. And so there’s no safety valve to absorb the excess production as there had been prior to really about the middle or beginning of 2014; that’s when the over supply really began to bloom.
Chris Martenson: And that’s also when I think OPEC decided particularly Saudi Arabia decided this time around they weren’t going to be that swing supply cutter. They weren’t going to come out and absorb the million and a half overage by dialing back their production. So there’s some geopolitics or some, obviously, some maneuvering going on in the part of Saudi Arabia here, which is a little different in the past. I’m not saying Saudi Arabia should be the swing producer. Maybe the United States could dial its production back or anybody else. But that’s potentially a new behavior at this time around too, isn’t it?
Arthur Berman: Not really. You know, our memories are short and if Daniel Yergin and enough pundits and journalists say that Saudi Arabia and OPEC are the swing producer and supposed to be the swing producer, then eventually people start believing that they are. But you can go on the EIA website and access a graph pretty quickly that has a very prominent data point which is somewhere in the middle of 1986 and the caption says “OPEC abandons role as swing producer.” So that was what, 30 years ago, almost 30 years ago? And so the truth is a swing producer in my view is kind of a dumb concept. The United States can’t be a swing producer because no one can pick up the phone and say “Okay tomorrow we’re dialing back production by one barrel or a million barrels." Saudi Arabia can do that, Russia – autocratic countries can do that. The US can’t do that; there’s too many moving parts. There’s thousands of independent producers that are all pursuing their own internal objectives and strategies.
But back to your point about Saudi Arabia. Whether or not they were or should be the swing producer—and I’m not a great apologizer for Saudi Arabia but, in truth, what they’ve done here is just good business sense. They looked at the situation and said, “Oh my God, there’s all this new supply in the world and, yeah, we and OPEC could cut – we could cut a million and a half barrels a day or two million barrels a day and bring the price up to whatever level that we might want on a short term basis." But here’s the problem, we bring the price up and all the companies and countries that are trying to cut back their production would say “Gee thanks guys, we’ll just dial up production” and in almost no time what happens is that the oversupply has now become even worse. And who suffers from it? Well the people that cut production. And who benefitted? All the cowboys that didn’t cut production.
So from a business standpoint, I think that OPEC is saying "well that’s a dumb thing to do. What we need to do is figure out a way to get those guys to cut back so that eventually price goes up or we can decide to cut and artificially increase price or just gain market share or, heck, just discover what the new order marginal barrel cost really is because we don’t know with all this tight oil and God knows what." So that’s the way I read it. Maybe I’m being too generous or naïve but that’s the way I see it. I don’t see that cutting production would accomplish very much of anything except make the situation worse in the fairly near to medium term.
Chris Martenson: Well I guess the way I look at what you just said is, if I’m OPEC, I’m looking across the near and the long term and I’m noting a couple of important trends and I’ve seen the rise of the shale oil and that’s sort of concerning on one level. But you put your finger on a different piece which is that they have very little – OPEC has less control right now. And they won’t have control, they won’t have the ability to both cut back and see prices rise until they gain some of that control back. So I could see that as part of the strategy.
Here’s another observation I’ve had is that with this pretty much two-thirds price cut in oil from its recent highs, there was supposed to be this big uptick in demand. Are you seeing that? Is demand really responding to price for oil?
Arthur Berman: No, is the simple answer. Of course it’s always more complicated than that. And so sure, there are bright areas—consumption of gasoline in places like the US and China showed a fairly predictable increase with much cheaper oil and therefore gasoline prices. But unfortunately—or fortunately—the United States and China being the two biggest economies in the world, they’re still not the whole world. And besides, these kinds of spurts don’t last forever. So it seems to me that whatever we saw let’s say in the United States in terms of an increase in gasoline and, let’s face it, transportation is a good 25% of total oil consumption; so it’s hardly trivial. But okay, so we did it and now it’s over. We’re not going to keep exponentially increasing our driving. We kind of did it – summer driving season's over so now maybe we’ve leveled off at a higher level but it’s not enough. The world 30 years ago, when we had our last big oil price collapse back in the 1980’s and 1990’s, petroleum consumption was limited then pretty much to the United States, North America, Western Europe, and now it’s a different story. Now we’ve got the whole world consuming a lot more oil than they did before. So everything is more complicated.
Chris Martenson: Okay, all right. Well thanks for that. The big picture obviously is supply and demand, that’s a real price driver here. Now I want to turn our attention a little bit closer to home. I just can’t wait to talk to you about the shale plays because I’ve been tracking them for a long time. I’ve been a fairly big proponent of David Hughes' work which is out of Post Carbon really talking about just the – it’s fairly simple at one level. In any given shale play there’s only so many places you can drill. And then secondarily, there’s sweeter spots and less sweet spots. And then thirdly, everything really depends on the ultimately recoverable amount of oil that comes out of a given well. I’ve been following some work over on Peak Oil Barrel, particularly by this guy, Enno Peters, who is just taking all of the well data in the Bakken and clearly showing vintage by year what each well has produced, each cluster of wells for that cohort. And you sort of draw those curves out by eye and you see that there haven’t been any massive improvements in well productivity over the past few years. And secondarily, just by eye you can sort of tell where they’re all sort of running out at about maybe 350,000 barrels per well, somewhere in that zone, as for an ultimate recoverable amount.
And still when I look at the operators in those plays they’re claiming that they’re going to get twice that, sometimes even more than twice that out of each well. When I’ve calculated the economics in that play myself—I got a little spreadsheet, I did my level best. And then I found that you had calculated what’s going on in that play as well. So let’s cut right to that. In the Bakken, how many wells that get drilled out here right now would be economic in today’s prices?
Arthur Berman: Almost none at today’s prices. The latest from the North Dakota Department of Mineral Resources says that wellhead prices are in the 20’s so… I published a report not very long ago that said that 1% of the Bakken was breaking even at $30 oil prices. So now we’re below that and I don’t remember exactly what percentage of wells but it was something like maybe 5 or 6%. But so right now let’s face it Chris, let’s just get it right out there in the open: Everybody is losing their ass at current oil prices. I don’t care what they say. I’m in this business, okay? I just drilled two discoveries in the last month or two at the bottom of the cycle and we can make a weak profit off of what we found—first of all they're conventional reservoirs so they didn’t cost us $6-$10 million to drill. And we don’t have to drill them horizontally. We don’t have to frack them. And we have got no overhead and we have got no debt; so that puts us in kind of a really different situation for most public companies.
The truth is that everybody—the best positions in the best plays in the United States, the core of the core, if you will—nobody can break even at less than about $45 a barrel and that’s just reality. That’s not sticking them with their land costs that they sunk and wrote off long ago; that’s just basic operating expenses and severance taxes and stuff that I publish in all of my reports and nobody ever argues with me about that. They may disagree with a lot of my conclusions or etc. but they never say “Oh no, your economic assumptions were way off base." No they’re not off base.
So take that to the bank and let’s just get that whole silly conversation off the table. Everybody is losing their ass at $20 or $30 oil, everybody. And that includes Saudi Arabia, Kuwait and everybody in the world is. But certainly US producers, very best of the best, they got to have $45 or $50, and that’s a small subset of their wells in a play. And realistically $60-$65 is bare bones for the average well positioned company, all of their better wells or current wells in play. That’s just the way it works. And if you hear something else, ask a lot of questions, like: “Tell me what costs you’re excluding,” because that’s the only way to get there is just be excluding costs.
Chris Martenson: Well I guess there’s one other way. I’m actually looking at a Bloomberg article right here and the headline says that shale companies can make money with oil at $30. And so digging into the article a little bit I think what they’ve done is they’ve found a company that took one well that’s producing extraordinary well—which happens from time to time, you get the so called monster well. And then the company can make the claim that at $30 we can make money off this well. Of course you can’t drill a monster well every time and so what matters is the average play. But I’ve been astonished at the degree to which the Wall Street Journal, Bloomberg, even New York Times, everybody has sort of been picking up that PR. It’s just PR to me because it doesn’t matter to me that one well in a company’s portfolio made money at $30, what matters to me is the portfolio. Of course that – there the data is really easy to come by. But I see so little analysis of it and the mainstream for sure. I don’t see any of it coming out of Wall Street. I have to go to your site and I have to go to other private sort of individuals who are just sort of scratching through and using common sense. It feels – the difference between common sense and what I read in the newspapers—it’s a pretty big gap right now. That’s how I experience it.
Arthur Berman: Well you’re right Chris. Some of it's PR for sure but a lot of it’s just ignorance. Most of the people that write these articles have never worked a day of their life in the oil and gas business, so how do they know? They’re smart people, don’t get me wrong. I’m not disparaging their skills or intelligence but if they’re looking at some data or they’re talking to some companies and the companies say “Look we can break even at $30 a barrel” and they say “Really? So what are your operating costs?" “Well our operating costs are $4 or $5 a barrel” they’re going to say “Okay that sounds reasonable." Where somebody that’s been in the business for a while says “Whoa, whoa wait a minute, really? $4 or $5 a barrel, that’s ridiculous." I work for a little bitty company that has four employees and no debt and we can’t operate for $4 or $5 a barrel, so what are you talking about? What are you excluding here? And it always comes to that question. Whenever you hear a number that sounds unbelievable, or too good to be true, it is. Because they’re not telling you about a certain cost.
Daniel Yergin published an op ed piece last week, I think it was in the Wall Street Journal or the New York Times, I don’t remember which. He said that a lot of these shale operators figured out how to make a profit at lifting costs of $20 a barrel. Well what does that mean? That’s not their total cost, that’s their cost of operating and lifting—getting the oil to the surface. That’s like saying that my housing cost is basically my gas and electricity and other operating costs, less the mortgage. Well what a sweet deal that would be if I didn’t have to make my mortgage payment; that’s what Yergin is talking about. People don’t understand the subtleties of the language and the jargon to know that no, he’s really not saying that they’re making money at $20. He’s leaving out all their capital expenditures. Well yeah, okay leave out major capital expenditures. You don’t have to account for that, gosh, I’m a rich guy if I don’t have to pay my mortgage every month. I got a couple thousand bucks that I didn’t have before. Except that I do, and they do too.
Chris Martenson: Well now this is a really interesting piece now. So if we look at the amount of—you mentioned this before—cheap debt financing. Obviously a component of this story. And we look at just the yield hungry people who are willing to toss prudence out the window and chase that yield. We’re seeing the ripples in the high yield market which is really heavily concentrated and some major distress of course in the energy side of this. But all the numbers I’ve read say that somewhere between $250-$300 billion of debt stands on these shale operators. And maybe they’ve got some more equity, let’s say it’s $100 billion.
So let me just round crazily and say that this is around $370 billion total outstanding debt and equity that investors would love to see back, and then I wander over and see a $36 barrel for oil—even if they were getting that full price it means that 10 billion barrels of oil has to be sold off just to service debt and equity. This is no SG & A, this is no overhead, this is no well disposal cost, no decommissioning, no severance tax, no royalty payments, nothing, right?
When I look at it that way, just sort of high level, I’m looking at 10 billion barrels, what are the reserves? Total reserves? Across all the plays that these operators are in? It can’t be a whole heck of a lot more than that, can it?
Arthur Berman: Proven reserves in the United States as of EIA’s latest report a couple weeks ago are 40 billion barrels of oil. Now there is a Proven Undeveloped which is another category that is also proven, which you can add another 40 or 50% but the number you’re talking about there is a huge proportion of the total United States' proven reserves, any way you cut it. And so yeah, be scared. That’s the message.
Chris Martenson: Well I’m thinking out of that 40 billion some of that is in the Gulf of Mexico, which doesn’t apply to the companies I’m talking about. Some of that is still locked in regular conventional fields that have been producing for a very long time. Some of that is associated with all the stripper wells that are out there doing that. But I’m thinking like the shale play operators who are squatting on most of that debt number I announced. They’re really just in a few plays, aren’t they at this point?
Arthur Berman: They’re really just in three plays. They’re in the Bakken that we’ve already talked a little bit about. They’re in the Eagle Ford, and to some extent—I think an exaggerated extent— they’re in the Permian. And all the rest of the plays put together don’t amount to really a hill of beans in my view.
Chris Martenson: Yeah so how many billions of barrels are standing across those three plays? I’ve seen wild claims. I don’t really know where truth lies at this point in time. In fact, they’ve been reasonably good at finding stacked plays, meaning that there are different layers of shales stacked one above each other geologically. They’ve gone into those and some companies have said “Well we can put dozens of wells right near each other and there’s no well interference" and others have been less... Art, I don’t know what’s actually ultimately going to come out of those plays, so where’s reality? Do you think reality is closer to what the EIA thinks or what the oil companies are saying or, where do you see reality in this story?
Arthur Berman: There is no difference between what EIA is saying and the companies are saying, okay? So there’s two realities here. There is the reality of truth, like go to jail truth—that’s what the companies actually report in their quarterly and annual filings to the Securities and Exchange Commission. That’s where EIA gets its data. That’s where EIA’s proven reserves come from; so there’s that reality and that truth, and I think it’s reasonably close to the truth. And then there’s what companies tell investors, who believe almost anything and don’t understand—again like Yergin’s lifting cost. They don’t understand, nor should they be required to understand that he’s not actually talking about total cost. He’s talking about a subset of costs. So your question: The proven reserves of the Bakken, according to the latest EIA, which comes from companies, is 6 billion barrels. The Eagle Ford is a little more than 5, and the Permian is about 700 million. You add up all the rest of them, the Niobrara and the whatever, the Mississippi Lime and you name it, and the total is about 13.5 billion barrels. That’s the truth. And there’s probably an almost – there’s a slightly smaller but large proven undeveloped reserve category as well.
Chris Martenson: Art I was just reading an investor presentation where one company claimed to have access to almost that same number just in the Spraberry play.
Arthur Berman: Well yeah, Pioneer Natural Resources, that truthfully is not a bad company, if you just look at their financials. But their CEO, Scott Sheffield, has been making just absolutely preposterous claims for several years now about this Spraberry resource that they have out in the Permian Basin. The Spraberry was discovered in 1946 for God’s sake. In the industry, we talk about and have talked about the Spraberry as being the largest non-commercial field in the world. And we’ve talked about that for 50 years because nobody can figure out how to make money off of that deal. So Sheffield says that they’ve got 10 billion barrels in the Spraberry. But listen to his words; what is he really saying? He’s got himself protected. He says that they’ve got 10 billion net recoverable, resource potential. That’s not a reserve.
Okay so what is a resource? Well a resource—and I’m going to the Society of Petroleum Engineers here. The definition is a known and yet-to-be-discovered accumulation. It's vapor. We kind of know it’s there but we haven’t found it yet. And so that’s a resource, and now he’s talking about a resource potential. So it’s not even a resource; it’s a potential resource. So what he’s saying is that it’s some vague number that we kind of think may be out there. And of course a resource has nothing whatever to do with price. It’s absolutely not – it doesn’t have anything – it's any price. It just says it’s technically recoverable. So it means nothing, zero, zip. It means nothing.
So he’s covered. I’m about to publish something here maybe today and the sub title of this section is called “It’s not a lie if we tell you it’s a lie." That’s the name of the game. As long as the investor presentation or the news release says somewhere that we’re using language here that we would never ever use in an SEC filing because they’d put us in jail. And so you guys need to know that. In other words, "we're lying," then it’s technically not a lie. It’s not fraud because we told you it was a lie.
Chris Martenson: Guess what, if they’re going to parse and play word games and do all of that and they are companies in the business of raising capital, I got to be honest, I’ll give them a little – I understand that’s the game they’re going to play, right? It’s the old saw about, what’s a gold mine? Well it’s a liar standing over a hole. That’s been part of the resource extraction business as long as possible. Where I part ways is with the so-called analysts who are supposed to know better, in particular. And then the Wall Street machinery that is really just pulling a Lucy with a football moment on investors again. And then a little bit less so because maybe they don’t know any better and they’re not—not every journalist has got the right training to write about what they’re writing about.
But once you leave the company’s lying lips, there should be some sort of a way of getting that data accurately parsed back into human language that investors can understand. And I just – I really have been astonished at how wide the disconnect is between the amount of money and the value at which that money was given to the shale plays in what I assess to be their actual realistic prospects. Where do you fall in that particular dynamic?
Arthur Berman: Well okay so let’s talk about the Permian basin, since we’re on the subject. I looked at Pioneer's Spraberry position and I did my best to be objective about it, even though I admit I – if everybody in the industry knows that it’s never been a commercial field, it’s hard not to have a certain amount of prejudice going in. But the bottom line on this thing is that the wells kind of stink. They’re just not very good wells. These wells cost about $6 million a piece to drill, and the most optimistic EURs that I can come up with here are something in the order of less than 150,000 barrels of oil. And so you don’t need an economic spreadsheet to figure out that you got to have at least $100. In fact, in the Spraberry you need something like $101.77 to break even at the specific reserve number—the most likely reserve number that I’ve chosen.
That’s something that would be marginally commercial at oil prices way before this crash occurred. So you’d really think twice about whether you’d want to bother with it then. So Pioneer and all these other guys can draw diagrams on whiteboards until the cows come home about the stacked nature of the thing and how they can drill multiple laterals. But, the question always is "Great, but what does it cost?" And at what point does the cost justify the return? This is not a hugely complicated business question; it’s not "can you do it?" It’s "can you do it and make money at it?" That’s what business is about and the answer in the case of the Spraberry is in the best of times you’d have to question whether it was worth doing. Now having said that, the Bone Spring play that EOG is involved in is a better looking play, and according to my numbers they can break even at something like $50 barrel oil. We’re at half that today so it’s not even remotely commercial at today’s prices. But at some kind of reasonable price, yeah that’s probably something you’d want to pursue.
Now the larger question is: Are these new reserves or is this just a secondary recovery project? In other words, instead of using water injection or CO2 injection, now you’re using horizontal drilling and hydraulic fracturing to more efficiently recover reserves that you already know were there. And that’s what I think it is, really, in the Permian Basin. That’s what I think.
Chris Martenson: So and to be clear the Permian Basin was discovered a long time ago. It’s got a lot of holes poked in it at this point in time. Are these people – are these companies really going after a fresh untouched place where they use hydraulic fracturing to open up something that was otherwise not going to be useful? Or are they in some cases drilling within and around existing pipes and holes that are already in the ground? Where are we in this play? Are we really exploiting a brand new undiscovered resource or are we kind of nibbling around the pockets that haven’t really been hit well enough yet?
Arthur Berman: It’s the latter Chris. If you look at a map, what you see is that a lot of the activity by companies like Pioneer and EOG are at the margin. They’re kind of at the margin of these accumulations where they weren’t commercial before and so they didn’t claim reserves and now by coming in and drilling horizontally they can recover some volume that technically I guess might be called a new reserve. But again, it’s a hugely more expensive process and so the question is—I mean a reserve is not a reserve if it isn’t commercial. This is something that maybe people don’t understand but a reserve is a volume at a price. And it’s not just any price, it’s today’s price when you book it, okay? So if it’s not commercial at $30/barrel, it isn’t a reserve. You can call it something different but it’s not a reserve, okay? And so you can’t call something a reserve that would be commercial like I just told you at $50 a barrel because you’re not getting $50 a barrel; so it ain’t a reserve.
Chris Martenson: So I guess this would be like if I had somebody – like I have a bank account, it’s in my name but it’s in England, okay? And I’m in Massachusetts. So it’s in England and there’s $100 in that but it’s going to cost me, due to taxes or whatever it costs, it’s going to cost me $100 to bring it back over here. The amount of money I have in reserve really in England is zero. If I can get it back over here for $50 then it’s worth $50 to me, but if it’s going to cost me $110 to get it over here it’s not even nothing, it’s less than nothing to me, right?
Arthur Berman: That’s exactly right. And that’s what I’m talking about. I don’t want to come across too negatively here because I think that at say like $45 a barrel there are pretty considerable areas of the Bakken that actually break even or make a little bit of money. They’re not hugely profitable at $45 but they work and the same is true for the Eagle Ford. The Eagle Ford and the Bakken, as tight oil plays go, are really pretty good. The rest of them are either pretty bad to mediocre to really bad. That’s just it.
This notion that somehow shale opens up this vast new world of previously unavailable or unknown reserves is only a little bit true. It’s only true for the very best of the best of a very specific kind of shale. It’s not just any shale; it’s a very specific kind. If you look at the world, well of course there’s more potential in the world than there is just in the United States. But I can list on one hand the number of comparable plays or potential plays in the world like the Bakken and Eagle Ford. That doesn’t mean there aren’t more, that’s just all that we know about right now.
So of all the gazillions of shale basins in the world, what I’m telling you Chris is that there’s probably five or six, fewer than 10, that we would say are in the same class as the Bakken and Eagle Ford, which are not commercial at current oil prices. So this end of history idea that shale changes everything—it adds some reserves at a high cost that we didn’t have before, okay? There’s no problem with that. We got to be a little bit careful about thinking that peak oil is now a dead or a bogus concept. It’s given us a few more years, is what it’s given us. But it’s given us a few more years at a considerably higher price and that’s what the world is reacting to right now. That’s a big piece of why we’re in trouble right now with oil prices because the world kind of voted with its feet and said “You know what, we can’t stand paying $100 a barrel for oil; so we’re going to use less."
Chris Martenson: Well yes with over 200 trillion dollars of debt outstanding of course you have to service that debt and high oil prices just don’t help that. The model I’ve been working with for a long time is there’s a price of oil at which the world economy chokes and there’s a floor at which the energy company’s don’t want to pursue oil anymore and that ceiling and that floor have been coming closer and closer together. So here we are, we’re clearly at a price below which oil and natural gas—in America here, I’m staring at natural gas at $1.83 is the quote I’ve got on my screen right now, yikes. That’s way below the all-in costs for most companies that I’ve been looking at.
But let’s dial this back a bit. Globally we've see this astonishing pull back in CAPEX spending by the oil majors, by the mids, the minors, national oil companies, all of them—over a trillion dollars, by a bunch of estimates. Talk to us about what’s the impact on future oil supplies with this just absolute destruction of CAPEX spending globally?
Arthur Berman: Somewhere between profound and extreme [laughter]. We’ve got to be constantly discovering several million barrels of oil per day to make up for our consumption. It’s easy to get confused and to say well geez, we’ve got such an oversupply right now, we don’t have to worry about that. Well we started this conversation with your important observation that we’re only talking about a million or million and a half barrels a day of oversupply. So we could go from over supply to deficit pretty quickly because we’re not investing in finding that additional couple of million barrels a day that we need to be discovering. So we’re deferring major, major investments and we’re not just deferring exploration, we’re deferring development of proven reserves. So just the capital cuts in US companies have effectively deferred $20 billion—or maybe the world, I’m sorry—$20 billion barrels of development of known proven reserves. And so if we get to a point— and we will, we almost certainly will—where suddenly everybody wakes up and says “Oh my God we don’t have enough oil." We’re now half a million barrels a day low, and what happens? The price shoots up, okay? That’s the way commodity markets work. And everybody says “Whoopee, let’s get back to drilling big time." Well there’s a big lag. There’s a huge time lag between when the price responds and people actually get around to drilling and they actually start bringing the oil onto the market and it becomes available as supply, because they’ve been asleep at the wheel for how many months or years. You don’t just turn a valve and all of a sudden everything is okay again.
We saw this during the Libyan Civil War. Saudi Arabia said “Don’t worry guys, we’ve got all this spare capacity. We’ll just turn it on and produce it and the world won’t see a shortage." It never happened because they had to actually drill wells. Their spare capacity means they have got to drill wells to produce it and that takes time. They have got to drill it, they have to test it, they have to build pipelines, and by the time they actually got any of that work done, the Libyan conflict was over. We’ve now seen low production because the Civil War continues, but that’s another story.
There’s this tremendous gap between "okay we know there’s a reserve," but what’s it take to turn it into supply? Well it takes time and it takes money and it doesn’t happen overnight.
Chris Martenson: Well no and as you mentioned it hasn’t just been the exploration but the more pedestrian stuff like infill drilling—that’s pretty much come to a complete halt in the North Sea as far as I can tell. And it looks like Mexico is not doing a lot with their investment down in their plays at this point in time, and Brazil doesn’t even begin to know how to get started with their whole Petrobras scandal and drilling through those really, really expensive deep water finds they’ve got. Just don’t make any sense at this price. So when I look across really where the oil supply growth is coming from, Art, I’m pretty much—like it’s really down to the Middle East and this hope that the United States could rapidly ramp up its shale “miracle” if prices spike back up.
But I’m with you. I think that as much as people are focused on the oversupply right now—and in two or three years I’ll be really surprised, unless the world economy crashes and demand goes down, with that caveat attached—I think the world will be equally surprised by the shortages that are coming, because you can’t just… Here’s what I see: I look at this chart and I talk about this in talks and I say “Hey look from 2005 to 2012 the world spent about three trillion dollars on upstream oil and gas exploration and production and basically got the same amount of crude and condensate out of ground for its trouble," right? We doubled our investment on a yearly basis from $300 to $600 billion and basically held production flat. I can only imagine what happens to production once you take a trillion in spend off of the top of that.
Obviously it looks like to me we’re going to be facing a multi-million barrel a day shortfall, as long as things don’t fall apart on the world economy stage.
Arthur Berman: And I think even if things do fall apart on the world economy stage. I haven’t done this, because the records aren’t there, but you go back to a period like the Great Depression in the world and it’s not as if people stopped buying and selling goods or transporting themselves or materials. It was a big – it was a depression, and there were a lot of people out of work, but the world moves along and consumption of oil and natural gas isn’t going to go to zero. I think the forecast that we’ve just recently seen from the International Energy Agency just last week, they’re saying "okay so demand is probably going to be down from 1.8 million barrels a day of growth to 1.2 million barrels a day of growth," and that’s awful. But wait a minute, 1.2 million barrels a day of growth is – you’re still growing at a fairly high rate. So you have got to be replenishing your supply or else you reach this zero point where you’re in deep trouble.
So I’m with you Chris. Even in my darkest view of where the economy could go, I find myself on a very different page than most of the forecasters who think that we’re in for a decade or decades of low oil prices. I think we’re going to be struggling under the yolk of much higher oil prices, probably beginning next year. I’m not a price forecaster but it’s hard for me to see—I am a supply/demand kind of guy and I would be very surprised if by this time next year we’re not seeing oil prices moving toward something like $60 a barrel. And you look at the forecast—EIA says average price in 2016 will be $53 a barrel. They’re not always right and in fact they’re often wrong but they’re not stupid either. They’re doing the best they can. They have got some good people there. So I think this notion that we’re somehow stuck in $30 or $40 oil forever and ever, it just doesn’t square with the reality.
Chris Martenson: Well it would mean that we’re anticipating that oil is going to stay below its marginal cost of production for a very long time. It’s very difficult for any commodity to stay there for long but oil in particular because of its stock versus flows. Yes there’s 3 billion barrels above ground right now but hey, that’s only so many days of consumption if you decided to stop producing. So yes, I’m with you. I think that obviously oil has to go up in price at some point and that’s even exclusive of any geopolitical accidents that might happen in the Middle East; just simple supply/demand and all of that.
If oil does go back up, last question, you study the companies that are involved in this very carefully and I think a lot of investors, especially the banks who have put the lines of credit out there, are really double fingers crossed hoping that the price of oil moves back up and all these problems that these companies are facing economically will sort of be in the rear view mirror. Would you share that view or do you think that even if oil rebounds there’s a number of companies here that have gotten themselves in over their heads with respect to debt versus assets?
Arthur Berman: Well just turn the clock back to 2012-2013 when oil prices were sky high, were $100 a barrel or more, and what we saw was consistent negative cash flow from virtually all of the major players. So what that says is they weren’t making money when oil prices were high, so is it a big shock that they’re hemorrhaging when oil prices are lower? So oil prices go back up—the bottom line Chris is the only way that they were able to stay looking fairly good back then to somebody, not me, was that people were giving them money. They had infinite access to capital at almost no cost, and so they were spending it. But their income statements and balance sheets look like crap and the investment community I guess was willing to look past that or didn’t want to look at it or whatever.
So rearview mirror? No, these are companies that are highly leveraged and unless and until that changes—maybe that’s one of the positive outcomes of this. Maybe we see a turnover of players. There are better companies whose balance sheets look better and they’re the ones who can afford to say “Okay, we’re going to slow down production right now because we don’t have the same debt service that the guy next door does." So my hope is that like all crises this is going to flush out a lot of the bad players, or at least some of them. But will higher oil prices solve the problem and save the day for the people that hold the debt? No. It won’t hurt, but if they couldn’t make a profit at higher prices, going back to higher prices doesn’t fix the problem.
Chris Martenson: So for many of these investors and players, in many cases, the best that they can hope for if oil prices rise is a higher recovery of cents on the dollar, but they’re probably not going to get back to whole on this?
Arthur Berman: No. Unless somebody is willing to forgive debt. If we get that bad, then there’s the solution of last recourse, right?
Chris Martenson: Absolutely. So I’ve been looking at your site and I would really advise people to go there and take a look. You’ve got a great piece on the Haynesville shale play where they need gas at $6.50 to break even and even at Henry Hubb it’s $1.85. I understand why—I'm in Massachusetts, its December 15 today, I’m in a T-shirt. It has just been extremely warm all across the east part of the country; so we’re not burning the gas I guess. But I would advise people to go take a look at that, look at some of the other things you have got on your site, great writing, great analysis. They find that at ArtBerman.com. Art, is there any other way people can find you and follow you?
Arthur Berman: That’s the best way Chris, ArtBerman.com and there’s contact information there. You talked earlier about, how do you decode all of this? I’m not the only one; you mentioned Dave Hughes. He’s just a solid, reputable analyst who does really good work and there are hosts of other people. So if investors really want to know the answer, they just need to look beyond the headlines and look beyond the propaganda, and certainly look beyond what the companies say. Find someone and say, "Tell me what this really means." But go to my site and there’s enough information there. Contact me and I’ll refer you to somebody if I’m not the right guy.
Chris Martenson: Thanks for that. And Art I want to have you back on because I have a dozen questions I didn’t get to, but I want to thank you so much for your time today and hopefully we’ll continue this conversation soon.
Arthur Berman: I look forward to it Chris, thanks a lot.
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