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Diving Into Stories of Energy Transition with Chris Nelder
Part Two of Four. Link to Part 1, and Part 3.
A transcript of our interview on Extraenvironmentalist #76 by Scott Bohachyk
Editor’s note: Last time we discussed nuclear power and the potential role it may have in the 21st century energy transition. This time we are discussing the story of peak oil and whether it has any validity.
Justin: A core part of the story we were just talking about, in the audio we were playing from the film Pandora’s Promise film is the idea that we’re going to hit 9 or 10 billion people and consume two, three, four times as much energy as we do now, but one story that really counters that is the idea of geology limiting oil output and the peak oil story. Now that we can reflect back on a few years of recession, and very slow growth in output for global oil companies, how is the peak oil story stacking up? Is it peak oil that can explain the slow growth in economies around the world?
Chris: The peak oil story is very much intact. The story of peak oil was that as you reach sort of the peak in global oil production and it becomes very expensive because the quality of the resource base and the quality of the reservoirs, the rocks that you’re drawing the oil and gas from, is now declining. Peak oil says that you’ve gone through the cheap and easy stuff and you’re getting down to the difficult expensive stuff, and that’s precisely what has happened. Light tight oil and the days of cheap and easy oil ended; that growth ended in 2005 and since then, we’ve been moving more and more towards stuff like tight oil from fracking, deep water oil, tar sands and so on. That stuff is very expensive and it’s difficult to reach and it’s also fraught with a lot of risk as we discovered in the Deepwater Horizon blow out and as we discovered with Shell’s attempt to start drilling in the Arctic last year.
Peak oil means problem after problem, lots of technical challenges, very risky, very dangerous. That’s what happens when you get into the hard and difficult energy resources and at some point, it just becomes so difficult and so expensive to try and keep your production rate growing, that it flattens out. The [stall in production growth] is what happened starting in 2012. Global oil production has grown just a little bit since 2012, but most of that is actually not been oil, most of that has been natural gas liquids and biofuels and then there comes a point where no matter what you do, we can’t keep increasing the rate of oil production, and it starts to fall. And that will probably be the case at any reasonable price.
I mean obviously if the world were suddenly willing to pay $20 per gallon for gasoline, I think we could continue to increase the production rate of oil. But that’s not realistic, so what you have to do is you have to bound the question between what’s a realistic price that people can pay, and what’s the real cost of producing oil as you go forward. So what has happened over the last few years? Capital spending, CAPEX, by the world’s publicly listed oil majors has increased more than a factor of five since 2000. But their production of oil has actually fallen back to the 2000 level, after a couple of years of very modest increases.
Justin: CAPEX is not a term that most people use, what does that mean when you say that CAPEX for oil companies has increased by a factor of 5.
Chris: Well I mean there’s really two ways of looking at the cost of doing something. So the initial cost, what you spend to drill a well or to buy a house, or whatever, that’s the capital expenditure. Then there’s the operating cost: what it costs to keep producing from that well, or to maintain that house. So we have CAPEX and OPEX, that’s all it is. CAPEX is basically upstream spending, and in the oil industry, that’s drilling wells, doing the completions, putting together the processing systems, and the transport and so on, so they’ve spent more and more money to try to keep finding more oil reserves and getting those new oil supplies to market, but the actual supply is just not keeping up with the explosion in cost.
You know the Wall Street Journal recently pointed out that oil and gas production by a couple of those majors, Chevron, Exon and Royal Dutch Shell, their production has fallen over the past five years despite their spending more than half a trillion dollars, $500 billion on new projects. Chevron’s costs have jumped 56% since 2010 and their production is actually falling with all that spending. And so it’s denting the profits of these big oil companies and their investors are starting to get very nervous.
Seth: What do shareholders have to say about that?
Chris: Shareholders are demanding higher dividends, they’re demanding share repurchases. There’s really a couple of ways, if you are an oil company to keep your market capitalization, the market valuation of your company. You can keep putting more reserves on the books, which is basically considered money in the bank. This is oil that you’ve found but you haven’t produced yet, it is sitting underground waiting for you to produce and it is considered to be an asset. In the oil industry that’s how they’ve continued to maintain their valuations, even as they’re pumping these reservoirs dry, as long as they keep exploring and discovering more to keep those assets up on the balance sheet their valuation goes up along with the price of oil.
In recent years, they’ve had a harder time replacing reserves. Reserves have actually started to fall, so now they’ve switched over to different metrics like return on capital employed and other sorts of accounting tricks, but this is basically trying to hide the fact that it’s just getting harder and more expensive to produce oil. If that’s the case and you can’t keep adding reserves to your balance sheet, to keep up the valuation of your company, you buy shares back; put them back on the company balance sheet so that you’ve got a shrinking pool of share holders. That’s one way to prop up your valuation.
The other thing you can do is to just pay out more money in dividends so that you’re no longer a growth company, you’re now a yield company, but it’s just gotten very difficult. I mean most people for example think of Exxon as an oil company, well, Exxon now has more gas reserves on its balance sheet than it does oil. This is because their efforts to explore and find more oil to add to its balance sheet have just been… I won’t say they’ve been failures, they have had some successes, but it’s just gotten to difficult to keep up the valuation of the company. Now they are putting more natural gas and natural gas liquids on their balance sheet. That’s exactly what happens when you have to leave oil behind.
This is an industry in sunset, and the industry is very nervous about this, there’s trillion of dollars of capital on the line, and so obviously they’ve been very anxious to tell the biggest possible story about fracking and incipient energy independence for the United States as a way of sort of sweeping that underlying story under the rug. They’ve been fairly successful at doing this for the last couple years, but the most transparent models that I’ve seen for the future of tight oil are that it is going to be back into decline in the United States before 2020. I think we’ve got 2 or 3 more years of modest growth in tight oil and throughout the several years we’re going to be treated to lots more stories about how peak oil is really dumb and fracking has buried the entire notion, and we’re going to energy independent and all that stuff, but this is just a very temporary thing and it’s also a very expensive bump in energy production and I think that by 2020, United States oil production will be turning back down again.
When we’re fracking, we are going into the source rocks. [The oil or gas] is being extracted from where hydrocarbons were formed. That’s where ancient organic matter plankton, and so on, were compressed and cooked down over geological time, hundreds and millions of years and turned into oil. That happened in the source rocks and that’s what the shale is: the source rocks. Until we actually found a commercially viable way through hydrofracking and horizontal drilling to produce oil from these shale formations, instead we were producing the oil that migrated up from these shale formations and accumulated in the reservoirs above the shale. That was the era of cheap and easy oil: going through these accumulated reservoirs. Now that we’ve gone through the cheap and easy oil, we’re getting down into the source rocks themselves. [These are] the shales, and when that game is over, when you’ve reached the maximum exploitation of your shale, or your source rocks, and that production starts to turn down again, then there’s no where else to go; that’s the end of the line.