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A Primer on Peak Oil

September 23rd, 2008 · 1 Comment

A nice article people send us serves as a primer on the so called ‘peak oil’ theory, the theory that soon, world oil production will reach it’s peak, and then fall off pretty sharply, causing mayhem as oil demand grows year by year.

From Fortune

While demand growth in the United States has slowed recently due to higher prices, the EIA projects that China and India will more than pick up the slack. And the IEA recently warned that high prices won’t slow demand growth in emerging economies. If demand wants to go north of 100 million barrels a day and supply can’t break 90 million (or drops below 80 million, as Simmons believes will happen within five years), it will be a price squeeze felt around the world. The peak-oil crowd will be able to declare victory – but nobody will be celebrating.

The peak-oil theory

The concept of peak oil was introduced to the world in the 1950s by a curmudgeonly Shell geophysicist named M. King Hubbert, who observed that the production of oilfields tended to follow a bell-shaped curve, peaking and then turning down sharply. He came up with a formula to quantify his theory. And in 1956 he was ridiculed within the industry for predicting that U.S. crude oil production would max out in the early 1970s. Sure enough, though, in 1970 the United States reached its apex at just under ten million barrels per day, or roughly what the Saudis produce now, and began a long slide down. (Hubbert later predicted that world oil production would peak in 1995. He was a bit early on that call.)

No one disputes that oil production will top out some day. It is, after all, a finite resource. The argument is about how far off the peak is. As Simmons and others point out, many of the world’s largest oilfields – Prudhoe Bay, the North Sea – have already gone into decline. The most optimistic estimate for the average depletion rate of the world’s currently producing oilfields is between 4% and 5% annually, or about four million barrels per day at our current rate of production. That means that each year we must find enough new oil to first replace those four million barrels of lost daily production before we even add enough to meet new demand. This is all the more worrisome because world oil discovery of new reserves has been slowing since the mid-20th century.

Despite this gloomy case, most of the oil establishment insists that, while oil may be harder to find, there is still plenty of it, and any peak in production is decades away. OPEC, whose member nations sit on 75% of the world’s reported reserves, pooh-poohs concerns about a peak.

Earlier this year Abdallah Jum’ah, CEO of Saudi Aramco, the kingdom’s national oil company, called peak oil “a myth.” The multinational oil giants are only slightly less optimistic. While they acknowledge that crude is getting harder to find and produce and that so-called unconventional oil (like natural-gas liquids) will be increasingly important, they don’t think a peak is imminent either. Exxon Mobil (XOM, Fortune 500) has run ads that dismiss peak oil as a far-off problem. This summer Tony Hayward, BP’s (BP) chief executive, bet a peakist that oil production in 2018 will be higher than it is today. “It’s unbelievable,” says Simmons. “These guys don’t even understand their own business.”

One difficulty in assessing the situation is the lack of transparent information about oil production and reserves, particularly in OPEC countries. Back in the 1980s, after OPEC decided to base its production quotas on reserve figures, several of the cartel’s producers abruptly raised their claims of “proven reserves” by 40% or more. Saudi Arabia, for instance, raised its proven-reserve figure from 170 billion barrels to about 260 billion in 1988. Amazingly, that figure has stayed more or less constant since then – even as billions of barrels have been pumped out of the ground. “We need to send in the audit troops,” says Simmons regularly in his speeches. “The major oilfields of the world need to be invaded by third-party inspectors so that we can figure out how bad things are and deal with it.”

A favorite target of Simmons and other peakists is Cambridge Energy Research Associates (CERA), a leading provider of supply data to the major oil companies. Led by chairman Daniel Yergin, the Pulitzer-winning author of the oil history “The Prize,” CERA rejects talk of an imminent peak and advises instead that the world may reach an “undulating plateau” of production at some point in the distant future, perhaps around 2030. The firm has opened itself to criticism over the past few years by consistently predicting that oil prices would fall back, only to watch them soar.

According to Peter Jackson, a geologist and CERA’s director of oil industry activity, the firm’s proprietary database of some 20,000 projects shows plenty of capacity growth through at least 2020. “Our analysis just doesn’t support a peak in the foreseeable future,” says Jackson, who declines to discuss Simmons directly. “I would love to see a decent analysis that shows something to the contrary.”

For his part, Simmons would love to get a detailed look at CERA’s proprietary information. “All this undiscovered oil they talk about has by definition not been found yet,” he says. “And it is as unusable as my unearned net worth. I can guarantee you that I wouldn’t have had the guts to go into any bank in the world and say I’d like a loan against my unearned net worth.”

Earlier this year, Simmons and other members of the Association for the Study of Peak Oil in the U.S. offered to bet CERA $100,000 that the world would not meet CERA’s production forecast of 112 million barrels per day in 2017. CERA didn’t respond. “I’m very cognizant of how annoying it is to be the guy saying I told you so,” says Simmons, leaning forward and peering over his bifocals. “It’s much better to use a bit of ridicule.”

Not a preordained prophet

When Simmons gets interested in something, he goes all out. In 2005, the same year that “Twilight in the Desert” came out, Simmons self-published a book of his watercolor paintings, the fruit of 30 years of carrying his paint set wherever he traveled. He and his wife sit on the board of the National Trust for Historic Preservation, and a few years ago he funded the restoration of an old movie theater in Rockland, Maine, near his house. Simmons is also an avid book and antique collector.

It’s no wonder a topic as complicated as oil would beguile him. But his path to peak-oil prophet was anything but preordained. In fact, he was raised to be a banker. He grew up in a Mormon family, the second oldest of six kids in Davis County, Utah, just north of Salt Lake City. His father, Roy, was a self-made man who in 1960 took over the struggling Zions National Bank, founded by Brigham Young, and built it into an empire. Roy always engaged his family in business discussions and even took a teenage Matt along on trips to New York to sit in on meetings. “I don’t remember us sitting around the dinner table discussing who was going to win the Super Bowl or anything like that,” says Harris Simmons, Matt’s younger brother and current CEO of Zions Bancorporation (ZION), which has a market cap of $3.5 billion.

Simmons got his first exposure to the oil business in 1969. After graduating from Harvard Business School a couple of years earlier, he took a job writing case studies for one of his professors. (On the side he was also operating a booming business as a money manager; his clients included former Michigan governor George Romney, the father of both Mitt and Simmons’s Harvard buddy Scott Romney.) That spring he traveled to Los Angeles for a case study interview and met up with his father, who was attending a conference in Palm Springs.

During a break, Simmons’s father introduced him to a fellow attendee, a deep-sea diver named Lad Handelman who had been doing underwater work for the oil companies on rigs off Santa Barbara. Handelman explained that his fledgling company was growing faster than he could manage it, and he was planning to sell out. Simmons told him he should bring in new money instead. “I can help you with that,” said Simmons. “Why don’t we raise some capital?” The venture, Oceaneering, became one of the country’s fastest-growing and most successful offshore-drilling service companies, and suddenly Simmons had a new career as an investment banker.

In 1974, Simmons moved to Houston with his younger brother L.E. to launch Simmons & Co. and take advantage of the exploding oil-services business. To get an edge over his bigger competitors from Wall Street, Simmons made it a point to learn his chosen industry inside and out. “He probably does more research than anyone I’ve ever seen in the energy business,” says Bob Long, the CEO of offshore drilling contractor Transocean and a longtime Simmons & Co. client. “He’s always been passionate about gathering and analyzing statistics.” His business thrived until the mid 1980s, when oil prices crashed and, as Simmons says, the services industry “fell off a cliff.” He found himself working on bankruptcies and liquidations. The fact that the experts missed the coming collapse of oil prices pushed him to study harder.

By the early 1990s, Simmons thought the industry had contracted too far and that at some point in the near future, America would be facing a new oil crisis as a result. He launched a securities business at Simmons & Co. to exploit the demand for research and trading that he envisioned in oil and gas. And at a stage in his career when most senior partners would be leaving the research to their young analysts and spending more time on the golf course, he did more and more independent research, publishing white papers for friends and clients. (He hates golf.)

In 1997 he wrote a prescient report called “China’s Insatiable Energy Needs.” And in 2001, when he realized there was no publicly available resource, he embarked on a study of the world’s major oilfields. He found that an alarming percentage of today’s oil production comes from a handful of giant fields that were mostly discovered decades ago. (Saudi Arabia’s Ghawar field, by some estimates, still accounts for upwards of 6% of the world’s daily output after 60 years of production.) By the time he arrived in Saudi Arabia in 2003, he began to suspect that worldwide oil production was reaching its peak.

Oil illiteracy

“John McCain is energy illiterate,” Simmons is saying. “He’s just witless about this stuff. As a lifelong Republican, I’m supporting Obama.” A dozen oil and gas men sitting around a conference table in Lafayette, La., chuckle nervously as he continues. “McCain says, ‘Oh, we’re going to wean ourselves off foreign oil in four years and build 45 nuclear plants by 2030.’ He doesn’t have a clue.”

On this humid day in early June, Simmons is visiting a gas exploration company called PetroQuest Energy. Lafayette is a hub for the Gulf Coast oil and gas industry, and Simmons is in town to give a talk at the local college this evening. But he and Mike Frazier, the CEO of Simmons & Co., have stopped off for a private visit with the PetroQuest board. After a bit of his usual sermon – “There’s no end in sight to higher oil prices, unless the world economy absolutely collapses” – Simmons opens the room to questions. It’s obvious that his rhetoric has surprised his hosts. But Simmons is not the sort to mince words. (“Matt is the smartest analyst I’ve ever seen on energy,” said Frazier to me later, “but we don’t always agree on everything. Including politics.”)

McCain’s midsummer move to begin campaigning on a platform of more offshore drilling has only hardened Simmons’s position. “What a hypocrite,” says Simmons, who supported McCain’s rival Mitt Romney in the primary – no surprise given Simmons’s history with the Romney family. “Here’s a man who for at least the past 15 years has strenuously, I mean strenuously, opposed offshore drilling. And now it’s ‘drill, drill, drill.’ And he doesn’t have any idea that we don’t have any drilling rigs. Or that we don’t have any idea of exactly where to drill.” (As for McCain’s running mate, Sarah Palin, Simmons says: “She’s a very colorful person, but I don’t think there’s a scrap of evidence that she knows anything about energy.”)

For the record, Simmons has been advocating more drilling off the coast of the United States since the early 1990s, but now he says that treating it as our salvation is misguided. “I’m not saying we shouldn’t do it,” says Simmons. “We should, and the sooner the better. But we shouldn’t think that it’ll have any impact for a decade or two.” The exception, he says, is the reservoir in the hotly debated Arctic National Wildlife Reserve. “ANWR,” he says, “is the only place that we could drill right now and it might actually make a difference in a year or two.”

As for some other currently voguish sources of fuel coming to the rescue, he’s dismissive. Oil shale? “Buck Rogers stuff. It just can’t work.” Ethanol? “It’s a joke. The numbers just don’t add up.”

Simmons believes that a radical change in the way we live is inevitable. “We should basically be going back to creating a village economy, so that we really reduce the energy intensity of how we live,” he says. “We need bigtime conservation, not feel-good conservation. Make things where they’re used. You’ll end long-distance commuting, and we have the tools to do that now with webcams. Grow food locally. Grow food in your backyard. If they’re not commuting, people will have time to do that.”

Ocean energy

One afternoon in 2005, Simmons was sitting in his study in Maine watching waves crashing ashore when he started to think about all the potential power to tap from the ocean. “I thought to myself, Wouldn’t it be fun to start an institute to study ocean energy?” he says. So he did. Sort of.

Today the sole employee of the Ocean Energy Institute is a physicist named George Hart, 62, who has spent the past 25 years working on the government’s Star Wars missile defense system. (In the 1970s, at the Naval Research Laboratory in Washington, D.C., Hart helped develop the excimer laser, which is used today for tasks as varied as Lasik surgery and printing the freshness dates on Budweiser cans.) The institute doesn’t yet have a headquarters, but it does have a big idea. And it doesn’t involve waves.

Last spring Hart and Simmons cooked up a plan to build a floating wind-turbine farm 20 miles off the coast of Maine that they say could easily power the entire state – the equivalent of five nuclear power plants (and far enough from the coast not to be visible). The Gulf of Maine has 100 gigawatts of wind power, or 10% of U.S. daily consumption. The hope is that Maine can be an example for the rest of the country. Playing off the high profile wind-farm plan recently proposed by Simmons’s buddy Boone Pickens, they’re calling this idea the Pickens Plan Plus. Things appear to be moving fast. Senator Collins has thrown her support behind it.

The day after the CNBC interview, Simmons and Hart drove up to the University of Maine to visit the Advanced Engineered Wood Composites Center (AEWC), a 60,000-square-foot structural testing facility. The lab’s director, Habib Dagher, is one of the world’s leading experts in composite materials. He’s working with Simmons and Hart to develop new windmill-blade technology.

The AEWC guys gave a presentation showing how the project could be ready by 2020. Simmons then donned a hardhat and safety glasses and got a tour of the testing floor. As it happens, the lab had already been hired by a large wind-power company to fatigue-test a prototype for a 55-meter turbine blade. A ten-meter segment of the blade was locked in a device called a hydraulic actuator – what looked like two massive steel vise grips – receiving 38,000 pounds of pressure up and down every second. “This is really incredible,” Simmons announced. “I’m going to come back up here with two or three investor types I know.”

On the way out, I asked Simmons if seeing the lab made his virtual institute feel more real. “Oh, yeah, very impressive,” he said. “But we need to compress the time frame – 2020 is way too far out. That plan is fine assuming that we go along like we are now, and everything is okay in the world. But it’s not going to be okay. We’re going to need this stuff much sooner.”

Tags: Natural Gas · The Markets

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