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Investment thesis for InterOil Part1, energy markets

February 12th, 2009 · 5 Comments

We assemble a series of sources that provide a comprehensive picture. There will be a couple of parts. The first part is the state of energy markets in general. Demand may be down now, but it will recover. Supply, already straining by lack of investment and declining of the major fields, looks to be more affected by the crisis then demand, setting us up for big price increases when the latter recovers.

Energy markets have boomed, and then busted. However, there are good reasons to think that when the world economy (and hence energy demand) recovers, prices will rise even higher:

1997 –2007 fundamentals changed:

  • Demand grew by 12.7 MMB/D Crude oil production grew by only 7.3 MMB/D [Simmons & co p10]
  • Gap was filled by:
  • Increased natural gas liquids
  • “Other liquids”
  • Refinery processing gains
  • Occasional stock liquidation

Hard data argues that sustained peak supply reached in 2005. [Simmons & co p15]

This despite record prices, flat-out production by OPEC and record expenditures on exploration and drilling, which didn’t leave a single drilling rig unused by 2008. The problem is that the backbone of supply, large major cheap oilfields, are declining at an average of close to 5% a year [IAE],

  • One big problem is that oil fields have a natural rate of decline as oil gets pumped out. The rate varies widely from field to field, but the global average is about 5 percent a year. So, just to maintain output, producers around the world must find and develop about six million barrels of oil a day. To increase global oil production by 1.5 million barrels a day, that figure rises to 7 million or 8 million barrels a day, or at least 2.5 billion barrels a year – a monumental task that gets tougher as production grows.
  • The prospect of accelerating declines in production at individual oilfields is adding to these uncertainties. The findings of an unprecedented field-by-field analysis of the historical production trends of 800 oilfields indicate that decline rates are likely to rise significantly in the long term, from an average of 6.7% today to 8.6% in 2030. “Despite all the attention that is given to demand growth, decline rates are actually a far more important determinant of investment needs. Even if oil demand was to remain flat to 2030, 45 mb/d of gross capacity – roughly four times the current capacity of Saudi Arabia – would need to be built by 2030 just to offset the effect of oilfield decline“, Mr. Tanaka added. [IEA]

And new discoveries cannot make up for this as they’re either:

  • Small and/or deep-sea (Brazil!), which makes them expensive
  • All peak fast and decline fast [Simmons & co p12]

See also:

There are other worries:

  • Political unrest and nationalization is often a big threat for supplies (so called ‘political peak-oil’)
  • Seeping nationalization especially is a big problem as most of the new sovereign owners of fields do not have big incentives to invest in maintaining, let alone expanding capacity because there is much more political capital to be gained from just spending the proceeds, rather than investing these back.
  • Some countries (Iran) lack the technology to exploit their resources.
  • Present low energy prices and lack of credit further cuts into investment, which is setting the world up for even more acute energy scarcity when the world economy, and hence energy demand, recovers
  • A sea change is underway in the upstream oil and gas industry with international oil companies facing dwindling opportunities to increase their reserves and production. In contrast, national companies are projected to account for about 80% of the increase of both oil and gas production to 2030“, said Mr. Tanaka. But it is far from certain that these companies will be willing to make this investment themselves or to attract sufficient capital to keep up the necessary pace of investment [IEA]

In short, looking at the energy picture in general by the time InterOil is supposed to deliver it’s first cargo of LNG (2014), and based on the assumption that the world economy will have recovered by then, it’s hard not to walk away with the scary picture of rather acute energy scarcity.

There is simply too little investment, and the low hanging fruit (the cheapest and easiest recoverable resources) seems to have largely been picked already, or are in territories where politics precludes the necessary investment.

This is what makes Papua New Guinea in general, and InterOil in particular, so interesting. It is potentially one of the last ‘low haning fruits’ accessible to international companies left in the world. There are other energy sources available to be developed, but all at very much higher cost:

  • Canadian oilsands
  • Deepsea drilling (Petrobras of Brazil)

On the first, not is all well, it’s expensive and polluting:

  • Transforming the tar, more properly known as bitumen, which is mixed with sand, into petroleum is energy intensive and creates significant carbon emissions. Steam created by burning natural gas separates the semisolid bitumen. Then, more natural gas is needed to turn the bitumen into synthetic crude, which can be processed by refineries. [The Costly Compromises of Oil From Sand]

The second is also very expensive, as the field is not only in deep-sea, but actually substantially below even that:

  • Petrobras has announced an aggressive business plan of raising its five-year investment plan by an astounding 55 per cent from $112.4 billion announced a year ago for the 2008-2012 period to the now revised $174.4 billion for 2009-2013 period and investing $28.6 billion in the current year itself. [Petroworld]

No immediate cheap alternatives to the old declining mega fields which need tens of billions of investment just to maintain their production rates. A rather bleak picture..

In the next episode, we will look whether the situation for natural gas is any better. Not really, as it turns out, in fact, in terms of political supply problems, the situation is even worse compared to that of oil.

Tags: Commodities · IOC · Natural Gas

5 responses so far ↓

  • 1 Darcy Patten // Feb 12, 2009 at 8:25 pm

    yep, the oil crisis could quite possibly be the defining moment of this century.

    I live only 6 hours from the oil sands in Alberta, and while existing production has continued, expansion is being halted as it just doesn’t make sense at the price of the barrel.

    I heard when it hits $75, things will start rolling again.

  • 2 rory mcgowan // Feb 12, 2009 at 8:30 pm

    take a look at tullow oil 2 great new finds

  • 3 admin // Feb 12, 2009 at 10:38 pm

    We’ll keep Tullow oil in mind, it’s British, right?

  • 4 rory mcgowan // Feb 14, 2009 at 12:26 am

    tullow is irish out of london. The Ghana property has three owners and one (Kosmos energy) is putting their interest up for sale. Anadarko says their interested at around 3 Billion that could put a new valuation on the property. Take a look at the Uganda find. they have another partner who can’t come up with the development cost. that owner is Heritage Oil out of Canada. Property for sale again thus a new property valuation.

  • 5 China prepares for energy crunch — shareholdersunite.com // Feb 16, 2009 at 3:52 pm

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