WHAT'S AHEAD IN 2000

Industry needs a culture change to address its problems

Forrest A. Garb, Forrest A. Garb & Associates, Inc., Dallas, Texas

t the doorstep of entering the new millennium, as I reviewed the forecasts I had prepared for World Oil during the last 10 years, I wakened to an obvious fact. The petroleum industry, in general, does not really forecast the future. It reacts to the immediate past. When I looked at oil price forecasts during the volatile 10-year period, there were few, if any, forecasts made on energy-balance estimates. Most analysts, bankers and consultants ricochet off recent events when making predictions of near-future ones. It is, therefore, obvious that the price history has been more the result of political events than the law of supply and demand. This is not expected to change as long as the capacity of exporting countries to produce petroleum exceeds our daily demand.

A second fact is also obvious when studying the domestic industry. The small world we now live in prevents a forecast for domestic operations independent from foreign ones. What we do in the U.S. will depend on what international oil industry conditions dictate.

Expectations, comments on personnel. Data I have studied suggests that the price for oil during 2000 will be in the range of $22 to $26. This, hopefully, is a good sign, as analysts have reported that $16 is sufficient to make North Sea and Gulf of Mexico development programs viable. The American motorist will be required to pay about 2.5 cents more per gallon of gasoline for each dollar crude price rises. This is an acceptable amount to guarantee the continued availability of gasoline. Gas is apparently going to reach between $3.00 and $3.50. The increase in price should cause larger withdrawals from gas-storage facilities, which are estimated to be about 97% full. If weather remains mild and gas consumption is low, such large storage volumes will dampen any price spikes.

The price plunge in 1986 had many so-called experts saying the last rites over the oil industry. Instead of dying, the industry rebuilt itself, confidence returned and investments were made. While industry is marking time right now to ensure that the apparent recovery trend is not a blip, I am confident that the future will again show our resiliency. I foresee a modest recovery in 2000. Unfortunately, when a valley occurs, some do not live to see the subsequent recovery. After all, 1998 production sank to the lowest level in 50 years.

Regarding personnel needs, a fundamental consideration – when studying the viability of the U.S. petroleum industry during the millennium – is the availability of qualified personnel at all technical levels. History has demonstrated that the first thing companies are forced to do when oil prices fall to a point of no net cash flow, is to cut research, personnel and capital expenditures for new projects. The cut in capital expenditures will obviously soon be felt in the "net" depletion rate. However, many of the reserves can be replaced after investments are once again initiated.

The releasing of personnel is another matter. The downscaling usually starts with older and more experienced professionals, but who also have the higher salaries. Younger engineers and earth scientists are sometimes retained, but this level of personnel often lacks the depth of experience required to prevent inventing old wheels all over again.

If layoffs continue very long, even if prices and motivation returns to the industry, we will have nothing but text books to solve our technical problems.

The following sections provide some information and statistics that are relavant. These include a background on how we got where we are and comments on: oil / gas prices; energy consumption and resources; depletion; and the importance of independent producers.

Background. The world’s capacity to produce more oil per day than is required should not be interpreted as an excess world reserve which can be relied on forever. Our capacity to produce relatively cheap oil is declining and our daily consumption on a worldwide basis is increasing. It had been estimated that, without an oil price increase, the international supply and consumption curves would cross somewhere between years 2003 and 2005. This was before the economic downturn in Asia. The revised forecast for energy requirements, with new forecasts for Asia, may extend the excess capacity life a year or two, but not for long.

Industry had hoped that, to avert an energy shortfall, oil prices would increase to encourage development of less-economic reserves. This, of course, appears to be happening now, and we all hope that it will continue. Federal energy analysts estimate that world oil supply presently exceeds demand by 600,000 bpd, and with reduced forecasts for oil demand in Asia, this excess may increase to 800,000 bpd. This excess varies, depending on whose numbers you believe. Estimates are that the excess reached between 1.5 and 2.4 MMbpd before some stabilization was achieved. Regardless of which number is correct, the excess has the ability to suppress price relief if production is not controlled.

U.S. industry activity is dependent on profit, and profit is extremely dependent on oil prices. The petroleum industry suffered a decade of doldrums – then came 1997. Activities in almost every aspect of exploration, drilling, production, education and financing were once again dynamic.

Results of the activity increase during 1997 were predictable. The U.S. Department of Energy reported that proved oil reserves in the U.S. increased for the first time in a decade, and gas discoveries were the highest they had been in 10 years, increasing gas reserves for the fourth consecutive year. The number of new oil field discoveries in 1997 more than doubled 1996 discoveries and was some five times the prior 10-year average. About 80% of the oil discoveries were attributed to the Gulf of Mexico federal offshore, with the majority of the rest attributed to Alaska.

The 1997 oil reserves of 22.546 Bbbl represented a 2.4% increase over 1996, and gas reserves of 167.223 Tcf represented a 0.4% increase. Natural gas liquid reserves increased by 1.9% to 7.973 Bbbl. Over one-half of the oil increase was attributed to heavy oil-reserve increases in California, proving that improved technology and a reasonable budget can generate reserves, even in older, well-known reservoirs.

This positive reaction to the price increase is a key element in forecasting that the U.S. petroleum industry is not terminally ill. The domestic oil industry is far from a sunset industry. It will require a new format, but it is re-inventing itself now by consolidating. I am a strong believer in the oil and gas industry; it is the engine that drives the world’s economy. It has been for a century, and there is nothing on the horizon poised to replace it. The domestic segment of the industry will remain a slice of the pie for years to come.

Prices and their effects. In the future, we will look at 1998–1999 and wonder what went wrong with oil prices. Why did they fall so drastically with an oversupply of less than 1%? With ample evidence that world oil prices are set in the NYMEX commodity trading pits and not by real-world factors, perhaps it is time that a new method for collecting, interpreting and reporting oil data is instigated. The manipulating of prices based on questionable data, and for questionable reasons, economically injured our industry. The reality of the situation is that the Asian demand exceeded the revised downward estimates of the alarmists.

The supply of the non-OPEC countries has been revised significantly downward, and even the revised numbers are reported to be optimistic. The International Energy Agency has revised non-OPEC supply estimates downward some 16 different times, now indicating capacity at 44.66 MMbpd – a drop of 4.14 MMbpd from the 48.8 MMbpd original number. The major question in my mind is how much of this drop is caused by the price decline – which I believe is somewhat an artificial drop caused by misinformation – and how much is the result of actual reservoir capacity depletion?

Prices are so volatile that it is impossible to predict what they will be six months from now with confidence. For most forecasts, short-term predictions are usually more accurate than long ones. However, when predicting oil and gas prices, the accepted thinking is that, in the long term, prices must increase. The "when" is the uncertainty, so short-term predictions are very uncertain. Unfortunately, companies can live or die on the merits of their short-term forecasts, never living to enjoy their long-term ones.

One interesting thing to note is the relationship between oil and gas prices at the moment. For decades, gas has been a bargain. The energy in one barrel of oil is roughly equaled by the energy contained in 6 Mcf of gas. Yet for years, one could buy 8, 10 and sometimes 13 Mcf of gas for the cost of a barrel of oil. For the first time in my professional career, 1999 saw gas receive a premium because of the low oil price – a barrel of oil would only buy 5 to 5-1/2 Mcf. This reflects the recent strong market for gas and is the reason that those companies more focused on gas than oil have weathered the recent times well.

GRI projects that the U.S. gas market will increase about 2% per year through 2015, with most of the growth attributed to electric power generation. The challenge to the industry will be to meet the supply requirements of from 22 Tcf per year of natural gas in 1997, to a forecast 32 Tcf in 2015.

The low and uncertain prices had a negative influence on 1999 drilling. The worldwide rig count fell to some 19% below 1998 levels. With recent price increases our industry, which becomes optimistic at the slightest positive indicator, is once again gearing up, but with a reduced work force and with less equipment to do the job. Acquisitions and mergers will continue to dominate the industry, with fewer and fewer companies left to develop and operate the same properties. Thus, consultants and service companies will have to provide a broad range of services to maintain a competitive position.

Current indications are that there will be ample financing for investments, but there have been severe staff reductions by both major and independent companies. Industry personnel will once again suffer the need to relocate from the exploration / producing companies to the consulting / service sector.

The single, biggest consequence of the 1998–’99 crude oil price plunge has been the decline in production from non-OPEC producers. Marginally economic production could not justify their operating costs with $10 oil, so many resources, both here and abroad, were shut-in, or capital investments required to continue the programs were canceled. If all of this sounds gloomy, remember that it only took one year for things to turn from good to bad. Perhaps the recovery will be equally fast when the world recognizes the proximity of the supply-to-demand crossover.

Even though petroleum prices appear to be rebounding, it should be noted that the trend is only back to a level one might extrapolate from prices preceding the collapse. Consolidation among companies of all sizes is apparent. Small independents are merging to form large ones, and the majors are joining forces to become "super-majors." The result of these mergers is expected to enhance the application of higher technology in both exploration and operation of producing properties. Everyone agrees that the industry needs a complete culture change to survive volatile prices, the need for high technology, reduction of experienced people and environmental / social pressures.

Energy requirements and current conditions. Oil and gas provide the U.S. with about 63% of its energy, and about 63% of this supply is produced domestically. The U.S. is importing oil at a record pace of more than 9 MMbpd. For the first time in history, crude plus products imports surpassed 11 MMbpd. Total imports are about 6% higher than this time last year. According to recent reports by the American Gas Association, the U.S. still has a 63-year gas supply. This is despite a 35% increase in natural gas consumption since the mid-1980s. Advances in exploration technologies, such as 3-D, have opened new resources for development, and estimates are that the resource base is available to meet 30 Tcf of annual demand. Though the resource may exist, whether there will be capital and financing available to produce this gas again depends on price.

The gas resource estimate of 1,038 Tcf is well above 167 Tcf of proved reserves, but includes 896 Tcf attributed to traditional reservoirs and 141 Tcf attributed to coal bed methane sources. These estimates, compared to 1990, represent a 2.8% increase, even though more than 150 Tcf were produced during the eight-year period. According to the International Energy Agency (IEA), estimated worldwide petroleum demand averaged 73.8 MMbpd for 1998, up only 400,000 b/d from the average 73.4 million b/d in 1997.

U.S. petroleum product demand averaged an estimated 18.684 MMbpd (>25% of world total). The U.S. natural gas demand for 1998 slipped to 21.29 Tcf in ’98, down some 3.1% from the previous year due to mild weather and stiff competition from cheap oil. During the year, oil prices averaged a decline of 34.8%, with an overall average of $11.92 per barrel. Average gas prices fell to about $2.03 from $2.44.

Reservoir depletion. This is the current "buzz topic" throughout the literature. Depletion reflects the rate at which the reserve of a well, field or country can be produced. It is a profile of the production curve and is sometimes broken into "gross depletion," when nothing is done to the producing entity to abate the decline in producing capacity, and "net depletion," that observed taking into account new drilling or development activities implemented to maintain production. The difference between the "gross" and the "net" is obviously impacted by the economics of the moment – which is essentially the price of petroleum.

What is becoming clearer, as more depletion data are collected, is that depletion in most of the important producing basins is steadily increasing. Gross depletion rates on the order of 15% are becoming commonplace which, if not countered with massive investments in exploration and development, can become the "net-depletion" rates for forecasting producing capacity.

While there are hundreds of published forecasts on oil supply / demand, some extending all the way to the year 2020, the industry has no published estimates as to the average decline rate, or depletion, of the existing supply base. All hydrocarbon reservoirs ultimately begin a production decline. Yet, no one publicly publishes reliable, field-by-field decline estimates, or even makes a guess at the current blended rate for the worldwide production base of oil and gas. The issue was not particularly serious for years, when a high percentage of the world’s oil and gas production was coming from giant fields years away from any decline when the world had tens of millions of bbl per day shut-in capacity. Decline rates were only relevant to the owners of a particular field.

Today, the world of oil and gas is quite different. The amount of shut-in capacity is, at best, only 3–4 MMbpd, less than 5% of present demand. An ever-increasing percentage of the world production base now experiences high decline rates, particularly if a massive amount of added development and workover activity is not done to slow these declines. Moreover, a large number of the giant, older fields – which anchor the world’s hydrocarbon production base – have now started to decline. As a result, it is becoming impossible to accurately predict the supply side of any oil or gas forecast without dealing with the issue of depletion. The rapid use of all the new forms of oil field technology tends to delay the decline rate of many fields until peak production has been achieved, but the decline rate is rapid thereafter, as all available technology has already been implemented.

The case for studying this issue is that it is estimated that the major large resources for the world’s supply are beginning to show severe decline. Oil still remains the world’s largest and most important commodity. An unrealistically low oil price can be just as destabilizing to the entire world’s economic health as an unrealistically high price.

Importance of independent oil companies. On the domestic scene, I believe there is still a future for independent and medium-sized producers. Members of this group, because the number of decision makers guiding each company is small, can react to industry conditions more quickly. The activity of majors does not seem to indicate reevaluation of their decision to put more than 70% of their eggs in overseas baskets. Further, consolidations to giant companies leaves projects too small for their consideration to the independents. Even then there appears to be a trend by the majors toward using consultants and contract personnel to a greater level than ever before.

The sale of mature properties by majors to independents will continue. However, a study of the recent past clearly shows that those acquisition programs with an element of exploration have performed much better than programs which simply continued production. In fact, those with exploration potential were, for the most part, the only acquisitions which met normal investment yardsticks because of volatile oil / gas prices.

Independents have always been, and will remain, an important part of whatever petroleum industry remains in the U.S. Independents have traditionally been the finders of new oil onshore, and they now appear to be syndicating to tackle offshore opportunities. This is supported by statistics. As of the end of August 1998, independents owned 57% of offshore acreage in less-than-400-ft water, and 60% in greater depths. In the Gulf of Mexico Lease Sale 172, 90% of the companies bidding were independents. The independents are challenged by a competitive environment. To succeed will require the use of high technology, not just blind luck.

In addition, there should be governmental policy changes to aid in maintaining an energy supply. U.S. independents and politicians are seeking incentives and reliefs to revive the industry and maintain jobs. The items being discussed are:

• Marginal-well production tax credits
• Guaranteed low-cost loan programs for small, independent producers
• Changes to the alternate minimum tax and percentage depletion
• Expensing geological and geophysical costs and delaying rental payments
• Non-reinstatement of expired Superfund taxes and the Oil Spill Liability Trust Fund Tax
• Revised royalty system for federal leases
• Streamlining of oil and gas regulations to cut filing costs.

And regulators should: reduce the cost, complexity and time required for permitting of oil and gas exploration and production, and remove prohibitions on oil and gas development on government lands having attractive prospects.

Forrest A. Garb received a BS degree in petroleum engineering in 1951 and the Professional Degree of Petroleum Engineer from Texas A&M University in 1963. After graduation, he joined Socony Mobil Oil Co. and was assigned to the Magnolia Petroleum Co.’s operations in Kansas, Texas and Louisiana. From 1955 to 1957, he served in Socony Mobil’s eastern and western Venezuela divisions. Mr. Garb joined H. J. Gruy and Associates in 1957 and was elected president in 1973. He became president of Gruy Companies, Inc., with its founding in 1975. In February 1988, he founded Forrest A. Garb & Associates, Inc. Mr. Garb is a member of SPE, AAPG and the Association of Computing Machinery, and is a past president of the Society of Petroleum Evaluation Engineers. He is a registered professional engineer in Texas and was the 1995 recipient of SPE’s Petroleum Engineers Economics and Evaluation Award for contributions to petroleum engineering.

Copyright © 1999 World Oil
Copyright © 1999 Gulf Publishing Company