Twilight Of The Oil Age

Includes: BP, CHK, CLR, CVX, XOM
by: John Rogers


Global oil production has been stagnant since 2005.

Unconventional oil production in the US will peak before the end of the decade.

All of the oil majors are experiencing dramatically higher upstream costs, placing increasing pressure on profits.

Mid-cap and small-cap oil producers are likely to fare the best as the end of the decade approaches.

The US is not going to become energy independent.

A seismic shift is taking place in the oil industry. Since 2005 global conventional oil production has remained flat. The industrialized world runs on oil, making faltering conventional production an issue of colossal importance. Since 2005 global oil production has grown by less than six million barrels a day (b/d). All of the increased production has come from unconventional sources such as tight oil ("fracking"), tar sands, and extra heavy oil. Nearly all the growth in oil production has come from North America. Global production increases will continue to be dependent upon unconventional oil production.

Despite the critical role oil plays in every industrialized country, appalling ignorance about the basic facts of oil is universal. The international unit of oil is a barrel, yet hardly any US citizen knows the volume of a barrel. Likewise the public is ignorant about the daily US consumption of oil. A barrel of oil holds 42 gallons and the US consumes 19 million barrels a day. This daily consumption equates to nearly 800 million gallons. Daily consumption is roughly equivalent to the volume 800 Olympic size swimming pools.

The media and segments of the oil industry convey a false sense of optimism about oil. Euphoric reporting by the media of America's energy "revolution" is commonplace. These reports portray a rosy future where the US will become energy independent in the near future. Sen. John McCain, in a speech given in August 2013, said, " . . . in just a matter of years, the United States will become a net exporter of oil and gas." Forecasts of US "energy independence" are misleading and grossly irresponsible since they convey a false reality of actual US energy production and consumption.

The US is not going to become anywhere close to being energy independent. The concept of energy independence has to include oil. In the US 70% of oil is used for transportation and mobility is essential to the health of the US economy. A vast infrastructure throughout the US services transportation. The US now produces about 7.5 million b/d. The Energy Information Agency [EIA] estimates oil production will increase to a maximum of 9.6 million b/d by 2019. Some highly regarded experts believe this forecast is too optimistic. Dr. Al-Husseini, former VP of production and development at Aramco for many years, forecasts the US will achieve a maximum production of 8.5 million b/d. This increased production, mostly from tight oil, will steadily decline after 2019 according to the EIA and nearly all industry experts.

The EIA data show that the forecasts of US "energy independence" are preposterous. As one expert observed tight oil extraction in the US is a retirement party instead of a revolution. "I look at shale as more of a retirement party than a revolution," says Art Berman, a petroleum geologist who spent 20 years with what was then Amoco and now runs his own firm, Labyrinth Consulting Services, in Sugar Land, Tex. "It's the last gasp."

High production decline rates typify tight oil extraction. In 2009 Chesapeake Energy's (NYSE:CHK) Serenity 1-3H well near Oklahoma City was a gusher, producing more than 1,200 b/d. Now 3 ½ years later the well produces less than 100 barrels a day. In North Dakota's Bakken shale Continental Resources' (NYSE:CLR) well known as Robert Heuer 1-17R produced 2,358 b/d in May 2004. Production declined 69% the first year. These high decline rates typify tight oil production. David Hughes, a geoscientist and president of Global Sustainability Research, has examined the lifespan of shale wells. "The Red Queen syndrome just gets worse and worse and worse," he says. "The higher production goes, the more wells you need to offset the decline." Hughes estimates the US needs to drill 6,000 new wells per year at a cost of $35 billion to maintain current production. His research also shows that newer wells aren't as productive as those drilled in the first years of the boom. Hughes has predicted that production will peak in 2017 and fall to 2012 levels within two years.

All of the oil majors are experiencing faltering production accompanied by upstream costs that increase 11% per year. This rise in costs places increasing pressure on profits. Since 2005 the majors have spent $4 trillion on upstream production. Historically much more oil was produced at much less expense. Most of the majors have announced big reductions in exploration and drilling. Many are selling off assets in response to rapidly rising exploration costs, and to oil prices that do not reflect the much higher costs of production.

Far from becoming energy independent the US will continue to be heavily reliant on foreign oil. The days of plentiful, cheap oil are gone forever. The global oil industry is in a permanent condition of being supply constrained. This supply constraint, combined with the dramatically higher costs of unconventional oil production, will keep oil prices relatively stable at historically high levels.

Global stagnation of conventional production signals that investors will need to carefully monitor the performance of the majors, such as Exxon (NYSE:XOM), Chevron (NYSE:CVX) and BP (NYSE:BP), as we approach the end of this decade. Steadily rising exploration and production costs, resistance to higher oil prices, and other challenges will place more and more pressure on the majors' profitability. Profits and growth of the majors are likely to stagnate and diminish in rough tandem with stagnating conventional production. Smaller, more nimble oil producers are likely to fare better than the majors as unconventional oil production continues to be the source of production growth. Smaller companies with the greatest expertise and most cost efficient operations in both conventional and unconventional oil production are likely to fare the best.

The stagnation of conventional oil production and the dramatic increase in much more expensive unconventional oil production is compelling evidence that the oil industry is scraping the bottom of the barrel. The American public needs to face the reality that we are in the twilight of the oil age.

Disclosure: I am long CVX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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