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True Cost of Oil

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I attended the Offshore Technology Conference the first week of May.  There were a couple of presentations which will be of interest to those aware of the Hubbert Peak predictions.    I attended a lunch where Matt Simmons spoke on “What do Oil Prices Need to Be?” I already posted some on that talk.  Here are the full notes. His presentation can be found at

http://www.simmonsco-intl.com/files/OTC-Future%20Cost%20of%20Energy.pdf

Simmons is an investment banker for the oil industry. The talk was not what one would expect from a banker who is a mover and a shaker in the industry.

He started by noting that it will take 16 trillion dollars to replace the production we now have on line and add to it by 2030.  Oil, is the miracle product of the 20^th century. It brought mankind potable water, transportation, airplanes etc etc.  It or another form of energy is an indispensable requisite for life as we know it.

But over the past 20 years, oil has been a terrible investment.  A 15% return on investment (ROI) is what one expects to get from a building.  Oil’s ROI has largely been less than 15%.  Scotch return 50% ROI, wine returns 15%.   As Simmons quipped, he has spent his career in the wrong kind of barrels.

Why has oil given such a lousy return?  Because spot energy pricing, where oil is bought and sold like a commodity has destroyed long term value for the oil industry.  The myth out there that oil companies are extremely rich is true and false at the same time.  When one can get better return owning a distillery than an oil well, the  investment money flows to distilleries.  Because of that, there has been a lack of investment in the oil business. Spot markets make all contracts short term so no one is looking out for the future. 

Because of this, from 1982 until the present, everyone in the oil industry got hammered.  Oil companies have cut about 2/3 of the people employed in 1982. Vendors, like drillers, seismic companies etc have been squeezed to give up lower and lower costs. 

Simmons didn’t say this but the fact is that R&D in the oil industry has almost gone to zero. As a percentage of sales, the oil industry spends .9% which places us between tobacco companies and beverage companies.  Pharmaceuticals spend 13%.  You can quickly see that no one is thinking about the future in my business.  Indeed, for a brief while after I came back from Scotland, I  WAS the R&D department for my company.   Basically I was told to go in a room and think deep thoughts.  I begged my way out of that one. They wanted someone to think about the future—long term. 

Simmons went on to say that the IEA says it would require 16 trillion dollars to ensure flat energy supply—10 trillion on electricity and 6 on oil.  Simmons thinks it will be $30 trillion to ensure a flat oil supply.

He then went into the part of the talk which one wouldn’t expect to hear from a banker.  He noted that in 1970 there were 6 million people in Saudi Arabia. By 2000 it was 21 million, today it is 24 million and it is expected to be 40 million people in 2014, just 10 years from today. Assuming Saudi Arabia produced 6 million barrels per day and wanted to give each of those people a $15,000 per year  lifestyle, it would take $50 dollars per barrel.    He suggested that to give the rest of OPEC such a life would require $182 per barrel.  He noted that if your key supplier is broke, you have a big problem.  The western world is living at the expense of the underdeveloped world.  He said this would give everyone a 10% ROI. 

Affordable energy is a luxury we wasted.  But it wasn’t only oil that was underpriced.  It takes 30 years for rubber trees to mature enough to be able to collect the rubber.  For the past 30 years, rubber prices, like all commodity prices have been in the tank. No one planted rubber trees and the people living off of them were underpaid  and thus were unable to ensure a long term supply. Rubber prices have recently risen 3X.  The demand has outstripped the supply and it will take 30 years to fix the problem.  The same thing is about to happen to oil.  He asked a very important question.  Was globalization, based upon the concept that transportation was essentially free, a big mistake?  

Now I will say this, not Simmons.  The poverty in the third world which has benefited us and our children is largely due to low prices.  Remember what I said above about if your supplier is broke, you have a problem. Well OPEC, the energy supplier for the world is broke. Since 1980 the per capita income in Saudi Arabia has gone from something like $30,000 per year to something like $6000 today.  That is why this can be written:

"Not so long ago, a certain well-known international figure penned a heartfelt speech he called his 'Letter to the American People'. In it, he said: 'You steal our wealth and oil at paltry prices because of your international influence and military threats. This theft is indeed the biggest theft ever witnessed by mankind in the history of the world.' The author was Osama bin Laden."  "What If?" Economist May 29, 2004p. 72

Don’t tell me I am explaining or helping bin Laden. I am not. Some of the fault lies with the government leaders in the OPEC countries, few of which are democratic.   But when low prices cause people to live in poverty, we have a problem. They view us as thieves.  And having been personally involved in multimillion dollar negotiations with various vendors in the oil industry, doing what was described above—squeezing the vendor for lower costs—I have played my part in this issue. Some vendors have not been very happy with me in the past because I pushed the price too low.  When that happens, the buyer usually gets lower quality or the vendor gets it back on the next negotiation or they cut R&D, but no one will take a loss to get business. Everyone needs a profit.    With states, and peoples, they get it back in flesh .

Lest anyone be tempted to blame the oil companies,  ask yourself this.  How many miles per gallon does your car get?  Do you use a refrigerator, and heat your home comfortably in the winter?  All of us are involved in this issue. The consumer wants low prices which means that the oil companies try to give it to them.  When the consumers don’t have low prices, they think the oil company is gouging them.  They squeeze us and the politicians.  We in turn squeeze the vendors, drilling contractors  and OPEC. To squeeze on this chain makes it doubtful you will have your warm home in future winters.

Back to Simmons’ talk.  He finished by addressing the skeptics of oil’s demise.  He said that several people had told him that people had doomed and gloomed it in the past. They often cited the Club of Rome’s book, The Limits to Growth. The gloom there didn’t happen.  Simmons said he found a copy of the book and read it on one of his vacations.  The book wasn’t talking about 1972. It was talking about 2025-2050.  They raised the issues in order to  give the world time to think about them and fix them.  But what happened, was right after the book was published, the Arab oil embargo occurred. Everyone thought the doom was upon them and when it went away, the book got discredited in the public’s mind.  To verify this. Take a look at http://dieoff.org/page25.htm

He also noted  some other problems coming up for the industry.  How re we going to recruite 50,000 people in the next 5 years to run the oil companies?  The average age in the oil business is something like 48.  Within 10 years we will all be gone or they will have to pay us a lot to continue at our oars.

Anyway, I am finally getting to type up my notes from those conferences.  There was a full morning on Hubbert’s peak which I hope to get to soon.  The room was packed full of oil men to hear the debate.  More later. 

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