From One of Our Insiders: Some Thoughts and Data about Prices and Exploration

I know the argument is consistently made that higher prices ALWAYS bring on increased exploration.  It is also argued that higher prices make things more economical.
Tubulars (pipe) are up 300% with a waiting list for delivery.  We have numerous projects pushed out due to delivery of tubulars already, and hurricane repairs are also being slowed by lack of tubular inventory and steel products.  Cement and mud costs have doubled in 2005 as well.

The fallout in prices from Katrina/Rita/etc. in terms of jackup rig daily costs going into 2006 is:

H2O Depth         2004        2006

200               $30K        $90k
300               $35k        $130k
300+              $42K        $150k

The numbers for each project scheduled for next year have been rerun with these newer costs, and the higher costs have resulted in a preliminary project death rate of at least 25%.  For those interested, this includes moving the expected sales price of the oil upwards to between $30-$40/bbl. Even with the new income calculations, many projects are simply too small to provide profit. Thus our project portfolio is actually shrinking in the face of current prices.

Small pockets of oil will not be worth recovering until the price of oil reaches a level of between $100 and $150/bbl. At those prices, rig costs begin to recede in importance. At current prices, it simply means that there aren't enough economic reason$ to drill and produce small fields or additions.

Now, think this through carefully. What happens now?

The logic of Simmons' forecasts for short term $100/barrel oil is revealed...
Shouldn't higher prices for the equipment spur more manufacturing of that equipment - I assume there will be at least a 2-3 year lag in supplying that demand. But as the price of oil goes up, all of the other inputs to retrieving that oil goes up, one of those classic feedback loops. I guess this is where the EROEI rubber hits the road. Since energy is a major factor in energy production, prices will start to increase simply based on their own momentum.
I do not think this is a matter of price stimulating supply for things like pipe and cement, etc... The rapid escalation of fixed project costs means that small projects will never be profitable.

Further, it may mean that medium projects get postponed...

Realistically, who is going to walk into the chairman's office at Exxon and say: "I have a ten year, hundred million dollar project, but I need 90 million to do it..."

So in a sense even though the high price has created an incentive to invest more in increasing supply, the base cost of creating that supply is now locked in at a much higher level than ever before.

And this is a profoundly inflationary development.

And thus the Five year out Supply will be going down, Even short term supply will not recover.

If to many Medium sized Production projects don't come on line, We get a sort of peak drop off!  When we are counting the 100's of thousands of barrels and ohhing and ahhing over them, every last drop seems to be very important right about now!!  Look for this to hurt sooner rather than later.

In theory - yes. In practice I don't think anyone will invest in producing oil rigs that are unlikely to payoff.

I think this  is actually is good news because it would help level a little bit the decline (with small projects coming later).

What recourse do the oil companies have but to slow down drilling en masse and wait for prices to return to normal for their materials? Or else just sit and wait until the price of oil climbs to offset their costs? If 25% of their projects got wiped, then in 24-36 months, what will be left in their bag or prospects?

Old Raymond over at ExxonMobil is revealed here to be not so dumb for his stance on exploration. And what it portends for the oil patch seems to be one very spiky roller coaster ride, upwards.

If our "great white hope (hype?) is deepwater drilling, and those costs are also rising comparatively, wouldn't it follow that the size of reserves required to fund a depwater project has just increased substantially as well? Where does that leave deepwater?

It seems that the economics are stuck in some type of limbo, where oil prices are not high enough for everything to be profitable. Yet that is what is needed for every scrap of oil to be corralled. But if prices climb that high, it would probably hammer the world economy into deep rec(depr)ession. Which would reduce demand....again, this the start of an "undulating plateau"?

Oil has not been at $60/b long enough for companies to have confidence that the number will be maintained over the life of a new project, which would not even begin producing for 2-3 years or more. But, imagine a couple of years from now, with prices climbing relatively slowly, say at $1/month, from 60 to 84. And, combine this with reduced shortages on account of more competition (tubing producers are making enormous profits, along with all service companies, such as drillers). We might then see increased prices and stable or falling costs, leading to increased confidence and investment.

And, if prices climb at a modest rate many consumers get used to it, maintaining demand.

These insider posts are very helpful. For a change, I can actually see see a silver lining in this situation.

There's no doubt that less oil onstream now will cause price rises, eventually causing more conservation. What's a little different is the fact that this influence on price will result from a restriction in supply rather than an explosion of demand.

This would be good because we'd get fewer emissions now, and the oil is 100% conserved until a later time when it's more precious. Hopefully we'll have economic and strategic reasons to use this oil more efficiently and wisely when we do drill these fields. If we tap them today, they'll simply fill the Silverados and F150s, and be gone in a flash.

I don't agree this is a good scenario.  I would prefer a steady, but shallower decrease in supply with the resulting upward trend on prices.  Very sharp changes tend to destabilize the economy, close businesses and put people out of work.

The problem as I see it is that we have an artificial amount of product (oil and gasoline) in the system right now.  With no market signals to curb demand.  We are living off stored reserves that can't be maintained or replaced.  When we come to the end of this artificial supply there will be a cliff drop off of supply that will really force less consumption and spike prices.  

NC-I agree entirely, and I did not mean to imply this restriction in supply would create a sharp increase in price. It probably would not, because the projects being deferred are smaller finds with smaller impacts. And our oil conservation for the future would be more like a jar of pennies than a serious 401K plan.

Steady pricing is the most important factor here. Sustained high prices will cause serious conservation. Volatile prices will cause less conservation as people react to uncertainty: "I'll keep the pickup because gas prices will go down eventually" or "I'll trade down to a small car when gas prices stay really high."

Unfortunately, I expect long-term price volatility (trending sharply up, but choppy), which may give us the worst combination of more pain that results in less conservation.

Could be like a mini 'Peak Oil' OR 'Peak Reserve' if you like...
I'm trying to judge the seriousness of this revelation.

Does our insider tell us the size (reserves, production flow rate) of the typical projects being postponed? And what about the type of project? The example indicates deepwater. For example, are we talking about a delayed GOM field with an estimated URR of 0.5 billion barrels and an expected daily production of 25/kbd? How much oil are we talking about here? If we're going to talk about inflationary pressures on oil price, what's the near term (3 to 5 years out) expected world production shortfall due to these delays?
Lets put things in perspective.  The biggest fields in the GOM (Mars, Thunderhorse, etc.) are 0.5 to 1 billion barrels with production rates that run from 100 to 200 thousand barrels per day.  Projects of this size are on their own schedule, were likely approved on oil selling for $18 to $25/bbl, and are only impacted by the current environment in that the market for everything from rigs to roughnecks to reservoir engineers is much tighter now than it was 2 years ago.  They might be delayed, but if anything, they are 2 to 3 times more profitable than they were when the go forward decision was made.

With commodity prices as high as they are now, everyone wants a piece of the extra profit.  Costs rise dramatically.  Consequently, some marginal developments that one presumed would now be profitable still don't make the cut.  I have seen analyses of various tar sand developments that make money at $35/bbl and make more at $70/bbl, but no where near as much as you might imagine.  The increased gross revenue is eaten up by greatly increased costs, as everyone demands to sup from the trough.

That said, marginal projects never really make a big difference in the overall scheme of things.  They only make a difference when a significant hurdle can be overcome and the volume from the marginal project is large.  Tar sands are also a good example of this.  If the price of oil stays low (e.g. below $25/bbl) none of these project make enough revenue per barrel to cover their operating costs.  None ever get approved and none of this oil ever comes on the market.  However, once companies are convinced that the price will stay above their threshold number, they start committing billions of dollars on these "marginal" projects.  Pretty soon you are making 1 million barrels per day.

Thanks for the reply, Bubba. But I'm still left with the question of what "marginal" projects are delayed due to price and what the supply impact of these delays are.

As far as "companies [being] convinced that the price will stay above their threshold number", I would think that it is obvious that the price will stay above their threshold numbers at this point. There is simply no evidence in the supply & demand equation that market prices will ever go down again much below current levels -- unless there is a serious worldwide recession. There's no Prudhoe Bay, no North Sea to bring online anymore. Pretty soon you're getting 1/mbd from marginal projects? When will they decide to go forward with these projects? Apparently, higher initial development costs are putting them off given the historical volatility of the market but I would submit that past experience does not apply here. Not to mention, as you have, that these oil business cultures are very conservative and risk-averse.
My own experience is that marginal projects are marginal in every sense.  Except in the unique types of cases I mentioned above, of which there are few, marginal projects don't make an impact on even a single company's bottom line or overall production level, much less the gross production of an entire country (or the world for that matter).
Marginal projects don't much effect company profits but they do affect product prices. 1% of the oil supply determines 10% of the prices because it's the marginal 1% that sets the prices.
A good example is the oil shock of 1973 that reduced supply by 5% and increased prices by 100%. 1980 increased prices by 400% and was the result of an even smaller decrease in production.
Marginal projects may not have made a difference when overall there was a surplus of supply. However when the surplus is gone every drop counts...
Wouldn't heavy and/or sour crude projects pencil out way before tar sand projects do?  

Given that we hear about so much heavy crude on the market, selling cheap, it seems like once this stuff starts to flow through, it will make tar sand unprofitable.

(Actually I think this applies in both cases but...) In the case of the heavy sour, it is my understanding that current refining capabilities are so constrained that they cannot handle more, which is why it is so expensive. So in some ways the crisis is one of lack of heavy refining (of course the real crisis is the peak, but we're also looking at the peak of light sweet here, so i guess its some of both, wow its late, time to sleep)
It's not just the economics, it's the availability.

Here's part of an email from a friend in the business (I hope I have stripped everything sensitive and identifying) in response to me saying Saudi are paying silly money for rigs etc:

"It is maybe worse than you think!  
Rigs:  I have never heard of this happening before, but Saudi is transporting land rigs from the USA to Saudi.  They have a requirement of some 20 extra rigs by the end of the year.  It is common to move jack ups and semisubs - the deep water semisub Jack Bates went to Australia last year; Ocean Nomad to Senegal year before last; two other rigs to the Gulf of Mexico - all from British waters, that I have seen with my own eyes . . .  And at say 100,000 to 150,000 dollars a day at that time of moving plus the moving vessel, is an expensive hobby.
Rig rates for deepwater semisubs are now up in the 400 to 600,000 dollars a day and fully booked until 2008.  Everybody is paying three times market rates.  North Sea rig rates are way up too - due to many rigs leaving the area and sudden upturn in activity.  The futures cost of rigs indicates that oil price is not coming down.  But you probably guessed that.  
(I flew up Invergordon - just North of Inverness, where they stack idle rigs, about two and a half years ago in a heliopter.  Price was only 23-30 dollars/bbl.  Oil companies still making up for the 10 dollar/bbl of a few years earlier, plus America was going to flood the market with its Iraqi '5 cents/bbl at the wellhead' oil weren't they?  I have never seen so many idle rigs in one place in my life.  So many that they did not fit into the shelter and some, at least three or four were outside the protection of the, can't think of the word like, fjord.  And now a bucket of bolts - the Pxxxxxxx - is commanding over 100,000 dollars a day.  The semisub Pxxxxxxx has been rejected by most oil companies for the last 10 years as it is junk - but now . . . come into the inner sanctum, meet my daughter . . . )
People:  Saudi has been poaching people with signing on bonuses and the like.  One drilling engineer in Nigeria went home at lunchtime on a Wednesday and was not seen again.  As he had not appeared at work they phoned his wife on Friday morning to see if he was OK.  She said yes, [he] flew to Saudi Thursday morning, and by the way, he has quit xxxxx.  
[....] in any case, drilling wells is not the entirety of it.  Pipelines, condensate knock out traps, flow stations, refineries, port upgrades and so on need to be designed and built.  Saudi crude is sour - has a lot of H2S in it.  
Long lead time items:  Casing, wellheads and rigs are all long lead items.  Have you tried to buy high grade pipe lately - OK, OK unlikely?  There is a world shortage of high grade steel.  The rolling mills lead time is around seven months at present.  If you want a wellhead - absolutely required for drilling a well, lead time is about 40 weeks.  If you want a dozen wellheads lets say, then the lead time will go out beyond the 40 weeks.  Factories are at full capacity.  As above, you want a load of stainless for a refinery ? - OK but you have just pushed back the delivery date . . .  And the Russians are talking about another monster long pipeline... "

My argument was that this [Saudi] behavior seemed odd for a producer who could easily increase production and my bet was they are desperately scrabbling to replace a sharp falloff. But the reply raises another fundamental problem: resources required to bring reserves into production and to convert probable into proven reserves are now a real constraint and will limit the exploitation of reserves in the short to medium term.

It could be that predictions like CERA's about planned projects will prove optimistic due to these constraints.

Good stuff, Agric, thanks.
Seems even the IEA are getting a bit nervous about Saudi capacity. Check out this article from the Financial Times - Looks like the IEA might be setting up the Saudis as scapegoats if supply isn't adequate.

IEA warns of 50% oil price rise by 2030
By Carola Hoyos in London
Published: November 2 2005 22:12 | Last updated: November 2 2005 22:12

IEA The International Energy Agency, the oil sector monitoring body, on Wednesday said that oil prices by 2030 would be 50 per cent higher than today if Saudi Arabia did not muster the political will to invest billions of dollars in new production.

Fatih Birol, the group's chief economist, said in an interview with the Financial Times that Saudi Arabia, the most important oil producer, might not make the investment needed to ensure production met the strong demand growth in China and India.


The IEA said Saudi Arabia would need almost to double current output of 10m b/d to meet the expectations of demand in 2030. But Mr Birol said the kingdom might muster the long-term political will only to produce just over half the extra barrels deemed necessary.

Iran and Iraq are also vital to ensuring adequate oil and natural gas supplies in the next 25 years. But both face political hurdles to achieving the necessary investment. Many Middle East countries fear that investing heavily in new oil supplies will deplete fields too quickly and cut revenues by depressing oil prices.

Mr Birol said: "We may end up with much less oil from the Middle East than we demand. There is substantial risk of substantially high oil prices if current investment in the Middle East is not stepped up substantially. "Such high oil prices would be an additional trigger for major consuming nations to introduce policies to save oil and look for alternative sources. If they don't, the global economy but mainly the economies of the consuming nations will suffer."


Exxon have just announced that they are keeping their exploration budget at $18 billion. With the cost of exploration rising as described above, this means a great deal less exploration.;_ylt=AsH GupgNMwywvrAm10ZHcNCs0NUE;_ylu=X3oDMTA3bGI2aDNqBHNlYwM3NDk-

I think that it is entirely possible that the majors are waiting to see of ARAMCO can actually do anything remotely resembling what thye have announced in the way of increasing output.

If they fail and cannot, then the calculations used for projects will reflect much higher oil values, simply because the majors have become convinced that ARAMCO cannot screw them over by flooding the market with cheaper oil.

This is not a game that will end this year...

I agree. The majors are enjoying record profits - why take chances with new exploration when the money can usefully be used buying back the stock that was earlier granted in stock options to brilliant executives? But it may go deeper than this; consider how the energy companies, not least Enron but not only them, screwed California. No collusion, but no reason to build more plants either, when each additional plant (read wells and refineries) will reduce prices in a short market.