Peak Oil & Peak Debt: How Energy Investors Can Profit

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I asked Cory Mitchell to explain two scenarios that could play out in the global energy markets, and what it means for energy investors. Here’s Part 1 of his story.

– Keith

The Macro Dilemma
by Cory Mitchell, CMT

Energy investors need to be aware there are two massive macro forces in our global markets and economies battling it out.  One is obvious (and positive!), and one is not—it’s negative.  But the new global credit crunch has brought this dilemma for energy investors into sharp focus:

1.   Stagnant or declining oil production, which should mean oil prices—and oil stocks—are going higher.

But as I’ll show you…

2.   If oil production declines, it will have a negative on global debt and GDP—declining oil production will in turn lead to a long-term decline in the global economy – and a declining economy should push the price of oil down.  The lack of continued growth in oil supply has been a constraint on global growth since 2004, says Canada’s Sprott Asset Management.

One scenario points to a higher oil price, and another to a lower price—yet they are two sides of the same coin.  And while it’s counter-intuitive, lower oil production can potentially lower oil prices by constraining demand. As these contrasting forces play out now and in to the future, oil markets are likely to remain volatile.

The volatility created by this global battle will present opportunities for energy investors as the macro forces play out.

Economic Relationships with Oil

Oil production (and consumption) drives GDP and debt.  While debt is often viewed negatively, it is what allows our economy to expand.  When a consumer goes to the bank and gets a loan, money is created.

This money is then spent and deposited into someone else’s bank account, allowing the bank to grant another loan and so on.  This is healthy for the economy as long as the process is not taken to extremes and leveraged too highly, like what occurred in the 2008 “credit crisis.”

US debt had been steadily rising but has now plateaued, as shown in Figure 1. The problem is, debt—and thus the economy—do not expand if oil production does not expand.

Figure 1. US Government and Non-Government Debt:

*Source: http://www.theoildrum.com/node/8268

Figure 2 shows the high correlation of oil production and GDP.  Oil production levelling off corresponds to the flattening in debt (above) and GDP that we are currently seeing.  Oil production levelled off in 2005 and GDP is failing to get above 2008 levels after a significant decline.  The plateaus in oil production, debt and GDP may be short-term, or may indicate a long-term lack of growth or decline in global economies.

It’s interesting to note that oil production and demand has increased steadily by 10 million barrels of oil per day per decade since 1970—just as the world experienced the largest debt increase in global economic history.

Figure 2 World Oil Production and GDP (Crude Production in blue and scale on the right, GDP in red and scale on the left):

*Source: Economagic

Figure 3 shows the high correlation of oil consumption to GDP.  The relationship of oil production to these major economic factors—debt and GDP—are unavoidable.  As goes oil production so goes the global economy.  The major issue presented is that oil production has levelled off.  If oil production cannot increase the world has reached “peak oil” and by extension, peak debt and peak GDP.

This means investors need to look for places which still exhibit growth prospects and may even benefit from peak oil over the next several years to decades.

Figure 3. Oil Consumption vs GDP:

*Source: Gail Tverberg,  The Link Between Peak Oil and Peak Debt

Issues the Relationship Presents

“Peak oil” occurs when global productions hits maximum output and can no longer continue to increase, leading to a long-term decline in supply.  Oil is what allows economies to operate, and without it to fuel many projects — well, companies, consumers and banks would have no need for debt.  Debt would dramatically drop, forcing down GDP in the process.

Therefore, peak oil and peak debt will create peak GDP.

When peak oil and peak debt (and by extension peak GDP) will exactly occur is unknown, but global production has levelled off and the idea that we are rapidly approaching a global peak oil production is becoming more prominent in the media.  Canada, however, is continuing to see its oil production rise—which is providing a very interesting opportunity for energy investors around the globe.

With debt and oil production levelling off, I believe that at some point the world will hit a “growth ceiling,” until some new technological advance drives us forward once again.  This has happened throughout history, when there have been moments of radical growth following a new technology or an increase in productivity.  Then growth levels off or declines until the next big idea comes along.

That big idea may or not be here yet — shale gas, hydrogen and electricity are some the alternatives currently being explored; though the transition away from oil will take at least 30-50 years according to Vaclav Smil in the book, Energy Transitions: History, Requirements and Prospects.  That’s not hard to fathom, given the vast infrastructure aligned with our dependence on oil.  At this time, creating or extracting an alternative fuel and transporting it stills relies on oil.

In conclusion, I see the combination of (at least short term) peak oil and peak debt, which should cause lower demand and lower oil prices, continuing to do battle against the idea that lower oil production should obviously mean higher oil price.

To me, this means the oil sector will continue to be a hot bed of macro volatility and investor opportunity.  And in my next article, I’ll explain how energy investors can best profit from the volatility created by these two forces.

– Cory Mitchell, CMT

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Venezuela Oil: The World’s Largest Reserves

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1940bkg
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While energy investors focused on the Arab Spring as a major cause of oil price volatility in 2011, a dramatic event in the Western Hemisphere has been overlooked.

Two months ago the Organization of the Petroleum Exporting Countries (OPEC) declared Venezuela to have the world’s largest oil reserves, estimated at 296.5 billion barrels, exceeding even Saudi Arabia.

And the country’s leader—President Hugo Chavez is ill, with some speculating upon his demise in two years. Given Venezuela’s importance to U.S. energy security, one would think that the news would have received more attention. Venezuela is the fourth largest source of oil imports for the US, at 930,000 bopd, according to the EIA—behind Canada, Mexico and Saudi Arabia.

As for the Venezuelan media, most currently assert that President Chavez will be well enough to run again for the presidency in 2012. But his health forces his retirement or death, what might be the way forward for Venezuela, and what does it mean for its energy clients and global energy prices?

Earlier this year President Chavez startled his electorate by stating that he had undergone emergency surgery in Cuba to remove a tumor. Since then, he has according to the government had four chemotherapy sessions and on 20 October President Chavez stated that his disease was over, telling state media “No abnormal cellular activity exists.”

Pictures show a disconcerting image of a bald and bloated President Chavez, both side effects from chemotherapy.

A former physician of Chavez, Dr. Salvador Navarrete Aulestia, said in a recent Mexican newspaper that the Venezuelan President had less than two years to live because of a “very aggressive” pelvic carcinoma.

On 27 October President Chavez said that Dr. Navarrete must have been paid to make the assertions about his health and called him a “liar.”

Navarrete has since fled the country,  and he and 20 colleagues founded the De Frente con Venezuela political bloc, which intends to contest next year’s presidential elections, according to el Nacional newspaper.

That’s an example of how the political positioning to succeed Chavez has begun in earnest. And with such huge oil reserves strategically located close to the United States, the stakes are high.

Should his illness incapacitate or kill him, the question is how much of Chavez’s “Bolivarian Revolution” would survive. While his +-social programs have proven popular with lower middle and working class Venezuelans, they have proven much less so with the country’s upper classes.

And the military has yet to be heard from, though it is undoubtedly unhappy with the fact that the U.S. has imposed embargoes on the country’s military equipment.

As the country’s politics have yet to throw up a highly visible opposition candidate, then it seems probable that the military would exercise command for an “interim” period to “ensure” social stability.

In such a scenario it is also likely that U.S. political and economic interests would pile the pressure on Caracas to modify or repeal some of Chavez’s more controversial policies, particularly in the energy sector by allowing disgruntled energy multinationals to revise or rescind his energy policies asserting state control over the nation’s oil and natural gas reserves.

Doubtless U.S. Secretary of State Hillary Clinton would rubberstamp such efforts and as the Venezuelan economy is heavily dependent on energy exports, it seems unlikely that a post-Chavez leadership would be able to resist such pressure. Washington would undoubtedly welcome such “regime change” by welcoming Venezuela back into the coterie of Western Hemisphere democratic nations.

And the stakes are high for the world’s leading owner of oil reserves. Whatever political change occurs in Venezuela, the only certainty is that it will not occur in a vacuum.

—————————————————
How Hot Is This North American Oil Play?

For starters, there’s a massive land rush happening. Companies are in a frenzy to secure positions.

And that’s great news for one junior with a huge land package in the play. Not only are they quickly accelerating exploration there… they’re also increasing their 2011 budget by millions to focus on the play.

To learn more on the situation, just follow this link.

—————————————————

Venezuela’s political uncertainty fits into a larger pattern of inevitable change throughout the oil exporting world since the beginning of the year. In the world’s largest oil exporter, Saudi Arabia, the recent death of 80 year-old Crown Prince Sultan Bin Abdul-Aziz Al Saud has led to the sprightly 78 year-old Prince Nayef being appointed his successor eventually to replace the ailing 87-year-old King Abdullah. To be kind, the Saudi political leadership is all getting rather elderly.

Libya? With Colonel Gadaffi dead, Libya’s Transitional National Council is attempting to forge a new state after 42 years of the Gadaffi regime, but its future composition is unclear and the Transitional National Council has declared that Shar’ia Islamic law will be a prime element in the future governance of the country.

Iraq? The government has requested that U.S. military forces complete their withdrawal by 31 December.

BACKGROUND

In May the U.S. imposed sanctions on Venezuela’s state oil company Petroleos de Venezuela, S.A. (PVDSA), the country’s state-owned oil company and the country’s fiscal crown jewel.

South of the border the issue of the chief executive’s health is not limited to Venezuela, as several Latin American presidents have seen their health deteriorate while in power. But none of the above has access to the current and potential fiscal reserves generated by Venezuela’s energy sector, and if and when illness incapacitates or kills President Chavez, then the Western Hemisphere’s largest oil reserves will undoubtedly become the object of a major international wrangle to secure them on more favorable terms than the administration of President Chavez allowed.

Given the centralized nature of political power in the Middle East, the way forward is murky at best and accordingly could have significant impact on global oil prices. But Venezuela’s reserves and its location in the Western Hemisphere have surprisingly attracted minimal attention thus far from Washington.

The health of President Chavez, the country’s chief executive since 1999, has apparently been dire for some time, possibly terminal, an event that will undoubtedly shape the country’s future energy policy, with enormous implications for Venezuela’s energy sector.

For foreign oil firms, President Chavez committed a mortal sin in 2005 when he handed effective majority control over the country’s oil assets to PDVSA.

PDVSA is the world’s fourth largest oil company, based on estimates of its proven reserves, production, refining and sales. President Chavez has since used PDVSA revenues to underwrite many of his social programs.

Venezuela’s oil industry had been under private control until 1974, when Venezuela nationalized it, setting up PDVSA. Venezuela’s oil production is centered in the Orinoco Oil Belt, which analysts believe contain an estimated 300 billion recoverable barrels. In the 1990s PDVSA began a so-called “oil opening,” where it allowed more and more foreign private companies to extract oil, via majority shares in joint ventures and the operating agreements.

This sunny picture was interrupted when in February 2007 President Chavez announced a new law nationalizing the last remaining oil production sites under foreign company control, to take effect on 1 May, allowing the foreign companies to negotiate the nationalization terms. Under the new regulations, the earlier joint ventures, involving ExxonMobil, ChevronTexaco, Statoil, ConocoPhillips, and BP, were renegotiated to give PDVSA a minimum 60 percent stake.

The process completed a government initiative begun in 2005 when the Chavez administration transformed earlier “operating agreements” in Venezuela’s older oil fields into joint ventures with a wide variety of foreign companies. Thirty out of 32 such operating agreements were transformed by the end of the year, and only two firms challenged the transition in court, and no guesses as to who the companies were. Most foreign companies accepted the new arrangements, including Chevron, Statoil, Total and BP, but ExxonMobil and ConocoPhillips refused, subsequently suing in court.

But the situation is in flux – three months ago, around the time that President Chavez first visited Cuba for medical treatment Venezuelan Energy Minister Rafael Ramirez told journalists, “We’ve never said we wouldn’t pay” the two U.S. multinational corporations Exxon-Mobil and Conoco-Phillips, “the only two that didn’t accept our laws and didn’t accept (the compensation deal) and took the dispute to the World Bank’s International Center for the Settlement of Investment Disputes.”

As Ramirez is also the president of PDVSA, his comments should not be taken lightly. Ramirez added that the arbitration processes “are moving forward and we have to defend ourselves because those mechanisms are so perverse that if you don’t show up they execute you.”

For better or worse, President Chavez has established an executive-heavy control system over PDSVSA and whether it will survive him is anyone’s guess and foreign oil companies are watching events closely.

– By John Daly
Guest Contributor to the Oil & Gas Investments Bulletin

U.K. firm Alleges that Fracking Caused Small Earthquakes in Northwest England

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1940bkg
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U.K. firm Cuadrilla Resources stated on November 2 that hydraulic fracturing or "fracking" was the impetus for small earthquakes that occurred in Blackpool in northwest England earlier in the year, which exacerbated already-existing concerns about the safety of the technology used.

Following the tremor, Britain temporarily prevented fracking activities and ordered that research be done into methods used, Reuters reports. After action by the country's government, Cuadrilla stated that the likelihood for repeat tremors is not high. The company stated that the geology of the site where the drilling occurred is highly atypical and very unlikely to be found at other drilling locations.

The company issued a statement which said that, "Cuadrilla's water injection operations take place very far below the earth's surface, which significantly reduces the likelihood of a seismic event of less than 3 on the Richter scale having any impact at all on the surface," according to the media outlet.  

A recent study released by Duke University provides evidence that drilling for gas causes drinking water to be contaminated by methane, but this contamination is due to how wells are built while drilling as opposed to the chemicals contained in the fracking mixture, The New York Times reports. 

Estrella International’s Mixed Operational Results Cause Canaccord to Lower EBITDA and Earnings Estimates

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Estrella International Energy Services' (EEN:TSXV) mixed operational results caused Canadian brokerage Canaccord Genuity to reduce its 3Q11 EBITDA forecast for the firm to C$2.04 million from C$2.62 million and its 4Q11 earnings prediction to C$3.1 million from C$3.36 million. Canaccord maintained its SPECULATIVE BUY rating for the oilfield services company and reiterated its target share price of C$0.80.

Rig 1201 that exists in Chile suffered a mechanical problem on October 27 and Estrella is currently investigating this incident. Canaccord lowered its estimated EBITDA contribution from this rig as a result of its lowered utilization.

Canaccord's C$0.80 target share price for Estrella is based on a 4.9 times multiple of 2012 estimated EV/EBITDA. The Canadian brokerage is maintaining its EPS estimates of C$0.09 for 2011 and C$0.01 for 2012. Estrella International Energy Services closed at C$0.25 on November 2 and hit a 52-week high/low of C$1.02 and C$0.22, respectively.  

Soaring North Dakota Oil Production Triggers Infrastructure Upgrades

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Booming production of crude oil in North Dakota is necessitating significant upgrades in transportation infrastructure in the state.

Oil output in the state has skyrocketed from practically nil within the last three years to 450,000 barrels per day, making North Dakota the fourth largest oil producer in the United States, according to The Wall Street Journal.

MarketWatch reports that oil production is rising so fast that around 25 percent of it is now being transported by rail, according to BNSF Railway. This spike has forced already-existing pipelines to operate at capacity, and more lines are not expected to be available until 2013, The Wall Street Journal reports.

Exploration and production companies are adapting to this situation by constructing rail terminals, which can be set up without a large investment of time, according to the media outlet. The amount of oil that can be transported by these rails is expected to double in 2012 to 700,000 barrels a day.

Focusing on railroads as a means of transporting crude means that capacity might grow too rapidly and leave the companies with idle resources they can't use, according to the media outlet. The companies that are investing their resources are betting that demand for this means of transportation will be sustained.
 

Will the U.S. Become World’s Largest Oil Producer? The Surprising News about U.S. Oil Production

By
Keith Schaefer
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The U.S. likes to fancy itself as a place that does everything a bit bigger and better than the rest of the world and while some of this might just be American bluster, the Yanks have plenty to crow about it when it comes to oil production in recent years.

James Burkhard, the managing director of IHS CERA’s Global Oil Group, said at a Montana Petroleum Association conference that U.S. production of oil increased by 1.2 million barrels per day between 2008 and 2010, reports the Billings Gazette. This reversed four decades of decreasing domestic oil production.

“Not only have we reversed the trend, we’re reversing that in a very big way,” Burkhard said.

However, the U.S. may not be done when it comes to upping its oil production as The Sunday Times recently quoted a report released by Goldman Sachs that predicts America will become the world’s largest oil producer by the year 2017. This estimate was obtained by using a different definition of oil and utilizing generous estimates for liquids-rich shale production, according to The Oil Drum.

Using these new parameters, the report predicts that U.S. daily production of oil will rise to 10.9 million barrels in 2017 from the current level of 8.3 million barrels, according to the media outlet. This estimate is not unreasonable when one considers the growth the country attained between 2008 and 2010.

The news source states that how Goldman Sachs arrived at the current production level of 8.3 million barrels of oil per day is ambiguous. June oil production for the country averaged 5.6 million barrels per day in June, the Energy Information Agency (EIA) reports.

Predictions for U.S. oil production released by the EIA differ from the figures released by Goldman Sachs. U.S. crude oil production will increase to roughly 6 million barrels of oil per day by 2020, according to the agency’s 2011 Annual Energy Outlook. The EIA attributes gains in production to larger shale oil resources and new enhanced oil recovery techniques. The agency states that the Eagle Ford shale, Bakken formation and the Marcellus shale will all contribute to this rise in production.

“There’s always a bull market somewhere.” There is more truth to this than most investors realize. And right now one of the biggest — if not THE biggest — bull markets in the entire Energy Patch is quietly taking shape. I’m referring to the technological revolution in oil & gas — the technologies, for example, that can increase yields by 4 to 7 times… launch huge new “discovery” fields… or even “extend the lives” of older fields. It is exactly these kinds of innovations that are creating triple-digit profit opportunities in the Oil & Gas Investments Bulletin portfolio. To learn more about what’s driving these opportunities in my OGIB personal portfolio — and how it all works, keep reading here.

I hope you’re still with me!

Thomas Petrie, vice-chairman of global corporate and investment banking at Bank of America, offered another estimate. He told Reuters that over the next five years, U.S. oil production stemming from shale plays such as Eagle Ford, Bakken and Niobrara could potentially increase to 2 million barrels per day.

What makes Goldman Sachs’ prediction even more surprising is that its estimate would place U.S. production higher than that of Saudi Arabia and Russia. Press reports stated that Russia will not increase its current production of 10.7 million barrels of oil per day by any more than 100,000 barrels in the coming years. For what its worth, Saudi Arabia says it can produce 12 million barrels of oil per day by 2020, reports The Oil Drum.

Increased oil production in the U.S. hinges on a number of important plays located across the country.

One of these plays, the Bakken shale, has grown rapidly in recent years. Production at Bakken-Three Forks has climbed to around 400,000 barrels per day and some industry insiders believe that number could eventually be greater than 1 million barrels of oil per day. The Permian basin will significantly contribute to rising production of U.S. oil. Permian production was at 841,000 barrels per day in 2004, according to Well Servicing Magazine. The Oil Drum estimates that in 2010, this figure crept up by 100,000 barrels.

Another play that could contribute significantly to production is the Marcellus shale. A United States Geological Survey report released in August estimates that the Devonian Marcellus shale formation holds 84 trillion cubic feet of natural gas that could be recovered and 3.4 billion barrels of untapped natural gas liquids.

The Utica shale, which exists below Marcellus, is another play that holds significant potential. Aubrey McClendon, President of Chesapeake Energy, told The Gartman Letter that it currently has 12 horizontal drills that are active in its section of the Utica. Some estimates put the amount of oil in the Utica formation at 5.5 billion barrels.

Regardless of what U.S. oil production is predicted to reach within the next decade, it is clear that the country will be one of the largest producers of oil in the world for years to come.
by +Keith Schaefer

Strong Potential Lies in Alaska’s North Slope

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1940bkg
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Excess capacity in the Trans-Alaska Pipeline System could provide a means for developing oil existing in Alaskan North Slope shale formations. If this play is explored successfully, immediate results could ensue, according to The Fairbanks Daily News-Miner.

Bill Barron, state director of oil and gas, stated on November 1 that the number of wells being used to develop shale could double in the next 10 years, the media outlet reports. More wells would be needed since shale wells produce less oil than other wells.

Great Bear Petroleum LLC acquired leases to 500,000 acres worth of state lands last year. Afterwards, the company filed a plan with the state that describes its intentions to drill up to four exploratory wells, according to Oil and Gas Journal.

"The interest in Alaskan shale has significantly increased since the lease sale last year about this time, when Great Bear stepped up and secured 500,000 acres of a ‘play’ that no one really even thought about," Barron said, the The Fairbanks Daily News-Miner reports. "In a year’s time we’re trying to make sure that we get everybody in place and look further down the road." 

ShaMaran Petroleum Announces C$50 million Private Placement and Pulkhana PSC Update

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1940bkg
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Exploration and development vehicle ShaMaran Petroleum (SNM:TSXV) recently announced a private placement that could raise as much as C$50 million and provided an update on the Pulkhana wells in Iraq. Canadian brokerage firm Canaccord Genuity responded to this announcement by reducing its target share price for the company to C$1.15 from C$1.45 and reiterating its SPECULATIVE BUY rating.

Vancouver-based ShaMaran's latest activity update on the Pulkhana PSC indicates that a test of the Pulkhana-8 re-entry well provided results as high as 3,530 barrels in a day and an average rate of 2,650 barrels per day of 31.6° API oil. The 1956 Pulkhana-5 discovery well provided test results of 2,950 barrels per day from two horizons.

The exploration and development vehicle announced its plans to conduct a non-brokered, private placement of as many as 125 million shares at a price of C$0.40 each. ShaMaran Petroleum closed at C$0.40 on October 28 and hit a 52-week high/low of C$1.43 and C$0.29, respectively.  

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