Option Investor

We Peaked!

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That was Boone Pickens message to the assembled multitudes at the ASPO conference in Houston this week. After listening to several days of various speakers dancing around the question of when we will see peak oil, Pickens closed his comments by answering that question from the crowd. With the speaker just before him talking about 2015 and others even more optimistic with 2020 estimates he rocked the room with his peak message. While there were hundreds of attendees that felt we were at the peak but no "official" speakers willing to bet their reputations with an official call, Pickens statement closed the conference for all practical purposes. It was the confirmation everybody wanted to justify Friday's $90 oil.

I would love to tell you everything I learned this week at the conference but it would be impossible to condense my two yellow pads of notes into anything coherent that would fit into this newsletter. It would be a very good start to a book on peak oil rather than a weekly update. I am not going to even make a good stab at it today due to time constraints. I am trying to squeeze this update in between presentations and then have to hit the road again.

Basically the bottom line to the peak oil story is the 88 mbpd demand estimate for Q4 from the EIA. According to EVERYONE in attendance the maximum sustained production available today is just over 85 mbpd including natural gas liquids. With a 3 mbpd shortfall expected in Q4 and part of Q1 we will be pulling from current inventory levels to make up that shortage. The IEA said just last week that global inventory fell to a 5-year low due to the production cut from OPEC earlier in the year. Now, with demand booming, OPEC is behind the curve and may have to open all the pipes in Q4 just to stay even with demand.

The wild card here is demand destruction due to price. According to Henry Groppe, a 61-year veteran of the oil industry, demand actually fell -.5% over the last three months. Without demand destruction we would have suffered a strong case of price rationing over the coming months. Price rationing is voluntary conservation by consumers simply due to the high price of fuel.

Pickens and others also discussed the coming peak in natural gas. Pickens is a strong advocate of switching to natural gas as a transportation fuel but he agreed that the peak in gas would follow shortly behind the peak in crude oil production. The gas scuttlebutt around the conference was the exploding number of wells being drilled and continued decline in actual gas production. I have mentioned it many times in the past but the market has not even begun to thought about a gas peak given the mild winters and drop in demand for the last two years. That will come back to the forefront very quickly if a real winter appears. Pickens is a heavy gas investor and he predicted $7-$8 in 2007-2008 and $8-$9 in 2009 without a cold winter. Once normal winters return that price could quickly go back to $12.

The drop in gas from Canada was a constant topic and rig counts in Canada are down -30% due to gas prices. Companies can't drill and produce gas in remote areas of Canada for $6 and make money. Canada is also worrying about the amount of gas being consumed by the oil sands operations and the slowing volumes in the pipeline. Lower volumes mean less available for upgrading and increasing oil sands production. I asked Boone if he was concerned about the falling volumes of gas impacting the oil sands output for Suncor (SU). He is a big investor in Suncor and he said Suncor had partial control of their own fate because Suncor had its own gas supply and was working to add to that supply. He remains bullish on Canada oil sands because of his views of oil production peaking worldwide. He confirmed he was still bullish on Suncor and I think we should be looking to enter a position on any pullback.

Pickens, Matthew Simmons and several other speakers kept using the current volume of global crude production as very near the top or already at it. Actual global crude production appears to have topped at just under 74 mbpd according to the monthly EIA numbers. Were it not for the addition of natural gas liquids from the vast number of gas wells being drilled we would already be seeing a decline in overall liquids production. Reportedly crude condensate and NG liquids are making up the shortfall on pure crude. NG liquids are the only liquid fuel still showing production increases. The problem there is the rapid decline rate for gas wells. The current wells being drilled in the U.S. are very rapid producers and very rapid decliners. Drillers have to race to drill new wells to offset the rapid decline of the wells they drilled just a year earlier. Remember there are over 1400 gas rigs operating in North America (a record high) and total gas production continues to fall. You may have noticed how well UPL and CHK did in Friday's sell off.

Leading the decline in the oil sector on earnings news was Schlumberger (SLB) with a minor earnings miss. SLB fell -12.30 after posting a +35% jump in earnings. SLB missed estimates by 2 cents after a factoring in a 4-cent benefit from a lower tax rate. That weak performance was due mostly to slowing services in North America from slowing drilling activity. It is hard to believe that drilling is slowing with oil at $90 but most drilling in North America is gas drilling not oil. America peaked in oil production back in 1970 although we still produce about 5 mbpd locally.

Matthew Simmons said on Friday that the water cut on east Texas wells was over 90%. That means for every 10 barrels of liquid pumped out of the ground nine of them are water and that ratio is continuing to rise. Reportedly that ratio in Saudi Arabia's biggest field has risen to more than 70%. It was widely reported by numerous presenters that Saudi production has fallen for the last 18 months and that was evident when OPEC cut their quota in the last round of output corrections. Saudi is currently spending $22 billion to hopefully increase their production capability from their current reported capacity of 11 mbpd to 12 mbpd by 2009. There are more than 120 active rigs in Saudi Arabia and that is six times the number of active rigs 5 years ago. When you consider their $22 billion expansion program and their falling actual production over the last 18 months it really causes concern that they will never see that mythical 12 mbpd target.

We should thank SLB for knocking the steam off the energy sector. I was about ready to write off all our watch list entries when oil hit $90 but you may have noticed that the oil sector has not followed the price of oil higher. If oil does tank next week on recession fears that riled the broader market on Friday then SLB could be the canary in the coalmine that leads the sector even lower. There may still be hope we can get some entries before the normal winter bounce.

I am going to cut this short tonight and head back to the last few presentations. This conference has rekindled my idea for a peak oil investor conference in the spring. I am going to work on some preliminary plans next week and see if I can make it happen. I would love to get our subscribers in front of about a dozen of these speakers and let everyone hear for themselves about the outlook for oil and gas as we head into the peak oil scenario at full speed.

November Crude Futures Chart - 15 min

November Natural Gas Futures Chart - Daily

November Gasoline Futures Chart - RBOB Daily


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