Traders Cooperative

[Joe Stocks]

As some of you may know a am a big fan of Jim Brown over at
OptionInvestor.com. I always look forward to his commentaries. Keene Little is a good technician there too. Last night Jim gave his perspective on the big oil find that has propelled RIG, CVX and DVN among others. I thought it was real interesting. Interesting enought that I did a pre-market order short on DVN before leaving today that now has a 3+ point gain. Unfortunately the letter by paid subscription only. However, I thought I would share this excerpt in hopes that Jim will look the other way in exchange for the 'plug'. I think they offer a free trial offer. http://www.optioninvestor.com/default.aspx

>>The big announcement for the day was another deep-water discovery in the Gulf by Chevron, Devon and Statoil. The well, Jack #2, was drilled to 29,000 feet in 7,000 ft of water. The estimated discovery was widely said to contain 3 billion to 15 billion bbls. The oil crisis was quickly claimed as over and dependence on OPEC was a thing of the past. You know I am a student of the energy industry and these kinds of comments in the press drive me crazy. But we all know, it is not a long drive.

Let's take this announcement and see what it really means. First, Chevron first announced this potential find back in 2004 followed by a successful test of Jack #1 and another announcement in Sept 2005. Nobody bothered to shout it from the rooftops before. BP, Devon and Anadarko announced a similar discovery in the same formation just last week. Devon said the discovery was "the largest to date" in the lower tertiary formation and could possibly hold 500 million bbls. Their stock rose $1 on the news. That BP/DVN/APC well Kaskida was drilled to 32,500 feet. Why were the past discoveries largely ignored? Because they did not claim they found oceans of oil like Chevron. The BP/DVN/APC claim was only 500 million bbls not 15 billion. The CVX/DVN/STO claim was for 3B to 15B NOT just 15B. How quickly the press seizes on only the big numbers. The Chevron well ONLY tested at 6,000 bpd from 40% of the net pay. That is good but quick math shows that it would take seven thousand years to pump 15 billion bbls at 2.1 mb per year or 1500 years to pump 3b bbls. The reason Chevron claimed such big numbers was the amount of acreage they hold in the 300-mile wide area that "may" produce oil from this formation. Probably the correct wording of the announcement would have sounded something like this. "Chevron announces today the discovery of oil in the lower tertiary formation in the deep water portion of the Gulf. If Chevron completes several hundred wells at the cost of $80-$120 million each over the next 50 years it is possible this field could produce 3B to 15B bbls of oil within this century. Completion of these wells could cost from $600 million to $1.5 billion per platform. Chevron acknowledges there are no pipelines in the area which is 175 miles offshore in 7,000 feet of water."

Chevron acknowledged it would cost tens of billions of dollars to complete these wells and they were not even sure at the present time if they could be commercially completed. That means it MAY cost more to get the oil out of the ground and delivered onshore than it is worth. All they have proven at this point is that oil exists 30,000 feet under the ocean in this formation. It will take years before any oil is actually produced if it does prove commercially feasible. The earliest date for potential production is 2011-2014 but without several more grossly expensive wells they don't have a clue how much they can produce. Estimates are 300,000 bpd to 500,000 by 2015. Until they spend several hundred million more dollars and several years they will not know for sure. BP and Chevron both set records for depth, pressure and duration while drilling the wells. The perforating guns were fired at record depths and the test tree and other drill stem test tools set records for operating at depth. Just setting records with specially constructed test equipment is not the same as producing oil from record depths. All production equipment would have to be specifically designed for this application. It could literally cost tens of billions of dollars before any commercial production appears from this formation. The official estimate I heard from several sources is production of one million bbls per day by 2020. That is a lot of oil and it will take many years for the companies to recover costs much less turn a profit.

To quickly put this into perspective we only need to look at the chart below. The world currently produces about 83 million bpd of oil and consumes 82.5 mbpd based on numbers provided by BP at the end of 2005. The depletion rate of existing fields is normally 4-5% and sometimes much higher. Saudi Arabia is currently facing an 11% depletion rate on Ghwar and Mexico's Canatrell field is losing production at an even faster rate. At the energy conference I attended in August the consensus among the major presenters there was about 8.5%. This means for every 100 bbls of oil produced today they have to find and produce an extra 8.5 bbls just to stay even next year, 17 bbls the year after, 25 bbls the year after, etc. This is the current gospel from major producers in the business, not from an analyst like myself. In the table below I only used a TWO PERCENT depletion rate, not 4%, 5% or 8% as the industry is currently seeing. Using only a 2% depletion rate and the current +1.5% increase in the annual consumption rate (per BP) the world will have to find and produce an extra 2,397,500 barrels per day just to stay even in 2007. Five million additional barrels per day by 2008, 8 million by 2009, etc. By the time 2020 arrives and the BP/CVX deepwater discovery is fully online the world will need an additional 39 million bbls per day just to stay even with current consumption trends. Obviously this demand/production chart will break down well before 2020 as the rising price of shrinking oil supply kills demand growth. However, just holding demand where it is today at 82.5 mbpd won't work either. By 2015 we will need to add 13 mb per day to existing production just to stay even. Unfortunately because of the long lead times from discovery to production we already know what oil should be online by 2015 and it is only about 7 mbpd of new production. That leaves us short by 6 mbpd. Are the Chevron/BP discoveries important? Heck yes but they are not the answer to the problem. They will produce huge amounts of oil by 2015 and it will be sold for record prices well into triple digits. Today's news is a tree falling in the forest. A month from now it will be forgotten and life will go on inexorably toward the point where demand finally exceeds production and the world changes as we know it. <<<