1
2	What Is A “Fair” Price For Oil? If oil was just invented, what should its price be?
3	How Are Other Important Goods Priced?
4	A Pillar Of Financial Security Long-term contracts at fair prices lower the cost of any valued product. Low cost debt safely anchors the total investment. AAA rated debt is extremely inexpensive. 15% return on equity is a great deal! Finance 101: Finance brick and mortar with long-term debt.
5	High Risk Projects Demand High Risk Returns No long-term supply contracts. Extremely volatile prices. Key products are priced on the “incremental cost” to create last 1%. Vendors crushed to steal their fair return.
6	Oil Did Create Phenomenal Value To Its Users Oil underpinned the 20^th century (oil and electricity won the century’s Academy Award). Its use enjoyed phenomenal growth.
7	Oil Occasionally Created Great Wealth Rockefeller wealth created to protect against “busts.” Sheiks, J. Paul Getty, Melons and Hunts all achieved lasting multi-billionaire status. Some service providers got rich too: Howard Hughes; Greek tanker tycoons; Occasional drilling contractor or inventor. 80% to 90% of oil players went bust. Service providers enjoyed one great year for every seven years of poverty. Host countries got increasingly poor (“The Oil Curse”).
8	Oil’s Pricing Committee Failed Miserably While the entire food chain lost value for two decades, oil prices were “reasonable, sustainable or normal.” “We just wrote off $6 billion but are well placed for coming era of $10 oil.” (Shell Group Chairman in early 1999)
9	Financial Returns Of “Good Barrels” Spirits enjoy operating margins of 50% to 80%. 2001 - 2003 wine glut collapsed margins to only 15%. Napa Valley Cabernet grapes now sell at $500 to $1,000 per barrel equivalent. The glut is ending as fewer vines are planted. Are energy barrels really so much less valuable?
10	Oil Prices Were Too Low For Too Long 1974 – 1981: Oil boom finally created burst of wealth. 1982 – 1992: Oil Depression took it all back. 2000-2001 Recreation of a tiny bit of Boom: wealth.
11	Most Oil Executives Believe Oil Prices Will Fall Prevailing views of many CEOs: “Oil prices are cyclical. What goes up must come down.” $20 to $30 oil is normal price. 2004 oil prices were created by abnormal events and fear.
12	Reality: It Is Expensive To Create Energy All forms of modern energy are expensive to create. Cost to convert raw energy into useable energy is extremely high. Energy CAPEX needs to be financed. Using long-term contracts at fair prices best insures reliable energy supply. If energy project is 100% safe, little expensive equity is needed. Early 1970s LNG projects were seamless. Seamless projects created real project financing.
13	How “Safe” Energy Projects Work The Perfect Model:
14	Spot Energy Pricing Destroyed Solid Energy Models Long-term energy supply contracts disappeared. Commitments to key suppliers (vendors) became increasingly short-term. Efficient free markets became a mantra for high volatility. Current financial risks might now exceed geological risks. Energy’s mistake: All commitments became short-term.
15	For Oil And Gas, GAAP Accounting And “Proved Reserves” Created Illusory Costs If abandoning long-term contracts was a mistake, GAAP accounting compounded this error. GAAP accounting enables all costs to be capitalized once “proved reserve” status is achieved. Capitalized costs to develop and produce oil and gas can total 90% to 95% of all real costs. These costs are expensed (DD&A) over the life of an oil or gas field (units of production accounting). This all works if total reserves and estimated life are correct. Most energy people think DD&A is not a real cost.
16	Our Building Costs $.02 Per Square Foot Bank of America Center is one of world’s great sky scrapers. It costs $.02 square foot! (using oil math). Building cost: $300 per square foot (1984 $). Estimated useful life: 50 years. 300 ÷ 50 ÷ 365 days = $.02 per square foot per day. The number is mathematically correct. F + D cost per barrel is equivalent of $.02 square foot!
17	The Real Cost Of Oil Land owners want fair share. Governments want taxes on all profits. Explorers want high returns for taking high risk. Service providers want fair return in proportion to their risk. Long-term contracts: 15% after tax on invested capital. Spot contracts: 40% + IRR is minimum venture capital. Downstream transportation and processing want same returns.
18	What Constitutes Illusory Financial Returns? Dividing costs by “Proven Barrels.” Calculating returns on net assets when 95% of assets are written off. Calculating 20% of foodchain’s fair return while ignoring the other 80% getting little or no return. Assuming smart money will lose time after time.
19	Low Oil Prices Created Proven Reserve Write Downs Instead, 3-D seismic, reservoir simulation models and “analog analysis” created knowledge of “how much was there.” By spending less, it was easier to find more.
20	Proven Reserves Grow by 25% More Than Production Many E&P companies spent last decade adding 15% to 40% more proven reserves than they produced. In perfect world, 4 years of 125% growth leads to output doubling. Instead, while cost to find and develop oil soared, most producer’s production growth waned.
21	Why We Drilled Appraisal Wells Appraisal wells are “other exploration” after new field wildcats determined hydrocarbon presence. They told how large a structure’s hydrocarbons really were. They also had a tendency to deliver “bad news” on limits to field sizes.
22	Without Bad News, Beauty Is In Eyes Of Beholder A minimal number of appraisal wells limited the knowledge of a structure’s recoverable reserves.
23	How The Cost To Create Energy Plummeted
24	Even $30 Million Exploration Cost Was Illusory Return on investment can be high when investment has been written off. “The R.L. Manning Syndrome” (1978). 17 Rigs = $5 Million PP&E 18 Rigs = $10 Million PP&E
25	Do We Have Any Idea How Much Future Energy Will Cost? IEA’s World Energy Outlook 2003 created glimpse of energy bill over the next 30 years: $16 trillion. $10 trillion for electricity. $6 trillion for oil and gas. This still leaves 1.5 billion people with no electricity. Over half are keeping current supply flat. The oil and gas expenditures are probably understated two to five fold. Real number could be $30 trillion. Why? In 2002, 40% of supply spent $160 billion to stay flat. If other 60% spent same, current spending would total $400 billion. $400 billion x 30 = $12 trillion.
26	Energy Prices Need To Create Energy Profits Merely covering replacement costs is insufficient. Shareholders and governments want their fair share, too. This “profit” is critical to insure sustainable energy. Shareholder returns induced the “food chain” to finance energy creation. Government returns covers “social costs.” (Taxes) Both stakeholder’s needs are extremely important.
27	Will Pending Data Reform Reveal Real Cost Of Oil? Many key governmental institutions are joining effort to create major energy data reform: Field-by-field (on key production units) accounting of “production by well bore” will create genuine decline rate analysis. Classifying key reserve data on same field-by-field basis will lift fog of proven reserve myth. This reform is urgent and will happen. Ignoring this for much longer is too dangerous. Its implementation could be swift.
28	Creating A Fair Return For All Stakeholders Is Important Owners of oil want to end “the oil curse” and begin creating prosperous economies. Providers of services and supplies to find, transport and process oil have to demand a fair price. Investors in oil’s future will either demand fair returns (commensurate with risk) or stay away from oil investments.
29	OPEC Demographics
30	What Prosperity Do Normal Countries Enjoy?
31	Cost To Create OPEC “Prosperity” Goal: Create average GDP per capita of $15,000 per person. Population 2015: 667.4 million people. Needed GDP: $10 trillion (versus $820 billion today). Cost to create: $2 per $1 growth = $20 trillion. Price of OPEC oil exports: 25 million: $182 per barrel 30 million: $140 per barrel 40 million: $105 per barrel
32	Is This “OPEC” Pricing Model Absurd? Could this world afford this energy cost? Instead, should we demand OPEC stay poor? Could this spending perpetuate global prosperity?
33	What Would A New Oil System Cost? Finished oil delivery system: Geophysical equipment Drilling equipment Plants to build bits, mud wellheads, etc. Oil, gas and water processing plants Pipelines to terminals Tankers Pipelines to refineries Refineries Pipelines/ships to finished product distribution “Gas stations”, etc.
34	Can We Recreate A Sound Energy System? Modern energy is the world’s most vital product. Merely keeping 200 million BOE/day of energy equivalent flowing is extremely expensive. Since steel and energy costs have doubled, the cost to keep supply flat has also doubled. We have no energy blueprints. We have no new factories to build rigs. We have an aging workforce. Why would anyone invest in this?
35	We Must Start Anew The world’s energy delivery system is very old. The majority of the world population is both young and poor. The world’s most important product is abundant and reliable energy. It would be nice if energy was also affordable. This might be a luxury we wasted. “Cheap” energy era was a bad deal.
36	Spot Market Efficiencies Created An Energy Illusion We pretended population growth was ending. We pretended energy demand was slowing. We “knew” moderate prices would create supply glut. We “knew” technology would steadily reduce costs. We assumed new generation of employees would create next generation of energy.
37	Other Valuable Raw Materials Were Also Too Cheap Until last year, most raw materials sold at 30-year lows. Majority of prices have suddenly soared. “It’s China’s fault.” Costs to transport raw materials have also soared. Was globalization concept also flawed? It assumed raw material cost was incidental. It assumed transportation costs were negligible.
38	It Is Time To Wake Up! The two-decade dream that things and values were also free is ending. We wasted a valuable decade to gear up for expansion. Are we sure there is a resource availability? Do we have enough time to find out?
39