Peak Oil: Where are we in 2009

Andrews:  How has demand for your presentations and TV experiences moved up or down with the price of oil?

Simmons:  The flow doesn´t seem to be as intense as it has been periodically.  There was one point late last May when there were five different programs doing something on oil and I just happened to be in New York for three days, so I´ve never had a busier back-to-back-to-back.  I´ve done three live interviews the last three weeks and I was interviewed six times last week in Europe. 

If you saw the story in [we'll call it X] a few weeks ago, their bureau guy in Houston had finally gotten the green light to do a major story.  When he came over he said, ìI can´t tell you how many times I badgered my editors to let me do a story about you and peak oil, but they didn´t want to touch it with a barge pole. ‘That´s just something we don´t want to associate ourselves with.´ Then, with oil prices collapsed, I got a call a few weeks ago saying, ‘okay, we´re finally going to let you do your story on Simmons.  We want to do a story on how much crow he´s had to eat since he was so wrong.´  Had oil prices collapsed, I could not have caught their interest to do the story.  And this story finally taught them something about what this issue was all about.”

Andrews:  The Economist, which ran their famously wrong story ìDrowning in Oil” 10 years ago this March, recently did a story on you.  How did that go?

Simmons:  The writer said that, ìmy editors were really quite surprised.” He did a very balanced job of reporting, and he said they had never really heard the peak oil story before. 

In the case of ìDrowning with Oil,” I got a call in late February 1999 from their writer who introduced himself as being new at the energy desk but a long-timer at The Economist.  He said, ìI´ve been working on a major story for the better part of a month, and people I interviewed said I ought to interview you because you would have an opposing view.”  He said, ìthe story is we´re going to have $5 oil for a decade or two because Saudi Arabia is sitting on a $100 billion war chest, and once and for all they´re going to lower the price of oil to $5 and keep it there long enough to knock out the Caspian and other stuff, including any form of alternate energy before it gets out of hand.  ìWhat do you think of that?” And I said ìit´s the dumbest thing I´ve ever heard of.  The oil and gas industry is suffocating on a price as low as $10-$12.  Saudi Arabia doesn´t have such a war chest.  Mexico and Venezuela are hurting.  If we keep oil prices this low for another year to 18 months, we´ll lose 4 million barrels a day of supply.   Then we´ll have an oil shock.”  And he said, ìoh, you can´t be right.  I´ve talked to Shell, Exxon, Amy Jaffe, Dan Yergin-everybody.”

The next week in Europe, I spotted a kiosk with The Economist with ìDrowning in Oil” on the cover.  I read it in the cab and realized this is twenty times worse than I ever would have thought.  That was on Tuesday.  On Friday, the oil ministers of Saudi Arabia, Mexico and Venezuela brokered a deal to take 2.1 million barrels a day off the market.  When they cut, they actually cut into a balanced market.  Within 18 months, oil was up around $30 and we were dumping 30 million barrels from the Strategic Petroleum Reserve into the market to cool it down before the election.

The writer didn´t start out with a hidden agenda.  He simply wondered what the implications of these low oil prices are.  This was the era when the majors believed that technology had brought the cost of oil way down for a decade or two to come. 

Andrews: Have the media treated you fairly?

Simmons:  A few people have been trying to paint me into a corner for a long time.  But by and large, I´ve been treated unbelievably fairly by the media.  And I think one of the reasons is based on the feedback I get, which is ìthanks for the easy way of describing these things so they aren´t so mysterious.  And you have facts-most people don´t.”  My thinking: do your analysis first; second, check it again; third, don´t rely on a third party; then, if that´s what you conclude, go ahead and speak out with the courage of your convictions.

Andrews: Do you recall when you started studying the peak oil story?  It was sometime in the 1990s?

Simmons: I wasn´t studying the peak oil story then.  In 1989, I began pondering-as it was clear to me that the worst was over in terms of the smashed rig count-when it would have a deleterious impact on oil supply in the US.  At that time, it hadn´t had nearly the detrimental impact that I would have thought.  We started running correlations of wells drilled vs. reserves added.  It appeared that there was a two- or three-year lag; there´s almost a perfect correlation of when the decline startsÖ That´s when I realized how few people knew that if you don´t drill, it eventually shows up.  Then in the early 1990s I started hearing the first of what became a loud chorus of commentators about how modern oil-field technology had been the game-changer-that we only needed one rig for what we used to do with 8 rigs because of horizontal drilling.  And because of 3-D seismic we no longer drill dry holes.  Since our firm did all the investment banking in all those technologies, I felt ‘what an unadulterated bunch of baloney.  None of this is true.´  That´s when I started realizing that few people in the industry really appreciated what decline rates were.  So I spent an enormous amount of time during the 1990s trying to analyze depletion data: the rates of decline.  As the fields started using those technologies, the decline rates accelerated. 

At that point I still didn´t understand what the peak oil issue was all about because I automatically assumed that we had so much oil in the Middle East that we´ll never have peak oil.  But I thought if we don´t spend a ton of money in the Middle East, we´ll have peak capacity.  And what´s the difference?  We have it in the ground but we can´t use it.  So it was probably when I started doing the study on the world´s giant oil fields that I started glimpsing maybe the Middle East is an illusion too. 

Andrews:  When did you publish that giant oil fields paper?  We still view it as a ground-breaking paper in the long-evolving peak oil story.

Simmons: December 2001, I believe.  I was speaking at a Council on Foreign Relations event in the winter of 2002 and Ken Deffeyes came up from Princeton and told me, ìYour giant oil fields study is the most important work since Dr. Hubbert did his original analysis.  It´s the first time that anyone´s looked at flow rates.”  It certainly gave me some context for when I finally spent a week in Saudi Arabia; you hear about that handful of enormous fieldsÖwell, take note because that´s all they have. 

So it was the late 1990s [the interest in peak oil].  But again, my fascination was, how do we replace these decline curves?  As flows start to slip, unless you start spending a lot of money in the Middle East, I don´t care much oil you have in the ground.  And by then, I started to realize that I don´t think ìreserves ìmean anything.  Because I´ve watched, being on several boards of oil companies reporting 130-140% proven production additions than they produced over the years, while in five years production growth has gone to zero.  I asked, are you sure these numbers mean anything?

Andrews:  What are the big differences between the demand drops post-1978 and today?

Simmons:  They´re as comparable as the Crimean War and the Vietnam War.  I recently heard Leo Drollas and Ed Morse presentations in which they lamented that ìwe should have learned from 1979 that high oil prices kill demand: they always have, they always will.” I have told people over the last few months that today has no earthly resemblance to what happened in 1979.  When oil prices were still rising in 1979, the world was seriously rolling out the only new form of energy in the 20^th Century-atomic energy.  It had been building for 15 years and that wasn´t in response to $30 oil.  In 1979, we were still bringing in oil from three of the last great frontiers, all discovered in 1967-69: Western Siberia, the North Slope of Alaska, and the North Sea. High oil prices kept those expensive projects afloat. 

Crude oil demand grew from 46 million b/d in 1970 to its then-all-time high of 62.7 mb in 1979.  The enormous swing in price-from $2 a barrel to $35 a barrel, from 1970 to 1979-didn´t slow demand.  By 1983, demand did drop to 53.3 million b/d.  The four major demand reduction drivers were fuel-switching to nuclear, fuel-switching to coal, vehicle efficiency and off-shoring heavy industry.  So only a fraction of the decline in demand came from what everyone has said for two generations: ìhigh oil prices workedÖconsumers changed their habits.”

With respect to demand today, some of the OECD countries are now very mature and haven´t been growing their populations or economies.  Japan and parts of Europe are pretty gray, pretty mature, so we shouldn´t be expecting robust growth in either their economies or in oil demand.

 Over the course of the 12 months preceding the price collapse, when we had oil going from $70 to $145 and backing off to $120, we had only a deminimus change in a few of our key demand markets for oil, even though we were capping off a decade-long rise of 15-fold in oil prices. That´s a little reminiscent of the 1970s, when oil prices rose 10-fold, though demand rose until the end.  The higher that oil prices went last year, the more that people who had staked their careers betting this would never happen said ìsupply is going to soar, and demand must be falling.”

Along came June-July-August numbers out of the EIA, which are the only sort-of-reliable near-term estimates we have on demand.  People started to observe that we´ve finally seen a crack in gasoline demand, starting to decline year-over-year.  All sorts of stories started circulating how gasoline demand has finally turned down for the first time since 1990. 

In July in Maine, which is peak tourist season, many of the gas stations we passed were down to one pump in operation.  When I asked why, I was told their supply was being allocated, restricted.  At least one of the distributors had small gas stations on credit watch, since they were lending them product to the tune of $400,000, leading to large exposure for skinny margins.  So they were limiting supply to avoid write-offs from dealers that might go bust. 

In the spring of 2007, I spoke with Linda Cook at the EIA event in April.  I said that with gasoline stocks at such unbelievably low levels, we need to be concerned about potential shortages leading to a panic that people would respond to by  topping up their tanks, which could dry the system dry in two or three days.  I asked her if they had ever considered this, and the need to possibly print up rationing tickets.  She did, and said she was laughed at-”Linda, you´re hallucinating.” She said she had been noticing that at service stations in the Beltway area, when she looked at the last purchases on the pumps, a lot of them were at $5 or $10, rather than filling up.  People were driving around with just-enough gasoline in order to avoid having to pay for a full tank.  Last summer, AAA reported that they had a 17% increase in their use of tow trucks for people who had run out of gas.

Then came September, and we had the big collapse, because we had two back-to-back hurricanes.  Right after Ike hit, Houston was without power for the better part of two weeks.  Refineries, with their own generators, were without power just long enough that we had service stations with outages that spread all across the south, as far up as Maryland.  Only the Atlanta part of the story was covered, other than by local news, because the national news was being totally dominated by failures of Lehman Bros., AIG, Merrill Lynch, etc.  Had we not had the financial meltdowns, those other stories would have been covered, then motorists would probably have topped up their tanks and we would have run out of gas. 

EIA´s weekly data in September was total junk because nobody was around in the Gulf Coast to measure it.  In late October, by the time they released their monthly report for September, it showed a gasoline decline of 11%.  People were saying, ìhigh prices started this avalanche, but it´s cascading.”

At the recent Yamani Conference, Paul Horshnell, who does a fabulous job, said that we´ve seen the worst of the demand destruction in the US, which clearly had to be impacted by the hurricanes.  But when you look at the IEA´s demand drop for 2009, two-thirds is coming from the US, based on the assumption that the third quarter wasn´t an aberration but a trend.  Yet if you look at gasoline consumption over the last five months, gasoline consumption is up 2%, then down 2%, then up again.  Diesel fuel is still down about 10%, but most of that is exports.  Then jet fuel is down 10%. Relative to the price collapse, you would expect a major drop as opposed to the modulation we´ve seen.   It´s more or less unchanged, vs. a headline story.

But what I´m now sure of is that, in North America-in the only easy place in the world to stop drilling-we have stopped drilling.  Hopefully we´re getting towards the bottom of the decline, but the decline has been savage.  Around the rest of the world, we´re slowing down every planned project that is supposed to be getting started, and a lot of things needed to complete ongoing projects are being put on hold.  There is an enormous effort by the major oil companies to use this low-price environment to finally get oil services inflation under control.  While there is a lot of lip service going around that their budgets remain unchanged, the fact of the matter is that they´re killing their contractors. BP apparently sent out a letter to all their suppliers saying ìBP has a large budget for this time of year, but if you want part of it drop your costs by 30%.” 

Andrews: Even with all the storage topped up and all the so-called floating storageÖ?

Simmons: The latter is a bunch of BS.  First of all, to play that game, it would basically mean that for the idea of possibly capturing some found money, you somehow airlifted oil out onto a tanker and you figured that somehow or other you´ll deliver it at Cushing. The near-month price for WTI was the only month that had this sharp contango; the others were way higher.  Do you know how much it would cost to store 80 million barrels? Over $5 billion. It´s an extremely expensive game to play, which is why no one does it, other than in the minds of oil traders.  Every time the price collapses, you gotta have a reason for it. 

Our finished supplies of gasoline are down to 89 million barrels.  We´re back to where we generally are after a long savage hurricane.  So we better hope that motor gasoline demand is way down because our stocks are very skinny.  Stocks of crude are back where they were in April-June of 2007.  They are on the high side of the historic averages, but for the last five years we´ve bounced around the lowest levels we´ve ever had.  Back in 2007, we weren´t saying we´re drowning in oil. 

If we don´t see a snap-back in prices for three to six to nine months, we should start preparing ourselves for a very large loss in supply, and brace ourselves for a shortage, unless suddenly demand does start to plunge, which so far it hasn´t done.  If oil prices just stay unchanged for 18 months, or just bounce around with no confidence, then the industry will say, ìOh, that was a mistake, we need to start drilling!”  The lag time in getting started is another 18 months.  In 30 months, we could find crude oil supply-which was 72.2 million barrels a day in the fourth quarter, according to EIA estimates-down to 66.5 million b/d, with worst case at 59.6 mb/d.  That´s obviously an utter catastrophe. 

So, the difference between today and 10 years ago, when we had the ìAsian flu,” is that the rig count recovered very quickly back then so we only had about 9 months when things could have really started to hurt.  It snapped back so sharply.  Also, back then we didn´t have decline curves nearly as vicious as we do today.  The market in 1997 was tight as a drum until about the end of the year.  It started weakening as 1998 progressed and then the surprise collapse grew momentum.  In September 1998 I remember talk of stacking rigs, but six months later we were off to the races. 

[Footnote: in December 1998, the EIA forecast that demand and oil prices would remain lower-the $14 range was cited-through 2007, thanks in large part to the Asian flu.]