OilVoice Magazine | August 2012

Edition Five – August 2012

Beyond Thunderdome: The Oil Scarcity Story

Investing in oil: 5 Questions to ask company management

Floating LNG: The new revolution in offshore natural gas

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OilVoice Magazine | AUGUST 2012

Adam Marmaras Manager, Technical Director Issue 5 – August 2012 OilVoice Acorn House 381 Midsummer Blvd Milton Keynes MK9 3HP Tel: +44 208 123 2237 Email: press@oilvoice.com Skype: oilvoicetalk Editor James Allen Email: james@oilvoice.com Advertising/Sponsorship Adam Marmaras Email: adam@oilvoice.com Tel: +44 208 123 2237 Social Network Facebook Twitter

Welcome to the 5th edition of OilVoice Magazine. This month we bring you all new content from our stable of industry experts. We also have the pleasure of adding some new authors to the magazine, and I'm sure you'll enjoy what they have to say.

Bill Haskett from Decision Strategies Inc. - Bill Haskett is a Senior Principal for Decision Strategies Inc., a Houston based management consulting firm that integrates strategy development with risk management by working closely with clients to gain clarity around the uncertainties, objectives, and key decisions associated with complex situations.

Gary Hunt from TCLabz - Gary Hunt is President, Tech&Creative Labs, a disruptive innovation business collaboration of software, data and advanced analytics technology companies working together to integrate their products to meet the changing needs of the energy vertical.

Saj Karsan from Barel Karsan - Saj Karsan founded an investment and research firm that is based on the principles of value investing.

Robert Kientz from Drop Shadow - Robert has been an investor for many years and has 7 years experience working as a corporate auditor and has 13 years corporate working experience.

Google+ Linked In Read on your iPad You can open PDF documents, such as a PDF attached to an email, with iBooks.

Andrew MacKillop - Andrew MacKillop is an energy and natural resource sector professional with over 30 years experience in more than 12 countries.

As always, if you enjoy what our contributors have to say then take a moment to visit their homepage/blog to learn more. Does this sound like something you'd like to get involved with? Drop us a line and we can get your commentary out to a global oil and gas audience within days. Our most popular articles get tens of thousands of pageviews online.

Have a great summer and enjoy the Olympics!

Adam Marmaras Managing Director OilVoice press@oilvoice.com | +44 208 123 2237

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OilVoice Magazine | AUGUST 2012

Contents

Featured Authors

4

Biographies of this months featured authors

Oil's saving graces

7

by Andrew MacKillop

Floating LNG: The new revolution in offshore natural gas

by Keith Schaefer

Insight: Tilting at Windmills...

12

by David Bamford

Recently added companies

14

The latest companies added to the OilVoice database

Insight: Give us a break...

15

by David Bamford

Evidence that oil limits are leading to declining economic growth

by Gail Tverberg

Exxon and the historic oil majors face troubled times

by Andrew MacKillop

Exploration: Hot spots and hot rocks

17 24 28

by David Bamford

Beyond Thunderdome: The Oil Scarcity Story

31

by Robert Kientz

How the shale boom is causing a drop in the NGL price

by Keith Schaefer

How much oil growth do we need to support world GDP growth?

by Gail Tverberg

The materiality question

43 47 51

by Bill Haskett

New oil and gas discoveries changes picture for alternative fuels

by Larry Wall

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OilVoice Magazine | AUGUST 2012

The Big Shift in energy is not what you think

59

by Gary Hunt

Lower oil prices - Not a good sign!

65

by Gail Tverberg

Investing in oil: 5 Questions to ask company management

by Keith Schaefer

Exploration: Hot spots...

72

by David Bamford

Oil 101: Tough predictions

75

by Saj Karsan

Energy security and cooperation in South China Sea

by Anita Abbott

China continues to boost its oil and gas assets with Talisman and Nexen bids

by Richard Jennings

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Jobs The OilVoice Jobs board is fast becoming the place candidates look for their next move in the industry. Featuring adverts from top draw recruiters, CV upload capability, and an easy application process. New jobs are appearing every day, so be sure to bookmark it.

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Free Membership Over the past ten years we've grown to over 30,000 members. If you're not a member then you should start now, it only takes a second. Then you'll be free to post job adverts, events and press releases.

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OilVoice Magazine | AUGUST 2012

Featured Authors

Andrew MacKillop OilVoice Contributor Andrew MacKillop is an energy and natural resource sector professional with over 30 years experience in more than 12 countries.

Keith Schaefer Oil & Gas Investments Bulletin Keith Schaefer, editor and publisher of the Oil & Gas Investments Bulletin.

David Bamford OilEdge David Bamford is non-executive director of Tullow Oil, and a past head of exploration, West Africa and geophysics with BP.

Gail Tverberg Our Finite World Gail Tverber has an M. S. from the University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty Actuarial Society and a member of the American Academy of Actuaries.

Robert Kientz Drop Shadow Robert has been an investor for many years and has 7 years experience working as a corporate auditor and has 13 years corporate working experience.

Larry Wall HubPages Larry Wall is a long-time observer of the oil and gas industry as a result of his 16 years newspaper reporter career.

press@oilvoice.com | +44 208 123 2237

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OilVoice Magazine | AUGUST 2012

Bill Haskett Decision Strategies Inc. Bill Haskett is a Senior Principal for Decision Strategies Inc., a Houston based management consulting firm that integrates strategy development with risk management by working closely with clients to gain clarity around the uncertainties, objectives, and key decisions associated with complex situations.

Gary Hunt TCLabz Gary Hunt is President, Tech&Creative Labs, a disruptive innovation business collaboration of software, data and advanced analytics technology companies working together to integrate their products to meet the changing needs of the energy vertical.

Saj Karsan Barel Karsan Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, has completed all three CFA exams, and has an engineering degree from McGill University.

Anita Abbott HubPages Abbott is a freelance writer, based in New Zealand.

Richard Jennings Spreadbet Magazine Richard Jennings' background is as an equities fund manager, being responsible for in excess of half a billion pounds at a local authority fund. He qualified as a CFA in 2000 and has been an active personal investor over the last 10 years, recently starting Spreadbet Magazine to enhance traders understanding of the markets with quality and thought provoking features.

press@oilvoice.com | +44 208 123 2237

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OilVoice Magazine | AUGUST 2012

Oil's saving graces Written by Andrew MacKillop from OilVoice Just when things looked so bad for oil its price was set upon greasy skids, on a downhill slope marked by slowing world oil demand, OPEC overproduction, increasing NOPEC output and large new finds of oil and "greasy gas" able to yield more NGL output, the mood changed and the bulls came back. US CFTC (the commodities trading watchdog agency) data will soon show investor buy intentions have firmed in the last few weeks, after a massive dip.

What happened has several strands, none of them good for where the global economy may be heading, and only good for oil in the short term. Ben Bernanke's careful way of saying he is not ready to do QE3 or clone versions of it surely caused some initial disappointment, but on mulling the way he said it oil turned around and rallied, as other harder-edged figures came in. The US housing market and an apparently strong number for US industrial production were able to outweight the bad news from China and even worse economic news from Europe. Both in the US and Europe, only bad news comes out on job numbers, in theory meaning there has to be more easing somewhere and sometime. Before then and easier to forecast, global oil demand is not set to bounce: the question is will it fall ?

SUSTAINABLE RECOVERY Wielding the keywords "sustainable recovery", and the lack of it, Bernanke's assessment of the US labor market means that easing has to come - sooner or later. How much of that trickles down to car purchases, and gas station frequentation is another can of worms, and barrels of oil the USA that will likely not be consumed because the new cars purchased are more gas efficient, drivers make shorter voyages, non-fuel driving costs are high, and a pile of other factors are operating to prevent US motor fuel demand ever regaining its last record - five years back in 2007.

Sustainable recovery is far from Mr Bernanke's only problem. China's economic slowdown, to some, was not as bad as expected at a 7.6% annual growth rate forecast going forward, but going back to June 2011-June 2012 the killer number was delivered: China's electric power consumption flat lined - zero growth. This has simply never happened before, meaning something big is happening - if Chinese statistics can be believed.

China's hopes for stimulus is running high but here again the signals are confused. Apart from the urban renewal and development program announced in May, with a 5 trillion yuan ($796 bn) price tag but no timelines ('through 2012-17'), and styled as targeting energy saving in Chinese cities, including caps on car fleet growth in several major cities , the latest announcement of Chinese stimulus spending intentions concerns China's railway infrastructures. Short-term investment spending may double in the second half of this year, and full-year spending will be a suspiciously exact 448.3 billion yuan ($70.3 billion), according to the National Development and Reform Commission's Anhui branch. Even this press@oilvoice.com | +44 208 123 2237

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program, like the "green cities" program directly attacks China's future oil demand. Chinese railways are set as backing out the spiraling number of trucks used to transport coal in China, and railway electrification with a fast-rising role for wind and solar power is also targeted.

Railway development in China is moving to high gear, not only as a job-creating alternative to China's flurry of "city building in the desert" that has gone awry. The document indicates a 9 percent increase from a previous plan of 411.3 billion yuan. Spending on railway construction dovetails with previous national spending on rail beds and bridges, already used as stimulus during 2008-10, and makes it easier for China to take the foot off the gas pedal of its car fleet - which this year will record its first single digit growth for at least 7 years. The global financial crisis, which heavily exposed the fragile non-sustainable underside of globalization, and also saw oil prices hit $147 a barrel in July 2008, has sent a set of new signals to Beijing.

INDIA, BRAZIL AND OTHER NON OECD G20, ALSO The same lessons have been learned by other G20 members outside the OECD group. The downturn in several of them, including India and Brazil has been sharp, with Brazil's growth rate falling to "OECD type" levels. India is also facing up to de-growth with official hope of more than 5% this year being put to the test daily, as inflation rises and growth shrinks. Also shrinking, India oil demand growth has fallen from a year-average close to 6% for 19992009, to around 3% going forward. For China the 2000-2010 yearly average was a whopping 9.5% but going forward it is unlikely to top 6%, and even that estimate may be high end.

Oil saving is worldwide now and apart from the global economy needing less oil for the same output, we have the gas-and-renewables phenomenon. Both can and will back out oil from the power generating mix: unlike the OECD group, where oil-fired power production is a folk memory (the US in 2011 got 1% of its electricity from oil), the Emerging and developing countries used around 2.2 billion barrels of oil for power production in 2011 based on IEA and UN agency data. Several low income countries still get 50% or more of their power using oil-fired plant, and the life expectancy of that plant is low because the alternatives exist.

World bulk and container shipping, too, was a regular 7%-a-year oil demand growth performer, until 2009, but since then the growth trend has broken. Like power production outside of the OECD using about 2 billion barrels-a-year, the bulk shipping sector is ripe for technology change. Alternatives to oil will include gas, even coal and the use of kite-assist windpower making it possible to see this sector's oil demand flat-lining within a short number of years, kickstarted by the global slowdown's heavy impact on shipping activity.

THE SYRIAN WILD CARD Nothing like the Gaddafi ouster and low level civil war in Libya, Syria's regime change is an epic flashback to the Cold War, and totally unlike Gaddafi, the Bashr el Assad regime has allies: Russia and Iran. Today's news of the Defence ministry attack and death of leading members of the regime only ups the ante. Where the Syrian civil war goes now is an open press@oilvoice.com | +44 208 123 2237

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subject. The regime could go down fast and fighting, or slow and fighting. Russia could treat it as their second Afghanistan war - that they intend winning this time around. Iran can treat it as a way to get a hit at its Gulf petromonarchy enemies, who are openly arming Syrian insurgents.

The oil connection is close and getting closer. Any concrete military moves by either Russia or Iran to salve the el Assad regime will start doing impressive things for oil prices in daily trading. The geopolitical risk premium will be back, and as previous experience shows this can spiral up to more than +30 dollars in short time, with a knock-on bolstering the world value of the dollar.

Article by Andrew MacKillop

View more quality content from OilVoice

Floating LNG: The new revolution in offshore natural gas Written by Keith Schaefer from Oil & Gas Investments Bulletin A decade after hydraulic fracturing, or fracking, started the shale revolution and ended high natural gas prices, another revolution is set to rock the industry-Floating Liquified Natural Gas-FLNG. It's the leading edge of the natural gas world, and it could impact Canadian and US hopes for huge LNG exports. A full 10% of the LNG world is expected to be sourced from offshore LNG by the end of this decade, with costs potentially as much as 40% lower than onshore projects.

You see, there isn't a single FLNG terminal/ship producing anywhere in the world-but they're press@oilvoice.com | +44 208 123 2237

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OilVoice Magazine | AUGUST 2012

coming. But Royal Dutch Shell's $10-$12 billion Prelude Project will be the first in 2017 when it anchors down 200 km off the northwest coast of Australia at the 3 tcf Prelude field-its home for the next 25 years.

Prelude will be-by far-the largest floating vessel in the world-and could produce LNG for just 60% of what onshore facilities do. While it will only produce 0.5 bcf/d of LNG, some industry players are forecasting rapid growth for FLNG around the world.

Shell estimates there is a mind boggling amount of stranded natural gas underwater, all over the world-some 240,000 billion cubic feet-and much like onshore shale gas, the industry knows where a lot of it is, but hasn't had the technology to produce it at a profit.

So is there potentially ANOTHER huge amount of cheap, clean natural gas available to the world? Yes, but unlike onshore shale gas, however, the capital costs are so high that only a handful of companies have the capital and expertise to do this. While this is THE leading edge in the natural gas space, I'm not expecting serious FNLG volumes until the end of this decade.

Shell's General Manager for FLNG, Neil Gilmour, told the Financial Times he thought FLNG could follow the same growth path of floating oil production ships, which were introduced in 1977. There are now over 150 around the world.

And the growth curve is already starting. In addition to Shell, other companies like Brazil's Petrobras, BG Group in the UK, Repsol in Spain and Portugal's Galp Energia are placing orders for ships, albeit with smaller projects offshore Brazil.

Shell itself has other FLNG vessels on the drawing board for projects in East Timor, South America, Indonesia and East Africa. Shell has specifically stated the smaller environmental footprint is a big selling point in geopolitically sensitive areas like East Timor.

Forecasts from most energy analysts are that by 2015, the liquefaction capacity of FLNG projects around the world will be 6.7 million tons per year or about one-tenth of global capacity. If Prelude is successful, FLNG usage will expand even faster.

I've written several times on how the global market for LNG is growing quickly. LNG is forecast to be the world's fastest growing fuel market (growing twice as fast as regular natural gas) through 2030, says BP's chief economist Christof Ruhl. He adds that LNG is already 25%-30% of internationally traded gas and makes up 9% of global gas demand. press@oilvoice.com | +44 208 123 2237

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--------------Have You Heard of the 'Other' Bakken Oil Play?

It's not on most investors' radar screens.

But a very special situation is quickly taking shape in the play. Not only are drilling results getting better with each new set of results‌ but the next set could validate a huge new area of production - and turn it into one of the top plays in Canada.

And for my # 1 junior company in the play, the best news may be just ahead.

That's why insiders have been scooping up shares lately‌ and why this junior could be the break-out oil trade for the rest of 2012.

Learn all about this opportunity here in my full research.

--------------The International Energy Agency forecasts that within a few years, LNG imports will meet about a fifth of the total incremental demand in the world for gas. In 2010, LNG accounted for about 10% of the total global demand for natural gas. This implies a double-digit growth rate for LNG over the next few years and possibly even longer with most of the demand growth coming from Asia and the Middle East.

FLNG ships like Prelude reduce both the project costs and environmental footprint of LNG development. Despite their massive size, they're still only one quarter the area of an onshore LNG plant.

(But it will still be longer than four soccer fields put together, and will hold 175 Olympic swimming pools of LNG.) But there is no need for long pipelines to shore, no compression platforms to push the gas to shore, no nearshore works such as dredging and jetty construction, and no other buildings and roads. Shell expects Prelude will produce 15% less carbon dioxide than an onshore LNG facility.

press@oilvoice.com | +44 208 123 2237

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OilVoice Magazine | AUGUST 2012

For $10-$12 billion, Prelude will, according to Shell's estimates, produce 110,000 boe (barrels of oil equivalent) per day (my math comes out with slightly different numbers), which is roughly broken down like this: 1. 1.3 million tons per year-or 35,000 bopd-of condensates 2. 400,000 tons-or 12,700 bopd-of liquefied petroleum gas (propane) 3. 3.6 million tons per year of LNG. (1 million tons of LNG = 48.7 billion cubic feet of natural gas, so 3.6 MM x 48.7/365=480.3 mmcf/d, or just under 0.5 bcf/d, or 86,454 boe/d) Despite the initial cost, some industry experts are suggesting LNG costs will be in the $550 to $700 per metric ton range versus the $1,200 to $1,500 per metric ton range for onshore LNG projects.

There are obviously huge risks with a project this size-huge storms, long-term economics, capital costs, etc.

But if Prelude works, FLNG has the potential to do for stranded gas offshore what fracking has done for trapped natural gas onshore.

View more quality content from Oil & Gas Investments Bulletin

Insight: Tilting at Windmills...

Written by David Bamford from OilEdge As I have remarked before, one intriguing aspect of media commentary on the hoped for 'turnaround' in global economic fortunes is a perception that the energy industry may play a key role, by dramatic increases in supply, thereby dragging prices, especially oil prices, down.

For example, see 'US economy is stepping on the gas' where one focus is on shale gas (the press@oilvoice.com | +44 208 123 2237

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'Shale Gale'), the investment it is attracting and the new jobs it is creating. When coupled with the emerging wave - that of shale oil - not only is a considerable drain on the US currency to foreign shores going to be avoided but the USA can begin to contemplate domestic energy security, not to say self-sufficiency, for the first time in over 40 years. No doubt Washington will claim that all this results from some sort of government 'master plan' but viewed from the outside, it looks like it is the result of the operation of market economics.

When it comes to 'master plans' of course we naturally look to Brussels - OK, OK, I was joking!!

What about the UK? Well, I continue to dig around in the websites that exist under .gov.uk beginning with that for DECC, or to give it it's full title, the Department for Energy and Climate Change which gives somewhat of a clue as to this body's priorities. It's a bit of a struggle to detect anything that could be called an Energy Strategy but I did find the 2011 Annual Energy Statement by the then (since resigned) Minister.

Apparently, DECC's vision is of steering us away from excessive reliance on fossil fuels and onto clean, green and secure energy; there will be a thriving and globally competitive lowcarbon economy. Apparently.

On the supply side, it foresees an interesting mixture of energy sources - renewables, new nuclear, and fossil fuels. Recognising that renewables may be marginal - at least for a while - and 'new nuclear' will take a while too, gas features strongly and there is reference to 'clean' coal via carbon capture and storage; I'm sure the word 'oil' is in there somewhere, I just can't find it!

So, what is actually happening? Well, there doesn't seem much sense of urgency but 'we' (I use this word in its loosest sense to describe the actions of the folk in Whitehall - elected and unelected) seem to be awfully keen on covering the UK's countryside and inland seas with windmills and considerably less keen on shale gas‌‌..at least to judge from the two most recent consultations (one from DECC and one from a group of earnest academics). These seem to propose regulations and hurdles which have very little to do with the reality of what happens in actual operations in the USA - I wonder if any members of the panels actually visited there and looked at typical operations in the Bakken, say?

View more quality content from OilEdge

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Recent Company Profiles The OilVoice database has a diverse selection of company profiles, covering new start-up companies through to multi-national groups. Each of these profiles feature key data that allows users to focus on specific information or a full company report that can be accessed online or printed and reviewed later. Start your search today!

Gastem

Golar LNG Partners

Oil and Gas

LNG, Storage

Gastem is a Quebec-based oil and gas exploration and development company holding exploration and storage rights to over 1.1 million acres of land in the St. Lawrence Lowlands, the Gaspe Peninsula and the Magdalen Islands in Quebec.

Golar LNG Partners are a growth-oriented limited partnership formed by Golar LNG Limited (NasdaqGS: GLNG; OSE: GOL) to own and operate floating storage and regasification units (or FSRUs) and LNG carriers under long-term charters, which we define as charters of five years or more.

Visit Gastem's OilVoice profile Visit Golar LNG Partners' OilVoice profile

American Sands Energy Corp.

Oil Sands

Mercuria Energy Group Oil, Gas, Power and Coal

American Sands Energy Corp. (a Delaware corporation) is committed to the efficient extraction of oil and other naturally occurring hydrocarbons contained in oil sands, shale, and similar types of geologic structures prevalent in the Mountain West region of North America using a proprietary technology.

Visit American Sands Energy's OilVoice profile

Mercuria is a privately-owned international group of companies active over a wide spectrum of global energy markets including crude oil and refined petroleum products, natural gas, power, coal, biodiesel, vegetable oils and carbon emissions.

Visit Mercuria Energy's OilVoice profile

Graystone Company

Stratex Oil & Gas

Mineral Extraction

Oil and Gas

The Graystone Company’s Natural Resources Division locates and extracts mineral deposits for refining.

Visit Graystone Company's OilVoice profile

TexStar Energy Corp.

Stratex is a privately-held independent energy company focused on the exploration, acquisition and production of crude oil in the Bakken, Three Forks, Heath and Tyler Formations in North Dakota and Montana.

Visit Stratex Oil & Gas' OilVoice profile

Oil and Gas

Altai Resources Inc. TexStar Energy Corp. is a Texas based oil and natural gas exploration company.

TexStar Energy Corp. and its experienced management team is well situated to take advantage of the many opportunities that are present in today’s energy markets

Natural Gas Altai Resources Inc. is a Canadian resource company with a diversified portfolio of natural gas and gold properties in Canada.

Visit Altai Resources' OilVoice profile

Visit TexStar Energy's OilVoice profile

press@oilvoice.com | +44 208 123 2237

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OilVoice Magazine | AUGUST 2012

Insight: Give us a break...

Written by David Bamford from OilEdge With future, major, investment, the UKCS sector of the North Sea has a fantastic future.

What contribution can oil field service companies make to making sure it is delivered?

Last week in its annual report, Oil & Gas UK said that declining UKCS oil and gas production - 2011's 19.2% slump to 656million barrels of oil equivalent (boe) was the biggest year-onyear fall on record - and that this means the industry has reached a crucial stage, adding: "The industry and government need to work together to progress the full range of potential projects through to their development. This will mean further changes to the fiscal regime beyond those announced in the Budget."

Now Oil & Gas UK has around 250 full members and getting all of these singing from the same hymn sheet is something they should be congratulated on.

And there is no doubt that some aspects of future oil & gas production require additional tax incentives to move ahead - improving Enhanced Oil Recovery by utilizing CO2 from Carbon Capture onshore would be a good example.

But here's an interesting question - at least I think so.

Only 40-odd of the 250 full members are oil & gas companies; the rest are oil field service companies and consultants of various sizes. And presumably these companies believe in the statement that "There is something like ÂŁ1 trillion worth of opportunities in the North Sea still to be developed and brought into production. It's a massive prize and it will take decades to deliver."

So, my question is this - are these oil field service companies, especially the big ones, and perhaps especially the drilling companies, prepared to drop their prices by say, 20%, as their contribution to delivering this nationally important target?

View more quality content from OilEdge

press@oilvoice.com | +44 208 123 2237

Health, Safety, Environment and Risk Management RPS Energy is a global multi-disciplinary consultancy, providing integrated technical, commercial and project management support services in the fields of geoscience, engineering and HS&E.

Contact James Blanchard T +44 (0) 20 7280 3200 E BlanchardJ@rpsgroup.com

rpsgroup.com/energy

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OilVoice Magazine | AUGUST 2012

Evidence that oil limits are leading to declining economic growth Written by Gail Tverberg from Our Finite World The usual assumption that economists, financial planners, and actuaries make is that future real GDP growth can be expected to be fairly similar to the average past growth rate for some historical time period. This assumption can take a number of forms-how much a portfolio can be expected to yield in a future period, or how high real (that is, net of inflation considerations) interest rates can be expected to be in the future, or what percentage of GDP the government of a country can safely borrow.

But what if this assumption is wrong, and expected growth in real GDP is really declining over time? Then pension funding estimates will prove to be too low, amounts financial planners are telling their clients that invested funds can expect to build to will be too high, and estimates of the amounts that governments of countries can safely borrow will be too high. Other statements may be off as well-such as how much it will cost to mitigate climate change, as a percentage of GDP-since these estimates too depend on GDP growth assumptions.

If we graph historical data, there is significant evidence that growth rates in real GDP are gradually decreasing. In Europe and the United States, expected GDP growth rates appear to be trending toward expected contraction, rather than growth. This could be evidence of Limits to Growth, of the type described in the 1972 book by that name, by Meadows et al.

Figure 1. World Real GDP, with fitted exponential trend lines for selected time periods. World Real GDP from USDA Economic Research Service.

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Trend lines in Figure 1 were fitted to time periods based on oil supply growth patterns (described later in this post), because limited oil supply seems to be one critical factor in real GDP growth. It is important to note that over time, each fitted trend line shows less growth.

For example, the earliest fitted period shows average growth of 4.7% per year, and the most recent fitted period shows 1.3% average growth.

In this post we will examine evidence regarding declining economic growth and discuss additional reasons why such a long-term decline in real GDP might be expected.

Connection of GDP Growth with Oil Supply Growth It should not be surprising to find that there is a close tie between GDP growth and oil supply growth. Oil is used in many ways, from the manufacture of goods (synthetic cloth, pharmaceuticals, chemicals, asphalt for roads), to transport of goods and people, to food production (plowing, harvesting, weed killers, diesel irrigation), to operating construction equipment, to mining. While it is possible to substitute away from oil in some situations, or to find more efficient ways of using the oil, we have literally trillions of dollars of machinery in the world that uses oil right now. Because of this, the rate of substitution away from oil is necessarily very slow.

James Hamilton has shown that in the United States, 10 out of 11 post-World War II recessions were associated with oil price spikes. He has also published a paper specifically linking the recession of 2007-2008 with stagnating world oil production and the resulting spike in oil prices. I wrote an academic paper, Oil Supply Limits and the Continuing Financial Crisis, explaining some of the connections I see involved.

One connection between oil supply and the economy is the fact that when oil prices rise, indicating short supply, salaries don't rise at the same time. Fuel for commuting and food (which is grown and transported using oil) are necessities, and their prices tend to rise as oil prices rise. Consumers cut back on buying discretionary goods and services, so as to have enough money for these necessities. This leads to people being laid off from work in 'discretionary' industries, and a whole host of other effects we associate with recession.

Figure 2, below, shows world oil supply (broadly defined, including biofuels) with trend lines fitted to periods exhibiting similar growth patterns. It is these same time periods that I fit trend lines to in Figure 1, with one small exception. I had consistent real GDP data going back only to 1969, so stopped at 1969 rather than 1965 with GDP.

Figure 2. World oil supply with exponential trend lines fitted by author. Oil consumption data from BP 2012 Statistical Review of World Energy.

press@oilvoice.com | +44 208 123 2237

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What we see in Figure 2 is a pattern of falling growth rates in oil supply rates, similar to the declining pattern we saw for real GDP in Figure 1. In Figure 2, the growth in oil supply falls from 7.8% per year in the first fitted period, to 0.4% per year in the last fitted period. The 'gaps' that I didn't fit lines to were periods of falling oil consumption. A glance up at Figure 1 shows that these periods where no line was fit (that is, the places where the black 'actual' data shows through on Figure 1) correspond to relatively flat GDP periods-as a person would expect, if high prices/short supply are associated with recession.

A person wouldn't expect the two types of growth rates (oil supply and real GDP growth) to be exactly the same. The GDP growth rate would likely be higher than the oil growth rate because the oil growth rate is theoretically depressed for several reasons: continued switching from oil to cheaper fuel (often electricity); improvements in energy efficiency; and a gradual change to more of a service economy. (Services use less energy per unit of GDP than the manufacturing of goods.)

If we compare the two fitted growth rates (world oil consumption and world real GDP), this is what the comparison looks like: Figure 3. World Oil Supply Growth vs Growth in World GDP, based on exponential trend lines fitted to values for selected groups of years. World GDP based on USDA Economic Research Service data. Earliest time-period uses 1969 to 1973 for both oil and GDP for consistency.

Downtrend in Real GDP May Be Understated The last thing governments want to do is to let their constituents know that the economy is currently doing less well than in the past. There are (at least) two ways that governments can increase real GDP: 1. Understate their inflation estimates. The way 'real GDP' is calculated involves first figuring GDP based on how much goods and services increased during the period in question, and then 'backing out' the amount of the GDP increase that was due to inflation.

There is latitude in figuring out how much inflation to reflect. For example, in the early years, my understanding is that if the price of beef went up, it directly affected the calculation of the inflation rate; now, there is an implicit assumption that they buyer will be willing substitute chicken to some extent instead, keeping the inflation assumption lower and the real GDP increase (as calculated) higher. There are many other things that be manipulated as well-for example, how the cost of housing goes into the calculation. The site Shadowstats gives one view of how changes since 1983 distort reported US real GDP amounts.

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are produced and sold, not how they are paid for. If the government sponsors a program to provide mortgages to people who have no chance of ever paying them back, and this results in the sale of more houses, this will help real GDP-at least until the borrowers start defaulting on their loans. Increases in other types of loans work to increase real GDP too, including auto loans, student loans, and government debt.

Besides increasing real GDP, increasing debt also acts to increase employment, since it takes workers to build the things that people who get the loans can now afford. In other worlds, the higher loan amounts increase employment of people who build new cars or new houses, or who teach at universities.

The problem with encouraging additional debt is that it at some point the amount of debt becomes too much for holders of the debt to service, and they start cutting back on other purchases. For example, recent graduates with a lot of debt are likely not to be in the market for new homes unless they have very high-paying jobs. So, at some point, additional debt becomes self-defeating, especially when the economy is not growing very quickly. Too much debt seems to be one of the limits, besides oil limits, we are reaching now.

Other Factors Holding Down Real GDP Growth We live in a finite world, and this fact imposes limits. The amount of land suitable for cultivation is not expanding over time. There is limited fresh water for irrigation and other uses. In many areas, water tables are dropping. Ores are declining in quality because the highest quality ore tends to be extracted first.

Pollution, including carbon dioxide pollution, leads to attempted substitution by higher cost alternatives. It also leads to the addition of devices such as expensive filters. Both of these add costs, without increasing the amount of usable goods and services (in the usual definition) produced. Peoples' funds for discretionary goods can be expected to drop as a result, (since funding through taxes or other approaches is mandatory) putting downward pressure on real GDP growth.

There is also the issue of how many new entrants are added to the paid labor force. If, for example, in the early years, many homemakers are being added to the paid labor force, their addition will tend to raise GDP growth, because the goods or services the homemaker creates will be added to real GDP, as well as the cost of daycare for her children, if this is purchased. Once homemakers have been pretty well absorbed into the labor force, that positive influence on real GDP will disappear. If the number of people employed starts declining (because of more retirees, or because people can't find jobs), or fails to rise as quickly, this will tend to slow economic growth.

Oil Importers are Likely to Have Lower Economic Growth than Others There are a couple of reasons why oil importers can be expected to have lower economic growth than other countries, especially when oil prices are high. First, oil importers have the problem of needing to pay exporters for crude oil or oil products. The revenue that is spent on higher priced crude oil could have been spent on discretionary expenditures. It is unlikely that the oil exporters will reinvest the money in the economy of the buyer of its oil-they are press@oilvoice.com | +44 208 123 2237

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just as likely to reinvest it in their own country.

The second reason is that oil importers tend to be the countries like the United States and Europe that 'developed their economies' early on. Since these countries have hired women in large numbers since World War II, most homemakers who want jobs already have them. If birth rates have slowed, these countries may be seeing disproportionate growth in the retiree population and fewer workers in ages where employment usually takes place.

In the United States, if we do curve fitting (of the type shown in Figures 1 and 2) to the reported number of non-farm workers employed in the United States (from the Bureau of Labor Statistics), and compare these employment trend rates with the corresponding trend rate in US GDP growth, we find a high correlation:

Figure 4. US growth in number of non-farm workers versus growth in real GDP. US real GDP from US Bureau of Economic Activity; Non-Farm Employment from US Bureau of Labor Statistics

Note that decreased growth in the number of employees could be taking place for any number of reasons-less growth in illegal immigrants, fewer homemakers going back to work, more people going to college, or more people retiring or taking disability coverage, or just generally discouraged.

It is my observation that the number of workers in the US today seems to depend on the number of jobs available. If jobs in some fields are being increasingly shipped to lower-cost countries-the ones we will see in Figure 7 are now using a disproportionate share of the world's oil-these jobs will not be available, no matter how many workers might be willing to take them, if they were available.

If we look at the trend in real GDP growth for three major areas (United States, European Union-27, and Remainder = World minus the US and EU-27) , we discover that indeed, all three of the areas show a downward trend in real GDP over time (Figure 4, above). The GDP growth of the EU-27 and the US start from a lower level, and drop off more in the 20072011 period, (when the price of oil imports was more of an issue) than the 'Remainder' grouping.

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Figure 5. Annual growth in world oil supply compared to annual growth in real GDP, both based on exponential trend fits to values for selected years. Oil supply data from BP oil consumption data in 2012 Statistical Review of World Energy; real GDP from USDA Economic Research Service.

One reason why the Remainder-GDP may be doing better than the others is that heavy manufacturing, and the jobs that go with heavy manufacturing, are finding their way to lower cost countries. High oil prices may also be discouraging oil importers from purchasing oil. If we look at oil consumption for the three groups, this is what we see:

Figure 6. Comparison of oil consumption by area (United States, European Union -27, and rest of the world), based on BP's 2012 Statistical Review of World Energy

Much of heavy manufacturing has been moved out of the United States and the European Union. Figure 7 on the next page shows that the rest of the world is now using well over half of the world's oil.

Figure 7. Percentage shares of world oil consumption based on BP's 2012 Statistical Review of World Energy.

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Going Forward We have seen (Figure 5, above) that all three grouping shown (United States, EU-27, and the rest of the world) are showing declining real GDP patterns, similar to the world pattern.

GDP growth rates of the United States and EU-27 are both at lower levels than the World and Remainder, for reasons explained.

It is hard to see why current trends wouldn't continue, with growth in real GDP continuing to decrease for all three groups. Regardless of the hoopla in the United States press about supposed growth in oil supply, the fact remains that growth in world oil supply has been worrisome for many for roughly 40 years, since US oil production started decreasing in 1970.

It is hard to believe that the latest 'fix' is going to turn things around. The typical pattern in oil supply is for extraction in an area to hit a maximum (or perhaps a plateau) and then decline.

Figure 8. Crude oil production in the US 48 states (excluding Alaska and Federal Offshore), Canada, and Europe, based on data of the US Energy Information Administration.

Figure 8 shows (among other things) how steep the US drop in oil production in the contiguous 48 states was starting in 1970. This decline set the stage for the 1973 Arab Oil Embargo, since oil-producing countries now had the upper hand. Production in Alaska and in the Gulf of Mexico eventually helped offset part of the drop, but the Alaska production (not shown) is now declining as well. Change in the balance of power regarding oil production following the decline in US production, and recognition that increased imports would cause balance of payments problems, seem to have influenced the US and Europe's decision to focus on service industries and on industries with little oil usage, holding their oil usage down (Figure 6).

Figure 8 also shows how new onshore techniques-fracking and other enhanced oil recoveryare affecting US crude oil production. While US-48 states crude oil production has shown a 25% increase since 2006, this production is still only 39% of the 1970 amount, and about equal to 1942 production. Oil production in Canada (which includes the oil sands) is rising, but not very rapidly, from a low base. It is hard for small increases such as those of Canada and the US-48 to make up for major declines in production occurring in Europe and elsewhere. World oil supply would be increasing by more than a fraction of 1% per year if changes frequently noted in the US press were really making an important difference in world supply.

If growth in world oil supply is constrained and may possibly begin to fall in total in not too press@oilvoice.com | +44 208 123 2237

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many years, this adds to the downward pressure on world GDP growth for all of the areas of the world. Thus, re-examination of GDP growth assumptions seems to be in order. Perhaps slow recent growth is not an aberration-perhaps future real GDP growth will be even lower.

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Exxon and the historic oil majors face troubled times Written by Andrew MacKillop from OilVoice Second-quarter results for Exxon, which was the world's biggest company by market capitalization until Apple moved into No 1 slot, confirm a stack of trends in world energy and the global economy. Exxon Mobil is still the world's biggest oil company by market value, even if its combined oil and gas reserves are now minuscule relative to those of a long list of both OPEC and NOPEC national oil companies. Using data for 2012 from Petrostrategies Inc, Exxon's combined oil and gas reserves place it 16th in the world - far behind the NOCs of Iran, the Gulf Arab states, Nigeria and Libya, and well behind Russia's Gazprom, Petro China - or the Egyptian General Petroleum Corp. http://www.petrostrategies.org/Links/worlds_largest_oil_and_gas_companies.htm The other "historic oil majors" are in the same plight, even lower than Exxon, and like Exxon have shifted to the refining downstream, energy trading, non-energy activities - and gas production and the radically successful hunt for global natural gas resources. This makes Exxon and the "historic majors" vulnerable to the global economy's performance, very vulnerable to falling oil prices, and highly exposed to a coming gas glut and falling global gas prices.

Its second-quarter results show that Exxon earned much less than most analysts had expected. Reasons included the simple fact that global oil demand has stalled, led by press@oilvoice.com | +44 208 123 2237

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stubborn shrinkage or at best "flat line demand" in the world's largest economies. Exxon was also heavily penalized by the USA's incredibly low natural gas prices, which at around $3 per mln BTU price US gas at about $17.40 per barrel equivalent. This is a 45 percent decline on prices even 1 year ago, and 66 percent since 2006.

DOWNSIZING AND COMMODITY PRICES Exxon is above all realworld, these days. Like the other "historic oil majors" (which included Exxon, Mobil, Shell, BP, Chevron, Texaco, ARCO, Total, Gulf, ENI, and others) Exxon has downsized. Only a few figures are needed to show this: announcing the new and downsized earnings of Exxon, its CEO Rex Tillerson said his corporation plans to spend $37 billion in 2012 towards the goal of adding 1 million barrels equivalent per day of new oil production capacity by 2016. Not only the total cost of this downsized goal, but the time needed to achieve it are striking, even stunning. The keyword "equivalent" underlines that a part, probably most of this extra 1 Mbdoe of capacity by 2016 will come as natural gas liquids, even shale oil and condensed oil from natural gas production streams.

Until 2009, world oil demand growth attained about 0.8 - 1 Mbd every year, and in some years well above this: up to 2 - 2.25 Mbd extra demand in a single year but that was "another age", before 2009.

Exxon's earnings fell short of analyst estimates for the second straight quarter, as the company's total production on an oil equivalent basis, with a fast-rising natural gas component and declining oil component, struggled to achieve an average output in second quarter 2012, of 4.15 million barrels a day. This was Exxon's lowest quarterly average since 2010, when oil prices were still recouping the losses made in 2008-2009.

Current weak performance of Exxon, and the other "historic majors" such as Shell and BP, underlines a major and somber fact for global oil: below about $75 per barrel it is getting hard not only to produce more oil, but to maintain current production output. For the "historic majors" producing oil at below this price level is becoming, as they say in corporate communiques "challenging".

Energy commodity prices are more important then ever, for corporate visibility going forward.

Inside the US what are suicidally low natural gas prices, for producers, do not help "integrated energy companies", like Exxon which produce both gas and oil. It makes them hostage to high oil prices, depending on high oil prices to cross-subsidize their gas exploration, development and production. Otherwise, rather simply, they risk to run out of business.

In second quarter 2012, Exxon's sales rose 1.5 percent to $127.4 billion. The company's initial claim that earnings based on this did not contain any special or one-time gains was quickly contradicted by the corporation itself: some $7.5 billion of earnings were due to asset sales-based gains, making up 47 percent of the per-share earnings. This came from asset sales. Asset sales and trading are now a normal part of Exxon's operations, and are of rising EBITDA importance for other "historic oil majors" which in Exxon's case are shown by the role of asset sales in the company's refining business.

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Exxon's refining profit quadrupled in the second quarter to $6.65 billion, but $5.3 billion of this came from the company's one-off sale of a chunk of its Japanese refining business, to Tonen General Sekiyu.

Just as troubling for Exxon's real profitability and showing its total dependence on high oil prices, the corporation's earnings decline has almost exactly tracked oil prices. Brent crude futures, now the benchmark for over 60 percent of world oil trade, averaged $108.76 a barrel during the quarter, a 7 percent decline from a year earlier. Exxon's earnings fell by a little more than that amount.

LOSING OUR SHIRTS ON GAS AND PRAYING FOR HIGH OIL PRICES The likelihood that Exxon CEO Tillerson will grab the microphone to say he wants and needs triple digit oil prices is of course low, but he needs them. For Exxon and any other integrated energy company without access to low cost recoverable oil reserves, producing both gas and oil under present and emerging global economy energy and oil demand trends is getting a worse prospect almost by the day. Oil demand in the U.S. and China, whose combined consumption of around 28.1 Mbd ranks at about 31 percent of world total oil demand, has now almost perfectly flat-lined for one year. The EU27 countries, in 2012, are in their sixth straight year of oil demand contraction.

Especially in the US, but this will progressively extend outside America in a predictable nearterm future, ultimate low gas prices are wreaking havoc on company profitability. Under rational trends continued analysis, this may even threaten their survival. Natural gas prices are, as shown by the company fortunes of gas-majority producers like Chesapeake and Exxon's gas subsidiary XTO, which cost Exxon nearly $40 billion to buy in June 2010, semi suicidal and offer no signs of major recovery.

Gas futures in New York through the second quarter fell 46 percent compared to a year earlier, and averaged $2.35 per mln BTU. This was the lowest quarterly average in 13 years, since 1999. These price levels, earlier in 2012, prompted Exxon's Rex Tillerson to warn that Exxon and other US gas producers are 'losing our shirts' amid a glut of North American shale gas supply. Outside the US the natural gas exists, not only as shale resources and in staggeringly immense quantities - but developing and producing it is costly.

The gas glut most surely does not only affect Exxon. Royal Dutch Shell has also "gone for gas" and today its energy output split is about 55 / 45 gas energy and oil energy. For the second quarter, Shell's earnings were also down, by about 13 percent at $5.7 bn, and like Exxon's earnings well below most analyst forecasts. The answer, for the "historic majors" is high oil prices.

Consumers are however already shifting away from oil, to gas, where they can. Gas is now the most-widely used US furnace fuel and the USA's second-largest generating source for electricity. Outside the US and especially in the Emerging and developing countries, oil-fired power production remains a major oil consumer, for a total of about 2 billion barrels a year in 2011: this market is not only threatened by gas, but also the fast declining cost of windpower and solar power equipment. For the "historic majors", suicidally low gas prices make it a losing bet for energy explorers, resulting in oil becoming the "only solution" for energy press@oilvoice.com | +44 208 123 2237

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producers who intend to stay in integrated oil-and-gas production and in the O&G downstream. To be sure: this can only mean expensive oil, because low-priced oil will be as lethal to company fortunes as bargain basement priced natural gas.

KEEPING OIL PRICES HIGH What this means is that if the ever more possible serious slump happens in world oil prices this will bring dangerous times for the "historic majors", and other energy players. Their corporate strategies will be an analyst's feast, predicting which one will break ranks first and sell more oil - despite falling prices. The range of major energy producers who will break ranks is in fact large, including many OPEC and NOPEC corporation, as well as the historic majors.

Already today, analysts criticize Exxon's acquisition of XTO Energy, ranking Exxon the largest US gas producer, in front of Chesapeake Energy Corp. The Chesapeake story or saga is well known today, prompting analysts who in 2010 thought Exxon's buy out of XTO was a great move, to say that today almost any other major oil company except Exxon, with less exposure to US gas, is a more compelling investment and trading play, under current and likely emerging market conditions.The oil-and-gas producers have already had to abandon all hopes of keeping natural gas prices high - which 5 years ago could attain over $12.50 per mln BTU in the USA. They have been forced to accept that natural gas prices, in the US, have fallen about 70 percent in 5 years - making their last, best hope "triple digit" oil prices.

On the world scene, not only the "historic majors" but once-powerful, recently-powerful players as big as Gazprom of Russia are being forced to contemplate an ever approaching and large cut in their earnings on gas production and exports. Quite soon, Gazprom will be forced to abandon "oil indexed" gas pricing, and the results will be terrible for Gazprom.

The upsetting and transforming role of surging gas finds, production and supply has now created a context where companies as big as Exxon, BP, Shell, Total, ENI, and the gas majors are trapped in a hole where the only way out is through "triple digit" oil prices. How these players strive to keep oil prices high will be an interesting scene to observe and analyze, but the largest threat is simple to describe: under real and current oil market conditions, even $75 per barrel is cloud cuckoo and massively overpriced!

Written by Andrew McKillop

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Exploration: Hot spots and hot rocks Written by David Bamford from OilEdge A new report shows that Deep Water exploration is of continuing importance and emphasis, although perhaps there is a tendency of exploration companies to behave like a swarm of 8 year old's playing soccer - to be drawn magnetically to where the ball is!

This seems to be true not only geographically but geologically.

The evidence is that explorers perceive prospective rocks in basins that are currently Frontier are restricted to plays in the Cretaceous and younger - however history tells us that as a basin Matures, insight and innovation will lead to a breakthrough in understanding - and therefore discoveries - in older rocks.

Three takeaways from the recent Richmond Energy Partners report: There is a significantly higher probability of making a 100 mm barrel discovery in a Frontier play than a Mature play (in fact it is about 7.5 times more likely!)

1. Overall, Frontier Exploration has been successful, with the 5 'big play breakers' all in Deep Water. For 2012, there is a huge focus on exploration drilling in the South Atlantic and East Africa (onshore and offshore).

2. In Frontier Exploration, there has been relatively little effort, and no discoveries, in stratigraphy older than the Cretaceous, whereas in Mature provinces, effort and discoveries reach down to the Devonian and older.

3. The first of these conclusions is obviously not a surprise, although the degree of difference may be to some.

The second and third points speak to Hot Spots and Hot Rocks respectively - let's examine them in more detail.

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Hot Spots

Frontier play exploration wells 2008-2012. Courtesy of Richmond Energy Partners

Frontier Hot Spots 2012. Courtesy of Richmond Energy Partners

Taken together these two pictures illustrate the location of Frontier exploration efforts, the continuing importance of Deep Water, and the tendency of exploration companies to behave like a swarm of 8 year old's playing soccer - to be drawn magnetically to where the ball is!

Somewhat cynically, one might ask whether many companies are in fact pursuing their own exploration strategy or whether their strategy is simply 'Me too!'?

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Hot Rocks

Comparison of primary target Frontier and Mature play wells 2008-2012. Courtesy of Richmond Energy Partners This picture raises an interesting question.

It is pretty unlikely that prospective rocks in basins that are currently Frontier are restricted to plays in the Cretaceous and younger - evidence from this picture and exploration history in general is that as a basin Matures, insight and innovation will lead to a breakthrough in understanding - and therefore discoveries - in older rocks.

The question which follows is - what insights and what innovations? How do we get to them?

Well, to repeat myself, explorers are by and large are engaged in the search for new plays in known basins, plays of increasing subtlety and complexity in basins that have been 'open' for a long time, where somebody has gone before them.

Here are just four of the questions that explorers might be trying to answer today: 1. Massive amounts of gas have been found offshore East Africa. Is there anywhere to go to find oil?

2. Where are the analogues for the much-talked-about Brazilian sub-salt successes?

Are there any in the South Atlantic other than offshore Angola?

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3. Where might big fields be hiding in the Deep Waters of South East Asia?

4. Is the North Atlantic really a poor relation compared with the South Atlantic?

And where, to tackle these questions, plenty of - sometimes huge amounts of - data are now available to explorers.

Satellites have delivered global bathymetry and topography; satellite gravity data shows us crustal thickness globally; some 200,000 exploration wells - that's 200,000 'wildcats', never mind appraisal, development production wells - have been drilled in the last 50 years or so; there are sea-bed cores; any government that is serious about its resources has a national data repository; there's data from Geological Surveys; there's a huge published literature‌.and so on.

The ability of explorers to deliver the increasingly difficult job of spotting the next big play depends on their ability to sift, organise and understand the Niagara Falls of available data, to solve what some have referred to as the 'Big Data' problem - or opportunity, perhaps?

Deploying a deep understanding of plate tectonics and chrono-stratigraphy - understanding what gets deposited where and when - is the key process by which this is achieved, the 'Know How' whereby opportunity is accessed.

What it is not about is simply banging in (yet another) regional 3D survey and believing that more and more sophisticated seismic interpretation can deliver all the answers.

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Beyond Thunderdome: The Oil Scarcity Story Written by Robert Kientz from Drop Shadow I have seen more fear in the articles discussing oil scarcity than I have in those proclaiming the economic Armageddon is around the corner. While I think we are setup for an economic crash, I am not convinced the end of cheap oil is the end of civilization as we know it.

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how we value energy and use it in our daily lives.

Instead of shoveling pig dung for methane-based fuel energy as depicted in Mad Max, we will more likely adopt natural gas and hybrid cars for transportation, while using cheap and safe LFTR-based thorium as a very cheap grid energy solution. Transportation will be more expensive, but grid energy will be much cheaper and more plentiful. In the end, we will adjust our energy usage patterns to match technological innovations and supply patterns.

But I doubt the earth will turn into a giant dust bowl due to a shortage in cheap crude.

Let us get into some facts about current oil demand and supply and then explore how our oil supply issues affect our energy demands in the future.

Demand Analysis To start the discussion, the most famous oil prognosticators have predicted that by our current date, we'd be in a much more dire oil shortage than we are. The thinking went, that by previous supply metrics and the increasing rate of usage due to population growth in emerging markets driving increasing rates of change, something had to give and give fast.

The problem with this argument is two-fold. First, the estimates on future supply have proved to be incorrect. And the prognostications tended to ignore technological advances that have, so far, allowed oil supply to just barely keep up with oil demand while keeping prices from going straight north.

US Energy Information Administration Non-OECD oil demand, including gasoil, oil, and gasoline has grown steadily since 1996 and this trend is expected to continue. OECD oil demand has remained almost the same over that time span, with strong reduction in gasoil and slight increase in gasoline demand. NonOECD demand increases are lead by Asia, the Middle East, and then the Russian bloc.

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US and European oil demand has remained relatively stable since the mid-1980s, while the biggest area of growth has been the Asia Pacific region emerging markets.

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Source: International Energy Agency Transportation fuels drive the large increases in non-OECD demand. Indian demand is rising by about 3.5%. Russian demand is rising by 3.4% over 2011 so far. Japanese demand is up owing to the recent shutdown in nuclear energy supply, but this may be relatively short term in nature as alternatives are explored that are cheaper than burning oil for grid power.

Chinese demand is rising but has slowed by recent economic developments. This may be one of the main reasons the price of gasoline in the US has actually fallen to the $3 per gallon level recently. The larger nations are demanding less oil within the last few months due to the economic slowdown, which has eased the price of gas. And note that while Asia's thirst for oil had increased dramatically, OPEC's has shown the ability to provide that oil.

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Supply As noted in two above graphs, the Middle Eastern supply of oil has kept up with aggregate demand increases in Asia. Interestingly, Europe and the US, while large demanders of oil, have not significantly increased their demand for crude in quite some time.

Let's take a look at current oil production graphed against the historical supply growth rate.

Production has recently fallen off the 30 year trend, but not as dramatically as originally predicted.

Source: Our Finite World Most supply increase has come from OPEC nations, with US production at 13 year highs owing to hydraulic fracking in shale and carbonate plays. Canadian supply is down slightly.

Brazillian supply is down. African supply is down sharply mainly due to conflicts in Sudan.

The outlook assumes that substantial production stoppages affecting the Sudans, Syria and Yemen persist for much of 2012. (International Energy Agency, May 2012 update)

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Source: International Energy Agency The demand and supply discussion is not complete, however, without examining overall costs of production and subsequent energy returns on investment.

Costs and EROI Getting oil out of the ground costs us money. Costs have been rising over time to produce a barrel of oil, and hence the price of oil has increased in unison.

Break-even costs for extracting oil have been rising.

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Not all oil is equal; costs of production versus market price gives some producers an advantage. The thought is that when price rises high enough above costs, then production will increase in some of the more expensive, smaller plays.

But the real question should be, are costs rising because the plays are more expensive, or because prices are rising in general due to inflation? One way to remove inflation from the cost picture is to plot the price of gold to the price of oil. Since gold tends to follow inflation closely, the ratio gives us an idea of whether oil is relatively more expensive or less expensive, sans inflation.

Note: I would use CPI to estimate inflation, but my contention for the last 2 years has been that government manipulation of CPI measurement has made the statistic basically meaningless. Gold has been a more consistent measure of inflation for thousands of years and the gold/oil ratio has consistently been used as a measure of the relative price of oil for a long time.

Source: Incredible Charts As we can see from the chart, the ratio has fallen substantially in the last 10 years, even during gold's miraculous bull run, suggesting that the 10 year costs of extracting oil have been substantially higher than the overall inflation rate noted in the economy.

Analysts have long noted the EROI (aka EROEI) statistic as a rate of return on energy invested per barrel of oil. EROI is a scary statistic at first, but with further examination the panic level tends to fall a bit.

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It is plainly obvious that the energy return on investment for oil has sharply fallen in the US since the beginning of the oil boom age. This is true everywhere. Common EROI values for major forms of energy are shown next.

Source: Oil Drum Just looking at the first EROI graph creates panic that the world as we know it is about to end. But EROI as traditionally presented is a bit of a math trick. EROI is the ratio of the amount of oil we get for each equivalent barrel of oil energy used in extraction. So a 20:1 return implies that for every barrel of oil energy equivalent expended, we get 20 barrels of oil energy in return. As the number falls to 7:1 for most oil sands projects in Canada, it is easy to imagine where gasoline prices should triple in short order. But that hasn't quite happened.

If you flip the numerator and denominator in the EROI calculation, you get a 5% cost of press@oilvoice.com | +44 208 123 2237

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energy extraction in the 20:1 scenario, and a 15% cost of energy extraction in the 7:1 scenario. Costs have tripled, but the energy provided by oil sands projects is still quite profitable in energy terms and worthwhile to pursue for global production. An decrease in 10% of oil energy available doesn't spell the immediate end of the world, just reasonably higher gas prices. And that is what has happened.

The rest of the rise in gas prices the last few years can probably be attributed to other factors, such as monetary inflation which has significantly raised the prices of other goods in general. So it's important to note that while oil is getting costlier, we aren't at Defcon 5 just yet.

Reserves Future oil production and supplies are what interests most economists and investors looking to make decisions on what to do next with oil. It is interesting to note that world proved reserves have increased quite substantially in the past 20 years.

South and Central America have contributed greatly to the rise in oil reserves. That's a good sign. However, not all oil is the same and reserves are increasingly being found in more expensive plays such as deep water and oil sands that ensure costs of production will remain high for the future.

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Heavy oil, which is harder to process, and oil sands bitumen make up a significant portion of reserves. In addition, the growing gap of new oil discoveries shows that we aren't going to see cheaper oil in our lifetime, unless an astounding breakthrough in mining technologies drives costs of more difficult oil extraction lower. The reasonable expectation here is that innovation in drilling oil will keep prices from rising exponentially in the near term, but not keep them from rising faster than the general level of economic inflation we see in other commodity prices or in gold. Oil is just going to get more and more expensive to gather.

Other Things to Consider There have been some interesting developments in regards to US oil availability. Heavy oil from Canada is trickling down to the refineries in the coastal regions of the US. But, because press@oilvoice.com | +44 208 123 2237

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the oil supply generally flowed the other way, there are not enough open pipelines to carry this heavy oil down to the Gulf region where refiners can process it. Hence, the refinery rates have fallen a bit.

We have plenty of refinery capacity, but it cannot be used until we can transport the heavy oil where it needs to go for processing. This, in addition to global slowdown, is contributing to the slight fall in heavy oil prices. We can expect this to continue as long as the heavy oil supply to the US is bottle-necked to the refineries and cannot make it into world supply to lower overall world oil and gas prices.

In addition, EROI is calculated using current grid energy prices. For oil projects fed by grid power, any technological advancement in grid energy production, such as the Thorium LFTR project advanced by Flibe Energy and overall Thorium energy revolution taking place, will significantly lower costs of production and boost EROI for oil.

In addition, technological advancements in extracting shale oil, such as the one that powered the vast increase in natural gas supply in the US which sharply dropped market prices, may also lead to an increased EROI number. We simply cannot count out advances in technology and their effect in the costs of extracting oil in the future of some of the oil sands and other expensive oil projects.

There are some substitutes to oil as a transportation fuel. One of those is natural gas, which has witnessed an outstanding boom in recent years. As the ability to transport NGLs overseas is increased by investment in the shipping industry for such vessels, natural gas will be made more available as a substitute transportation energy. Natural gas cannot by current reserves make up for oil's 33% role in the global energy economy, but it can make a substantial dent and buy us more time to develop a true, long term substitute for oil as a transportation energy source.

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At the end of the day, we are running out of cheap oil. But several factors will mitigate how much damage is done by this, and how quickly. If we act on the several profitable energy projects available to us, and intelligently shift usage of other transportation energy substitutes, we can mitigate the impact of the coming oil drain will have on our way of life.

And perhaps we can stop spending $1.2 trillion on oil wars and realize THAT money could have been much better spent proactively planning for the changes in our energy futures.

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How the shale boom is causing a drop in the NGL price Written by Keith Schaefer from Oil & Gas Investments Bulletin The shale oil boom is causing a steep price drop in Natural Gas Liquids (NGLs) in North America, hurting gas producers.

Natural Gas Liquids are the raw, associated gases and liquids that come up along with oil and natural gas from the well. NGLs are very important-vital even-now for regular, dry gas (methane) producers, as they are separated and sold as more expensive products like ethane, propane, butane and condensate.

But for shale oil producers-especially in the new prolific Texas oil shales-they're just a byproduct. The oil pays for the well and the NGLs are just gravy.

For the last two years, many natural gas producers have been acquiring and drilling gas plays with high liquids content. NGLs are typically valued as a percentage of crude oil prices, and are worth 2-10x what dry gas is worth.

In fact, junior Canadian and American gas producers have been desperately trying to portray themselves as 'liquid rich' gas producers. Analyst reports from brokerage firms promote their increasing NGL production.

The problem for the gas producers is-the oil producers have been acquiring and drilling them, too.

Between oil and gas NGL production, supply has overwhelmed the petrochemical industry, which uses most of these NGLs as feedstock.

Prices have rebounded from lows seen in late June, but are still down a lot from last year: 

Ethane at 31 cents/US gallon is down 61% from last July



Propane at 85 cents/US gallon is down 44%

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

Butane at 121 cents/US gallon is down 31%

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Condensate at 192 cents/US gallon is down 24%

Profitability is down even more-add another 15% to each of those numbers. (This means ethane profits are down 70% or more.)

These prices come from Mont Belvieu, Texas, which is the main pricing hub for NGLs in the US. What Cushing is to oil in the US, Mont Belvieu is to NGLs. Even these numbers don't tell all the pain-some gas processing plants aren't accepting ethane at all, which of course lowers the price to crazy levels-the 2nd NGL hub in the US, in Conway Kansas, has seen ethane prices fall to 8 cents a gallon.

Here's a rough guide on these products.

The 'C2' type number you see beside each entry is how many carbon atoms a molecule of each product has, and the industry interchanges the names Ethane and C2 (Propane and C3 etc) all the time.

Ethane (C2) - Demand is primarily driven by the ethylene production industry, which uses ethane to meet nearly half of its feedstock needs to produce chemical compounds used in making plastics.

Propane (C3) - Propane use is predominantly split between heating, which is seasonal, and for certain petrochemical applications.

Butane (C4) - Demand for butane is usually quite robust since it has a wide range of uses. It has both industrial and residential heating uses and is often blended with propane to produce liquid petroleum gas. Butane pricing is most similar to that of crude oil.

Pentanes or Natural gasoline (C5-C9) - The heaviest of the non-condensate liquids. It's frequently used as a fuel additive and blended with regular gasoline as well as a petrochemical feedstock. Receives a premium to crude oil at times.

Condensates (C10+) - It is basically equivalent to crude oil with many of the same end markets. Its pricing is also similar to crude oil.

As juniors-and even seniors like Encana (ECA-NYSE; TSX) and Chesapeake (CHK-NYSE)have tried to increase NGL production, the market has not been impressed. The stock prices of these gas producers has not improved much of the last year. My experience is that until the juniors have reached about 70% oil and NGLs of overall production, the market doesn't care.

This huge rise in NGL production is primarily due to the Shale Gas Revolution-especially in Texas where a lot of the new 'oil' plays are really 25%-35% gas and NGLs. Then there's also the Marcellus and Utica shale gas plays in the US Northeast and the press@oilvoice.com | +44 208 123 2237

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Granite Wash play in western Oklahoma that have NGLs, along with Canada's Montney and Duvernay plays on the BC/Alberta border‌ which are also NGL rich-and just ramping up.

In 2011, NGL production hit a then record of about 2.2 million barrels a day. The U.S. Department of Energy estimates that in March of this year (the latest data available), NGL production rose to 2.3 million barrels a day. This figure is a jump of nearly 50 percent from January 2009 levels.

In fact, NGL output in the first quarter of 2012 accounted for a record of almost 30 percent of the U.S. oil production. At the beginning of this decade, according to industry estimates, this figure was only 20 percent.

It looks like the shale boom will only make the pricing situation worse in the years ahead.

Bentek Energy estimates NGL production will increase by more than 950,000 barrels a day to over 3.1 million barrels a day by 2016, adding to the NGL surplus.

BENTEK's Jack Weixel adds that 'as (NGL) pricing continues to decline, operators will continue to pursue even oilier plays, with the activity in the Utica being the best example of this.'

The US is exporting more NGLs to help relieve this production glut. About 220,000 bopd are exported, mostly to Latin America, and by 2016 BENTEK expects that to be 400,000 bopd of mostly ethane and propane. Canada is doing its part, as US condensate exports to the USwhere it's used to dilute heavy oil; make it flow better-have increased 10x in the last year.

However, Weixel adds 'the real constraint is domestic demand. While several world scale ethylene crackers have been proposed, until facilities are actually built that can use product such as ethane and propane, we'll continue to see downward price pressure.'

US public companies whose stock prices are tied to NGL profitability include Targe Resource Partners (NGLS-NASD) and Enterprise Products Partners (EPD-NYSE).

The bottom line here is that the NGL surplus looks set to be around for several years, which is good for the petrochemical firms but bad for gas producers. Wells Fargo Bank, one of the biggest lenders to the U.S. natural gas industry‌ with intimate knowledge of the industry, recently sounded a pessimistic note. It warned that the price downside for NGLs had a 'few more legs' to go and that 'the pain could continue into 2013.'

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How much oil growth do we need to support world GDP growth?

Written by Gail Tverberg from Our Finite World A few days ago, I showed the close relationship between growth in world oil consumption and growth in world GDP. In this post, I will extend that analysis by building a model that shows how much of an increase in world oil supply is need for a given increase in world GDP. This model indicates that if we want the world economy to grow by 4% per year, world oil supply will need to grow by close to 3% per year. This is more than world oil supply has grown per year since the 1970s-giving a clue as to why the world is having so much problem with economic growth now.

Theoretically, the model should also be able to predict what would happen on the downside as well-what would happen if world oil supply should suddenly start to contract. We will talk about what these indications are, but also discuss why they are probably misleading. The result may very well be quite a bit worse than the model predicts.

In my earlier post, we saw that over time, both the rate of growth in oil supply was declining, and the rate of growth in GDP was declining. In both the previous and the current post, we are looking at 'real' GDP growth-that is GDP growth, with the inflation component removed.

Figure 1. World Oil Supply Growth vs Growth in World GDP, based on exponential trend lines fitted to values for selected groups of years. World GDP based on USDA Economic Research Data.

In my earlier post, we looked at several groups of years, based on time periods when world oil supply was increasing. Let's look at oil supply growth for the same ranges, on a year on year percentage growth basis. Note that the time periods are one year shorter (1969 -1973 becomes 1970 - 1973), because we are looking at year on year percentage increases.

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Figure 2. Annual percentage increases in world oil supply with simple averages for the ranges indicated in Figure 1. Amount of colored line is simple average of amounts for range shown.

In Figure 2, notice that average oil supply growth is gradually becoming lower and lower, looking at the time periods down the side of the graph. This is similar to what we saw in Figure 1. computed on a slightly different basis.

If we look at annual changes in world real GDP, the indications are similar.

Figure 3. Annual percentage increases in world real GDP with simple averages for the ranges indicated, corresponding to the ranges shown in Figure 1.

Here again, as we go down the exhibit to later periods, we see declining average growth in real GDP. In fact, comparing Figures 2 and 3, we see that they are similar in several respects. Not only do they both tend to have growth rates that trend downward, but the 'gaps' between the colored lines tend to be low on both graphs, indicating that when oil supply growth is low, world real GDP tends to be low as well.

In my previous post, we talked about the close link between oil supply and the economy.

While many people believe that oil supply use grows because a growing economy gives rise to greater demand for oil, the reverse seems also to be the case. If there is short supply of oil, indicated by high price, people cut back on discretionary expenditures, and recession ensues.

Tentative Indications for the Future We can use the relationships between the individual year changes in oil supply and real press@oilvoice.com | +44 208 123 2237

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GDP to build a simple model showing how much of an increase in GDP can be expected to take place for a given increase in oil supply.

If we graph the annual percentage changes in real GDP versus the annual percent changes, what we see is the following:

Figure 4. An 'X Y' graph showing the percentage changes in world real GDP that correspond to percentage changes in world oil supply, for the years 1970 to 2011.

It is clear in looking at the data (for example Figure 2) that the pattern in the earliest part of the period is different from that in the later periods. In the very earliest period (1970 to 1973), oil use increased more rapidly than GDP. Once we realized we had a problem, there was a mad dash to try to reduce usage. If we look at only the period since 1983, when there was more of a sustained attempt to transfer to lower priced fuel, this is what the graph looks like.

Figure 5. An 'X Y' graph showing the percentage changes in world real GDP that correspond to percentage changes in world oil supply, for the years 1983 to 2011.

Using only the recent data, the R2 is similar (.53 for 1983-2011 data vs. .52 for 1970 to 2011), but the slope of the line is a little steeper. While at R2 of .52 or .53 is not exceptionally high, it does explain a significant portion of the total variance, so let's look at what the indications of the trend lines are.

If the annual percent change in oil supply is 0.4% (as it seems to be now), the predicted annual increase in world real GDP is 2.5% per year using the 1970-2011 fit, or 2.2% using the 1983-2011 fit. Thus, both fits suggest that with the small increases we are seeing in oil supply currently (about 0.4% per year), we are already at a point where world real GDP can be expected to be much lower than most economists would prefer (2.2% or 2.5% per year).

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The Figure 5 fit (using 1983 to 2011 data) would seem to be slightly better for predictive purposes, since it is more representative of the current situation.

If we want world real GDP to grow by 4.0% per year, the fit from Figure 5 (based on the equation y = 0.741 x + 0.0193) would suggest that world oil supply needs to rise by 2.8% per year. If we want world real GDP to grow by 3.0% per year, we need oil supply to grow by 1.4% per year.

Indications if Oil Supply is Decreasing We can also look at what theoretically would happen if world oil supply starts declining (but here we are on shakier ground, because of many follow-on effects). If oil supply declines by 1.0% per year, the regression line in Figure 5 would suggest that world real GDP can be expected to increase, but by only 1.2% per year. If world oil supply declines by 2.0% per year, the model would suggest world GDP can be expected to increase by only 0.4% per year. If world oil supply declines by 4.0% per year, the model would suggest that world real GDP can be expected to decline by 1.0% per year.

In a decline situation, there would be very substantial changes of many types. Many countries and businesses would find their financial situations much worse. For example, oil exporters who discover large decreases in the amount of oil they export may be subject to political disruption or civil disorder, and oil supply could fall off further. Or buyers of oil might discover that their current financial problems have worsened. All of these thing point to the possibility that what started out as a small decline in oil supply could quickly become a much larger decrease. Or financial impacts could spread, if one bankruptcy leads to other bankruptcies.

Even without adjustment, the GDP indications if oil supply should decline are very concerning. They would seem to indicate long-term major recession or depression, especially in countries such as the United States and most European countries, which tend to have lower GDP growth rates below the world average.

World Real GDP Estimates Less than Perfect I should point out that in this analysis I used real GDP data from the USDA Economic Research Service, in 2005$. The USDA data shows world real GDP growth of 4.10% for 2010, and projects 2.68% for 2011, 2.95% for 2012, and 3.59% for 2013.

There are other calculations of World Real GDP with somewhat different indications. In particular, I know that the International Monetary Fund indicates higher world GDP, especially on recent years. It is now showing 5.3% growth for 2010, 3.9% growth for 2011, and 3.5% for 2012, and 3.9% for 2013. (The IMF's data only goes back as far as 1980, however.) The USDA report, which is the only one that I am aware of that is specifically in 2005 US$, indicates that its indications are based on 'World Bank Development Indicators, International Financial Statistics of the IMF, IHS Global Insight, and Oxford Economic Forecasting, as well as estimated and projected values developed by the Economic Research Service all converted to a 2005 base year.'

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As far as I can tell, part of the issue of multiple estimates of world GDP is that some methods give relatively more weight to emerging and developing economies in the calculation of the world average. This would tend to make their world average real GDP amounts higher.

Developing real GDP indications for a country is not too difficult; it is that aggregation that is the problem.

I have tried to find out more about the issue. One economist told me, 'World GDP is a difficult thing to compute, there are a number of aggregation issues that can be solved in a variety of ways.' Another told me 'All such numbers need to be taken with a grain of salt.'

The relationships I have shown are based on USDA Economic Research Service world GDP numbers. To be made comparable to IMF world real GDP growth percentages, they might need to be adjusted upward by as much as 1.2%. Thus, for example, instead of saying, 'If we want world real GDP to grow by 3.0% per year, we need oil supply to grow by 1.4% per year,' perhaps we should say, 'If we want world real GDP to grow by the IMF's 4.2% per year, we need oil supply to grow by 1.4% per year.' The principle would be the same, but the world GDP as reported by the IMF would be a little higher.

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The materiality question Written by Bill Haskett from Decision Strategies Recently, a client planning to participate in a Play in the Western Canadian Sedimentary Basin raised a seemingly simple question with a very complex answer: how much land should we buy?

Clearly, there are a great number of variables involved in making this decision, but many of them hinge on the concept of materiality. In the context of hydrocarbons, materiality essentially means 'how much presence do we need to make this opportunity worthwhile and

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control our own destiny?' How much acreage will make the purchase worth the cost, effort and risk? How much will ensure leverage to achieve my business goals efficiently?

I tackle this kind of question (as I did for this client) by assessing materiality from two angles: internal and external.

Internal materiality Internal materiality examines how a Play ranks versus other opportunities and Plays in your portfolio. Is it big enough to merit the overhead and internal resources required to make it productive? What portfolio effect will it have on the company's outcome? Is the profit potential and available working interest large enough to merit displacing other opportunities which will compete for funding and technical support?

With a very small portfolio, factors to examine include anticipated value, regret potential and cost, and portion of total investment. Companies will set their own thresholds, of course, but for example, less than a 1Tcf (recoverable) resource Play would rarely make sense.

External materiality External materiality is quite a different concept. It comprises nuanced concepts such as competitive advantage, leverage, sway and what I call 'sitting at the grown-ups' table.'

Interest in a Play must be sized to assure the ability to get things done and be a significant influence in the area. Is the size of your investment big enough to earn you accommodations from suppliers?

What size positions does the local competition have, and will they hold more sway over infrastructure development and timing? If eventual sale is a goal, does it have the scale to appeal to more than the neighboring producers and thus command a higher value in the market?

External materiality also has an operational component. Is the holding sized such that a factory-phase development would be operationally efficient? In my analysis, complete operational efficiency, while asymptotic, is rarely achieved in less than 100-150 wells.

Deciding on land investment is a balance. Too small an areal extent and the acreage doesn't matter. Too large and it gets very expensive to assess and establish reliable viability across press@oilvoice.com | +44 208 123 2237

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the acreage (see 'over-materiality,' below).

The most significant bump in value occurs as confident productivity potential is established across the acreage. And the value is higher when the acreage is contiguous, as it allows a critical production scale to be achieved more efficiently than disparate, broken-up islands.

A sample calculation Opinion will, justifiably, vary widely on what is the optimal acreage for a particular Play, as optimal positioning is far more than arithmetic. But let's take a stab at it for argument's sake. 

Let's assume an average well provides 4 Bcf recoverable. By the time operational efficiency has peaked so that well costs are greatly reduced, about 600 Bcf (150 wells) recoverable has been tapped.



In an era of relatively low gas price, these first 150 wells have allowed the company to create a profitable factory, establish a critical scale production center, and marketing infrastructure has been pulled into the area.

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About 2/3 of the wells are sub-average in recovery (as expected). The next 300 wells will be the real money makers, and maximum profit is realized through operational efficiency. At a minimum the size of the interest must be multiples of the number of wells it takes to reach the efficiency threshold.



This 400-500 well development area has recoverable resource of around 2 Tcf, but there is significant productivity uncertainty, including variable production and reservoir character across the acreage. The production uncertainty dictates that the land position needs to be somewhat larger than the simple math might indicate. The initial land position may have to be increased to allow for downside avoidance or sweet-spot inclusion.

So, based on an operating model, critical scale materiality is probably somewhere between 2-3Tcf for larger shale gas Plays. This is not a hard and fast rule. It is influenced by Play extent; subsurface and production uncertainty; and the ability to effect control over access to and timing of processing/market infrastructure. But it provides a good illustration of the threshold-based, decision making process.

The saleability question Many smaller companies have an end goal of a liquidating event. This could be as simple as a segregated asset purchase, or as extensive as a corporate acquisition. An asset buyer needs to see a meaningful critical-scale operation. A production center establishes cash flow and provides significant benefit to the acquiring company. The delineation wells of the pilot phase have de-risked and at least partially high-graded the acreage. press@oilvoice.com | +44 208 123 2237

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Potential buyers focused on growth would see the area potential and be willing to purchase early, seeking upside potential. Buyers focused on efficiency, on the other hand, would see the potential but also have efficient factory-phase capability. Critical scale is important to both camps.

Smaller or disjointed acreage positions may be attractive to neighboring operators, but to be attractive to significant, well-funded Players, a roughly contiguous block greater than criticalscale threshold will be far and away more marketable.

We also have to assume that buyers have the option to buy other blocks along trend. The small company acreage will be competing against other properties, and materiality is a benefit. But more important, how does the amount of acreage in the small company aggregate compare with the distribution of sizes across the area? What is distinctive about the company's holding that makes it more attractive than the competing opportunities?

From the production perspective, a production center of even modest size may rapidly fill the existing lines and exceed local plant capacities. New/expanded lines and plant capacity will be needed in order to draw necessary infrastructure to the area in a timely manner.

The push to liquids Many Plays have been explored and developed through the years as shale gas Plays. As the push to shale liquids continues, materiality takes on a slightly different context.

The industry continues to learn and to improve liquids production technology and completion methods. Early exploration in liquids Plays has shown the potential for extreme profit (though it is debatable if the highest profit comes from exploitation). The location of the best liquids potential is far more selective than the broad based, basin centred or Shale Gas Plays. It remains true that the larger a Play is, the more land it takes to have a persuading influence on what happens there. For liquids, however, acreage extent is often less important than acreage location where materiality is concerned. Critical scale is still needed, but the areal extent is not as important as having critical scale in the 'right' spot.

As profitability in liquids and liquids-rich shale is recognized in more and more Plays, it's clear that acreage materiality for critical scale is decreasing. At the same time, due to the uncertainty of liquids production location, the gross acreage acquisition is increasing, with some small investors (and lenders) eyeing the 100,000 acre mark for acquisition. Many entry strategies now recommend a series of material blocks along and/or across the uncertain unconventional potential‌especially in shale liquids Plays.

Due to the high profit potential, liquids are seen to be infrastructure creating. Gas is infrastructure demanding. The areal extent of material gas-driven projects will be substantially larger than liquids-driven opportunities. In international contexts, the shale liquids opportunities will create the infrastructure necessary for local shale gas.

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Enough, but not too much Further complicating the simple 'how much to buy' question is the very real notion of overmateriality. In a new Play, the temptation may be to grab it all, but with that early investment comes a disproportionate share of the risks and learning-curve costs. Significant offsetting acreage needs to be left to the competition in order to share the learning costs of drilling and completion. There has to be viable profit potential for industry to help with the learning.

Several operators have spent $500 million to $1 billion prior to 'figuring out' how to drill, complete and produce. Securing all of the acreage in a particular Play may seem like a good value proposition, but dominating a Play inhibits others from entering. In order to take advantage of OPM (other people's money), it is advisable to leave blocks of material interest available. With ultimate control comes ultimate expense and maximum downside risk.

Beware of being over-material.

Conclusion Appropriate materiality is the key. Recognizing and including the factors that provide materiality in your decision making enables you to create competitive advantage. Strategies for one company may not be appropriate for others and the Play and corporate objectives will strongly influence the shape, timing, and extent of the holding, as well as potential partnering efforts.

How much acreage you obtain in a Play is dependent on a number of elements. The highlevel goal is to have control over your own destiny. Projects must be material within the portfolio so as to influence the scarce resources within your company (people, time, and money). Immaterial projects are a distraction and have a high probability of loss. Companies benefit competitively and from a valuation perspective by having contiguous materially-sized holdings. The objective should be to have material positions in material Plays.

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New oil and gas discoveries changes picture for alternative fuels Written by Larry Wall from Larry Wall Gasoline prices are down. Oil prices are lower. New reserves of oil and gas are being developed around the world. U.S. refineries are exporting refined products to other countries and the United States produced more oil in the last quarter of this year than it has in 15 years.

The old Bob Dylan song confirmed, 'The Times, They Are A-Changin'.'

From the consumer point of view lower prices are good. No one wants to pay more for gasoline than they have too.

From a governmental standpoint and a royalty owner standpoint, lower prices mean less tax and royalty revenue, which is not good.

Oil companies are concerned about lower prices, because despite their large dollar amount of profits, some are only receiving a five percent return per dollar on their investment. If the price of oil drops too low, then there may be a cutback in production because it will not be profitable.

If there is a cutback in production, oil and gas prices will go up and the entire cycle will start over again.

This is not a new situation. The boom-bust cycle has been a mainstay of the oil and gas industry. Sometimes the fluctuations are not so great, while other times they can be tremendous.

Then there is the long standing problem of when the oil and gas industry is doing well, the rest of the economy suffers, because higher oil and gas prices mean higher energy prices, higher transportation costs, and higher manufacturing costs.

When the industry is not doing well, then usually the overall economy is doing well because everything is cheaper. Of course this is the exact opposite of what happens in the major oil producing states like Texas and Louisiana. North Dakota is now a major producing state, but that state is a relatively new player in the oil and gas industry. There is going to have to be a wait and see period to determine if North Dakota has allowed itself to become too dependent press@oilvoice.com | +44 208 123 2237

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upon oil and gas revenues. It is an easy trap to fall into.

There is another twist that has to be considered and that is the push toward finding alternative fuels to replace oil and gas. People with environmental concerns want to replace oil and to a lesser extent gas, with things like wind power, solar power, hydro power, hydrogen, and other alternatives.

According to the U.S. Energy Information Administration, in 2010 renewable energy accounted for eight percent of the U.S. Energy Supply. However, 31 percent of the renewable energy was hydroelectric, which has been in use for a long time.

The other sources were wind, 11 percent of the renewable energy; biomass, 52 percent of the renewable energy, solar, 1 percent of the renewable energy and geothermal 3 percent of the renewable energy.

In 2010 petroleum accounted for 37 percent of the U.S. energy supply, followed by natural gas with 25 percent and coal with 21 percent. Nuclear accounted for 9 percent.

Now we are in 2012 where we are producing more oil and gas than we did in 2010. We are exporting natural gas and refined products. Thus the demand for the alternative fuel sources is decreasing. Granted, people have environmental concerns, but we are finding more oil and gas-the nation and the world are not running out. The peak production date will have to be moved again and again in the coming months.

Every energy source has its positive and negatives. However, the one point to remember and it cannot be emphasized enough, none of the alternatives that have been proposed can replace oil as a building block, nor can they provide the liquid fuels that are extracted from natural gas.

Thus, their application is limited.

Solar power can be used to provide electrical power to houses at a lower cost, thanks to federal subsidies that will not last forever. However, in the northern part of the United States, where it snows frequently and the days are overcast, the traditional electrical companies are going to have to be present to provide power. Also while solar power may be practical for a house, it may not be usable for a 20 story building with tremendous lighting, heating and air conditioning demands.

So what is the solution?

The solution is to slow down and think. As a nation and as a global entity the issues of determining which one or two alternative fuel sources are practical for use on a large scale basis and can be integrated into our current life styles. For years people have been talking about capturing methane from garbage dumps. It has never been put in practical use.

Someone once suggested recycling old tires to make gasoline, but did not have the numbers to support how much investment it would take and how much a gallon of the reclaimed gasoline would cost. press@oilvoice.com | +44 208 123 2237

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It is most likely that oil and natural gas, followed by coal and hydroelectric are going to be the primary fuel sources for many decades to come. Natural gas can be used as a motor fuel, but it is going to be more practical in fleet situations where a limited number of refueling stations would have to be built instead of having a natural gas pump at every gasoline station.

Electric cars have not drawn the attention that carmakers expected. First, they are expensive, and secondly, they are dependent upon gasoline engines for backup power and finally, the batteries that are now being used are expensive to replace.

We are going to continue to see up and down in the oil and gas industry. The relatively recent discovery of the oil and gas shale plays shows there is energy to be found. The U.S. has a potential for finding even more energy, if moratoriums on the east and west coast are lifted, as well as the moratoriums against drilling in the Arctic National Wildlife Reserve (ANWR) and the Rocky Mountains.

Our energy picture is changing daily. It is necessary to examine what energy resources we have today, what we expect to find in the next 10 to 15 years and then determine a plan for phasing in alternative fuels where they can be of the most benefit without having to rebuild an entire energy infrastructure and force a change on a public that is not yet ready to accept such a massive change.

(Larry Wall is a former newspaper reporter and was also served 22 years as Director of Public Affairs for the Louisiana Mid-Continent Oil and Gas Association, the oldest trade group in the state exclusively representing all aspects of the oil and gas industry. Today, Wall is an observer of the oil and gas industry and a freelance writer. Wall writes about many subjects besides oil and gas. You can see much of his work by visiting is him on HubPages.Com. The web address is http://larrywall.hubpages.com .

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The Big Shift in energy is not what you think Written by Gary Hunt from TCLabz

The energy business cycle has always been dominated by boom and bust cycles. Through changes in technology, economic conditions and regulation nothing has altered that cyclical pattern. We have, however, seen driving forces of change affect the energy business cycle both for the good and not so good.

The Big Shift in energy today is not what you think. It is not going to be driven or dominated by political correctness or government industrial policy. The big shift in energy is not pro-coal. It is not pro-renewable energy. It is pro-business and a pro-competitive, prosustainable business bottom line.

The recovery from this recession may be slow and feeble but it is coming. And when it roars to life there will be no stopping the pent up economic energy, demand and willpower it brings. If you study the lessons of the boom and bust cycle energy history, you realize now in the feeble stages of recovery is precious lead-time you should not waste to position your business and refine your strategy for the build-up and then boom to come.

Electric power has traditionally tracked the rise and fall of GDP. And so it will in this business press@oilvoice.com | +44 208 123 2237

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cycle as well. But that does not mean that the energy industry is not also continuously adapting to change and reinventing itself for the business stages ahead.

The boom and bust cycle is not new but the factors driving it are changing it radically from our recently history: 

From Falling to Rising Marginal Cost of Power Generation. For the long period of post World War II growth across America improvements in technology and other factors led to declining marginal cost of production. That is each new baseload coal fired generator added to the power generation fleet reduced the marginal cost of electricity because these power plants operated more efficiently at lower cost. Early enthusiasm for nuclear energy was based upon the belief that it would continue to add low cost electricity supply to power America's economic growth. But it didn't work out that way with high inflation, constantly changing regulatory requirements, construction delays, and growing public opposition after Three Mile Island. The result was that first generation of US nuclear power plants cost orders of magnitude more than expected and stopped future nuclear energy expansion in its tracks to this day.

It also shifted the marginal cost of energy higher. Rising marginal cost of energy create powerful incentives for efficiency and technology change. Low natural gas prices offer a safe haven from rising marginal costs.



From the Fuel Use Act to the Growth of Unconventional Gas. There was a time when America thought it would run out of natural gas. Conventional supplies in sufficient volume difficult to find with the technology available and the depletion rates were a steep slope. The Fuel Use Act prohibited the burning of natural gas for power generation in the Jimmy Carter era to save the gas for home heating purposes. As little as five years ago the conventional wisdom was that the US would soon become a net importer of natural gas in the form of LNG securing from the same volatility and unfriendly places that provide imported oil. Technology in the form of horizontal drilling and hydraulic fracturing combined with the ingenuity and persistence of wildcatters like Mitchell Energy and others used the disruptive potential of these new technologies to turn this natural gas situation completely on its head. By 2011 America is exporting excess natural gas, gas prices have fallen to historic low levels on the oversupply and been decoupled from oil prices. Low priced natural gas is America's global strategic competitive weapon of choice.



From Renewable Energy for Fuel Diversity to Clean Energy and Back. As marginal costs rose concerns were raised about putting too many of our eggs in one fuel basket. Too much coal, too much nuclear energy and then later too much natural gas. The Clean Air Act and other environmental legislation raised our consciousness

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about smog and greenhouse gas emissions that caused acid rain conditions in New England from Midwest coal plants. The adoption of the foundational environmental legislation of the Clean Air Act and the Clean Water Act created a market for clean energy resources from wind and solar. The technologies were new, untested and costly. Renewable Portfolio Standards were designed to create a slice of system place in the power supply mix for these new technologies in hope that their marginal cost would fall as the installed capacity increased much as it did with coal and natural gas generation previously. Today, more than thirty years later the marginal cost of wind and solar are falling due mostly to oversupply of wind turbine and PV panel production in China, many states are nearing achievement of their RPS targets, wind and solar resources are considered mainstream and their market share has growth to about 13% of total installed generation capacity. The problem is few are satisfied with this outcome. Hydropower remains the largest contributor to renewable energy today at 63% of the total as it did 30 year ago. Without hydro factored in wind makes up 60% of the renewable market share (23% when hydro is included in the total). This is very close to the 2/3 of renewable market share that we predicted wind would capture back in 2005 in the work we did at Global Energy Decisions, on my watch as Global Energy Advisors division president, in a report for our investment banking clients worried about bankability called Renewable Energy: The Bottom Line. But solar energy is still tiny at 1%. Subsidies are still required for renewable energy to be economically viable. Low natural gas prices force renewables to learn to compete without subsidies-or else. Tough love.

The Big Shift in energy is being more competitive to sweat out excess costs.

We learned in the early days of competitive wholesale power generation markets that it often was better to be the third buyer of merchant generation assets as the enthusiasm of the pioneers gave way to the reality therapy of the financiers and then saw the assets flipped to find their optimized, rationalized home in a competitive portfolio. So it is today with renewable energy, with coal, with natural gas assets as the markets adapt to change.

The cumulative cost of our electricity bill is going up because of renewable portfolio standards, smart meter deployment, greenhouse gas emissions reduction, power grid security and ongoing investment in maintaining, replacing and extending our energy infrastructure to meet our future needs. Upward pressure on rates at a time of intensive economic uncertainty is forcing competitive balance to the equation.

Low natural gas prices are an equal opportunity competitor undermining the economics of

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coal-fired power generation with a ruthlessness effectiveness even the US EPA admires. But low gas prices have also stopped new nuclear power plant projects in their tracks and they are bearing down on renewable energy with the same low price efficiency.

Ten factors favor natural gas as fuel of choice for future power generation: 1. We've got plenty of low cost natural gas-why not use it?

2. Gas fired generation is fast to build, easy to site with no technical risk.

3. Natural gas is available in every regional market today.

4. Wind and solar have locational issues and require difficult to build transmission 5. Natural gas displacement of existing coal reduces emissions 40%!

6. Intermittent wind and solar require gas back-up to be dispatchable.

7. Gas fired generation can be built in load centers to improve grid stability.

8. Gas makes combined heat and power projects and microgrids practicable.

9. Natural gas can be stored to balance peak demands.

10. Low gas prices encourage strategic industrial security and manufacturing growth.

The Big Shift in energy is toward a competitive distributed energy future Natural gas fired generation improves grid security allowing faster evolution to a distributed energy future in a more modular grid made up of resources that can be isolated to avoid major grid failure in a natural disaster or terrorist attack. There is a place in the distributed energy future for every fuel type including renewable energy. But each must be placed in our modular, self-sufficient, reliable, cost competitive cleaner distributed energy future based upon the least cost, best fit principles that guided integrated resource planning for years until RPS standards, win and solar carve-outs and other politically correct industrial policy rules hijacked the process. That time is combining to an end as the distributed energy future is press@oilvoice.com | +44 208 123 2237

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assembled microgrid by microgrid by the private sector, using competitive forces and reliability standards at least as substantial as the governments to assure continuous operation of their business.

The big shift in energy use is toward competitive performance optimization from the convergence of energy, technology, supply chain operation including distribution and the use of energy by end use consumers in the distributed energy future. The role of the utility is no longer producing energy for us but to choreograph the reliable delivery and the diverse access of various energy sources, energy products and energy management services in a perfectly choreographed dance taking place 24/7.

We should anticipate the return of direct retail access to energy competition. But we should also expect it to be vastly different than the crude first attempts that worked in Texas but fell flat on its face in California's energy crisis. The big shift in energy will bring more customer aggregation vendors or buying co-ops acting as purchasing agents for businesses and homeowners. We should expect bundling of energy, technology, information, security and other services designed to provide convenience and value tailored to meet our needs.

Yes, there will be 'apps' for that!

So what does this big shift in energy mean?

The Big Shift in energy means new strategies and risk in competitive energy markets.

It means new knowledge available from a tsunami of data available about our energy use. It means new choices not just in energy sources like fuels for power generation, but also new vendors, new bundles of services. It also means new connections made possible by collaboration and mutual interest both designed to help us get a better deal, optimize the performance of our business, and deliver a better value proposition to our own customers and our households.

When all this low cost energy gets put to work focused on building a better future, America will be prepared to compete anywhere in the world across every stage of the business cycle.

The big shift is using energy-low cost domestic energy growth-to reinvent America's competitive economic position for the future. A future that makes America more secure, more technologically advanced, more globally competitive, more environmentally responsible and more self-confident than ever.

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Doing more with data Kuala Lumpur, October 24-25, 2012

Finding Petroleum / Digital Energy Journal is running 2 one day conferences in Kuala Lumpur, Malaysia, on October 24 and 25 on doing more with drilling and subsurface data.

These 2 events will present the most exciting new technology to help manage and work with all aspects of data in the upstream all and gas industry.

The conferences are for people who want to learn about new ideas and new technologies to make their data work harder, to improve efficiency and safety of drilling, ability to find new reservoirs and extend existing ones, and maximise production.

The event is scheduled to co-incide with the Energistics National Data Repositories conference in KL on October 21-24.

Attendance is free - register now to secure your place.

October 24 - Doing more with with drilling data October 25 am - Doing more with subsurface data October 25 pm - Getting data tools implemented faster The aim is (i) to make it easier for people working in KL oil and gas companies and service companies to find out more about the latest new technology to help manage data, and (ii) to provide technology companies attending the National Data Repositories event with a chance to meet a local audience during the same trip.

The events will be free to attend.

For days 1 and 2, we will look for financial contributions from speakers - in the range 14600 MYR / USD 4760 / GBP 3000 for a morning slot and MYR 9750 / USD 3200 / GBP 2000 for an afternoon slot.

Sponsorship opportunities are also available.

For enquiries about sponsorship and speaking please contact our sales manager John Finder on +44 208 150 5292, e-mail jfinder@onlymedia.co.uk

Reserve your place now at FindingPetroleum.com

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Lower oil prices - Not a good sign!

Written by Gail Tverberg from Our Finite World Are lower oil prices good news? Not really, if it means the world is sinking into recession.

We know from recent past experience and from common sense that higher oil prices are a drag on oil importing economies, since if more $$$ are spent on the same amount of oil, there is less to spend on discretionary goods and services. In addition, oil money sent to oil exporting countries is likely to be spent within those economies, rather than being reinvested in the oil importing country that the funds came from.

Figure 1. A rough calculation of expenditure (in 2011$) associated with oil imports or exports, based on 2012 BP Statistical Review data, for three areas of the world: the Former Soviet Union (FSU), the sum of EU-27, United States, and Japan, and the Remainder of the World. (Negative values are revenue from exports.)

A rough calculation based on 2012 BP Statistical Review data indicates that the combination of the EU-27, the United States, and Japan spent a little over $1 trillion dollars in oil imports in 2011-roughly the same amount as in 2008. Governments have been running up huge deficits and have been keeping interest rates very low to cover up this damage, but it is hard to make this strategy work. The deficit soon becomes unmanageable, as the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) countries in Europe have recently been recently been discovering. The US government is facing automatic spending cuts, as of January 2, 2013, because of its continuing deficits.

Furthermore, lower interest rates aren't entirely beneficial. With low interest rates, pension funds need much larger employer contributions, if they are to make good on their promises.

Retirees who depend on interest income to supplement their Social Security checks find themselves with less income. The lower interest rates don't necessarily have a huge stimulatory impact on the economy, either, if buyers don't have sufficient discretionary income to buy the additional services that new investment might provide.

Below the fold, we will discuss what is really happening with oil prices, and consider reasons why lower oil prices may be a signal that the world is again headed for deep recession.

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Oil Supply is Not Rising Enough The big issue is that oil supply is not rising enough-and hasn't been for a long time.

Figure 2. Actual and fitted oil consumption, based on BP 2012 Statistical Review. Fitted trend value of 2.0% is based on 1983 to 1989 actual data; fitted trend value of 1.6% is based on 1993 to 2005 actual data.

When oil supply doesn't rise fast enough, there are two opposite effects that can take place:

Figure 3. West Texas Intermediate (WTI) and Brent oil prices, in US dollars, based on weekly average spot prices from the US Energy Information Administration.

(1) The most common effect is that prices will go higher. This can be seen in the upward trend in prices in the last eight years.

(2) The other effect is that prices can drop quite sharply, as they did in late 2008. This happens when parts of the world are entering recession, and their demand is decreasing.

It seems to me that this second effect may be happening this time around, as well. The down-leg we are seeing in the prices may have farther to go, as the recession plays out.

One Problem Area: PIIGS Oil Consumption is Declining If we look at three-year average growth rates for the PIIGS, we find that there is a close correlation between oil growth, energy growth, and GDP growth. Furthermore, in recent years, a growth (or drop) in energy use seems to proceed a growth (or drop) in GDP. Not all of this energy is oil, but for the PIIGS countries, even natural gas is a relatively high-priced import. Recently, oil consumption has been declining sharply, which could imply further economic contraction. press@oilvoice.com | +44 208 123 2237

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Figure 4. A comparison of average three-year growth rates on three bases: GDP, oil consumption, and total energy consumption. GDP from USDA Research Real GDP database; oil and energy consumption from BP's 2012 Statistical Review.

Furthermore, data from the Joint Organizations Data Initiative (JODI) shows that recent PIIGS oil demand is down even more. Comparing oil demand for February-April 2012 with February-April 2011, demand is down by 10% for the five PIIGS countries combined. This would suggest that these countries are sliding more deeply into recession.

US Oil Consumption Is Also Shrinking US oil consumption is also shrinking.

Figure 5. US average consumption of petroleum products, during the months January to April, based on data of the US Energy Information Administration.

US oil consumption shrank by 3.2%, comparing the first four months of 2012 with a similar period of 2011. This is concerning, because based on Figure 5, it looks much like a repeat of the pattern that took place in the 2005 to 2009 time period. Oil consumption was stable during the period 2005 through 2007, then dropped in early 2008 by an amount not too different from the decrease in oil consumption from 2011 to 2012. The bigger step-down in oil consumption came in 2009, after oil prices dropped, and the follow-on effects (reduced credit availability, layoffs) had started. Now oil consumption has been relatively stable in 2009 to 2011, but there has been a step down in consumption in 2012, similar to the stepdown in early 2008.

If Oil Prices Stay Down, or Drop Further, Not All Oil is Economic Oil prices make a difference in a company's willingness to drill new wells. For example, oil sands production in Canada is quoted as being not economic below $80 barrel, and the West Texas Intermediate price is below that level today. In most instances, existing production will be continued, but new production will be stopped. There are quite a few other types of oil extraction elsewhere (for example, arctic extraction, new very small fields, very press@oilvoice.com | +44 208 123 2237

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deep oil wells, steam extraction outside Canada) that may not be economic at lower prices.

Saudi Arabia makes frequent statements about offering its production to keep prices down, but if a person looks at production patterns in the past few years, they have been highest when oil prices have been highest. Production has dropped as oil prices drop. So a rational person might conclude that oil wells which cannot be operated continuously (of which there are some in Saudi Arabia) tend to be operated when prices are highest, and turned off when prices are lower, thus maximizing profits. As oil prices drop this time around, we can expect Saudi Arabia and others to find excuses to save production until prices are higher.

Countries exporting oil depend on the revenue from the sale of oil, plus taxes on this revenue, to help support country budgets. As oil prices drop, governments find themselves with less money to fund promised public welfare programs. This dynamic can cause lower oil prices to lead to political instability in some oil exporting nations.

Thus, any drop in oil prices tends to be self-correcting, but not until oil production drops, prices of other commodities drop, and many workers have been laid off from work. We saw in 2008-2009 that this kind of recession can be very disruptive.

What's Ahead?

We can't know for certain, but the big issue is chain reactions, as one problem causes other problems around the globe. We are dealing with an interconnected international economy. If countries are in financial difficulty, their banks are likely to be downgraded as well. Other banks hold debt of the bank, or of the country in difficulty, or derivates relating to a possible default of the country or bank. If default occurs, these other banks may be affected as well.

Thus one default may start a chain of defaults.

Banks that are facing difficulty (inadequate capital, poor ratings), are likely to become more selective in their lending. This makes it even more difficult for small businesses to obtain loans, and may lead to layoffs.

A country which appears to be near default is likely to face higher interest rates, making its cost of borrowing higher. The higher interest costs, by themselves, push the country closer to default.

One of the issues with high oil prices is that the higher prices, especially among oil importers, give rise to a kind of systemic risk that affects many kinds of businesses simultaneously. High oil prices tend to do several things at once: lower the real growth rate, make it more difficult to repay loans, and increase the unemployment rate. All of these issues make it more difficult for governments to function, because governments play a back up role. If workers are laid off from work, governments are expected to compensate laid-off workers at the same time they are collecting less in taxes and bailing out distressed banks.

This type of systemic risk leads to the possibility of multiple government failures.

Promises of Future Oil Capacity Growth Aren't Very Helpful We keep reading articles claiming that world oil production will grow by some large amount press@oilvoice.com | +44 208 123 2237

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by some future date. One of the latest of these is by Harvard Kennedy School researcher (and former oil company executive) Leonardo Maugeri, called Oil: The Next Revolution.

According to the report, 'Oil production capacity is surging in the United States and several other countries at such a fast pace that global oil output capacity is likely to grow by nearly 20 percent by 2020, which could prompt a plunge or even a collapse in oil prices'.

Even if the forecast were true (which I am doubtful), the problem is that this is simply too late. We have been having oil supply problems for quite some time-since the 1970s. The rate of oil supply growth keeps ratcheting downward, and the world keeps trying to adapt, with recessions to show for its efforts. (James Hamilton has shown that 10 out of 11 recent recessions were associated with oil price spikes.)

We don't have time to wait until 2020 to see whether the supposed additional capacity (and production) will actually materialize. We have a problem right now. The downturn in oil prices and the reduction in demand in the US and PIIGS is looking more and more like the current oil price spike (of 2011 and early 2012) may give rise to yet another recession. Based on our experience in 2008-2009, and our difficulties since then, this recession may be severe.

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Investing in oil: 5 Questions to ask company management Written by Keith Schaefer from Oil & Gas Investments Bulletin The North American oil market is going through a fundamental change that will affect the price of oil for the rest of this decade-fast-rising shale oil supplies from North Dakota and Texas.

(Other shale oil plays will contribute as well, but none will come close to the revolution happening in those two states.)

This could mean lower oil prices for the next several years. I don't foresee the collapse in oil press@oilvoice.com | +44 208 123 2237

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prices like what happened to natural gas, but even a 30% permanent drop to $70/barrel from $100 will impact junior and intermediate producers who spend all their cash flow.

And folks, almost all of them spend all their cash flow.

To me, this situation has two outcomes: 1. The juniors/intermediates will reset to a lower valuation/lower multiple to take into account lower profitability from lower oil prices. That is happening now and is almost done, IMHO. 2. Balance sheet will become more important than it was in a bull market, when juniors could raise money with no problem to fill the gap between cash flow and spending. Now the financing market is very fickle-one day it's open; the next-no way.

With this in mind, here are a few questions for you to ask management teams in your research. Most of these answers can also be found in the middle of the Management Discussion and Analysis (MD&A) in the quarterly financial statements.

QUESTION #1 – What price deck are they basing their cash flow on? Because if it's above $75, I would expect downward revisions this year. OK, maybe they can use $80, but that would be, IMHO, a bit optimistic (especially north of Cushing, Oklahoma, which includes all of Canada ;-)).

The price of oil in 2012 may average better than that, but moving forward from now, it's tough to see North American oil improving much more than $10 a barrel (i.e., over $80-$85) for the next 18-24 months.

I hope I'm wrong and we all make buckets of easy money in the next year at $95 oil, BUT the fast-growing supply in the US is competing with Canadian oilsands for pipeline and refinery capacity, which is already close to being full. Whoever is willing to take the lower price gets to sell their oil.

QUESTION #2 What is their net cash/net debt? Make sure you use the word NET, as the number you get could be GROSS… as going into this downturn, in April, the market was still focused on growth and the income statement. Now it will be focused on the balance sheet. That's a BIG change, especially for Canadian producers who for the most part spend AT LEAST 100% of cash flow… often up to 150-200%.

The 'growth at any cost' mantra of a bull market could mean that some high growth companies that got premiums in their stock in the past will now have their valuations lowered by the market.

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QUESTION #2b What is their 'total liquidity'-how much money do they have available to them? This would be how much room they have left on their debt capacity, plus any net cash they have. If they have $10 million net debt on a $50 million line, they have totally liquidity of $40 million. With $10 million net cash, the total liquidity is $60 million.

QUESTION #3 What is their debt to cash flow ratio at $70 oil? Anything over 1.5:1 in the juniors will get punished a bit, and over 2:1 will get punished a lot. Institutions will buy those stocks last in any new bull market, and without institutional liquidity those stocks will not move up.

QUESTION #3b With the yield stocks, the same question is phrased like this-what is your all-in, payout ratio at $70 oil? When you put their drilling budget and dividend payouts up against cash flow, if it's even over 100%… that's bad news now.

As reference, every single one of the 10 companies in a most recent Macquarie Capital weekly energy update showed payouts higher than cash flows. 10 of the 17 US mid-cap producers were scheduled to spend more than their cash flow. It was 8 for 14 in the Canadian mid-caps, and all 12 of the small caps were spending more than cash flow. You get the picture. Spending cutbacks this year must happen, which will reduce growth.

QUESTION #4 Will they reduce their spending to meet their new lower 2012 cash flow? As I said above, there is almost NO FREE CASH FLOW in the Canadian junior/intermediate energy patchthey regularly spend more than they cash flow.

And in a declining price environment, the market gets more sensitive about energy producers spending within their cash flow. If the oil price declines so much that their cash flow goes down below what they plan to spend, they may have to cut back drilling-slowing production growth. Slower growth means a lower multiple in the stock.

That makes companies NOT want to cut back spending/drilling. But once The Market KNOWS a management team must cut back, it starts to price all that in, anyway.

Investors will punish a stock quickly when it announces a spending cut (despite the fact that saving the money and preserving the balance sheet is the right thing to do)… and punish it slowly if management doesn't quickly cut back spending. So the stock either does a quick cliff dive when management does the prudent thing, or it drowns slowly until they do cut spending or everyone thinks the price of oil will stay high.

The reality is, they won't tell you that. By law, they have to say 'no' even as they are sending out the press release that they are indeed reducing spending ('lowering capex' is the industry jargon)… because that's a material fact, and they need to make disclosure to everybody at press@oilvoice.com | +44 208 123 2237

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the same time via a press release.

QUESTION #5a, b, c and d How much production do they have hedged now-at what prices? (i.e., how much future profits have they locked in?) What percentage of their production is that? And when do the hedges run out? Not many companies have hedged production at higher prices, but those who have will get rewarded with a slightly higher valuation-especially if it's a Tier One junior.

So what kinds of stocks should I be investing in as the market adjusts to this new, lower oil price scenario?

1. Those with net cash, then those with very low debt ratios (less than 0.5:1) 2. Oil focused (there are only 4-5 gas stocks worth looking at in Canada now) 3. International stories that get Brent pricing, which is based out of London, England-it is now $10-$15 above WTI, the US benchmark oil price.

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Exploration: Hot spots...

Written by David Bamford from OilEdge Perhaps more than any other sector of the oil and gas business, exploration encourages rumour and anecdotes, with much important information being traded by 'networking'. For example, sitting at lunch at a recent Finding Petroleum event, I learned more about the reported 2.5 billion barrel Johan Sverdrup oil discovery in Norway than I could attending a year's worth of formal presentations!

I seize on anything that is factual and so I was very pleased to get in my hands a copy of press@oilvoice.com | +44 208 123 2237

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Richmond Energy Partners' report on the exploration performance of 32 mid-cap and 8 large-cap E & P companies (outside North America) over the 4 years 2008 - 2011.

I found a couple of their results especially compelling - before saying what they are, I need to take a little segway into some terminology: The Exploration 'Life Cycle' The Exploration 'Life Cycle' of exploration plays (and, occasionally, whole basins) illustrates the essential discussion about 'Where shall we explore?'

A cartoon representation of the 'Life Cycle' of exploration plays (David Bamford)

The status of any play can be considered in terms of its position in this Cycle. To illustrate, the movement of the UKCS North Sea Brent (oil) province can be positioned over its 45+ year history: Frontier - in the 1960's: Prolific - in the early 1970's: Mature - in the late 1970's and in the 1980's: 'Red' - today.

Explorers are often accused of being only concerned with Volumes but of course this Cycle has profound implications for Value.

In the early, Frontier, phase, of course there is only expenditure with as yet no production of even significant discoveries.

In the Prolific phase, value creation is at a maximum, as discoveries are large (typically, press@oilvoice.com | +44 208 123 2237

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'Giant' accumulations of >250mm boe gross), and therefore F&D costs are spread over a large number of barrels.

In the Mature phase, value creation can still be good but technology application and cost reduction become important in order to enhance economics.

In the 'Red' phase, value destruction is probable, occasionally inevitable, as success rates plunge, the very few discoveries are small, and costs escalate. Of course, it remains possible for a company to 'win' during this phase but the number of 'winners' is small, the number of 'losers' very high!

The following sketch illustrates the evolution of discovered resources, value, costs and a notion of 'reward', through these cycles of exploration from Frontier to 'Red'.

Exploration 'Life Cycle': Value Generation (David Bamford)

It is important to emphasize that the right level of analysis is the play level. It would be absurd to pretend that a whole region lies in the 'Red' zone for example; indeed the Johan Sverdrup discovery demonstrates the power of 'new play' thinking even in a basin with a long exploration history.

Three takeaways from the Richmond report 1. There is a significantly higher probability of making a 100 mm barrel discovery in a Frontier play than a Mature play (in fact it is about 7.5 times more likely!) press@oilvoice.com | +44 208 123 2237

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2. Overall, Frontier Exploration has been successful, with the 5 'big play breakers' all in Deep Water. For 2012, there is a huge focus on exploration drilling in the South Atlantic and East Africa (onshore and offshore).

3. In Frontier Exploration, there has been relatively little effort, and no discoveries, in stratigraphy older than the Cretaceous, whereas in Mature provinces, effort and discoveries reach down to the Devonian and older.

The first of these conclusions is obviously not a surprise, although the degree of difference may be to some.

The second and third points speak to Hot Spots and Hot Rocks respectively - I'll examine them in more detail in an article later this week.

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Oil 101: Tough predictions Written by Saj Karsan from Barel Karsan Those of you who follow me on Twitter know I recently read Oil 101 by Morgan Downey.

Downey is clearly an expert on all things oil, as he provides a detailed analysis for the reader on a wide range of oil-related topics from oil history to refining and drilling processes to transportation to storage to regulations. But to regular readers of this blog, it should come as no surprise that even an expert's predictions can be significantly off the mark.

The book was published in 2009 by an expert in the oil industry, a relatively mature, slowchanging industry that has been around since the early 1800s. But in just three years, a few things have changed that throw cold water on some of Downey's predictions. For example, consider the following quote from the book: "If oil is expensive and scarce in the future then so will [be] natural gas..."

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Of course, in the ensuing three years, a massive spread has emerged between the price of oil and that of natural gas. This has caused many companies to convert their truck fleets from diesel/gas to natural gas, reducing demand for oil.

In another example of how unforeseen changes can blindside forecasts, horizontal drilling and fracking are mentioned very briefly in the book. But of course, we now know that these have the potential to be game-changers in this industry. For example, they have helped increase production in the Bakken to 500,000 bpd (from 400,000 in 2011 and 300,000 in 2010). Such increases in supply have caused supply gluts at various points throughout North America's oil pipeline network, resulting in significantly different prices throughout the country.

With oil prices as high as they are, we may continue to see innovations that alter our perception of what is considered normal in this industry...just don't expect to be able to predict what they are!

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Energy security and cooperation in South China Sea Written by Anita Abbott from Anita Abbott The South China Sea is currently the subject of dispute involving China-ASEAN members.

Most ASEAN (Association of Southeast Asian Nations) members and China have claimed the Spartlys and the Paracels as their territories, and acknowledge the importance of the South China Sea for its shipping routes and vast reserves of oil and natural gas. According to a 2008 report from the U.S. energy information administration, oil reserves in South China Sea are estimated to be more than 213 billion barrels, which is equal to ten times the American oil reserves. Vietnam's accusation that China's vessels cut the cables to exploration ships, China's claim to a gas rich zone near Natuna Island, which Indonesia press@oilvoice.com | +44 208 123 2237

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occupies, and China's claim to the Mischief Reef that is also claimed by the Philippines as part of its territory, render to the on-going dispute. Recently China and the Philippines have disputed the ownership of Scarborough Shoal, 100 miles off the coast of the Philippine, in which both have claimed as theirs.

China's view is that multilateral negotiations for the dispute resolution will complicate matters, preferring instead unilateral negotiations, which give China distinct leverage, whereas ASEAN agree that international intervention by way of multilateral negotiation is essential. ASEAN members, however, are unable to pressure China to accept international intervention, specifically negotiation, as the basis for the dispute resolution. Non-alliance with great powers, such as the United States renders to ASEAN states' inability to pressure China.

ASEAN members have approaches to the conflict resolution: cooperative security, such as 1976 Treaty of Amity and Cooperation (TAC) for the peaceful settlement of disputes, and ASEAN's 1992 Manila Declaration; comprehensive security, such as Indonesia's approach to foreign diplomacy; and national security as they have developed naval forces to defend their Exclusive Economic Zone (EEZ) claims.

With regard to ASEAN's response to China's claim to part of South China Sea, Malaysia desires to include the United States as Malaysia distrusts China. Indonesia claims to be a neutral country, and although not intimidated by China, does not confront China but expects the United States to play a role as a mediator in the dispute. By including the United States, Indonesia has more bargaining power. Vietnam distrusts China and seeks support from the United Support for the dispute. Singapore, although not involved in the maritime dispute, is engaged in the advanced stage of talks with the United States over the deployment of new, highly advanced warships. The Philippines also distrusts China due to their dispute over the Mischief Reef. Like other ASEAN members, the Philippines seeks support from the United States under an historic 1951 treaty in which the US was obligated to defend the Philippines.

Like Singapore, Thailand does not have a maritime dispute with China but China's aggressive stance towards the Philippines inflicts Thailand with suspicion. Nonetheless, Thailand maintains a relationship with China by having China as its weapons supplier. Laos, Cambodia, Myanmar, and Brunei do not have disputes with China but enjoy friendly relationships with China.

The South China Sea disputes, however, are not a serious threat to the national security of ASEAN members. This explains why ASEAN members do not confront China. Nonetheless, several ASEAN members welcome the presence of the United States' navy. The challenges for ASEAN members would remain: it is unlikely that China will give up territory in the South China Sea as China is hungry for energy resources. Welcoming the United States' presence is a good start as the United States can be a buffer for China's presence in South China Sea. Involving the United States in ASEAN Regional Forum (ARF) and East Asia Summit (EAS) without leaving Russia out has been a strategic approach in ASEAN-China dispute in South China Sea. The United States also has its interests in the South China Sea: the Sea lines of Communication (SLOCs). It is then likely that the United States is willing to be involved in the South China Sea. One formidable challenge for ASEAN members remains: China is ardently avoiding multilateral negotiations, and has so far refused to negotiate

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outside bilateral agreements. It then depends on the assertiveness of ASEAN members to encourage China to be involved in multilateral agreements.

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China continues to boost its oil and gas assets with Talisman and Nexen bids Written by Richard Jennings from Spreadbet Magazine Despite all the market turmoil over the last few days as a result of the fears over Spanish and Italian sovereign debt, all appears well in the world of oil and gas mergers and acquisitions with the announcement of two deals yesterday involving North Sea assets.

What's more they are both at significant premiums for existing share holders. Confirmation yet again that companies like Bowleven, Chariot Oil and Gas and Xcite Energy will continue to be attractive with their assets trading at large discounts to industry merger/takeover multiples. Any hint of drilling success or confirmation of oil field commerciality is likely to bring on more cash rich predators.

Oil & Gas UK said Monday's deals reflected 'the renewed attractiveness of our province as a place to invest'. It added: 'Given the new ownership, we would expect investment activity to remain high.'

China's largest energy and petrochemical group, Sinopec made a $1.5 billion deal with Calgary based but Toronto listed Talisman Energy to acquire a 49 per cent stake in the company's North Sea assets. Talisman currently focuses on the UK, North America and Asia but it decided to sell a proportion of its North Sea business to strengthen its balance sheet in the face of falling shale gas prices in the US. Sinopec's deal will allow more investment in North Sea oil assets, adding to field life and press@oilvoice.com | +44 208 123 2237

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also allow greater exploration. Good news for oil and gas production for the UK. Talisman's North Sea assets produced 71,500 boepd last year.

CNOOC (China National Offshore Oil Corporation), swooped on Candian listed, Nexen with a $15.1 billion bid. Nexen has oil sand and shale gas reserves in Canada as well as assets in the North Sea, Nigeria and United States (Gulf of Mexico). CNOOC is the third-largest oil company in China after CNPC (parent company of PetroChina), and China Petrochemical Corporation (parent company of Sinopec).

Nexen is second largest oil producer in the UK North Sea. Its net UK production of both oil and gas is 114,000 barrels of oil equivalent per day (boepd).

CNOOC's cash offer of $27.50 a share represents a 61 per cent premium to Nexen's closing price last week and is potentially controverisal given that it may raise political opposition in Canada with concerns about the Chinese buying such a significant flagship asset. An $18.5 billion deal to buy US company, Unocal, in 2005 fell apart after political intervention.

Canadian opposition to Chinese acquisitions may be less than the U.S. but BHP Billiton investors will remember the regulatory obstacles put in the way of the $39 billion bid for Potash Corp. of Saskatchewan in 2010. CNOOC made a $2 billion purchase of Alberta oil sands developer OPTI Canada in July 2011 after the company's bankruptcy. Canada's trade minister, Ed Fast, said he expected 'reciprocity' with China in investment and trade.

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