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Art Berman: Like It Or Not, The Future Remains All About Oil

Art Berman, 40-year veteran in the petroleum production industry and respected geological consultant, returns to the podcast this week to talk about oil.

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After the price of oil fell from its previous $100+/bbl highs to under $30/bbl in 2015, many declared dead the concerns raised by peak oil theorists. Headlines selling the “shale miracle” have sought to convince us that the US will one day eclipse Saudi Arabia in oil production. In short: cheap, plentiful oil is here to stay.

How likely is this?

Not at all, warns Berman. World demand for oil shows no signs of abating while the outlook for future production looks increasingly scant. And the competition among nations for this “master resource” will be much more intense in future decades than we’ve been used to:

Since the 1980s, we simply have not been replacing reserves with new discoveries. So how does that work? Well, obviously, we’ve got a lot of oil on production and in reserves, so we’re essentially drawing down our savings account if you want to think about it that way. You can do that for a long time if you’ve got a whole lot of money in your savings account, and we as a planet do. But you can’t do it forever.

Eventually, you either have to stop spending as much so you don’t draw down your savings, or you need to put some money back in the account. And it doesn’t seem like we’re doing much of either, and haven’t been doing much of either for a long time. So the concern is tremendous, at least, in my estimation(…)

We have to go back to FDR to understand that the centerpiece of U.S. foreign policy ever since World War II has been to maintain supply of oil. And, of course, back in FDR’s time, the U.S was 100% oil self-sufficient. I think we produced something like 52% of the world’s supply. So here’s a guy who, without any immediate supply issues even on the horizon, said “We’ve got to look after our own oil security” and made a deal with Saudi Arabi to provide that. But now we’ve had the Obama and the Trump administration saying, “We don’t need your stinking oil any more. We’re the big guys on the block.” China’s saying, “Whoa. Here’s an opportunity for us.”

What does that mean to us other than political gamesmanship? Well, whatever else people might believe, the United States still imports 7+ million barrels a day of crude oil. Even if you work to net out our exports, we still import, pretty nearly on average, 6 million barrels a day. That’s a huge volume. We get an awful lot of it from the Middle East. Well, if the Middle East is diverting their supply to countries like China, guess what? It’s not available to us, or it’s not available at the price that we want it. Not to mention that fact that Saudi Arabia’s population is exploding. They’re using more and more of their oil output for domestic consumption, so there’s increasingly less to export.

These should be primary concerns to anyone who even remotely thinks about the future. Certainly to anyone who connects the supply and usage of petroleum to economic wellbeing.

Click the play button below to listen to Chris’ interview with Art Berman (59m:44s). https://www.youtube.com/watch?time_continue=2&v=gWC5SJjBdqc

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Transcript

Chris: Welcome, everyone, to this Peak Prosperity podcast. I am your host, Chris Martenson, and it is January 15, 2018. We are off to the 2018 podcast cycle. Hey, I think there’s an oil price shock coming in a few years at most, and I think that’s going to upset the global pile of debt as surely as a shocking rate hike would. Why do I think that? You know, this is a fairly contrarian position to take at this time with many people, a lot of analysts even convinced that oil is abundant, and that, specifically, U.S. shale oil growth is going to keep oil abundant forever. But here’s a shocking statistic. In 2017, the least amount of new oil was discovered since the 1940s, less than 7 billion barrels reported as discovered. Now, this is in a world that burns more than 30 billion barrels a year. And guess what? 2016 was almost as bad, which followed a terrible 2015 that itself followed a disappointing 2014.

So taken together, that’s four terrible years of oil discoveries that have, together, no historical parallel. The very worst four years of global discoveries in the entire history of oil leased, as far as my data set is concerned, which begins in the 1920s. So here’s why you should care a lot about that particular statistic and the subject of oil in general. There is simply no question about this. Economic growth requires energy. Specifically, oil energy, especially in a global, just-in-time delivery, economic model like we have right now.

All right, so, if you want more economic growth, then we’re saying, by definition, you want to consume more energy. So, if you’re a believer in, or perhaps, holder of record high stock and/or bond markets, then your financial wellbeing is tightly wedded to the future price and availability of oil. It’s really that important and that simple, which is why we continue at Peak Prosperity to focus on the topic of oil when virtually everybody else has turned their attention away, except maybe the Chinese, but we’re going to get to that in just a second.

Today, we’re going to talk with one of the leading experts on oil and gas production in the U.S., and someone I personally like and admire, and I also happen to trust the most to analyze and tell the truth, as unpleasant as that might be sometimes, about oil and particularly the shale place. Arthur Berman is our guest today. Art is a geological consultant with nearly 40 years of experience in petroleum exploration and production, 20 of those at Amoco, now know as BP. He’s published way over a hundred articles on geology, technology, the petroleum industry just over the past five years. Now, he’s got the chops; he’s published more than 20 article and reports on shale oil plays and shale gas plays, including in the Barnett, the Haynesville, the Fayetteville, Marcellus and Bakken, I follow him very closely at his blog artberman.com. You should, too. Welcome, Art, it’s great to have you back on here in 2018.

Art: Thanks, Chris. It’s always great to talk to you, and Happy New Year.

Chris: Thank you. And Happy New Year to you. We have so much to talk to you about, and I want to start here with the piece I introed with. Let’s talk about oil discoveries. Now, I think it’s an issue. So does the International Agency, or IEA, but kind of in a muted way, I thought. Perhaps a few other analysists like those a HSBC, but generally, Art, I think the propaganda – and I think that’s the right term here – is aligned with the idea that American shale will fill any potential void. Let me quote a senior analyst here at Rystad Energy who wrote, just a month ago, “We haven’t seen anything like this,” this being low discoveries, since the 1940s. “The discovered volumes averaged 550 million barrels of oil equivalent per month. The most worrisome is the fact that the reserve replacement ratio in the current year reached only 11 percent for oil and gas combined, compared to over 50 percent in 2012.” So, Art, how concerning are these lack of discoveries, in your opinion?

Art: Well, they’re huge, Chris. And the last sentence you stated from Rystad – let’s think about that. So the reference is a year where we only replaced 50 percent of reserves. I mean, how good is that? I mean, that’s terrible.

Chris: That’s the reference. Yeah.

Art: Yeah. And we’ve been in that situation now since really the 1980s, where we simply have not been replacing reserves with new discoveries. So how does that work? Well, obviously, we’ve got a lot of oil on production and in reserves, so we’re essentially drawing down our savings account, if you want to think about it that way. And you can do that for a long time if you got a whole lot of money in your savings account, and we as a planet do. But you can’t do it forever. And eventually, you either have to stop spending as much so you don’t draw down your savings, or you need to put some money back in the account. And it doesn’t seem like we’re doing much of either, and haven’t been doing much of either for a long time. So the concern is tremendous, at least, in my estimation. And Rystad, I think is – I don’t agree with everything that they do. They probably don’t agree with everything I do either; nobody does, including me sometimes. But I think they have considerable credibility, in my opinion. And I pay attention to what they say and what they write, so there you go.

Chris: The reason I – well, I’m hoping this creating more alarms behind the scenes than is apparent out here in the cheap seats, Art. I can’t see any apparent concern in the U.S. government anywhere at this point in time. I’m not even sure where Europe stands on this. But, to me, a world that’s replacing 11 percent of what’s it’s using clearly has some issues coming forward. I believe the maxime in your business says you got to find it before you can pump it. We’re not finding it. I guess some people are thinking, well, shale’s going to fill in the gaps. Or, guess what? When oil goes back up in price we’ll find more of it. Hey, Trump just opened up a lot of the coast for drilling; we’ll find more. But talk to us about the lags that – I don’t think most people appreciate this. Not like we could ram oil up to $200 a barrel tonight, and tomorrow we find a big field, and the day after that we’ve got some gas at the pumping station. Talk to us about the lag that exists in your industry.

Art: The lags are variable, of course, but I think, to be fair and even a little optimistic, from discovery of a big field, giant field even, historically, we’re talking about somewhere between six and seven years absolute minimum to get to first production, and more commonly we’re out nine, ten, eleven years. And the real poster child, if you will, is the Kashagan Field in the Caspian Sea, which was discovered, I think, in the early 2000s, and here we are in 2017, and they’re finally just maybe getting ready to ramp up to full production. Now, it’s a great example because they’d had all kinds of political problems, economic problems, high sulfur oil problems. I mean, they had every problem in the world. So perhaps it’s extreme. But it’s also the biggest discovery that’s been brought online in the last 20 years. So in a way, maybe it’s a cautionary tale. To convert a reserve to supply is not trivial. It takes not only time, but it takes a lot of money. And so, just because you’ve made the discovery doesn’t mean you’re out of the woods as far as finding the capital, getting the cooperation among partners – there are always partners. Hopefully, you’ve got the cooperation of the government who hosts that field. So there’s a million problems. Nobody’s figured out a way to shorten that time.

And that’s part of the appeal of the shale plays because you’re not required, then, to get into these big issues of platforms, production platforms, that often cost billions of dollars and putting pipeline, Sub C and all that kind of thing. With a shale well, you can go out to West Texas or North Dakota or South Texas or wherever, and you can punch a well down pretty quickly, and you can get it on production reasonably quickly because the infrastructure is there. And so this gets to the whole notion on return on capital employed, which is a biggie for any corporation. How quickly can you show a return for the money you spent? And if you’re putting your money in Kashagan or some long-term expensive, multiyear kind of capital intensive program versus spending a few million on a well in Eagle Ford for shale, well, there’s no question.

The tradeoff is – well, the tradeoffs are multiple, but principally, it’s size. You go out and you drill one well in a shale play, and let’s just be middle of the road on it – let’s say it gets you maybe 250 or 300 thousand barrels of oil, whereas you go out and you develop a Kashagan, and you’ve got 30 billion barrels of oil. So you’re making lots and lots of little, bitty contributions that in total don’t add up to anything close to what the big fields. We can talk about decline rates and all the other problems with shale plays, but just to keep it simple, that’s what you’re talking about. It’s death by a thousand cuts. You can get it pretty quick in the shale plays, but it’s not really contributing all that much to our global supply, certainly not on a one-off basis.

Chris: Now, Art, I want to make an analogy here. Maybe it’s not appropriate, but maybe close enough for our listeners, which is the idea of electricity production. You have two major components in there. You got your base load – so this is your hydro, your nuclear, sometimes your coal fired plants – these things spin up very slowly, very capital intensive. But that’s your baseload. And then, there’s little things at the edges that help you get to your peak load. That would be maybe you’re on-demand gas turbine or maybe solar and wind maybe have these peaky sort of components to them. Really, what we’re talking about is these big, big plays like the Kashagan Field or the North Sea or the Gulf of Mexico. There are big, giant things, very capital intensive, billions of dollars to get them going, but they’re going to produce for decades. Shale wells are 85 percent depleted in three years, so there’s a drilling intensity that sort of gets swapped out for capital intensity.

But as I’m looking forward at all of this, the piece of data that really caught me last year, that goes in partnership with the low discoveries, was this – China’s Beijing Petroleum University came out with a study commissioned by the State and said, hey, where are we with oil? And China’s Beijing Petroleum University came out and said, hey, we’re going to peak – China’s going to peak from all conventional and unconventional sources – they’ve been pushing their own shale as best they can, but discovered they have geologically molested plates, just like the California shale beds were – not as much as they hoped. At any rate, they said, hey, we’re peaking in 2018, and by the way, here’s what we think our oil imports are going to look like in over the next 12 years, taking them to 2030. They said, wow, we’re going to be importing twice as much oil as we are today. To me, that’s a really big deal because China’s looking to import basically that baseload oil that’s out there. So those are the two pieces that really caught my attention last year, was low discoveries, long lags to get those big, long baseload discoveries online. Yes, there’s some shale that can sort of step into the void, but it’s really flash in the pan kind of stuff relative to this sort of data. Did you notice that? And I think China is taking this seriously. Did you notice that, and what do you think that the implications there are?

Art: Well, the implications are sobering. China is the world’s largest importer of crude oil right now. So, if this study – and I think it’s a credible study – if they’re projecting that they’re going to have to substantially increase imports, that’s a really big deal. The U.S. remains the largest consumer, but China’s the biggest importer. So the question that raises for me is, okay, great, where are you going to get it from? And I think the answer is they plan to get a lot of it from Saudi Arabia. And, of course, Saudi Arabia, Saudi Aramco, is planning maybe some sort of IPO for a fraction of their company sometime this year, and now there’s speculation, well, will it actually be an IPO, or will it be a private placement? And that private placement speculation is it will be with China because they’re the guys with the biggest demand.

So kind of back to the beginning of your question, yes, beginning certainly with the Obama administration, we in the U.S. have infinite faith and belief that we basically don’t need Middle East oil anymore, that the shale plays have given us this whole new end-of-history sort of renaissance sense of ourselves. And you can see it in our foreign policy. The pivot, or the shift, if you will, from Saudi Arabia to Iran, the shift away from other of our long-standing Middle Eastern allies including, of course, Egypt and Israel who don’t have a lot of oil.

And you have to go back, really, to FDR to understand that the centerpiece of U.S. foreign policy ever since World War II has been to maintain supply of oil. And, of course, back in FDR’s time, the U.S was 100 percent oil self-sufficient, and we were by far – I think we produced something like 52 percent of the world’s supply. So here’s a guy who, without any immediate supply issues even of the horizon, said we’ve got to look after our own oil security, made a deal with Saudi Arabia to provide that. And here we have the Obama and the Trump administration saying, ah, we don’t need your stinking oil any more; we’re the big guys on the block. China’s saying, whoa, here’s an opportunity for us.

And so what does that mean to us other than political gamesmanship? Well, we get – from whatever else people might say – the United States still imports seven million barrels a day plus of crude oil. And even if you work the net to some of our exports, we still import, pretty nearly on average, six million barrels a day. That’s a huge volume. We get an awful lot of it from the Middle East. Well, if the Middle East is diverting their supply to countries like China, guess what? It’s not available to us, or it’s not available at the price that we want it, not to mention that fact that Saudi Arabia – I was there a year ago – their population is exploding. They’re using more and more of their domestic consumption domestically, so there’s always less to export. So these should be primary concerns to anyone who even remotely thinks about the future, and certainly to people that connect, as you and I do, the supply and usage of petroleum to economic well being.

Chris: Indeed. And, to me, it’s a really big deal. And I think my concern is that – and I used the word propaganda before – I don’t think that’s too strong of a term because I think one of the effects of propaganda is that it disconnects you from the underlying reality, and it does it in an emotional way. And I’ve noticed a lot of people coming forward with emotional arguments, practically, or sometimes overtly, saying hey, it’s going to be electric cars. The propaganda takes the form of saying peak oil demand. That’s it. Including all the way and out to a Stanford University professor who proclaimed that there won’t be any more internal combustion engines by 2030. I don’t think that guy’s ever run a manufacturing anything. I don’t think he’s even manufactured sandwiches before to make such a crazy statement.

That argument says, hey, we’ll just wander away from oil any time we want on our own terms. I think that’s just evidence of a remarkably effective, but ridiculously shortsighted and probably ultimately damaging view about how central oil really is to our economy. And I think to notice how central it is all you have to do is pay attention when you’re driving somewhere. So what are your thoughts there?

Art: Right. Well, first of all, let me say that I’m all in favor of moving away from a petroleum based economy. It’s inevitable. We have to go there eventually, either for reasons of what it costs to continue to power our economy on petroleum, and then there are planetary and climatic issues that I, for one, take quite seriously. And I don’t know that we need to get into that right now, but there are multiple reasons. Now, having said that, I don’t quite know what to make about those who believe that this transition can be made any quicker. Let’s go back to our discussion of getting from discovery to first oil. We’re talking a decade, let’s just say. Well, how about transitioning an entire country or an entire civilization from one form of energy to another? And sure, we all want to be optimistic about how we can do that, but let’s be realistic for a minute and understand that renewables – and you got to be careful when you look at the data.

Let’s just talk about solar and wind for a minute because there are a lot of other categories that are murky. We’re looking at best – those supply about three percent of the world’s primary energy needs right now, okay. So let’s say that our usage is expanding at the speed of light, and that the cost is going to zero. I think that any practical person knows that you don’t go from 3 percent to even 20 percent, much less 100 percent, in a world of 7 billion plus people in anything less than decades. It just takes forever to get those, no matter how much you want to, and no matter how much you can afford to, you just can’t make those changes very quickly. That’s just a fact of statistics, if you will.

The other thing that you have to look at is, well, is there any evidence that we see for demand for oil peaking and again, understand where I come from. I would like to see that. First of all, because I think we ought to conserve the resource we have left. But I see absolutely no evidence that is the case. I mean, global demand for 2017, which is over, is higher than it was in the previous year. And you look at historical numbers going back to 1970 or so, and on average, demand for oil increases about 1.3 million barrels per day, per year. And it doesn’t deviate very much from that except in years of profound economic distress like the 2007, 2008 financial collapse. And it bounces right back. So, again, my sense is that I want to believe, and when I see it, I’ll sure tell everybody about it, but I don’t see it yet.

Chris: I would agree. I’ve even read articles in Bloomberg, of all places, probably by some junior journalist, so let me not be too dismissive here. They’ll learn. But they’re saying that peaking oil demand is already in the rear-view mirror; it’s a done deal. But the data, it looks to me like a pretty straight line, 1.3 million more barrels per day, per year. Might be even higher this year. I think we’re looking a maybe 1.7 million barrels per day increase. But that’s the data. The data says we’re burning more of this stuff. And, of course, whenever I travel, Art, I’m burning oil. But all I see is oil use everywhere. It’s kind of like Neo in The Matrix, once you can see the matrix. Oil is just very central.

And this is why I’m really focused on, and I want to stay focused on, and I think the lack of discoveries is going to bite supplies in another three, four years, somewhere in that zone at most, maybe as early as two years. I don’t know. We’ll see. And this is why I really want to focus on a couple of near-term things with you. You wrote recently that higher oil prices are likely in early 2018. Last time we talked a year ago, you were calling for higher oil prices; oil was up 50 percent since that conversation. When you’re talking about higher oil prices in 2018, you’re talking supply and demand. You’ve got your finger really on the pulse of what’s going on. This is a big shift that’s different, I think, from what we’ve seen over the past three or four years. A regime of where supply and demand seem to be balanced, at least from the data I’ve got. Talk to us about that, and why you’re calling for higher oil prices here.

Art: Sure. So I wrote a post a couple of months ago – I think it was in early November, and I said, if things keep on the way they’re going I would expect to see oil prices of around $67 a barrel, WTI, U.S. or domestic oil, add $5 or $6 if you want international prices, by the end of 2017 or very early in 2018. And we’re not quite there yet, but we’re at $64, $65, so pretty darn close. Well, does that make me a – I’m not a predictor of prices normally, and it doesn’t make me a genius that I actually got that right. It’s, as you say, it’s based on some rather fundamental considerations. For me, the issue is always what’s happening to the oil that you have in storage as kind of the best measurement of the supply and demand that are so essential, that are hard to measure. And what we’ve been seeing is the global inventories, that is, oil in storage, has been going down really, really impressively over the last year. And we’re getting quite close to the five-year average, and when you get to the five-year average, you’re looking at something like $70, $75 oil prices.

And so it’s really just kind of that simple. So again, there are a lot of benefits, certainly to consumers and to industry and economies, to having cheap oil prices. So in a way, I’d like to see a little bit more of that. But that’s not what the data is telling me. And I’ve been, for better or worse, I’ve been pretty darn right all the way through this ever since oil prices collapsed, saying hey, guys, this recent move up to $60 or so that we saw in early 2015, it’s a head fake. And everybody said oh, no, no, no, we’re going back to good old days. Well, it was a head fake, and similarly when prices got to $30 in late 2015, early ’16, I said, guys, this is too pessimistic. We’re undershooting. And sure enough, it came up.

But again, it’s not because I’m so smart, it’s just because you can’t get caught up in, as you say, the propaganda. You can’t get caught up in sentiment. You pay attention to all that, but in the end, I look at what happens to inventory. So to my way of thinking, Chris, we are coming out of this three years of oversupply pretty darn quickly, and we can talk about why, but that’s the bottom line. And so the next question is, if you like that, and some people do, then the next question for me is, well, what’s the impact of higher oil prices on the global economy and – some people think that the economy is getting better. Well, if oil prices go to $70, will that flicker of growth continue? And I don’t know, but my guess is it can’t be good for it.

Chris: I would totally agree because when you are a weaker element of the global scene, I don’t care whether you’re struggling as a low-income family having to commute 30 miles because that’s the cheapest housing you can afford, or you’re Greece, where you import 100 percent of your oil and you’re so dependent on tourists, higher oil prices are just sand in the transmission of that global economy. And with the world having so much debt, well, it remains to be seen. I mean, I’m on the record here that if oil really gets in to structural shortfalls and shoots way up in price for whatever sets of reasons, I think that that’s going to be a shock to the global system. We’ll see. But a lot depends, Art, on this idea that the United States is the swing producer, that we’ve got a lot of drilled but uncompleted – the so-called duck wells sitting out there that if we want to we just open the spigots, and we’re good to go. Lot’s of oil can be brought to market quickly. Certainly, there’s some truth to that.

But first, Art, help people understand, so when we say oil, I’m worried that it’s almost like we’re talking to kindergartner’s and we say the word tree, and they have this little cartoon outline of a tree. But as you grow older you understand there’s maples and ash and sumac – that there’s some gradations to it. Oil is the same way. All oil is not oil; it’s not completely fungible. Once you get into it there’s a lot of weeds and carpet fibers you begin to parse, but I think people need to understand that shale oil is kind of a special substance, and it has a lot of uses, but it’s not fully utilizable within our refining system. Help people understand this without going – how far can we go to help people understand some of the complexity they would need to – or the details they would need to understand how to see this forest for what it really is?

Art: Right. Well, this is an important point that you raise, Chris. And I think that most people, certainly people in government and a lot of journalists – oil is oil for them. They don’t see that there’s any real difference to speak of. Maybe it’s like coffee – there’s different flavors, but it’s coffee. It’s oil. So the oil that is produced in these various tight oil plays is very, very light. That means that it’s watery, it’s not heavy, thick stuff. And the global average is much thicker or heavier. And therefore, all the world’s refineries, ours included, are engineered for the heavier stuff. And therefore, there is a limited capacity to refine this ultra-light oil, which is what it is. And there are many, many reasons for that, but that is the way that it is.

And so, in order to accommodate that problem, and it is a problem, then those who believe in perpetual technological progress would say, well, gee, you know, let’s just add some capacity for this ultra-light stuff to power refineries and global refineries and no problem. Well, there is a problem because that’s another discovery-to-first-oil kind of issue. It’s a big deal. It’s a huge investment. It takes a lot of time, and to do it you’ve got to believe that, in fact, this ultra-light shale phenomenon is going to be with us for at least 30 or 40 years because that’s the life, the economic life, of these refinery modifications – ten of billions of dollars. And the fact that it isn’t happening maybe tells us something that those that make those investments are not quite as optimistic about the longevity of tight oil production as our political leaders may be. Or perhaps they’re just saying, look, as long as oil is as cheap as it has been, why should we do it? We don’t need to. As long as the price of oil is $40 or $50 bucks, why should we spend tens of billions of dollars to accommodate something that we can get other places already cheap.

So that’s a huge issue. There’s another component, which I don’t want to get into too much of the detail, but because it’s lighter it contains less energy. So just to give you a ballpark, if a barrel of oil, say from Saudi Arabia, is the standard, then a barrel of oil from the Permian Basin probably has 90 percent of the energy content. So it just has less energy in it, so you can’t do as much. Now, the other thing that is important is that a lot of companies and a lot of people talk about oil equivalents. They say, oh, well, you know, our average well in the X, Y, X shale play is going to make half a million barrels of oil equivalent. Well, what does that mean? Well, what that means is that it makes a lot of gas, and they’re doing some kind of a conversion to say well, so much gas is about equal to a barrel of oil. Okay, that’s great. I get that from an energy content standpoint, but the last time I know about it, you couldn’t put natural gas in an airplane. I can’t put it my car. There’s just a lot of things that you – natural gas is good stuff, but just because it has the same certain number of cubic feet of natural gas, contains the same jewels or calories as a barrel of oil, doesn’t mean that I can use it for what I want to use it for. So part of that number that you hear is, in a way, inflated by maybe 20 percent of it is actually natural gas. There’s nothing illegal or even unethical about using that conversion, it’s just that not everything is what it seems. So things are not quite as good as some people would like to think.

Chris: Well, I want to talk about this in particular because I think this is an important component. A barrel is not a barrel. This is important to understand. And if I was a refiner, if anybody listening to this was in the refining business, you’re a business. You have some inputs, you have some outputs. A barrel comes in. What are you going to do? What are the outputs? Well, there’s the ones we know about that are pretty obvious. I want to get some gasoline out of that. I’d like to get some diesel, some jet fuel, maybe some heating oil, some bunker fuel, some things like that. And the light oil just has a different blend of outputs which you have to have markets for, and there would have to be enough people willing to buy that. Which is why when we talk about the U.S. becoming and exporter of oil – I read this all the time – what we’re really doing is we’re exporting the stuff that we can’t get rid of anyway, these NGLs, the natural gas liquids that condensates, the super light stuff. We’re putting it in big ships, and sending it away because we don’t really have any place to store more of it, or use it at this point. It’s just – so that complexity I think is important to understand.

But in particular, when we get to shale oil, this is something that I wrote about recently. It so much depends on these individual wells delivering what people are expecting. So I sought your input on this; it was really helpful. I did this piece, I’m trying to bring some of this complexity out – where I noted that none of the data that I could find, including your own excellent decline analysis of shale wells – you were doing specific shale wells in the Permian area – l looked at other decline data from the Bakken area. None of these supported what I was reading about as the average ultimate recoverable oil from shale wells.

And so I pulled up an article where it was using Rystad data – not to pick on them, but that was the article I pulled – where they were quoting EURs, or these estimated ultimate recoverable per well data for the Bakken, they were saying the average was 7000 thousand barrels per well. The data that I have is, at best, half that. And the data is good, Art. It’s broken out by vintage, by quarterly year, like 2015 first quarter wells, you could look at all of it. You could grab all the data. It’s all there. It’s public. Nothing’s supporting this story that’s being told. And I think it’s important because the narrative says we’ve got X. But if we have X divided by 2, that’s a very different story, I think. What are your thoughts here?

Art: I’ve had this problem ever since I started evaluating first shale gas and then the tight oil plays. So this is that, for me, goes back to 2008, 2009. As you mentioned in your introduction, I’ve been doing this kind of work for forty years, and I learned how to do decline curve analysis on semi-log paper when I was a graduate student 45 or 50 years ago. It’s not that hard to do. It’s literally not rocket science, and the engineer that I work with – he’s been doing this for as long as I have. And it’s troublesome that we have never been able to come close to these industry or analyst stated numbers in any of these plays.

Now, let’s be honest and let’s be fair. Somebody says that 750 thousand, let’s just say, from the Permian or the Bakken, they’re definitely wells, and more than a few that absolutely will make that amount of oil. There’s no doubt. But is that the average? Absolutely not. I mean, that’s not even the average for the companies that are the leaders in the play, that have the best positions in the core areas or the sweet spot. So what’s going on here? Well, there’s a couple of things. The first is, you got to be careful when a company says, our average well is whatever it is, X, let’s say it’s 750 thousand barrels. The first question is what do they mean by average well? Is that the average of all your wells, or is that the average of all your wells in McKenzie County? Or is that the average of the last five wells you drilled in McKenzie County? What are you talking about here?

And that seems like a simple fact checking issue, but when you go and check the facts, what you find out is it’s pretty important. So they’re cherry picking. That’s not their average well. There’s no way that’s their average well. And if it’s an investor presentation, there are asterisks, and you can follow those to some appendix, and there’s actually a footnote that – they’re not lying, it’s just you gotta be pretty sophisticated to figure out what’s really going on. The other thing though is just the way that you project these things out. Does this well have a life of 30 years, or is the well have a life of 15 years? And, of course, if you let it go 30, you’re going to have a bigger number. Now, the fact that none of that production from year 15 to 30 is commercial is kind of an unfortunate problem for you. So you also have to look at the economics of that thing. So in some of the plays, we’re, again, back to this gas to oil conversion. Bakken not so much. There’s not a lot of oil there.

So the bottom line is I’m standing by the numbers that I’ve always used, and if somebody wants to say the average is 750, great. Show me the data. That’s what I’ve always said. I show the data. I show the decline curves, not that anybody or everybody really understands that, but I show how I come up with that. And just to give you a ballpark number for the Bakken, you know, I’d say that the better wells, on average, are in the 400 to 500 thousand barrels of oil equivalent, and that’s being pretty generous and optimistic. So I’ve shown how I get there. The people on the other side never show how they get there. I’m sticking to my story. It’s that simple.

Chris: I just ran across an article that talked about – so just to paint this picture for people – an average well in the Bakken might come out – I’m just going to round wildly here – start with an initial production of maybe 500 barrels per day for that first month, and it goes down rather rapidly from there. And at some point, though, as you say, people project, hey, this will be in operation for 30 years. But an average well in the Bakken drills down ten thousand feet, tips sideways, and then might go another mile or two depending on the well off to the side in that horizontal component. And what I’ve been reading lately, Art, is that once the initial pressure of the well is gone, now you’re in the business of putting the nodding donkey, as they call that – that ubiquitous oil pumping device – that has to pump the oil up from a very deep area.

And by the way, this is a pump like if you could see it there’s a rod that goes down into the ground, and it connects to something down there. So it’s moving parts that have to go down a very, very long wellbore that, by the way, we’d love to think is perfectly straight, but probably takes a few wiggles and jiggles along the way. It’s got some peaks and valleys, and it takes a big bend, and so does that pumping rod. And so I’ve been reading articles that say, gosh, you know, these things are lasting maybe five, six, seven, maybe eight years, but they’re breaking down. And so this idea that we’re going to be able to fight that entropy of the breaking and the wearing out of this very long, complicated, bendy, twisty, pumping apparatus – that has to be economic, to use that term, like from years 15 to 30, that has to be economic oil, meaning the cost of maintaining and replacing and repairing can’t be greater than the value you extract from the oil that comes up, which, by the way, may have a higher and higher water cut as well, meaning you got to separate that, etc. etc. So the cost of all that. Art, do we have any sense of, yet, that these wells really are going to be economic for 30 years? Don’t we have enough data to begin to say there’s some question marks here?

Art: Right. Well, that brings up a number of points. So the first, since we’re talking about the pump jacks, or the nodding donkeys, those are designed for conventional reservoirs that have good quality when it comes to porosity and permeability. Now, almost everyone listening to this podcast knows that shale wells don’t have that, and they have to be hydraulically fractured to produce anything at all. And so we’re talking about wells that have a millionth to a billionth of a Darcy of permeability. Maybe an average conventional well has half a Darcy, so we’re talking about things that are – it’s a comparison of a bacterium to a salt grain or something, orders of magnitude smaller. So the point is, is that I cannot find any evidence that putting a pump on an artificially fractured shale well accomplishes anything whatsoever as far as bringing more oil to the surface. And I’ve got sources in places like the Eagle Ford Shale where they’re doing that that say two things – first of all, it’s not effective, and secondly, the point you make, is that they’re always in there fixing rods and suckers and all of the mechanical equipment, and that’s a cost.

The EURs that we just mentioned a little while ago, all we’re doing there is just predicting out the oil production. But what happens as a well losing its energy, it reservoir energy, is you start to produce more water. Nobody ever talks about the water. The water has to be disposed of, and that’s a cost. And so water production increases, oil production decreases, you’re having to spend, let’s just say, a dollar a barrel to dispose of that water. So you may still have some oil to produce, but eventually the water production gets too costly, and you have to abandon the well because you’re spending more than you’re making. So the artificial lift, or pumping, it doesn’t work on a shale well. Nobody ever talks about the water production. The mechanism that brings the oil to the surface is the natural gas that’s dissolved in the oil as it goes into the well bore, it expands because it sees a lower pressure environment at the surface, and it’s that expansion of natural gas that actually lifts the oil to the surface.

Well, the study I did on the Bakken shows that the gas/oil ratio, the percentage of gas, is declining. Okay. That says you’re running out of the fundamental energy to bring the oil to the surface. If you believe what I said, which is that pumping it is really not a viable option, that says you’re done. That says you’re done when the gas goes to too low of a level. Now, all of those decline curve analyses don’t take that into account. They assume that the way the well starts is the way the well ends. And then, the final point I’ll make is that an awful lot of these very optimistic, 750 thousand-barrel equivalent EURs are based on comparing the first few initial months of production in the new wells with older wells. And so the initial production rates are higher and therefore the analyst says, or the company says, oh, well, since the initial rates are, let’s just say, a third higher than wells that we drilled in 2015, ’14, ’13, then the EUR ought to be a third higher. Well, no.

What’s going on is you’re spending more money, you’ve got better completion technology, better fracking technology, you have a much higher initial rate, fair enough. And the decline rates are also much more acute, and therefore, you’ve done nothing to improve the EUR. You’ve just accelerated the early rate of production. And that may be nice from an economic standpoint. You might pay out the well a little quicker, if you ever do, but it doesn’t give you any additional oil. Those are – and that may be a level of complexity that is a lot for our listeners to absorb, but those are really important issues for those of us who live in the oil business that are never talked about.

Chris: Well, indeed, and to wrap this up, one of the things I’d like to point people towards is that this is the kind of complexity though, that if you want to be an investor in this space, if you maybe you’ve – people I know have got portfolios where drilling and resource companies have been put in there, but this is really critical to understand. And one of the things that I’ve been jumping up and down, and I know you have as well for a long time, is that listen, under any price environment, whether oil was over a hundred a barrel or under thirty, or it was fifty or sixty, it doesn’t matter, the entire shale business has been cash flow negative, and has been burning cash. And it’s done it through equity raises, debt raises, and you name it. But their capital expenditures had exceeded their operating income for a long time – operating cash flows.

So I look at that and I just say, wow, what is going on here? There must be something to this story because if you have a principle thing, which is called a well, that depletes in three years, and you’ve been in operation for eight years, sooner or later – or ten years – sooner or later there ought to be positive cash flows kicking out from that at some point along the way. And it’s not insignificant. It’s hundreds and hundreds of billions of dollars have been thrown into that negative cash flow machine. So, Art, all things being equal, if you have something that primarily depletes within three years, and you’ve already expensed the capital for that, and that was a negative cash flow environment for you, I am personally hard pressed to understand how that gets better even if the price of oil goes up and your current operations somehow become cash flow positive. Isn’t all that cash burn burnt? I mean, that’s the capital that’s been betrayed been betrayed? I can’t square that circle. I’m having trouble with it.

Art: It’s gone. Yeah, you’re right. And so you asked the question, well, when oil was $100 a barrel, these companies were cash flow negative. When oil was $40 a barrel they’re cash flow negative. So the price of oil maybe doesn’t matter all that much. And what really matters, and the reason that that’s true, is that when prices are high, all the costs associated with it are high, and when prices are low, oil field service companies – the guys that lease you a drilling rig or do a frack for you or sell you pipe, they discount their rates so that – it’s fundamentally, to use a cliché, it’s the same difference. If you’re not making money at one price, it doesn’t mean you’re going to do better at a higher price.

The other thing to say is that – let’s just talk for a second about reserves. I mean, I did a study about a year ago based on the year-end reports by all these public companies in the shale business, and they’re required to say, look, these are out reserves in this play, that play, and the other play. And I focused on the Permian Basin because we kind of know what the reserves are of the Bakken and the Eagle Ford. They’ve been around for long enough, and the EIA publishes that, and roughly it’s about 5 billion barrels per play. So Permian is the great hope. It’s got to be much bigger than any of those guys, and by taking all this company data – this is what they provide to the U.S. government – and then doing a little bit of extrapolation to the producers that don’t explain that, I came up with a number that was shocking. It was about 3.75 billion barrels based on the companies that operate for the Permian. So less than the Bakken, less than the Eagle Ford.

Well, wow. What’s that about? And that’s not my interpretation. That’s what they’re saying. Let’s say it’s conservative. Let’s say it’s twice that. Well, you know, we’re still not – the United States uses five billion barrels of oil a year. So people have these sugar plum fairies dancing around in their head about how we’re going to be the swing producer of the world, and I’m asking the question, well, show me – I told you, Kashagan is 30 billion barrels. Well, that’s one field, and you take the Bakken and Eagle Ford and anywhere close to what I came up with in the Permian and at best, we’re half that. Tell me exactly where this big bonanza is anyway. So yeah, I’ve got all kinds of questions like you do, Chris.

Chris: Well, that is shocking, Art, because I’ve heard CEOs – I won’t name them right now – saying that just the wolfcamp alone is ten times the number you just quoted me.

Art: Well, you got to ask. Show me. Show me exactly how you get to that number because I’m using your numbers, buddy. You’re one of the guys whose year end 2016 report is a big part of the way I came up with 3.75 billion barrels. I’m not saying that’s right, Chris. I’m completely dependent upon other people, but that’s the number I come up with. And so my point, and I think yours, too, is that we, the United States, is, and will remain, utterly dependent on other people’s oil. We always have been, I mean, since the 1970s, and I don’t see any way that’s going to change.

And so we need to think about that, the way China is apparently thinking about that. Where are we going to get it from? What kind of relationship do we have to have with those countries that could supply it, and what’s it going to cost? And I promise you that it will not get cheaper. And so if energy is absolutely fundamental – it is our primary cost, it is our master resource – you cannot double your cost of doing business, which is what we’ve done since the early 2000s and say oh, it’s not a problem. We’ll be fine. I can’t find a business, certainly none I’ve been around, that could accept a doubling of their fundamental cost and be fine. This is something we really need to worry about.

Chris: I agree. And thank you for bringing this all the way back around because I’m not here to say we shouldn’t be drilling shale. I do take a little umbrage at the idea that I think some investors might get fleeced, but caveat emptor, do your due diligence next time. But the point is that shale is not infinite. You called it a retirement party, but I want to use that party to build out the infrastructure that we know is coming, as you mention a while ago in this interview. Yeah, we’re going to be off of oil someday. We know that. So what’s our plan? And that’s where I take – that is my personal offense that I take in this story is like any quality company, Art, has a strategy. And the strategy always has two parts: where are we trying to go, how are we going to get there. What’s the vision? What are the resources? Because you can’t go anywhere without resources. Those might be human resources, etc.

But the master resource is energy. So we have energy – we have shale, we got gas, we have oil – that’s true. What are we going to do with it? And as we delude ourselves with this idea that it’s infinite, and it’s just a little more ingenuity, a little better fracking, and next thing you know we’re going to find even more. To people who study it we know that’s just not the case. And so that’s why I do what I do, and really applaud what you do is to surface these ideas, surface the details, de-cartoonize a barrel of oil into its actual components that are important so that we can begin to have the conversation that we need to have which is where are we going and how are we going to get there? And so that’s really why I focused on this. And if people lose or make a little money along the way – whatever. It’s not the important part.

The important part is there’s a big change coming. Oil isn’t a forever substance. We know we’re getting off of it, so why don’t we get off it on our own terms rather than some other terms? And I do worry that those other terms could be unpleasant if we don’t plan for it. So that’s what I’m trying to do here, is open the conversation up and say, hey, people, we’re at that part of the story where it’s time for adults to step up and take control of the party and notice that things have changed. We’re not in the 40s and 50s anymore. Welcome to the 2018s and ’20s soon. And this is just a different world. So with that, I’m Chris Martenson. We’ve been talking with Art Berman. You can find him at artberman.com. Art, any other place people can find you? Any conferences coming up or a way to tune into your excellent work?

Art: Well, the best way to see what I’m thinking every day is either on my website or on Twitter at aeberman12. I post at least one chart a day, often two or three. Get into conversations with people who know a lot, and that’s the both – and my Twitter feed is also on my website. Those are the two best places, Chris.

Chris: Excellent. Well, Art, thank you so much for your time today.

Art: My pleasure. I look forward to talking to you again. Thanks.

Article by Peak Prosperity