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What Hubbert And Pickens Got Right About Oil, And What’s Next

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When a barrel of crude oil hit $145 in July of 2008, no one predicted that 8 years later it would be trading at less than $50. T. Boone Pickens, among other oil pros, has predicted that oil can now go to $175 under certain conditions first described by Marion Hubbert. Bruce Pile explains what the non-geologist experts are missing, and tells us what he is waiting to see before committing capital to the best values in the energy sector.

Bruce started his Marketocracy fund in January, 2001. Since then, his returns have averaged 7.49%, which compares nicely to 5.07% for the S&P 500 over the same period. Before taking anyone’s investment advice, you should always check out their track record. Here’s Bruce’s.

T. Boone Pickens (Photo by Slaven Vlasic/Getty Images)

Ken Kam: What is your outlook on oil?

Bruce Pile: I’ve just written an article on why oil investing is a train wreck right now. I’ll try to give a condensed version here. I’m not saying it’s going lower or higher, just that it has near zero predictability, and will have for awhile.

To understand all this, you have to understand peak oil – few really do. In the early days of oil in 1956, a Shell geophysicist named Marion Hubbert developed a math model of oil production. His projection method called for a peak in US production by 1970, after which would be a permanent decline.

He was reviled as crazy, almost unpatriotic in the robust American oil business of the 1950s. But it actually happened:

Hubbert_Upper-Bound_Peak_1956

Hubbert’s Peak.  Source: Wikipedia

The red line is Hubbert’s math projection made in 1956, and the green line is how it actually turned out. The above Wikipedia chart is for the lower 48 and doesn’t show the large contribution of Alaska in the ’80s. But Alaska wasn’t even a state in Hubbert’s 1956 model. His math was for conventional oil from naturally pressurized reservoirs (the only kind of oil they knew back then) and it has essentially proven to be correct.

Kam: But aren’t we back to around the all time output highs in the US?

Pile: Yes, but all that is being added to the Hubbert curve is what is being added to conventional oil. It’s produced a whole different way. This unconventional bonanza has blown the needle far away from Hubbert’s curve of physics for conventional reservoirs. Two things happened to take us away from this curve: first, deepwater oil in the Gulf, which started in earnest in the mid ’90s as the above chart shows, and second, the recent shale explosion.

Kam: So that was Hubbert’s prediction for the US. What about his prediction for a global peak?

Pile: As Hubbert’s projection for a global peak approached in the early 2000s (he had calculated around 2000), slightly fewer considered him a lunatic because his US prediction had been so accurate. His global peak prediction was refined mathematically by Ken Deffeyes, a Shell associate of Hubbert’s, as being 2005. And he was right.

We’ve been on an undulating plateau since that peak of about 74 mb/d and are now down to about 70 mb/d depending on whose numbers you go by and what they have added to straight conventional. Deffeyes pegged it in his 2005 book “Beyond Oil” and in his 2001 book “Hubbert’s Peak: The Impending World Oil Shortage.”

Kam: So why do we constantly hear that peak oil was baloney?

Pile: This chart explains it.

Source:Gail Tverberg ourfiniteworld.com

Source:Gail Tverberg ourfiniteworld.com

Here we see just what is propping us up from the disasters of peak oil. The two big props are the pale green one and especially the pink one – that is fracked gas liquids (NGL, actually from natural gas production) and shale oil (unconventional crude).

This difference in conventional crude and total liquids is behind all the arguing. “Peak total liquids” has not happened yet, and with shale, may not happen for a long time.

Peak conventional crude did happen, and it happened exactly as Hubbert and Pickens said. Without the pink prop, we would be back on Hubbert’s curve, and Pickens estimates something like $175 oil. And without the natural gas shale fracking giving us the green prop, total “oil” price would go even higher.

The two vastly different types of oil source never get explained very well, and few understand the difference or its immense implications.

This is very evident, for example, in the tempestuous Dec. 23, 2014 CNBC Squawk Box interview with Pickens, right after the sharp collapse in oil, where Joe Kernen calls anyone who still believes in peak oil a nut saying “that was a horrible call”. Pickens responded, “You need to go back and look at what happened to oil production without the United States.” Kernen then goes on about the Malthusian bet on world catastrophe. Pickens responded, “Yeah, well that’s all good bullshit and all  [this cracks Kernen up] …in 2005, you peaked. Go back and look at it … I’m the expert, not you …what saved you was the shale.”

Kernen complains “oil is oil”. But shale is like we traveled to a new planet and began farming it and adding it to our earth oil that we’ve been poking holes in underground balloons for. There is such a vast difference, especially in the math of net energy; and it explains why industry sages like Pickens tend to view the 2005 conventional peak as the only one that really matters, which is the topic of my next article. The difference is critical, because if anything happens to shale, we’re back on Hubbert’s curve and in a severe energy shortage..

Kam: Is anything happening to shale?

Pile: There are two big things happening to shale. First, as if all this natural oversupply wasn’t enough of a price killer (we’re running out of storage) we have the price war aspect of oil production.

Saudi Arabia, thought of as the swing producer, operates conventional fields at very low costs and they frown on significant competition. They not only frown on it, they annihilate it.

Some say this is really what happened with the fall of the Soviet Union in the late 1980s. Reagan’s arms race helped. But as it is pointed out in “It’s Time To Drive Russia Bankrupt – Again“:

It wasn’t Reagan’s massive defense build-up, or his Star Wars program, that drove the Soviet Union to the wall; it was the decline in real oil prices caused by the Reagan/Volcker/Greenspan strengthening of the US dollar.

The Saudis rubbed salt into those monetary wounds, because Russia was co-leader in the world’s oil production at the time with higher costs. The Saudis gunned production to levels beyond prudent oil field physics and flooded the market with cheap oil –  the USSR treasury was empty and the Soviets were done.

The Saudis have been aiming that same gunnery at their new enemy, the US shale producers now, as Pickens has often pointed out. In a 4/28/16 article in “The Tulsa World” titled “T. Boone Pickens calls U.S. oil industry ‘dead in the water’.”  they said of Pickens:

Since 1980, he recalled in an interview, he has watched oil prices plunge five times worldwide. Four of those times, he said, Saudi Arabia stepped in to cut its oil production, balance the market and bring prices up again. The fifth time — this time — the Saudis kept pumping away, prices stayed low and U.S. companies let their drilling grind to a near-stop. Pickens doesn’t expect them to resume anytime soon …

You could, however, make the case that it’s mainly the shale explosion that is acting as the swing producer nowadays, not the Saudis. Take a look at this chart:

Source:Gail Tverberg ourfiniteworld.com

Source:Gail Tverberg ourfiniteworld.com

Here we see that total shale has added 5 mb/d whereas the Saudis have been flat since mid 2011, and their market moving excess capacity is thought by Pickens to be only about 1-2 mb/d – a pea-shooter compared to the shale guns.

Still, they are dangerous. Aramco is a state run company, meaning they run the government with their oil profit. They need $80 oil or they must cut government and risk unrest or dip into their cash reserves of $750 billion built from $100 oil. In the current price melt, they are burning that reserve at $6 billion a month. The Saudis are limited time-wise.

Kam: What’s the second thing happening to shale?

Pile: The second thing happening to shale is, of course, the whole banking aspect of it. The zero interest years have put the drillers’ fortunes in the same boat with the banks. But this isn’t 1988, and in our derivative crazed banking of today, if Aramco does to shale what they did to the USSR, we all could be in a heap of trouble.

Kam: Given this complicated set of problems that have come with what should be a great blessing – the shale revolution – how should we invest?

Pile: I have said all the above to say this: the price of oil is now controlled by malinvestment cycles gone crazy, price wars, and about everything under the sun investors avoid. For 5 years from 2003 to 2007, we were between price wars and recessions; and Hubbert’s curve took firm control as the peaking of conventional ran us short of oil. Shale fixes that. But we’re in a false start transition zone before we get to any stable shale industry, similar to dot-com 15 years ago.

The only investing angle might be the cash rich big oil companies looking to rebalance between conventional and shale. The shale properties will survive. For all the damage the Saudis inflicted on Russian oil in the ’90s, Russia is now the world leader.

There is debate on the other side of this transition zone concerning how much commercial shale is really out there and its net energy profile. If people like Art Berman are right, a “stable” shale industry might only last a few brief years before we are making our way back to Hubbert’s curve.

Kam: If your forecast for shale is right, which companies will benefit the most?

Pile: Some companies that could reap a windfall in shale bankruptcies are Exxon Mobil (XOM) Royal Dutch Shell  and ConocoPhillips COP +0.12%.

Conoco in particular is making a “massive wager” on US shale according to a Bloomberg release from a little over a year ago “ConocoPhillips Bets On Shale In Major US Spending Shift”.  They are “pledging” to spend 50% more over the next three years, and much of that may be at good bargains if the shale bust continues.

If we get a sell-off in stocks and these names get hit, they may be good pick-ups for when shale eventually comes back. But there may not be that much of a shale “industry” for the big companies on the other side of our transition zone.

Kam: So there are companies that will benefit, but you aren’t ready to invest in them yet?

Pile: I think for now we have a confluence of unstable, opposing mega forces acting on oil. Price-wise, we are in a high leverage zone on the Hubbert curve where the shale prop is making a huge difference in pricing according to Pickens, and you have a frantic kicking down of that prop going on. So my best investment advice is – don’t even go there.

My Take: When someone with a superior long-term track record starts to perform well it is a strong indicator that his investment style is back in favor and warrants consideration as a replacement for an underperforming manager.

Bruce has outperformed the S&P 500 for over 15 years, but in 2016 he is up 40.03% year-to-date compared to 8.39% for the S&P 500.

To explore whether Bruce’s portfolio makes sense for you, click here to schedule a One-on-One with Ken Kam.

About my column.

Disclosure: I am the portfolio manager for a mutual fund advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.

Forbes



9 Comments on "What Hubbert And Pickens Got Right About Oil, And What’s Next"

  1. Apneaman on Tue, 30th Aug 2016 6:04 am 

    Oil Discoveries at 70-Year Low Signal Supply Shortfall Ahead

    “New finds at lowest since 1947 and headed even lower: WoodMac
    Explorers replacing just 6% of resources they drill: Rystad”

    http://www.bloomberg.com/news/articles/2016-08-29/oil-discoveries-at-a-70-year-low-signal-a-supply-shortfall-ahead

  2. Boat on Tue, 30th Aug 2016 7:45 am 

    rock,

    When they talk about exploration slowdown do you know if that includes 3D and 4D sesmic. Seems they would continue this work on leases.

  3. peakyeast on Tue, 30th Aug 2016 8:14 am 

    I found myself agreeing with all of this article – I am still a little chocked… But then I havent read it very carefully yet. But I certainly will do that later. I saved it for a time where I am well again.

    I look forward to reading the local geniouses comments to this one.

  4. joe on Tue, 30th Aug 2016 8:39 am 

    Looks like hes describing the bumpy plateau model of peak oil. Simple as that. There wont be any more easy oil, so now we must use tight, the swings in activities of both is driven by the fact they are not substitutes for each other rather they are complementary goods. They have joint demand curves that act inversely to one another. Only in conditions of scarcity will we see the effect of the bumpy plateau. We move from scarcity to oversupply, balance is hard because tweaking all these little operations in relation to Aramco is tough and needs US cooperation. Will we volunteer ourselves to pay $147 again or more when we know at that price theres black gold in the ground?

  5. vegeholic on Tue, 30th Aug 2016 11:50 am 

    Stop the presses! This is a mainstream financial journalist writing in a mainstream rag (Forbes) who seems to understand net energy, conventional vs. unconventional oil, and the precarious nature of the “shale revolution”. Mirabile dictu. There is yet hope.

  6. shortonoil on Tue, 30th Aug 2016 1:24 pm 

    An awful lot of talk about Shale, even though it has never accounted for more than 3.5 % of total world production. A third of Saudi Arabia. With over 10 years of development, and over a $trillion in investment it has still to turn a profit. It limbs along with a pathetic $360 billion per year in gross sales. Less than one oil company, EXXON.

    But, all the pundits have failed to ask, or answer one very simple question. How much can the economy afford to pay for a barrel of oil? Until they have answered that they are whistling Dixie in a hurricane. They don’t have a clue as to what is happening, or going to happen.

    Of course, that doesn’t seem to slow them down one bit?

    http://www.thehillsgroup.org/

  7. Robert Spoley on Tue, 30th Aug 2016 2:00 pm 

    Read “Twilight in The Desert”. When written the water cut in big Saudi oil field was 45%. Lord knows what it is today. This is the largest “conventional” oil field on the planet and it is in serious decline. Other smaller fields, although large, are also in decline. We are finding some new ones, but no where near at the rate the old ones are declining. The entire “shale” industry has, at most, a small fraction of the reserves that the older “conventional” oil fields have (had). About all the shale drillers can do is make the decline curve less steep. It will still be steep unless a lot of very big conventional fields can be found quickly. To allow for the money to accomplish this the price of oil must rise so the exploration can go on worldwide. Hello proration! If we get lucky, we will find these fields that will last another 40 – 60 years because what we have now is very, very wobbly

  8. Boat on Tue, 30th Aug 2016 2:55 pm 

    short,

    An awful lot of talk about Shale, even though it has never accounted for more than 3.5 % of total world production.

    That shows your knowledge of markets. 3.5 percent of the market would be one hell of a glut.

  9. rockman on Tue, 30th Aug 2016 11:29 pm 

    boat – “When they talk about exploration slowdown do you know if that includes 3D and 4D sesmic?”

    Not a simple answer. The primary purpose of 3d is to better define the structural traps. (I’ll skip 4d: beside being very rarely shot it’s focus is management of discovered reservoirs…not exploration.) So I need to break 3d into differernt theaters.

    Onshore US: primatially used to find undrilled areas of already producing structural traps. Typically looking for undrilled fault blocks (FB) in a known field. About 5 years ago I drilled such a well in S LA. The FB actually had produced 2 million bbls of oil low in that FB. Others tried it unsuccessfully: the target area was small: less the 150 acres. New 3d gave me a shot but it was far from low risk. Found several reservoirs oil productive. First one made 400 bopd before the water production began. Still doing 180 bopd after making 380,000 bo and still have two more shallower zones behind pipe. An expensive ($6.5 mm) 17,000′ well that required setting intermediate casing before we knew we had anything. The good news: we made a nice well. The bad news: drilled the adjacent FB and got a $7 mm dry hole for the effort.

    So 3d can find such unproduced areas but no guarantee they’ll be productive. Many of the good wells drilled in Texas, LA. and the Gulf of Mexico in the last 20 years are a result of 3d. And what’s not known outside the oil patch is that 3d has also prevented the drilling of hundreds (if not thousands) of wells. Many companies wouldn’t even revue a prospect if there wasn’t 3d.

    But here’s the bad news about 3d today: you’ll find very little areas in the major hydrocarbon producing areas in the US that haven’t had 3d shot. And in some areas shot twice. So any great expectations that future 3d programs will have the same impact as those shot during the last 20 years will meet with disappointment. BTW many 3d’s were shot n areas where deep NG was the primary target.

    But there is one trend with some good future potential: the deep plays in Mississippi and Alabama. The potential is still there because it’s the playground of small independents most of which no one here has ever heard of. They were slow to embracing 3d because of the upfront cost.

    So even before oil prices fell companies were running out of viable places to shoot 3d. Obvbiously the lower oil price has cut that list even shorter. Just like it did when NG prices fell some years ago. The Rockman’s current company was formed 7 years ago to hunt deep NG with 3d. Was working OK as we spent over $400 million (100% but we had partners) the first 3.5 years. And the NG prices fell and we haven’t drill a single well since. And we had been targeting trends where there were high condensate yields in those reservoirs.

    So yes: 3d seis has had a huge impact on exploration…starting many years ago. Which also explains why the pubcos jumped on the shales instead of chasing conventional oil with 3d: not much potential left in the US. And while I still don’t care much for the term “low hanging fruit” one could say most of the “low hanging 3d seis” has already been harvested.

    Which leads me to repeat what I’ve posted many times before: with modern seismic exploring for oil/NG is much, much easier today then it was in the 40’s and 50’s when all those big discoveries were made. The problem isn’t finding the undeveloped conventional oil/NG…the problem is that there are so few reservoirs left to find. The 3d seis is great for finding what’s left but it can’t create what isn’t there.

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