Sunday, October 16, 2011

World Oil Demand

(Click "Oil" tab above for more oil data and trends)
Time and time again, we hear or read on the news how the price of gasoline has gone up, which essentially means the price of oil has gone up. In the the short term, the words "oil price" and "volatility" seem to go hand in hand as assumptions in supply disruptions come and go. However, long term, there seems to be an indisputable upward trend based on three main themes: Oil Price, Oil Demand, and Population Growth.

If you notice the table to the right, you'll see the trend I'm referring to.  As global population grows, consumption increases, and the price of oil goes up. However, these three aren't quite increasing proportionately.  Notice how over the last 50 years population has doubled, while over that same period of time, oil demand and price (adjusted for inflation) have quadrupled, which means that on average every person today is consuming twice as much oil as they were 50 years ago.
Recently in my economics class, I was reminded of a few simple  principles:  Demand, Supply, and Elasticity.
In general, as price increases, demand decreases; however, the price of oil is highly inelastic. Nearly all economies depend on oil as a main source of energy to modernize, grow, and to go about daily activities. And even though developed countries like the U.S. are becoming more energy efficient, there still hasn't been a viable substitute for the growth in oil demand in emerging economies.
We know that the higher the price, the more incentive oil companies have to produce. The opposite holds true as well: the lower the price, the less incentive firms have to produce.
Putting all the pieces together we see that:
  1. World Oil Demand has been increasing. On average, every person today is consuming twice as much oil as people were 50 years ago.
  2. Higher oil prices don''t necessarily translate into lower demand, evident by the increasing consumption despite "high" prices for oil.
So if demand isn't dependent on price, then maybe price is dependent upon demand.  If demand continues the increasing trend, then price may be the determining factor as to who gets what.
Another interesting fact pointed out by Dave Anderson: Population is expected to grow to 9 billion within thethe next 20 years.
If this trend continues,where will demand be? And where will price be?

The EIA expects a subtle increase in oil prices reaching around $125/ barrel while forecasting demand to increase to 112 mmbo/d by year 2030. They also consider a  "High Oil Price," which is shown below by the black dotted line.

In the last 5 years:
  • Demand increased by 7 mmbo/d 
  • Crude prices increased by a roughly $45/barrel. It's also important to note that the price of crude was just over $110/barrel in May before macro factors caused the decline. 
EIA 2030 Forecast (aprox. 20 yrs from now):
  • Demand increases by 10 mmbo/day 
  • Price increases by $40 in reference case, or
  • Price increases by roughly $100 in "High Oil Price" case.
You can read the EIA 2011 International Energy Outlook here:
A very wise man once said, "We don't crunch numbers so we have all the right answers, we crunch numbers so we ask the right questions."

Sunday, October 9, 2011

The Bakken

David Anderson, retired Hedge Fund manager and Director of Energy Research of Palo Alto Investors, recently published a great article expanding on how to value an oil well in the Bakken, an area attracting a fair amount of attention lately, with its growing amount of proved oil reservoirs and production capacity.   You can find the article here:

The advances in drilling techniques and technology (i.e. horizontal drilling, hydraulic fracturing, infill drilling and other advanced recovery techniques) have contributed to the increase in U.S. oil production, something that hasn't happened in quite some time now..  The Bakken shale oil formation, with plenty of growth potential and room for further exploration, has become a highly profitable region for E&P companies.
Below is an excerpt from a WSJ interview with Harold Hamm, the CEO of Continental Resources, regarding how much oil the Bakken is estimated to have:
How much oil does Bakken have? The official estimate of the U.S. Geological Survey a few years ago was between four and five billion barrels. Mr. Hamm disagrees: “No way. We estimate that the entire field, fully developed, in Bakken is 24 billion barrels.”
If he’s right, that’ll double America’s proven oil reserves. “Bakken is almost twice as big as the oil reserve in Prudhoe Bay, Alaska,” he continues. According to Department of Energy data, North Dakota is on pace to surpass California in oil production in the next few years. Mr. Hamm explains over lunch in Washington, D.C., that the more his company drills, the more oil it finds. Continental Resources has seen its “proved reserves” of oil and natural gas (mostly in North Dakota) skyrocket to 421 million barrels this summer from 118 million barrels in 2006.
Looking further into the topic of valuing oil reserves I came across another interesting publication, written by Rhett Campbell. The article is titled, “Valuing Oil and Gas Reserves,” and is a bit broader than the one written by Dave Anderson, but informative nonetheless. Rhett Campbell discusses some of the main components that go into valuing an oil reserve. Below is an excerpt discussing proved reserves, which are generally one of the most important types:
The category of proved reserves, occasionally called P-1 reserves, is generally broken down, at a minimum, into four subcategories:
  • Proved developed producing (PDP) reserves are those for which the well is completed, and the reserves are currently being produced. This is the most valuable category of P-1 reserves because volume, pressure, and production data are readily available and generally accurate.
  • Proved developed non-producing (PDNP) reserves are those for which the well-bore exists and the reserves are identified but are not currently producing for some reason. In this category, the reserves can be produced by either turning on production or accomplishing a mechanical repair operation. The significance of this category is that no additional capital expenditure within the well-bore is required, though expenditures may be required on the surface.
  • Proved behind-pipe (PBP) reserves are those for which a reservoir different from the one currently producing but accessible through the same well-bore has been identified. However, because the operator must conduct operations (such as perforation and fracture stimulation) in a different zone, there is greater risk that the PBP reserves may not be recovered.
  • Proved undeveloped (PUD) are the lowest category of proved reserves and the least valuable because a new well-bore is required to be drilled and completed, with accompanying risk, to recover the value. Exploiting these reserves requires the most capital investment and entails the greatest risk.
You can find the full article here: