Transcript

Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson and it is June 14th, 2016. Energy. Specifically oil and natural gas. These are always front and center on my mind because I’m not confused. The economy is a subset of energy and not the other way around. Either a species has access to surplus energy or it doesn’t. If you are a wolf who does not eat enough you waste away and you eventually die. If an economy does not have surplus energy it to skinnies down and simplifies. Less energy means less stuff being made, less stuff being produced and less stuff being transported. Less energy means fewer jobs and fewer opportunities something that should concern everyone.

Now the common story or meme if you will in the western press today is that the world is awash in oil and absolutely over run with natural gas. While such abundance may be temporarily true from a supply and demand standpoint it would be a colossal mistake to then project that this abundance will always be true. Yet many make this mistake today – I talk to people all the time who have zero appreciation for the actual state of our dependence on petroleum and natural gas and no understanding that both are of limited supply and will someday peak and then be entirely exhausted. What I am saying here is energy is the master resource. So we have to wonder deeply about what these currently low prices for oil and natural gas are really telling us.

Separating the signal from the noise is essential but never more so than when you are talking about the master resource. To help us make sense of all of this is by far my favorite oil analyst and energy specialist out there. Arthur Berman is a geological consultant with 37 years of experience in petroleum exploration and production with 20 of those years at Amoco now known as BP. He has published more than 100 articles on geology, technology and the petroleum industry during the past five years. He has got the chops and he has published more than 20 of those articles and reports on shale plays including the Barnett, Fayetteville, Haynesville, Baken and Eagleford shales. I follow him very closely at his blog ArtBerman.com and you should too. Welcome, Art. It’s great to have you back on. Let’s dive right back in. I am reading lots of reports in Wall Street journal, other places that say that shale companies could make money at $30 a barrel, oh no they are going to come roaring back at $40 a barrel. Well, here we are at $50 a barrel has the shale business come roaring back?

Arthur Berman: If we are talking about a break even oil price of $30 and you are not talking about royalties and taxes and paying your employees and paying your you know your debt service well yea, you look pretty darn good. But you add in the normal cost of doing business and now we are talking about a different story. Bottom line, Chris, is that there isn’t an oil play in the United States or Canada that can break even at less than $50. And there isn’t an oil play in the world, in fact, when you include country overhead which is to say what a country like Saudi Arabia or Kuwait needs to balance its fiscal budget which is overhead. There is nobody in the world that can break even at less than $50. By the way Kuwait is the cheapest producer.

What we have seen is a situation where not very long ago in the 1990s – in the 1990s oil prices in real dollars 2016 dollars were $20 and companies and countries were making money enough to stay in business at least on $20 oil. What I am telling you now is that in less than 20 years or about 20 years nobody can stay in business at less than 2.5 times that basic cost. And so the cost of energy certainly the cost of crude oil has gone up two and a half times in two decades and that has absolutely very significant implications for everything that we talk about and think about. And when we read in the press or on television that oil is just getting more and more abundant well okay I am not going to argue with the abundance issue because that is another argument. But if it costs two and a half more times to have this abundance then what is it really worth? That is an important piece of information to understand.

Chris Martenson: Let’s cover that information in more detail. I think that is vital here. It seems to me that when I look across the landscape everybody – my listeners are all pretty much familiar with the idea that the amount of capital destruction oil business has been just absolutely alarming and lots of people are beginning to understand that today’s lack of investment is tomorrow’s shortfall. What you are saying is that even if oil prices went up some that the – if I am interpreting right that the types of oil finds that are left are going to require a much higher price for oil in order to justify them as you see it as much as two and a half times.

Arthur Berman: That is absolutely correct. Yea, we are talking about you know the shale plays you know I can give you an optimistic view of them in terms of remaining resources and break even and all that. As I said 50 is the cheapest and really we need to be talking about 60, 65 kind of on average for the best of the plays in the core areas. Deep water is higher. Oil sands are depending – can be sort of in that range for existing projects. Probably higher. Probably 80 for new projects. And I just told you that OPEC for the most on average OPEC needs $80, $85. Some are higher, some are lower. That is how it always is. That is the world we live in.

Chris Martenson: Continuing this world I keep reading – a lot of disagreement let’s just say that existing conventional fields are declining at rates of between 3 and 6% depending on who you are listening to. First, where do you fall on that natural decline rate and second, it is those natural decline rates that if I read a Bloomberg report correctly are going to swamp new online efforts that are coming online from prior investment. Is this a seminal year with 2016 being that crossover point where declines are going to exceed new supply? Is that important? And second, has it happened before?

Arthur Berman: Again, we are talking about overshoot and undershoot. And what is happening right now that at least according to the international energy agency has never happened before is that we had two consecutive years where investment in oil production, infrastructure, exploration is significantly lower than the year before and we may be going on a third year. With that in mind we are talking about half a trillion dollars less in 2000 if you take what we are going to spend in 2015 and 16 on these projects versus what we did in 2014. Half a trillion dollars. That is going to come back and hammer us. It is absolutely going to hammer us. You can’t do that. You can’t do that in any business and you certainly can’t do it in a capital-intensive long-term business like we are in. It is important to understand that the time from discovery to first oil for big fields in the world has increased tremendously. It has gone from a couple of years not too many decades ago to six to 10 years on average and a lot of the biggest fields that have been discovered over the last several decades Kashagan is the one that comes to mind in the Caspian Sea 30 billion barrel field is going on 15 years between discovery and first production for a million reasons that we don’t want to get into. It is complicated, okay? We have got politics you got all kinds of people’s budgets, you got prices all sorts of issues. So that is the problem that there are leads and lags that go into this.

Back to your decline rate issue – conventional oil is declining. It is in terminal decline. Nobody is investing in conventional oil projects that move the needle in terms of global supply, which doesn’t mean that there aren’t important things going on. Little guys like me I am drilling wells okay? These could make a lot of money for me and my investors. Not reserves that really matter. All of the investment that is going on today is in expensive oil. What I am telling you is that over the last two years the level of that investment has fallen off of a cliff. Just to put it in perspective a big piece of that investment is in proven reserves. Things that already are discovered, already appraised, the oil is there. We just have to spend the money to drill the wells and put in the platforms or whatever to develop it. 20 billion barrels of production has been deferred because of low prices.

What we are going to have an di don’t want to create any sort of sensationalistic fears or anything, but I got to tell the truth. The truth is that we are going to see an absolutely moon shot in terms of oil prices sometime sooner than later I think. Let’s just say in the next five years. And I shudder to imagine the devastating impact that will have on the global economy. It is going to be paralyzing.

Chris Martenson: Certainly because people who are unaware of energy have been busy conducting monetary and fiscal policy and goading us all – corporations, households and governments alike to get into more and more debt. Different discussion. Let’s just say a moonshot in oil prices and well over $200 trillion in debt not talking unfunded liabilities just in debt alone that is going to be a collision that is sort of a Hollywood blockbuster.

I want to put this in perspective. Last year the world pumped out and consumed some 31 billion barrels of liquids. We discovered in new reserves so this helps to separate what you are saying some of that CAPEX went into existing fields known that doesn’t increase the reserve count. But new reserves came online of only 2.8 billion barrels in 2015. So we pumped 31 and we found 2.8 billion new. I will go a little further. I don’t know if this is sensationalizing, Art, but to me I want to grab people by the lapels and say your hair should b e standing on end. This is a really big deal.

Arthur Berman: It is a really big deal there is no question about it and yet we are in this state of intoxication at the moment about the fact that the world is drowning in oil and that people can actually make money at $30 or $40. So there is a disconnect and those who pay attention to your analysis and mine and some other people hopefully understand that and consider that in their – how they manage their lives and their investments because there is just no way that it isn’t going to be a factor in the relatively near term.

Chris Martenson: Absolutely. To finish out this point on oil I am reading a lot about shut in production in places like Libya, Nigeria, mostly geo political reasons. If those came back online would that help to – well not help would those continue to perpetuate the over supply issue or are these just sort of noisy things at the edge of the story?

Arthur Berman: Oh no they are fundamental to the story. So a big part of the resurgence in oil to almost $50 it is a little bit less than that today has been what we call outages. Supply interruptions and Libya has been a longstanding I say longstanding since 2011 or so when that country got into civil unrest. There is a million barrels a day plus or minus that has been pretty much offline for a better part of five years. Iran is back online and they are now producing something like 800 barrels of crude oil or more per day than they were in December. That is a plus. Libya is a minus. Nigeria is having all sorts of issues. The government decided it wasn’t going to pay off the folks that are now bombing pipelines and disrupting things. I don’t know what that is going to be. It is a few hundred thousand barrels a day. Then we have these huge fires in Canada that have taken another 800,000 barrels offline. That is temporary. And there was a big worker strike in Kuwait for a couple of days took a lot off. What all that did is it created a wake up call for those who trade oil and they said oh my god we have this oversupply but it is fragile and it is. A couple of unanticipated events can move the balance very, very quickly. And so one of the phenomena that I’ve pointed out before is that we have had a couple of years with the exception of Libya really. A couple of years where there just haven’t been a lot of outages in the world for reason that I can’t imagine.

What is happening right now – and Venezuela by the way is on the verge of political collapse and who knows what that is going to do, but it isn’t going to be good. What we are seeing right now is kind of more normal. Maybe it has moved to the extreme side of normal, but we had a couple of years with very few supply interruptions and we coupled that with high prices and low interest rates and we got the over supply. My point, Chris, is that I think some of the enthusiasm of this latest price rally if you want to call it that – I’m going to be a little bit more skeptical about its lasting power. I will just end with a final comment that there are no straight lines in the real world and that could not be more true than with oil and natural gas prices that these things are cyclic. You look at the price cycles we have seen just in the last year and a half and this rally will end and prices will fall. They probably won’t fall as low as they have been previously, but they will go down to some support level – maybe 35, maybe 45 I don’t know what it is. It is probably closer to 40 or 45. Then they will rise. The overall trend I think is up. But it isn’t going to be a straight line. There is going to be ups and downs. We are seeing right now another factor. We haven’t had a lot of economic – global economic bad news in the last six months. Now we are starting to see it resurface and that is starting to dampen people’s enthusiasm for oil prices.

Chris Martenson: Yea that is the big asterisks on this story for me, Art, of course is that if we do get into another capital R recession or capital D depression worldwide the demand side could easily take prices down. I will note that we are starting to see reports that many hedge funds and large money smart players or so called sophisticated players I guess they are positioning for a steep rise in oil prices two, three years out mainly on the futures chain and using options and things like that. My summary for that would be I think it would be a mistake for the average individual to not also in their mind at least entertain the idea that oil prices could go up a lot and the impact that might have on their life personally and then more broadly on the economy. But that is not a very commonly held view and could be wrong. Would you agree that people really ought to be seriously entertaining those sorts of knockon effects?

Arthur Berman: Oh absolutely. So we have the short-term, the short say medium term of a year, year and a half in which I think we are going to be on an upward trending roller coaster of oil prices. But upward trending in general now things go terribly wrong with China, particularly things go terribly wrong I don’t know with a Brexit or a Grexit or whatever. I don’t think that will have quite the impact of China. Those are factors that we need to think about. That is the near to medium term. The longer term is the moonshot and I just don’t see – I don’t see any way that the global economy can withstand a return to even $100 oil prices much less higher. It always kills the economy. This time around the economy is so fragile because of debt and just poor performance under employment, under participation. It scares me to imagine what the effect of that could be.

Chris Martenson: I totally agree. Let’s reel it down a little more granular. If you have the point of view I would love to get your view on the sort of economic damage that has been inflicted on places like North Dakota during this run down in oil prices. I am looking right now at only 25 active drilling rigs here on the June 14th report of 2016 and the same day the year prior there was 187 drill rigs operating. That is an 85% decline in drill rigs. That is a lot of activity that is not taking place. That has got to be hurting.

Arthur Berman: Oh it is. We heard all kinds of sophisticated economists early on in this price collapse talk about how this was going to be a net benefit for the global economy. I don’t think that has exactly worked out the way that they thought and the reason for that is I think that they failed to recognize just exactly what proportion of global CAPEX, global GDP energy has become. And so sure it is great that it doesn’t cost us as much to fill up our cars and etc., and that is a benefit for the consumer. On the other hand you talk about North Dakota – imagine entire countries like Nigeria, Venezuela, Russia to some extent, Angola. I mean these are entire countries where consumer’s ability to survive and to buy goods and services is largely dependent on revenue from oil companies and service companies spending money paying salaries and that isn’t happening. Part of the reason we are seeing so much political unrest in places like Nigeria and Venezuela today are because not only are oil prices low, but spending is low and therefore people aren’t making any money.

I see it in Texas. Texas is probably as bad as north Dakota. It is not just the drilling rigs it is all the associated things. The people, the people who drive cars and trucks who stay in hotels, restaurants – have their cars fixed, need their houses or their apartments or their trailers services all of that – the amount of spending goes way down. That is difficult for these local economies.

Chris Martenson: Absolutely. Speaking of Texas, let’s turn our attention now on the time we have left for gas. I love your recent data filled piece entitled Shale Gas Magical Thinking and the Reality of Low Gas Prices, found right at artberman.com of course. You know, Art, you had me right at the opening two sentences which were, I’ll quote here, “Enthusiasts believe that shale gas is simultaneously cheap, abundant and profitable thus defying all rules of business and economics. That is magical thinking.” What is magical about that thinking?

Arthur Berman: It sounds so good, doesn’t it?

Chris Martenson: It does. Cheap, abundant and profitable. Lovely.

Arthur Berman: You got to love it. It is back to the nursery. That is not the way things work int eh world and the piece that is absent from those kind of people’s thinking is yea and it is all funded by debt. You can carry on pretending like you are making money because you continue to drill and product as long as somebody keeps giving you money. What happens when they stop? This is Wile E. Coyote all over again. He can run out over the Grand Canyon and keep on moving until he looks down and realizes he is not on solid ground and then of course he crashes and burns. And that is exactly what we are seeing with shale gas.

Shale gas has been a marginal business at best for all of the years I have been looking at it. I have my share of critics who constantly point out well you were wrong. You have been wrong all along. I don’t mind being wrong because you know I get more information and I am going to change my opinion. I am not a politician. Flip flops are okay for a scientists if data says you got to change your mind. To me that is intellectual honesty. The thing I’ve been most wrong about was the longevity of shale gas company’s ability to keep getting money and therefore to continue running themselves into the ground on unprofitable ventures. I completely blew that. I just couldn’t imagine that could go on as long as it has. And I was wrong.

Chris Martenson: You keep - -in this article you keep posting these very damning tables of the actual break even costs for these shale companies. Not just being a little bit higher than the current price of gas but sometimes as much as 100% or 200% higher. First, how do you arrive at such calculations? And then second, with hindsight, how is it that you and I have been so both wrong at how long they have been able to keep this magical fantasy going? First, the break evens – why are yours so out of alignment with what the industry says?

Arthur Berman: I think it is pretty simple and I’ve done this long enough and I have an engineer colleague that works with me. I mean we have been over and over plays like the Barnett and the Fayetteville and the Haynesville and the Marcelles since go. Yea, it is fine if you – maybe you don’t have enough information in 2008 or 2009 to predict exactly how things are going to work out as far as reserves and everything, but now e do. How does that work? Well, we start with the basics. We look at what wells are probably going to produce – their estimated ultimate recovery. And we do that through a very standard process that has a certain amount of uncertainty if that is a correct sentence. Over time you get more confidence with more production history.

One place where you get a big disconnect is that I don’t know where the analysts that talk about shale gas breaking even at $2.00 I don’t know where they get their reserve numbers, but they must get them from a really different place than we get them and I feel you know – we are pretty confident that we are right within 15 or 20%. If you got a really bit reserve number well, your economics work out very favorably because you got a big number that is creating revenue.

That is one half of the story. The other half of the story is out. What does it cost you to go business. As I said earlier in this discussion if you exclude a bunch of costs and you come up with a much lower break even. By the way, we don’t include eland costs anymore. We should and we would like to but we just finally gave up on that. we don’t want to be that far out of calibration with the rest of the industry. People they have written those costs down a long time ago so fine. Base the cost of doing business you know like paying your employees if you don’t have another profit center other than the well then it has got to come back to the well. We look at the costs. Where are the costs? The companies are required to disclose them to the Securities and Exchange Commission every quarter. So we don’t make up the costs. We get the costs from the companies. And I assume they are right or else they could go to jail. You take the costs. You take the reserves and you take the price and you can run different price scenarios. And then it is just basic economics. I mean there is nothing magic. There is nothing complicated here at all.

Chris Martenson: Now in this same report you also have a nice chart and it shows that out of all the shale fields you are tracking only one of them is producing more gas today than it was in a prior period. Leaving all the rest of the plays of which I didn’t even count them a dozen more they are all producing less than they used to. Is this post peak of production is that an economic peak or a geologic peak that has been experienced?

Arthur Berman: Well it is a bit of both. The first shale gas play the Barnett shale which is in North Central Texas and the second the Fayetteville which is just up the road in Arkansas basically the same rocks those were plays that were supposed to last 50 to 100 years and here we are a decade into their production and there are zero rigs in the Fayetteville and there are zero rigs in the Barnett. Does that mean that they have reached full development? No. At current gas prices, and by the way at much higher gas prices our estimates say you need something like $5.00 or $6.00 gas before additional drilling makes any sense. We haven’t produced all the gas but we have produced all the gas that makes any sense to companies that get free money to keep on going at anything close to the prices that we have today. And companies are – as one of my friend’s says, voting with their feet. So if they have a choice of spending money to drill a well in the Barnett versus drilling a well in the Marcelles and they have a position int eh Marcelles they are going to put the money there every day of the week because break even prices lower, the cash flow is higher. They are not going to drill the Barnett. The Untied States has got a ton of gas. I don’t’ want anybody to come away form what I say or what they read from what I write thinking that I am saying that the resources aren’t there. The resources are large. Not as large as the enthusiasts want you to believe, but they are quite large. The problem is what you can reasonably drill and produce at anything close to what realistic prices might be.

Chris Martenson: Speaking of large I noticed that the EIA just recently came out in a shale base in Colorado and said yea there is maybe – we are going to have to up our estimate by 10 fold higher than we thought. They announced 66 trillion cubic feet there for the taking in this basin in Colorado. Doesn’t this massive reassessment support that view of the enthusiasts that says we will just keep finding more and more forever?

Arthur Berman: No because that is a resource. There is an important distinction between a resource and a reserve. A reserve is a volume that is – can be commercially produced at a price at today’s price. A resource is a volume that can be technically produced if you don’t care about price. So they are very, very different. I point out the only thing that is the same are the first three letters. They both start with RES. The EIA is talking about what they call a technically recoverable resource. People should just ignore that number. That is like saying well, if I eat well and get the right medicine I can grow to be seven feet tall and live to be 150. Well nobody does or very few people do so forget that idea. Let’s stick with something that actually can be commercially produced that is a reserve. Those numbers are large and anybody can find what those numbers are. They are available on the EIA’s website and you know I recently just did an evaluation – there is a group out of Philadelphia called The Pipeline for the Future, and in their executive summary they say that there are centuries of reserves in the Marcelles and Utica shale plays at current production rates. Well that is just absolutely untrue. You take what the EIA shows for reserves even including undeveloped reserves and you know you add those up and you divide by current production rates and you end up with 20 years.

Even 20 years is a lot of gas don’t get me wrong, but centuries? How do you get from centuries to 20 years when all you do is go online and look at a number – look at two numbers – a reserve and a production rate. That is not Art Berman’s interpretation. That is data. That is the background.

Chris Martenson: Speaking of those cheerleaders – close to my final question – I notice that US companies are still building massive new facilities massive production and industrial uses that will use gas. Well gas producers themselves they are scrambling to figure out how to export more of it as quickly as possible. Let me as you this, Art, there are a lot of very intelligent people involved in these projects. A huge amount of capital. Well, what can possibly go wrong?

Arthur Berman: Well everything has gone wrong. That is the problem. There were all kinds of misbegotten efforts over the last 10 years to try to increase US consumption. You know let’s have natural gas powered cars, let’s export more gas, let’s do all this stuff and the truth and the reality is that the only growth area for natural gas consumption is an electric power generation. All the rest have kind of fallen by the wayside – gas powered cars are I won’t say they are a bad idea but there are a lot of problems with getting – people just haven’t bought into it let’s just leave it at that. Gas export you hear an awful lot of furor about that the truth is we are not hardly exporting any natural gas right now except by pipeline to Mexico and a little bit to Canada, but by the liquefied natural gas very, very tiny volumes. And looking out to say 2020 or whatever maybe 5 or 6 bcf a day billion cubic feet of gas a day compared with what we produce right now which is about 75 or so of dry gas – it is not nothing, but it is a relatively small percentage.

The problem is that we are just not consuming enough to compensate for the grotesque level of over production. The result therefore is crushingly low gas prices that are now starting now to show up in a very negative way in everybody’s balance sheets and companies are going bankrupt. They are in serious, serious trouble all of them.

Chris Martenson: Now that brings me to my final question which is that – let’s say that someone listening agrees with us that oil and gas have to go up in price at some point, but there are all these hidden, crushing landmines of poor economic performance out there. What is the right way for an average investor to go about investing in this space?

Arthur Berman: Carefully. There is a lot of risk because of all the things we have been talking about here for the last 50 minutes. It is important – you want to listen to Kramer, you want to read what people write in the Wall Street Journal, fine. Go ahead and do it, but you really need somebody guiding your investments that has a better understanding of all the uncertainties in the big picture involved. Now having said that I am on record as saying that I think natural gas is the more attractive of the two commodities as an investment. I’ve been saying this for some time and just in the last couple of weeks the price of gas has gone up dramatically and that in spite of the fact that we still have a very large overhang of storage. And what is the reason for that? Well, markets. I won’t say that markets are smart because I don’t know who markets are but markets are fairly good at anticipating what is coming in the future. And the gas market right now – and there are people that are thinking about this. They are saying oh my gosh you look at the additions to gas storage compared with a year ago or compared with the average and they are puny.

We see that there is going to be a supply deficit down the road. Oh, by the way all of this expert of pipeline gas to Mexico and Canada and L&G export is contributing to that. Some of that is due to lack of investment because of low price. Shale gas which is the only growth in US gas supply has rolled over. At best it is flat and I say that just because it is a moving target that changes monthly, but it is not growing. And conventional gas like conventional oil it is in terminal decline. There is a convergence that is on us right now in the US with natural gas because it isn’t a global commodity. We can’t import it from Saudi Arabia or wherever. Natural gas prices are going up because the market anticipates that we are not going to be able to keep up with demand. That is the bottom line.

I see and I have written about this – I think gas prices could easily be $3.00 by the end of the year and could be $4.00 a year from now. That is still below the break even price for most of these plays. But for an investor if you got a company that looks reasonably attractive at $2.00 gas then they got to look great at $3.00, right?

Chris Martenson: That is the hope. Of course the easy part of this is buying into a commodity play when it is below the cost of production. That is the easy part. The hard part you articulated is that some of these companies have already stepped on their own personal economic land mines and so you have to dig through. Some of these companies deployed capital when prices were far higher. Those wells have already gone into their decline phase. That capital has already been betrayed. Trying to detangle all of that and figure out who is upside down on the debt bandwagon is not always an easy task, but I agree. I think there is a no brainer component of this which is things have to get back up to at least the marginal cost of production. That is going to create some winners but boy, teasing out the losers takes something other than your usual Wall Street, cheerleader analyst to help you untangle. Yes, pick carefully. Do your due diligence or find somebody you can trust. That would be my advice. I agree there are some great investments to be had here.

With that thank you so much for your time today, Art. As always I can hardly wait to have you back on. Today was so good. It has been a real pleasure speaking with you.

Arthur Berman: Always fun to talk to you, Chris. Thanks a lot.

Chris Martenson: We have been talking to Art Berman. His website is ArtBerman.com you should read it and this is Chris Martenson signing off.