Wealth Manager

It’s another story in the 21st century.
History’s first triple-digit close arrived
just this past February, and no one saw it
coming—certainly no one back at the end
of the 20th when talk of supply glut dominated
the energy conversation.

Well, almost no one. For years, a few
mavericks have bucked the conventional
wisdom and advised that cheap energy
wasn’t long for this world. One of the contrarians
was Matthew Simmons, chairman
and CEO of Simmons & Co. International, a
Houston energy-focused investment bank.
Simmons and a handful of other analysts
started warning in the 1990s that raising
global crude production would become
increasingly difficult. The challenge, they
correctly predicted, will be compounded
by strong demand growth driven by China
and the developing world

Simmons’ forecasts draw on analysis of
the world’s oil fields. He has routinely said
the data paints a troubling picture of declining
discovery rates, particularly among
the world’s giant fields. Meanwhile, demand
keeps rising.

Simmons has supplemented his research
with a deep focus on Saudi Arabia, the
world’s single-biggest national source of
crude oil and the hub of global production.
No wonder that most projections for inexpensive
oil are culled from optimistic forecasts
for Saudi production. But Simmons
has long been skeptical, citing his meticulous
investigation of the country’s aging oil
fields. The bottom line: Saudi production is
nearing a peak, a forecast he detailed publicly
in Twilight in the Desert: The Coming Saudi
Oil Shock and the World Economy (Wiley, 2005).

There are many who disagree, of course.
The optimists say that there is still plenty
of oil left, and that supply growth will
match demand in the years ahead. Their
reasons include the relatively untapped resources
of so-called tar sands oil in Canada
and elsewhere. And technology, they say,
will also help squeeze more oil out of existing
fields than was possible in the past.

Perhaps, although Simmons’ sober outlook
is finding a more receptive audience
these days. Nor does it hurt his credibility
that global crude production hit a peak in
May 2005 at 74.298 million barrels a day,
according to data published by the U.S. Energy
Information Administration. As we
go to press, the 2005 pinnacle still stands.

So, what is Simmons thinking now? In a recent
interview with Wealth Manager, he speaks
candidly, including a forecast that the bull
market for oil still has a long way to go.

Q: What has been the reaction to your
book’s somber view of Saudi Arabia’s
oil supplies?

A: I’ve had tons of feedback from people with
various aspects of involvement in this
story. That includes a surprising number of
people who finally broke the silence within
Saudi Aramco [Saudi Arabia’s government run
oil company] by contacting me.

About six months after the book came
out, I’d heard that there had been an edict
that if I was speaking at a conference, no
one from Saudi Aramco could be on the
program; I was persona non grata. Then, at
last October’s Oil and Money Conference in
London, I had an interesting encounter at
the annual oil-man-of-the-year award. Mr.
Jum’ah, CEO of Aramco, was being honored.
I asked the conference host if I should
show up because I thought I’d be a Darth
Vader there. But he said, yes, of course you
should come. And Jum’ah could not have
been more charming to me. He said, “I’m
so honored you could come. We know
you’re our friend. Some of us don’t necessarily
agree with all of the interpretations in
your book, but you didn’t do it maliciously.
You’re worried about us.” And in the middle
of the award dinner, a guy comes up to me
and says, “I’m the vice president in charge
of all the new projects at Saudi Aramco, and
I’ve got to tell you, I just finished your book
and it’s fabulous.”

Q: That’s surprising, considering that
your book directly questions Aramco’s
optimistic outlook for its crude oil
production.

A: What I’ve heard, from a variety of people, is
that [Saudi Aramco executives] had heard
and told each other that some stupid guy
in Houston wrote a book that said Saudi
Arabia had no oil left and, through stupidity
and incompetence, the country destroyed
its oil fields. Of course, the book doesn’t say
that. It says that Saudi Arabia’s oil fields are
too few, and they’re too old, and they’re applying
more technology than anyone’s ever
done to fight falling oil production.

The other thing I’ve heard from a fair
number of other people is that the culture
within Aramco—and you could say the
Middle East generally—is one of secrecy.
Nor does anyone want to report bad news.
In Aramco, going back to Dhahran [where
Saudi oil was first discovered in the 1930s],
the culture has been: Don’t talk to your
neighbor about what you’re doing in the
field. As a result, all of the people working
on specific challenges [related to increasing
oil production] didn’t have any idea that
their problems weren’t unique, but instead
were systemic to all the great fields.

Q: Nonetheless, doesn’t Saudi Aramco still
disagree with your book’s core thesis?

A: The [Saudi] petroleum minister certainly
does. But let me tell you about Dr. [Sadad
Ibrahim] Al Husseini (a retired Saudi
Aramco executive), who spoke at the Oil
and Money Conference last fall. Afterward,
someone asked me if I wrote his speech!
Dr. Al Husseini was, until three years
ago, the executive vice president of Saudi
Aramco in charge of E&P [exploration and
production]. He’s got a Ph.D. from Brown,
and he’s been quietly saying that the world
needs to realize that the Middle East is basically
at its [oil-producing] peak.

Q: What do you make of the relatively
optimistic projections from Cambridge
Energy Research Associates (CERA),
an influential energy consultancy in
the U.S.? The firm recently forecast
that the decline rate in global oil
production will be a relatively modest
4.5 percent, which is quite a bit lower
than other predictions. The implication
is that replacing old fields with
new discoveries will be easier than
you and some others expect.

A: CERA’s view so starkly contrasts with my
analysis that it’s almost like they’re talking
about oil on Mars, and I’m talking
about oil on Venus. I can’t understand
where they get their numbers; I can’t
reconcile what they report. They say the
average worldwide decline rate is only 4.5
percent. Meanwhile, I did an exhaustive
study...and one of the big conclusions is
that we’re down to about 110 oil fields [in
the world] that each produce 100,000 barrels
of oil per day [bpd] or more. What’s
more, very few [of the big fields] are new.
But according to CERA’s study, they found
400,000 fields that produced on average
90,000 bpd. So one of us is totally wrong.

Q: Any thoughts about why there’s such a
chasm in your view versus theirs?

A: Maybe they found some data that no one
else has seen. But I’ve been a student of
tracking field-by-field decline rates. We had
a vivid reminder of the challenge when the
chairman of Pemex [Petróleos Mexicanos,
Mexico’s state oil monopoly] gloomily
predicted that by the end of next year, production
from Cantarell [one of the world’s
largest oil fields] would be down to just over
1 million bpd from its peak of 2.2 million bpd
in May 2005. [Cantarell’s November 2007 output
was 1.28 million bpd.] By the way, in the
same month, the world set an all-time record
for global crude oil production at 74.3 million
bpd [based on conventional crude output].
But I don’t think it’s possible to raise crude
oil production.

Another interesting fact is the stunning
pattern that shows that we haven’t made
any giant field discoveries that can produce
500,000 bpd, let alone 1 million bpd.
The last 1 million bpd discovery was Cantarell
in 1975, which ironically is now the
second-largest field that’s declining most
vividly. In fact, it’s been a long time since
we’ve discovered a 300,000-bpd field. The
last three great basins were discovered
more than 30 years ago: Western Siberia
in 1967, Alaska’s North Slope in 1968 and
the North Sea in 1969. Meantime, all three
have peaked.

Q: A more optimistic school of thought
reasons that the low oil prices in the
1990s were a disincentive to search
for new supplies, and so we’re still
dealing with that legacy. Meanwhile,
the high prices of late are now spurring
efforts to find new reserves, and
therefore, higher production is coming.

A: That was the case for a long time, but
we’ve basically been back in the clover for
seven years.

Q: What about Saudi Arabia’s potential?
Some analysts say that it has not been
fully explored, and the possibility for
big discoveries still exists.

A: That’s true in a sense. Saudi Arabia can
still explore in its deep waters and the Red
Sea. They can still explore along their border
with Iraq. And they say that they can
still explore in their empty quarter, but
so far the gas exploration there has been
dismal. In the rest of the Arabian peninsula,
they’ve searched as diligently as they
can and, yes, they’ve found structures. But
despite all the spending, none of the new
structures discovered have hit the radar
screen in terms of developing them.

Q: Why is that?

A: They must not have any potential for
hydrocarbon production.

Q: Meanwhile, global demand keeps
growing.

A: Despite a 10-fold increase in oil prices, demand
didn’t slow. But demand growth
in the United States is going to come to a
dead halt because we literally can’t bring
any more oil into our system, meaning our
refineries, our import structure, pipelines.
We’re basically capped out right now.

Q: And that means...

A: It means that prices will go up because inherent
demand is greater than supply. The system
is constrained. The big danger is that we
keep doing what we’ve done too much of recently,
which is basically drawing down our
petroleum inventories to bridge the gap.

Q: If the U.S. oil infrastructure is capped
out, as you say, does that imply a ceiling
on the country’s economic growth?

A: No, it can still grow, but it’s going to
have to shift into some other forms of
growth. Our economic growth and oil
demand growth aren’t necessarily highly
correlated as they are in the developing
world. It was only few years ago that
economists said that if we ever had $30
oil, we’d have a recession. Do you remember
that recession?

Q: We seem to be in one now.

A: If we are, it’s because of the subprime
mortgages; it’s not because of $100 oil. We
were kidding ourselves that we always had
to have low oil prices to sustain demand
growth. In fact, high oil prices didn’t impact
demand.

Q: Is that because the previous oil crises
have been triggered by supply shocks
whereas the latest bull market in oil
is demand driven?

A: Yes, and also because of the stealth growth
that we didn’t see coming, which used up
all our spare capacity. So now we don’t
have any wiggle room.

Did you see the statement [in mid-January
2008] when President Bush was in Saudi
Arabia? Bush publicly asked for higher
Saudi oil production. Then [Saudi Arabia’s
oil minister] Ali al-Naimi gave Bush a big
lecture that the markets don’t need any
more oil, that the markets are well served,
that demand will fall in the spring, etc. A
couple of wire services reported something
along the lines of: al-Naimi blows off Bush.
That night on ABC’s “Nightline,” according
to the transcript I read, Bush was asked why
he didn’t tell the Saudis to give us the damn
oil. And Bush said, you can’t force someone
to give you something they don’t have. My
guess is that Bush has been briefed that
they [the Saudis] don’t have any spare capacity.
They’re out.

Q: So your book’s warning about Saudi Production
nearing a peak remains intact?

A: Yes. We shouldn’t be surprised when these
fields go into decline. The uniqueness is
their size; but they’re not a reservoir that
never gets old. They’ve been working those
fields as hard as they can. They should rest
them. They bought into the same technology
miracle that mesmerized the major oil
companies. It was only five years ago that
the major oil firms as a unit were telling analysts
that they’d grow production by 5 percent
to 7 percent a year— forever—and now
their production growth is negative. They
didn’t understand their decline curves.

Q: Does the market agree with your
general outlook?

A: No. If it did, oil would be $200 a barrel.

Q: Will we get to $200 oil?

A: Sure, but I don’t know when. Meanwhile,
I keep telling people that $100 for a barrel
of oil is cheap. And they ask, “How can you
say that?” Well, it’s 15 cents a cup. Do you
know of anything else we can buy for 15
cents a cup?