Transcribed by Barry Silver
David Strahan: Hello, I'm David Strahan, the author of "The Last Oil Shock - A Survival Guide to the Imminent Extinction of Petroleum Man", and this is a podcast from lastoilshock.com, sponsored by Global Public Media, public service broadcasting for a post-carbon world.
Henry Groppe, thank you for talking to me. Many people are trying to work out at the moment what was the cause, what was the meaning of production cuts in Saudi Arabia over the last couple of years, and some people believe that this is evidence, really, that Saudi Arabia has already peaked. But you've just said in a presentation that you think it's all the result of a terrible mistake - and how can that be?
Henry Groppe: We think that the Saudis are always preoccupied with avoiding the terrible fiasco of the early 80s for them, where they were stuck with high contract prices with the mistaken view the market was going to go turn at any time and come back, and they watched their market decline from ten million barrels a day to a low of two and a quarter million barrels a day in April of '85. And Eumoni was responsible for that, and he got fired for it. And so they never want to repeat that again. The IEA was very strong a year ago in forecasting that there would be a 1.8 million barrels a day total increase in non-OPEC production in '07 - the largest non-OPEC increase since 1984 that got the Saudis' attention. Theoretically, the OPEC Secretariat has a staff that develops their own supply/demand forecast for the use of OPEC, but in reality they don't do it, they use the IEA data - tweak it a little bit - and that's what OPEC operates on, unfortunately for them.
DS: So what went wrong?
HG: What went wrong was that, with that looming ahead of them, they decided they would anticipate it and made a very aggressive total quota cut of 1.7 million barrels a day - a little over about 1.1 million barrels a day of real oil. They made those cuts at the beginning of this year, and then non-OPEC production did not increase by that amount - only a tiny increase (400,000 barrels a day) - and there wasn't enough oil. All during the year that was - if you were working with real numbers and if you knew the whole picture - that that was a mistake, and so when you start the normal build up for the winter peak demand, they were just short of oil, and there'd been a continuing inventory draw down all during the year because of that 1.1 million barrel a day cut. And so the reason for the big price increase was not demand, but it was short supply, and that's never been discussed in any of the analyses of the reasons for the oil price increase.
DS: So, everything that's been shocking the oil market and getting everybody talking over the last few months, in fact, has been because the Saudis mistakenly relied on the IEA's over optimistic forecast is what you're saying?
HG: Exactly.
DS: Why is it do you think that the IEA got it so badly wrong then?
HG: They have a number of errors that they make, some of their own making, others because of their position and their circumstances. One of the biggest continuing sources of error is that they are an isolated bureaucracy and they have no leverage on anybody in the world, except whatever their supporters might do for them. So they are just dependent on whatever data anybody around the world wants to supply them, and when you're in that position, if you critically analyze those data and modify them in any way, your sources of data cut you off. So, they just blindly take all of this data and use it as fact, and there are several important reasons why producers, particularly, exaggerate their production. Within OPEC, it's because one of the - probably the principal criteria for allocating changes in quota is what's your current production? So, every producer wants every other producer to believe that his is as high as possible. And, as we've monitored this in a careful way by carefully analyzing their exports to various countries, we've found over the years that they - the total over reporting of production by OPEC has ranged generally from about 1.25 to 2 million barrels a day each year, and so that is an erroneous high supply number that they get. Another distorting factor is that when you process a barrel of crude, you're converting the heavy dense molecules to lighter less dense ones, so you get about 4.5-5% volumetric expansion - that's called a processing gain. And to get from - what we call deliveries - which are the total volume of petroleum liquids - including crude oil, condensate, natural gasoline, and LPG - to refineries, that rose by this volume - it's currently a total of about 3.5 million barrels a day. To get the volume of petroleum products consumed, they use an arbitrary number for some reason I've never been able to discern - they've used it for years - 1.9 million barrels a day. So, there is an error in all of their work embedded by that mistaken methodology, and there's no consistent manner in which they adjust for that - as they try to get balances that make sense. And so they - their over reporting of total supply ranges from, maybe, 300,000 to almost two million barrels a day.
DS: You seem to be suggesting that Saudi Arabia got its sums wrong because it relied on the IEA, but the IEA is getting its sums wrong because it's relying on data from OPEC and, particularly, Saudi Arabia - it's all going around in a circle, you seem to be saying.
HG: Well, generally, the Saudi Arabian data is correct. The biggest continuing over reporting is Iran, and the reason for that is Iran is unable to produce its quota, and they don't want the other members to observe that, and adjust their quota downward - so they fill the gap. It gets filled in two ways: one, for logistics reasons, they receive cross-border crude imports from Kazakhstan, Turkmenistan, and they deliver an equivalent volume of crude at their offshore loading port at Kharg Island. So that's double counting. They import some products - again, for logistics reasons - from various neighboring countries, and that gets double reported. And whenever that's not enough, they report some of their gas liquids production - so that, routinely, Iran's production is accepted by everyone as approximately 4 million barrels a day, and in reality it's about 3.3 million. And then various other OPEC producers - generally through double counting (including the gas liquids as their crude oil production) - that varies quite a bit depending on what they want to assume at a given time. Venezuela does that, Libya does that; different members do that at different times. But we generally found the Saudi Arabia data to be accurate.
DS: You've argued that the IEA's forecasts have been pretty badly wrong, and that led to mistakes by Saudi Arabia. But how good or bad would you say their historical - the IEA's historical oil production data is - and does it matter?
HG: Their historical data that's never corrected is generally high by from 500,000 to, roughly, two million barrels a day, and since those are - and, then, as they do their total balances, that generally ends up over reporting consumption in order to make all of this balance. So, you have the world operating on petroleum ministry data that is generally high for production and consumption by a half million to two million barrels a day, and that matters enormously.
DS: Well, why does it matter? Because if it's presumably - if it's reasonably consistently wrong, at least it's a consistent series.
HG: It's not consistently wrong. They make different kinds of adjustments at different times - there's no way to use the data in a consistent way because it's wrong in varying inconsistent ways.
DS: I started off by asking you about Saudi Arabia because there are a lot of people who are trying to figure out what's going on in Saudi Arabia using either the International Energy Agency's numbers or the Energy Information Administration's numbers. Do you think that, in fact, any meaningful analysis can be done on the basis of those numbers?
HG: I don't think that's a problem. I think that the Saudi Arabia production numbers are - we found them to be consistently accurate, they make an accurate distinction between their crude oil production and their gas liquids production, and that's one of the production sources that we find to be consistently accurate.
DS: Well, what about the IEA and the EIA numbers more generally. If they are inaccurate, can anybody - can governments, can analysts - rely on those numbers in any way and come to any reasonable conclusions - how much does it matter?
HG: We think that it matters significantly if you are using them for other than trading purposes. Well, one of the contrasts I draw is that over the last 20-25 years, the financial services industry has shifted from its historical role of developing long-term provision of funds and a long-term relationship with a client. And that worked very well for the energy business because it requires enormous amounts of capital. Most of the capital has to be invested at the beginning, and you'll know whether you made a good decision in, maybe, four to eight years, and so you spend a lot of time trying to understand what the supply/demand balance and the prices are going to be over the next ten year environment in which this massive new investment has to operate. And so you need to do as much careful analysis as that as you can, but if you're having to do it on the basis of the IEA and EIA numbers that are full of errors, it's totally misleading for the largest business in the world - and one of the largest commitments of capital in the world.
DS: It all sounds like a bit of a mess to me. Is it possible to get better data, to come up with some better numbers, and if so, how do you go about it?
HG: The method that we found - and we've been at this for 52 years - is the one accurate source of data for this industry is oil import numbers. And those are accurate because in most cases there's an import duty being charged, and it's dangerous to try to slant those numbers in any way. The difficulty with it is that every country has a different statistical reporting system. Some of them use barrels, some use short ton, long ton, metric tons - to convert it all to consistent barrels you have to have good knowledge of the gravity of the total volume of products, and you don't get those data depending on what kind of staffing they've got - sometimes as late as 24 months after the fact - and then it's a massive calculation problem, and so nobody does that anymore. We've been doing it for 30 years; by doing it year after year after year, you continually improve your calculations and the quality of what you derive from that.
With that you have, then, an accurate statistic on the total amount of oil imported into the world. If you compare that with the volumes of oil that were claimed to be exported by all the producing countries - both OPEC and non-OPEC - we have found over the years that there appears to have been a 1.25 to 2 million barrels a day of oil exported than ever showed up as imports around the world. So, obviously it was never produced, and that gives you a direct measure of the over reporting of production. By putting these together as balances, and, in time, then, calculating total internal consumption, total exports, where each country exported their oil, and doing the balances for the receiving country, you ultimately end up with, we think, the most accurate measure you're able to develop for both consumption by countries and production by countries.
DS: I'll come back to the original question. Now, you've said that you think that the Saudi production cuts were the result of a mistaken reliance on the IEA's numbers and, therefore, that the Saudi has not yet peaked - geologically speaking - what do you forecast for Saudi production over the next few years?
HG: Our analysis has been that the Saudis, I think, in a very sound fashion developed a long-term business plan many, many years ago - a goal of producing from 8 to 9.5 million barrels a day of oil for the foreseeable future. And their reasoning was that that was something that they could expect to accomplish - considering not only the resource base, but also all of the required infrastructure, the capital investment, the technology, the personnel - recognizing that as their production declines in the big oil fields, like Ghawar, and so on, they have to replace it from other, smaller, more difficult to develop and manage fields, they will be having to use more of all of this per barrel produced. And the other factor was that Saudi Arabia is an unusually barren and hostile environment except for this one-time hydrocarbon resource - only two percent of the land is arable. I lived and worked their in 1948, '49, and '50 - followed it closely ever since - it's a place you would never choose to live unless you were working on this hydrocarbon industry; and to make it livable, they use enormous amounts of this energy for air conditioning - it's routinely 113-120 degree Fahrenheit in the shade during all of the summer months, and also they use all this energy to recover fresh water from sea water. When you run out of this one-time hydrocarbon supply, then all of those things go away, and it becomes a barren, inhospitable desert peninsula again.
DS: Many people are, nevertheless, still pretty bearish about Saudi oil production prospects. What do you think they're going to do in the next few years - when and how long can they maintain that production do you think?
HG: Since they are the incremental producer of the world - everybody else in the world is producing at - essentially - at capacity - they have been very intent on creating some cushion above this 8 to 9.5 million barrel a day production goal range. So, during the last several years, they launched an effort to take their total crude oil producing capacity up to roughly 12.5 million barrels a day in order to have the ability to respond in emergencies, which they've done in the past. And I think they can maintain this 8 to 9.5 million barrel a day of production for a number of years to come. I don't know how difficult it will be to maintain that degree of cushion - the 12.5 million barrels a day - but I think they'll be able to maintain that for most of the next decade, and it may then gradually begin to decline. I think that'll be slow, but that means you can maintain 8 to 9.5 million barrels a day for - I would expect them to be able to do that for the next 15 to 20 years - beyond that we don't know enough yet. And in this supply-constrained new era that we're in because of peaking in so many of the other producing areas, I think we're in an environment in which the Saudis, by adjusting their production to achieve the price that will balance consumption with available supply, I think that they will gradually get better at it, and not make the kind of mistake they made. And one of the major modifications would be to adopt all of the methodology - as the Texas Railroad Commission used for stably controlling world oil prices for about forty years - and that was to adjust production monthly, and you don't have to be very accurate in your forecasts - you make a mistake, you adjust it the next month. I think that's very workable. They've been to Austin a number of times to study this history of that methodology, and they just need to get better at executing it.
DS: You seem to have a fairly confident, fairly bullish outlook on Saudi Arabian production, whereas many people are very suspicious of the claimed reserves. How can you be so sure in your view, given those doubts?
HG: We've analyzed the work of some of the people with the greatest doubts, and we don't find it to be very deeply rooted in long - real factual analysis of reserve data. For example, one of the reasons for confidence is that, first, the whole approach to managing their business in Saudi Arabia - unlike many of the other OPEC countries - is still modeled very strongly after Exxon's methodology. Exxon and three other majors owned all of the oil there, established the business there, discovered the oil, and ran it all until the early '70s when U.S. production peaked and OPEC started expropriating. But the Saudis were the slowest to do that, and they had the Exxon-type companies continue to run the whole business for a number of years after they'd actually done some of the financial arrangement to shift the ownership participation.
Also, one of my youngest partners left after 14 years with me, four and a half years ago, and has been working there in long range planning for significant parts of their business. And he comes back to visit regularly. We have visited Saudi Arabia regularly for 50 years, and we've found no significant departure from that use of Exxon standards. Furthermore, they contracted with Core Laboratories, beginning about four years ago, to do probably the most extensive field reservoir analysis that they'd ever done for any company for any field in the world, and they're the world's eminent laboratory, consulting, reservoir and reserve evaluation company. And they came up with a very different conclusion from these views that they're going to have trouble maintaining production, and production through Ghawar is on the verge of imminent collapse. So, I have much more confidence in all that than I do in any kind of outside analyses based on much, much more superficial data than all of those evaluations. Plus, I maintain my relationships with the key people who work there, who ran the business, who are still in constant communication with the Saudis, still have very close relationships, and most of them share the view that I've just expressed.
DS: So, you're pretty confident about Saudi Arabia's ability to maintain its production for the next 10 or 15 years - does that mean that global peak oil can be put off for that long as well? HG: Not at all. The system we're operating under is that production will be declining in all of the rest of the world. The Saudis have the ability to maintain a relatively constant level of 8 to 9.5 million barrels a day. So, they, therefore, will manage this incremental supply to achieve a price which constrains total consumption to match whatever the production is at that price in all the rest of the world, declining, plus 8 to 9.5 million barrels a day.
DS: So, when do you expect the global peak to happen, and what do you think will happen to the oil price, then, when it does?
HG: We think that production has been peaking the last two or three years. It reached a peak, basically, in 2004 - that's why oil prices started rising - and the actual physical peak of total crude oil, gas liquids, and the synthetics, we think will probably occur in 2008. That some of these, remember these big, new non-OPEC production projects - Deep Water U.S. Gulf, Deep Water Brazil, and so on - that were expected to come on this year will be coming on next year. We may have an increase of 800,000 to a million barrels a day in total non-OPEC production next year as a consequence. We think that will be the all time total peak - it'll just be a little blip upward. And from then on, irreversibly slowly declining.
DS: If you expect peak oil in 2008, what do you think is going to happen to the oil price in 2008 and beyond?
HG: We think that for, perhaps, the next six or seven years, the oil price will range - without extraneous disruption - in the $65-85 range. That at that price there will continue to be a growing transportation fuel use, and home heating oil use, and raw material use - but of the order of 25% of all of the oil that is used is used solely to provide heat to generate steam for industrial operations or to generate electric power. And for that use there's much cheaper oil alternatives than the equivalent of $65-85 oil - in the form of coal and natural gas and nuclear - and that that fuel oil being burned for that low value use will be converted in refinery expansions which are being made now - convert that fuel oil to transportation fuel. After that has all been substituted, then, and most of the oil is being used for the high-value, special quality uses - transportation, raw material and home heating - it will require a higher price level to restrain consumption, and that's - we haven't done that work yet - but that's over this $65-85 a barrel range. And, during the next several years, it'll become clearer what level that may have to be - probably $85-100 plus.
DS: Those numbers seem to me extraordinarily low. Most people, when they think of peak oil, think of extremely high oil prices. We've already had oil go up to $90 a barrel, even almost through $100 a barrel. Is it really credible that we can have peak oil - that the oil supply will start to shrink and oil prices will be lower than they are today - really in this $65-85 a barrel range?
HG: We think so because as we observe the responses among all of the consumers, we have found that instead of growing at a historical rate of 2.5% a year, consumption has actually been essentially flat for three years because we've had prices in the $60-70 a barrel range. So, if we - we've eliminated all growth in consumption at the $60-70 range - if prices are above that, consumption - based on all the results we're seeing - will continuously decline.
DS: How is it that consumption has stayed flat, then - what has happened in the last three years to make that happen?
HG: All of the users of this fuel oil that I described, who have suddenly found that the cost of that energy has risen to - something of the order of $10 a million Btu - and there are other energy supplies like coal that are available for $2 a million Btu are hard at work to improve their efficiency of usage and convert to these cheaper fuels as rapidly as they can. The biggest conversion is taking place in China, where almost two thirds of China's oil is used for these fuel uses rather than transportation fuel. And they're half way through the world's largest expansion of coal mining and coal fired power generation in the history of the world, and they're releasing that consumption of fuel oil.
DS: It sounds, then, as if peak oil is terrible news for climate change. But, on the other side, it sounds as if - if prices are going to be as low as $65-85 a barrel - economically, perhaps - it doesn't matter.
HG: We don't know yet. We've only had high prices for three months. And I suspect we'll see increasingly significant economic responses occurring as we have more time to see what happens as these high prices work their way through the economic systems around the world.
DS: Henry Groppe, thank you very much for talking to me.
HG: You're very welcome. I've enjoyed it.
DS: You've been listening to a podcast from lastoilshock.com, sponsored by Global Public Media, public service broadcasting for a post carbon world.
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